I would have posted this earlier this evening, but the US House Committee on Financial Services site was down due to the overwhelming response to download the act.

Here is the full proposed Act emergency-economic-stabilization-act-2008-ayo08c04_xml (EESA)

Here is the more useful part for most their one page summary – emergency-economic-stabilization-act-2008-summary-ayo08c04_xml

There are five parts:

1. Stabilizing the Economy
2. Homeownership preservation
3. Taxpayer Protection
4. No Windfall for Executives
5. Strong oversight

I took away a few thoughts:

Much of the rhetoric in the bill worded to protect the US taxpayer and punish the big bad banker, will do much of neither.  There is a general theme to the Act that bankers have engaged in predatory lending on poor people with bad mortgage terms that pressed those poor people into losing their home.  Sensitive issue.  One thing that does make sense in the Act is the ability of the Treasury to alter the terms of the mortgage to make it more affordable.

EESA requires the Treasury to modify troubled loans – many the result of predatory lending practices

This provision is of course unfair to the average middle class with mortgages who happen to be able to afford them.  That same middle class were also not complicit in questionable information practices between mortgage brokers and banks.  Nonetheless this provision makes sense, if for no other reason than some locations will lose their ability to have a consumer credit market otherwise, eg. Detroit.

However we are where we are, and finding ways to make the mortgages affordable for those people will bring back some semblance of stability to the real estate market.

The issue I have with this legislation, and the one dead moose on the table <sorry, Canadian expression> that no-one has spoken of is Bank debt.  The notion of managing bank executive pay is ludicrous.  Stupid banks will always find ways to remunerate stupid executives.  Has no-one heard of forgivable loans?  Take a dig on financial statements and see the size of those for junior growing executives.

No, the way to harness Banks is to increase their capital requirements.  This is the one ting that makes banker cringe.  Banks are over-extended with debt, and in a normal bank to customer negotiation, if the bank were applying for credit, the bank would not qualify for debt.  {for non-bankers:  debt = customer deposits}

Some examples:

Bank	Debt (deposits)	Equity (Capital)	D/E ratio
Bank of America	1,554,184	162,691	10 : 1
Wells Fargo	561,110	47,964	12 : 1
JP Morgan	1,642,494	133,176	12 : 1

We could continue but the results would be similar.  This is also little different in other countries;  its not an American thing.  Why is it important?  If one of those Banks loses an amount equal to or more than their capital base, they are bankrupt.  Capital is the basis for solvency in a company, the protection against rainy days.

Thats the dead moose.  Banks have no room to manoeuvre.  The banking system works so long as everyone trusts each other, and money can move freely between qualified institutions; banks that are organisations with banking charters.  Thats why the situation in the last two weeks has gone critical.  Banks have refused to lend to each other, and instead have been forced to borrow from their respective Central Banks.  This is borne out by treasury bill being bid higher and higher until reaching close to par.  In layman’s terms that means the interest rate on T-bills reached close to zero twice in the last couple of weeks.  Thats not a good thing.  Its a sign the economy has come to a standstill, and that’s why this EESA is required.  Banking cannot be compartmentalised from the rest of the economy.  The influence of banking transactions is a reflection of the entire economy.   This is a partial nationalisation of banks, and there is little alternative because government regulations permitted the banks to get into this predicament.

This is recognised in the Act on page 13, wherein they note that financial assistance to Banks will be necessary:

In exercising the authorities granted in this Act, the Secretary shall take into consideration—

(6) providing financial assistance to financial institutions, including those serving low- and moderate-income populations and other underserved communities, and that have assets less than $1,000,000,000, that were well or adequately capitalized as of June 30, 2008, and that as a result of the devaluation of the preferred government-sponsored enterprises stock will drop one or more capital levels, in a manner sufficient to restore the financial institutions to at least an adequately capitalized level;

Relevance to Bankwatch:

The word capital exists once in the act.  Capitalization exists twice.  The thing that is missing from EESA is the requirement for Banks to recapitalise.  That is the final test that would penalise bankers, and bank investors, but so be it.  It would be tough medicine with far reaching consequences, for banks and for the economy, but its time has surely come.