(Excerpt from a client folio published by Morgan Stanley)
Financial Crisis/Economic Rescue
Obama envisions fiscal policy as a central tool for spurring the economy and blunting the coming recession. To build upon the first economic stimulus package passed in February 2008, Obama supports passage of a second stimulus bill to inject infrastructure and benefits-related spending into the economic engine (Obama did not vote on the final version of the first stimulus package). Obama has proposed a twoyear, $175 billion total package, with:
- $25 billion in state relief, via a State Growth Fund designed to prevent cuts in state and local housing, education, health care, and heating assistance;
- $25 billion in infrastructure spending in the form of a Jobs and Growth Fund to prevent spending cuts in road maintenance and school repair; The Obama team estimates that this will save one million jobs;
- Extension of unemployment benefits, and a suspension of taxes on unemployment benefits;
- Tax credit of $3,000 per new worker hired, to stimulate employment;
- 90-day moratorium on foreclosures for homeowners making a good faith effort to pay off their mortgage;
- Bankruptcy reform to allow judges to modify a borrower’s mortgage terms to make the loan affordable;
- For struggling families, permissible withdrawal of up to 15 percent of an individual’s retirement account without early withdrawal penalty; and
- A program to lend federal money to cash-strapped state and local governments, in the model of the Treasury Department’s Capital Purchase Program to troubled banks.
Obama proposes to pay for these expenditures with tax increases on families that earn over $250,000 per year and individuals earning over $200,000 (see taxation discussion above). He will also look to impose a windfall tax on oil companies and close certain corporate tax loopholes to offset the stimulus’ price tag. Should Congress not act on a stimulus in a lame-duck session this fall, Obama will make his package one of his first priorities in 2009.
On housing reform, Obama seeks tighter regulation of mortgage lenders, greater transparency in the mortgage process and stricter enforcement of mortgage-related abuses. In 2007, Obama introduced the STOP FRAUD Act to increase penalties for mortgage fraud and provide additional protections for lowincome homebuyers. Going forward, he will look to increase funding for federal and state enforcement programs, create additional criminal penalties for mortgage fraud, hold industry to greater reporting requirements, and expand disclosures to borrowers under existing mortgage laws. He also hopes to create a Home Obligation Made Explicit (HOME) score, to provide borrowers with a simplified, standardized metric to more easily compare mortgage products. Obama’s mortgage reform approach will be decidedly more consumer protection-oriented than McCain’s would have been, and would also include a 10 percent tax credit for 10 million mortgage borrowers who do not itemize.
With respect to Fannie Mae and Freddie Mac, Obama has said very little as to what his plan is for these entities and how he might look to restructure them to bring them out of government conservatorship. Given their current condition and the other economic and financial regulatory problems the new Administration and Congress currently face, there is little expectation that the Obama Administration will look to take any aggressive action to change the present status of Fannie and Freddie any time soon.
With seismic shifts in the federal government’s approach to market intervention in recent months, the financial services regulatory landscape will be reshaped significantly in 2009 and beyond. Congress has clearly announced its intention to review the regulatory structure for the industry, and with Obama, it has a President with like-minded goals.
Obama’s record on financial services regulation is rather limited, as his committee assignments during his senatorial tenure focused his sights elsewhere. However, Obama has echoed his colleagues’ call for restructuring, announcing plans for expanded oversight of financial institutions that borrow from the federal government, transferring jurisdictional responsibilities, and improving transparency of investment firms.
Obama will also seek to streamline federal regulatory agencies, establish a financial market advisory group, and crack down on trading activities that he deems are manipulating the markets. Regulatory reform will dominate the congressional banking agenda in 2009 and 2010, and large-scale regulatory changes are expected. The Treasury Department postulated its ideas for financial reform in March 2008 with its Blueprint for a Modernized Financial Regulatory Structure. This only set the table. The events of the past several months – market turmoil blamed in part on regulatory lapses, the federal government drastically increasing taxpayer risk with direct and indirect investments in troubled financial institutions, and the Federal Reserve significantly expanding access to its lending facilities – have radically altered the regulatory debate in Washington.
At a minimum, the Federal Reserve stands to augment its regulatory jurisdiction markedly. Whether through the Fed or another agency, Congress is likely to establish a systemic risk regulator to police the markets, and Obama has endorsed this approach. Other fundamental questions will be considered, including: how best to allocate responsibility for prudential/market stability/enforcement regulation of the markets; how best to regulate the activities of hedge funds and other investment firms that are largely unregulated today; how to regulate investment banking activities within commercial banking regulatory structures; and whether certain federal agencies should be merged in the interest of regulatory efficiency (e.g. SEC and Commodities Futures Trading Commission, or the Office of the Comptroller of the Currency and the Office of Thrift Supervision). The answers to these and related questions will go a long way in determining what our financial markets regulatory structure looks like for the next decade and beyond.
In the wake of the Federal Reserve’s intervention in AIG, and after the credit market seizure created by the Lehman collapse, Congress and the federal agencies are focusing on credit derivatives more so than ever before. This scrutiny will undoubtedly grow as we enter 2009.
Congress has held several hearings on credit default swaps during the subprime crisis, and leadership has indicated its interest in legislating a stricter approach to CDS in the 111th Congress. The bipartisan critique has largely centered on: how to improve CDS market transparency; how best to mitigate counterparty risk and systemic risk posed by outstanding CDS positions; how best to establish a clearinghouse(s) to facilitate clearing and settlement of CDS; whether CDS should be traded on-exchange; whether CDS contracts should be standardized; and whether CDS can and should be regulated as insurance products.
As with regulatory restructuring, neither the Obama nor the McCain campaigns had clearly articulated their positions on credit derivatives aside from sharpening their rhetoric as the election approached and the economy spiraled. Accordingly, Obama is largely a clean slate with respect to credit derivatives, although it can be expected that he will endorse aggressive action to increase transparency, at a minimum, and likely more aggressive efforts to enhance the infrastructure of, and place limits on, the CDS market.