AIG 03-02-09 Equity Restructured, Additional $30B of Taxpayers Money

Executive Compensaton: 02-16-09 Memo from

Class, the memo below is from Sullivan & Cromwell LLP, as printed in the Harvard Law School Corporate Governance Blog Because of its importance in our class, I am reposting. All credit goes to Sullivan & Cromwell and the Harvard Law School Corporate Governance Blog.

The final version of the American Recovery and Reinvestment Act of 2009, which was passed by the House on February 13 and was expected to be passed by the Senate later that night, includes extensive new restrictions on the compensation arrangements of financial institutions participating in the Troubled Asset Relief Program (“TARP”). The new legislation, which the President is expected to sign into law shortly, rewrites Section 111 of the Emergency Economic Stabilization Act of 2008 (“EESA”) (1) and directs the Treasury Department to establish standards and promulgate implementing regulations.

TREASURY TO ESTABLISH NEW STANDARDS

The new standards will codify many of the executive compensation guidelines for TARP recipients announced by the Treasury Department on February 4, 2009, impose additional restrictions and apply to all existing and future TARP recipients. It is not clear whether the standards will be immediately effective or will only be effective after regulations are issued.

Under the legislation, the standards are required to include the restrictions and other provisions summarized below, which include a variety of terms the meaning and scope of which have not been made clear.

• Financial Institutions Affected. The restrictions apply to all entities that have received or will receive financial assistance under the TARP during the period the TARP recipient has an obligation outstanding that arises from TARP financial assistance. However, the restrictions cease to apply if the Federal Government only holds warrants to purchase common stock of the TARP recipient.

• Employees Affected. Many of the restrictions extend beyond the TARP recipient’s CEO, CFO and three next most highly-compensated executive officers (the “senior executive officers”) and apply to other highly-compensated employees as well. It does not appear that other highlycompensated employees need to be officers of the TARP recipient, nor do any provisions specify how to identify such highly-compensated employees (for example, whether based on current or prior year compensation, whether a potential highly-compensated employee could drop off the prohibited group because of the bonus limit and how compensation would be defined for this purpose.

• Prohibition on Bonuses, Retention Awards, and Other Incentive Compensation. During the TARP restricted period, a TARP recipient may not pay (or accrue) any “bonus, retention award or incentive compensation” to a group of employees that depends on the amount of TARP assistance the financial institution has received. The restricted group ranges from the most highly-compensated employee for institutions with less than $25 million of TARP assistance to the five senior executive officers and at least the next 20 most highly paid employees for institutions with more than $500 million of TARP assistance.

The prohibition does not apply to (1) any bonus required to be paid pursuant to written employment contracts executed on or before February 11, 2009 (“as such valid employment contracts are determined by” Treasury) or (2) payment of “long-term” restricted stock that has a value not exceeding 1/3 of the employee’s total annual compensation, that does not fully vest during the TARP period, and that is subject to such other terms and conditions as Treasury determines are in the public interest. The legislation does not make clear how the term “fully vests” is to be interpreted and whether other forms of equity compensation and long-term incentives could qualify for the restricted stock exception. This prohibition also does not appear to apply to salary.

• Prohibition on Golden Parachutes. No golden parachute payments may be made to the five senior executive officers or the next five most highly-compensated employees during the TARP restricted period. Unlike the current regulations that apply to companies in the TARP Capital Purchase Program, “golden parachute” is broadly defined to include “any payment. . . for departure from a company for any reason, except for payments for services performed or benefits accrued”.

• Expanded Clawback. An expanded clawback applies to any bonus, retention award or incentive compensation paid to the five senior executive officers or the next 20 most highly-compensated employees based on “statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate”.

• No Incentives that Encourage Unnecessary and Excessive Risks. Compensation may not include incentives for the five senior executive officers to take unnecessary and excessive risks that threaten the value of such recipient.

• Prohibition on Compensation Plans that Would Encourage Manipulation of Earnings. Compensation plans may not encourage the manipulation of reported earnings to enhance compensation.

• Independent Board Compensation Committee Review. Each TARP recipient must establish a Board Compensation Committee comprised entirely of independent directors to review its compensation plans. This Board Compensation Committee must meet at least semiannually to assess any risks posed to the TARP recipient by its employee compensation plans. In private companies that receive or have received TARP assistance not exceeding $25 million, the board of directors will handle the duties of the Board Compensation Committee.

OTHER NEW RESTRICTIONS AND PROVISIONS

In addition to requiring Treasury to establish new standards as described above, the legislation includes the following restrictions and other provisions:

• Early Repayment Explicitly Permitted. TARP recipients are permitted (subject to Treasury’s consultation with the appropriate Federal banking agency, if any) to repay any assistance previously received without regard to any waiting periods and without regard to whether the financial institution has replaced the funds with funds from any other source. Upon repayment of assistance, Treasury is to liquidate warrants associated with the assistance at the current market price and the financial institution will no longer be subject to any of the TARP compensation restrictions.

• Retroactive Review of 2008 and Early 2009 Bonuses. Treasury must retroactively review bonuses, retention awards and other compensation paid to the senior executive officers and the next 20 most highly-compensated employees of each TARP recipient before the date of enactment of the new legislation. The review is to determine whether such compensation is inconsistent with the purposes of the new legislation or the TARP or is otherwise contrary to the public interest and, if so, Treasury must seek reimbursement from the TARP recipient and individual employee with respect to such compensation or bonuses.

• Annual Say on Pay Vote. At each annual or other meeting of shareholders during the TARP period, TARP recipients must allow a separate nonbinding “say on pay” shareholder vote to approve executives’ compensation. The legislation requires the SEC to issue any final rules and regulations required by the “say on pay” provision within one year after enactment. It is not clear if this requirement will apply to upcoming annual proxies or only after regulations have been issued.

• Policy on Luxury Expenditures. Boards of directors of TARP recipients must adopt companywide policies on excessive or luxury expenditures (as identified by Treasury), including excessive spending on transportation (including aviation) services, entertainment, office and facility renovations, and other events or activities that are not “reasonable expenditures for staff development, reasonable performance incentives, or other similar measures conducted in the normal course” of the TARP recipient’s business operations.

• Required Certification by CEO and CFO. The CEO and CFO of each TARP recipient must provide written certification of compliance with Section 111 of EESA. Public companies will provide the certification to the SEC together with their annual filings, and private companies will provide the certification to Treasury.

• $500,000 Tax Deduction Cap. The legislation provides that, during the TARP period, each TARP recipient will be subject to the provisions of section 162(m)(5) of the Internal Revenue Code, “as applicable”. Section 162(m)(5), recently enacted by EESA, imposes a $500,000 cap on deductible compensation for financial institutions that sell more than $300 million of assets through their participation in the TARP auction purchase program.(2)

* * *
ENDNOTES
(1) For more information about the Emergency Economic Stabilization Act of 2008 and its executive compensation standards, please see our memoranda entitled “Emergency Economic Stabilization Act” and “Financial Bailout Legislation Restricts Executive Compensation”, both dated October 7, 2008; “Treasury Implements New Executive Compensation Standards” dated October 21, 2008; and “Strict New Executive Compensation Standards Under TARP” dated February 5, 2009.
(2) For more information about this provision, see our memorandum entitled “Financial Bailout Legislation Restricts Executive Compensation”, dated October 7, 2008, pages 6-7.

Treasury: 01-27-09 New Rules, Transparency, Lobbyist Influence

Washington, DC – In light of President Barack Obama’s firm commitment to transparency, accountability and oversight in our government’s approach to stabilizing the financial system, U.S. Treasury Secretary Tim Geithner today announced several key reforms to the Emergency Economic Stabilization Act (EESA).  As one of his first acts as the 75th Treasury Secretary, Secretary Geithner outlined new, stepped up rules designed to limit the influence of lobbyists and special interests in the EESA process and ensure that investment decisions are guided by objective assessments in the best interest of the health and stability of the financial system.

“American taxpayers deserve to know that their money is spent in the most effective way to stabilize the financial system.   Today’s actions reaffirm our commitment toward that goal,” said Secretary Geithner.

Today’s announcement builds on several reforms to the EESA previously outlined by President Obama, including monitoring and tracking lending patterns by financial institutions, limiting executive compensation, and preventing shareholders from being unduly rewarded at taxpayer expense. These new rules go beyond the approach taken under the EESA to date and will help ensure a new level of openness and accountability going forward.

The new rules include:

Combating lobbyist influence in the EESA process: The Treasury Department will implement safeguards to prevent lobbyist influence over the program, including restricting contacts with lobbyists in connection with applications for, or disbursements of, EESA funds.

Keeping politics out of funding decisions: The Treasury Department will ensure that political influence does not interfere with EESA decision making, using as a model for these protections the limits on political influence over tax matters.

Certification to Congress on objective decision making: In reporting to Congress, the Office of Financial Stability (OFS) will certify that each investment decision is based only on investment criteria and the facts of the case.

