News Release

WASHINGTON - U.S. Rep. John Spratt (D-SC) issued the following statement on H.R. 1424 (formerly H.R. 3997), the Emergency Economic Stabilization Act of 2008.

"I understand your concerns, share many of your frustrations, and appreciate the opportunity to explain the bill, as finally revised, and how I voted.

"After weighing all the considerations, I voted for the bill twice, but believe me, those votes did not come easily.  Adverse events in the financial sector have produced a perilous situation for South Carolinians and all Americans.  Leading economists believe that if the Congress does not take appropriate action, local merchants, farmers, car dealers, real estate developers, students seeking tuition loans - all will be faced with malfunctioning credit markets, and a protracted recession.  I am convinced that something significant must be done to restore liquidity and stability, because our financial system is the circulatory system of our economy. 

"On Friday, October 3, the House passed the Emergency Economic Stabilization Act of 2008 by a vote of 263 to 171, and the President signed the bill into law on the same afternoon (The Senate approved the Act by a vote of 74 to 25 on the evening of October 1).  Congress took this necessary step to strengthen our weakened economy, and I believe that it must continue to do everything it can to protect Americans as this crisis evolves. 

"I have written an analysis of the current situation, which explains in much greater detail my view of the situation and how I voted.  I hope that you will find it persuasive, or at the very least, informative."

An Analysis of the Emergency Economic Stabilization Act of 2008

Introduction

For more than a year, the Secretary of the Treasury, Hank Paulson, and the Chairman of the Federal Reserve, Ben Bernanke, have tried to halt a free fall in our financial markets, but the downward spiral has shown no sign of abating.  Peter Orszag, Director of the Congressional Budget Office (CBO), described the situation on September 24, 2008, as follows:  

“Since August 2007, the Federal Reserve and the Treasury have been attempting to address a series of severe breakdowns in the financial markets that emanated from the bursting of the housing bubble, leading to substantial losses on mortgage-related securities and great difficulty in ascertaining the financial condition of the institutions holding such securities.  Those problems generated significant increases in risk spreads...and to a collapse of confidence, with the result that financial institutions became increasingly unwilling to lend to one another.

“Over the past several weeks, the collapse of confidence in financial markets has become particularly severe.  Short-term loans between financial institutions have fallen off sharply. Instead, the Treasury and the Federal Reserve have become financial intermediaries for them. Rather than financial institutions with excess money lending to institutions needing short-term funding, many institutions with excess short-term money have purchased Treasury securities, the Treasury has placed the proceeds on deposit at the Federal Reserve, and the Federal Reserve has lent money out to those institutions needing short-term funding.

“A modern economy like the United States depends crucially on the functioning of its financial markets to allocate capital, and history suggests that the real economy typically slows some time after a downturn in financial markets. Moreover, ominous signs about credit difficulties are accumulating. The issuance of corporate debt plummeted in the third quarter, and the short-term commercial paper market has also been hit hard. Bank lending...will undoubtedly be severely curtailed by the difficulties that banks are facing in raising capital. Businesses and individuals will find it increasingly difficult to borrow money.

“In sum, the problems occurring in the financial markets raise the possibility of a severe credit crunch, which could have devastating effects on the U.S. and world economies.”    

The Fed and the Treasury have concluded that the best way to stop the credit crisis is to purge the financial markets by having the government take over “toxic assets.” As Secretary Paulson has said, “We cannot get our financial markets straightened out until we get mortgage-backed securities straightened out.”  After a year of ad hoc measures and stopgaps, the Fed and the Treasury have decided that a systemic solution is required.  Paulson has explained, “I have a substantial tool kit, but it is still not sufficient.”

Here is a chronology of the events leading to their conclusion.   

Chronology

In May 2007, the Chairman of the Federal Reserve announced that sub-prime mortgage foreclosures were growing, but not at a rate that would seriously harm the economy.  By August 2007, the Fed had changed its tune.  It was clear by then that the housing bubble was bursting.  On August 7, the Fed acknowledged that the slump in housing posed “a risk to the economy.”  On August 9, the Fed pumped $24 billion into the economy, followed by $38 billion on August 10.  At the same time, the Fed declined requests from Fannie Mae and Freddie Mac to take on more debt.  On August 9, the Dow Jones Industrial Average dropped by nearly 400 points.

