Roll out the TARP

I have been reading the legislative draft of the new Troubled Assets Relief Program (or "TARP") that would be put in place through the Emergency Economic Stabilization Act of 2008. This is the compromise legislation that would enable the Bush Administration to buy assets from ailing financial institutions. While it isn't perfect, it looks better than I feared. The question now is: will the rank and file of Congress--especially the Republicans who are showing themselves to be as short-sighted on this issue as they have been for the past eight years on other issues--support the bill and pass it quickly?

Mark-to-market accounting
In light of my previous posts, you will understand how gratified I am that the proposed legislation takes explicit aim at mark-to-market accounting. In short, this legislation empowers the SEC to suspend market-to-market accounting for financial institutions if it is "necessary or appropriate in the public interest and is consistent with the protection of investors." It further requires the SEC to study:

1. How mark-to-market accounting affects a financial institution's balance sheets;
2. The impact this has had on bank failures in 2008;
3. The impact of such standards on the quality of information available to investors;
4. The process by which accounting standards are created and implemented;
5. Potential alternatives to mark-to-market accounting.

I hope the SEC does a thorough job of it because this is where they are going to find the smoking gun behind financial meltdown. The report is due back to Congress within 90 days.

Executive compensation
The Act contains language limiting tax deduction for executive compensation for firms who avail themselves of the TARP. The language for this section is fairly obtuse and I need to review it more thoroughly (and in the light of day) before I am ready to pass judgement on it. After my first reading, it appears to be pretty lax, meaning it gives a lot of room for firms to navigate around the conditions that would spring the loss of tax deductibility. The compensation limit is $500,000 which may sound like a lot, but these senior executives generally make multiples of that, so it is a fairly big deal.

Limits on spending authority
As has been widely anticipated, the legislative draft severly curtails the initial spending authority granted under TARP. Initially, the Treasury Secretary will get a blank check worth $250 billion with an automatic approval to raise that limit to $350 billion if requested by the President. If the President submits a report to Congress detailing the Treasury Secretary's plan to use the $350 billion of authority, then the limit will increase to $700 billion unless there is a joint resolution of Congress opposing that increase. This is setting up the executive and legislative branches of government for some high drama if someone is unhappy with Secretary Paulson's progress, especially since his term will likely last no more than another 3 months. While I understand the political calculus behind this requirement, and generally favor the sense of accountability it engenders, I think the uncertainty it creates works against the aims of the overall plan. The last thing the markets need right now is uncertainty.

Accountability of TARP
The legislation is full of requirements to report to Congress. I view this as a very important aspect of the program. Reports to Congress mean accountability. The Bush administration has a clear record of arrogance and this aspect of the legislation should help keep that in check. In addition, the Treasury's progress reports will give all of us a clear view into the progress they are making. Remember, the point to this entire exercise is to get the capital markets working again so the economy can get back on track. The capital markets need confidence and confidence will come from concrete progress made and reported.

Regulation reform
The legislation requires that the regulatory framework for financial institutions be reviewed and updated. It have been a long time since a systemic overhaul was attempted. There have been piecemeal attempts at it, but no attempt to review and rework the overall framework. This situation, as bad as it is, will allow us to take a broad view and (hopefully) update the regulatory framework in a constructive way.

Overall impression
I think this package is generally pretty good--not perfect, but probably as good as we could have expected to receive. Let's hope they get it passed quickly. On Friday, Washington Mutual collapsed in what is, by far, the largest bank failure in U.S. history. This afternoon, two new major international news reports hit the wires. The first was the nationalization of the U.K. mortgage banker Bradford & Bingley. The second was the potential intervention by Holland, Belgium and Luxembourg in Fortis, a major European insurer. The crisis is growing. Decisive action is required.