What Was the Bank Bailout Bill?
Cost, Impact, How It Passed
Treasury Secretary Henry Paulson had asked Congress to approve a $700 billion bailout to buy mortgage-backed securities that were in danger of defaulting. By doing so, Paulson wanted to take these debts off the books of the banks, hedge funds, and pension funds that held them. His goal was to renew confidence in the functioning of the global banking system and end the financial crisis.
The bill established the Troubled Assets Relief Program. Paulson's initial version was designed around a reverse auction. Troubled banks would submit a bid price to sell their assets to TARP. Each auction was to be for a particular asset class. TARP administrators would select the lowest price for each asset class. That was to help assure that the government didn't pay too much for distressed assets.
But this didn't happen because it took too long to develop the auction program. On October 14, 2008, the Treasury Department used $105 billion in TARP funds to launch the Capital Purchase Program. It purchased preferred stock in the eight leading banks.
By the time TARP expired on October 3, 2010, Treasury had used the funds in four other areas.
- It contributed $67.8 billion to the $182 billion bailout of insurance giant American International Group.
- It used $80.7 billion to bail out the Big Three auto companies.
- It loaned $20 billion to the Federal Reserve for the Term Asset-Backed Securities Loan Facility. The Fed lent TALF money to its member banks so they could continue offering credit to homeowners and businesses.
- It set aside $75 billion to help homeowners refinance or restructure their mortgages with the Homeowner Affordability and Stability Plan.
The Bailout Bill Was More Than Just TARP
On September 20, 2008, Secretary Paulson submitted a three-page document to the House of Representatives. But many in the House felt it was forcing taxpayers to reward bad banking decisions. Supporters added many safeguards to try and get the bill to pass. Despite them, the House voted against it on September 29, 2008. As a result, global markets plummeted. The Dow fell 777.68 points during intraday trading. That was its most significant single-day point drop ever.
The Senate reintroduced the proposal by attaching it to a bill that was already under consideration. The House also approved that version on October 3, 2008.
The final Act included other much-needed oversights.
It increased Federal Deposit Insurance Corporation limit for bank deposits to $250,000 per account. It allowed FDIC to tap federal funds as needed through 2009. That allayed any fears that the agency itself might go bankrupt.
The bill allowed the Securities and Exchange Commission to suspend the mark-to-market rule. This law forced banks to keep their mortgages valued at present-day levels. This meant that bad loans had to be valued at less than their probable true worth. These loans could not have been resold in the panic-stricken climate of 2008.
EESA included an extension of the Alternative Minimum Tax “patch,” tax credits for research and development, and relief for hurricane survivors. The senate vote gave the bailout plan new life with these tax breaks.
It kept six other provisions added by the House:
- An oversight committee to review Treasury's purchase and sale of mortgages. The committee was comprised of Federal Reserve Chair Ben Bernanke, and the leaders of the SEC, the Federal Home Finance Agency, and the Department of Housing and Urban Development.
- Bailout installments, starting with $250 billion.
- The ability for Treasury to negotiate a government equity stake in companies that received bailout assistance.
- Limits on executive compensation of rescued firms. Specifically, companies couldn't deduct the expense of executive compensation above $500,000.
- Government-sponsored insurance of assets in troubled firms.
- A requirement that the president propose legislation to recoup losses from the financial industry if any still existed after five years.
Why the Bailout Bill Was Necessary
On September 16, 2008, the $62.6 billion Reserve Primary Fund was under attack. Investors were taking out money too fast. They worried that the Fund would go bankrupt due to its investments in Lehman Brothers. The next day, businesses pulled a record $140 billion out of money market accounts. They were moving the funds to Treasury bills, causing yields to drop to zero. Money market accounts had been considered one of the safest investments.
The U.S. government bought these bad mortgages because banks were afraid to lend to each other. This fear caused Libor rates to be much higher than the fed funds rate. It also sent stock prices plummeting. Financial firms were unable to sell their debt. Without the ability to raise capital, these firms were in danger of going bankrupt. That's what happened to Lehman Brothers. It would have happened to the American International Group and Bear Stearns without federal intervention.
Congress debated the pros and cons of such a massive intervention. Political leaders wanted to protect the taxpayer. They also didn’t want to let businesses off the hook for making bad decisions. Most in Congress recognized the need to act swiftly to avoid a further financial meltdown. With banks afraid to disclose their bad debt, it became a case of fear feeding on fear. That would have led to a downgrade in their debt rating, then to a decline in their stock price. They would have been unable to raise capital. They would have gone bankrupt. The rumors and resulting panic locked up the credit markets.
The taxpayer was never out the entire $700 billion.
First, Treasury disbursed $439.6 billion of TARP funds in total. By 2018, it had put $442.6 billion back, making $3 billion in profit. It did this by nationalizing companies when prices were low and selling them when prices were high.
Third, the bill required the president to develop a plan to recoup losses from the financial industry if needed. As a result, the taxpayer was never at risk of losing $700 billion.
Many argued that the mortgage crisis and bailout could have been prevented. They argued that the Fed should have responded in 2006 when housing prices fell. It triggered mortgage foreclosures when homeowners realized they couldn't sell their homes. In 2007, the crisis became obvious when banks wouldn't lend to each other. But the Fed thought it averted the crisis when it bailed out Bear Stearns in March 2008.
When the bill was introduced, many legislators wanted to save the taxpayer $700 billion. Here is a discussion of many of them and their probable impacts.
Buy mortgages - 2008 Republican presidential candidate John McCain proposed having the government buy $300 billion in mortgages from homeowners who were in danger of foreclosing. That might have reduced the amount of toxic mortgages on banks' balance sheets. It could have even helped stop falling housing prices by reducing foreclosures. But it didn't address the credit crisis. The crisis was caused by banks being afraid to lend to each other and their consequent hoarding of cash.
Cut taxes for banks - In opposing the bailout, the Republican Study Committee proposed suspending the capital gains tax for two years. That would have allowed banks to sell assets without being taxed. But it was losses on assets that were the issue, not gains. The RSC wanted to transition Fannie Mae and Freddie Mac to private companies. They also proposed stabilizing the dollar. Neither of those addressed the credit crisis.
On the other hand, the RSC's proposal to suspend mark-to-market accounting would have alleviated bank write-down of assets sooner. The U.S. Financial Accounting Standards Board eased the rule in 2009.
Do nothing - Many suggested just letting the markets run their course. In that scenario, businesses around the world would likely shut down due to lack of credit. That would have created a global depression. The large-scale unemployment could have led to riots or another Great Depression.