Over the past few days, Members of Congress have engaged in intensive debate over the terms of the bailout package, now commonly referred to as the Troubled Asset Relief Program (“TARP”). Both Democrats and Republicans have offered criticisms and alternatives to the original Treasury proposal which are summarized below.

Senator Dodd Proposal

Senator Christopher Dodd (D-CT), Chairman of the Senate Committee on Banking, Finance and Urban Affairs has drafted a 100 page bill that encompasses many of the Democratic proposals discussed to date. His bill would:

  • define “troubled assets” as those originated or issued on or before March 14, 2008;
  • fund the TARP in graduated tranches, beginning with $250 billion;
  • require the Secretary to receive in exchange for purchasing any troubled asset: warrants to receive non voting common stock or preferred stock in the case of a purchase from a publicly held financial institution or senior debt in the case of a non-public financial institution;
  • permit the FDIC to be selected as an asset manager under the TARP;
  • create within the Treasury an Office of Financial Stability to administer the program and a new agency, the Financial Stability Oversight Board, to review those actions taken under the Act;
  • require the Secretary to maximize assistance for homeowners, including requesting loan servicers to avoid preventable foreclosures to the greatest extent possible;
  • ensure that modifications to mortgages on residential rental properties continue to provide tenant protection by ensuring continuation of any rental subsidies;
  • provide financial assistance to financial institutions with assets less than $1 billion and whose capital adequacy classification drops one level as a result of the impairment of Government Sponsored Enterprise (“GSE”) preferred stock;
  • deposit 20 percent of the profits realized on the sale of troubled assets (up to $120 billion) into the Housing Trust Fund and the Capital Magnet Fund. The Housing Trust Fund is a permanent federal program whose purpose is to increase and preserve the supply of rental housing for extremely low and very low income families, including homeless families. The Capital Magnet Fund is a fund within the Treasury Department designed to make grants for affordable housing;
  • limit compensation to executives of firms that sell troubled assets to the Treasury. Prohibits the payment of inappropriate or excessive severance or change in control benefits to executives of financial institutions participating in TARP;
  • In the case of the Secretary making a direct purchase of equity in a financial institution, the institution must permit shareholders holding 3 percent of the equity to have direct shareholder access to the proxy solicitation and shareholder vote for any election of the board of directors, require “say on pay” non-binding votes on executive compensation, and prohibit severance or change in control compensation during any period in which the Secretary holds an equity position in the institution;
  • permit judicial review of actions taken by the Treasury under the plan, although the bill permits injunctive relief only in the event of constitutional claims or extraordinary circumstances involving clear irreparable harm;
  • require that the terms of any mortgage loan purchased under the TARP would remain subject to all claims and defenses that would otherwise apply. This would allow a homeowner to preserve any claims that originate under State law against the original mortgagee;
  • authorize the Treasury to establish a temporary insurance or guaranty program for money market mutual funds;
  • amend Section 162(m) of the tax code to disallow corporate deductions for executive compensation in excess of $400,000 for firms selling troubled assets;
  • amend the bankruptcy code to permit bankruptcy judges to modify the terms on residential first mortgages; and
  • treat losses on GSE stock held on September 6, 2008 or sold or exchanged on or after January 1, 2008 but before September 7, 2008, as an ordinary loss for tax purposes by financial institutions.

Letter from Economists and Senator Shelby Proposal

Another document being widely discussed on Capitol Hill is a letter from more than 200 economists that takes great issue with the Paulson proposal from an economic perspective. The letter cites three criticisms of the Treasury proposal: its unfairness as a subsidy for investors at the expense of taxpayers; the ambiguity of the proposal as to the mission and oversight of the plan; and its long-term effects on the U.S. capital markets. Senator Richard Shelby (R-AL), the Ranking Republican on the Senate Banking Committee and now others have sighted this letter as a basis for their concerns with the current Treasury proposal and as an argument for restarting the process from scratch.

