The bill also also includes much-needed oversights attached by Congress. It provides helps for homeowners facing foreclosure by requiring Treasury to both guarantee their loans and help them adjust terms through HOPE NOW. It increases FDIC insurance for bank deposits to $250,000, and allows the agency to tap as much federal funds as needed through 2009, allaying any fears that FDIC itself might go bankrupt.
It allows the SEC to suspend the mark-to-market rule. This law forced banks to continually write down the value of their mortgages to present-day levels. This meant that bad loans, which could not be resold in the current panic-stricken climate, had to be valued at less than their probable true worth. (Source: Bloomberg, Bank-Rescue Plan Wins Approval as House Reverses Vote, October 3, 2008)
The bill contains an additional $150 billion in tax breaks, to be phased in over 10 years. These include an extension of the AMT patch, tax credits for research and development, and relief for hurricane survivors. For more of the tax breaks, see WSJ, Senate Vote Gives Bailout Plan New Life, October 1, 2008.
By October 3, the Senate had re-introduced the proposal by attaching it to a bill that was already under consideration. This side-stepped the House, which usually must introduce any funding bills. The Senate's tactic resulted in successful passage of the bill by the House, and President Bush signed it into law.
It also keeps many of the provisions added by the House of Representatives:
- An oversight committee that will review Treasury's purchase and sale of mortgages. The committee is comprised of Federal Reserve Chair Ben Bernanke, and the leaders of the SEC, the Federal Home Finance Agency and HUD.
- Bailout installments, starting with $250 billion.
- The ability for Treasury to negotiate a government equity stake in companies that receive bailout assistance.
- Limits on executive compensation of rescued firms. Specifically, companies will not be able to deduct the expense of executive compensation above $500,000.
- Government-sponsored insurance of assets in troubled firms.
- A requirement that the president propose legislation to recoup losses from the financial industry if any still exist after five years. (Source: Senate Banking Committee, Bailout Bill Summary pdf; CNNMoney, Rescue Bill Released, September 28, 2008.)
The proposal had been defeated by House Representatives who were opposed to a taxpayer bailout of bad banking decisions. However, this caused the Dow to drop 770 points, and global markets to plummet. Therefore, the Senate created an amendment to an existing bill, and the House finally approved that version on October 3, 2008. (For more, read Bank Bailout Bill Implodes)
The bailout was triggered by a record $140 billion being pulled out of money-market accounts, usually considered the safest of investments. That's because investors were moving the funds to U.S. Treasuries, causing yields to drop to zero. To stem the panic, the Treasury agreed to insure these funds for a year. In addition the SEC banned short-selling of financial stocks until October 2 to reduce volatility in the stock market. (For more, see What Triggered the Bank Bailout Bill?)
The government is buying these bad mortgages because banks have become afraid to lend to each other. This fear is what is caused LIBOR rates to be unnaturally higher than the Fed Funds rate, stock prices to plummet, and financial firms unable to sell their debt. Without the ability to raise capital, these firms are in danger of going bankrupt, just as Lehman Brothers did, and AIG and Bear Stearns would have without Federal intervention.
As it should, Congress debated the pro's and con's of such a massive intervention. Political leaders wanted to protect the taxpayer and not let businesses off the hook for making bad decisions. Most in Congress recognized the need to act swiftly to avoid further meltdown. It has become a case of fear feeding on fear, with banks afraid to disclose their bad debt, which would lead to a downgrade in their debt rating, which would lead to a decline in their stock price, which wouls lead to their inability to raise capital, which would lead to bankruptcy. This fear of disclosure has led to an overall panic, fed by rumor, which has locked up the credit markets.
Will the taxpayer be out $700 billion? Probably not, since the government will be buying when the prices are depressed and selling later, when prices have returned to normal. Furthermore, the bill requires the President to develop a plan to recoup losses from the financial industry.
