WASHINGTON, DC- At a Senate Banking Committee hearing today on the turmoil in the credit market, U.S. Senator Bob Casey (D-PA) called for more work and more explanations from the Treasury Department. Senator Casey sent a letter today to Secretary Paulson outlining some of his concerns.
Senator Casey said: “It troubles me that the Treasury has committed $250 billion to an effort to provide help to banks, without modifying a single mortgage. That is not what the Congress intended. So Secretary Paulson has more work and more explaining to do.
“We must see more urgency in loan modifications and in getting the asset purchase program up and running. This sentiment was echoed recently by FDIC Chairman Sheila Bair.
“After hearing from housing counselors in Pennsylvania who aren’t having their calls returned when they try to renegotiate mortgages to keep people in their homes, I can’t help but think that banks are holding off on modifying loans because they are waiting to see if they can sell to Treasury.
“The worst thing we can do now is to wait. Treasury needs to move more quickly to explain their plan and they must commit to modifying more mortgages.”
In his latest letter to Secretary Paulson, Senator Casey also discussed the following main points:
1) Financial institutions receiving direct investment from Treasury or guarantees from the FDIC on their debt should agree to exercise all reasonable best efforts to avoid foreclosures through loan modifications and exercise rights of mortgage related securities to ensure broadest possible mortgage modifications in a manner comparable to the Treasury Department’s obligations under Section 109 of the EESA.
2) Treasury must provide greater clarity as soon as possible in order to encourage additional private capital investments on an equal basis with the government (pari passu) in financial institutions.
3) Treasury must demand warrants for participants in the asset purchase program.
A copy of the letter is attached.
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October 16, 2008
Dear Secretary Paulson:
I write today to respond to the recent discussions at the Treasury Department regarding how to best administer the Troubled Asset Relief Program (TARP), which was authorized by Congress as the centerpiece of the Emergency Economic Stabilization Act (EESA) and signed into law by the President on October 3, 2008. I have examined your statements and the Treasury Department’s releases to date and have a number of questions.
Specifically, I have concerns about the impact of Treasury’s decision to use its new authority to make direct capital investments in banks in exchange for equity. I am pleased that these investments will be accompanied by restrictions on executive compensation. I have the following concerns:
Treasury’s diversion of at least $250 billion in TARP funds from the purchase of distressed assets to direct investments in banks will reduce its ability to affect the restructuring of a significant number of distressed mortgages;
Potential private investors don’t have the certainty they need about what the government may do in order to invest in a way that reduces the chances their investment will be diluted or wiped out; and
Treasury has not definitively committed to seeking warrants from financial institutions that sell distressed mortgage-related assets through the auction program.
I know that you are currently evaluating a range of options with the goal of making the TARP program successful and stabilizing financial markets and the broader economy. With that in mind, I would like to suggest that you consider the following options.
1) Financial institutions receiving direct investment from Treasury or guarantees from the FDIC on their debt should agree to exercise all reasonable best efforts to avoid foreclosures through loan modifications and exercise rights of mortgage related securities to ensure broadest possible mortgage modifications in a manner comparable to the Treasury Department’s obligations under Section 109 of the EESA.
As you know, negotiations over the EESA were largely focused on the degree to which mortgage markets would be stabilized through increased loan modifications. In those negotiations, Treasury agreed to a number of obligations, including those laid out in Section 109 of the legislation. I remain firmly convinced that securities markets will remain volatile until a bottom is found in housing markets. I also believe that unless we stem the rising tide of foreclosures, prices in housing markets will overcorrect. We have all seen the damage that the price corrections to date have wrought. Over-corrections pose additional threats which we must act to mitigate.
Financial institutions receiving significant benefits from government investment or guarantees should agree to modify loans which they hold in their portfolios and, similar to Treasury’s obligations under TARP, exercise rights tied to securities in their portfolios in a way that will facilitate loan modifications. They should also agree to share with Treasury, on a confidential basis if necessary, information that would be helpful to the Treasury meeting its obligations under Section 109 (b).
