Warren Kirshenbaum from O’pen Mind is sitting in the guest blogger’s chair today, helping to make sense of the government’s $700 billion bailout. Warren is a Needham real estate attorney whose practice focuses on residential and commercial purchases and sales, commercial leasing, and development. He can be reached at Orsi Arone Rothenberg LLP, 160 Gould Street, Suite 320, Needham, MA 02494. Thanks, Warren!

In a time of economic uncertainty our government is being pushed into an interventionist role in the private marketplace, and while our lawmakers are working fastidiously toward an appropriate response, the legislation being passed is complex and multi-faceted, yet thinly worded and correctly, but hastily considered.

On October 1, 2008, the U.S. Senate passed the Emergency Economic Stabilization Act of 2008, also known as the Troubled Assets Relief Program (”TARP”). It includes the following:

• An increase in the statutory limit of the public debt to $11.3 trillion;
• A US Government purchase of “troubled assets” in the order of $700 billion, funded by the issuance of treasury securities pursuant to Title 31 Ch. 31 of the US Code;
• An equity stake in financial institutions that sell their troubled assets to the Government;
• Foreclosure mitigation efforts;
• Executive compensation and corporate governance standards for sellers of “troubled assets,” such as a limitation on golden parachutes and claw-backs on compensation based upon materially inaccurate information;
• A temporary increase in FDIC protection to $250,000 per applicable account;
• A patch for the alternative minimum tax and extensions for the wind energy production tax credit, the new markets tax credit, and the investment tax credit for solar energy projects; and
• Authority for the SEC to suspend the application of Financial Accounting Standards Board Statement 157, which is the “mark-to-market” accounting standard (”MTM”) adopted after the S&L collapses of the 1990’s. MTM forces financial institutions to value assets based upon their market value, rather than their purchase price.

The proposed easing of the MTM rules is a challenging issue, and one that requires deep thought and discussion. MTM has required write-downs that may approach $1 trillion due to the deterioration in value attributed to mortgage backed assets. Proponents of the suspension of MTM argue that these write-downs have precipitated the market woes we now face. Regulators favor the easing of the MTM rules, as it would lessen the cost of the bailout proposed by TARP, while opponents argue that the current crisis is one of confidence due to overvaluations. Specifically, valuing mortgage backed assets based upon purchase price would lead to illusory balance sheet values and resulting confidence issues. In considering this issue, it must be noted that Wachovia was to be purchased by Citibank for only $2 billion when it collapsed, yet it had an asset value of $75 billion.

The underlying goal of TARP seems to be to spend $700 billion to inject confidence into the marketplace. TARP essentially transfers the “troubled assets” to the U.S. Government, the only entity currently strong enough to hold these assets until a market for them recovers. TARP swaps toxic paper for cash loaned to the U.S. Government by foreign and U.S. investors. The hope is that this will lead to an easing of the credit-crunch we are now facing. But will it?

In the short term, cash-rich financial institutions may still be uncomfortable lending that cash to consumers and businesses, unless confidence, arguably the underpinning of our markets, makes them loosen up some capital. This so-called credit crisis may be more appropriately termed a confidence crisis, if not a loss of trust in the financial engineers of our economy. TARP is about restoring trust and confidence, but it proposes spending upwards of $700 billion to do that. Impossible as it seems to value the cost of the “troubled assets” that now have no market, the market is marking TARP with a cost of no less than $700 billion, and it would be remiss to consider easing up those mark to market valuation rules.