What Was the Bank Bailout Bill?
Cost, Impact, How It Passed
The Senate passed the $700 billion bank bailout bill on October 3, 2008. The guts of the bill were the same as the three-page document submitted on September 21, 2008 by Treasury Secretary Henry Paulson.
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.
The goal was to renew confidence in the functioning of the global banking system, which had narrowly avoided collapse.
The bill established the Troubled Assets Relief Program. Troubled banks had the right to submit a bid price to sell their assets to TARP as part of a reverse auction. 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 end up happening. It took too long to develop the auction program. So instead, Treasury lent $115 billion to banks by purchasing preferred stock.
The Bailout Bill Helped More Than Just Banks
Congress attached other much-needed oversights. As a result, the bill included help for homeowners facing foreclosure. It required the Treasury Department to both guarantee home loans and assist homeowners in adjusting mortgage terms through HOPE NOW.
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.
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.
The bill contained an additional $150 billion in tax breaks to be phased in over 10 years. These included an extension of the Alternative Minimum Tax “patch,” tax credits for research and development and relief for hurricane survivors. A senate vote gave the bailout plan new life with these tax breaks.
How the Bailout Bill Was Passed
Secretary Paulson submitted the bailout bill to the House of Representatives on September 21, 2008. But many in Congress felt it was forcing taxpayers to reward bad banking decisions. The House voted against it on September 29, 2008. The Dow fell 770 points and global markets plummeted.
The Senate re-introduced the proposal by attaching it to a bill that was already under consideration. This side stepped the House of Representatives, which must introduce any funding bills. The House finally approved that version on October 3, 2008. President Bush signed the Emergency Economic Stabilization Act of 2008 into law within hours.
EESA kept six of the 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 HUD.
- 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. (Sources: "Bailout Bill Summary," Senate Banking Committee. "Rescue Bill Released," CNNMoney, September 28, 2008.)
Why the Bailout Bill Was Necessary
Investors and businesses triggered the bailout when they 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.
To stem the panic, the U.S. Treasury Department agreed to insure money market funds for a year. The SEC banned short-selling financial stocks until October 2 to reduce volatility in the stock market. In September 2008, the Reserve Primary Fund broke the buck and caused a money market run.
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 AIG 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 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 lent out the entire $700 billion. First, Congress only authorized $350 billion to be lent out in 2008. The other half was saved for the new president when he took office in 2009. Obama never used the TARP funds for more bank bailouts. Instead, he launched the $787 billion Economic Stimulus Package.
Second, the government bought bank stocks when the prices were depressed. It sold them later, when prices were higher. By 2012, banks had repaid $292 billion of TARP funds. That left only $120 billion still outstanding. These funds were used for the HARP program to help homeowners facing foreclosure.
Third, the bill required the president to develop a plan to recoup losses from the financial industry if needed.
These articles explain the events that led to the crisis: Financial Crisis Timeline, Could the Mortgage Crisis and Bailout Have Been Prevented?, and What Was the Global Financial Crisis of 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 therefore hoarding 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.