This week the Congress passed the controversial $700 billion Bailout Bill. This Bill comes with blame and finger-pointing.
Democrats blaming Republicans for deregulation. Republicans blaming Democrats for failing to reel in Fannie Mae and Freddie Mac. Our nation blaming Wall Street.
So who is really to blame?
Mortgage Lenders. Lenders who made exotic loans to people who shouldn't have gotten them.
Real estate agents. Agents who sold houses to people who should have been looking at cheaper homes where they didn't need an interest only loan, adjustable rate mortgage, or to "state" their income to qualify.
Congress. Democrats and Republicans. Aside from a few warnings from select members on each side of the aisle that fell on deaf ears, neither side saw this coming.
Wall Street. Based on historical data that told them that real estate never depreciates nationally, they created some of the most exotic loan products we have ever seen. Remember 100% stated-income option ARM's with 1.00% start rates?
Fannie Mae and Freddie Mac. For buying these exotic products in the name of shareholder profit.
Credit rating agencies. They gave investment-grade ratings to subprime loans. These high ratings encouraged the flow of investor funds into these securities, helping finance the housing boom.
The Government of the 1990's. The government pressured Fannie and Freddie to lower credit restrictions to create homeownership opportunity for lower income families and minorities, who were getting bilked by subprime lenders. The shareholders loved it as they sought more profit.
Is there any need to go on?? I am sure you can add a few more.
There will be a post-disaster Congressional Committee that will hold weeks of hearings someday. This will culminate in a nice, glossy, table-top, "What Went Wrong?" 800-page report that you can buy on Amazon for $29.95. Pre-order now for $24.95.
Today, we are being asked to pay a very big price for these mistakes. A $700 billion bailout bill that has been promised to save the economy....for now. There is anger. Many people don't understand how we got here. Many more don't understand why we need to do this.
Let me try and explain. These toxic mortgages, in combination with foreclosure losses, have driven many lenders and financial institutions out of business. For most that remain, their capital has been dramatically reduced.
Investors who provide capital have had their confidence shattered by these events and this has limited capital further.
This has created a situation where it is very difficult to get credit. There is a decrease in money to lend. This means credit is limited. Most Americans, rightfully or wrong, run their lives, their businesses, and their households on credit.
We could have done nothing. No bailout. We could have let the market sort itself and let all of the broke banks and institutions collapse.
What would have happened then?
People with debt would have had most of it forgiven. Those with savings would lose a big portion of it.
You would get title to your home for almost nothing and your debts would probably be written off. You would probably only lose your home if you didn't stay up on your property taxes.
The banks and financial institutions would drop dead. Currently there are over 100 banks on the FDIC watch list of institutions that could fail soon.
Small businesses that run on credit, which is most, would fail. Millions would go unemployed with nowhere to go and the economy would fail with the promise of returning someday.
The U.S. Government, with 11 trillion in debt, would likely collapse. We could start over.
One of my closest friends owns an air conditioning company with a staff of about 40. Some of whom have been with him since day one. 15 years.
They do large jobs for big companies. The average cost of a job is about $25,000 and they bill out $35,000 for this work. A profit of $10,000 per job. Nice little business.
However, these clients take, on average, 60 - 120 days to pay. Sometimes he is owed $500,000 or more at any one time. He has a credit line that allows him to make his payroll, pay his employees health care, his rent, utilities, etc. while he waits for his money.
Last week, he was told by his bank of 15 years that his credit line would be frozen at the end of October. He didn't do anything wrong. His business still thrives and is successful. He has never missed a single payment with the bank and is one of their very best customers.
The bank just couldn't keep offering it. He now has 30 days to find a new credit line, which is next to impossible today, or he will be out of business and his 40 loyal staffers out of work.
This is not an isolated tale. This is the norm. His is one business and there are 100,000's, if not millions, just like it. This is what Congress was faced with.
So, the bill passed. The "Emergency Economic Stabilization Act of 2008."
BOTTOM LINE: If you are late on your mortgage, in arrears, or struggling to make your mortgage payment on time each month, your loan is likely considered "toxic."
If your bank thinks your loan is toxic, they can now sell this loan to the Government, get it off their books, and turn it into cash for their other lending trade like credit lines for business.
This will free up capital that they can now lend to borrowers and businesses that need it, can pay it back, and get the economy flowing again.
The Government can then allow for you to refinance into the Hope for Homeowners program that started on October 1, 2008, they can work out your loan, or they can foreclosure on you and sell your home to the highest bidder to pay back taxpayers.
The lender can also have your loan insured by the Government to protect it from further deterioration. In that case, you will have to continue to workout your toxic mortgage with the bank you have now.
Let's break it down. Say you bought your home for $300,000 and you borrowed $300,000. Today, the home is worth $250,000.
You are behind on your mortgage, or you have missed a few payments in the past year. Maybe you have a few recent late payments or you pay late fees each and every month.
If any of these apply to you, your bank probably considers your loan "toxic."
Based on the Bailout Plan, your bank can now sell this toxic loan to the Government or get it insured. The bank will likely get somewhere between 20 - 70 cents on the dollar for it, depending on how bad your situation.
Let's say the bank get 50 cents on the dollar for your home. They sell your loan to the Government for $150,000. This gets the bank the cash they need for survival and to make good loans.
It's now easier for the Government to work with you to stay in the home. If they have to foreclose on it, they actually have a chance at profitability for taxpayers when they sell it to the next guy.
