The House democrats have three major fears:

One, even though they have the parliamentary power to pass the bailout bill on their own, without requiring Republican votes, they are afraid to act unilaterally and thus demonstrate their leadership. They recognize that the devil is in the details and that should something go wrong, it is likely to become a campaign issue in the next election cycle.

Two, they are afraid that the current Bush Administration will spend all of the allocated money prior to a potential  Administration shift on January 20, 2009 and that the democrats would have waning influence over who gets the money and the campaign funds that are sure to flow from lobbyists seeking to grab a larger chunk of change for their clients.

And three, they are deathly afraid of what the current Administration may do to influence the current Presidential election as they prepare to dole out the funds.

According to preliminary reports, said to originate from House Speaker Pelosi’s office …

Final details will not be formally released then until the legislation is formally drafted. But a number of hints about what may be included have been dropped to the media.

Disbursement:  While the $700 billion amount is fully authorized, the legislation will call for the money to be disbursed in phases to preserve Congressional control and oversight. Code words to insuring that the democrats get their fair share of the spoils and collateral benefits such as campaign donations from lobbyists and others who might be seeking bailout funds. Preliminary details indicate that the first authorization for $350 billion will be made available to the Treasury department almost immediately. The second half would be contingent upon notification by the Treasury and the approval of Congress which can be no later than 15 days after the request. The form of the request is said to be a joint resolution which is subject to debate and the necessity of a two-thirds majority vote in both the House and the Senate. The resulting legislation would then be sent to the President for his signature. Of course, the President retails his veto rights under this scenario. Thus, the democrats insure their control over at least half the money and their ability to keep the campaign money flowing to the democrats.

Independent Authority: Treasury Secretary Paulson’s request for absolute authority without the possibility of judicial review and/or other interference may be diluted by legislation which may require greater oversight of Paulson’s activities and some increase in transaction transparency, including the potential requirement for disclosure via an Internet reporting structure.

Unfortunately, transparency in financial matters is often further obscured by providing funding to financial institutions without showing detailed information. Only aggregate details may be displayed. There is also the problem of accidently influencing investor opinions by the granting or withholding of toxic paper purchases or their timing. This is definitely a minefield to be negotiated.

More Bureaucracy: After all, who would permit such a large amount of money to be spent without enlarging, in some way, the bureaucratic influence over the disbursement of funds. It is anticipated that a new oversight board may be created. It is said to be bi-partisan in nature and that the GAO (Government Accountability Office) and an independent inspector general may be attached to the new board to monitor fund disbursements and reporting requirements. I wonder if anyone plans to track the campaign contributions to legislators and match them to timelines developed around fund disbursal?

Feel-good provisions: If nothing else, the democrats love to play the class warfare card and thus will be writing in socialistic-style provisions to limit executive pay and golden parachutes for executive’s whose companies receive bailout funds. Again the devil is in the details, as the democrats have indicated that they want to set aside existing legal contracts and agreements and make some of the provisions of this legislation retroactive. It is unknown if the issue can be sidestepped by transferring the toxic securities to a subsidiary which would receive the funds thus shielding executives from the effects of this type of provision. Considering that the democrat party is the party of lawyers, look for the “lawyers full employment opportunity act” as companies seek counsel to protect their executives and to “prepare” fund requests.

Equity Interests: It is likely that the government will want a piece of the action, possibly through non-voting warrants that could be exercised and the stock sold to provide some measure of public payback for the use of the funds.

Workout Provisions: It is likely that the government will be encouraged to seek a beneficial workout in favor of distressed borrowers that still have enough income to service the loan at the original teaser rate. Most attempts to mitigate foreclosures involve resetting the loan at lower rates with longer maturities to compensate for the reduced rate. As for those financial institutions holding second or third mortgages, or have attached a HELOC (Home Equity Line of Credit), they will still have to book the full loss as their will be nothing left after the first mortgage is modified.

