Historical Context and the Nuts and Bolts of the G20 Communiqué

In 1961, a young American president made his first trip abroad to confront the major international issue of the day. History has judged that his perceived weakness on that trip led to serious troubles down the road. That chain of events has echoed through the presidencies of each man who has followed John F. Kennedy. It echoes today as President Obama prepares to make his first foreign trip since taking office. While the American press is playing up the G20 as a confrontation between American-style capitalism and a more social-democrat model, the Obama administration seeks to play down the drama by saying there is no need for all G20 leaders to agree on the specifics of recovery policies. However, there may be leaders at the meeting who see an advantage in setting themselves apart from the U.S. approach to recovery, in particular with regard to stimulus. If some seek confrontation, President Obama will be under pressure to push back and be perceived at home as having "stood up" to the world.

The potential for posturing at the G20 is increased by the fact that this is a one-day meeting. There will be no time for venting followed by a cooling off period and then a coming together around common goals. Each leader will walk into the meeting with a plan and the opportunity for adjustment during the day will be limited.

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G20 - The Beginning of a New World Economic Order, After All?

On Thursday, U.S. Treasury Secretary Tim Geithner unveiled the Obama administration’s comprehensive framework for reforming the regulation of the financial system. The plan will be a hot topic ahead of next week’s G20 summit in London and is being closely scrutinized in capitals worldwide.

In his testimony yesterday before the House Financial Services Committee, Geithner told the panel,

“Our hope is that we can work with Europe on a global framework, a global infrastructure which has appropriate global oversight, so we don't have a Balkanized system at the global level, like we had at the national level."

He added that that the financial sector needs to be tightly regulated so that it can never again threaten the collapse of the wider economy.

Geithner said the administration is first focusing on systemic risk because the issues around it require the most global cooperation and will be at the center of the G20 agenda. Clearly, the Obama administration is moving towards a position that would enable substantive discussions with European leaders. Such discussions may result in new roles and powers for international organizations, including the Financial Stability Forum and the International Monetary Fund (IMF).


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Bailout Bonuses - Round 2

In a more subdued response to the AIG bonus brouhaha than last week, the House Financial Services Committee yesterday approved legislation that would amend the Emergency Economic Stabilization Act to prohibit companies receiving TARP money from paying “unreasonable and excessive compensation and compensation not based on performance standards.” Two Republicans, Reps. Ed Royce (CA) and Walter B. Jones (NC), broke ranks to vote with the committee’s Democrats in favor of the bill (H.R. 1664). Some of our Congressional sources have said the full House may vote on H.R. 1664 as early as next week. The Senate, however, is almost certain not to address executive compensation until after it returns on April 20th from the spring Congressional recess. Democratic leaders from both sides of the Capitol have greatly dialed down the executive compensation rhetoric since last week.

Under H.R. 1664, the Treasury Secretary, with the members of the Financial Institutions Examination Council, would have a month to define “unreasonable and excessive compensation” and set performance based standards that companies would use to determine circumstances under which a bonus or retention payment would be allowed. Examples of the standards Treasury is to include are the stability of the financial institution; its ability to repay the government; individual performance; employees’ adherence to risk management requirements; and any others that would provide greater accountability to shareholders and taxpayers.

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Presidents Obama and Sarkozy Volunteer to Lead

Following a cautiously, positive welcome of the Obama Administration’s “toxic asset” plan to revive banking activity earlier in the week, the U.S. President yesterday evening delivered a speech that included comments on the G20 preparations. A few hours earlier, the French President Sarkozy had delivered a keynote speech with some striking similarities but also with a few, noticeable, differences.

President Sarkozy re-emphasized his statements from September 2008, which some observers at the time regarded as exaggerated, that the financial crisis is unprecedented in its scope, that nobody knows when or how it will end, but that the world will look different once it is over. He went on to underline that the crisis, in his government’s view, is both an intellectual and a moral one and that a more “moral” capitalism will have to emerge as result. Sarkozy, unsurprisingly, put government action and intervention at the center of the required policy response, which is not inconsistent with the Obama administration’s policy response.

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At Last

At last Treasury has come forward with its Public Private Investment Program for dealing with toxic assets, only now that there is a plan, the proper term is “troubled legacy assets.” Stocks have rallied since Treasury announced the plan this morning, and legislators on Capitol Hill have halted their rush to claw back the AIG bonus money, some say partly in order to study the new plan. The Treasury Secretary is scheduled to testify before the House Financial Services Committee on Thursday. Will the positive momentum continue up to and following his hearing performance? Secretary Geithner has a lot riding on this week.

