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November 4th, 2008

The Changing Face, Part Next

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The original direction of the $700 billion bailout plan is evolving over time. It began as a means of buying ‘toxic’ assets from financial institutions, and expanded into buying equity stakes in banks as another way to inject capital into financial institutions; both are intended to unfreeze the credit markets and to spur more lending. Now, as we note here, the program may expand further as the Treasury contemplates doing the same for other credit-related industries.

But meanwhile, back on the banking ranch, a rift has developed between a growing number of lawmakers and the Bush administration over the use of the cash that’s been extended to the banks which have received stock investments.

Democrat Barney Frank claims that the banks’ use of the cash for anything but lending is a “violation” of the bailout act:

The chairman of the House Financial Service Committee accused financial institutions on Friday of “distorting” the government’s $700 billion economic bailout plan by using funds for bonuses, dividends and acquisitions.

Rep. Barney Frank, D-Mass., said such uses of the funds are a “violation of the terms of the act.”

Frank joins a growing chorus of lawmakers on Capitol Hill who are criticizing the Bush administration over management of the bailout plan.

Nine banks have received a $125 billion stock investment from the Treasury Department. The law contains some relatively weak limits on compensation, but does not prohibit recipients of Treasury investments from paying dividends to investors, making acquisitions or awarding bonuses.

Treasury Secretary Henry Paulson has said the capital infusion’s purpose is to persuade banks to do more lending. Frank said the money should be used for “relending and for no other purpose.”

The White House defended the plan on Thursday, noting the Treasury investment will lead to more lending and pay dividends to the government.

The disagreement is more than simply philosophical, and the devil is in the details. Bankers participating in the bailout would have to be more than tone-deaf to use taxpayer money for bonuses. However, if Rep. Frank would forbid the payment of dividends to investors, he should keep in mind that the investor class includes some 35 million of middle-class Americans whose retirement accounts invest in stocks.

Moreover, according to the New York Times, bank mergers are a feature, not a bug:

In a step that could accelerate a shakeout of the nation’s banks, the Treasury Department hopes to spur a new round of mergers by steering some of the money in its $250 billion rescue package to banks that are willing to buy weaker rivals. [...] “Treasury doesn’t want to prop up weak banks,” said an official who spoke on condition of anonymity, because of the sensitivity of the matter. “One purpose of this plan is to drive consolidation.”

This runs counter to the feelings of some Democrats in Congress that further “deregulation” (in this case, mergers) is to be avoided, if not reversed. Hopefully, we’ll get some clarification during Congressional hearings slated for later this month.

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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