On August 17, 2007, the Fed cut the discount rate, and on September 18, the fed funds rate.  On September 20, President Bush finally acknowledged  “some unsettling times” in the credit and housing markets.  The Fed continued to cut its key interest rates through January, 2008, and it auctioned large amounts of funding to commercial banks in an effort to bolster their reserves and thereby promote their lending to corporate, small business and individual consumer interests.

In February 2008, with storm clouds gathering over the economy, Congress passed $150 billion in stimulus measures.  In March 2008, the Mortgage Bankers Association reported home foreclosures at historic highs. 1.1 million homes were in foreclosure; 3 million households had missed a payment; 737,000 were three months delinquent.  

On March 16, 2008, the Fed met on a Sunday night to direct cash into investment houses and stop a widening credit crisis from sinking the whole economy.  On April 30, 2008, the Fed cut interest rates to their lowest level in four years. On June 17, the Fed held its fourth auction, this time to fund $75 billion in loans to banks, again to augment their reserves and help enable them to extend credit to customers. 

On July 13, 2008, the Treasury announced plans to shore up Fannie Mae and Freddie Mac, stressing its resolve to take whatever steps necessary to sustain their secondary market roles.  On July 23, the House passed a bill to boost the housing market, including $300 billion in FHA guarantees to help struggling homeowners.  On July 30, President Bush signed a bill to help up to 400,000 mortgagors avoid foreclosure through government-backed mortgage loans.  Congress further affirmed that Freddie Mac and Fannie Mae were backed by the government and had unlimited lines of credit at the Treasury.  On August 12, the Fed auctioned another $25 billion to distressed banks to alleviate their obstacles to lending.

On September 7, 2008, the Treasury announced that it was taking over Fannie Mae and Freddie Mac, and putting both in conservatorship in order to forgo a run and restore stability to the credit and real estate markets.  

On September 14, 2008, Lehman Brothers, filed for bankruptcy when it could not balance $60 billion in bad real estate investments and after the Treasury declined to help.  On September 15, Merrill Lynch, fearing the fate suffered by Lehman, merged with Bank of America.  The Dow Jones Industrial Average dropped by 504 points.

The following day, the Fed and the Treasury arranged an $85 billion loan to the American International Group (AIG) to spare it from a disorderly break-up, with repercussions throughout the world.  On September 17, 2008, the SEC temporarily banned certain short-selling practices.

Institutional Problems Leading to the Troubled Assets Relief Program

On September 18, 2008, the financial markets began to freeze up due to a “collapse of confidence” among institutions and investors.  Shareholders made massive withdrawals from money market funds.  The Fed and the European Central Bank pumped $180 billion into the monetary system in response.  

Financial institutions here and abroad had been incurring huge losses on sub-prime, alt-a mortgages and mortgage-backed securities.  The nation’s largest mortgage lender, Countrywide, plummeted in value and was acquired by Bank of America for a fraction of the price at which it traded only months before.  In March 2008, Bear Stearns faced bankruptcy until the Fed and the Treasury brokered a take-over by JPMorgan Chase, backed by the Treasury’s guaranty of $28 billion in mortgage-backed securities. When the threat of failure turned next to Lehman Brothers, the Fed and the Treasury declined assistance, deferring to the market.  Unable to find a merger partner, Lehman was left with no option but bankruptcy. 

In the meantime, IndyMac Federal Bank, with $32 billion in deposits, also failed.  It was seized by regulators after a run on the bank left it short of funds.  Washington Mutual was also laboring under bad mortgage loans, and it became the largest bank in history to fail.  It was seized by the Federal Deposit Insurance Corporation (FDIC), and its assets were sold to JPMorgan Chase.  The FDIC increased the number of banks on its watch list to 117, against its $45 billion in reserves, much of which would be depleted if many of the listed banks  failed.

These and other problems led to the “collapse of confidence” in the credit markets. On September 17, 2008, Secretary Paulson watched in awe as his financial data terminal lit up with alarms. One market after another began going hay wire. The market for short-term and interbank loans froze up, and investors took flight from money-market mutual funds, withdrawing billions and causing several major funds to close.   

The Bush Administration’s rescue plan emerged from the fear that this panic might shut down the economy’s circulatory system, our financial markets, and lead to a wider economic debacle, affecting everything from venture capital to small business loans to credit cards to student loans.  The Fed and the Treasury decided that a systemic solution was needed and proposed the Troubled Assets Relief Program (TARP), which would  purchase  various assets including mortgage-backed securities. Through the TARP, the Treasury can acquire residential or commercial mortgages or any other financial instruments necessary to promote financial market stability. 

