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U.S. Bailout Plan For Dummies

Obviously, there’s a lot of info on the proposed U.S. government bailout of the financial system circulating around cyberspace this Monday morning. Filtering out the noise, I tried to get at the nuts-and-bolts of what is being proposed in this post.

For those of you who prefer a short, multimedia-based breakdown of the bailout proposal, John Bussey of the Wall Street Journal talks about what’s at stake in a 3-minute MarketWatch video:

MarketWatch Video Link

For an in-depth, print-based explanation of the $700 billion scheme, this morning the Journal’s Deborah Solomon picked apart the proposed legislation and talked about its components:

The Troubled Asset Relief Fund:

The bill authorizes $700 billion for the fund in installments. Treasury will first get $250 billion, with an additional $100 billion immediately accessible. Congress would have the option of blocking the final installment of $350 billion by issuing a joint resolution within 15 days of any requests.

How it works:

Treasury plans to hire asset managers to determine how to buy bad loans and other ailing assets from financial institutions. Many of the details, including pricing and purchase procedures, will be worked out between those managers and Treasury. The legislation requires Treasury to set guidelines within 45 days for pricing methods and setting the value of troubled assets, as well as mechanisms for purchasing assets, procedures for selecting asset managers and criteria for identifying troubled assets to buy.

The legislation requires Treasury to purchase assets at the lowest price, and allows the government to buy through auction or direct from institutions.

Treasury expects to start buying the simplest assets first — mortgage-backed securities, for example — followed by more complex securities. Treasury likely will publish a list of the assets it is seeking to purchase. Banks and other institutions are expected to submit bids in a competition to sell bad loans and securities.

Executive compensation:

The legislation places restrictions on executive compensation for certain companies that sell assets to Treasury. If Treasury buys assets from a company directly — something it would do if a firm were failing — then no “golden parachute” exit payments could be made during the period when Treasury has an ownership stake in the firm. Companies that sell assets to Treasury through an auction process will be subject to some limits. Firms that sell more than $300 million of assets to Treasury won’t be allowed to make any new golden-parachute payments to top executives. A tax-deduction limit on compensation above $500,000 also will apply.

Equity stakes:

The legislation requires Treasury to receive warrants in companies that participate in the program. If a company sells its assets through an auction, Treasury will get a nominal amount of nonvoting warrants. If Treasury buys assets directly, it could get a majority equity stake.

Oversight:

The Troubled Asset Relief Fund will be overseen by a bipartisan congressional commission that will receive reports from Treasury every 30 days. The program will also be overseen by a board comprising the heads of Treasury, the Federal Reserve, the Securities and Exchange Commission, the Housing and Urban Development Department and the Federal Housing Finance Agency.

The office of accountability will have an inspector-general office within Treasury.

Treasury will have to submit a written report to Congress no later than April 30 on the overall financial regulatory system and “its effectiveness at overseeing the participants in the financial markets, including the over-the-counter swaps market and government-sponsored enterprises” and recommend improvements.

Protecting taxpayers:

If after five years the government has a net loss, the president will be required to submit a legislative proposal to seek reimbursement from the financial institutions that participated.

Help for homeowners:

Treasury will buy mortgage-backed securities, mortgages and other assets secured by residential real estate. The legislation requires Treasury to use its position as the investor in those loans and securities to “encourage the servicers of the underlying mortgages” to help minimize foreclosures.

It also calls for Treasury to “identify opportunities” to acquire “classes of troubled assets” that will improve the ability of Treasury to help modify and restructure loans. The idea is that Treasury would be more patient with homeowners who have fallen behind on their payments than commercial lenders.

Insurance:

The bill would require Treasury to establish, alongside the asset-purchase plan, a program to insure mortgage-backed securities. Financial institutions that want to participate would essentially pay the government a fee and, in return, the government would insure their assets against any future losses.

Accounting:

The legislation would require the Securities and Exchange Commission to study so-called mark-to-market accounting standards, which require that firms reflect the market value of assets on their books. Such accounting has culminated in many financial institutions writing down big losses as the value of certain assets has fallen in price. The SEC would have to study the accounting rule’s effect on balance sheets and report to Congress within 90 days of its findings.

The bailout legislation (in .pdf format) can be accessed here.

Sources:

MarketWatch Video
MarketWatch, September 28, 2008

“Shape of Massive Bailout Bill Starts to Develop Definition”
Deborah Solomon
Wall Street Journal, September 29, 2008