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Updates from Senate Banking Committee Hearing

September 23, 2008

Turmoil in U.S. Credit Markets: Recent Actions Regarding Government Sponsored Entities, Investment Banks, and Other Financial Institutions

Bracewell & Giuliani is closely monitoring the pending legislative and regulatory responses in Washington, D.C. to the ongoing financial crisis. In our continuing efforts to keep you informed, we are sending you the following update from today on Capitol Hill.

1. This hastened legislative effort will focus solely on tempering the escalating crisis on Wall Street, but the political will for comprehensive, innovative regulatory change will withstand the election season. The Senate Committee on Banking, Housing, and Urban Affairs was unanimous in calling for a regulatory overhaul of the U.S. financial system. Secretary of Treasury Henry Paulson agreed, saying that he is fully supportive of an overhaul after the crisis is abated and referred the Committee to the proposed regulatory framework he released last year. The Federal Reserve is also completely committed to this effort. Several ideas were presented at the hearing today—including the issue of executive compensation and proper oversight of the derivatives market.  While Secretary Paulson might like to defer these issues until the regulatory stage, Chairman Christopher Dodd (D-CT) made clear that executive compensation should be included in legislation.

2. The fate of this legislation hinges on the ability to frame the relief package as a necessary step in the effort to help Main Street, as opposed to a bailout of Wall Street. Every Member of the Committee stressed the need to protect American taxpayers. This is an easy political slogan to put on the record; however, Members from both parties seemed to want more than Treasury's promise that stimulating the flow of credit will trickle down to the overall economy. Proposals from the Committee included financial institutions issuing warrants to Treasury so that taxpayers could share in the upside, and giving courts the ability to reconstruct mortgages to keep people in their homes.

3. Members from both parties are equally concerned about the prospect of committing $700 billion to a relief effort without fully comprehending the nature of the proposal or the prospects for success. A vast majority of the questions centered on how the purchasing and valuation of assets would occur and how Treasury could be sure that taxpayers would not be overpaying for certain illiquid assets. Secretary Paulson assured the Committee that the appropriate mechanisms—such as reverse auctions— would be put in place to mitigate taxpayer risk; however, he did confirm that taxpayer dollars would be put at risk.

4. Congress is concerned about oversight of this massive effort going forward and will be reluctant to grant Treasury the authority included in the proposal. Chairman Dodd noted that giving Treasury such sweeping powers without the prospect of judicial review will be viewed by many in Congress as unpalatable and unconstitutional. He suggested that greater oversight measures would likely have to be put in place in order for the proposal to pass. Secretary Paulson understands the need for oversight and welcomes insight from Congress.

5. The Treasury and the Federal Reserve view swift passage of this legislation as the only way to avert a deepening of the financial crisis, while Congress is concerned that they will have to answer to constituents in the event this hastened legislative effort does not produce satisfactory results. One exchange drove home the dynamic underlying the entire hearing: Senator Charles Schumer (D-NY) suggested passing a bill that would give the Treasury the requested $700 billion in tranches in order to test the system before committing such a large sum of money. Secretary Paulson dismissed this approach for the simple reason that commitment to the relief package has to be absolute in order to inject some sense of confidence in the market.