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WASHINGTON, D.C. — With his proposal to give taxpayers an ownership stake in firms that participate in a federal bailout of the financial system, Sen. Jack Reed may have found the crux of the issue over how to quell the widening crisis.
Reed’s plan — along with demands for a curb on "golden parachutes" for officers of bailed-out companies — was one of a few ideas that sparked a day of lively, sometimes combative byplay between the architects of the Bush administration’s $700-billion rescue proposal and the senators who grilled them yesterday during a hearing of the Senate Committee on Banking, Housing and Urban Affairs.
In his opening statement at the session, Reed touted his proposed system of "warrants," intended to give taxpayers a potential stake in the profits of companies that take the bailout.
"The custom on Wall Street is, if you assume the risk, you get paid to do that," Reed told Federal Reserve Chairman Ben Bernanke and fellow committee members.
Reed said it is only fair for the government — and by extension, the taxpayer — to get paid for taking the big risk associated with the $700-billion bailout now before Congress.
But Treasury Secretary Henry Paulson and Bernanke argued against Reed’s plan — which amounts to a mechanism for giving the government the right to take shares in companies from which it buys bad debt under the bailout. Paulson and Bernanke argued that the Reed provision for "warrants" could complicate the bailout and undermine its primary goal of getting credit to flow once more through the financial system.
Reed suggested that his warrant condition is not so different from the strings already attached to smaller bailouts of individual companies during this year’s struggle to contain the mortgage market crisis.
But in blunt exchanges, Paulson and Bernanke resisted Reed’s comparisons.
As part of the historic bailout now under consideration by Congress, Reed has proposed that the government demand of participating businesses much the same type of equity stake that the sprawling finance and insurance company American International Group (AIG) surrendered in order to obtain the Fed loans that kept the company from collapsing.
During his round of questioning, Reed asked the architects of the $700-billion bailout plan whether they had imposed "punitive" conditions last week when they intervened to save AIG from bankruptcy.
Bernanke replied that the Fed had insisted on "very tough" conditions as the price for the $85-billion loan that helped AIG stave off bankruptcy. The interest rate was more than 11 percent, executives were forced out with no "golden parachute" bonus payments, and the Fed demanded "warrants" that could give it an ownership stake in AIG as big as 80 percent.
These measures were aimed at enforcing repayment of the loan, plus some gain to compensate for the risk that the Fed has taken to save a company that got in trouble with sophisticated mortgage-related deals.
But Bernanke and Paulson both testified that there is an important difference between the recent bailouts of individual financial institutions and the huge federal intervention now before Congress.
The earlier rescues were ad hoc actions aimed at individual companies — though each of them represented the risk of many billions of taxpayer dollars, they said. Bernanke described this as the "bad bank" rescue model, which properly involved such tough conditions as the prospect of taxpayer stock ownership.
The bailout now under negotiation is not only many times larger, Paulson and Bernanke said, but it also aims at a far broader range of companies, large and small — including many that are comparatively healthy but hampered by their holdings in mortgage-related assets that have gone bad.
They suggested that the imposition of a warrant mechanism on the bailout system would deter many institutions from participating in the sale of bad-mortgage-related assets. Limited participation, in turn, could limit the effectiveness of the bailout itself, they testified.
Some of the companies "don’t need a bailout," Reed retorted, so it is not a bad thing if they do not sell their bad assets to the government.
Paulson did not explicitly reject Reed’s proposal of a bailout-for-stock swap during the Rhode Islander’s round of questioning. But in subsequent testimony, he said, "I don’t think that’s the right way to go."
Still later, Paulson told Sen. Birch Bayh, D-Ind., "If you have companies grant equity stakes, grant options, that would render this ineffective."
Reed worked with colleagues over the weekend to include his reimbursement mechanism in the Senate Democrats’ version of the bailout bill.