Administration and congressional negotiators reached agreement
early Sunday on a package of actions to address the alarming
financial situation facing the U.S. economy. Although several
drafts of legislative language have been circulating, it is not yet
possible to provide an overall assessment until the agreement's
final language is examined carefully. The devil is always in
the details, and so it is wise to look at the details. But
several concerns and questions arose with earlier versions of a
proposed package last week. So far, it appears that the negotiated
agreement addresses these concerns in the following ways:
Major Financial
Provisions
The agreement creates a new Office of Financial Stability within
Treasury that is empowered both to purchase troubled assets from
financial institutions and other bodies and to use other methods to
address the current financial situation. This office would be
immediately empowered to purchase up to $250 billion worth of
troubled assets at any one time. If necessary, the Secretary
of the Treasury could increase that amount by an additional $100
billion after notifying Congress that this additional sum is
necessary.
If still more taxpayer money is necessary, the Secretary could
use up to an additional $350 billion, but only after providing
Congress with a notice and if Congress does not pass a resolution
of disapproval within 15 days. That notice would be in the
form of a joint resolution that must be passed by both the House
and the Senate and signed by the President.
In addition to buying troubled assets from financial
institutions, the new Treasury office will also be allowed to
purchase those assets from local governments, pension funds, and
small banks that serve low- and middle-income families. In
any case where the Treasury office purchases assets, if the entity
subsequently fails, taxpayers will have first call on using its
remaining assets to repay any assistance that the firm
received.
These tools would appropriately address the dangerous situation
currently facing the credit markets.
Oversight and Separation of
Powers Concerns
The new oversight board would be responsible for the
following:
- To review any and all actions taken by the Secretary and the
new office in implementing the agreement, including the appointment
of any private sector financial agents to implement the plan;
- To make recommendations to the Secretary on the implementation
of the agreement: and
- To report to the Treasury Inspector General or the Attorney
General any instances of fraud, misrepresentation, or
malfeasance.
In addition, other sections of the draft law would provide for
limited judicial review of actions made by the Treasury Secretary,
with additional restrictions for transactions between the new
office and participating companies. Further provisions would
require that GAO have personnel permanently placed within the new
Office, and both GAO and the Treasury would be responsible for a
detailed series of reports to Congress. While such oversight would
address economic policy concerns, these specific provisions,
including the board itself, raise important constitutional
concerns.
The current draft bill has not addressed several
serious constitutional issues, at least three of which warrant
particular concern. With regard to the sweeping delegation of
discretion to the Treasury Secretary (the "legislative delegation"
problem), the latest text has not narrowed the scope of his
authority. There is a possibility that the courts would strike down
the law if it is challenged as an improper delegation of
legislative authority-i.e., that the law provides no "intelligible
principle" to guide and direct the Secretary's actions. As
Heritage research has explained,
how the courts may rule is not the only concern; what the
Constitution actually requires and whether separation of powers
principles are significantly undermined also require careful
consideration. Our Constitution allows no Czar, with standardless
discretion to prop-up or manage various industry sectors. Previous
Heritage papers elaborate on this concern and suggest
ways to define the Secretary's range of discretion in a more
objective manner that also permits more meaningful judicial
review.
It is also of considerable concern that several of the oversight
mechanisms that were added as a substitute for the constitutional
separation of powers amount to an attempted "power-sharing"
arrangement. Instead of alleviating the separation of powers
problems, these mechanisms make them worse. Congress and the
President may be satisfied with a power-sharing deal that permits
broad executive authority with opportunities for congressional
micromanagement and political nitpicking (e.g., enhanced GAO
audits, additional "independent" Inspectors General, new
congressional oversight structures, and enhanced reporting), but
the constitutional separation of powers was designed to protect the
individual liberty of citizens precisely because the Framers feared
the branches would otherwise work out such deals.
