President Barack Obama has repeatedly rejected the stock market’s performance as a measure of his Administration’s efforts to repair the financial system and bolster the economy.
But he might want to reconsider that view in light of the market’s reaction to the plan Treasury Secretary Timothy Geithner announced last week for purging the toxic assets that are clogging the nation’s credit markets and slowing the economic recovery. The Dow Jones Industrial Average jumped, gaining more than 280 points by mid-day – a marked contrast to the 380-point decline that greeted Geithner’s announcement in February of a plan to stimulate lending by injecting capital directly into financial institutions.
The Public Private Investment Program Geithner detailed last week provides a mechanism through which banks will be able to sell the “legacy” securities and loans (a.k.a. “toxic assets”) that are burdening their balance sheets, making it difficult for them to raise additional private capital and originate new loans.
The plan uses a combination of debt and equity financing from the government to encourage private sector participation in the program —a key feature that Geithner and other Administration officials have emphasized. “This is the best way to get through this,” Geithner told reporters. “We don’t want the government to assume all the risk. We want the private sector to work with us.”
Treasury would initially tap $75 million to $100 million of the funds remaining from the $700 billion in funding Congress has already approved for the Toxic Asset Rescue Program (TARP) established in the latter days of the Bush Administration. That funding would leverage the purchase of at least $500 billion in assets, with the possibility of doubling that target in the future, Geithner indicated.
The plan has two components, one for purchasing loans and the other for purchasing securities. Both use an auction process to set market prices for the assets, with the government acting as auctioneer, bringing buyers and sellers together. Under the “Legacy Loans Program,” public-private investment funds will purchase mortgage pools from banks “on a discrete basis.” The FDIC will guarantee the debt the funds issue to finance these purchases; Treasury will provide 50 percent of the equity capital for each fund and will oversee the investments “to ensure the public interest is protected.” But private managers will be responsible for managing the assets, subject to “rigorous” FDIC oversight, Treasury’s plan summary emphasizes.
The “Legacy Securities Program” piggy-backs on the Federal Reserve’s existing “Term Asset-Backed Securities Facility (TALF), expanding the program to make non-agency residential and commercial mortgage-backed securities eligible for purchase. TALF will provide non-recourse loans to investors to purchase eligible assets; Treasury will provide seed money to create the investment funds by making “co-investment/leverage available to partner with private capital providers.”
This approach, in which government shares the risk with investors, Geithner said, “is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly.
The plan also has the advantage, from the Administration’s perspective, of avoiding direct government takeovers of ailing banks (which is precisely what some analysts think should be done) and delaying, at least for now, a request for additional bail-out funds that legislators, already suffering from “bail-out fatigue” and furious over bail-out recipient AIG’s bonus payments to executives, are loathe to approve.
The key question about Geithner’s plan, of course, is will it work. And on that, analysts are divided. The most pointed and fervent critique has come from Paul Krugman, the Nobel-prize-winning economist and columnist for the New York Times, who has dismissed as “financial hocus-pocus” and a warmed-over version of the “cash for trash” plan floated by Geithner’s predecessor, Henry Paulson. In a widely quoted column, Krugman said, the plan “would offer a one-way bet: If asset values [increase], the investors profit, but if they go down, the investors walk away from their debt….This isn’t’ really about letting markets work,” Krugman argued. “It’s just an indirect, disguised way to subsidize the purchase of bad assets.”
But what is most disturbing, and most damaging, he believes, is that it delays the inevitable and necessary government response, which, he contends, is to nationalize the banks, stabilize them, clean them up, and then sell what remains to investors. The Obama Administration’s failure to recognize that economic reality and bite the political bullet it requires, Krugman said, leaves him not just disappointed but “filled with despair.”
Washington Post columnist Stephen Pearlstein, for one, thinks Krugman’s critique fails to recognize the plan’s strengths. “It looks to me like it has a good chance of bringing significant amounts of private capital back into the financial system and relieve banks of some of their worst assets,” Pearlstein wrote last week.
Taking aim at Krugman’s key argument – that nationalization is necessary because bank assets have been properly devalued – Pearlstein argued, the financial crisis doesn’t involve one problem (solvency) or the other (liquidity), but rather, “it is the interaction of the two problems…that has caused the market to break down and prices to collapse.” Nationalizing the banks, Pearlstein said, would probably cost more “at least initially” than Geithner’s plan, and would put the federal government “in the uncomfortable position of managing large and complex businesses with 535 members of congress suddenly sitting on their boards of directors. Now that,” Pearlstein said in his column, “would be something to fill any columnist with a sense of despair.”
