Oct 01 2008

Shelby Opposes Bailout Legislation

U.S. Senator Richard Shelby (R-Ala.), ranking member of the U.S. Senate Committee on Banking, Housing, and Urban Affairs, today delivered a statement regarding his opposition to the proposed bailout of the banking industry on the floor of the Senate. 

Senator Shelby’s remarks as prepared and included in the record:

“Mr. President, I rise today to speak before we take what will be one of the most important votes, unrelated to war, many of us will cast in the United States Senate.

The proposal before us provides 700 billion dollars to buy illiquid assets from financial institutions.  The stated goal of this scheme is to return confidence and liquidity to our credit markets.

We did not get into this situation in a matter of days, and we are not going to fix it with a piece of legislation quickly cobbled together in back rooms of the United States Capitol.

In fact, this crisis has been years in the making. Over the last decade, trillions of dollars were poured into our mortgage finance markets, often at the direction of well-intended, albeit ill-conceived government programs.

At first, the money backed conventional mortgages with standard down payments and properly verified incomes. 

Over time, the number of home buyers that met conventional loan requirements dwindled.  In order to fuel the upward spiral, mortgage products became more exotic, requiring less of borrowers and involving more risks.

Without regard for fiscal prudence and simple economics, mortgage brokers, Realtors, homebuilders, mortgage bankers, and home buyers created the conditions that helped inflate the housing bubble.

At the same time, Wall Street was developing ever more sophisticated finance vehicles to ensure that money continued to flow into the mortgage markets to meet the demand.

Mortgages were pooled, packaged, and rated “investment grade” by the credit rating agencies.  They were then sold into a market eager to purchase securities with a wide range of risks and yields. 

Many purchasers employed massive amounts of leverage, layering risk upon risk in an effort to maximize return.  To cover their risks, many of these buyers also bought credit protection from one another, entering into derivatives contracts with nominal values in the hundreds of trillions of dollars.

Eventually, economic reality caught up with us.  Housing prices stalled and then began falling. 
                                               
Many who bought homes with unconventional loans were unable to afford their rising payments.  Because home values were dropping, they were unable to refinance and delinquency rates skyrocketed.  This trend has not yet abated.    

Once homeowners began defaulting, the value of mortgage-backed securities plummeted. 

Collateralized debt obligations, or CDOs, that were comprised of the riskiest mortgage-backed securities became worthless.  As a result, financial institutions holding securitized assets have suffered enormous losses and have been desperately trying to raise new capital.

Mr. President, I have been a member of the Senate Banking Committee for over twenty years.  When I joined the Committee, the Savings and Loan crisis was just beginning to unfold. 

Let me remind my colleagues that it took nearly 10 years, 5 Congresses and 3 Administrations until that smaller, more contained crisis was resolved.

Personally, I learned a few solid lessons from that experience.  I came to understand that bank management, bank capital and sound regulatory policy make a major difference.

What I learned then has guided me ever since.

For example, in 1995, I opposed the expansion of the Community Reinvestment Act.  I did not take this position because I am against lending to minorities or low income individuals.  My concerns were based on the simple fact that credit cannot be safely extended on any basis other than risk, and risk cannot be mitigated through social engineering. 

The appropriate allocation of credit is not political, it is based on merit.  Those with good credit receive the best terms and lowest rates.  Those with bad credit receive the worst terms and the highest rates, or in some cases, no credit at all.

The CRA was an attempt to get around this fact and it failed.  I remind my colleagues of this as we prepare to buy assets backed by the very same mortgages born of this flawed policy. 

Mr. President, I find it ironic that many of those who supported the legislation that upended the basic concept of risk based lending are now saying that our present circumstances are an indication that the free market failed.  Federal policy, not free market decisions, fueled risky loans to unqualified borrowers.        

In 1999, I opposed the financial modernization bill.  Despite Alan Greenspan’s proclamations, I did not think it provided a sufficient regulatory structure to oversee the financial system it created.  I was also concerned that it lacked some basic consumer privacy protections.  Many are now claiming that that deregulatory effort led us directly to where we are today.  

