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The financial crisis rescue plan: What is it, will it work?
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We’re witnessing an almost unprecedented time in the U.S. The news has been dominated by dire headlines, and now the government is stepping in to help restore credit. The recent events have been an enormous shock to our economy. We often say corrections in the market are normal, but there was nothing at all normal about the following:
• The simultaneous collapse of so many large financial companies
• The seizing up of the credit markets
This prompted the federal government to put forth legislation to help get the economy moving again. Here we try to answer some questions and provide more details about the government’s plan.
Q. What’s your reaction to government efforts to bail out the bad assets of financial companies?
A. We can understand why the words “bail out” would make people skeptical and, in some cases, angry. But consider these points:
1. We don’t believe these assets are worthless because, in most cases, underlying those assets are home mortgages. The current delinquency rate is 6 percent; an additional 3 percent of home mortgages have gone into foreclosure. That means 90 percent are being paid on time.
2. The market for these loans is not very liquid right now because of fear. In other words, there are just no buyers, even though these assets are at depressed prices. The government’s idea would be to invest money to buy these loans, with the intent of selling them at a higher price when the market has recovered.
3. There are risks to the plan. And yes, there will likely be a cost to taxpayers; but if done correctly, this could unclog credit markets and help get the economy moving again.
Provisions of the Financial Rescue Plan
Lawmakers have finally agreed on a $700 billion plan to revive credit markets and restore the flow of credit into the U.S. economy. We’ve summarized the main provisions of the plan as follows:
• Treasury purchase of distressed assets
The Treasury can purchase distressed debt securities from financial companies affected by the record number of home foreclosures.
• Available funds
The plan calls for $250 billion to be immediately available, with another $100 billion to be used at the president’s request for debt purchases. Congress could bar the expenditure of the remaining $350 billion only by passing a resolution to that effect.
• Addressing any net loss
After five years, if there is a net loss to taxpayers the president must submit a plan to Congress to recoup the funds.
• Oversight and accountability
The proposal includes oversight and accountability provisions, limits on executive pay for participating companies and provisions for foreclosure mitigation.
• No executive “golden parachutes”
The package includes a provision aimed at preventing golden parachutes for executives who leave firms that have sold troubled assets to the government.
• Stock warrants to government
Companies that sell debt to the government will issue stock warrants to the government so taxpayers can gain as companies recover from economic difficulties.
• Possible government insurance for mortgage-backed securities
The plan also includes a proposal by House Republicans, whose objections scuttled an earlier agreement in principle, that provides for government insurance of mortgage-backed securities.
Secretary of the Treasury Henry Paulson has opposed the idea, testifying that it wouldn’t work. The measure leaves the program’s structure up to the Treasury.
•Raising FDIC insurance limits
The insurance limit on FDIC deposits would increase to $250,000 from the current $100,000 level, which would cover current and future deposits.
• Favorable taxpayer provisions
New tax provisions added include:
Relief from the alternative minimum tax (AMT) for one more year
Extension of the business research and development tax credit
Extension of the child tax credit
Tax credits for alternative energy programs
A proposal that would allow judges to modify mortgage terms for struggling borrowers in bankruptcy proceedings was not included in the final version of the plan.
Frequently Asked Questions about Rescue Plan
There have been numerous discussions about the plan in general and its specific provisions. We try to answer some of the most frequent — and what we consider the most important — questions.
Q. The plan is very expensive. What protections are included for taxpayers?
A. Revisions to the original proposal will cut the payment of $700 billion in half, condition future payments on Congressional review and give taxpayers an ownership stake and profit-making opportunities with participating companies.
This puts taxpayers first in line to recover assets if a participating company fails and guarantees taxpayers are repaid in full if other protections have not produced a profit.
Q. From whom can the government purchase assets?
A. The plan allows the government flexibility to purchase troubled assets from a broad range of institutions, including pension plans, local governments and small banks.
Q. What limits are there on excessive compensation for CEOs and executives?
A. New restrictions for participating companies include:
• No multimillion-dollar golden parachutes
• Limits on CEO compensation that encourages unnecessary risk-taking
• Recovery of CEO bonuses paid based on promised gains that later turn out to be false or inaccurate
Q. How will the provisions for independent oversight and transparency work? In other words, who is responsible for overseeing this plan?