The investment process will be transparent and based on objective criteria:

• Only banks recommended by the primary bank regulator will be eligible for capital investments.
• OFS will publish a detailed description of the investment review process undertaken by the regulators and OFS.
• The Treasury Department will ensure adequate resources exist to process applications as quickly as possible with priority to the date of the application as received by OFS and will formulate procedures to ensure integrity and regularity in the application process.

TARP: 01-13-09 Neel Kashkari, Review

Washington – Good morning. Thank you, Dean Daly, for that kind introduction. I would also like to thank the McDonough School of Business at Georgetown for hosting us today.

Today, I will provide a review of the financial market crisis and Treasury’s strategy to implement the Troubled Assets Relief Program (TARP) to promote financial stability. First, I will briefly explain why the Administration took the unprecedented action to request Congressional approval for a $700 billion program to support the financial system. Second, I will explain why- as a first step- we decided to invest in healthy banks through purchases of capital, rather than buying illiquid assets. Third, I will discuss how the capital is being used by recipient banks. Finally, I look forward to answering your questions.

Before I begin, I will give you a brief update on the latest statistics of the Capital Purchase Program, a program to invest in healthy banks of all sizes. On Friday, we executed 43 investments, bringing our total investment to $189 billion in 257 banks in 42 states and Puerto Rico. The largest investment was $25 billion and the smallest investment $1 million. In addition, after extensive preparation, we have also completed a term sheet for S-corps to participate in this program. The S-corp term sheet will be posted on the Treasury website tomorrow. The application period will open at that time and will remain open for 30 days.

The Importance of the Financial System

Let me begin by reviewing how the financial system affects Americans and their families. Banks serve as the primary intermediary between borrowers and savers. Americans save for their futures and their families. These savings of individual Americans are combined and made available to other people and businesses who need to borrow money for their specific needs. The financial system links millions of savers around the country with millions borrowers around the country through billions of individual transactions. This extraordinarily complex, but usually efficient system includes both banks, where people have their savings accounts, and other financial institutions that provide, for example, car loans and student loan financing. This system has developed over our Nation’s history and it is built on confidence and on trust. Savers – be they individuals or businesses – must have confidence in the people and institutions they entrust with their money. And because no single bank can touch every family or every business, banks must have confidence to lend to each other for the system to work. If the financial system were to collapse, families might not be able to access the money they have saved. The economic implications of a financial system collapse are profound – for every single American.

Causes of the Credit Crisis

With that background, let me briefly describe the fundamental causes of the credit crisis. The seeds of the credit crisis were planted during a decade of benign economic conditions, including low interest rates and low inflation. Financial innovation, which has served the U.S. economy well over the years, also accelerated. Investors gained increasing confidence in the effectiveness of new financial products to diversify and distribute risks. With this perceived reduction in risk, leverage increased across the financial system. Underwriting standards for mortgages weakened as more and more reliance was placed on the value of the collateral (the home) rather than the willingness and ability of the borrower to repay the loan out of income. Homeowners took out ever larger mortgages with little or no down payment and little or no documentation of income. Regulators, investors and homeowners took comfort from the belief that home prices only go up.

As we have learned, that belief was incorrect. To understand the consequence of that miscalculation, consider that the residential mortgage market in the United States is an $11 trillion market. With banks’ highly leveraged balance sheets and minimal down payments on home loans, even a minor drop in home prices and rise in defaults can result in a large hit to banks’ capital. Large losses can threaten the solvency of financial institutions.

Rooted in housing, this credit crisis is complicated by a number of related factors: First, home prices adjust downward slowly, in part due to homeowners’ reluctance to realize losses; most people would rather keep their home than sell for a loss if they can avoid it since it usually is their largest financial asset. Next, this necessary housing correction, which is not over, is setting the pace of the credit crisis. Finally, this slow adjustment makes it difficult to value mortgages and mortgage-backed securities, because investors don’t know for sure where the bottom of the housing market is and when it will be reached.

But investors are forward looking. With the high leverage in our financial system, the large and necessary housing correction, and credit problems arising in other sectors of the economy, investors quickly realized that the financial system had insufficient capital to withstand the expected losses. But the opacity of mortgage-backed securities and the difficulty in valuing mortgage assets meant it was hard for investors to determine exactly which institutions were at greatest risk.

Not wanting to be exposed to a failing institution, but also not being able to determine for certain which institutions were at risk, investors pulled back wherever they could.

A capital problem for some institutions led to a liquidity problem for all institutions. That liquidity problem created a serious risk that our financial system as a whole, both in the U.S. and abroad, could fail.

Secretary Paulson and Chairman Bernanke recognized early that there might come a time when the private markets would become unwilling to provide the necessary capital to our financial system to deal with the large losses from the housing correction. In such a scenario, only the Federal government would be in a position to support the financial system – to step in to provide the needed capital to prevent a collapse. Government intervention was not our first choice, as it often has unintended, far-reaching consequences. But it was a necessary choice.

Capital is essential for a healthy financial system; it permits banks to take risks and absorb losses while honoring their obligations to depositors and other creditors. During an economic downturn, many businesses and consumers want to see extra capital in their bank in order to have confidence the bank is sound and their money safe. Similarly, in such times, many banks want to see increased capital in other banks in order to have confidence to do business with them.

Although government leaders have numerous tools to combat financial market crises, there was no existing tool to provide capital to the financial system. In early 2008, we evaluated numerous policy alternatives and focused on a program to strengthen banks’ balance sheets by purchasing illiquid mortgage assets in very large scale. By ridding their balance sheets of hard to value and troubled assets, banks would be better able to attract the private capital needed to recapitalize our system. We all hoped such government intervention would not become necessary, but recognized the possibility and began contingency planning.

In late summer, after the failure of Bear Stearns, the crisis intensified and our financial institutions came under even more pressure from deteriorating market conditions and the loss of confidence. In a very short period of time, some of our largest financial institutions failed. In July, IndyMac failed. In the month of September alone, we witnessed the conservatorship of Fannie Mae and Freddie Mac, the bankruptcy of Lehman Brothers, the rescue of AIG by the Fed, the distressed sale of Wachovia, and the failure of Washington Mutual. Eight major U.S. financial institutions effectively failed in 6 months – six of them in September alone.

As a result, credit markets froze. The commercial paper market shut down, 3-month Treasuries dipped below zero, and a money market mutual fund “broke the buck” for only the second time in history, precipitating a $200 billion net outflow of funds from that market. The savings of millions of Americans and the ability of businesses and consumers to access affordable credit were put at serious risk.

The Need for Government Action

Recognizing the threat to our financial system and to every American family, Secretary Paulson and Chairman Bernanke knew the time had come to provide government support for the U.S. financial system. On September 18, they went to the Congress to ask for unprecedented authority to prevent a financial collapse. Congress also recognized this threat and just two weeks later, on October 3, the Congress passed and President Bush signed into law the Emergency Economic Stabilization Act of 2008. We worked hard with the Congress to build tremendous flexibility into the legislation because the one constant throughout the credit crisis has been its unpredictability.

In our discussions with the Congress, we focused on a two part plan: one, our initial, market-based plan to purchase illiquid mortgage assets as a means to attract private capital to the financial system, and two, providing sufficient flexibility to deal with any individual contingencies that arose. In the two weeks between the time we submitted the draft legislation and the time the bill passed, credit markets deteriorated more quickly than we had expected. One key measure we looked at was LIBOR-OIS spread – a measure of perceived credit risk in the financial system. Typically, 5 – 10 basis points, on September 1, the one month spread was 47 basis points. By the 18th, when we first went to Congress, the spread had climbed to 135 basis points. By the time the bill passed, just two week later on October 3, the spread had nearly doubled to 263 basis points.

Why did we switch from illiquid asset purchases to capital investments? Simply put, our Nation was faced with the potential imminent collapse of our banking and financial system and more immediate and powerful actions were needed. It was clear to Secretary Paulson and Chairman Bernanke that we needed to use the authority and flexibility granted under the law as aggressively as possible to quickly stabilize the system. Purchasing equity in healthy banks around the country would be a faster and more direct way to inject much-needed capital into the system and restore confidence compared with asset purchases. We began immediately designing a capital purchase program in addition to continuing work on illiquid asset purchases, which would take longer to implement.

Meanwhile, credit markets continued to deteriorate. On October 10, the LIBOR-OIS spread had risen to 338 basis points. So, four days later, on October 14, when our Capital Purchase Program was ready, we announced a plan to invest $250 billion in banks and savings institutions of all sizes, in combination with the FDIC’s announcement of its guarantee of senior bank debt. These combined actions were taken to build confidence in the U.S. financial system. We believe these actions were successful.

The Capital Purchase Program was not a bailout of participating banks. Only healthy, viable banks are eligible for the program and it is designed to generate a positive return to the taxpayer.

At the same time, we continued working hard on our illiquid asset purchase programs. We were keenly aware that, while $700 billion is a large sum of money, it is a finite amount. We needed to use the available funds to provide the maximum benefit to the system, while leaving enough dry powder to deal with contingencies. Throughout the process, we carefully monitored how the markets were responding to our actions and conditions in the broader economy. We asked ourselves: Would banks apply for the capital? Would credit markets respond? What was happening in the economy?

