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The $700 Billion Question

Washington Tries to Wrap Up the Bailout

By Theo Francis and Jane Sasseen

White House and party leaders must sell a revised financial rescue to Congress, with a wary eye on market reaction.

Is the deal finally on?

Lawmakers from both parties once again announced the broad framework of a pact on Sunday afternoon, Sept. 28, to rescue U.S. financial markets. Many details of Treasury Secretary Henry M. Paulson Jr.'s proposed $700 billion plan remained vague, and opposition by conservative Republicans in the House of Representatives stayed strong. Still, legislative aides and business lobbyists said they expected the House to pass the measure. Indeed, with investors in markets around the world anxiously awaiting progress on the package, legislators know that further delays would likely cause another rout for stocks.

House leaders eager to keep up the sense of urgency were aiming for a vote as early as Monday. If it passes the House, the Senate -- where a bill is expected to find more support -- will vote by Oct. 1.

After days of intensive negotiations, Paulson released a statement early Sunday evening, lauding the bipartisan efforts and pledging to move as quickly as possible to begin implementing the legislation as soon as it is signed. "Members on both sides were focused on the right things: creating an effective program that can be implemented quickly and effectively, and doing everything possible to protect the taxpayers," Paulson said in the statement. "Quick, effective, and bipartisan action sends a signal to investors large and small, here and abroad, that we are committed to taking the necessary actions to protect our financial system and our economy." Asian markets were up in early trading on news of the accord.

A Continental Bailout: Fortis

President George W. Bush issued a statement calling the bill necessary "to help protect our economy against a system-wide breakdown." He added: "The bill will help allow access to credit so American families can meet their daily needs and American businesses can make purchases, ship goods, and meet their payrolls. And this plan sends a strong signal to markets around the world that the U.S. is serious about restoring confidence and stability to our financial system. Without this rescue plan, the costs to the American economy could be disastrous." Early in the day, both Presidential contenders said they would likely support the bill.

Meanwhile, the financial crisis seemed to cascade in Europe. As recently as last week, European officials said they had no intention of mimicking a U.S.-style bailout of Old World banks, claiming their financial situation wasn't as dire.

But the rapidly deteriorating financial situation at Brussels-based banking giant Fortis, whose shares plunged 35 percent last week on concerns over its balance sheet, prompted an emergency $16.3 billion bailout engineered over the weekend by the governments of Belgium, Luxembourg, and the Netherlands. According to a Bloomberg report, the Belgian government will buy a 49 percent stake in the bank's Belgian business for $6.9 billion, while Holland will pay $5.8 billion for the bank's Dutch business. Fortis -- one of the victorious partners in a hard-fought takeover battle last year for Dutch investment bank ABN Amro -- was hammered over concerns that its capital base had been too depleted by the acquisition.

More Pages Added Little in D.C.

Also in Europe, the BBC reported late Sunday that the British government will take over the $92 billion loan portfolio of mortgage lender Bradford & Bingley, whose shares have tumbled 93 percent in the past year. Spanish banking giant Santander will acquire B&B's retail banking and savings business, including 200 branch offices around Britain.

In Washington on Sunday afternoon, a flurry of draft bills were circulating, often leaving recipients confused as to which was most current and what provisions remained in play. By day's end, Paulson's initial three-page proposal had swelled to more than 100 pages, filled out with provisions designed to bolster congressional oversight, boost the amount of money that taxpayers can potentially recover in return for helping struggling financial institutions, help homeowners struggling to pay their mortgages, tighten executive-compensation rules for companies selling assets to the Treasury, and even potentially allow a significant alteration in corporate accounting rules. By early evening, a unified draft was distributed by lawmakers and Administration officials.

But for all the intense negotiations over the weekend -- key talks lasted until after midnight Sunday morning -- the broad outlines of the bill remained remarkably similar to what was in the works Wednesday afternoon, before hopes collapsed Thursday in partisan acrimony at a White House meeting among congressional leaders, Administration officials, and presidential candidates John McCain and Barack Obama.