Scoring the Troubled Assets Relief Program

The $700 billion requested by President Bush is unprecedented in size and purpose.  But, three key points should be kept in mind:   

(1)  $700 billion would be the gross cost of the rescue package if maximum funding is ultimately drawn down, but the net cost is substantially less because the funds would be invested in assets that have potential value.

(2)  $700 billion would not be booked as a budget outlay, because the Credit Reform Act calls for recording only the net cost of the loan, which is likely to be a fraction of $700 billion.

(3)  The rescue plan was extensively revised in negotiations with Congress; it now includes a plan for recouping losses from the financial industry, if after 5 years the rescue plan results in a net loss to the government.

Both the Congressional Budget Office (CBO) and the Office of Management and Budget (OMB) have decided that the rescue package should be scored for budget purposes under the Federal Credit Reform Act. They look upon the Treasury as stepping into the shoes of lenders and essentially making loans.  The Credit Reform Act was passed in 1990, and has been used ever since as the way to score the cost of government loans and guaranties.  

Under the Credit Reform Act, government loans are not booked as outlays in the federal budget, and repayments under the loan are not booked as receipts.  Instead, at the outset of a loan, CBO and OMB estimate the likely losses, based on experience with loans of this kind and the cost of interest rate subsidies and market risks. These costs and repayments are discounted to a present value. If the loan is considered likely to repay less than the original principal amount, CBO records the shortfall as a cost or outlay in the year the loan is made. If the loan is likely to pay back more in present value than the principal amount, the gain is booked as an offsetting receipt.   

CBO has told us that the eventual impact on the budget will almost certainly be less than $700 billion, because the Treasury will use the $700 billion to acquire assets. CBO testified that “over time, the net cash disbursements under the program would be substantially less than $700 billion, because, ultimately, the government will sell the acquired assets and generate income that would offset at least much of the initial cost.”   

Because of uncertainty regarding what the Treasury will purchase, when it will draw funds, what price it will pay, and how much it will gain or lose, CBO cannot score the cost of the rescue package at this point, but the three key points mentioned above are considerable.

The President sent to the Capitol his request for $700 billion in a bill, with all of three pages, on Saturday, September 21.  The bill consisted mostly of two book-ends, with a notation that contents would follow and time was of the essence. The bill was a massive grant of money, accompanied by a sweeping grant of authority, not subject to judicial review or outside oversight. The President asked for quick approval of his Troubled Assets Relief Program, but the American people asked for diligence and deliberation.  After nearly two weeks of diligence, negotiation, and deliberation in both the House and the Senate, an improved bill emerged. 

Improvements to the Rescue Plan

To show how extensively the rescue plan was revised by Congress, here are ten major improvements that were made to the President’s plan:

(1) The revised bill no longer provides for a massive grant of money accompanied by a sweeping grant of authority to the Secretary of the Treasury.  In the revised bill, funds are not made available in one lump sum, but in three stages or tranches.  Instead of making $700 billion immediately available, the initial authorization is for $250 billion.  A second tranche of $100 billion would be obtainable upon Congressional receipt of a Presidential certification as to the requirement.  The final $350 billion tranche may be made available if the President submits a detailed report explaining why the  funds would be needed and how they would be used; however, Congress may block these funds by a resolution of disapproval.

(2) As revised, the bill authorizes a Financial Stability Oversight Board. Its members include the Chairman of the Federal Reserve and the Secretary of the Treasury but also the Director of the Federal Home Loan Finance Agency, the Chairman of the Securities and Exchange Commission, and the Secretary of Housing and Urban Development.  The board’s charge is to oversee operations of the TARP.  The revised bill augments oversight with a separate Special Inspector General for the TARP who would be assigned solely to this office, plus on-site auditors from the Government Accountability Office.  The Special Inspector General is directed to report to Congress quarterly and the Comptroller General every sixty days on the operation of the program.

(3) The Financial Stability Oversight Board is backed up by a Congressional Oversight Panel, with five outside members appointed by the leadership of the Congress.  This panel is charged with reviewing the condition of the financial markets, the effectiveness of the regulatory system, and the conduct of the TARP, especially its foreclosure mitigation efforts.

