Stocking Filled with TARP

Just in time for the holidays and for their survival, General Motors and Chrysler will get $13.4 billion in short-term (three year) financing from the Troubled Asset Relief Program (TARP) as announced by President Bush this morning. Another $4 billion in loans will be available for the companies in February, if necessary. By March 31, 2009, the companies must demonstrate they are financially viable or else immediately repay the loans. Treasury Secretary Hank Paulson issued a statement asserting that, "As a result of this decision, Treasury has effectively allocated the first $350 billion from the TARP." He went on to urge Congress to release the "remainder of the TARP to support financial market stability." News outlets are reporting the automakers will sign the loan agreements later this morning. The term sheets can be downloaded here (Chrysler, General Motors).

The money comes with several conditions:

  • warrants for non-voting stock;
  • executive compensation limits;
  • no dividend distribution until TARP loans are repaid;
  • government approval required for transactions over $100 million;
  • labor agreement modifications; and
  • debt reduction by two-thirds.
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EU Reaches Agreement on Economic Stimulus and Climate Commitments

The EU leaders’ meeting on 12 December delivered results on all the main agenda items, including the stimulus package to counter the economic recession and the energy/climate legislative package intended to substantially reduce carbon dioxide (CO2) emissions and demonstrate global leadership.

The European Economic Recovery Plan, described by many observers as not aggressive enough, provides a framework for action to be taken at the EU level as well as for measures adopted by each Member State, taking account of their individual circumstances. It is based on an effort equivalent in total to approximately 1.5 percent of the EU’s gross domestic product (GDP) and also envisages the initiation of priority action to enable the EU economies to adjust more rapidly to current challenges.

The Plan will thus largely be implemented by the individual Member States according to national preferences, which may render it less effective than if the states were to work in total concert. The appetite and capacity for fiscal stimulus at this point in time varies among EU countries, with, for instance, Germany dragging its feet and going against the views of many economists, including this year’s winner of the Nobel Prize in Economics, Paul Krugman. Some reports say that Italy’s stimulus plan actually is negative because it includes more tax hikes than measures to stimulate the economy.

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Fed Makes Unprecedented Cut to Key Interest Rate

Today's actions by the Federal Open Markets Committee may have a salutary effect on the credit market. But they do point out that the limits of the benefits of monetary policy are being severely tested in the current crisis. The committee took three major action's today, it:

  • dropped the federal funds target rate to a range of zero to 25 basis points;
  • announced it is committed to keeping interest rates low "for some time"; and
  • announced plans to purchase longer-term Treasury bonds.

In announcing the actions the Fed stated it was using all the tools at its disposal to "support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level."

When interest rates are effectively set at zero, there is little room left to maneuver for the Fed, at least in that area. The Fed continues to add currency to the money supply and appears ready to purchase federal debt over a sustained period. The fact that all these actions are being taken and the economy continues a downward slide would appear to leave the way open for further efforts of a fiscal nature to achieve recovery and restore the credit markets.

New economics text books are being written as we write.


Auto Bailout Dies in Senate

For those interested in the financial services rescue and reform mission on which the US government has embarked who may have been only casually observing the auto industry rescue process, now would be a very good time to pay attention.

The failure last night of the United States Senate to pass a loan package for the "Big Three" now puts the ball squarely—and quite uncomfortably—in the court of the Bush Administration. Throughout this crisis, Democratic leaders on Capitol Hill have urged the Treasury Department to step in with TARP funds to assist the auto manufacturers. Treasury has resisted saying that was not the intent of the legislation that created TARP. They have never said, however, that the legislation does not allow it.

While it is true that the auto industry does not have the same systemic importance as the financial sector, the ripple effects of a collapse of GM, for example, would be substantial. In some ways then this is Lehman redux. Only now we have a President-elect taking office in five weeks who has said bankruptcy is unacceptable for any one of the Big Three.

If the Treasury Department does not act, that amounts to a decision by the outgoing President to allow GM to go bankrupt. That would be one of the most momentous decisions made by a President at the end of his term in memory. It will also deepen the already daunting challenges facing the new President.

We will be watching for hybrid Malibus with Michigan manufacturer plates pulling into the White House driveway. Stay tuned.