We were pleased that healthy banks of all sizes were signing up for the program and credit markets were showing signs of thawing. But the economic indicators were less positive. On October 31, data on third quarter GDP showed negative 0.3 percent growth. In addition, data released on October 28 showed that through August, home prices in 10 major cities had fallen 18 percent over the previous year.

A large contingency also arose that threatened the financial system and we had to restructure the Federal Reserve’s loan to AIG, using $40 billion of TARP funds. With about half the original $700 billion available for asset purchases, we asked ourselves: would such a program still be the best approach? For an asset purchase program to be effective, it must be done in very large scale. We concluded that capital would provide the most benefit given available resources.

It is also important to support the non-banking market, which is essential to helping consumers, businesses and our economy get the credit they need. The Federal Reserve is setting-up a $200 billion program, the Term Asset-Backed Securities Loan Facility (TALF). With $20 billion from the TARP, we will help make it easier for American families to get affordable auto loans, student loans, and consumer credit, as well as loans for small businesses.

Where We Are Today

As of today, we have fully allocated the first $350 billion and, at the President-Elect’s request, President Bush has asked Congress to make available the remaining $350 billion for the next Administration. As I mentioned when I opened, we have invested $189 billion of the $250 billion Capital Purchase Program in 257 institutions in 42 states across the country, as well as Puerto Rico. There is a huge demand for the program: the number of applications under-review at the regulators is in the thousands, representing every state in the country, and hundreds more have already been pre-approved by Treasury. We are pleased with the large number of banks that have applied. As I also noted above, we have also allocated $20 billion for the TALF to support consumer and small business lending. Today, the LIBOR-OIS spread has fallen to 19 basis points. We believe the combined actions of Treasury, the Federal Reserve and FDIC have prevented a financial collapse.

We have also had to deal with several contingencies, including a possible loss of confidence in Citigroup, and the impending failures of AIG and the domestic auto companies which have consumed the remaining allocation within the first $350 billion. We believe that when government intervention is required to prevent the failure of a firm, the firm’s shareholders should pay a high price to discourage imprudent risk-taking in the future. Our actions to stabilize Fannie Mae, Freddie Mac and AIG demonstrate this perspective where existing shareholders were severely diluted and the taxpayers received warrants for 80 percent of the companies.

This approach has challenges, however, when the system as a whole comes under pressure and several similarly-situated institutions are at risk. We have worked hard to develop programs to encourage private capital to flow into the banking sector. Whenever possible, we have designed programs that avoid the government controlling private institutions. We have used a combination of tools such as preferred investments and asset guarantees as a means to enhance the confidence of systemically-important institutions on a case-by-case basis.

Update on Lending

People recently have begun to ask what the banks are doing with the money we’ve invested in them. We designed important features into our investment contracts to limit what banks can do with the money: one, we restricted dividend increases and share repurchases and, two, placed restrictions on executive compensation. By increasing a bank’s capital, the bank will have strong economic incentives to deploy the capital profitably. Banks are in the business of lending and they will provide credit to sound borrowers whenever possible. They may also use the capital to absorb losses as part of loan write-downs and restructurings. If a bank doesn’t put the new capital to work earning a profit or reducing a loss, its returns for its shareholders will suffer.

What about mergers and acquisitions? Why didn’t Treasury prohibit them? We must remember that when a failing bank is acquired by a healthy bank, the community of the failing bank is better off than if the bank had been allowed to fail. Branches and financial services in that community are usually preserved. Costs to the taxpayers via the FDIC deposit fund are also lower than had the bank been allowed to fail. Prudent mergers and acquisitions can strengthen our financial system and our communities, while protecting taxpayers.

People then ask: when will we see banks making new loans? It is important to note that over $60 of the $250 billion CPP has yet to be received by the banks. Treasury is executing at a rapid speed, but it will take some time to review and fund all the remaining applications. This capital needs to get into the system before it can have the desired effect. In addition, we are still at a point of low confidence – both due to the financial crisis and the economic downturn. As long as confidence remains low, banks will remain cautious about extending credit, and consumers and businesses will remain cautious about taking on new loans. As confidence returns, Treasury expects to see more credit extended.

This reduced demand for and provision of credit is common in an economic downturn. During the past nine recessions, inflation-adjusted total private sector lending per quarter has contracted on average 30 percent from peak to trough, while real GDP has contracted 2.0 percent. So we should not be surprised that lending and borrowing will be lower during this current economic downturn. We absolutely need our banks to continue to make credit available – especially given the disruption in the non-banking financial markets. Our banks’ role as provider of credit in our economy is even more important now. But we must not attempt to force them to make loans whose risks they are not comfortable with. Bad lending practices were at the root cause of this crisis. Returning to those practices will not help end this financial turmoil.

People have then asked: how will you track lending activity? Treasury has been working with the banking regulators to design a program to measure the activities of banks that have received TARP capital. We plan to use quarterly call report data to study changes in the balance sheets and intermediation activities of institutions we have invested in and compare their activities to a comparable set of institutions that have not received TARP capital investments. Because call report data is infrequent, we also plan to augment that analysis with a selection of data we plan to collect monthly from the largest banks we have invested in for a more frequent snapshot.

The provision of credit that is vital to our economy will not materialize as fast as any of us would like, but it will happen much faster as a result of deploying resources from the TARP to stabilize the system and increase capital in our banks.

Conclusion

The EESA is not an economic stimulus plan, nor is it an economic growth plan. It was one of several initiatives taken by the Federal government to stabilize the financial system – a necessary precondition to any economic recovery. We believe the combined actions of Treasury, the Federal Reserve and FDIC have helped stabilize the financial system and prevent a financial collapse. Nonetheless, the current crisis took years to build up and will take time to work through, and we still face some real economic challenges. As Secretary Paulson has said, there is no single action the Federal government can take to end the financial market turmoil and the economic downturn, but the authorities Congress provided last fall dramatically expanded the tools available to address the needs of our system. Thank you and I would be happy to take your questions.

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Mortgage Cram-down 01: 01-13-09 What is it? What effects?

From the WSJ

Mortgage lenders who wake up Thursday with a New Year’s hangover are likely to face another headache soon: The effort to give bankruptcy judges the power to rewrite mortgages is gaining steam.

The banking industry hoped the mortgage “cram-down” measure died when Congress removed it from the $700 billion bailout bill that passed in October. But it has been gathering momentum in Democrat-controlled Washington, as evidence emerges that current voluntary foreclosure-prevention programs are falling short.

In a cram-down, a judge modifies a loan, often reducing principal so a borrower can afford it.

The Heritage Foundation makes a good argument on why we should not allow mortgage cram-downs. See here and below

Senate Democrat/Citigroup plan to allow bankruptcy judges to rewrite mortgage contracts becomes law, there is no doubt that many homeowners who are struggling to pay their mortgages will be helped in the short term. But there is never any such thing as a free lunch. What benefits these homeowners in the short term, only hurts other homeowners trying to sell their homes, and all home buyers trying to afford one.

A mortgage cram down law would:

• Add the government as a silent third party to all private contracts between a home buyer and a lender. Until now, the government has rightly stayed out of these transactions. A cram down would create an incentive for mortgage seekers to agree to any terms, confident that a bankruptcy court will bail them out at a later date.
• Such a move builds in a greater chance that the mortgage contract will not be paid as agreed. In order to protect their shareholders, financial institutions must price that uncertainty and add it to the cost of a mortgage.
• It will be much harder for low-income homebuyers or new homebuyers to find mortgages. Because of the even higher risk that courts may restructure loans to those groups, lenders will focus on upper-income borrowers or those with high downpayments and good credit histories.
• If the cram downs are allowed, this premium is likely to be higher until the industry has enough experience to more accurately price the added uncertainty.
• Even if they can get loans, low-income workers, first-time borrowers, and those with impaired credit histories will pay much higher interest rates since they have the highest probability of running into financial trouble.

As the Mortgage Bankers Association still opposes the cram downs “because of the destabilizing effect it will have on an already turbulent mortgage market.” Markets need stabilizing rules, not more uncertainty, in order to recover.

TARP: 01-10-09 Frank Introduces TARP Reform & Accountability Act

Washington, DC – House Financial Services Committee Chairman Barney Frank (D-MA) today introduced H.R. 384, the TARP Reform and Accountability Act to amend the Troubled Assets Relief Program (TARP) provisions of the Emergency Economic Stabilization Act of 2008 (EESA). The legislation will strengthen accountability, close loopholes, increase transparency, and require Treasury to take significant steps on foreclosure mitigation.

Click Here for H.R. 384 “TARP Reform and Accountability Act of 2009″

Summary of TARP Reform and Accountability Act

This bill will amend the Troubled Assets Relief Program (TARP) provisions of the Emergency Economic Stabilization Act of 2008 (EESA) to strengthen accountability, close loopholes, increase transparency, and require Treasury to take significant steps on foreclosure mitigation.  It further requires that Treasury act promptly to permit the smaller community financial institutions that have been shut out so far to participate on the same terms as the large institutions that have already received funds.

