Public Law 110-343 the Crisis

Public Law 110-343

The Crisis -- The first decade of the 21st century showed a surge in the housing, consumer spending, and economic markets for most of the developed world. However, all was not what it appeared, and by 2008 a series of bank and insurance company failures, based primarily on lending huge amounts of money to individuals and institutions that were unable to pay, triggered a financial crisis that was global in perspective. This crisis required an unprecedented level of government intervention and the huge lenders of Fannie Mae and Freddie Mac were both subsumed by the government (Stewart). Several large financial institutions either declared bankruptcy or were in the process of going under. Lehman Brothers declared bankruptcy on September 14, 2008; Bank of America agreed to purchase Merrill Lynch, and AIG was saved by an $85 billion capital loan from the federal government (Andrews). By September 25th, J.P. Morgan Chase agreed to purchase the assets of Washington Mutual, which became the largest bank failure in history (Ellis). By September 17, more public corporations had filed for bankruptcy in the United States than in all of 2007 (2007 Public Company Bankruptcies Surpassed, According to BankruptcyData.com). These failures caused a crisis of public confidence that had a major domino effect: banks were reluctant to loan money to consumers or even amongst themselves; consumers simply stopped spending; businesses were unable to get short or medium-term capital loans, and therefore many went under or laid off numerous people, only contributing more to the crisis.

As the crisis continued to explode, there was very real concern that there might be a significant and serious Wall Street crisis; the so much of the fiscal backing was unstable that the public was in panic mode, and that even a simple event could cause the entire house of cards to tumble. The government knew it had to do something drastic, and after much debate, compromise, and political deal making, the government acted to give Treasury Secretary Paulson the authority to help the failing businesses (Solomon). Public Law 110-343, also known as the Troubled Asset Relief Program (TARP) is a program initiated by the Bush Administration to purchase marginalized assets and troubled accounts from financial institutions (Nothwehr). This purchase, $700 Billion allocated, would clear many problem accounts from banking institutions and hopefully allow greater banking and economic stimulation. The necessity for this law was based on the "Subprime Mortgage Crisis," and is part of the overall economic stimulus package than ran between the Bush and Obama administrations. There are several parts to this law, patches that seem to raise questions of its initial validity (Department).

While the purpose of TARP is to remove toxic assets from qualifying financial institutions, many politicians and pundits see it as a set of rewards for banking cronies, a way for firms to dump their poor decisions upon the American taxpayer, a way for firms that lacked financial acuity to skate by, and a way to prop up, with equity, firms that hardly deserve such treatment. Unfortunately, then Secretary Paulson now admits that the permutations and changes made to TARP were somewhat outside of his intention (John). Thus, an "idea" to help stimulate has turned into a hydra in the marketplace. It remains to be seen what the effects of TARP will be medium and long-term, but it was likely not in the best interests of the general public to implement such changes, which reek of cronyism and certainly do not fit the criteria of "free market capitalism" as promised. (Crittenden).

Definitions -- The first version of the Economic Stabilization Act of 2008 was rejected by the House, but the Senate decided to amend an existing bill in order to circumvent problems. Thus, HR 1424 was then passed by the House of Representatives and an amendment would transform it into a Senate approved Emergency Economic Stabilization Act ((Ives). As noted, there were several parts to this mega-legislation. The compromise between the Senate and House created over $700 billion dollars in Troubled Asset Relief and Emergency Economic Stabilization. It also enacted the Energy Improvement and Extension Act of 2008, Tax Extenders and Alternative Minimum Tax Relief Act of 2008, which also included the Paul Wellstone and Pete Domenici mental Health Parity and Addiction Equity Act of 2008, and the Heartland Disaster Tax Relief Act of 2008 (Kennedy). Interestingly enough, one of the major players in this location was Representative Patrick Kennedy of Rhode Island, yet he was not part of the negotiation at all. In order to improve the chances of the legislation being passed, some dealing was made which consisted of tweaking Kennedy's old bill -- eliciting charges of cronyism and over pork within the final bill (Mulligan).