Of particular concern is the unprecedented structure and power
of the Financial Stability Oversight Board. In sum, the Board would
be granted broad power to "ensure that the policies implemented by
the [Treasury] Secretary are" in accordance with the "purposes of"
the act, which could be used as a blank check to veto or modify
actions taken by the Secretary. At the same time, the President's
ability to direct the Board may be unconstitutionally
circumscribed. The Board would be composed of the Chairman of the
Federal Reserve Board, the Treasury Secretary, the Director of the
Federal Home Finance Agency, the Securities and Exchange Commission
chair, and the Department of Housing and Urban Development (HUD)
Secretary. A majority of these board members are not removable by
the President except for cause. Two precedents cited by the White
House for the constitutionality of this provision are
distinguishable. Congress sometimes has granted less sweeping
authority directly to a stabilization board, but it has never
attempted to give the discretion and responsibility to one cabinet
official who is directly answerable to the President, and then
subject his actions to the direction, modification and veto of
another board, especially one not wholly subject to the President's
direction and control. It remains dubious whether such an entity
would pass muster in the courts, as it clearly offends Article II
and the lines of democratic accountability that it established.
An Optional Federal Insurance
Program and Other Ways To Deal with Troubled Assets
During the negotiations, House Republicans raised an alternative
method of dealing with problem assets. This alternative has
been included in the final agreement as an optional method.
Under the plan, the federal government would be required to create
a program to provide financial institutions with insurance against
losses on mortgage backed securities (MBS). Currently, a
large proportion of MBS are insured against loss of principal, and
the new plan would cover the rest in return for an insurance
premium that would be set by the Treasury Department and be at
least partially determined by the risk of the securities. In
addition to this insurance program, the Treasury would also have
the ability to deal with the current economic crisis by using
public/private auctions of troubled assets, loan guarantees, and
direct support to financial institutions.
The insurance provision could prove to be very useful in some
situations, and its inclusion into the final agreement will give
the Treasury a valuable additional method to deal with potentially
very large MBS losses.
Who Will Pay?
While many of the assets acquired under the agreement will later
be sold for more than their purchase prices, many probably will
not. Although the overall cost of the plan is impossible to
estimate reliably at this point, negotiators agreed that, if after
five years the overall plan loses money, a fee will be assessed
upon financial institutions to repay the taxpayers. Under the
agreement, after five years, the President will be required to send
to Congress a plan to implement this repayment provision. No
new tax on financial institutions is included in the agreement.
In practice, such a repayment could operate very similarly to
the existing FDIC trust fund used to protect bank deposits.
Under the law, financial institutions are assessed a fee in the
form of higher premiums when the FDIC trust fund drops below a set
level. In this way, those institutions that benefit from FDIC
insurance end up paying for the protection even if the Treasury has
to advance money to them in the case of a major loss.
This could be a good compromise and, if well designed, would
help protect taxpayers. If financial institutions recover
quickly, it is only right that they should repay the costs of the
rescue.
The final agreement also contains a provision allowing community
banks to take capital losses that reflect the reduced value of
preferred stock issued by Fannie Mae and Freddie Mac in their
portfolios. Until those entities were taken into
conservatorship, banks were encouraged to purchase their assets as
part of their capital bases. Now that the two are in
conservatorship, their preferred stock has lost value. This
provision appears to be a good way to strengthen community banks
that might not otherwise have the type of assets the plan would
purchase but still have suffered from the current financial
situation.
Executive Pay
In an effort to prevent the same executives who may have
endangered their companies through poor decisions from benefiting
from the plan, the agreement imposes restrictions on both the pay
and termination compensation ("golden parachutes") received by such
executives. But it draws important distinctions in how to
handle particular cases. In the case where the government has
taken over a firm, executives are prohibited from receiving any
form of severance pay or other termination compensation. This is
already the practice that the government has followed for its
actions regarding AIG, Fannie Mae, and Freddie Mac. In
addition, taken-over companies would be encouraged to seek to
reclaim any bonuses paid that were based upon gains that
subsequently failed to materialize.
If the purchases of troubled assets from a single firm reach
$300 million or more, the Treasury would impose similar
restrictions on termination pay on the top five most highly paid
executives in that particular company. In addition, the
company would not allowed to deduct from its taxes any salary costs
in excess of $500,000. The Treasury Secretary would
issue guidelines that determine when such restrictions should be
applied and to whom. This provision may spur litigation by
executives who claim contractual rights to this now-prohibited
compensation. Such lawsuits could limit the savings to the
taxpayers if the government is forced to pay successful executives'
claims pursuant to the Constitution's Takings Clause or Due Process
clause for the loss of moneys that might occur through the
operation of this executive pay restriction
Although Americans are understandably insistent that executives of
firms with troubled assets should not profit from the plan,
government fixing of salaries and bonuses is dangerous and could
undermine the plan's goal of encouraging an orderly market to
develop for "toxic" assets. This provision appears to be a
compromise that will not undermine the goal of the plan.