TONING IT DOWN
The continuing public uproar over the bonuses paid to AIG executives (and now mostly returned)—marked by heated rhetoric and a House bill that would impose a 90 percent tax on those payments – may complicate Administration efforts to enlist the private sector partners it is seeking for the newly announced toxic asset purchase plan (see related item above).
Some analysts are predicting that investor response will be “tepid at best” because of concern that the Administration might change the rules of engagement in the future, or that legislators might lash out similarly at them. The New York Times reported that executives at some of the private equity companies and hedge funds Geithner has approached have indicated that they won’t participate in the plan unless the Administration promises not to impose future compensation limits or other punitive measures on them.
“Given the way Congress has been behaving, I’m not sure there are a lot of investors wanting to participate with the government as a partner,” Bob Clarke a senior partner at Bracewell & Giuliani and former comptroller of the currency, told Business Week.
To allay these concerns, President Obama, who has joined in the criticism of the AIG bonuses, has also sought to cool raging tempers, telling CBS’ “60 Minutes” last week that he was not enthusiastic about the attempt to tax the AIG bonuses. “Main Street has to understand that unless we get these banks moving again, we can’t get this economy to recover. We don’t want to cut off our nose to spite our face,” Obama said. In his prime time news conference last week, Obama repeated that he is “as angry as anyone” about the bonuses, but cautioned against governing “out of anger.”
Other Administration officials made similar calming noises in appearances on various Sunday morning talk shows leading up to Geithner’s announcement of his plan. Companies that step up to participate in the asset purchase program shouldn’t be put in the same category with AIG, Christina Romer, chairman of the Council of Economic Advisers insisted, because “they are kind of doing us a favor….The President realizes they’re in a different category, and I think they are going to have confidence that they are going to be able to come into this program.”
Romer also targeted continuing complaints about bailing out Wall Street on the back of Main Street, insisting, “This has never been about helping Wall Street or helping a firm that made mistakes. It is absolutely about helping a system so that people can get their student loans, and families can buy their house and buy their cars and small businesses can get their loans.”
HARD TO STOP
Financial industry prospects for defeating or even substantially moderating proposed restrictions on abusive credit card practices are dimming measurably with each successive report of rising unemployment rates, falling incomes and soaring bankruptcy filings. Public fury over the Wall Street bail-outs and AIG bonuses isn’t helping to boost sympathy for industry arguments that the expanded consumer protections lawmakers are seeking would impose costly and counterproductive burdens on card issuers.
The House Financial Services Subcommittee held hearings recently on two measures sponsored by Rep. Carolyn Maloney (D-NY), one targeting credit card rate-setting and billing practices and the other aimed at overdraft programs that, critics say, take unfair advantage of consumers. Industry trade groups testifying at the hearing argued that the Federal Reserve’s newly approved regulations barring “unfair and deceptive” practices, which take effect in July of n2010, largely duplicate these measures and make them unnecessary. But Rep. Maloney and the consumer advocates backing her bills insist that the Fed rules don’t go far enough and don’t take effect soon enough. Maloney’s bills would become effective 90 days after enactment.
That is not enough time for financial institutions to revise their policies and their systems, Douglas Fecher, president and chief executive officer of Wright-Patt Credit Union, argued. Testifying for the Credit Union National Association, Fecher said the earlier compliance date “would require significantly more resources, which would have a direct impact on member service, [and would] come at a time when credit unions are [already] struggling with enormous regulatory burdens resulting from a number of new and significant laws and rules that have been enacted over the past decade.”
Financial industry regulators have agreed that financial institutions would be hard-pressed to meet the earlier compliance date. “These rules represent the most comprehensive and sweeping reforms ever adopted by [the Fed] for credit card accounts and will apply to more than one billion accounts,” Sandra Braunstein, director of the Fed’s Division of Consumer and Community Affairs, testified. “Given that the changes affect nearly every aspect of credit card lending,” she stated, “card issuers must be afforded sufficient time for implementation to allow for an orderly transition that avoids unintended consequences, compliance difficulties, and potential liabilities.”
The primary differences between Maloney’s credit card bill and the Fed rules, in addition to the implementation date, are its ban on “universal default” practices (where a missed payment on an unrelated account can trigger an increase on the credit card rate) and its mandate of a longer payment cycle before a consumer’s payments can be deemed late.
Separately, a subcommittee of the Senate Judiciary Committee is considering a measure that would allow consumers to eliminate their credit card debt in a bankruptcy filing if the card issuer has increased the rate above 15 percent plus the then current yield on the 30-year Treasury bill. The bill targets complaints about card issuers that boost rates steeply and suddenly for relatively minor payment missteps by borrowers, some of them resulting from practices consumer advocates say are intentionally misleading.
