Monday, September 29, 2008

Review of the bailout

Yet another letter to my representatives

This is in regard to the Wall Street Bail out program titled "Emergency Economic Stabilization Act of 2008" (pdf).

I must first congratulate Congress on the openness of the process in making the full text of the proposed legislation available and open for public comment before being proposed on the floor. Such a process clearly opens up government to be truly of the people and allows us to make sure government is working for the people. Thank you.

About the legislation itself, there are many good things in it. I do have hesitation about some aspects and am strongly opposed to one main clause. As I was reading the bill, I kept a running Twitter stream going of my thoughts.

Beginning with the aspects of this bill that I like, the general outline of the plan is a good idea. While I don't believe that an insurance program will be effective, allowing Sec. Paulson to either apply such a system or buy the securities themselves directly gives him the flexibility necessary to handle such a large and complicated issue. I am also really happy with the openness of this program. The regular reports detailing what securities are being purchased or insured will significantly improve the trust of the American people that their money is being used appropriately.

Requiring this program to work on renegotiating mortgages is probably the single thing that will do the most good in this bill. I also appreciate that executive pay will be restricted if they take part in this program; such a protection will ensure the executives aren't taking advantage of the tax payers for their own personal gain.

There are a couple parts of this bill that I do find issues with. One is the incredible power Sec. Paulson will wield under this bill. Not only is he being put in charge of guiding this program through the Department of Treasury, but he is also one of the five members of the oversight board, with the other four members also being significantly involved in the troubles facing us now. The only other actual oversight is provided by the Office of the Comptroller. Congress will set up another oversight board, but that board will only be set up in a review role, unable to require changes to the program. This concentrates an enormous amount of power over as much as $700 billion in the executive with minimal checks from other branches. I believe that at the least, Congress should be allowed active oversight of the program as well, to ensure tax payer money is being appropriately used.

That however, is not the main issue for me in this bill. Also contained in this bill is the suspension of mark-to-market accounting (section 132). It is my understanding that this accounting procedure requires banks (and other entities) to list the value of their assets at current market value, not at their expected future value of those assets. Such a write-down has played a factor in this crisis because banks' asset sheets have dropped in value significantly. However, suspending such a rule allows the banks to effectively lie to investors and officials that would loan to them. Were such a rule to be passed for someone such as myself, I could apply for a loan saying that I have $1 million in assets based on a 401k with $10,000 and a $100,000 house -- if I hold on to them long enough, it is estimated that they will be worth $1 million. I would be laughed out of any bank office were I to ask for a loan using that logic.

I do believe that mark-to-market should be reviewed as required in section 133, but the mark-to-market rule should not be suspended until after such a review. There are types of trades that shouldn't be able to affect market value of some of these assets and as such, the rule does need refining. Suspending it wholesale removes the transparency so desperately needed on Wall Street now to improve investor and credit trust. PLEASE, fight against this section of the bill.

h/t to BAC for linking to the proposal text

UPDATE: The bill as it was written failed to pass (Yes, ignore the title, this appears to be the correct roll call). My congressman, William "Lacy" Clay did vote against the bailout.


Comrade Kevin said...

It's failed in the House.

I appreciate your analysis. It will be interesting to see what a revised bill will look like compared to this one.

no_slappz said...

john j,

You do not understand the basics of credit.

There is no comparison between the stocks in a 401-K account and bonds, mortgages or other credit instruments that are at the center of the current crisis.

In short, credit theory is based on the expectation of periodic cash flows arriving where they are supposed to arrive. Monthly mortgage payments, for example.

The future value of a steam of cash flows is simple to calculate. Nothing about these cash flows is analogous to the price of a stock. There is no legally binding contract between the debtor and the creditor in the world of stocks. There is also almost no collateral in the stock world.

A stock represents the "residual value" remaining after all the other obligations of a corporation have been satisfied.

In other words, what's left after all the banks are paid off, after the bondholders are paid off, and all the vendors are paid off.

When a company is in trouble, stockholders' equity is negative. But even when it's negative, the banks and bondholders often get full reimbursement.

Things may get tricky with Credit Default Swaps and other seemingly exotic credit derivatives, but they are not as esoteric as journalists invariably suggest.

That aside, none of our current problems would exist if it were not for the 1977 enactment of the Community Reinvestment Act, which forced banks to offer mortgages to people with low credit scores, poor work histories and no downpayment money.

If we were all required to cough up 20% to buy a house, our current problems would have been stopped before they started.