What Was the Bailout Bill for Banks?
Sep 26, 2022 By Triston Martin

After Treasury Secretary Henry Paulson requested a bailout to purchase mortgage-backed securities that were at risk of default. Paulson hoped to remove these obligations from the records of the financial institutions that owned them, including banks, hedge firms, and pension funds.

What Are Bailouts?

When a group of investors or the government steps in to save a failing enterprise, this is called a bailout. These measures serve to forestall the inevitable collapse of the company and the resulting bankruptcy and default on its debts. 2

The recused party might be required to repay the bailout money if the money was given to a company or government in the form of a loan, the purchase of bonds, stocks, or an infusion of cash. 1

Difficult Assets Relief Program

Each auction was supposed to be for a different type of asset that troubled banks may sell to TARP for a predetermined price. TARP officials would choose the lowest price for each asset type to prevent the government from overpaying for troubled assets. Unfortunately, this did not occur since it took too long to create the auction software. 1

The Treasury Department began buying preferred shares in the eight largest banks under the Capital Purchase Program on October 14, 2008, using $105 billion in TARP money.

A Lot More Than TARP

Secretary Paulson presented a three-page plan to the House of Representatives on September 20, 2008, but many lawmakers believed it compelled taxpayers to reward irresponsible financial decisions. Supporters added many protections to approve the law, but on September 29, 2008, the House voted against it. The outcome was a worldwide market crash.

The Senate resurrected the idea on October 3, 2008, by adding it to a bill already under discussion in the House. The essential provision of the final measure was assistance for homeowners in danger of foreclosure. It mandated that the Treasury guarantee mortgages and help homeowners negotiate new conditions for their loans under the HOPE NOW program.

The Importance of the Bailout Bill

The $62.6 billion Reserve Primary Fund came under fire on September 16, 2008, when investors withdrew their money too quickly. They were concerned that the Fund's exposure to Lehman Brothers would lead to its demise.

The following business day saw a record outflow of $140 billion from money market accounts, with the proceeds being redirected to Treasury notes, resulting in rates falling to zero.

Since financial institutions were hesitant to extend credit to one another, the U.S. government stepped in to buy up the subprime mortgages. Stock prices plummeted, and Libor rates shot up relative to the Fed funds rate as investors panicked.

Financial institutions like Lehman Brothers were at risk of failing without the capacity to issue debt and obtain money. Without government involvement, both AIG and Bear Stearns would have died.

Options Alternately

Many lawmakers voiced opposition and alternative proposals when the measure was first introduced. Here are several and the potential consequences they pose:

Obtain Mortgages

To limit the number of bad mortgages on bank balance sheets, John McCain advocated having the government acquire $300 billion in mortgages from homeowners at risk of foreclosure. Without addressing the credit crisis, which was created by banks' reluctance to lend to each other and the resulting hoarding of cash, it may have helped stem the decline in house values by lowering foreclosures.

Finance Industry Tax Cuts

The Republican Study Committee (RSC) suggested a two-year moratorium on capital gains taxes, which would have freed financial institutions from paying taxes when selling assets. Rather than benefits, asset losses were the problem.

The RSC recommended transitioning Fannie Mae and Freddie Mac to private corporations and stabilizing the dollar. However, neither of these measures proved effective in resolving the credit crisis.

Bank write-downs of assets may have been avoided if the RSC's suggestion to halt mark-to-market accounting had been implemented sooner. U.S. regulators at the Financial Accounting Standards Board relaxed the norm in 2009.

Do Nothing

The idea of letting markets find some proposed equilibrium. It's possible that a worldwide downturn would have resulted from the failure of numerous companies worldwide owing to a shortage of finance. Mass unrest and a new Great Depression were possibilities because of the high unemployment rate.

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