Political risk high for Wall Street as TARP unfolds

Tue Jan 13, 2009

Reuters

By Kevin Drawbaugh – Analysis

WASHINGTON (Reuters) – Congressional Democrats and the incoming Obama administration are uniting around strategies for saving the U.S. financial system, but a fog of political risk still hangs over Wall Street and the banks.

That cloud won’t lift for a long time, policy analysts say, as Congress proceeds down a two-track effort to rescue the financial system and then to restructure it.

That process is expected to take many months, with the potential outcome hard to predict.

“The industry will face more political risk in the next six to 12 months than it has faced since the savings and loan debacle ended in the early 1990s,” said Jaret Seiberg, financial services analyst at Stanford Group Co.

Some visibility emerged on Monday around the biggest of the government’s many emergency rescue projects, the $700-billion Troubled Asset Relief Program, or TARP.

President-elect Barack Obama and House of Representatives Financial Services Committee Chairman Barney Frank signaled agreement on new conditions for spending the TARP’s second $350 billion.

Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said he and Obama concur that the massive TARP program needs a “sharp course correction.”

Frank has drafted new TARP rules to make the program do more to prevent home foreclosures, limit executive pay and make companies receiving TARP money say what they did with it. Obama agrees on the need for rules along these lines.

But beyond that, the TARP’s future is murky.

The first $350 billion of it has already been committed by Treasury Secretary Henry Paulson to aiding Citigroup (C.N), insurer American International Group (AIG.N), major automakers General Motors (GM.N) and Chrysler LLC, and others.

TARP VETO SHOWDOWN

A request for the second half of TARP funding was sent to Congress by President George W. Bush, giving lawmakers 15 days to decide whether to block release of the funds.

Senate and House leaders from both parties on Monday voiced wary support for releasing the funds. But many lawmakers are deeply dissatisfied with the handling of the program so far.

Frank, a Massachusetts Democrat, will hold a committee meeting on Tuesday afternoon to air complaints from lawmakers.

House Republican Leader John Boehner said on Monday he opposes releasing the $350 billion. “I remain disappointed about the way TARP has been managed,” said the Ohio lawmaker.

If Congress votes to block release of the funds, a resolution to that effect would then go to the White House. A presidential veto would release the funds, but it is unclear if Bush or Obama, who takes over on January 20, would use the veto pen.

If one of them were to veto that resolution, in order to block the funds, Congress would have to override the veto. That requires a two-thirds vote in both the House and the Senate.

MULTIPLE RESCUE MISSIONS

Beyond the TARP, the Obama administration and congressional Democrats are coalescing around other rescue approaches.

One is a push to reform bankruptcy law so that courts can relax the terms of primary home mortgages to help struggling homeowners. Most of the financial industry opposes this.

Another is an effort to encourage mortgage servicing companies to ease the terms of home loans for distressed borrowers. Proposals call for giving the servicers new legal protections and payments for doing mortgage modifications.

While these and other rescue programs play out — widening the government’s role in the markets beyond anything seen in generations — Frank’s committee is expected to begin a series of hearings in February on permanent changes to the financial system. That process is likely take many months.

Fed Vice Chairman Donald Kohn, in testimony prepared for delivery to a U.S. House Committee, said the second half of the $700 billion financial bailout fund was “essential” to restore credit flows and backed the idea of using money to reduce foreclosures and further bolster banks.

Kohn said additional funding could help expand the size or scope of the TARP and could provide financing for commercial mortgage-backed securities.

Congressional Democrats also want to fix weaknesses in the oversight of mortgage giants Fannie Mae and Freddie Mac; the markets for mortgage-backed bonds and derivatives like credit default swaps; and the capital standards of banks.

A major realignment of regulatory agencies looks likely, with the Securities and Exchange Commission and Commodity Futures Trading Commission possibly being combined.

Daniel Arnold, associate director at financial group Sandler O’Neill, said agreement on new rules for the TARP “is one thing that will be cleared up a little bit.

“But there’s still a million other questions out there on what’s going to happen. We’re still knee-deep in uncertainty with regard to future regulatory actions.”

(Reporting by Kevin Drawbaugh; Editing by Dan Grebler)