Breaking the Law

I finally got around to reading some of the Emergency Economic Stabilization Act of 2008. I was a bit surprised - even a little impressed - by the level of specificity written into the bailout legislation. Yes, Congress did grant wide discretion to the Treasury Department. But the discretion was not boundless. The law does not give the executive branch of government the authority to spend $700 billion as it wishes; Timothy Geithner cannot go around buying whatever he wants. Rather, "The Secretary is authorized to establish the Troubled Asset Relief Program (or "TARP") to purchase . . . troubled assets from any financial institution on such terms and conditions as are determined by the Secretary, and in accordance with this Act . . ."

That may not sound like much, but in light of recent actions by Treasury, I would like to delve a little deeper into that straightforward instruction. Anyone who has taken a basic accounting class can tell you that an asset is something a company owns. It is worth something greater than zero. It can be a factory, a troubled mortgage bond or a patent. But it cannot be a liability. An asset cannot be something that will result in the company having less money in the future. (I apologize if this sounds obvious, but I promise I am going somewhere here.) When a company issues a share of stock, a preference share, or a bond, then a new liability is created. That LIABILITY is not an ASSET. Indeed, an asset is the opposite of a liability.

Ok, now take another look at the excerpt from the TARP law. It gave Treasury the authority to purchase assets. But not liabilities. So then how in the heck did we taxpayers end up spending billions of dollars on common shares and preference shares? The best answer I can come up with is that the Treasury Department decided it was above the law. I will refrain from expounding on the importance of democracy and adherence to the system of government outlined in the American Constitution. Suffice it to say that certain Treasury officials apparently believe they have more important concerns and that I respectfully disagree.

The law does contain a definition of the term "troubled assets." They are assets related to mortgages or "any other financial instrument." I'm sure the Treasury Department could find a lawyer to argue that therefore assets can be liabilities. However, even if that argument were to succeed, the Treasury would still be operating outside of the law because Congress specified how the Secretary must go about acquiring these assets (also know as liabilities to creative types). The Treasury is instructed that any publicly traded institution that sells assets to Treasury must also give the government a warrant or equity stake designed "to provide additional protection for the taxpayer against losses from sale of assets." In other words, the government must demand equity stakes as an additional compensation for buying troubled assets. But if the government is only buying equity stakes, then it would be impossible to receive any "additional protection" from equity stakes. It is therefore impossible to adhere to the law without the government acquiring more than just preferred shares or common stock. Any way you cut it, both former Treasury Secretary Hank Paulson and current Secretary Timothy Geithner broke the law by using TARP money to buy equity stakes instead of troubled assets.