The Loophole the Size of the Universe.

There have been many stories like this:

[I]f market conditions continue to deteriorate, [Treasury] could make use of another tool at its disposal: investing directly in troubled companies.

Treasury has the power to directly inject capital into a failing firm by taking a significant equity stake. In an unusual statement issued Monday, the President's Working Group on Financial Markets, noting that "conditions in the U.S. and global financial markets remain extremely strained," said Treasury could "directly strengthen the balance sheet of individual institutions."

The article, however, does not tell us where Treasury's authority comes from. Thom Lambert asks, "What gives? Did the ultimately enacted bailout legislation permit the sort of direct investment Prof. Bebchuk advocated? Or does Treasury possess independent authority to purchase securities issued by ailing financial firms? Or is Treasury just exaggerating the scope of its authorization?" A good question: the main objection to the bill among critics was that it failed to give Treasury this authority, instead authorizing it buy up mortgage-related securities, a more indirect approach to the crisis.

Let's look at the statute.

True, section 101(a)(1) seems to authorize Treasure merely "to purchase, and to make and fund commitments to purchase, troubled assets from any financial institution…." But, as always, the work is done in the definitions. Look at section 3(9):

The term ''troubled assets'' means—

(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and

(B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.

Only section (A) refers to mortgage-related assets. Section (B) refers to any other financial instrument -- more or less full stop. That would presumably include preferred stock issued by a distressed firm in return for a capital infusion from Treasury. It sounds odd to call the purchase of newly issued equity the purchase of a "troubled asset," but there you go.

So while commentators were complaining that the bill did not give Treasury sufficient authority to make equity infusions, it did so right under their noses.

Old33 (mail):
This was mentioned at the end of This American Life on Chicago Public Radio last week, in the second of two outstanding hour-long programs on the current financial crisis. Outstanding the sense that each program explains core aspects of the financial crisis in easy-to-digest-and-understand chunks.

Program One - The Giant Pool of Money (May 9, 2008)

Progam Two - Another Frightening Show about the Economy (October 3, 2008)

Both are well worth your time.
10.8.2008 10:48am
donaldk2 (mail):
I downloaded Program One and it is great. But in Program Two, I can't find how to download the transcript. Can anyone help please.
10.8.2008 12:54pm
Paul Allen:

So while commentators were complaining that the bill did not give Treasury sufficient authority to make equity infusions, it did so right under their noses.

Professor: this is your best post yet: factual and informative. Too bad you had add this attempted zinger to the end. Perhaps you can update, and apologize to us for saying that every informed person supports Paulson's proposal--while now just about everyone agrees that the MBS purchase program is pointless and the real meat is else where. Oops.

People were not faulting the Bill for not including equity purchases; we were faulting the MBS purchase program as pointless and a dangerous distraction.
10.8.2008 1:40pm
Eric Posner:
Paul, did I say that? I thought I said, whether clearly or not, that every informed person (well, okay, that was an exaggeration) supported the version of the bill that the House voted down (not the original Paulson plan), in the sense that the bill was superior to doing nothing at all (not that the bill was optimal). Is that wrong? As for the plan to buy up MBS's, the reaction seems to have been mixed, with some people seeing it as reasonable but not nearly sufficient.
10.8.2008 2:57pm
(I actually thought this was going to be a cosmology thread when I read the header. Dang it.)
10.8.2008 5:46pm
Joshv02 (mail):
Eric: Justin Fox asked Treasury about this, too, and writes about it here: link.
10.8.2008 7:18pm
SenatorX (mail):
Yeah this is actually a big deal and I don't think the market has digested it yet. The question then becomes who gets the capital injections? Looks like it will be a room full of guys at the Fed and Treasury deciding arbitrarily. I'm sure there will be talk of the "core American businesses" but will it only be financial companies? Financials in drag like GE and IBM too? Anyone they feel like?
10.8.2008 11:11pm

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