In 2001, I became concerned about the banking regulators effort to modernize bank capital standards through what is known as “Basel II.”  While it was very important to update those standards, it appeared to me to that “modernization” was focused more on reducing bank capital levels than improving bank capital standards. 

During the process, it often seemed that the regulators were more interested in industry priorities than protecting the banking system.  I spent nearly five years trying to ensure that the regulators produced a balanced rule that focused on safety and soundness.

When I became Chairman of the Banking Committee in 2003, I immediately became concerned with the financial health and regulatory structure of the government sponsored enterprises, Fannie Mae and Freddie Mac. 

I did not think the entities had sufficient capital, management controls or regulatory oversight.  I was particularly troubled about their size because their combined portfolios amounted to nearly 2 trillion dollars at that time. 

I believed that their operations posed a systemic risk to the financial markets.  After each disclosed that they had committed serious accounting fraud, my concerns grew more focused and I stepped up my efforts to pass legislation. 

Those efforts were rebuffed by the Democrats on the Banking Committee.  And, let’s be clear as to what the GSE’s were doing at this time.

From 2004 when we began considering GSE legislation, up until very recently, the GSE’s went on a nearly trillion dollar sub-prime and Alt-A mortgage backed security buying spree.  Mr. President, one trillion dollars.

I do not know for sure what motivated them in this effort, but I do know the GSE’s were spending hundreds of millions of dollars lobbying Congress in an effort to stave off additional regulation. 

Fannie and Freddie’s greatest allies were those that advocated and, at times, demanded that the GSE’s continue to facilitate sub-prime and Alt-A borrowing.  As long as they complied, real regulation was dead. 

This symbiotic relationship, in turn, fueled an already over-heated market to grow even hotter.

As the driving force in mortgage finance, this purchasing effort also broke down what scant underwriting standards remained in the market place.  Many, if not most, of the toxic assets that this taxpayer funded bailout is designed to buy were originated in an atmosphere created by the GSE’s and facilitated by their supporters here in Congress.

Mr. President, during the securitization boom that took off in the last five years, I also became very concerned about the regulatory oversight of the Credit Rating Agencies whose ratings were crucial to getting securities sold. 

When I looked at the system in place, I soon realized it was dominated by two companies and that the regulatory structure provided no real oversight and actually prevented competitors from entering the market.

Considering the value that mutual, money market, retirement pension funds and insurance companies and other important investors place on the ratings, I recognized that immediate legislative action was necessary to address the shortcomings of the oversight regime.  We took that action in the Fall of 2006. 

Unfortunately, it now appears even that effort came too late.  The rating agencies provided investment grade ratings on securities worth hundreds of billions.  A large percentage of those ratings have since been downgraded. 

I remind my colleagues that those securities also happen to make up the troubled assets that are now the focus of this bailout.

Finally, Mr. President, in 2007, I publicly questioned the adequacy of the Securities and Exchange Commission’s Consolidated Supervisory Entity program. 

This non-statutory program was put in place by the SEC to allow the five big investment banks meet European regulatory standards without having to submit to Federal Reserve supervision as provided in the Financial Modernization Act.  The program also allowed the investment banks to significantly reduce their capital requirements.                 

Because I already felt that the 1999 Act did NOT provide adequate supervision, I was troubled that the investment banks continued to chafe even at this minimal supervision.

With their trillions in assets, global operations and hundreds of thousands of employees, they were content to be “regulated” by a program with a staff of less than 20 people and they vigorously lobbied the Banking Committee to keep it that way.

Needless to say, I had serious concerns about this arrangement. 

These concerns crystallized when Chairman Dodd marked-up legislation that would not only have codified the SEC’s regulatory concoction, but also would have expanded the powers of the investment banks, allowing them access to taxpayer insured funds through ownership of insured depositories. 