A. Five separate independent oversight entities or processes will be employed to protect taxpayers:
1. A strong oversight board appointed by bipartisan leaders of Congress
2. A Government Accountability Office (GAO) presence at the Treasury to oversee the program and conduct audits to ensure strong internal controls and prevent waste, fraud and abuse
3. An independent Inspector General to monitor the Treasury Secretary’s decisions
4. Transparency — requiring posting of transactions online — to help jump-start private sector demand
5. Meaningful judicial review of the Treasury Secretary’s actions
Q. What help will be provided to prevent home foreclosures from crippling the American economy?
A. The government can use its power as the owner of mortgages and mortgage-backed securities to facilitate loan modifications (such as reducing principal or interest rates, or lengthening the time allowed to pay back the mortgages) to help reduce the 2 million projected foreclosures in the next year.
The plan extends a provision (passed earlier in this Congress) to stop tax liability on mortgage foreclosures. It also helps small businesses that need credit by allowing community banks hurt by the mortgage crisis to return to previous lending practices.
Q. Will the rescue plan work?
A. It remains to be seen whether the provisions allowing the government to receive an ownership stake in companies and limits on executive compensation will discourage certain companies from participating in the program.
However, we’re hopeful the plan is a positive step toward removing distressed assets from the balance sheets of troubled banks and unclogging the credit markets. Of course, problems that built up over a number of years are unlikely to be resolved overnight.
Therefore, we believe the economy is likely to remain sluggish in the weeks and months ahead until credit conditions normalize and confidence is restored. This is not an easy time to be an investor. With uncertainty and a seemingly endless supply of bad news, it can be tempting to throw in the towel.
Although we understand the temptation, we don’t believe it’s the best course of action. You probably still want to retire, maintain your current retirement lifestyle or send kids to college. Giving up now wouldn’t help you reach any of those goals.
Talk with your financial adviser about your concerns and finding opportunities today so you’re better positioned tomorrow.
(Alan Skrainka is CFA and chief market strategist for Edward Jones, www.edwardjones.com Member SIPC)
(Belfanti, AAMS, is available for free consultation at the local Edward Jones office, 106 W. Main St., Bloomsburg. Call toll-free, 1-877-784-9001)
• The simultaneous collapse of so many large financial companies
• The seizing up of the credit markets
This prompted the federal government to put forth legislation to help get the economy moving again. Here we try to answer some questions and provide more details about the government’s plan.
Q. What’s your reaction to government efforts to bail out the bad assets of financial companies?
A. We can understand why the words “bail out” would make people skeptical and, in some cases, angry. But consider these points:
1. We don’t believe these assets are worthless because, in most cases, underlying those assets are home mortgages. The current delinquency rate is 6 percent; an additional 3 percent of home mortgages have gone into foreclosure. That means 90 percent are being paid on time.
2. The market for these loans is not very liquid right now because of fear. In other words, there are just no buyers, even though these assets are at depressed prices. The government’s idea would be to invest money to buy these loans, with the intent of selling them at a higher price when the market has recovered.
3. There are risks to the plan. And yes, there will likely be a cost to taxpayers; but if done correctly, this could unclog credit markets and help get the economy moving again.
Provisions of the Financial Rescue Plan
Lawmakers have finally agreed on a $700 billion plan to revive credit markets and restore the flow of credit into the U.S. economy. We’ve summarized the main provisions of the plan as follows:
• Treasury purchase of distressed assets
The Treasury can purchase distressed debt securities from financial companies affected by the record number of home foreclosures.
• Available funds
The plan calls for $250 billion to be immediately available, with another $100 billion to be used at the president’s request for debt purchases. Congress could bar the expenditure of the remaining $350 billion only by passing a resolution to that effect.
• Addressing any net loss
After five years, if there is a net loss to taxpayers the president must submit a plan to Congress to recoup the funds.
• Oversight and accountability
The proposal includes oversight and accountability provisions, limits on executive pay for participating companies and provisions for foreclosure mitigation.
• No executive “golden parachutes”
The package includes a provision aimed at preventing golden parachutes for executives who leave firms that have sold troubled assets to the government.