In general, the Emergency Economic Stabilization Act of 2008 was part of an effort to help (bail out) firms holding mortgage-backed securities in an attempt to restore liquidity and confidence in the credit markets (Bardeesy).The three major divisions of the act were:

Tax Extenders and Alternative Minimum Tax Relief Act -- This included $100 billion in tax breaks for businesses and the middle class, plus a provision to raise the cap on FDIC (Federal Deposit Insurance) from $100,000 to $250,000. This was designed to keep the alternative minimum tax from hitting 20 million middle-income Americans and to provide fiscal relief for those hit with hardship after natural disasters (Senate).

Energy Improvement and Extension Act of 2008 -- Contains a new tax credit for certain hybrid vehicles; extends tax credits for renewable energy, and establishes electricity as a clean-burning fuel for tax purposed (O'Dell).

Mental Health Parity and Addiction Equity -- Mandates that if U.S. health insurance companies provide coverage for either substance abuse or mental health issues, the coverage must be equal for conditions such as drug addiction, etc. This was essentially a provision that mental health advocates had been working toward for over a decade -- making it illegal for insurance companies to discriminate. However, it is notable that it helped individuals, but was really outside the initial purview of the intention of the bailout (Glantz).

Implications of the Crisis -- Many scholars and analysts viewed the crisis in a similar manner to the Great Depression -- out of the blue. Others pointed to a number of issues that led up to the crisis in the late 1990s and early 2000s. One critic of the management of much of the financial markets noted that rational expectations theory in regard to economics is no longer a part of a realistic paradigm. "The two-way, reflexive connection between the cognitive and manipulating functions introduces an element of uncertainty or indeterminancy into both functions" (Soros). This is exactly what occurred, and is especially noted in the five major implications of the crisis:

Bank Lending -- The perceed failure of banks to manage their own risks has led to bank closures, increased scrutiny from regulators, fewer depsitis, fewer loans thus fewer assets. The banks then, drained of liquidity, demanded relief from the government yet, besides not trusting each other, they did not trust either their customers nor the government. However, the decision of the U.S. And other European governments to address the banking issue directly indicated to the world that governments simply will not allow the financial industry to become unstable and fail -- at whatever the cost (Gregoriou).

Real Estate Issues -- In the real estate mrket, there was significant downward pressure on valuation of both residential and commercial values. Housing supply vastly overwhelmed demand; defaults and other costs into the trillians. That there was abuse is uncontested, that the market needed to be propped up in order to keep from failing, debatable (Hockett).

Credit Default Swaps -- This market was a very loosely regulated body of firms that bought and sold insurance to protect against losses on collateralized debt and asset-backed securities. So much money was lost in these swaps that the government will scrutinize much deeper to prevent what was essentially a shell game of transfering money from one entity to another to protect a third without adequate concern if the protected asset was viable (Pavlov).

Retail Sales -- Analysts estimate retail sales to have decline upwards of 4-5% during the 2008 Holiday Season. This not only had vast repurcussions in the local economy (e.g. many big box retailers were unable to make a profit and had to discount deeply just to keep the doors open), but to the international market as well -- the places that provide many of the goods for American consumption. Consumers were hoarding their money, uncertain what would happen in the next few months, quarter, or year -- the crisis was as much pscyhological as tangible (Lotto).

Housing Starts -- So many houses wer built in the early 2000s, counting on mortgages remaining easy to get and affordable went too far. This was the first indication of the crisis, with inventories by 2007 reaching all time highs and sales all time lows. This only exaserbated the consumer confidence issue, along with the very serious contention that many loans should never have been made; and that these loans were not backed with tangible securities (Bucznski).

Conclusions -- Was TARP Necessary -- A five member Congressional committee echoed a number of criticisms regarding TARP that many consumers, academics, and fiscal analysts were considering. What exactly was the Treasury's strategy with the $700 billion dollars for the supposed bail out? How can Treasury explain the significant gaps in their ability to find hundreds of billions of taxpayer money? In a nutshell, it appears that the departments that control the money given by the Congress (from the American people) have no ability to ensure that the bailed out banks will do what was needed and lend money; have no real standards of measuring success of failure of the program; and for ignoring pointed and specific questions from Congress about their performance (M. Crittenden).