Returning Possible Profits to
The Taxpayer
Taxpayers should expect to benefit from any realized profits on
asset sales because hundreds of billions of dollars of their money
is being used to purchase poor quality assets from financial
services firms. If individual companies recover and prosper after
selling their bad investments to the new Treasury office, taxpayers
would recoup those costs through the use of warrants that empower
Treasury to purchase and then resell stock in those
companies. However, the agreement carefully structures
taxpayer profit sharing so that it will avoid endangering the
economy's recovery by discouraging firms to participate in the
plan. Further, the provision wisely allows the government to obtain
only nonvoting stock to prevent it from owning parts of a company
or meddling in its management.
Under the agreement, the government would receive warrants for
the future purchase of company stock at a set price in any total
takeover situation. This is similar to the action taken in
the AIG rescue. In addition, the Secretary of the Treasury
would be able to require warrants proportional to the amount of
assets purchased under the agreement if such a move is deemed
appropriate.
Mark-to-Market
Many financial experts have criticized a recent accounting
change that required financial institutions and others to revalue
assets they held to their market value on the day that the
reporting period ended. Previously, firms had either used an
average value of their assets over a period of time or valued
long-term investments that they had no intention of selling at
their purchase price until they were eventually sold. Known
as "mark-to-market," the new standard was intended to give
investors a better idea of the current value of a firm's assets and
to reduce the ability of firms to manipulate their earnings or to
hide bad investments. However, mark-to-market introduced
additional volatility to firms' balance sheets as asset prices
changed, and under extreme conditions, firms' changed book value
could trigger both regulatory actions and fear about their
viability. Many experts have called for the mark-to-market
standard to be suspended or repealed.
Accounting principles fall under purview of the private Financial
Accounting Standards Board (FASB), which sets standards and
determines their implementation with oversight by the Securities
and Exchange Commission (SEC). Political interference in the
setting or implementation of accounting standards could be very
dangerous. The agreement restates the authority of the SEC to
temporarily suspend the accounting rule if it determines that doing
so is both in the public interest and protects investors. It also
requires the SEC to undertake a study of the rule's contribution to
the current financial situation. While it is important to
leave accounting in the hands of the professionals and out of the
way of political tinkering, this authority will enable the SEC to
correct the flaws in the accounting rule.
Bad Policy Provisions That Were
Dropped
During the early negotiations, a number of particularly bad
policy options were added to the original Treasury proposal.
The final agreement appears to drop all of them. Among the
dropped provisions are:
- Allowing bankruptcy courts to
change mortgages. An early draft of the legislation would
have allowed bankruptcy judges to arbitrarily reduce mortgage
payments by either reducing the interest rate to the current market
level or reducing the amount owed to the current value of the
house. This provision has been dropped from the final
agreement. Its elimination is welcome because, if it had
remained in, it would have been much harder for new or low-income
homebuyers to find mortgages, and all homebuyers would have found
it more expensive to get a mortgage.
- Using the bailout plan to
finance low-income housing and provide money to activist
groups. Another dropped provision would have required
that 20 percent of any profitable transaction be deposited into a
special fund that pays for low-income housing. This would have
applied regardless of whether the overall agreement was profitable.
If it had remained, the provision would have both increased the
cost to the taxpayer as well as circumventing the usual
appropriations process, thus making it harder to keep track of
spending.
- Changing corporate governance
and proxy rules. Yet another dropped provision would
have changed the corporate governance laws to enable any holder of
3 percent of a firm's stock to place its nominees on the same proxy
statement as that used by management. It also would have
facilitated stockholder votes on a number of issues including
executive compensation. While superficially attractive, such
a provision would have allowed interest groups to use shareholder
meetings to advance their own agendas. It also would make it
much harder for corporate boards to obtain the balance of skills
and knowledge that the corporation needs for optimal management by
making board of directors elections into popularity contests.
Alison Acosta Fraser is
Director of the Thomas A. Roe Institute for Economic Policy Studies
and Todd Gaziano is Director of the Center for Legal and Judicial
Studies at The Heritage Foundation.
Robert Alt, J.D. Foster, Ph.D.,
James L. Gattuso, Andrew M. Grossman, and David C. John contributed
to this report.