The Mother of All Bailouts

Financial markets around the world remain extremely anxious as the US Congress ponders the Troubled Asset Relief Program (“TARP”) proposal, aka the Mother of All Bailouts (“MOAB”). Under this proposal, the US Government will spend up to US$700 billion to buy “troubled” mortgage-backed securities in the hope that this will lubricate the markets that have well and truly seized, encouraging banks to start lending once more to each other, corporates and individuals.

There has been criticism of the plan both from some Democrats who want to see curbs on executive salaries and from some Republicans who are decrying the plan as financial socialism. Nevertheless, most observers expect the plan to be passed by the end of the month particularly since Paulson seems to be conceding ground on the subject of executive compensation.

One interesting perspective on the chances of success comes from the prediction market intrade which allows bets to be placed as to whether or not the plan will be passed. At the time of writing, this market puts the chances at 77%. (The chart originally published here is no longer available).
For such a big bailout, the proposal itself is remarkably brief and light on detail. It has been widely published in full, but for the benefit of Mule readers I have reprinted it below. Section 8 is particularly interesting, as it places any decisions made under this proposal beyond review by the courts or any other body. Despite this, Paulson said that he was “not looking for extraordinary power”. But the most important point that the proposal does not address is price. How much will the Government pay for these troubled assets? If they offer too little, no banks will sell and the plan will fail. If they pay too much, the US taxpayer will be on the hook for what could be very hefty losses down the track. This is a delicate line for Hank Paulson and his advisors to tread. So even if Congress approves TARP, many challenges lie ahead.



Section 1. Short Title.

This Act may be cited as ____________________.

Sec. 2. Purchases of Mortgage-Related Assets.

(a) Authority to Purchase.–The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

(b) Necessary Actions.–The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:

(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;

(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;

(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;

(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and

(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.

Sec. 3. Considerations.

In exercising the authorities granted in this Act, the Secretary shall take into consideration means for–

(1) providing stability or preventing disruption to the financial markets or banking system; and

(2) protecting the taxpayer.

Sec. 4. Reports to Congress.

Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.

Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.

(a) Exercise of Rights.–The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.

(b) Management of Mortgage-Related Assets.–The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.

(c) Sale of Mortgage-Related Assets.–The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.

(d) Application of Sunset to Mortgage-Related Assets.–The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.

Sec. 6. Maximum Amount of Authorized Purchases.

The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time

Sec. 7. Funding.

For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Sec. 9. Termination of Authority.

The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.

Sec. 10. Increase in Statutory Limit on the Public Debt.

Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.

Sec. 11. Credit Reform.

The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.

Sec. 12. Definitions.

For purposes of this section, the following definitions shall apply:

(1) Mortgage-Related Assets.–The term “mortgage-related assets” means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.

(2) Secretary.–The term “Secretary” means the Secretary of the Treasury.

(3) United States.–The term “United States” means the States, territories, and possessions of the United States and the District of Columbia.

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13 thoughts on “The Mother of All Bailouts

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  3. Mat Packer

    I don’t pretend to fully understand a lot of what is going on with this proposed bail out, however I’ve read a couple of interesting articles tonight basically stating that Chinese banks have been told not to lend to US banks and that could be enough of a spark to throw the entire US, and world, economy into meltdown.

    Is there any truth to that, or is it still too early to call?

  4. CV

    the bail out is simply a sideshow and does very little (nothing?) to address the core problem in the US financial system which is solvency, or lack thereof. (In) solvency probably explains why Chinese banks are supposedly restricing their interbank lending to US banks but it does precious little to address their major problem, which is being massively long US dollar assets. If the Chinese Banks were to start unloading those it would further damage the already broken global financial system. But, that’s most unlikely as there are simply no buyers left now…

  5. AJ

    I would much prefer idealogues like “free market” Rebublicans simply sit in their corner and count their chromosomes….if they can. What don’t they understand about a government bailout? They’ve been in one for 6mths already. The government has stumped up money now for Bear, the GSEs, and AIG, and these muppets are arguing about financial socialism? Here they are agreeing (with Democrats) that intervention is necessary, and they quibble about the form it takes. Breathtaking.

    Dear Mat Packer, I believe the funding story was incorrect in the sense that Chinese banks denied it, but where there’s smoke there’s fire. Basically, the entire Emerging Market thingamee is not as solid as it once was. EM countries always struggle when the developed nations move into recessions (their customers buy less of their cheap goods,raw materials). So the point is, large debtors like, say, oooooh, the US, can’t continue to rely on the “uphill” flow of capital in the way they used to in funding themsleves. Not to mention there being a heck of a lot more deficits to fund now. I say heck b/c I was reprimanded at lunch by a church-going friend who labelled me blasphemous. Icing an infidel, however, is ok.

    CV makes a good point that the US financial system is effectively insolvent, and now we have the banks in distress, along with a hedge fund industry that’s not quite sure of its role any longer. Look for more redemptions as these entities struggle with short selling restrictions (see earlier Mule) and a lack of the liquidity (both types) in order to conduct their business.

    But I’m starting to become more worried about the local financial sytem as well, particularly regional banks and other minnows that simply can’t continue to fund at today’s prices….and which Wayne Swan’s bumbling announcement was all about today. I swear he had an RSL tan. Shouldn’t do press conference while being on the squirt.

  6. stubbornmule Post author

    @Mat: given that US banks will not lend to each other, you would wonder why Chinese banks would, so as AJ suggests there is probably something behing the story despite the denials.

    What’s interesting is that for now, at least, while the banking sector in the US is broken, the world still seems happy to lend money to the US Government. If China and other countries were to start worrying about the whole box and dice and start to dump Treasuries, then you’d really see a financial meltdown!

  7. stubbornmule Post author

    Interestingly, on Monday afternoon Sydney time when everyone still expected the bailout to be passed, the prices on the intrade prediction market had falled to 20c.

  8. CV

    Mule. I strongly suspect that the fall in price on the intrade bailout prediction was entirely due to the “Rebublicans” (to quote AJ) shorting the crap out of it. Dagnabbit. Where’s the SEC when you need them?

  9. Carlee Potter

    I found your blog via a reference @servantofchaos made about your recent post on affluenza/consumerism/couch potato-ism… and then I kept reading my way down to here.
    I’ve just launched an “online magazine” for businesswomen and have recently attempted to strike up conversation there (via comment) about the current financial crisis, in order to hopefully get an explanation that allows those fairly uneducated on the topic to grasp some understanding of what’s going on, and why it happened.
    I started with my “stab in the dark” and have had exactly ZERO response (haha). So I’m trying to find people in the blogosphere who DO have an idea, and could maybe help out with a layman’s terms explanation?
    The (so far one-way) discussion is here:

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