Title I – Modification to TARP and TARP Oversight

Reporting, Monitoring and Accountability

General – Treasury shall require any existing or future institution that receives funding under TARP to provide no less than quarterly public reporting on its use of the funding.  Treasury may establish additional reporting and information requirements and must establish mechanisms to ensure appropriate use and compliance with all terms of use of TARP funds, as described below.

Insured depository institutions. Any insured depository institution that receives funding under TARP is required to report quarterly on the amount of any increased lending (or reduction in decrease of lending) and related activity attributable to such financial assistance.  Where an institution cannot categorize effect of investment it shall report on lending and related activity during the period, with comparable prior period data. Treasury, in consultation with the bank regulatory agencies, shall establish standards for the required reporting (expanded version of LaTourette amendment from House auto bill)

Agreements on use of funds. In connection with any new receipt of TARP funds, Treasury is required to reach agreement with the institution and its primary federal regulator on how the funds are to be used and benchmarks the institution is required to meet so as to advance the purposes of the Act to strengthen the soundness of the financial system and the availability of credit to the economy.

Examinations. Examinations by a recipient institution’s primary federal regulator must specifically examine use of funds and compliance with any program requirements, including executive compensation and any specific agreement terms.

Acquisition of healthy institutions from TARP funds prohibited. Treasury shall require that any acquisition of another depository institution by an institution receiving TARP funds be conditioned on a finding by Treasury, in consultation with the relevant bank regulatory agencies, 1) that the acquisition reduces the risk to taxpayers or 2) that the transaction could have been accomplished without funds provided under the TARP.

Non-depository institutions – For recipients that are not insured depository institutions or that do not have a federal regulator, Treasury shall directly require any reporting and impose other terms no less stringent than those applicable to insured depository insitutions, and shall examine the institution, or may delegate such functions to the Federal Reserve.

Executive Compensation

All types of funding get same treatment. For any new receipt of TARP funds (except those by small financial institutions as defined below), applies the most stringent non-tax executive compensation restrictions (see note) from EESA across the board:

1) requires Treasury to prohibit incentives that encourage excessive risks,

2) provides for claw-back of compensation received based on materially inaccurate statements

3)prohibits all golden parachute payment for the duration of the investment

Stricter auto bill rules apply. Also applies the executive compensation requirements included in auto bill to any new receipt of TARP funds:

1)  prohibits paying or accruing any bonus or incentive compensation to the 25 most highly compensated employees;

2)  prohibits any compensation plan that would encourage manipulation of earnings to enhance compensation; and

3).  requires divestment of private aircraft or leases.

Authority retroactive. Provides authority to Treasury to apply these expanded executive compensation provisions retroactively to existing recipients of direct assistance.

Removes de minimus exception. Prospectively removes de minimus exception under which institutions smaller than $300 million in assets are not subject to the golden parachute limitations in auction purchases of troubled assets.

[Note: Existing tax-related executive compensation provisions under EESA Section 302 are not modified in this draft bill.]

Government board representation – Authorizes Treasury to have an observer at board or board committee meetings of recipient institutions.

Directive to make TARP funds available to smaller community institutions – Directs the Treasury to promptly make funds available for smaller community institutions, few of which have received funding to date.  Depository institutions that have applied and are still waiting for action on their applications (C-corporations, privately-held institutions and community development financial institutions) or for which no funding terms have been issued (non-stock corporations, S-corporations, and mutually owned institutions) will not be penalized and may receive funding on terms comparable to institutions that received funds prior to this Act.

Changes to structure and authority of TARP board – The Financial Stability Oversight Board is expanded to include the Chairman of the FDIC and two additional members who are not currently federal employees, who shall be appointed by President and subject to Senate confirmation.  The Board will have the authority to overturn policy decisions of the Treasury Secretary by a 2/3 vote.

Warrants – Unless otherwise specified, Treasury must obtain warrants equal to no less than 15% of any financing provided, and the $100M de minimus exclusion from the warrant requirement is removed.

No impediment to withdrawal – Subject to consultation with the appropriate bank regulatory agency, Treasury shall permit a recipient of TARP funds to repay those funds, whether or not the recipient has replaced those funds with private capital, as currently required by Treasury.

Clarifies status of capital injections – Clarifies that any provision of capital or other assistance to any institution is a purchase of troubled asset for the purpose of the Act.

Title II – Foreclosure relief

TARP Foreclosure Mitigation Plan – Use of the second $350 billion is conditioned on the use of up to $100 billion, but no less than $40 billion, for foreclosure mitigation, with plan required by March 15, 2009.  By that date, the Secretary shall develop (subject to TARP Board approval) a comprehensive plan to prevent and mitigate foreclosures on residential mortgages.  The Secretary shall begin committing TARP funds to implement the plan no later than April 1, 2009.  The Secretary must certify to Congress by May 15, 2009, if he has not committed more than required minimum $40 billion.

Required Elements of Plan – The foreclosure mitigation plans must apply only to owner-occupied residences and shall leverage private capital to the maximum extent possible consistent with maximizing prevention of foreclosures.  Treasury must use some combination of the following program alternatives:

1) guarantee program for qualifying loan modifications under a systematic plan, which may be delegated to the FDIC or other contractor

2) bringing costs of Hope for Homeowner loans down (beyond mandatory changes in Title V below), either through coverage of fees, purchasing H4H mortgages to ensure affordable rates, or both

3) program for loans to pay down second lien mortgages that are impeding a loan modification subject to any write-down by existing lender Treasury may require

4) Servicer incentives/assistance – payments to servicers in connection with implementation of  qualifying loan modifications

5) Purchase of whole loans for the purpose of modifying or refinancing the loans (with authorization to delegate to FDIC)

Implementation of Plan – In consultation with the FDIC and HUD and with the approval of the Board, Treasury may determine that modifications to an initial plan are necessary to achieve the purposes of this act or that modifications to component programs of the plan are necessary to maximize prevention of foreclosure and minimize costs to the taxpayers.

Servicer authority for foreclosure mitigation – Provides a safe harbor from liability to servicers who engage in loan modifications, regardless of any provisions in a servising agreement, so long as the servicer acts in a manner consistent with the duty established in Homeowner Emergency Relief Act (maximize the net present value (NPV) of pooled mortgages to all investors as a whole; engage in loan mods for mortgages that are in default or for which default is reasonably foreseeable; the property is owner-occupied; the anticipated recovery on the mod would exceed, on an NPV basis, the anticipated recovery through foreclosure).

Requires persons who bring suit unsuccessfully against servicers for engaging in loan modifications under the Act to pay the servicers’ court costs and legal fees.

Requires Servicers who modify loans under the safe harbor to regularly report to the Treasury on the extent, scope and results of the servicer’s modification activities.

Report required by Congressional Oversight Panel – The Panel is required to report to Congress by July 1st on the actions taken by Treasury on foreclosure mitigation and the impact and effectiveness of the actions in minimizing foreclosures and minimizing costs to the taxpayers.

Title III – Automobile manufacturers – Clarifies and confirms Treasury authorization to provide assistance to automobile manufacturers under the TARP.  With respect to the assistance already provided to domestic automobile industry, includes conditions of the House auto bill, including long-term restructuring requirements.

Clarifies Treasury’s authority to provide support to the financing arms of automakers for financing activities to ensure that they can continue to provide needed credit, including through dealer and other financing of consumer and business auto and other vehicle loans and dealer floor loans.

Title IV Clarification of authority under TARP for additional uses

Consumer loans – Clarifies Treasury’s authority to establish facilities to support the availabliity of consumer loans, such as student loans, and auto and other vehicle loans.  Such support may include the purchase of asset-backed securities, directly or through the Federal Reserve.

Commercial Real Estate Loans and MBS – Clarifies Treasury’s authority to provide support for commercial real estate loans and mortgage-backed securities.

Municipal securities – Clarifies Treasury’s authority to provide support to issuers of municipal securities, including through the direct purchase of municipal securities or the provision of credit enhancements in connection with any Federal Reserve facility to finance the purchase of municipal securities.

Title V – Hope for Homeowners Improvements

Eliminates 3% upfront premium

Reduces 1.5% annual premium to a range between .55% and .75%, based on risk-based pricing (also makes technical fix to permit discontinuation of fees when loan balance drops below certain levels, consistent with normal FHA policy)

Raises maximum loan to value (LTV) from 90% to 93% for borrowers above a 31% mortgage debt to income (DTI) ratio or above a 43% ratio

Eliminates government profit sharing of appreciation over market value of home at time of refi. Retains government declining share (from 100% to 50% after five years) of equity created by the refi, to be paid at time of sale or refi as an exit fee

Authorizes payments to servicers participating in successful refis

Administrative simplification: (a) eliminates borrower certifications regarding not intentionally defaulting on any debt, (b) eliminates special requirement to collect 2 years of tax returns, (c) eliminates originator liability for first payment default, (d) eliminates March 1, 2008 31% DTI test, (e) eliminates prohibition against taking out future second loans, (f) requires Board to make documents, forms, and procedures conform to those under normal FHA loans to the maximum extent possible consistent with statutory requirements.

