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Howard Schweber

Howard Schweber

Posted: September 22, 2008 05:41 PM

Paulson's Plan -- Annotated


LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY
TO PURCHASE MORTGAGE-RELATED ASSETS


Section 1. Short Title.

This Act may be cited as ____________________.

Sec. 2. Purchases of Mortgage-Related Assets.

(a) Authority to Purchase.--The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

[Comment: Notice that the program only applies to mortgage-related assets (although some financial firms are already lobbying to expand the definition.) Mortgage related assets were specifically identified as exempt from traditional securities regulations requiring disclosure of underlying valuation data in the December 15, 2000 Commodities Futures Modernization Act. That act was added to the budget by Phil Gramm -- two days after the Court's decision in Bush v. Gore when no one was paying very much attention. "Nobody in either chamber had any knowledge of what was going on or what was in it," says a congressional aide familiar with the bill's history (quoted in a story in Mother Jones). The act, said Gramm, would ensure that neither the SEC nor the Commodity Futures Trading Commission (CFTC) got into the business of regulating credit default swaps. Those swaps -- insurance policies to protect mortgage holders against the possibiity of default extended to enormous bundles of mortgages -- were what brought AIG down. The new proposal does nothing to bring mortgage backed securities in general, or credit default swaps in particular, within the regulatory system that governs traditional securities. It only provides that if these investments go sour, the government will take them off the hands of financial institutions.]
What brought down Freddie Mac and Fannie Mae was something else; the assumption that the government would bail them out of any failures. That assumption created perverse incentives, leading to complete recklessness in lending. (AIG then insured those reckless decisions against loss. Lehman went down because it got caught in the general unavailability of short-term credit.) The phrase is "socialization of risk, privatization of profit."
What sort of incentives would the new proposal create? The particular strategy will depend on whether the government pays high prices (to get capital into the system) or low prices (to attempt to secure a long-term recovery for the future) We can assume that the prices will be reasonably high, since if the prices paid by the government are too low the plan simply doesn't work -- banks are still left to absorb their losses, and face the risk of failure, a danger that dissuades lenders from extending credit In the 1990s, Japan suffered a "lost decade" when no one was willing to loan money because there were too many bad debts mixed into the asset pools.
This measure is designed to prevent that kind of illiquidity -- but it is perfectly possible to go too far in the opposite direction. Isn't that how we got here, actually? That's a bipartisan swipe -- the Clinton administration in its last two years had a lot to do with encouraging relaxation of regulations in order to make it easier for people to get mortgage loans. From there it was the clever people who figured out how to bundle those mortgages into securities, and the even cleverer people who figured out how to get those securities insured against losses who gave the whole thing nuclear potential. Any purchase prices sufficient to help the banks out of a hole represent near-certain losses for the taxpayers, and in the meanwhile all those clever people are just licking their chops: this proposal creates a system that is subject to an almost infinite degree of gaming.]


(b) Necessary Actions.--The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:

[Comment: The terms "necessary" and "without limitation" mean just what you think they mean: this is a complete transfer of control over this sector of the economy from Congress to the Executive. There used to be something called "non-delegation doctrine," which stated that there were Congress was not permitted to give the Executive unlimited, "standardless" authority -- so, for example, it would not do for Congress to pass enabling legislation that said "the EPA shall make whatever regulations it wants." In recent years, that doctrine has been treated as something of a dead letter -- then again, there has never been a transfer of authority that would remotely equal this one.]


(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;

(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;

[Comment: Alternative title for this section: "The Bankers and Lawyers Full Employment Act of 2008." Back in the S&L days the Office of Thrift Supervision (later the Resolution Trust Corporation) hired private lawyers to litigate its liability cases because there simple were not enough government lawyers to do the work. The level of hiring in the private sector, and the size of the additional government bureaucracy that would be required by this measure is difficult to estimate. It may also be difficult to comprehend, but it is clear that there will be tens or hundreds of millions in fees to be made. As a story on the front page of today's New York Times puts it, "nobody wants to be left out."]


(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;

[Comment: This provision appears to be a back-door way of asserting a kind of conservatorship whereby the government officials, as a condition for purchasing devalued mortgage-backed securities, would get to take control of some aspects of the governance of the affected institutions. Taken literally, the term "agents" implies a complete government takeover, including authority over hiring and firing, all financial decisions, and - something that has not been mentioned -- the ability of the government to order employees and officials of the institutions involved to refrain from publicly discussing what is going on.]


(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and

(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.

[Comment: "Necessary *or* appropriate"; this language is even broader than the Necessary and Proper Clause included at the end of Article I, section 8 that described the powers of Congress! Likewise the phrase "other guidance" is striking in its near-total lack of semantic content.]


Sec. 3. Considerations.

In exercising the authorities granted in this Act, the Secretary shall take into consideration means for--

(1) providing stability or preventing disruption to the financial markets or banking system; and

(2) protecting the taxpayer.