Some argue that the Bill makes it better for the Government not to work with you to stay in your home. It's much more profitable for them to kick you out, sell the asset as soon as possible, and limit taxpayer losses. In addition, the Note they are buying may not allow for any changes. This will be interesting to watch.
This Bill is certainly not guaranteed to work. Most experts agree this will not change the economy overnight.
However, many believe it's the first step in a very long road for recovery.
Here are some of the Bill's highlights:
Section 101. Purchases of Troubled Assets.
Establishes a Troubled Asset Relief Program ("TARP") to purchase troubled assets from financial institutions.
Section 102. Insurance of Troubled Assets.
Establishes a program to guarantee troubled assets of financial institutions.
Section 104. Financial Stability Oversight Board.
Establishes the Financial Stability Oversight Board to review and make recommendations regarding the exercise of authority under this Act and to protect taxpayers.
Section 105. Reports.
Tranche Reports: For every $50 billion in assets purchased, a detailed description of all transactions, a description of the pricing mechanisms used, and justifications for the financial terms of such transactions is required.
Section 106. Rights; Management; Sale of Troubled Assets; Revenues and Sale Proceeds.
Requires profits from the sale of troubled assets to be used to pay down the national debt.
Section 107. Contracting Procedures.
Allows the FDIC to be selected as an asset manager for residential mortgage loans and mortgage-backed securities.
Section 109. Foreclosure Mitigation Efforts.
For mortgages and mortgage-backed securities acquired, there must be a plan to mitigate foreclosures and to encourage servicers of mortgages to modify loans through Hope for Homeowners and other programs.
Allows use of loan guarantees and credit enhancement to avoid foreclosures.
Requires coordination with other federal entities that hold troubled assets in order to identify opportunities to modify loans, considering net present value to the taxpayer.
Section 110. Assistance to Homeowners.
Requires federal entities that hold mortgages and mortgage-backed securities, including the Federal Housing Finance Agency, the FDIC, and the Federal Reserve to develop plans to minimize foreclosures.
Requires federal entities to work with servicers to encourage loan modifications, considering net present value to the taxpayer.
Section 111. Executive Compensation and Corporate Governance.
Provides that Treasury will promulgate executive compensation rules governing financial institutions that sell it troubled assets.
Section 112. Coordination With Foreign Authorities and Central Banks.
Requires the Secretary to coordinate with foreign authorities and central banks to establish programs similar to this one.
Section 113. Minimization of Long-Term Costs and Maximization of Benefits for Taxpayers.
In order to cover losses and administrative costs, as well as to allow taxpayers to share in equity appreciation, requires that the Treasury receive non-voting warrants from participating financial institutions.
Section 114. Market Transparency.
48-hour Reporting Requirement: The Secretary is required, within 2 business days of exercising authority under this Act, to publicly disclose the details of any transaction. There will likely be a website that reports all of the transactions.
Section 115. Graduated Authorization to Purchase.
Authorizes the full $700 billion.
Allows to immediately use up to $250 billion.
Upon a Presidential certification of need, may access an additional $100 billion.
The final $350 billion may be accessed if the President transmits a written report to Congress requesting such authority.
Section 116. Oversight and Audits.
Requires ongoing oversight of the activities and performance, and to report every 60 days to Congress.
Section 117. Study and Report on Margin Authority.
Directs the Comptroller General to conduct a study and report back to Congress on the role in which leverage and sudden deleveraging of financial institutions was a factor behind the current financial crisis. (this is what you will pre-order on Amazon)
Section 120. Termination of Authority.
Provides that the authorities to purchase and guarantee assets terminate on December 31, 2009. Can be extended for an additional year upon certification of need to Congress.
Section 122. Increase in the Statutory Limit on the Public Debt.
Raises the debt ceiling from $10 trillion to $11.3 trillion.
Section 124. Hope for Homeowners Amendments.
Strengthens the Hope for Homeowners program to increase eligibility and improve the tools available to prevent foreclosures.
Section 125. Congressional Oversight Panel.
Establishes a Congressional Oversight Panel to review the state of the financial markets, the regulatory system, and the use of authority under TARP. The panel is required to report to Congress every 30 days and to submit a special report on regulatory reform prior to January 20, 2009. The panel will consist of 5 outside experts appointed by the House and Senate Minority and Majority leadership.
Section 131. Exchange Stabilization Fund Reimbursement.
Protects the Exchange Stabilization Fund from incurring any losses due to the temporary money market mutual fund guarantee by requiring the program created in this Act to reimburse the Fund. Prohibits any future use of the Fund for any guarantee program for the money market mutual fund industry.
Section 134. Recoupment.
Requires that in 5 years, the President submit to the Congress a proposal that recoups from the financial industry any projected losses to the taxpayer.
Section 136. Temporary Increase in Deposit and Share Insurance Coverage.
Raises the FDIC and the National Credit Union Share Insurance Fund deposit insurance limits from $100,000 per account to $250,000 until December 31, 2009.
Section 302. Special Rules for Tax Treatment of Executive Compensation of Employers Participating in the Troubled Assets Relief Program.
Applies limits on executive compensation and golden parachutes for certain executives of employers who participate in the auction program.
Section 303. Extension of Exclusion of Income From Discharge of Qualified Principal Residence Indebtedness.
Extends current law tax forgiveness on the cancellation of mortgage debt.
You can read all 451 pages of it here:
http://www.house.gov/apps/list/press/financialsvcs_dem/essabill.pdf
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