Title VI – Home Buyer Stimulus

Requires Treasury to develop a program, outside of the TARP,  to stimulate demand for home purchases and clear inventory of properties, including through ensuring the availability of affordable mortgages rates for qualified home buyers.  In developing such program, Treasury may take into consideration impact on areas with highest inventories of foreclosed properties.  The program will be executed through the purchase of mortgages and MBS using funding under HERA.

In developing such program, Treasury shall provide mechanisms to ensure availability of such reduced rate loans through financial institutions that act as either originators or as portfolio lenders.

Treasury shall make the affordable rates available under this program available in connection with Hope for Homeowner refinancing program.

Title VII – Permanent Increase in FDIC and NCUA Deposit Insurance Limits

Makes permanent the increase in deposit insurance coverage for banks and credit unions to $250,000, which was enacted temporarily as part of the Emergency Economic Stabilization Act and is scheduled to sunset on December 31, 2009, and includes an inflation adjustment provision for future coverage.

Extends the time limit for an FDIC Restoration Plan to rebuild the reserve ratio of the Deposit Insurance Fund from 5 years to 8 years.

Increases the FDIC’s borrowing authority from $30 billion to $100 billion and allows the FDIC to obtain sums in excess of $100 billion upon the FDIC’s written request and the Secretary of the Treasury’s approval on the basis that the additional amounts are necessary.

Allows FDIC to charge systemic risk special assessments by rulemaking, on both insured depository institutions and depository institution holding companies. For holding company assessments, the concurrence of the Secretary of the Treasury would be required.

Treasury: 01-02-09 EESA Report

Summary

Washington – Treasury today released the attached report, required by section 102 of the Emergency Economic Stabilization Act. As required by section 102(a), Treasury established the Asset Guarantee Program to provide guarantees for assets held by systemically significant financial institutions that face a high risk of losing market confidence due in large part to a portfolio of distressed or illiquid assets.

This program would be utilized as needed to improve market confidence in a systemically significant institution and in financial markets broadly and it is not anticipated that the program will be made widely available.

Complete report below

This report fulfills the requirement under section 102 of the Emergency Economic Stabilization Act (EESA) for the Treasury Department to report to Congress within 90 days of the passage of the bill on the insurance program established under Section 102(a).

Asset Guarantee Program

Treasury is exploring use of the Asset Guarantee Program to address the guarantee provisions of the agreement with Citigroup announced on November 23, 2008. Under the agreement, the Treasury Department will assume the second-loss position after Citigroup on a selected group of mortgage-related assets.

As required by section 102(a), Treasury established the Asset Guarantee Program (AGP). This program provides guarantees for assets held by systemically significant financial institutions that face a high risk of losing market confidence due in large part to a portfolio of distressed or illiquid assets. This program will be applied with extreme discretion in order to improve market confidence in the systemically significant institution and in financial markets broadly. It is not anticipated that the program will be made widely available.

Under the AGP, Treasury would assume a loss position with specified attachment and detachment points on certain assets held by the qualifying financial institution; the set of insured assets would be selected by the Treasury and its agents in consultation with the financial institution receiving the guarantee. In accordance with section 102(a), assets to be guaranteed must have been originated before March 14, 2008.

Treasury would collect a premium, deliverable in a form deemed appropriate by the Treasury Secretary. As required by the statute, an actuarial analysis would be used to ensure that the expected value of the premium is no less than the expected value of the losses to TARP from the guarantee. The United States government would also provide a set of portfolio management guidelines to which the institution must adhere for the guaranteed portfolio.

Treasury would determine the eligibility of participants and the allocation of resources on a case-by-case basis. The program would be used for systemically significant institutions, and could be used in coordination with other programs. Treasury may, on a case-by-case basis, use this program in coordination with a broader guarantee involving one or more other agencies of the United States government.

Justification

The objective of this program is to foster financial market stability and thereby to strengthen the economy and protect American jobs, savings, and retirement security. In an environment of high volatility and severe financial market strains, the loss of confidence in a financial institution could result in significant market disruptions that threaten the financial strength of similarly situated financial institutions and thus impair broader financial markets and pose a threat to the overall economy. The resulting financial strains could threaten the viability of otherwise financially sound businesses, institutions, and municipalities, resulting in adverse spillovers on employment, output, and incomes.

Determination of Eligible Institutions

In determining whether to use the program for an institution, Treasury may consider, among other things:

1. The extent to which destabilization of the institution could threaten the viability of creditors and counterparties exposed to the institution, whether directly or indirectly;

2. The extent to which an institution is at risk of a loss of confidence and the degree to which that stress is caused by a distressed or illiquid portfolio of assets;

3. The number and size of financial institutions that are similarly situated, or that would be likely to be affected by destabilization of the institution being considered for the program;

4. Whether the institution is sufficiently important to the nation’s financial and economic system that a loss of confidence in the firm’s financial position could potentially cause major disruptions to credit markets or payments and settlement systems, destabilize asset prices, significantly increase uncertainty, or lead to similar losses of confidence or financial market stability that could materially weaken overall economic performance;

5. The extent to which the institution has access to alternative sources of capital and liquidity, whether from the private sector or from other sources of government funds.

In making these judgments, Treasury will obtain and consider information from a variety of sources, and will take into account recommendations received from the institution’s primary regulator, if applicable, or from other regulatory bodies and private parties that could provide insight into the potential consequences if confidence in a particular institution deteriorated.

TARP Accounting and Treasury’s Loss Position

Treasury generally achieves a greater impact per TARP dollar absorbed by taking an early loss position over a narrow interval of losses rather than a late loss position over a larger range of losses.

Treasury’s purchasing authority under TARP is reduced by the total value of the guaranteed asset less the cash premium received, where the premium is equal to the expected loss on the guaranteed asset. If the Treasury collects a non-cash premium – for example, preferred shares – the TARP purchasing authority is reduced by the entire value of the guarantee until the preferred shares are sold and converted to cash. These accounting rules imply that if guarantees for two assets of different values have the same expected loss, the larger asset will be more TARP-intensive to insure. For example, suppose Treasury has the choice between guaranteeing two different assets, one of which is worth $50 and has a 10 percent chance of losing all of its value and the other of which is worth $10 and has a 50 percent chance of losing all of its value. For the sake of simplicity, the premium in this example will be paid in cash. If the premium received equals the expected value of the losses to TARP from the guarantee (thereby meeting the statutory requirement), Treasury would collect a $5 premium for guaranteeing either asset. However, the TARP purchasing authority would be reduced by $45 for the guarantee on the first asset (the $50 covered minus the $5 premium) and just $5 for the guarantee on the second asset (the $10 covered minus the $5 premium). Although the net expected payouts of the two guarantees are equal, the second guarantee is more valuable per dollar of TARP absorbed: covering the first asset uses $9 of TARP per $1 of expected loss, whereas the second asset uses only $1 of TARP per $1 of expected loss.

Because of this feature of TARP accounting under Section 102 of the EESA, Treasury in using the AGP will generally take a relatively early loss position over a narrow range of losses to provide the greatest protection per TARP dollar absorbed.

Other Potential Asset Guarantee Programs

Treasury is reviewing options for the development of other programs to insure troubled assets pursuant to the legislation. Two design considerations will be important factors for any potential program developed under Section 102:

(1) Accounting under the TARP purchasing authority: The TARP purchasing authority is reduced dollar-for-dollar by the amount guaranteed less the premiums received; the expected net payout from the program is not considered for this purpose. This means that insuring an asset under section 102 has almost an equivalent impact on the TARP purchasing authority as purchasing the same asset (Section 102.c.4).

(2) Adverse selection: Information on the credit risk underlying a particular asset, notably complex assets such as mortgage backed securities, can often be understood only through intensive research—and even then, the risk will ultimately depend on outcomes such as future home price appreciation that can be forecast only imperfectly. If an insurance program were to offer a set premium for a specific asset class – even one that is narrowly defined – it could well be the case that only the holders of assets for whom the premium was either appropriate or underpriced would buy insurance. By construction, the credit risk associated with the securities that would actually be insured at any given premium would be higher than the premium would cover. Individually pricing the assets – a resource-intensive endeavor – is the only way of achieving an expected net payout of zero. In practice, this means that setting the pricing of the insurance premiums will inevitably require particular assumptions and judgments; the ex-post financial outcome involved with the guarantees could deviate substantially from the ex-ante actuarial analysis—for better or for worse.

To assist in the consideration of programs under Section 102, the Treasury issued Federal Register Notice (Docket # TREAS-DO-2008-0018 posted 10/16/2008). Treasury asked for comment on programs consistent with Section 102 of the Emergency Economic Stabilization Act of 2008 (EESA). Treasury particularly invited comments on the appropriate structure for such a program, and whether the program should offer insurance against losses for both individual whole loans and individual mortgage backed securities (MBS), as well as the payout and triggering event, estimation of losses, and setting the appropriate premium. A summary of the comments received is attached next as an Appendix to this report.

Appendix: Summary of Responses to Request for Comments

Treasury received 85 responses to the Request for Comments from a wide variety of respondents, including individuals, academics, financial institutions, municipalities, and trade groups. Many submissions chose to urge the eligibility of the represented group to EESA-related programs rather than to outline an insurance program structure.

