Deliberations in Davos

This week, more than forty heads of state are meeting in Davos, Switzerland for the annual meeting of the World Economic Forum. The title of the deliberations is forward looking, although unclear how exactly HOW forward looking: "Shaping the Post-Crisis World.” No doubt, the proposals for financial regulatory reform discussed on these pages in the past weeks will be on the Davos agenda.

On both sides of the Atlantic, those working on getting financial markets out of crisis and those planning for the post crisis world are dealing with fundamental structural issues surrounding monetary policy, fiscal policy, and market regulations. While the emphasis points shift depending on time and location, significant issues are in play in European capitals and in the United States and those issues overlap in myriad ways.

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Exploring Under the TARP

There is a new team in town, and in one of his first public acts as Treasury Secretary, Tim Geithner established a policy aimed at increasing the transparency and accountability of the Troubled Asset Relief Program (TARP). Treasury will now post all TARP contracts on the Internet. New contracts will go on Treasury’s website within five to ten business days, and the department will post existing agreements on a rolling basis. At the time of the Secretary’s announcement, Treasury had already posted the agreements of the major nine institutions that first partook in the Capital Purchase Program; the Citigroup contract under the Targeted Investment Program; the AIG deal under the Systemically Significant Failing Institutions Program; and the GM, GMAC, and Chrysler contracts under the Automotive Industry Financing Program. At the request of individual institutions, the department will redact confidential and proprietary information.

The Secretary also met today with the individuals tasked with TARP oversight – the head of the General Accounting Office, the TARP Special Inspector General at Treasury, and the TARP Congressional Oversight Panel. Geithner promised to unveil more reforms in the coming weeks.

U.S. Department of Treasury, EESA Contracts

When Is A Bad Bank Good?

The TARP may soon come full circle as the notion of a “bad bank” for taking control of toxic assets gains momentum on Capitol Hill. The bad bank, sometimes referred to as an “aggregator bank,” would purchase bad securities from healthy banks and from those unhealthy institutions requiring major restructuring or more drastic measures. The theory is that moving the bad assets off of bank balance sheets would enable them to lend money again while still maintaining their capital requirements. Under the TARP model developed under Secretary Paulson, the federal government became the banks’ preferred shareholder, and some argue that hindered banks’ lending capacity because of the expectation that those shares would be bought back and, in effect, repaying the government. The bad bank model removes that burden but is likely to have stringent lending requirements to get loans flowing again on Main Street.

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Radical Reform Recommended for Both EU and U.S. Financial Sectors--Part III

The flow of substantive input regarding the global financial architecture continues. While the recommended actions differ, most commentators concur that action is urgent and reform should be sweeping.

On 15 January, the Group of 30, chaired by Paul A. Volcker and comprised of leading policy-makers and business leaders from across the globe, issued the Framework for Financial Stability—a set of 18 recommendations for financial reform, including that:

  • “In all countries, the activities of government-insured deposit-taking institutions should be subject to prudential regulation and supervision by a single regulator (that is, consolidated supervision).”
  • “Gaps and weaknesses in the coverage of prudential regulation and supervision must be eliminated. All systemically significant financial institutions, regardless of type, must be subject to an appropriate degree of prudential oversight.”
  • “In general, government-insured deposit-taking institutions should not be owned and controlled by unregulated non-financial organizations, and strict limits should be imposed on dealings among such banking institutions and partial non-bank owners.”
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Geithner and Bair Outline Potential Strategy for Financial Rescue

On the first full day of the Obama Administration, key federal officials outlined a potential strategy for managing the government rescue of the financial sector. At his confirmation hearing today, Treasury Secretary-designate Tim Geithner told the Senate Finance Committee that the Obama Administration is considering the establishment of a “bad bank” or an “aggregator bank” that would take over the toxic asset-backed securities currently corroding the U.S. banking system. Several lawmakers have suggested the concept of a federally-operated entity modeled after the Resolution Trust Corporation, which, from 1989 to 1995, took over and liquidated 747 failed thrifts with assets of $394 billion. An aggregator bank would cost several trillion dollars according to various experts, including former Federal Reserve Chairman and current Obama economic advisor Paul Volcker.

