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Weekly UpdatesEfforts to kick-start the nation's credit markets came in the way of a $700 billion rescue measure signed by the president on October 3, 2008. The Emergency Economic Stabilization Act of 2008 (Public Law 110-343) is intended to help stabilize the financial markets and ease the credit crisis plaguing private companies and state and local governments.
At the heart of the measure is the creation of the Troubled Asset Relief Program (TARP), which initially focused on rescuing the financial industry by allowing the Treasury Department to purchase distressed assets linked to mortgage-related securities. That approach has since been abandoned in favor of putting capital directly into healthy banks in exchange for partial ownership.
The enactment of the new law came with great speed, but also with considerable obstacles. A majority of Republicans in the House of Representatives, along with some Democrats, initially voted against the legislation, arguing that the scope of Treasury's power was too broad, the cost to taxpayers too high, and the crux of the measure--government intervention in the market m would fundamentally alter the U.S. financial system and undermine free-market principles.
But members of Congress reconvened to consider a slightly modified measure in the face of continued dire warnings from Treasury officials and the private sector that economic disaster would be inevitable without Congressional intervention. Another impetus was the general public's realization that the impact of the crisis was not limited to Wall Street executives, but was in fact hurting "Main Street" vendors and individuals. This new measure also included popular tax breaks and an increase in federal deposit insurance limits in an effort to garner support from additional members of Congress. The final bill, H.R. 1424, was approved overwhelmingly.
TARP AND OTHER AGENCY ACTIONS
The new law was intended to authorize the Treasury Department to create the TARP. It confers upon the Secretary of the Treasury broad powers to purchase up to $700 billion in residential and commercial mortgages and any mortgage-backed securities, obligations, and other instruments that were originated before March 14, 2008, from financial institutions that have significant operations in the United States and are not owned by a foreign government. Congress initially appropriated $350 billion for TARP, and under certain conditions, the Treasury may request another $350 billion from Congress. To keep a check on the broad powers granted to the Treasury Department as part of the TARP, the new law created the Financial Stability Oversight Board to oversee the agency's activities, although this board has yet to be formally established.
In November, Treasury Secretary Henry Paulson backtracked from his initial proposal and said none of the initial $350 billion in TARP dollars would be used to purchase troubled assets. Instead, the funds would be used to infuse capital into the financial sector. Thus far, the Treasury has used $310 billion in an effort to shore up financial institutions. As of mid-November, the Treasury had invested $125 billion in large banks and investment banks and $125 billion in regional banks, provided $40 billion in emergency aid to insurer AIG, and another $20 billion to help stabilize Citigroup. In exchange for buying direct equity stakes in the financial institutions, the Treasury is hoping to recoup the money, earn 5-9 percent in dividend income over five years, and receive warrants worth 15 percent of the face value of preferred stock. Additionally, TARP has provided $20 billion to create a program that will help finance consumer loans (autos, credit card debt, student loans, small business loans). The program is known as TALF--Term-Asset Backed Securities Loan Facility.
The Federal Reserve also plans to purchase $600 billion in debt from Fannie Mae, Freddie Mac, Ginnie Mae, the Federal Home Loan Banks, and other mortgage-backed securities that these institutions guarantee. This new purchasing power from the Federal Reserve is seen as a way to bring about more affordable mortgage financing for individuals by relieving some of the debt from these institutions.
Other industries have also asked the Treasury and the Federal Reserve for assistance but have been rebuffed, along with elected officials from some state and local governments.
Members of Congress have expressed dismay over Paulson's decision to abandon his plan to purchase troubled assets from financial institutions, as well as his unwillingness to directly help homeowners and tackle the country's foreclosure crisis. During a November 18, 2008, hearing, House Financial Services Chairman Barney Frank (D-Massachusetts) tussled with the treasury secretary about the lack of assistance to homeowners, which Frank believes is the direct intent of the act, which he co-wrote. Additionally, at his own committee hearing on November 17, 2008, Senate Banking Chairman Chris Dodd (D-Connecticut) said "it is confounding to me why the secretary of the treasury and others refuse to understand that this [foreclosures] is the heart of the problem. Until we solve the foreclosure problem, we will not have any hope of solving the larger problem" Many members of Congress have also expressed concern that recipient banks have not used the capital infusion provided by the TARP for loans to consumers, but instead have used it to shore up their balance sheets and acquire other banks. New initiatives were being discussed in early December to deal directly with the housing crisis (see the GFOA Newsletter for updates).