My take …

The original Federal Reserve liquidity injection model was not a long-term solution.  Apparently based upon their statutory authority, the Federal Reserve provided loans to financial institutions via an auction mechanism which required firms to bid for funds availability. The subsequent loans were collateralized with the a firms assets which could include the toxic paper. Under this scenario, the firms would receive needed capital and could work out their own problems. However, the Federal Reserve’s liquidity injections were short term semi-solutions, 28-day, 35-day and 84-day loans, which did little to resolve the matter of the firm’s balance sheet – but temporarily staved off the institution’s legal obligation to report their true and correct financial position using GAAP (Generally Accepted Accounting Principles) -- which might have led to adverse consequences such as having to meet additional core capital requirements or be ruled to be unsound or insolvent. Therefore, the uncertainty over a financial institution’s balance sheet remained and lending activities and counterparty transactions continued to be imperiled.

According to my calculations, the Fed has had 21 announced auctions with a face value of approximately $1.085 TRILLION dollars. (2 @ 20 BILLION, 2 @ 25 BILLION, 4 @ 30 BILLION, 4 @ 50 BILLION, 9 @ 75 BILLION). Since the majority of these loans are short term and the Federal Reserve does not release the names of the bidders, it is unknown how many of these loans were simply roll-overs and how much total interest was received by the Federal Reserve (did they deduct the interest from the loan proceeds like all good bankers?) In addition, it may be unknown if the Federal Reserve plans to continue this temporary financial support on top of the bailout funds disbursement and whether or not any of the financial institutions using these relatively costly loans will be among the first to be bailed out. Considering that the Federal Reserve is a private institution owned by its member banks, the transparency regarding these operations may be withheld.

I strongly believe that $700 BILLION is a number generated by legislative consultants as the spin-tested number most likely to insure public support. Large enough to be serious, small enough to allow for the legislators to push it forward with minimal public opposition. I believe the true and correct number is somewhere between $1.2 and 3.0 TRILLION dollars when everything is, if ever, finally tallied. It is also believed that the Treasury and the Federal Reserve will continue to make money available to financial institutions outside of this bailout plan and that there will be subsequent bills to enlarge the amount and scope of any passed legislation. Based on previous Congressional actions, this is a pretty safe bet.

Example:

“The US Senate Saturday approved 25 billion dollars in loan guarantees for the financially strapped US auto industry, intended to spark a wave of automotive innovation.”

“The loan guarantees were included in a continuing resolution that included funding for the US government and the wars in Iraq and Afghanistan.”  <Source>

I guess, the bailout was not the only thing being discussed over the weekend. Amazing, when it comes to real money and political power, our legislators have the initiative to work whatever hours it takes – in spite of their normally relaxed workday schedules, frequent absences and generous holiday provisions. Just wondering: why are we paying Senators Obama, McCain, Biden, Clinton and others while they campaign for office. Shouldn’t they be refunding that money to the Treasury. (Yeah – Right!)

Bottom line: no guarantees!

In light of alternatives, it is not so much that additional funds are actually required, but the entire purpose of this legislative exercise is simply to shore up the balance sheets of financial institutions which would be required to report large losses, possibly threatening their soundness and solvency, should these toxic securities be  subject to current “mark-to-market” requirements.

It should be said noted that nothing has been said about suspending the “mark-to-market” requirement or the repatriation of transactions from off-balance sheet accounts. Two accounting rules which are at the root of this financial crisis.

Whatever the final legislation may contain, there is no guarantee that this maneuver will succeed as counterparty risk is something that each institution must judge for themselves -- relying on an accurate and complete balance sheets of financial institutions. Considering that many of these institutions have off-balance sheet transactions which have not been repatriated to the parent’s balance sheet, full disclosure and transparency may be much harder to achieve.  And given the sorry state of large public accountancy firms in producing accurate audit data, there is also another degree of uncertainty introduced in the process.

Perhaps, along with curtailing executive bonuses and pursuing claw-backs of previously disbursed funds, we should also include those law and accounting firms who sanctioned this crisis by providing opinion letters and accounting trickery to present

Well, it is now a matter of waiting and watching to see what the democrats are putting in the draft legislation and whether or not the Republicans will accept the plan as written.
-- steve

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