Today Geithner assured the Senate panel that President Obama “will come before the Congress in the next few weeks and lay out to the American people a comprehensive plan to help stabilize the core of the financial system so that banks, which are so critical to our economy, are able to provide the credit necessary to get recovery going again.” He also promised to reform the TARP program with increased taxpayer protections, transparency, foreclosure mitigation for homeowners, and access to credit for small business owners.

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Chrysler Financial Receives $1.5 billion TARP Loan

The U.S. Treasury today announced a $1.5 billion, five-year loan to Chrysler Financial to help fund Chrysler auto loans made on or after January 1, 2009. This is a new loan made through the TARP’s Automotive Industry Financing Program, which was established as part of the December auto bailout. News outlets reported that shortly following Treasury’s announcement, Chrysler began offering zero percent interest financing for up to 60 months on several of its vehicles.

According to Treasury, the Automotive Industry Financing Program is intended to “prevent a significant disruption of the American automotive industry that poses a systemic risk to financial market stability and will have a negative effect on the real economy of the United States.” Treasury evaluates each application on a case-by-case basis and requires participants to conform to executive compensation standards, expenditure limitations, and other corporate governance requirements deemed necessary to protect taxpayers’ interests. The terms of the Chrysler loan are attached.

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Senate Rejects Withholding Remaining TARP Funds

President-elect Obama and his economic team can celebrate an unusual pre-inaugural, legislative victory tonight. This afternoon, the Senate voted 42 to 52 to reject a “resolution of disapproval” aimed at blocking the release of the second tranche of the Troubled Asset Relief Program (TARP) funds. Obama made the right call in waging the battle in the Senate rather than the House where the vote count was less certain.

While the Senate vote was largely along party lines, there were nine Democrats who opposed and six Republicans who supported releasing the remaining $350 billion of TARP funds. Sen. Tester (D-MT) and Sen. Hatch (R-UT) each voted “present.” Three Senators—Brown (D-OH), Bunning (R-KY), and Kennedy (D-MA)—did not vote.


Radical Reform Recommended for Both EU and U.S. Financial Sectors - Part II

In the past days, more leading stakeholders have added their voices to the chorus arguing for a strategic re-design of global financial markets regulation.

On 9 January, the President of the European Central Bank, Jean-Claude Trichet, spoke at a conference organized by the French Government, which also featured President Nicholas Sarkozy, German Chancellor Angela Merkel, and former British Prime Minister Tony Blair among its speakers. Trichet, speaking on the topic of “A Paradigm Change for the Global Financial System,” provided a scathing assessment of the failures of the financial system, not too dissimilar to that of Willem Buiter. Trichet remarked:

“The current crisis stands out because it is affecting the heart of the global financial system. Its root cause was a widespread undervaluation of risk in the global financial system, especially in the most advanced economies. This included an underestimation of the quantity of risk financial institutions took upon themselves and an under-pricing of the unit of risk. Risk was under-priced because, among other things, financial market participants largely extrapolated ongoing trends and the very low levels of volatility in financial markets and in the real economies going forward. “

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Bush Requests Release of Remaining TARP, Congress Calls for Conditions

At the request of President-elect Obama, President Bush today agreed to ask Congress for the remaining $350 billion of the Troubled Asset Relief Program (TARP) funds. Steps taken by the Obama economic team over the weekend appear to have smoothed the path for the release of the funds. Congressional posturing began late last week and into this weekend in anticipation of the request. The funds are released unless Congress passes a resolution of disapproval within 15 days. If Congress wants to take formal action to put strings on the money, they would need to enact a resolution detailing them within that time frame.