At the Financial Services Committee hearing, Federal Deposit Insurance Corporation (FDIC) Chairman Sheila Bair discussed her proposal, which would provide incentives for financial institutions to help troubled homeowners restructure their mortgages and reduce their monthly payments. Under Blair's plan, in exchange for reducing a qualified borrower's monthly payments, the federal government would cover half the costs mortgage companies would incur if the loan fails. Bair told the committee that this effort to keep people out of foreclosure would be cost-effective for the federal government. The treasury secretary, however, has expressed opposition to the idea.
In a related move, in late September, the Treasury Department also announced expansion of the Exchange Stabilization Fund to guarantee money market mutual funds, including municipal securities funds. Funds that existed on September 19, 2008, can now pay premiums to participate in the expanded program, which will cover shareholders for the amounts held in these funds if they should fail. The Treasury determined that this guarantee was necessary because of concerns that in the current market environment, investors would flee money market funds because they are not insured deposits. Additionally, the Federal Reserve created the Commercial Paper Funding Facility to purchase commercial paper from U.S. companies to help with their short-term cash flow needs.
OTHER PROVISIONS
In addition to creating the TARP, the new law contains tax and other provisions of interest to state and local governments, including:
* An increase in the FDIC deposit insurance limits from $100,000 to $250,000, through 2009, although no special provisions were provided for municipal deposits. The new law also provides unlimited insurance coverage, through 2009, to non-interest-bearing checking and transaction accounts participating in the FDIC's Temporary Liquidity Guarantee Program.
* A two-year extension, through 2009, of the provision allowing state and local sales taxes to be deducted on federal returns, which is particularly valuable to residents of states with no income tax.
* An increase in the alternative minimum tax exemption for 2008, which will prevent more than 21 million people from having to pay the tax for the first time.
* A one-year extension, through 2009, of a provision permitting homeowners who do not itemize their income tax deductions to take a standard deduction for state and local property taxes. The amount of the deduction is the amount of real property taxes paid during the year or $500 ($1,000 for a married couple filing jointly), whichever is less.
* A three-year extension, until January 2013, of a law enacted in 2007 permitting homeowners to refinance their mortgage and pay no taxes on any debt forgiveness they receive.
* Parity in mental health coverage by requiring private health insurers to offer mental health benefits equal in cost and scope to those offered for other medical conditions. This applies both to the private and public sector.
* Reauthorization of the Secure Rural Schools program through 2011.
* An additional $400 million in 2008 and 2009 for the school construction tax credit bond program (Qualified Zone Academy Bonds).
* An additional $800 million for the clean renewable energy bonds program.
* A new tax credit bond program financing state and local efforts to reduce carbon emissions.
* Assistance to those states recovering from Hurricane Ike (Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, and Wisconsin), with a new Midwestern Disaster Area Bonds program. Homeowners will also be allowed to tap into funds from Mortgage Revenue Bonds for home repairs.
STATE AND LOCAL GOVERNMENT INVESTMENT AND DEBT MANAGEMENT ISSUES
The credit crisis has significantly affected state and local governments already struggling to address skyrocketing foreclosure rates, decreasing tax revenues, growing unemployment, and the increased demand for services that come with these difficulties. Some governments have seen reduced returns in their investment portfolios, and some disruption has occurred in the municipal bond market. This is especially true for those that had investments or contracts with the now-defunct Lehman Brothers, and the ailing AIG. The Government Finance Officers Association (GFOA) has created a page on its Web site of resources and checklists related to the capital markets crisis and its impact on government investment and debt management practices. The page is at www.gfoa.org/ navigateeconomy.
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