May Treasury Buy Newly Issued Securities of Ailing Financial Firms?

Thom Lambert —  7 October 2008

Last week I posted about Lucian Bebchuk’s thoughtful bailout plan, which would have expanded Treasury’s powers to include the ability to make direct investments in ailing financial firms (as opposed to just buying their distressed assets). I was under the impression the bailout legislation didn’t provide Treasury with such authority. An article in today’s WSJ, though, suggests otherwise.

The article reports:

The Treasury Department is under pressure to show meaningful results from its newfound authority to buy $700 billion of distressed assets, which Congress approved last week. Treasury is expected to begin buying assets within a few weeks through the use of auctions. But if market conditions continue to deteriorate, it could make use of another tool at its disposal: investing directly in troubled companies.

Treasury has the power to directly inject capital into a failing firm by taking a significant equity stake. In an unusual statement issued Monday, the President’s Working Group on Financial Markets, noting that “conditions in the U.S. and global financial markets remain extremely strained,” said Treasury could “directly strengthen the balance sheet of individual institutions.”

Such a move, however, is likely only to occur if a firm is teetering on the brink of collapse and poses a systemic risk to the financial sector, according to people familiar with the matter.

What gives? Did the ultimately enacted bailout legislation permit the sort of direct investment Prof. Bebchuk advocated? Or does Treasury possess independent authority to purchase securities issued by ailing financial firms? Or is Treasury just exaggerating the scope of its authorization?

Thom Lambert

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I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.

2 responses to May Treasury Buy Newly Issued Securities of Ailing Financial Firms?

  1. 

    …rather than listen to an hour long episode of This American Life, the text of the stock injection can be found in section 113 of the bill:

    CONDITIONS ON PURCHASE AUTHORITY FOR WARRANTS AND DEBT INSTRUMENTS.

    1.

    IN GENERAL.The Secretary may not purchase, or make any commitment to purchase, any troubled asset under the authority of this Act, unless the Secretary receives from the financial institution from which such assets are to be purchased

    1. in the case of a financial institution, the securities of which are traded on a national securities exchange, a warrant giving the right to the Secretary to receive nonvoting common stock or preferred stock in such financial institution, or voting stock with respect to which, the Secretary agrees not to exercise voting power, as the Secretary determines appropriate; or

    2. in the case of any financial institution other than one described in subparagraph (A), a warrant for common or preferred stock, or a senior debt instrument from such financial institution, as described in paragraph (2)(C).

  2. 

    Thom, I first heard that the injection plan (which I strongly support) made it into the passed version of the bill on Sunday via NPR (about 3/4ths of the way through the episode): http://www.thisamericanlife.org/Radio_Episode.aspx?episode=365

    Secretary of the Treasury has a new tool in the bag ‘o tricks…now we can only hope your old colleague knows how to wield it properly or appoints someone who can.