In addition, Senator Shelby has put forth his proposed alternative to the Treasury’s plan. In a statement issued today, Senator Shelby stated that the first, and most urgent problem, is liquidity. Then the Congress must address the solvency of financial institutions and declining home values, as well as the entire regulatory structure. He stated his belief that Congress can address the liquidity issue by increasing the combined resources of the Federal Reserve System and the Treasury. Enhancing the Federal government’s existing lending facilities and guarantee programs can help stabilize money market funds and provide loans to troubled financial institutions without exposing taxpayers to massive losses. He also stated, “As a member of Congress, I’m concerned that we are being asked to ratify the Secretary’s plan without having given meaningful consideration to any alternatives. This I can not support.”

Republican Study Group

One additional document has emerged that is having great impact on the current negotiations on the TARP. The document is entitled “Economic Rescue Alternative Principals” and has been prepared by the Republican Study Committee (RSC), which has more than 100 Members in the House of Representatives. These Members are philosophically opposed to more government regulation and have been highly concerned from the beginning about Secretary of the Treasury Henry Paulson’s proposal as government intervention in the free market. The salient points in the document are:

  • Wall Street should fund the bailout through a mortgage insurance program charged to holders of mortgage backed securities;
  • Utilize private capital by removing regulatory and tax barriers that are currently blocking private capital formation;
  • Increase transparency by, among other things, requiring participating firms to disclose to Treasury the value of their mortgage assets on their books, the value of any private bids within the last year for such assets, and their last audit report.
  • Create a blue ribbon panel with representatives of Treasury, SEC, and the Fed to make recommendations to Congress for reforms of the financial sector by January 1, 2009

The Members of the Republican Study Group have become very important to the debate because Speaker Nancy Pelosi (D-CA) has made it clear that she will not pass a bill out of the House of Representatives with only Democratic votes - she wants this to be a bi-partisan vote because the feedback from most constituents is they are not in favor of this bill and she does not want Democrats to be blamed for this bill heading into an election. As it was described to a member of the Locke Lord Strategies group by a key Republican involved in the talks, this bill must be like a Congressional pay raise bill in that both parties select Members from the safest congressional districts in the country to take the lead in soliciting enough votes to pass with both parties shouldering the blame. The problem for Republicans is that those Members in the safest seats are usually the most fiscally conservative and they are clearly against this proposal. They also happen to make up the vast majority of the RSC. If there is not a bill that RSC Members will vote for, there is probably no bill unless the Democrats come to believe there is no risk in this bill passing with only Democratic votes - and right now, they don’t believe that to be the case.

One other issue that is emboldening House Republicans is the response from “Main Street”. Their constituent calls are running almost 100 percent in opposition to the so-called “bailout of Wall Street”. In addition, both the public polling and private polling for the Presidential campaign and key house races is showing that fiscal conservatives are very frustrated. This is reflected in the national polls that many have seen in the last few days. While Democratic Nominee Obama has opened up a lead on Republican Nominee McCain of 3 to 5 points in the last week, in none of those polls has Senator Obama’s numbers significantly increased from the 45 to 47 percent range. What has happened has been a falling of Senator McCain’s support due to opposition to the bailout by fiscal conservatives. House Republicans are seeing this strongly reflected in their private polling in Congressional districts and when they study the “cross tabs” of those polls, they are seeing palpable anger among those voters that identify themselves as fiscal conservatives. As a consequence, being philosophically opposed to the bailout and now seeing nothing but a downside to this with a very key segment of the Republican voting bloc, there is very little incentive for House Republicans to back away from their position at this time. A change in their view would be expected only if there was a significant deterioration of the financial markets as this process drags out.

As it stands now, House Minority Leader John Boehner has assigned House Minority Whip Roy Blunt to take the lead on the negotiations for House Republicans, so Leadership is now taking this issue over instead of relying solely on House Financial Services Committee Members.