An Overview of The Financial System “Bailout”
After much political wrangling and market turmoil, the Emergency Economic Stabilization Act of 2008, or what has become commonly known as the “bailout bill” (the "Bill") was passed by the House and Senate, and signed by the President. Under the Bill, the treasury department will be given $700 billion to attempt to revive the faltering financial system by restarting lending, both interbank and to businesses/consumers. The federal government will become involved in the U.S. financial system in ways not seen since the great depression.
The breakdown in the financial system is, in large part, due to factors that have not been seen before; therefore, the powers given to the Treasury by the Bill were made extremely broad. The most widely known of the Treasury's new powers under the Bill is the Troubled Asset Relief Program ("TARP"). Under TARP, the Treasury may buy "troubled assets", with the hope being that once banks have sold troubled assets, they will be able to lend more freely, both due to the reduced capital requirements that come with selling these loans and with the new capital they will receive for selling them. "Troubled Assets" were defined to include securities tied to residential or commercial mortgages, as well as "any other financial instrument that the Secretary [of the Treasury] . . . determines the purchase of which is necessary to promote financial market stability."
The Treasury has made clear that it interprets its broad powers under the Bill to include the ability to make capital injections into falling banks in return for equity in those banks. Already, on October 14, the Treasury announced that it would use $250 billion of the $700 billion to purchase equity in U.S. controlled banks. Of the $250 billion, $125 billion has already been earmarked for JPMorgan Chase ($25 billion), Citigroup ($25 billion), Wells Fargo ($25 billion), Bank of America ($25 billion), Goldman Sachs ($10 billion), Morgan Stanley ($10 billion), Bank of New York ($3 billion) and State Street ($2 billion). The Treasury will be taking preferred positions in each of these companies equal in seniority to the most senior class of preferred equity in existence for the company. Other financial institutions that wish to participate must elect to do so by 5:00 pm (Eastern Time) on November 14, 2008.
As an additional step towards ensuring the smooth operation of the financial system, the Federal Reserve has announced that it will be lending directly to companies by buying commercial paper through its Commercial Paper Funding Facility (the "Facility"). The Facility will purchase three-month commercial paper, both unsecured and asset-backed, directly from eligible issuers. This will make the federal government the 'lender of last resort' not only to banks, but to much of the corporate world.operation of the financial system, the Federal Reserve has announced that it will be lending directly to companies by buying commercial paper through its Commercial Paper Funding Facility (the "Facility"). The Facility will purchase three-month commercial paper, both unsecured and asset-backed, directly from eligible issuers. This will make the federal government the 'lender of last resort' not only to banks, but to much of the corporate world.
In addition to the Treasury's attempting to jump start lending by injecting capital into and buying distressed assets from U.S. financial institutions, the FDIC is attempting to assist in the process, as well, by announcing that it will guarantee, for a fee, all newly issued senior unsecured debt of banks, thrifts and certain holding companies. Additionally, the FDIC will now guarantee all deposits up to $250,000 and will guarantee non-interest bearing deposit transaction accounts regardless of the dollar amount.
In an attempt to ensure that the government's actions in this regard do not encourage excessive risk-taking in the future by firms counting on a government bail out, the Bill imposes restrictions on executive compensation and increased corporate governance standards for any institution participating in the Capital Purchase Program. These include greater transparency requirements and a clamp down on "gold parachutes".
How the Bill will affect any individual company will require a more detailed analysis of that company's position, as well as paying careful consideration to new programs announced as the Treasury continues to fully implement the Bill.