(4) Within 60 days, and every 30 days thereafter, the Secretary of the Treasury has to report to Congress on the activities undertaken by the TARP, including current financial reports.  Within 48 hours of any transaction, the Secretary must publicly disclose the details of that transaction. Upon disbursement of each $50 billion increment for the TARP, the Secretary must render a complete report on all transactions, together with justifications of their terms.  By April 30, 2009, the Secretary must report on the condition of the financial markets and the effectiveness of the financial regulatory system, with recommendations for improving both.

(5) Unlike the original bill, the revised bill allows for judicial review, injunctive relief, and temporary restraining orders with respect to execution of the TARP.

(6) Whenever the Secretary of the Treasury acquires troubled assets such as mortgage-backed securities, he must also acquire non-voting warrants issued by the seller.  The warrants would grant the government an equity stake in the seller to protect the taxpayer against any shortfall in selling the assets or to share in any market value gain enjoyed by the seller due to the sale of the assets.

(7) Whenever the Secretary of the Treasury acquires residential mortgages, he is authorized to modify the terms of the mortgage to minimize foreclosures.  The Secretary is directed to help mortgagors make use of the Hope for Homeowners Program by adjusting mortgages to a 90% loan-to-equity ratio, and re-amortizing mortgages with an FHA guarantee. Other agencies of the federal government are likewise directed to mitigate foreclosure and help mortgagors under government mortgages.

(8) The revised bill, unlike the original bill, has limits on executive pay. Whenever the Treasury buys assets at auction from a firm that has sold it more than $300 million in assets, the firm would be prohibited from entering into new employment contracts with golden parachutes. Whenever the Treasury buys assets directly, and acquires an equity position in the seller, the seller must observe standard limits on incentives, allow claw-backs, and prohibit golden parachutes. These limits are less than what Democrats sought, but if be passed, they would become a precedent, and they could be built upon in future legislation.

(9) The revised bill, unlike the original bill, provides for recoupment of losses.  If, after five years from enactment, OMB and CBO submit a report showing that a net loss has been incurred in the operation of the TARP, the President must submit a plan to Congress for recouping the loss, so that the program does not add to the national debt, and the loss is borne by the financial industry.

(10) When the revised bill went through the Senate, it was amended to temporarily increase FDIC deposit insurance from $100,000 to $250,000 per depositor.

Summary

Thus, there is a lot that is better about this bill after more than a hundred pages of substantive change. But questions remain: Is this bill necessary?  Is this the best way to inject liquidity into our financial  markets?  Should we even attempt to shore up insolvent firms?  Does the problem require the massive sum of $700 billion? 

I cannot answer these questions definitively, but I have to listen when Ben Bernanke, the Chairman of the Fed, answers by saying: “This is the most significant financial crisis of the postwar period.  I see the financial markets as already quite fragile...Credit will be restricted further.  It will affect spending; it will affect economic activity; it will affect the unemployment rate; it will affect real income; it will affect everybody’s standard of living...Despite the efforts of the Federal Reserve, the Treasury, and other agencies, global financial markets remain under extraordinary stress. Action by the Congress is urgently required to stabilize the situation and avert what would otherwise be very serious consequences for our financial markets and for our economy.”

Ben Bernanke is a renowned economist who has made a life-long study of economic crises from the Great Depression to the East Asian recession.  He has no axes to grind and is not given to exaggeration---far from it. When he warns that the situation is dire and that the cost of doing nothing could be catastrophic, we have to listen. Indeed, we ignore his advice at the peril of letting this crisis spread beyond the financial markets to a wider economic debacle.

Many members of the House, like me, come from districts that are rural and made up mostly of small towns. We tend to think that we are far removed from the ripple effects of crises like this.  But when we suddenly find that Wachovia is troubled and targeted for acquisition, we know the crisis can reach us all, sooner or later, unless we act now, and act decisively.  

Final Votes

I spoke to the House on Monday, September 29, and began by saying, “Nobody comes to the well of the House today with any relish or enthusiasm. This bill is as unappealing to those of us who will vote for it as it is to those who will vote against it.”  Nevertheless, after weighing all the considerations, I felt that the cost of doing nothing was likely to be more than the cost of passing the Administration’s plan with all the positive changes we had made.  I decided that the right vote was a vote for passage. When the bill was first voted upon, five of the six members of our delegation came to the same conclusion. When the bill came back to the floor on October 3 for a second vote, this time with the Senate’s amendments, I voted for it again. It passed easily by a vote of 263-171. All six members of our House delegation voted for the bill that time.  Senator Graham voted for it, Senator DeMint did not.

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