Congress Holds Two Cards

The bill would give Treasury the authority to invest up to $700 billion in a wide variety of securities tied to the foundering mortgage market, with an eye toward stabilizing the financial sector. The government would eventually resell those assets to recoup funds for taxpayers. It would also receive warrants for equity in some participating firms. The huge outlay would be doled out to Treasury in chunks under provisions similar to those in last week's drafts. The payments would commence with $250 billion; another $100 billion would come upon certification from the President that it was required; and the final $350 billion could be withheld by Congress.

One key addition: If the invest-and-sell program fails to break even after five years, Congress is to devise a way to recoup the loss from the financial industry.

The bill also gives Treasury the option -- but doesn't mandate using it -- to insure the assets instead of buying them. That provision was championed by conservative Republicans late last week as preferable to government investment. Many economists consider the insurance option unworkable, and some analysts say it has been included primarily to win the support of unhappy conservatives. "It's window dressing," says a source who is closely following the talks.

Insurance Plan Could Cost Months

"It's essentially the same plan we've been looking at since last week, with the addition of the insurance fund," says Howard Glaser, formerly a housing official in the Clinton Administration and chief lobbyist for the Mortgage Bankers Assn., who now runs the Glaser Group consultancy. "Everyone got a little of what they wanted: Democrats have better oversight and more foreclosure aid; Treasury got the ability to purchase assets in sufficient scale; and Republicans got the insurance fund. Everyone can claim it as a win. Whether it's actually effective or not is a different question."

Glaser adds that as the government moves ahead with the insurance plan, it could take months to create the needed bureaucracy and determine appropriate premiums and other nitty-gritty details. By contrast, he says Treasury already has a team -- headed by a Goldman Sachs alumnus -- studying which tranches of toxic assets should be bought up first, and which institutions need the most help. This means Treasury could be ready to start buying assets within a month of whenever the President signs a final bill, he says.

The most optimistic timetables still suggest passage by midweek at the earliest. Even if the House were to pass the measure by Monday, one analyst noted, the Senate would be unlikely to take it up until Wednesday, after Tuesday's Jewish holiday of Rosh Hashanah.

Some Republicans Remain Opposed

Echoing more than a week of warnings from Administration officials, Senator Judd Gregg, one of a handful of Republicans who negotiated the deal with the Democrats and Paulson, urged fellow lawmakers to support the measure. "The downside of not doing this is such a catastrophe for our nation that we don't even want to contemplate it," Gregg said. "This is about Main Street, it's about America, it's about the fabric of American life."

Despite support from key lawmakers of both parties, it was clear the bill would still face substantial opposition among some Republicans, particularly those philosophically opposed to market intervention by the government.

Those fighting the bill suggested that Republican activism had improved it, but that the proposal remained, as Representative Mike Pence argued in an open letter to fellow lawmakers, "the largest corporate bailout in American history," and one that "forever changes the relationship between government and the financial sector."

Significant Bipartisan Support Claimed

"Economic freedom means the freedom to succeed and the freedom to fail," Pence wrote, noting that he would oppose the bill. "The decision to give the federal government the ability to nationalize almost every bad mortgage in America interrupts this basic truth of our free market economy."

Still, analysts said it looked likely that House and Senate leaders in both parties had corralled enough support from Republicans to ensure not only passage, but significant bipartisan support. Democratic leaders had made clear that they have little appetite for passing a bill -- initially proposed by the Bush Administration and derided by much of the public as a Wall Street bailout -- that lacked substantial GOP support.

The bill that took shape over the weekend toned down some provisions sought by Democrats in last week's drafts, particularly those opposed by the financial services industry and the broader corporate community.

Here are some of the details of the legislation as of Sunday night:

• EXECUTIVE PAY: While the bill continues to include measures to rein in executive pay, the final measures are less harsh than those many Democrats have been advocating. Some of the restrictions -- including a 20 percent excise tax on "golden parachute" severance agreements and limits on tax deductions for top executives' pay over $500,000 a year -- apply only to companies selling $300 million or more in assets to the Treasury in the reverse auctions it is expected to hold; other measures include "claw-backs" of executive bonuses based on what turn out to be "materially inaccurate" financial results. Treasury officials said such measures would apply only to the top five executives at any participating firm on contracts signed in the future. Any severance clauses or golden parachutes included in executives' current contracts would continue to be valid; Treasury officials say they will not abrogate those contracts. Measures opening corporate proxy filings to dissenting shareholders also appeared to be dead.

