Bailout funds being spent in ways Congress never foresaw

Posted on Thursday, October 30, 2008
Bailout funds being spent in ways Congress never foresaw
By Kevin G. Hall | McClatchy Newspapers

WASHINGTON " After a bruising battle to get it through a doubting Congress, the Bush administration's $700 billion Wall Street rescue plan to purchase distressed mortgages and other bad assets has morphed into something else entirely.

Today the Emergency Economic Stabilization Plan, signed by President Bush on Oct. 3, involves the government taking direct equity stakes in banks, and at least one bank used the money to buy a rival. The taxpayer money's also expected to be used to buy stakes in life insurance companies, and may soon even go to help two struggling Detroit automakers merge.

In short, what once was disparagingly referred to as bailout for Wall Street now looks like a broader bailout of all sorts of troubled businesses. Some lawmakers and outside analysts question whether that's serving the public interest as intended " or whether it's becoming a taxpayer-financed giveaway to favored firms.

"I could say I told you so," said Rep. Joe Barton, R-Texas, who helped lead a revolt against GOP leaders and sunk the $700 billion plan on its first pass. "It was so open-ended and we put so little accountability into it, they can basically do whatever they want to with the money."

Lawmakers in both parties worried when the Treasury Department announced on Oct. 14 that $250 billion of the $700 billion plan would be used to inject cash directly into troubled banks. That pushed Treasury's previous emphasis on purchasing troubled mortgage assets to the back burner.

Some $125 billion was used to take equity stakes in the nine largest U.S. banks, and now lenders across the nation can ask, through Nov. 14, for more. At least a dozen other banks have done so.

In an interview with McClatchy, Massachusetts Rep. Barney Frank, the House Financial Services Committee chairman, who shepherded the legislation through Congress, disagreed that the plan has morphed beyond its original intent.

"Buying equity was always in the plan," he insisted. Still, he said he'd hold a Nov. 18 hearing to look at some of the developments that are troubling other lawmakers.

Among them is the fact that Pittsburgh-based PNC Financial Services used some of its $7.7 billion in taxpayer money to purchase Cleveland-based lender National City for $5.8 billion on Oct. 24.

That raised a question: Did the taxpayer money spur more lending, as the plan was intended to do, or did it just let one strong bank, PNC, get stronger by absorbing a weaker rival?

Some experts think that's just fine.

"I think it is very positive if it's a healthy bank buying a weak bank, and it's an all-stock deal," said Bert Ely, an expert on banking regulation. PNC's purchase of National City was in the taxpayer interest because it promoted an orderly and needed consolidation in the banking sector, he said.

However, on the same day as the PNC deal, the American Council of Life Insurers confirmed that Treasury was considering giving cash to some big insurance companies whose failure could pose risks to global finance.

"The purpose (of the rescue plan) is not to sell life insurance policies," Frank acknowledged, noting that Treasury hadn't told him that it might take stakes in insurers, too.

Yet another concern is that banks that receive cash from the government were allowed to continue to pay dividends to shareholders. That raises the prospect that taxpayer money will be funneled not to new lending but to well-heeled investors who buy bank stocks.

That's unlikely, the Bush administration insists.

Ed Lazear, the chairman of the White House Council of Economic Advisers, said on Thursday that he isn't worried that banks will use taxpayer money to pay shareholders because it's in their own interest to lend.

"So if they take that money and simply pay interest on it or pay dividends on it and don't lend it out and make money themselves, that's not a very good position for them to be in," he said.

Now, in perhaps the bailout's strangest twist, reports this week said that negotiations to merge General Motors and Chrysler hang on the government providing cash injections into the carmakers' auto-financing arms. For that to work though, the auto-finance arms first must convert themselves into commercial banks to be eligible for taxpayer loans.

It's all a far cry from Treasury's sales pitch of September " that the rescue plan would provide a two-for-one, rescuing banks and homeowners in one fell swoop.

"It really highlights that if you are not working from a set of core principles, you can drift. And this rescue package has drifted," said Vincent Reinhart, a former top Federal Reserve director from 2001 to 2007 and now a senior fellow at the American Enterprise Institute, a conservative research group.

John Coffee, a law professor at Columbia University in New York and adviser to Wall Street regulators, said the government missed an opportunity by taking equity stakes in banks without attaching requirements that they use the bailout funds for new loans to spur the economy.

"If we could do this all over again . . . you could have conditioned the loan (plan) on how the proceeds could be used," he said. "Some banks are still hoarding the money . . . and others simply are not interested in lending in areas where they classically lent, like construction lending, because they see a major recession coming. . . .

"Before this is over that we're going to have casinos in Las Vegas reconstituting themselves as bank holding companies" and applying for government loans, Coffee warned.

Other experts are more forgiving.

"I think Treasury's thought is that whatever risk they may run by creating confusion about the program is outweighed by the risk of failing to plug the holes in the financial dike, on a case by case basis, as they seem to be emerging. This is not an unreasonable judgment," said Robert Litan, an expert on regulation and banking for the Brookings Institution, a center-left policy research center.

There is no playbook for getting out of financial crisis like the current one, he said.

"This is like the New Deal on speed, or on Internet time. Treasury is trying to do its best to stop each potential crisis as it pops up," Litan said. "Another metaphor, Treasury's decision-making reminds me of 'whack a mole.'"