The plan, which will use $100 billion of TARP funds, has two parts intended to revive the anemic financial system—the Public Private Investment Fund (PPIF) for Legacy Loans and the PPIF for Legacy Securities. Both are aimed at residential and commercial real estate-related assets. Banks tend to hold the assets as loans and entities such as insurers, pension funds, mutual funds and individual retirement accounts tend to hold the assets as securities backed by loans. The Federal Deposit Insurance Corporation with Treasury will work to create PPIFs that will purchase “loans and other asset pools” from participating banks, and the FDIC will determine eligibility criteria. The FDIC will also be using contractors to help it analyze loan pools and determine the level of debt to be issued by the PPIFs (with leverage not exceeding a 6 to 1 debt-to-equity ratio). The FDIC will then auction off each loan pool to the highest bidder. Treasury will provide 50 percent of equity financing and the private sector auction winner will provide the other 50 percent. The private sector winner can obtain financing by issuing new debt, which the FDIC will guarantee, that is collateralized by the purchase.

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Toxic US Assets & Shuttle Diplomacy

The Obama Administration has stepped up its preparation for the G20 summit next week by moving on two fronts—a plan to purchase toxic assets from banks and a new regulatory regime for financial products and companies. Taken together, these emerging plans appear designed to allow President Obama to come to London saying the U.S. has addressed the three major pillars of a recovery program—stimulus, bank rescue and regulatory reform .

Today's announcement by Treasury Secretary Geithner of the plan for toxic assets follows the broad outline he announced to poor reviews last month. The stock market's swoon after the previous Geithner announcement was blamed on the lack of detail he offered. Today, Geithner described how a program of up to $1 trillion to relieve banks of bad assets will be managed. Based on a public/private partnership concept, the Geithner plan allows for the participation of hedge funds and private equity funds as managers of portfolios of assets. Those managers will have the opportunity to make significant profits if they are successful in selling those assets back into a healthier market in the future. The government will also share in those profits. The reaction of the media and Congress to this plan bears watching. They will focus immediately on the issue of executive compensation for managers participating in the program and on the issue of allowing the very kind of firms that helped create the mess to make a profit on cleaning it up. Careful selection of managers will be crucial.

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Bonus Backlash

Congress took the first major step yesterday in levying heavy taxes on bonuses paid to executives of AIG and to institutions who have been recipients of significant (more that $ 5 billion) assistance from the Troubled Asset Relief Program (TARP) in recent months. In a move best described as spasmodic, the House voted 323-93 to place a 90 percent tax on the bonuses of TARP-recipient executives with adjusted gross incomes over $250,000.

Senate Majority Leader Harry Reid (D-NV) moved to bring the legislation to the floor yesterday, but Sen. Kyl (R-AZ) blocked the attempt, saying the Senate needs more time to consider the ramifications. Senate Finance Committee Chairman Max Baucus (D-MT) and Ranking Member Chuck Grassley (R-IA) introduced a bill late yesterday that would impose a 70 percent excise tax—35 percent on the TARP recipient companies and 35 percent on their executives—on excessive bonuses, defined as anything exceeding $50,000 in a calendar year.

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Hammering Out the G20 Agenda

Over the past months, the G20 has gone from being regarded as yet another over-sized talk shop with little clout to becoming one of the main vehicles for a global response to the crisis.

With stakeholders now hosting increasing and sometimes contradicting expectations, there is a risk that the summit will become a victim of its own success. However, even with an outcome that falls short of producing broad consensus on an all issues, significant progress will have been made if the result is the firm establishment of G20 as the primary, global forum to deal with the crisis.

The G20 preparations now involve the full range of international organizations, trade blocs and stakeholders. The British Government's Business and Enterprise Department and the Confederation of British Industry, the UK's largest business organization, co-hosted a special summit of business leaders from G20 countries—chaired by Lord Peter Mandelson, the Business Secretary—in London on March 18. Separately, the UK Financial Services Authority presented the long-awaited Turner Report with proposals that, if enacted, will introduce dramatic changes to the regulatory framework that governs the City.

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Auto Bailout Part Two - The Auto Supplier Support Program

The U.S. Treasury announced today a new program that will provide $5 billion to finance auto suppliers and hopefully unfreeze credit in the auto sector. Treasury will provide the money to participating domestic auto companies, which will in turn decide “which suppliers and which receivables” to support.

In the course of reviewing GM’s and Chrysler’s viability plans and the state of the industry, the President’s Auto Task Force determined the need for immediate action “to help stabilize the auto supply base,” which employs more than 500,000 workers across the country. Declining auto sales have left many suppliers unable to access credit. The task force concluded,

“This vicious cycle of frozen credit markets, growing supplier uncertainty, and growing auto company uncertainty has the potential to unravel the industry and short-circuit restructuring efforts at companies like GM and Chrysler.”