I requested that the Banking Committee hold hearings to examine this structure in greater detail before we ratified that which the SEC created through regulatory fiat.

Mr. President, once again, we did not. 

Instead, my Democrat colleagues voted not only to codify the CSE program, but also to expand it.  My Republican colleagues voted to reject it and argued for additional Committee action.

Today, the CSE program is gone because our investment banks have either gone bankrupt, merged, or become that which they fought so hard to avoid . . . bank holding companies supervised by the Federal Reserve. 

I would also like to point out to my colleagues that a large number of the assets that will be purchased under the Paulson plan were either originated or held by the CSE regulated firms: Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley or Goldman Sachs.              

Mr. President, we did not get to where we are today by accident, it was a path we chose.

My warnings about the risk of basing credit decisions on well-intended social mandates rather than sound, fact-based underwriting were dismissed.

My concerns about the inadequacy of the regulatory structure put in place in the financial modernization legislation went unacknowledged.

My efforts to ensure that bank capital standards were designed to ensure safety and soundness, rather than industry concerns, were conducted largely alone.

When I urged focus on the SEC’s Consolidated Supervisory Entities program, my Democrat colleagues ignored me and instead voted to ratify and expand the program.
   
When we attempted to pass meaningful GSE reforms, we were repeatedly stopped. 

I commend Senator Dodd, who in the end, worked with me to pass a bill.  Unfortunately, that effort came too late because the GSE’s had already gorged on billions of dollars of toxic sub-prime paper and no longer could function on a stand alone basis.

As often as I have argued that we needed to address systemic risks in the financial markets, my advice has been dismissed and my concerns have proven to be fully justified.

I now have serious concerns about the bailout package we are preparing to pass. 
My foremost concern relates to the manner in which we are attempting to address the problem.  

The Paulson plan focuses on a single problem - illiquid assets held throughout the financial system. 

I believe we have a number of interrelated problems that need to be addressed in order of their significance. 

First, and most urgent, is liquidity.  Then we must address the solvency of our financial institutions and declining home values, not to mention our entire regulatory structure.

I believe Congress can address the liquidity issue by increasing the combined resources of the Federal Reserve System and the Treasury.

By enhancing the Federal government’s existing lending facilities and guarantee programs, we can help stabilize money market funds and provide loans to troubled financial institutions without exposing taxpayers to massive losses.  This act alone would allow us some time to consider thoroughly our next steps.

Thereafter, we must determine how to address the troubled assets on the books of financial institutions and continue the process of dealing with declining home values.  This will likely be a long and difficult process, a fact that is not being shared with the American people.

As long as we address the immediate liquidity problem by expanding lending facilities using the illiquid securities as collateral, we can then take the necessary time to do our work in a more responsible and thoughtful manner.  It appears, however, that we are not going to subject this bill to our normal process.

With that in mind, Mr. President, I would like to take some time to look more closely at what this unprecedented piece of legislation would do.

The Emergency Economic Stabilization Act of 2008 would create the Troubled Asset Relief Program. 

It would authorize the Treasury Secretary to purchase up to $700 billion worth of troubled assets from just about any type of institution.

In exercising this authority, the Secretary would be vested with nearly unfettered power. 

The Secretary could purchase any financial instrument he deems necessary to promote financial market stability.  He could purchase not only mortgage-related assets, but securities based on credit card payments, auto loans, or even common stock. 

The Secretary could purchase assets from any institution, not just financial institutions so long as they have “significant operations in the United States.” 

What constitutes “significant operations” is left undefined, leaving the Secretary a great deal of latitude in determining which institutions would qualify for the program.

Certainly the Secretary could purchase assets from private equity firms and hedge funds, but also corporations and state governments.  Given the lack of standards and the breadth of the Secretary’s authority, it should be no surprise if politically-connected entities get special treatment under this program. 

Under a provision hidden deep in the legislation, the Treasury Secretary also has the authority to purchase troubled assets from foreign central banks and governments.

