WASHINGTON, DC- Following yesterday’s U.S. Senate Banking Committee hearing on financial markets, U.S. Senator Bob Casey (D-PA), a member of the Committee, today sent a follow-up letter to Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson on the financial crisis. In particular, Senator Casey addressed the issues of executive compensation, foreclosure prevention through loan modification, and warrants and taxpayer protection.
“In yesterday’s Banking Committee hearing, I asked you why you are opposed to limits on executive compensation for firms that sell assets to the Treasury. With all due respect, your answer to my question and the questions of other members on this matter did not provide sufficient justification for your opposition,” Senator Casey wrote. “I know that my constituents find the failure to address executive pay unacceptable, as do I.”
Foreclosure Prevention Through Loan Modification:
“Helping families stay in their homes will reduce foreclosures and reduce the number of homes sold at fire-sale prices. This will help break the negative feedback cycle in which we are trapped, stabilize home prices, and reduce the chances of an overcorrection in housing,” wrote Senator Casey.
Warrants and Taxpayer Protection:
Senator Casey wrote, “finally, I would like to stress to you the importance of the government receiving warrants or some equity option in firms that sell distressed assets to the Treasury.”
He went on to write, “If institutions that participate in this plan are able to sell some of their troubled assets to Treasury at a price they find acceptable, and the cash they receive from us improves their condition and improves the condition of their creditors, as I believe is your intent, shouldn’t the government once again take warrants?”
In closing, Senator Casey wrote: “The greatest risk we face this week is that we will not do everything we can here and now. The American people and the entire world are watching what we do. We must get it right.”
Last week, Senator Casey sent a letter to Chairman Bernanke and Secretary Paulson outlining his concerns on the financial crisis. In the letter, Senator Casey called for measures to help homeowners including an expansion of the HOPE for Homeowners program, encouraging modification of GSE-backed loans and facilitating early intervention with lenders to work out solutions to keep people in their homes – a program modeled after a successful effort in Philadelphia.
The full text of the letter is attached.
September 24, 2008
The Honorable Henry M. Paulson, Jr.
Secretary of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220
The Honorable Ben S. Bernanke
Chairman, Board of Governors of the Federal Reserve System
Twentieth Street and Constitution Avenue, NW
Washington, D.C. 20551
Dear Secretary Paulson and Chairman Bernanke:
I write today to amplify some points I have made to you in both my letter of September 19th and our conversations and to ask further questions. I understand that this is an extremely busy time for you but I am sure you appreciate the unprecedented decisions all members of Congress are facing over the next week.
In particular, I would like to reiterate my support for executive compensation limits for any firms that would sell assets to the Treasury under your proposal, the need for comprehensive measures to address the foreclosure crisis, and the addition of provisions requiring the government to receive warrants in exchange for purchasing distressed assets.
My primary concern in writing to you and advocating for these positions is that we ensure that any final legislative package works. Additionally, the American people need and deserve adequate protections. At the same time, they must know that participating firms and executives are not receiving a free pass at taxpayer expense.
In yesterday’s Banking Committee hearing, I asked you why you are opposed to limits on executive compensation for firms that sell assets to the Treasury. With all due respect, your answer to my question and the questions of other members on this matter did not provide sufficient justification for your opposition.
Senate Democrats have advanced a reasonable measure that would require firms to limit executive compensation, prevent golden parachutes, and require claw-back provisions based on performance. You have stated that your opposition to this provision is based on your concern that it will limit participation.
I find this reasoning totally unpersuasive. If executives are willing to place their own short term compensation above the need to participate in this program, then I would suggest that their Boards of Directors seriously reconsider their senior management choices.
Furthermore, this rescue is only necessary because due diligence and prudential management were noticeably absent from some of our nation’s largest and supposedly sophisticated financial institutions. Their stockholders, creditors, customers, employees, and the American people are now suffering the consequences of all of the poor decisions that were made. In this environment, we must be sure that market discipline reaches into the executive suites and board rooms of companies that now seek taxpayer assistance.
I know that my constituents find the failure to address executive pay unacceptable, as do I.
Foreclosure Prevention Through Loan Modification
As you know, I am extremely concerned about the need to prevent more foreclosures. I know you have expressed the same goal, but regardless, under current circumstances not enough preventable foreclosures are actually prevented. The HOPE NOW Alliance has not provided the relief it was intended to, and voluntary loan modifications are not taking place. The recently passed HOPE for Homeowners program will help as many as 400,000 homeowners, and I have proposed ways to increase that number. However, more must be done.
It is especially disturbing that despite your efforts and sustained attention for the past year, debt holders are not acting in their own rational economic interests, let alone the interests of the economy. The breakdown of normal economic incentives and rational behavior is directly related to the financial alchemy that has brought us to our current situation.
