Today Paulson announced that although he would purchase some of the so-called toxic assets on bank balance sheets, he may also, like Britain, take equity in banks. Can he do that? Paulson said:
the EESA adds broad, flexible authorities for Treasury to buy or insure troubled assets, provide guarantees, and inject capital. We will use all of the tools we've been given to maximum effectiveness, including strengthening the capitalization of financial institutions of every size. We will design programs that encourage healthy institutions to participate.
The "strengthening ... capital[]" phrase - or partly nationalizing banks, if you want to be statist about it - is the key move in the speech. That's not what the TARP was all about - it is a "Troubled Assets Relief Program," and, based on the debate that happened when the statute was passed, we may have thought that the assets at issue were the mortgage backed securities that no one can sell. But it was a program passed in a hurry, with plenty of flexibility given to Treasury. Here's the relevant general grant of authority:
The Secretary is authorized to ... make and fund commitments to purchase, troubled assets from any financial institution, on such terms and conditions as are determined by the Secretary, and in accordance with this Act and the policies and procedures developed and published by the Secretary....
[including] establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase, hold, and sell troubled assets and issue obligations.
So the plain language move that Treasury must make to change its toxic assets program into a nationalization program is to interpret the stock of ailing banks as "troubled assets." Or, put another way, the question would be whether taking equity in an ailing bank could reasonably be interpreted as taking a troubled asset (that is this case). And I don't see why that interpretation wouldn't fly.
But moreover, the statute has some explicit guidance for the Secretary if he does decide to take equity (or warrants, anyway), viz encouraging him in some cases to take for the troubled assets:
a warrant giving the right to the Secretary to receive nonvoting common stock or preferred stock in such financial institution, or voting stock with respect to which, the Secretary agrees not to exercise voting power, as the Secretary determines appropriate
So Congress contemplated that the Secretary could end up with some equity under the program (and I don't think this means only non-voting equity, I think the Secretary has discretion to take voting or non-voting as he likes).
UPDATE: It's even easier than I thought, because "troubled assets" are defined as, in part (Eric Posner has analysis here):
(B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.
A comment: this is why congressmen give up their jobs to run the DEA or the Department of Transportation. The executive branch has flexibility in how it interprets congressional directives, and though Congress probably wouldn't mind, changing the TARP from a toxic asset program to a bank nationalization program is a pretty big change. But the statute doesn't preclude it, so that appears to be what the Secretary may do.
Finally: how do we know, based on that speech, where injecting capital is just one of a number of options Treasury is entertaining, that it will probably go the equity route? We don't, but the journalists think they know. It's Washington inside baseball, but if the Times headlined its story about the speech "US May Take Ownership Stake in Banks," the odds aren't bad that Treasury is telling it off the record that that's precisely what it is planning on doing.
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1. Posted by fedgovernor on October 9, 2008 @ 4:53 | Permalink
David,
Let's get something straight. The TARP legislation gave Henry Paulson the right to move into your house and eat out of your refrigerator if that's what he wants to do.
The law gives Mr. Paulson and the FED unlimited power to do anything. That includes stealing certain banks from their owners and then using the money at those banks to lend to other insolvent banks.
That's why the Democrats-controlled Congress pushed through the legislation so quickly - so there could not be extended debate.
Nancy Pelosi held a press conference and warned the American people that if the legislation was not passed, then the stock market would fall precipitously.
And yet, since debate began on September 26, 2008 ... the market has fallen almost 2,000 points. I'd say that Pelosi and the Democrat-controlled Congress has failed us.
Paulson and the FED don't have any other choice but to take the banks from their owners and raid their capital.
Like I've been warning all along ... this is the largest bank heist in history, and it's occurring right out in the open.
It's legal thievery.
2. Posted by fedgovernor on October 9, 2008 @ 4:59 | Permalink
PS: I'm not making a value judgement on Paulson's plans ... just calling a spade a spade.
When the government "takes" an equity position in a bank, it dilutes the shareholders. This is a taking under the Constitution. It's the same as if the government took your land to build a road, I imagine, except that the government has to offer you a fair market price for your land.
In this case, Paulson can just take the bank (by threatening to otherwise close it). The owners ... the shareholders who put up the cash to capitalize the banks operations ... will have no say in the matter.
So, in this way, it's the same as if I robbed the banks' capital at the barrel of a gun. Only I'd get arrested for it.
Paulson won't.
3. Posted by fedgovernor on October 9, 2008 @ 5:05 | Permalink
PSS:
Make no mistake about it ... this is a taking.
The FED will say they are merely offering an investment to the bank (ala Warren Buffett). That will be pure spin, because while the FED will be gladhanding the banker with one hand, with the other hand, the Fed will be holding a gun to that same banker's head.
The gun will be the discount window. The Fed will threaten the bank that, unless it takes the Fed's offer of help in the form of an investment that dilutes shareholder equity in the bank, the Fed will close its discount window to that institution (and, as we all know, that would make the bank insolvent).
So, there won't be any choice on the part of bank owners. They'll take the Fed deal, because it will be a "deal they cannot refuse."
Legal. Thievery.
4. Posted by fedgovernor on October 9, 2008 @ 16:20 | Permalink
Bill Seidman, former head of the FDIC, puts it just a little bit better than I did:
"The only reason [Paulson] is putting money in those banks and the banks are accepting is that the banks will go broke without it. [Banks] are not taking this because they love the government. They're taking it because the regulator (the Fed) is saying, ‘You don't have enough capital. If you don't get more capital, we're going to close you down.’
Read the whole story here:
http://www.msnbc.msn.com/id/27101763/page/2/
5. Posted by Bruce Kraus on October 10, 2008 @ 8:16 | Permalink
For authority to inject capital directly, Paulson appears to be relying on a colloquy he arranged to have inserted in the floor debates, right before passage of the bill, when it was too late to change the text. See "Dr. Doom," Professor Nouriel Roubini on this point.
http://www.rgemonitor.com/roubini-monitor/253956/how_authorization_to_recapitalize_banks_via_public_capital_injections_partial_nationalization_was_introduced_-_indirectly_through_the_back_door_-_into_the_tarp_legislation
It's a slender reed to hang the nationalization of the banking system on, but if that's what needs to be done I suppose we should be grateful for that broad exculpation/unreviewablity clause, which didn't come out all that different from the imfamous first draft.
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