The Secretary has unlimited authority on how the purchased assets are managed and sold. Treasury could even set up government-run hedge funds that compete with private companies. 

While the Treasury Secretary’s authority expires at the end of 2009 and can be extended for only one additional year, the Treasury’s authority to manage purchased assets is perpetual. 

Treasury could also purchase assets after the termination of its authority, if it has entered into agreements to purchase prior to the termination date.  This program will be with us for decades to come. 

The few restrictions imposed on the Treasury Secretary’s authority could undermine the effectiveness of the program.  If the Secretary purchases more than $100 million in troubled assets from an institution, he must obtain non-voting common stock or preferred equity in the institution. 

To complicate matters further, the bill does not provide clear guidance on how many warrants the Secretary should obtain or what their terms should be. 

If the Secretary makes direct purchases of troubled assets, the selling institution must adopt standards on executive compensation and corporate governance. 

If the Secretary purchases more than $300 million in trouble assets from an institution, the institution must adopt restrictions on executive pay and golden parachutes for any new senior executives it hires. 

The legislation also restricts the amount of executive compensation participating institutions can deduct for tax purposes.  While this may make us feel good, these provisions will likely limit the number of institutions that utilize the program.

Not to mention that the compensation restrictions are prospective.  In other words, the people who created this mess get to walk away with cash in hand, and the people hired to clean it up get penalized. 

This will no doubt undermine their efforts to resolve their financial problems by hindering their ability to hire new management.

Upon enactment of the legislation, the Treasury Secretary is authorized to purchase up to $250 billion in troubled assets.  This purchase authority can be increased by another $100 billion if the President certifies that such additional authority is needed. 

The Secretary’s authority can be, and likely will be, increased to $700 billion if the President certifies the need and Congress does not enact a joint resolution of disapproval.

It is extremely difficult to obtain the 2/3 votes in both the House and Senate to override a veto.  Therefore, for all intents and purposes, this distribution system is a mirage.  It does not effectively limit the Treasury Secretary’s ability to spend $700 billion.

The bill would establish a Financial Stability Oversight Board to review and make recommendations on the Secretary’s operation of the program.  The Oversight Board is fatally flawed. 

First, the Secretary of the Treasury is one of its members.  This means that the Treasury Secretary is reviewing his own actions.

Second, the other members of the Board include the Chairman of the Fed, the Director of the Federal Home Finance Agency, the Chairman of the SEC, and the Secretary of Housing and Urban Development.  I think there is a Constitutional question about whether a Secretary can have his actions reviewed by any person other than the President. 

Even if the Board is Constitutional, why is the Chair of the FDIC not a member?  After all, the FDIC has the most experience of any Federal agency in buying and selling bank assets.  It also is concerned about resolving bank problems with the least cost to the taxpayers. 

Regardless of who sits on the Board, we will be setting a bad precedent by having heads of agencies oversee our Cabinet Secretaries.

Finally, the Oversight Board’s authorities are not well defined, so it is not clear what happens if the Oversight Board disagrees with the Treasury Secretary’s actions.  Can it prevent him from acting?  Will disagreements result in litigation?  Such bureaucratic infighting could very well undermine the effectiveness of the program, to the extent it can be effective at all.

The bill also establishes a Congressional Oversight Panel, whose members will be selected by the leaders of the House and Senate.  The Panel is charged with providing reports on the program, the effectiveness of foreclosure mitigation efforts, and the state of our financial regulatory system. 

This is work the Senate Banking Committee and House Financial Services Committee should be doing.

The bill also provides for oversight of the program by the Comptroller General, establishes an Office of the Special Inspector General for the program, and subjects the Secretary’s actions to judicial review.  

While I think it is important to oversee this new entity’s activities, this hodgepodge of authority is likely to hamper the program’s effectiveness as it struggles to satisfy redundant and time-consuming requests for information. 

These oversight bodies might not check the Secretary’s authority, but they will ensure that this program generates lots of paper.  More importantly, they do nothing to address the fundamental flaws with this plan. 