First, loans have been sliced up and many have second liens, so lenders have conflicting interests and will not allow modifications. What will Treasury do to purchase second liens? What rights will Treasury exercise with respect to these second liens to allow more loan modifications? What legal and logistical impediments exist that would prevent Treasury from removing the obstacles second liens pose to loan modification?
Second, servicers have both financial incentives and contractual obligations that limit or prevent them from pursuing loan modifications. What will the Treasury plan do to alter the incentives and obligations that servicers face?
Finally, these markets have a collective action problem. If all lenders reduced principal and modified loans into affordable structures, home prices would stabilize and all homeowners and all lenders would get some benefit. However, no lender can achieve this through individual actions, and there is significant risk of a free-rider problem if competitors refuse to follow a similar course of action. These problems have prevented lenders from seeking loan modifications, even though the experience of the Federal Deposit Insurance Corporation’s (FDIC) management of the IndyMac mortgage portfolio demonstrates that loan modification improves the performance and value of loan pools.
This final problem, coupled with the enormity of our challenges, is what leads me to believe that judicially supervised loan modification is the only way to effectively stem the tide of foreclosures and give your asset purchase plan a chance to succeed.
As you know, nearly 10,000 homes enter foreclosure each day. The Center for Responsible Lending estimates that 6.5 million homes will enter into foreclosure in the next few years. These numbers continue to depress home prices and threaten to overwhelm the efforts of the recently enacted HOPE for Homeowners program, which I hope to expand but remains dependent upon voluntary lender participation.
In yesterday’s hearing you each expressed concern that judicially supervised loan modification would add further uncertainty to debt holders. Once again I must disagree with you and I believe that economic theory and experience are on my side. In addition to the demonstration that FDIC’s efforts provide, Chapter 11 bankruptcy procedures and your own interventions over the past six months use a similar approach of restructuring debt and providing equity options.
Chapter 11 proceedings allow the conversion of debt to equity stakes in a way that improves the condition and expected payments of debt holders. The rescues of AIG, Fannie Mae, and Freddie Mac protected debt holders while at the same time providing equity to taxpayers whose money preserved the respective institutions.
The proposed judicially supervised loan modifications would share these features. These modifications would reduce the principal and interest homeowners owe in order to restructure the loan at sustainable levels. If this could not be achieved then the modification would not take place and the home would go into foreclosure.
At the same time, lenders would be given an equity stake in the home secured by the modified loan. If the home appreciates in value, the lender would share in that gain. In fact, the more widely this loan modification process is used, the more likely it is that lenders will realize some later appreciation. Helping families stay in their homes will reduce foreclosures and reduce the number of homes sold at fire-sale prices. This will help break the negative feedback cycle in which we are trapped, stabilize home prices, and reduce the chances of an overcorrection in housing.
Finally, it is worth noting that this was done once before in the 1990s for struggling farm owners. In this instance, the modification program was targeted, limited, and most modifications were performed outside of the court system because borrowers and lenders each had incentives to do so.
Warrants and Taxpayer Protection
Finally, I would like to stress to you the importance of the government receiving warrants or some equity option in firms that sell distressed assets to the Treasury.
I know that we are facing exigent circumstances, and we need to move quickly. However, if we had more time I suspect we would be using mechanisms like Chapter 11 for some financial institutions. Senator Jack Reed and others have been advocating that the government take conditional warrants from companies that sell us debt. Under this proposal, the warrants will only be used if what is purchased declines in value but the selling institution’s condition improves. I strongly support the inclusion of this provision in the final plan.
It is my understanding that there are some potential investors that would like to purchase some of the assets the Treasury is now proposing to acquire. However, would be sellers and potential buyers cannot reach a deal because of the problems you described with the difference between the fire-sale price and hold to maturity price. Private investors would like to buy closer to the fire-sale price and the holders are only willing to sell near the hold to maturity price. In other words, there are potential buyers and potential sellers, but they cannot agree on price.
If institutions that participate in this plan are able to sell some of their troubled assets to Treasury at a price they find acceptable, and the cash they receive from us improves their condition and improves the condition of their creditors, as I believe is your intent, shouldn’t the government once again take warrants? Aren’t we providing more cash than markets are willing to and shouldn’t that come with some protections?
I know that these are complex matters and that you are working feverishly to further develop your proposal and reach an agreement with Congress. In normal times we each have our spheres of influence and our ideological preferences. Unfortunately, these times are far from normal. Just as we in Congress are considering a program whose size, scope, and goals were unimaginable just a short time ago, you must consider supporting action you would normally oppose. The greatest risk we face this week is that we will not do everything we can here and now. The American people and the entire world are watching what we do. We must get it right.
Thank you, and I look forward to your answers to my above questions and our continued dialogue.
Robert P. Casey, Jr.
United States Senate