Congressional Democrats are divided over whether or not to release the remaining funds and what strings to attach. Despite the fact that the Obama Treasury Department will oversee the funds, House and Senate Democrats want to ensure the release of the remaining TARP money has strict conditions attached. They are struggling with how to impose new conditions outside of passing legislation, which requires too much time. Both House Financial Services Committee Chairman Barney Frank (D-MA) and Senate Banking Committee Chairman Chris Dodd (D-CT) indicated over the weekend that a written pledge of reform by the incoming administration would give them enough assurances to release the second half of the TARP.

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Another Link Between Recovery Bill and Financial Sector Regulation

As President-elect Obama made the case yesterday for an expensive economic recovery plan, Democrats on Capitol Hill announced a renewed effort to empower bankruptcy judges to restructure home mortgages. This change to bankruptcy law could be attached to the economic recovery package as it moves through Congress.

The Obama announcement yesterday was designed to state the need for a large package of tax cuts and investment in order to halt the momentum of the recession and to save and create jobs. He offered few specifics. Because he has yet to specify how he plans to spend the funds, more and more advocates for different programs are coming forward to seek inclusion in the plan. In just the last week, a group of governors initiated a push for an education block grant and other education advocates stepped-up a push for Head Start funding for early childhood education. This kind of pressure will continue to build until the President-elect outlines his own plans. The only part of the plan on which the Obama team has committed itself is $300 billion in tax cuts and incentives. The overall size of the program—widely rumored to be $ 775 billion—has yet to be confirmed.

As we indicated in Financial Reform Watch on Monday, there are several connections from a policy and political standpoint between the economic recovery plan in formation and the financial industry rescue program already underway. However, the connection between the two issues became even more concrete yesterday with the announcement by Senators Dick Durbin (D-IL) and Chuck Schumer (D-NY) of their intention to include the bankruptcy law changes relating to mortgages—referred to as "cramdown"— in the economic recovery bill (S.1) that Congress will take up in the next few weeks.

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Radical Reform Recommended for Both EU and U.S. Financial Sector

In spite of the holidays and new year celebrations, financial sector events have continued to unfold unremittingly, forcing EU policy makers to consider policy readjustments, yet again.

The scandal surrounding Bernard L. Madoff Investment Securities LLC, the financial implications of which are global and yet to be fully discovered, is one of the most recent examples. No doubt, Madoff will give those supporting new financial regulation and oversight the upper hand in reform discussions just as Enron provided carte blanche for those promoting the Sarbanes-Oxley legislation, and its EU siblings, a few years ago.

One of the calls for new, drastic, financial reform—more difficult to argue against in a post-Madoff environment—comes from the distinguished Financial Times columnist Willem Buiter. In a recent speech, Buiter provided a damning analysis of the shortcomings of the financial system and also provided his recommendations for the appropriate policy responses. It would have been less surprising if these radical proposals had emanated from outraged elected officials, rather than from a professor of political economy at the London School of Economics.

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The 111th Congress convenes tomorrow and repairing the damage left by the financial crisis of 2008 will be at the top of the agenda. The early talk and action will center on what President-elect Obama has dubbed the "American Recovery and Reinvestment Plan (ARRP). Even the pronounciation of the acronym tends to draw a connection to "TARP"—the $700 billion package Congress passed and the Treasury reinvented in the fall and early winter of 2008.

The two packages are tied beyond just their rhyming acronyms. Discussions within the Obama transition team—and between the team and Congressional leaders—over the size of the recovery package are pivoting on the question: "Can the recovery plan for Main Street be smaller than the bailout plan for Wall Street?" House Speaker Nancy Pelosi (D-CA) has indicated she is pointed at a $600 billion program, smaller than the TARP. However, the Obama transition team appears to be aiming at a target of $775 billion and the nation's Governors have been pushing for a number above the TARP number. Our sense is the ultimate proposal from the Obama team and Democratic Congressional leaders will be closer to the $775 billion number, so more for Main Street than for Wall least for now.

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