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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Question Time

Who appointed the G7 (+1) to its perch? The finance ministers for the main protagonists in World War II (1939-1945) met in Rome over the weekend to discuss the world economic crisis. Does a meeting of this nature that excludes India and China truly have a hope of wrapping its collective mind around the problems and their possible solutions?

Is ideology standing in the way of the most elegant solution to the U.S. banking crisis? Give former President George W. Bush his due: when the dimensions of the banking crisis became apparent to him, he scrapped a "market guy" ideology and poured taxpayer money into the banks. Is the Obama Administration willing to take what for them would be a similar ideological leap? Is their unwillingness to do so behind the complex public-private partnership at the center of the Geithner proposal to deal with troubled assets? Is there a similar reason behind the relatively light-handed approach Geithner would take to pushing the banks to resume lending?

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TARP in the Stimulus--Executive Pay Backlash

Buried in the American Recovery and Reinvestment Act (ARRA), which is making its final march through Congress on its way to the president’s desk, is a section imposing limits on executive compensation for Troubled Asset Relief Program (TARP) recipients. The White House and the Treasury Department announced new executive compensation restrictions last week, but Congressional leadership obviously believed there was a need to codify some of those rules and strengthen others.

Here is an overview of the legislative provisions that, when enacted, will apply to companies until they repay their TARP money.

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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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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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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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Stimulus and Auto Bailout Not Likely in Lame Duck

The Senate returns to work today and the House is scheduled to convene on Wednesday. In the past several days, it has become clear that neither significant economic stimulus nor aid to the auto industry is likely to be approved during this "lame duck" session of the 110th Congress. The sticking point appears to be the inability of Democratic leaders to attract sufficient Republican support for either measure.

CPP for Community and Regional Banks

As the stock market continues its seesaw sessions this week, the Treasury Department is focusing on implementation of the programs that flow from the financial rescue package assembled in recent weeks.

After Monday's announcement of the capital infusion to the nine largest US banks, attention is turning to the thousands of community and regional banks nationwide that may be eligible for assistance from the capital purchase program. The Treasury Department has announced that November 14 is the deadline for institutions to get their applications in for assistance under the program. Our report on Tuesday, October 14 included the details of the capital purchase program.

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