Eligible suppliers must be U.S. based and ship to a participating auto manufacturer. GM and Chrysler have already signed up for the program. An eligible receivable is one “created with respect to goods shipped after March 19, 2009 that is made on qualifying commercial terms between a supplier and a participating auto company.” Suppliers will have to get consent from their lenders to participate in the program and will have to pay a “modest” participation fee. Suppliers will also have the option of selling their receivables into the program for “a modest discount” in order to gain liquidity. Further details are available in the attached fact sheet.

Treasury:  Auto Supplier Support Program (PDF)

Momentum for Mark-to-Market Reform

It has been a good week for opponents of mark-to-market (M2M) accounting. The markets have rallied around comments made throughout the week by Warren Buffet, Fed Chairman Ben Bernanke, and SEC Chairman Mary Schapiro that M2M needs rethinking.

House Financial Services Subcommittee Chairman Paul Kanjorski (D-PA) topped it all off today with an exhaustive hearing on M2M accounting. Kanjorski opened the hearing with comments that appear to be the emerging view:

“We can, however, no longer deny the reality of the pro-cyclical nature of mark-to-market accounting. It has produced numerous unintended consequences. And it has exacerbated the ongoing economic crisis. If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself.”

Momentum is clearly building in Washington for M2M relief. The question is who will make the fix—Congress or the regulators ("inspired" by Congress)?

EU Preparing a United Front in Advance of G20 Meeting

The G20 meeting is fast approaching and has become the single most important focal point for the global efforts to tackle the financial crisis.

The EU has sought to develop a common program for the G20 and to hammer out the main differences between diverging European interests. While nothing should be taken for granted, it seems plausible that the EU States will be singing from a common hymn sheet in London and that they will be defending a joint set of proposals. Their purpose appears to be to advance the cause of global regulation of financial markets.

The EU framework appears to be following the template laid out in the de Larosiere Report, to which we referred in last week’s international update. Following its publication—including 31 proposals providing a comprehensive set of concrete solutions for regulatory, supervisory and global repair action—the EU Commission reaffirmed that:

“the crisis has exposed unacceptable risks in the current governance of international and European financial markets which have proved real and systemic in times of serious turbulence . . . Market surveillance and enforcement of contractual and commercial practices will play an important role in restoring consumer confidence in retail banking.“

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In Pursuit of Financial Stability

There was plenty of activity in Washington this week but none of it enough to settle the roiling stock market, which keeps sinking like a rock. Is there too much activity or not enough of the right kind of activity?

From the White House and the Treasury—The Obama Administration released the details of its “Making Home Affordable” program, which was introduced in February. With incentives for mortgage holders and servicers, audit and documentation requirements, and qualification limits, major industry players such as the Mortgage Bankers Association and the American Bankers Association reacted positively to the new details.

From the Treasury—Secretary Tim Geithner was on Capitol Hill most of the week defending and explaining the president’s budget proposal, especially the $250 billion “contingent reserve” amount in the Treasury budget to support up to $750 billion worth of asset purchases. Geithner assured the Senate Finance Committee that the $750 billion is not an estimate of future rescue efforts, but rather “just a recognition of reality that it’s possible we’re going to need to do this with more resources.” The Secretary promised to provide more details in the coming weeks on future bailout efforts, including plans for the remaining $300 billion of TARP funds, and the eagerly anticipated public private partnership to take on troubled assets.

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A "New Deal" in Bank Regulation?

In his visit to the White House this week, British Prime Minister Gordon Brown called for a global "New Deal" for financial industry regulation. While harmonization is always tricky across international borders, the outline of just such a new regulatory regime may have taken shape with the release last week of the long-awaited de Larosière report in Europe.

The analysis and recommendations outlined in the de Larosière report attempt to provide for a comprehensive view, and despite being quite drastic by many measures, most commentators seem to approve of the group’s recommendations. Some observers believe that the group should have gone even further.

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Some surprises were included in today's announcement by the Federal Reserve and the Treasury on new developments with the soon-to-be $1 trillion Term Asset-Backed Securities Loan Facility (TALF). Of particular note is the statement that the two agencies will push for legislation to re-tool the program.

According to the joint release, the TALF is “designed to catalyze the securitization markets by providing financing to investors to support the purchase of certain AAA-rated asset-backed securities” and will at first be limited to newly and recently originated auto, credit card, student, and SBA-guaranteed small business loans. The TALF funds will go out monthly starting in March, and they are already anticipating a program expansion for April that will include “asset backed securities (ABS) backed by rental, commercial, and government vehicle fleet leases and ABS backed by small ticket equipment, heavy equipment, and agricultural equipment.” The Treasury and the Fed are also analyzing how to expand the program in future months to include commercial mortgage backed securities and other AAA-rated, newly issued ABS.

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