• Stock warrants to government
Companies that sell debt to the government will issue stock warrants to the government so taxpayers can gain as companies recover from economic difficulties.
• Possible government insurance for mortgage-backed securities
The plan also includes a proposal by House Republicans, whose objections scuttled an earlier agreement in principle, that provides for government insurance of mortgage-backed securities.
Secretary of the Treasury Henry Paulson has opposed the idea, testifying that it wouldn’t work. The measure leaves the program’s structure up to the Treasury.
•Raising FDIC insurance limits
The insurance limit on FDIC deposits would increase to $250,000 from the current $100,000 level, which would cover current and future deposits.
• Favorable taxpayer provisions
New tax provisions added include:
Relief from the alternative minimum tax (AMT) for one more year
Extension of the business research and development tax credit
Extension of the child tax credit
Tax credits for alternative energy programs
A proposal that would allow judges to modify mortgage terms for struggling borrowers in bankruptcy proceedings was not included in the final version of the plan.
Frequently Asked Questions about Rescue Plan
There have been numerous discussions about the plan in general and its specific provisions. We try to answer some of the most frequent — and what we consider the most important — questions.
Q. The plan is very expensive. What protections are included for taxpayers?
A. Revisions to the original proposal will cut the payment of $700 billion in half, condition future payments on Congressional review and give taxpayers an ownership stake and profit-making opportunities with participating companies.
This puts taxpayers first in line to recover assets if a participating company fails and guarantees taxpayers are repaid in full if other protections have not produced a profit.
Q. From whom can the government purchase assets?
A. The plan allows the government flexibility to purchase troubled assets from a broad range of institutions, including pension plans, local governments and small banks.
Q. What limits are there on excessive compensation for CEOs and executives?
A. New restrictions for participating companies include:
• No multimillion-dollar golden parachutes
• Limits on CEO compensation that encourages unnecessary risk-taking
• Recovery of CEO bonuses paid based on promised gains that later turn out to be false or inaccurate
Q. How will the provisions for independent oversight and transparency work? In other words, who is responsible for overseeing this plan?
A. Five separate independent oversight entities or processes will be employed to protect taxpayers:
1. A strong oversight board appointed by bipartisan leaders of Congress
2. A Government Accountability Office (GAO) presence at the Treasury to oversee the program and conduct audits to ensure strong internal controls and prevent waste, fraud and abuse
3. An independent Inspector General to monitor the Treasury Secretary’s decisions
4. Transparency — requiring posting of transactions online — to help jump-start private sector demand
5. Meaningful judicial review of the Treasury Secretary’s actions
Q. What help will be provided to prevent home foreclosures from crippling the American economy?
A. The government can use its power as the owner of mortgages and mortgage-backed securities to facilitate loan modifications (such as reducing principal or interest rates, or lengthening the time allowed to pay back the mortgages) to help reduce the 2 million projected foreclosures in the next year.
The plan extends a provision (passed earlier in this Congress) to stop tax liability on mortgage foreclosures. It also helps small businesses that need credit by allowing community banks hurt by the mortgage crisis to return to previous lending practices.
Q. Will the rescue plan work?
A. It remains to be seen whether the provisions allowing the government to receive an ownership stake in companies and limits on executive compensation will discourage certain companies from participating in the program.
However, we’re hopeful the plan is a positive step toward removing distressed assets from the balance sheets of troubled banks and unclogging the credit markets. Of course, problems that built up over a number of years are unlikely to be resolved overnight.
Therefore, we believe the economy is likely to remain sluggish in the weeks and months ahead until credit conditions normalize and confidence is restored. This is not an easy time to be an investor. With uncertainty and a seemingly endless supply of bad news, it can be tempting to throw in the towel.
Although we understand the temptation, we don’t believe it’s the best course of action. You probably still want to retire, maintain your current retirement lifestyle or send kids to college. Giving up now wouldn’t help you reach any of those goals.
Talk with your financial adviser about your concerns and finding opportunities today so you’re better positioned tomorrow.
(Alan Skrainka is CFA and chief market strategist for Edward Jones, www.edwardjones.com Member SIPC)
(Belfanti, AAMS, is available for free consultation at the local Edward Jones office, 106 W. Main St., Bloomsburg. Call toll-free, 1-877-784-9001)
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