• Update: The Global Credit Crisis and the US Government's Response
  • October 8, 2008 | Author: Frank M. Conner
  • Law Firm: DLA Piper - Washington Office
  • In a stunning repudiation of the Bush Administration and of US Congressional leadership, the House of Representatives rejected today, by a vote of 228 to 205, the Emergency Economic Stabilization Act of 2008 (H.R.3997), which is the legislation providing authority for the US government to purchase and insure up to $700 billion of certain troubled assets. Voting against the bill were 95 Democrats and 133 Republicans. Many members, facing difficult re-election campaigns, were apparently influenced by calls from constituents expressing opposition to the proposal, which in some jurisdictions were running over 100 to 1 against the plan.

    The key provisions of this legislation included the following:

    • Permitting the US government to buy troubled assets, meaning residential or commercial mortgages and any securities based on or related to such mortgages, in each case originated or issued on or before March 14, 2008 from financial institutions;
    • Financial institutions would include banks, savings associations, credit unions, broker/dealers or insurance companies established and regulated under the laws of the US or any state thereof, and having significant operations in the US;
    • Establishing an initial tranche of $250 billion for purchase of troubled assets, with a subsequent amount of $100 billion being available upon the certification of the President, and the final $350 billion being available subject to a resolution of disapproval by the US Congress;
    • Placing limitations on the employment compensation, including termination arrangements, for senior executives at institutions participating in the loan purchase program;
    • Creating a Financial Stability Oversight Board, consisting of senior representatives from the executive and the legislative branches of government (including the Secretary of the Treasury, the Chairman of the Federal Reserve, and representatives of both houses of Congress), to provide administrative supervision;
    • Authorizing an insurance program which would guarantee repayment of the principal and interest on the assets in question, with coverage to be provided upon payment of appropriate insurance fees; and
    • Providing for termination of authority under the program on December 31, 2009, subject to an extension to not more than the second anniversary of the enactment of the legislation.

    The actions of Congress come against a backdrop of increasing global concern. The US government arranged and facilitated the acquisition of banking giant Wachovia by Citigroup, and the Benelux governments bailed out established Belgo-Dutch financial institution Fortis, S.A. (representing the third major European bank salvaged through such intervention during the course of the past weekend). The Dow Jones index plummeted 777 points on the legislative news, reflecting uncertainties that the troubled assets problem could be solved. In the US, the Federal Reserve injected huge levels of additional liquidity to stabilize the banking sector at this critical moment.

    Treasury Secretary Henry Paulson pledged to work toward a resolution of the issues and perhaps renew the plan’s consideration. But doubts linger whether, even if ultimately enacted, the scope of the proposed purchase program will be adequate to address sufficiently the extent of the crisis facing the global financial services industry.

    The plan is designed to address the concerns of short-term providers of credit: fears that keep them from providing liquidity to their banking counterparties. Given that the initial loan purchase funding tranche in the legislation has been reduced to $250 billion, it must be asked whether these sums will be sufficient to effectuate a market turnaround. There simply may not yet exist an appreciation in Congress as to the severity of the ongoing economic contraction, and the extent of the force necessary to reverse it.

    The House has adjourned until Thursday, preventing action in that chamber at least until then. It is possible that the legislation may be introduced first in the Senate, before returning to the House. Among the changes being considered is a proposal to increase the amount of FDIC insurance to be provided for each specified insured account; this provision may be designed to respond to the concerns of Main Street bankers in smaller communities who are expressing anxiety at recent market turmoil, and communicating to their legislative representatives the fear that the Wall Street upheaval may result in contagion by smaller market participants in communities and industries throughout the US. Indeed, legitimate fears exist, given European market developments, that such systemic breakdowns will accelerate beyond the shores of America to Europe and Asia, as well.

    Only one certainty remains: both the regulatory and the market landscape will be a radically different one in the months to come. While once-hallowed institutions meet their demise by restructuring, liquidation, acquisition or bankruptcy, governmental authorities across the globe are calling for a new system of financial regulation amidst frank acknowledgements, as recently as last Friday by Christopher Cox, the Chairman of the Securities and Exchange Commission, that the old regulatory regimes are obsolete. In announcing that it was terminating its Consolidated Supervised Entities program, Cox observed, “[t]he last six months have made it abundantly clear that voluntary regulation does not work”. These calls for action echo the recent address by President Nicolas Sarkozy of France, in which he articulated the need for transnational regulatory requirements designed to safeguard market participants active across a myriad of national boundaries, as well as British Prime Minister Gordon Brown’s invocation of an international regulatory regime that could fill the void often left by overlapping, inconsistent and, at times, inapplicable capital, risk-management and leverage requirements. In calling for dramatic new action by both national legislatures as well as by global regulatory bodies, these individuals have invited the commencement of a process whose ultimate contours and outcome remain unknown at this time.