“The standard credit card agreement gives the lender the power to bleed their customer through revolving and ever more crafty tricks and traps,” Sen. Sheldon Whitehouse (R-RI), co-sponsor of the bill, with Sen. Richard Durbin (D-IL), said at the hearing. “Under this business model,” Whitehouse charged, “the lender focuses on squeezing out as much revenue as possible in penalty rates and fees, pushing the customer closer and closer to the edge of bankruptcy.”
Testifying for the American bankers Association, Kenneth Clayton, senior vice president and general counsel of the organization’s Card Policy Council, warned that this legislation, like the measures aimed at credit card abuses and overdraft programs, would lead card issuers to increase rates or fees “or both” and limit the availability of credit. “This would significantly hurt tens of millions of Americans at the very time they can least afford it,” Clayton said.
RETHINKING BANKRUPTCY REFORM
It took the financial services industry nearly a decade to win sweeping changes in the nation’s bankruptcy laws; it may take consumer advocates considerably less time to overturn some of those hard-won reforms. Industry trade groups argued successfully that the changes, making it more difficult for consumers to discharge their debts in bankruptcy, were needed to prevent widespread abuses of the process. But consumer advocates, who opposed the 2005 bankruptcy reform bill, say the soaring bankruptcy rate that has accompanied the economic downturn affirms the argument they made unsuccessfully at the time: Consumers seek bankruptcy protection not in an effort to game the system but as a last resort, because financial circumstances leave them no alternative.
One primary goal of the reform bill was to force more consumers to restructure their debts under Chapter 13 rather than eliminating them under Chapter 7. But a recent study found that Chapter 7 filings continue to outstrip Chapter 13 reorganizations, representing 76 percent of total personal bankruptcies in 2008 compared with 72 percent in 2004. The higher filing costs and more stringent eligibility standards the reform bill imposed haven’t reduced overall bankruptcy filings either; filings increased by 32 percent last year, totaling more than 1.1 million, and are expected to reach the 1.6 million mark this year, according to some estimates.
The primary effect of the bankruptcy reform bill, critics say, seems to have been not to reduce bankruptcies but to delay them, increasing the debt load consumers carry when they finally get to bankruptcy court. “All we have done with the law is to delay the inevitable and possibly made situations worse,” John Pottow, a law professor at the University of Michigan Law School, told USA Today.
By making it more difficult for consumers to eliminate debts in bankruptcy, the law is also making it more difficult for them to get the “fresh start” bankruptcy has offered in the past. That’s turning out to be not such a good thing for the economy or for financial institutions, when millions of people are losing their jobs, burning through their savings, and facing the need to rebuild their decimated finances.
Pending legislation that would allow bankruptcy judges to “cram down” the principal balance of a residential mortgage, may shift more debtors to Chapter 13 filings as a means of avoiding foreclosure. But financial institutions, caught between something of a rock and a hard place, are doing all they can to defeat that measure. Once work on that legislation has been completed (the House has approved a bill; the Senate has not yet considered it) lawmakers say they intend to focus more broadly on the 2005 bankruptcy reforms.
“There is continuing concern about what its effects have been,” Sen. Sheldon Whitehouse (D-RI), told USA Today. “We are looking at a number of things that we can do to address that problem.”
ANOTHER DAY, ANOTHER SCAM
The Federal Trade Commission is cracking down on companies offering loan modification services they fail to deliver. A U.S. district court has approved an agency request for a restraining order against two companies claiming falsely to be part of the Hope Now Alliance, a government-endorsed network of lenders and counselors working to help financially strapped borrowers avoid foreclosure. In fact, the FTC complaint claims, the two companies – calling themselves “New Hope Modifications” and “Hope Now Modifications” — did not provide modifications at all or even negotiate with lenders on behalf of the borrowers they purported to help. Instead, they accepted up-front fees, sometimes diverting a mortgage payment to that end, and then refused to refund the fee, as their marketing materials promised, if the modification was unsuccessful.
Among the “misleading” statements, the FTC cited: “[We] can help you save your credit and your home, often within 60 to 90 days,” “We stop foreclosure in its tracks,” and “the fast and easy way to save your home.”
“With many consumers desperate for relief and afraid they might lose their homes in these difficult economic times, some unscrupulous individuals are preying on these fears for their own financial gain,” FTC Chairman Jon Leibowitz said in announcing the court decision. “We won’t hesitate to take action against these types of con artists now and in the future,” he added.