The Secretary is required to issue regulations to address conflicts of interest.  Interestingly, the Secretary may start buying assets before these rules are put into place.  This is a loophole that could have serious long-term consequences for the program.

The bill does not require that taxpayer losses be repaid by its beneficiaries.  It only directs the President to present a legislative proposal to recoup such losses from the financial services industry. 

This is something that the President could do even without this legislation.  Furthermore, there is no guaranty that the beneficiaries of the program will pay. 

Indeed, it is likely that companies that did not participate in the program would end-up covering its costs.

The bill would grant the SEC the authority to suspend mark-to-market accounting, establishing a dangerous precedent that could lead to the politicization of our accounting standards, something I have fought for years.

The newest addition to the bill is a precipitous increase in the deposit insurance amount from $100,000 to $250,000.  Mr. President, we are about to more than double the exposure of the already depleted deposit insurance fund, and by extension, the American taxpayer, on a whim. 

I will remind my colleagues that the track record for overnight increases in deposit insurance is not pretty.  In 1980, Congress increased deposit insurance coverage for all accounts from $40,000 to $100,000 without the benefit of hearings or open discussion. 

At that time, proponents argued such a change was necessary to stabilize the banking industry.  What followed was a massive bailout of the savings and loan industry to the tune of well over $100 billion.

This time around, we are proposing a 150% increase when the Deposit Insurance Fund is already stressed and in need of recapitalization. 

At a time the FDIC’s problem bank list is growing and more failures are anticipated, this higher deposit insurance coverage will increase the FDIC’s expected payments for failed insured depositories.  Those costs, which would ordinarily be passed on to the banking system in the form of higher premiums, will instead be placed directly on taxpayers.

Let’s also be realistic about this. To the extent this measure is intended to address the concerns of those who handle large transaction accounts, such as corporate treasury deposits, those people are not going to be comforted by additional coverage levels.

If they believe a bank is in trouble, they will withdraw their money because deposit insurance does not increase confidence in a failing institution.

Let’s also be clear about what this means for taxpayers.

If, on the front end, the $700 billion dollar bailout is not enough to shore things up, rest assured, there will now be more insurance on the back end should banks begin to fail.  The American taxpayer will pay, both coming and going.

The bill does do some good things, however.  It permits the Federal Reserve to pay interest on reserves, which will improve its ability to conduct monetary policy and serve as a lender of last resort. 

The bill does marginally increase the availability of the HOPE for Homeowners program and requires the Secretary to implement a plan to assist homeowners to the extent it acquires mortgages or other assets backed by mortgages. 

While I generally do not support bailing out corporations or individuals, if we are going to get into the bailout business, then funds should be directed to individuals as well.  The provisions in this bill for individual homeowners, however, are inconsequential compared to the $700 billion going to Wall Street.

Mr. President, as I said, I am no advocate of bailouts.  I voted against the Chrysler bailout.  I cannot say I would have supported a bailout in this instance, but I can say the chances would have been much greater if the underlying plan had been subjected to greater scrutiny and examination. That said, I agree that we need to do something to address the current liquidity crisis in the marketplace.

My greatest concern is that we have not spent any time determining whether we have chosen the best response.  There are many well informed people who argue that we have not.

In fact, just this morning, a Nobel prize winning economist indicated that using a reverse auction program to buy distressed assets from financial institutions was not going to be enough to “revive the operations of the banks.”

I am not sure whether he is right or wrong.  I am also not certain whether the Secretary is right or wrong.  To the extent other options exist, I believe we failed the American people greatly in not examining them.

Mr. President, many around here are finding comfort in the notion that “something is better than nothing.”  I believe that is a false choice.  The choice we faced was between pursuing an informed response or panic.

Mr. President, unfortunately we chose panic and are now about to spend $700 billion dollars on something we have not examined closely.  Yes, in the end, we will have “done something.”  At the same time, however, we will have done nothing to determine whether it will accomplish anything at all.”