The responses to the Request for Comments largely envisioned a standard insurance program, in which the Treasury would offer a guarantee on some portion of the principal and payments from a security in return for a premium. The respondents recognized the difficulty associated with setting prices for these premiums, but argued that in order to avoid adverse selection, premiums for the securities must be priced either individually or on pools of homogeneous assets. Several respondents commented that a guarantee program could offer greater flexibility than asset purchase programs in structuring timelimited or partial support (by incorporating loss-sharing, for example).

Respondents expressed differing view along two important dimensions of the program: the assets that should be eligible and the share of the assets that should be insured.

Proposed structure of guarantee

Most respondents focused on guarantees of existing individual loans or MBS. In guaranteeing whole loans, Treasury would receive insurance premiums and pay the insured (the owner of the mortgage loan) for a realized loss relative to principal and future interest payments due on the mortgage loan. Factors that would affect the premium include the degree of loss coverage (co-pay), the size of the deductible, and loan characteristics.

In guarantees of pools of existing loans owned by financial institutions, Treasury could, in exchange for a premium, purchase any loan that reaches a certain level of delinquency at a predetermined price. Alternatively, Treasury could offer to share loss on a loan, once the institution carried the loan through appropriate workout adjustment including foreclosure.

Other proposed structures included:

• Limiting participation in the insurance program to institutions that successfully execute a private capital raise.

• Conditioning participation on foreclosure mitigation efforts.

• Guaranteeing securitizations of whole loans or MBS

o In return for a fee, Treasury would purchase existing loans or MBS pools, issue securities backed by these assets, and guarantee principal and interest on securities if an institution that issued the loans in the pool defaults.

o This could be made operational through an SPV set up to purchase and hold the assets and issue short- and medium-term obligations against them, with Treasury guaranteeing the performance of the SPV securities.

o This securitization and pool guarantee could be applied to shorter-term securities that are also troubled due to market seizure, for example asset backed commercial paper (ABCP).

o There is a question of whether this satisfies the statute, which states that the guarantee must apply to assets originated before March 14th, 2008. The guaranteed assets, in this case, would be payments from a securitized pool issued through the SPV, not the assets underlying these pools.

• Guaranteeing severe loss for insurance entities holding portfolio credit risk. For example, rather than guaranteeing individual assets, the program could compensate holders of MBS or mortgage loans for losses in excess of a threshold in exchange for a fee.

• Issuing derivatives correlated with the performance of an existing index of mortgage related credit. For example, the Treasury could sell put options on the ABX index, or link payout to an existing house appreciation index such as the Case-Shiller index. This structure allows institutions to hedge their exposure to aggregate risk associated with the assets in their portfolios but not asset-specific risk.

o For the institutions’ capital position to be improved by this program the derivatives must qualify as “highly effective” hedges – their performance must be highly correlated with the performance of the hedged assets.

Eligible assets

Respondents generally commented that the guarantee should be offered where it may be more efficient than asset purchase under Sec. 101. Respondents suggested that performing but illiquid assets – such as senior tranches of non-agency residential and commercial MBS, performing whole mortgage loans, ABS (credit card, auto loans, and student loans), auction rate securities (ARS), and municipal bonds – would be most
suitable for such a program. The assets that received the most attention were whole residential loans and residential MBS.

Determining risk and pricing premiums

Respondents uniformly agreed that – no matter which assets are insured in this program – pricing is a monumental task that will almost certainly have to be contracted out. Respondents suggested that Treasury use the methods and models standard in the industry to determine risk. No feasible alternative to individually pricing the assets was offered.

Payout

Most respondents suggested paying out 100 percent of principal and expected interest, or some portion thereof. Arguments in favor of each were as follows: 100 percent of principal and expected interest: The higher the guarantee the government provides, the more liquidity and confidence will be restored to the market. Most respondents favoring this structure argued that the 100 percent guarantee should be applied to the current value of the asset, on an expected cash-flow basis, rather than the original value of the asset.

A portion of the principal and expected interest: Guaranteeing less than 100 percent ensures that the participating institutions share in the loss, thus incentivizing them to pursue all their loss-mitigation options. Institutions holding whole loans and MBS with deductibles or other loss-sharing mechanisms would be far more likely to attempt to restructure those loans.

Respondents suggested either guaranteeing a fixed percentage of the original value of the asset, regardless of the current expected cash-flows, or guaranteeing a fixed percentage of the current value of the asset, as measured on an expected cash-flow basis. Several respondents suggested that the level of guarantee should reflect the broad risk characteristics of the asset class. For example, a higher level of coverage should be available for senior tranches of MBS than for junior tranches, and residential mortgages should be insured at a higher level than incomplete residential development projects.

Setting premiums

Premiums should reflect the risk of default and total losses for the insured assets. Respondents agreed that premiums will vary for different classes of assets to reflect the risk and total credit loss associated with that asset class. The majority of respondents recommend pricing the premiums either on an asset-by-asset basis or on a homogeneous pool of assets and periodically re-evaluating the assets and premiums as the program
continues.

The premiums can either be paid up front as a lump sum or periodically. Respondents cited the flexibility of periodic payments as a desirable feature; the premium can be adjusted based on long term performance, actual loss, and improvements.

Market value of the guarantee

Respondents argued that making the guarantee transferable is essential to establishing liquidity to the market this guarantee program is targeting. The guarantee should be attached to the asset and transferred to the asset’s new owner when the asset is sold.

Administrative issues

Management of the program, including premium setting, determination of institution and asset eligibility, and extensive monitoring of guaranteed institutions and assets will be complex and resource-intensive. Most proposals recommend Treasury seek outside expertise in accounting, insurance, pricing, and administration.

Treasury: 01-02-09 Targeted Investment Program

Washington – Treasury today (01-02-09) released the program description for the Targeted Investment Program under which the Citigroup investment that was announced on Nov. 23 was made. This program description is required by Section 101(d) of the Emergency Economic Stabilization Act. Other EESA program descriptions are posted here.

Guidelines for Targeted Investment Program

The United States Department of the Treasury will determine eligibility of participants and allocation of resources under the Emergency Economic Stabilization Act (EESA) pursuant to the Targeted Investment Program. Financial Institutions (as defined in EESA) will be considered for participation in the Targeted Investment Program on a case-by-case basis. There is no deadline for participation in this program.

Justification

The objective of this program is to foster financial market stability and thereby to strengthen the economy and protect American jobs, savings, and retirement security. In an environment of high volatility and severe financial market strains, the loss of confidence in a financial institution could result in significant market disruptions that threaten the financial strength of similarly situated financial institutions and thus impair broader financial markets and pose a threat to the overall economy. The resulting financial strains could threaten the viability of otherwise financially sound businesses, institutions, and municipalities, resulting in adverse spillovers on employment, output, and incomes.

Eligibility Considerations

In determining whether an institution is eligible for participation, Treasury may consider, among other things:

1. The extent to which destabilization of the institution could threaten the viability of creditors and counterparties exposed to the institution, whether directly or indirectly;

2. The extent to which an institution is at risk of a loss of confidence and the degree to which that stress is caused by a distressed or illiquid portfolio of assets;

3. The number and size of financial institutions that are similarly situated, or that would be likely to be affected by destabilization of the institution being considered for the program;

4. Whether the institution is sufficiently important to the nation’s financial and economic system that a loss of confidence in the firm’s financial position could potentially cause major disruptions to credit markets or payments and settlement systems, destabilize asset prices, significantly increase uncertainty, or lead to similar losses of confidence or financial market stability that could materially weaken overall economic performance; and

5. The extent to which the institution has access to alternative sources of capital and liquidity, whether from the private sector or from other sources of government funds.

In making these judgments, Treasury will obtain and consider information from a variety of sources, and will take into account recommendations received from the institution’s primary regulator, if applicable, or from other regulatory bodies and private parties that could provide insight into the potential consequences if confidence in a particular institution deteriorated.

Form, Terms, and Conditions of Treasury Investment

Treasury will determine the form, terms, and conditions of any investment made pursuant to this program on a case-by-case basis in accordance with the considerations mandated in EESA. Treasury may invest in any financial instrument, including debt, equity, or warrants, that the Secretary of the Treasury determines to be a troubled asset, after consultation with the Chairman of the Board of Governors of the Federal Reserve System and notice to Congress. Treasury will require any institution participating in this program to provide Treasury with warrants or alternative consideration, as necessary, to minimize the long-term costs and maximize the benefits to the taxpayers in accordance with EESA. Treasury will also require any institution participating in the program to adhere to rigorous executive compensation standards. In addition, Treasury will consider other measures, including limitations on the institution’s expenditures, or other corporate governance requirements, to protect the taxpayers’ interests.

These program guidelines are being published in accordance with the requirements of Section 101(d) of EESA.

EESA: 12-31-08 Treasury Oversight

Letter to Elizabeth Warren, Congressional Oversight Panel You may contact Elizabeth at cbateson@law.harvard.edu. Her homepage at Harvard is here. For a copy of the letter, click here.