"It looks like what they did was react to a lot of industry's negative comments [about] executive compensation and corporate governance," said Frank Lawatsch Jr., a partner with Day Pitney in New York. "You're really only going to be picking up big, big institutions."

• OWNERSHIP STAKES: Congress would give Treasury the ability to acquire ownership stakes in larger companies that sell it assets under the program, but the draft legislation indicates these will be nonvoting stakes, removing one objection raised by corporate lobbies. The bill would let the Treasury exempt from such ownership companies that sell it $100 million or less in securities.

• ELIGIBILITY: The bill also left the Treasury with a fair amount of flexibility in determining just which assets it will buy up, a subject of intensive lobbying throughout the week. For now, the Treasury is authorized to buy up mortgages and mortgage-related assets. That could include mortgage-backed securities, as well as the complex derivatives created on top of them, and the whole home loans that have not been securitized. Efforts by lobbyists to include securities based on credit-card, auto, and other types of loans were not successful, for now. However, Treasury officials say that they won the ability to ask for the authority to include nonmortgage related assets if the Secretary determines that doing so is necessary to ensure financial stability.

Also, financial institutions not headquartered in the U.S., including foreign central banks and other official holders such as sovereign wealth funds, will in some instances be eligible to participate in the program.

• OVERSIGHT: In addition to establishing an oversight board made up of Administration officials and congressional appointees, the bill would set up an inspector general's office and provide for regular public reports from the Treasury as well as regular audits -- all measures designed to address concerns that Treasury's original proposal let it operate unchecked. Treasury would also be required to establish rules to minimize conflicts of interest, a specter raised by the prospects that the agency could hire Wall Street and commercial banks to help it value, manage and sell assets held by similar and competing institutions.

But the legislation is still likely to give Treasury broad protections against litigation, allowing its actions to be set aside only if it has violated the law arbitrarily, capriciously, or through abuse of its discretion. Injunctions for non-Constitutional claims would be restricted in many cases.

• MODIFYING MORTGAGES: A measure strongly advocated by Democrats, which would allow judges to modify the terms of residential mortgages in bankruptcy proceedings, has been dropped. Fiercely opposed by business groups, the provision had persisted through some versions Saturday, but many believed it was kept on the table as a bargaining chip by Democrats.

Other elements, intended to help homeowners who face foreclosure or have trouble making mortgage payments, remained in place. But they are relatively vague. Much of that language boils down to requiring Treasury to do what it can to modify loans for struggling homeowners, or, in the case of mortgages controlled by the private sector, to do what it can to encourage relief for homeowners. The agency can also offer loan guarantees and credit enhancements to prevent foreclosures. Treasury officials say that the large ownership positions they will take in pools of mortgage-backed securities will give them much more leverage to push mortgage servicers to modify troubled loans than has existed so far. Under the voluntary programs that Treasury has backed to date, many homeowner advocates have complained that servicers have been far too slow to work with borrowers to help them renegotiate more affordable home loans.

"We'll have a lot of influence over securitizers and we'll encourage them to work through loans" to avoid unnecessary foreclosures, said one Treasury official.

• ACCOUNTING CHANGES: The bill also contained language that Treasury officials said "reaffirmed the Securities & Exchange Commission's authority" to suspend a key accounting rule, should the agency decide it is necessary, and directing the Government Accountability Office to study the proposal. The rule in question requires companies to "mark to market" many assets on their balance sheet, or to reflect changing market values regularly, rather than say, carrying them at the purchase price until sale.

Industry trade groups argue that this rule makes corporate balance sheets too volatile, obscuring the true value of companies and contributing to the shaky financial markets. The financial services industry had lobbied heavily to require the SEC to temporarily suspend the rule, but negotiators rejected going that far. Most accounting experts argue that the rule simply requires companies to reflect reality, and that eliminating it would leave investors in the dark as to the true worth of many companies.

Scott Talbott, senior vice-president of government affairs for the Financial Service Roundtable, said his industry would have preferred that the rule be suspended, but was encouraged by the call for further study. "This keeps the possibility alive," he said.