[Comment: The phrase "shall take into consideration" is a familiar one in administrative law. It is purely hortatory -- even assuming we could agree on what "protecting the taxpayer" actually means. Keep in mind that this incredibly broad authority would have been in the hands of Alan "fixed rate mortgages are a sucker's bet" Greenspan a few years ago. Or Phil Gramm's hands if the timing of all this had been different: if this crisis had hit two years from now and McCain had won the presidency in the meantime, there is a better than good chance that Gramm would have been his Treasury Secretary. So for example: does this measure give the Treasury Secretary authority to cancel federal law by deregulating the financial system? Note that the purchasing authority is restricted to mortgage-backed securities, but the rule-making authority has no such limitation.]


Sec. 4. Reports to Congress.

Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.

[Comment: If you have not studied the history of the War Powers Act, you cannot appreciate how utterly meaningless this is as a check on executive power.]


Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.

(a) Exercise of Rights.--The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.

(b) Management of Mortgage-Related Assets.--The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.

[Comment: Okay, the government has purchased large numbers of bad loans, presumably at a discount. Now what? Only one possibility that arises under this provision is that the government might get into the junk bond business. Which raises the obvious question; what are the long term consequences of this measure for the bond market? (Yes, I know, "much better than the likely consequences of doing nothing," but that's not the question -- the question is whether this particular "something" is a good idea.)]


(c) Sale of Mortgage-Related Assets.--The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.

(d) Application of Sunset to Mortgage-Related Assets.--The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.

Sec. 6. Maximum Amount of Authorized Purchases.

The Secretary's authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time

[Comment: What does "at any one time" mean? In any one transaction? Total value of assets held by the government on a given day? Total amount paid by the government for assets currently held?
Borrowing $700 billion raises some interesting questions, starting with "from whom?". The Chinese sovereign fund is looking to purchase up to half of Merrill Lynch, and in general foreign sovereign funds are the most likely sources for this kind of capital. What could possibly go wrong?]


Sec. 7. Funding.

For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.

[Comment: 31 U.S.C. chapt. 31 is about "Public Debt." This is the provision that establishes the debt ceiling that is being raised in order to accomodate this system. In other words, while we hope that eventually some of these assets will make money in the meantime we will need to borrow in amounts featuring twelve zeroes after the units digit. Keep in mind that these are assets that the government is purchasing only because they are so bad that they cannot be sold in private markets and are dragging down the banks that issued them, the investors who purchased them, and the insurance companies that covered them.]


Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

[Comment: If you were surprised to hear that Guantanamo Bay was outside the reach of the U.S. Constitution, how do you feel on learning that the same is true of our nation's entire financial system? Particularly coming close after the repeated rulings in the detainee cases, this is just outright chutzpah. Did John Yoo contribute this be e-mail? Or is the idea that the current crisis is Even Worse Than Terrorism? This provision has about as much chance of surviving review in the Supreme Court as I have of being elected Homecoming Queen.]


Sec. 9. Termination of Authority.

The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.

[Comment: Don't bother looking: what expires is the authority to purchase securities (assuming this is not renewed, of course.) What does not expire is the new authority to issue any and all regulations -- or declare existing regulations inapplicable? -- the authority to borrow money, and the authority to dispose of assets already purchased.]


Sec. 10. Increase in Statutory Limit on the Public Debt.

Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.

[Comment: The current debt ceiling is $10.6 trillion, an amount that was raised from $9 trillion and change in July as part of a housing bill. Current U.S. GDP is about $13.5 trillion; so the new ceiling puts the maximum debt at well over 80% of GDP. Some economists worry about these things.]

Sec. 11. Credit Reform.

The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.

[Comment: Unless I missed something, the FCRA doesn't actually impose any particular substantive limitations on purchase prices, it only imposes calculation and reporting requirements.]


Sec. 12. Definitions.

For purposes of this section, the following definitions shall apply:

(1) Mortgage-Related Assets.--The term "mortgage-related assets" means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.

[Comment: A welcome note of sanity! At least newly issued mortgage-backed securities would not be covered. But! Notice the phrase "based on or related to such mortgages." There are securities that consist of bundled mortgages, credit swaps based on those securities, derivatives based on both the securities and the credit swaps, and securities that mix residential mortgages with other kinds of assets. And it has already been announced in the past hour that Congress and the administration are working on expanding the scope of assets subject to government purchase. Meanwhile, mortgage-backed securities remain exempt from regulation. And the next time some clever members of Congress decide to deregulate a category of transactions, and then some clever financial professionals succeed in creating another disaster, we'll be back talking about yet another intervention. Nothing in this plan does or is intended to do anything to prevent future recurrence of the same stupidities.]


(2) Secretary.--The term "Secretary" means the Secretary of the Treasury.

(3) United States.--The term "United States" means the States, territories, and possessions of the United States and the District of Columbia.

[Comment: Including Guantanamo Bay.]