The fact that many of the institutions bailed out with TARP funds, funds from the American taxpayer, did not distribute these funds back into the economy to get the jump start in spending promised. Indeed, numerous examples abound that many companies used the money to buttress their balance sheet, pay executives, and in a few cases, even to fund company promotional events. Following the money often points to a club, cronyism if you will, of individuals who are connected at some political level, funding one arm of a company in order to protect that individual, or more accurately, that individuals portfolio, from damage or reduction (D. Ellis).

The bailout of Freddie Mac and Fannie Mae, for instance, is considered by some to be nothing more than a case study in crony capitalism.While this is a very conservative remark, echoing President Ronal Reagan's view that, "When government and business get in bed together, the taxpayer doesn't get any sleep." When asked about whether they thought the government would every bail them out if they got into financial trouble, Fannie and Freddie Executives were reluctant to comment. Fannie and Freddie provided "risk coverage for all the commercial lending institutions that extended credit where credit normally wouldn't have been extended. Why? Because politicians wanted to increase home ownership. The only way to do this was to remove the risk associate with some loans. Consequence, Fannie and Freddie 'bough' the bad loans and encouraged participating banks to go original more…. Nice thought…. Poor execution…. The road to h*&* was also paved with good intention (Scontras).

Still, some feel that TARP was necessary at the time, and criticizing it is like the Monday morning quarterback -- one already knows the score and can adjust the view to the results. Even President Obama promised that, on his watch, banks "will have to clearly demonstrate how taxpaer dollars result in more lending for the American taxpaer" and won't be allowed to pad bonuses or redecorate corner offices (Editorial).

If we assess what TARP was designed to do, though, we find that then Secretary Paulson indicated that lending had stopped because of toxis assets (really mortgage backed securities). Because banks did not know their actual value, the were reluctant to lend. Paulson argued for the $700 billion to purchase these toxic assets and allow the banks to have more solid balance sheets with which to base decisions upon. Paulson also, it appears, forced the nation's nine largest banks to issue stock to the Treasury department, but paid for with TARP money. In a set of strong-arming tactcs, Paulson told banks that didn't want to participate that others would, and if they didn't, it would define them as weaker than the others, and less desirable for future work (McCain).

Did the bailout program work? Again, without a blind, statistically valid experiement, it is hard to decide definitively. Had the government not stepped up to do something, Wall Street may have collapsed, indeed, the entire economy could've been in shambles instead of just minorly injured with scrapnel fire. In the time since the bailout consumer are reducing debt and increasing savings; the average houshold debt is decreasing slightly; and personal consumer goods spending is rebounding a bit (likely as a result from yet another Wall Street bailout -- the Cash for Clunkers program, and currently the Energy Efficient Home Applicance program). Yet, commercial real estate is absolutely devastating for regional banks -- unpaid loans on malls, hotels, and apartments stood at a 16-year high of 3.4% in Q3-2009 and is on the way to reach an average of 5.3% (See Appendix and Harding).

Thus, are things improving -- yes, they are, but many say not for the reasons one might hear on the nightly news. According to9 this view, the improvements in life have as part of the desire for better margins, not sales growth. They are seeing this within their domain, most having not been part of the executive management team in the early 1990s. The future, will depend on consumer confidence and sales growth, thus providing the assets for continued exploitation, low saving balances, and high credit card debt. This is something that must be understaken on an individual basis, but thinking as a collective. There are probably enough global resources to shore up the population and redistrict assets based on need. The United States, feel most economists who have studie this current decision in depth, believe that the U.S. is still the world's most synamic, entrepeneurial country in the world -- but, we need to ensure the recovery doesn't push us backward, but does propel us forward (Trumball).

APPENDIX A -- Current Economic Indicators (Harding)

Figure 1 - Personal Consumption Index

Figure 2 -- Reduction in Household Debt

Figure 3 -- Personal Savings Rates Grow

REFERENCES and WORKS CONSULTED

"2007 Public Company Bankruptcies Surpassed, According to BankruptcyData.com." 17 September 2008. AllBusiness.Com. 11 April 2010 http://www.allbusiness.com/company-activities-management/financial-performance/11564300-1.html

Andrews, E., et.al. "Fed's $85 Billion Loan Rescues Insurer." The New York Times 16 September 2008: http://www.nytimes.com/2008/09/17/business/17insure.html?_r=1&hp.