September 26, 2008



UPDATE: THE GLOBAL CREDIT CRISIS AND
THE US GOVERNMENT’S RESPONSE

Since our last Update (September 24, 2008), the financial markets have been anxiously expecting news from Washington, DC, concerning Congressional negotiations with respect to the asset purchase proposals formulated by the US Treasury.

Wall Street recovered from initial losses, as most market participants await the outcome of these negotiations. In addition, the largest bank failure in US history occurred yesterday when Washington Mutual, previously the nation’s largest savings and loan institution, was seized by the Federal Deposit Insurance Corporation, and most of its assets were sold to JP Morgan Chase. The severity of market and liquidity concerns that gave rise to this development has placed unprecedented pressures on the remaining members of the financial community, leading to speculation about further dramatic events relating to the restructuring of certain major institutions in the event legislation is not enacted.

The optimism of earlier this week about a forthcoming legislative deal being concluded began dissipating as House Republicans, after listening to intense opposition from their constituents, advocated competing proposals. They opposed the Treasury plan because of their core belief that the government should not be intervening with public resources in such a massive bailout, particularly in favoring Wall Street financial interests at the expense of Main Street taxpayers.

In place of the Treasury proposal, House Republicans have offered an insurance program designed to mitigate losses on those underlying troubled assets that have given rise to the problem at hand. While the details of the plan are not fully available, seemingly it would act as a credit enhancement on these securities, thereby avoiding further losses on these instruments. The plan avoids the need for an initial conveyance of these assets and related transfer of significant resources in connection with the mortgage-backed and other securities in question and imposes a guarantee fee on those financial institutions seeking its benefits. Further, House Republicans would seek additional regulatory reform and tax relief to stimulate the economy and return health to the financial sector.

Congressional negotiators now have the difficult task of forging a compromise that will satisfy members of both parties, while at the same time meeting the minimum requirements of the Treasury and the Federal Reserve. Speaker of the House Nancy Pelosi is reluctant to permit legislation to pass purely on party lines, in light of concerns that such an action would expose Democratic members of the House to political criticism and sole responsibility for imposing a bailout of Wall Street interests. Senate leaders have gone so far as to indicate that they will not permit an adjournment until action has been taken on this legislation.

Both presidential candidates have pleaded with their loyalists in the House and in the Senate to complete the negotiations and move towards enactment. White House voices are more optimistic than Capitol Hill sources, saying that the President believes “something” acceptable will be completed this weekend.

We will continue to monitor these and other legislative and regulatory developments concerning the issues raised by the credit crisis.

Please read our earlier comments on the credit crisis here, here
and here.