RESPONSES TO QUESTIONS OF THE FIRST REPORT OF THE CONGRESSIONAL OVERSIGHT PANEL FOR ECONOMIC STABILIZATION

Submitted by
Department of the Treasury
December 30, 2008

Question 1: What is Treasury’ s strategy?

Answer:

The Nation has been experiencing an unprecedented period of financial market turmoil with market events occurring rapidly and unpredictably. The Treasury Department has responded and adapted quickly to these events. Throughout the crisis, Treasury’s strategy has been to work in coordination with all government agencies to use all the tools available to the government to achieve the following critical objectives:

Stabilize financial markets and reduce systemic risk

Support the housing market by avoiding preventable foreclosures and supporting mortgage finance

Protect taxpayers.

The measures taken by Treasury under the Emergency Economic stabilization Act (EESA) are part of a comprehensive strategy by Treasury and the federal regulators since the onset of the crisis to stabilize the financial system and housing markets, and strengthen our financial institutions. Treasury has acted quickly and creatively in coordination with the Federal Reserve, the FDIC, OTS, and the OCC to help stabilize the financial system. In addition, because the crisis is global in nature, Treasury and the Federal Reserve have also worked in close coordination with Finance Ministries and major Central Banks around the world, which have taken similar measures to stabilize their financial systems. It is clear that our coordinated actions have made an impact. Our coordinated effort to strengthen our financial institutions so they can support our economy is critical to working through the current economic downturn.

The following is a list of many of the actions taken by Treasury and other federal agencies as part of our comprehensive approach. Detailed information on all of these programs is available on websites of the respective federal agencies.

a) Actions to Stabilize Financial Markets

Term Asset-Backed Securities Loan Facility (TALF): Treasury is providing TARP support for this program, which was created by the Federal Reserve, to support consumer lending. The TALF will help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration.

Term Auction Facility (TAF): Under the TAF, the Federal Reserve auctions term funds to depository institutions. All depository institutions that are eligible to borrow under the primary credit program are eligible to participate in TAF auctions. All advances must be fully collateralized.

Term Securities Lending Facility (TSLF): Under the TSLF, the Federal Reserve lends Treasury securities to primary dealers secured by a pledge of other securities, including federal agency debt, federal agency residential mortgage-backed securities, and nonagency AAA/Aaa-rated private-label residential MBS.

Primary Dealer Credit Facility (PDCF): The PDCF is an overnight loan facility that provides funding to primary dealers in exchange for a specified range of eligible collateral. On September 14, 2008, the Federal Reserve announced that collateral eligible to be pledged at the PDCF had been broadened. The program is intended to foster the functioning of financial markets more generally.

Money Market Investor Funding Facility (MMIFF): The MMIFF supports a private sector initiative designed to provide liquidity to U.S. money market investors. Under the MMIFF, the Federal Reserve Bank of New York (FRBNY) provides senior secured funding to a series of special purpose vehicles to facilitate an industry-supported private sector initiative to finance the purchase of eligible assets from eligible investors.

Temporary Guarantee Program for Money Market Mutual Funds: This program offers unprecedented government insurance in order to address concerns about the safety and accessibility of these investments and enhance market confidence. Treasury quickly set this program up after a mutual fund ¡§broke the buck¡¨ for the second time in history.

Commercial Paper Funding Facility (CPFF): The Federal Reserve created the CPFF to provide a liquidity backstop to U.S. issuers of commercial paper. The CPFF is intended to improve liquidity in short-term funding markets and thereby contribute to greater availability of credit for businesses and households. Under the CPFF, FRBNY finances the purchase of highly-rated unsecured and asset-backed commercial paper from eligible issuers via eligible primary dealers.

Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility: The Federal Reserve established this lending facility to provide funding to U.S. depository institutions and bank holding companies to finance their purchases of high quality asset-backed commercial paper (ABCP) from money market mutual funds under certain conditions. The program is intended to assist money funds that hold such paper in meeting demands for redemptions by investors and to foster liquidity in the ABCP market and money markets more generally.

Swap Lines with Foreign Central Banks: On September 29, 2008 the Federal Reserve authorized a $330 billion expansion of its temporary reciprocal currency arrangements (swap lines). The Federal Reserve enacted this program to improve the distribution of dollar liquidity around the globe and it is available to other central banks through April 30, 2009. The program was enacted because, at the time, dollar funding rates abroad had been elevated relative to dollar funding rates available in the U.S., reflecting a structural dollar funding shortfall outside of the U.S. The increase in the amount of foreign exchange swap authorization limits enabled many foreign central banks to increase the amount of dollar funding that they can provide in their home markets.

b) Actions to Strengthen U.S. Financial Institutions

Temporary Increase in Deposit Insurance: On October 3, as part of the EESA, the FDIC temporarily raised the deposit insurance limit from $100,000 to $250,000 for all deposit categories until December 31, 2009.

Temporary Liquidity Guarantee Program (TLGP): On October 14, 2008, the FDIC established the TLGP in the following two parts:

o Debt Guarantee Program (DGP): The DGP temporarily guarantees all senior unsecured debt newly issued by FDIC-insured institutions and certain holding companies on or after October 14, 2008, through June 30, 2009.

o Transaction Account Guarantee Program: the FDIC also temporarily provides full deposit insurance coverage to deposits in non-interest bearing transaction accounts (mainly payment processing accounts) until December 31, 2009.

Capital Purchase Program (CPP): The CPP is a key component of the TARP.

Treasury established this voluntary program to stabilize financial markets by providing capital to healthy institutions, increasing the flow of credit to businesses and consumers and supporting the U.S. economy. Under the CPP, Treasury will purchase up to $250 billion of senior preferred shares on standardized terms as described in the program’s term sheet. The program is available to qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies engaged only in financial activities. Institutions participating in the program must adopt the Treasury Department’s standards for executive compensation and corporate governance for the period during which Treasury holds equity issued under this program.

Systemically Significant Failing Institutions Program (SSFI): The SSFI program is another key component of the TARP. Treasury will provide capital on a case-by-case basis to systemically significant institutions that are at substantial risk of failure. In determining eligibility, Treasury may consider the following, among other factors: the extent to which the failure of an institution could threaten the viability of its creditors and counterparties; the number and size of financial institutions that are seen by investors or counterparties as similarly situated to the failing institution, or that would otherwise be likely to experience indirect contagion effects from the failure of the institution; whether the institution is sufficiently important to the nation’s financial and economic system; or the extent and probability of the institution’s ability to access alternative sources of capital and liquidity.

c) Initiatives to Support the U.S. Housing Market

FHASecure: Announced by HUD in August 2007, the FHASecure program offers homeowners who have missed payments an opportunity to refinance into affordable FHA-insured loans. More than 450,000 homeowners have refinanced through FHASecure since the launch of the program.

HOPE NOW: In October 2007, Treasury actively helped facilitate the creation of the HOPE NOW Alliance, a private sector coalition of mortgage market participants and non-profit housing counselors. HOPE NOW servicers represent more than 90 percent of the subprime mortgage market and 70 percent of the prime mortgage market. Since inception, HOPE NOW has kept roughly 2.9 million homeowners in their homes through modifications and repayment plans, and it is currently helping more than 200,000 borrowers per month.

Stabilizing Fannie Mae and Freddie Mac: Treasury took aggressive actions in 2008 to stabilize and strengthen Fannie Mae and Freddie Mac, and prevent the collapse of two institutions with $5.4 trillion in debt and mortgage-backed securities held by investors and financial institutions throughout the United States and the world. The systemic importance of these two enterprises, and the systemic impact of a collapse of either, cannot be overstated. Treasury’s efforts to stabilize them by effectively guaranteeing their debt has increased the flow of mortgage credit and insulated mortgage rates from the rapid increases and fluctuations in the cost of other credit.

Hope for Homeowners: On October 1, 2008, HUD implemented Hope for Homeowners, a new FHA program, available to lenders and borrowers on a voluntary basis, that insures refinanced affordable mortgage loans for distressed borrowers to support long-term sustainable homeownership.

Streamlined Loan Modification Program: On November 11, 2008, Treasury joined with the FHFA, the GSEs, and HOPE NOW to announce a major streamlined loan modification program to move struggling homeowners into affordable mortgages. The program, implemented on December 15, 2008, creates sustainable monthly mortgage payments by targeting a benchmark ratio of housing payments to monthly gross household income (38%). Additionally, on November 20, 2008, Fannie Mae and Freddie Mac announced that they would suspend foreclosure sales and cease evictions of owneroccupied homes to allow time for implementation of the modification program.

Subprime Fast-Track Loan Modification Framework: Treasury worked with the American Securitization Forum to develop a loan modification framework to allow servicers to modify or refinance loans more quickly and systematically. Subprime ARM borrowers who are current but ineligible to refinance may be offered a loan modification freezing the loan at the introductory rate for five years. Treasury, working with the Federal Reserve, the FDIC and other regulators, has taken the necessary steps to prevent a financial collapse. The authorities and flexibility granted to the Treasury Department by Congress have been essential to developing the programs necessary to meet these objectives. Strong financial institutions and a stable financial system will smooth the path to economic recovery and an eventual return to prosperity.