I understand that institutions may be reluctant to agree to these requirements. However, the government has emerged as the investor of last resort for these institutions. Additionally, the Federal Deposit Insurance Corporation has demonstrated with its management of IndyMac that these measures can actually increase the value and performance of mortgage portfolios. Since seizing control of the bank, FDIC has implemented a loan modification program that has helped people keep their homes while increasing the net present value of loans individually and of the loan portfolio as a whole.
In the case of IndyMac, FDIC acted alone and despite the free-rider and collective action problems associated with mortgage modification, was able to perform sensible loan modifications. If a majority of the financial services industry undertook similar measures it would further enhance to long-term value of these modifications to lenders by more quickly and broadly stabilizing housing markets. For these reasons, financial institutions should be required to adopt the same net present value procedures that have already proven successful.
2) Treasury must provide greater clarity as soon as possible in order to encourage additional private capital investments on an equal basis with the government (pari passu) in financial institutions.
As you know, many market participants with capital to potentially invest are not doing so. There are a variety of reasons for this hesitance, but one reason of importance to policymakers is the fear that the government will act in a way that dilutes or wipes out any private investment. This fear has only been reinforced by recent government actions.
For example, after Treasury was granted the authority to preserve Fannie Mae and Freddie Mac, market participants were unwilling to commit capital to those institutions, fearing that the government would dilute or wipe away their investment. In effect, granting explicit authority to Treasury to intervene made that intervention necessary by scaring away potential private actors.
The government should intervene to prevent institutional failures that pose systemic risk and in asset markets which are clearly broken. However, I believe that a clear consequence of the commitment to do so places private investors in an untenable position when evaluating investment options. Treasury is now the proverbial $700 billion gorilla in the room. This may have been unavoidable, but it also complicates any potential course of action and places an even greater burden on the government.
In light of these challenges, I urge you to provide greater clarity for markets about what Treasury will and will not do so that investors can react accordingly
3) Treasury must demand warrants for participants in the asset purchase program.
There has already been considerable debate over this matter and I have already expressed my thoughts in previous letters and discussions with you. This matter is of such critical importance that I raise it once again with you here, and hope that you will consider the following reasons, which I do not believe have received enough attention.
In many of the discussions that I have had with economists examining the program, one sentiment has been nearly universal: Treasury must pay the right price for assets. Prices that are too low may only exacerbate problems in financial institutions. Prices that are too high expose the taxpayer to risks and would fail to stimulate private trading of these assets because of a lack of faith in the newly established marks.
It is also relevant that since the passage of the EESA, the Securities and Exchange Commission has issued guidance which I believe weakens mark to market accounting. Though I believe Congress should not be involved in writing accounting rules, this action by the SEC is a mistake. I also believe that it increases the chances the TARP program will purchase assets at too high a price and therefore make carefully conceived warrants all the more important to constrain bidding behavior.
Potential participants have obvious and understandable incentives to seek the highest price they can. They also face pressures to realistically price their assets for fear of losing the auction. Weakening or elimination of mark-to-market accounting rules changes the incentives and consequences auction participants have. Losing the auction need not require them to realize the decline in value of their portfolios. The discretion provided may allow them to mark assets to their own models and paper over losses on their balance sheets. From the perspective of investors, banks with good and bad balance sheets will become indistinguishable as each bank uses marks of their own creation and fails to provide real disclosure to markets. If this takes place, the success of the entire program may be compromised.
For these reasons, I believe you should seek warrants similar to those initially proposed by Senators Jack Reed and Christopher Dodd. Their initial proposal was for warrants that were only valuable to the government if assets purchased were later sold at a loss. This structure complements Treasury’s desire to achieve the right price in auctions by further constraining bidding behavior.
I understand that you have argued against the use of warrants in part because they may drive up the costs for bidders and therefore the prices they will demand. This may be true for typical warrant arrangements, but it is not the case for the Reed/Dodd proposal. I believe in light of new circumstances and the effect conditional warrants would have on bidder behavior, that you should include them in your TARP program.
Thank you once again for considering my concerns and suggestions in this time of national economic crisis. I remain willing to discuss these ideas in greater detail with you and look forward to your response.
Sincerely,
Robert P. Casey, Jr.
United States Senator