EU Finance Ministers Agree on Framework for Government Assistance to Banks

EU leaders will meet later this week for their bi-annual meeting signalling the end of the French EU Presidency.The meeting will allow the Prime Ministers and Heads of State to take stock of progress in fighting the financial crisis and to prepare for the G-20 meeting to be held in London on April 2, 2009.

In preparation for the EU summit, Member State finance ministers met this week and agreed on a common framework for providing government assistance to banks. While each state will design its own package of assistance, there are EU rules that could stand in the way of certain forms of aid. Relaxing these rules is an important goal for the finance ministers. At the same time, it is important to many of the ministers to ensure government assistance doesn’t penalize healthier banks.

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Congress Poised to Consider Auto Bailout

Congress appears poised to take up legislation to create a $14 billion credit facility for the auto companies. Whether or not it will pass is an open question as this is written. Under the draft legislation agreed to by House and Senate Democratic leaders and the White House, a "car czar" would be appointed by the President and given authority to offer "bridge financing" to the Big 3. It appears that GM and Chrysler would apply for the assistance early on, while Ford continues to say it may not need the help.

In exchange for the support, the companies would have to agree to submit long range restructuring plans to the "czar" so they could be approved by March 31, 2009—or 30 days later if an extension is granted. If their plan is not approved by the deadline their loans would be recalled immediately. Over time, if the "czar" found that adequate progress is not being made towards meeting the goals of the plan he or she could accelerate repayment of the loans. Other strings attached to the support include executive compensation limits and a prohibition on the payment of dividends so long as the loan is outstanding.

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Jobless Numbers May Work in Favor of Auto Bailout

The prospects for approval next week of a "lifeline" for the auto industry are greater today than they were a week ago. Two major factors contribute to that fact. First, the "Big 3" submitted restructuring plans that, while not met with universal approval, did pass a basic credibility test. Second, and more important, unemployment statistics released today create a greater impetus to preserve manufacturing jobs in the auto sector. According to the Bureau of Labor Statistics, the country lost 533,000 jobs last month and unemployment now stands at a 15 year high of 6.7 percent. Earlier this year, the average monthly job loss was 82,000. Not since 1974 has the United States lost so many jobs in one month.

Referring to the dismal employment news, House Financial Services Committee Chairman Barney Frank (D-MA) opened today’s hearing by saying, "Context is especially important this morning." As a supporter of assistance to the industry, Frank clearly sees today's news as strengthening the case for swift action. Top House leadership has also indicated an interest in advancing the legislation quickly if agreement can be reached between Capitol Hill and the Bush Administration.

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EC Commission Fast Tracks Regulatory Reforms for Hedge Funds, Private Equity, and Derivatives

Regulation seems to be dominating the agenda in Europe. The EC Commission on 1 December made a sudden shift in policy when it announced that it is fast-tracking a review concerning new regulation for important sectors of the financial industry, including hedge funds, private equity firms, and derivatives.

Heeding the mounting criticism of a laissez faire attitude and for being asleep on his watch, the EC Commissioner in charge of banking, financial services and securities legislation, Charlie McCreevy, in a speech before the European Parliament presented a number of initiatives that could lead to new and far-reaching regulation of several sectors of the financial markets.

McCreevy defended his track-record by pointing to the significant number of legislative measures introduced during his tenure. The exchange in the European Parliament confirms the drastic change in philosophy among regulators where success now is measured by the number of initiatives for regulation introduced, a trend that most probably will continue into the foreseeable future.

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GAO Submits First Report and Recommendations on TARP to Congress

When the General Accountability Office (GAO) reports, Congress listens. The GAO is the non-partisan investigating and auditing arm of Congress, and in its first bi-monthly TARP oversight report, it provides a comprehensive overview of the financial crisis and Treasury’s response to it. As the subtitle conveys, the GAO recommends “Additional Actions Needed to Better Ensure Integrity, Accountability, and Transparency.” There is no scandal or surprise in the 60-plus page report. While GAO acknowledges that Treasury’s Office of Financial Stability (OFS), which is charged with executing the TARP, has only existed for 60 days, the report points to critical areas for improvement. In its analysis, the GAO said that the Treasury Department generally agrees with eight of the nine GAO recommendations.

Despite the lack of drama, however, the report is an important guide for the OFS. Upcoming congressional hearings are likely to focus intensely on the following nine recommendations and how (quickly) Treasury can implement them. The GAO recommends that Treasury should:

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