Question 1b: What specific facts changed that led to your change in strategy?

Answer:

In the discussions with the Congress in mid-September during consideration of the financial rescue package legislation, Treasury focused on an initial plan to purchase illiquid mortgage assets in order to remove the uncertainty regarding banks’ capital strength. At the same time, Treasury worked hard with the Congress to build maximum flexibility into the law to enable Treasury to adapt our policies and strategies to address market challenges that may arise. In the weeks after Secretary Paulson and Chairman Bernanke first went to the Congress, market conditions deteriorated at an unprecedented and accelerating rate. One key measure Treasury assessed was the LIBOR-OIS spread ¡V a key gauge of funding pressures and perceived counterparty credit risk. Typically between 5 ¡V 10 basis points, on September 1, the one month spread was 47 basis points. By September 18th, when Treasury first went to Congress, the spread had climbed 88 basis points to 135 basis points. By the time the bill passed, just two week later on October 3, the spread had climbed another 128 basis points to 263 basis points. By October 10, LIBOR-OIS spread rose another 75 basis points to 338 basis points. During this period, credit markets effectively froze. The commercial paper market shut down, 3-month Treasuries dipped below zero, and a money market mutual fund ‘broke the buck’ for only the second time in history, precipitating a $200 billion net outflow of funds from that market.

Given such market conditions, Secretary Paulson and Chairman Bernanke recognized that Treasury needed to use the authority and flexibility granted under the EESA as aggressively as possible to help stabilize the financial system. They determined the fastest, most direct way was to increase capital in the system by buying equity in healthy banks of all sizes. Illiquid asset purchases, in contrast, require much longer to execute.

Treasury then began immediately designing a capital program to complement the asset purchase programs under development. Since launching the program on October 14, 2008, we have invested $162 billion in 208 institutions of all sizes across the country.

As Treasury continued very serious preparations and exploration of purchasing illiquid assets, scale became a factor; for an asset purchase program to be effective, it must be done in very large scale. With $250 billion allocated for the CPP, Treasury considered whether there was sufficient capacity in the TARP for an asset purchase program to be effective. In addition, each dollar invested in capital can have a bigger impact on the financial system than a dollar of asset purchase; capital injections provide better ‘bang for the buck.’

As markets continued to deteriorate through October, it became clear that the preservation of market stability would require that Treasury support non-bank financial institutions and the securitization market, both of which are crucial sources of lending for consumers and business of all sizes.

Question 2: Is the strategy working to stabilize markets?

Answer:

Yes. The most important evidence that our strategy is working is that Treasury’s actions, in combination with other actions, stemmed a series of financial institution failures. The financial system is fundamentally more stable than it was when Congress passed the legislation. While it is difficult to isolate one program’s effects given policymakers’ numerous actions, one indicator that points to reduced risk of default among financial institutions is the average credit default swap spread for the eight largest U.S. banks, which has declined by about 240 basis points since before Congress passed the EESA. Another key indicator of perceived risk is the spread between LIBOR and OIS: 1 month and 3-month LIBOR-OIS spreads have declined about 220 and 145 basis points, respectively, since the law was signed and about 310 and 240 basis points, respectively, from their peak levels before the CPP was announced.

Treasury is also monitoring the effects our strategy is having on lending, although it is important to note that nearly half the money allocated to the Capital Purchase Program has yet to be received by the banks. Treasury is executing at a rapid speed, but it will take some time to review and fund all the remaining applications. Clearly this capital needs to get into the system before it can have the desired effect. In addition, we are still at a point of low confidence ¡V both due to the financial crisis and the economic downturn. As long as confidence remains low, banks will remain cautious about extending credit, and consumers and businesses will remain cautious about taking on new loans. As confidence returns, Treasury expects to see more credit extended.

The increased lending that is vital to our economy will not materialize as fast as anyone would like, but it will happen much faster as a result of deploying resources from the TARP to stabilize the system and increase capital in our banks.

Question 3: Is the strategy helping to reduce foreclosures?

Answer:

Yes. Treasury has moved aggressively to keep mortgage financing available and develop new tools to help homeowners. Specifically, Treasury has achieved the following three key accomplishments:

1. To support the housing and mortgage market, Treasury acted earlier this year to prevent the failure of Fannie Mae and Freddie Mac, the housing GSEs that affect over 70 percent of mortgage originations. These institutions are systemically critical to financial and housing markets, and their failure would have materially exacerbated the recent market turmoil and profoundly impacted household wealth. Mortgage finance is available today on attractive terms because of Treasury’s actions with the Federal Reserve and the Federal Housing Finance Agency to stabilize Fannie Mae and Freddie Mac. In addition, Treasury and the Federal Reserve have both announced programs to purchase GSE mortgage-backed securities. These programs are lowering borrowing rates for homeowners, to both purchase homes and to refinance into more affordable mortgages.

2. October 2007, Treasury helped establish the HOPE NOW Alliance, a coalition of mortgage servicers, investors and counselors, to help struggling homeowners avoid preventable foreclosures. HOPE NOW estimates that roughly 2.9 million homeowners have been helped by the industry since July 2007; the industry is now helping more than 200,000 homeowners a month avoid foreclosure. In addition, Treasury worked with HOPE NOW and the ASF to develop a fast-track loan modification program to modify loans of subprime ARM borrowers facing unaffordable rate resets.

3. Treasury worked with HOPE NOW, FHFA and the GSEs to achieve a major industry breakthrough in November 2008 with the announcement of a streamlined loan modification program that builds on the mortgage modification protocol developed by the FDIC for IndyMac. By targeting a benchmark ratio of housing payments to gross monthly household income, HOPE NOW servicers and the GSEs will have greater ability to quickly and efficiently create sustainable monthly mortgage payments for troubled borrowers. Potentially hundreds of thousands more struggling borrowers will be enabled to stay in their homes at an affordable monthly mortgage payment. Many private-label mortgage-backed securities pooling and servicing agreements reference the GSE servicing standards, giving this new program reach far beyond GSE loans.

An important complement to those guidelines was the GSEs’  announcement on November 20, 2008 that they will suspend all foreclosures for 90 days. The foreclosure suspension will give homeowners and servicers time to utilize the new streamlined loan modification program and make it possible for more families to work out terms to stay in their homes.

Question 4: What have financial institutions done with the taxpayers’  money received so far?

Answer:

The goal of the Capital Purchase Program is to stabilize the financial system and restore confidence in financial institutions, which will increase the flow of credit. To date, 208 financial institutions of all sizes have received investments through the CPP. These institutions include regional, small and community banks, as well as Community Development Finance Institutions, all of which play a vital role in their communities. We expect communities of all sizes to benefit from the investments into these institutions, which now have an enhanced capacity to perform their vital functions, including lending to U.S. consumers and businesses and promoting economic growth.

As the GAO noted in its report, given the number and variety of financial stability actions being put in place by multiple entities, it will be challenging to view the impact of the Capital Purchase Program in isolation and at the institutional level. Moreover, each individual financial institution’s circumstances are different, making comparisons challenging at best, and it is difficult to track where individual dollars flow through an organization. Nonetheless, Treasury is working with the banking regulators to develop appropriate measurements and Treasury is focused on determining the extent to which the CPP is having its desired effect.

The CPP began in October 2008 and the money must work its way into the system before it can have the desired effect. Moreover, we are still at a point of low confidence ¡V both due to the credit crisis and due to the economic downturn, during which lending and borrowing levels normally drop. While confidence is low, banks will remain cautious about extending credit, and consumers and businesses will remain cautious about taking on new loans. As confidence returns, we expect to see more credit extended. This lending won’t materialize as fast as anyone would like, but it will happen much faster as a result of having used the TARP to stabilize the system and to increase the capital in our banks.

We also know that credit quality at banks is deteriorating. This has led banks to build up their loan loss reserves and to work with troubled borrowers to restructure loans. The level of loan loss provisioning by banks doubled in the third quarter from one year ago, putting pressure on bank earnings and capital. By injecting new capital into healthy banks, the CPP has helped banks maintain strong balance sheets and eased the pressure on them to scale back their lending and investment activities.

As a direct result of Treasury’s actions through TARP, all participating financial institutions in the CPP have stronger capital positions, and with higher capital levels and restored confidence, banks can continue to play their role as financial lenders in our communities. While difficult to achieve during times like this, this lending is essential to economic recovery.

In the case of the SSFI program, Treasury did not provide funds to a financial institution directly. The $40 billion in Treasury funds was paid directly to the FRBNY to restructure AIG’s balance sheet. AIG did not receive those funds. The FRBNY credit facility has helped minimize the disorderly collateral effects on healthy banks, which were counterparties that bought insurance from AIG. Treasury’s investment in AIG was necessary to preserve stability in the financial system and to give AIG time to sell assets in an orderly manner to pay back taxpayers.

Question 5: Is the public receiving a fair deal?

Answer:

Yes. The American people have benefited from the financial rescue package. The financial crisis, and the ensuing economic downturn, would have been far worse without this legislation and our implementation of it. In addition, Treasury has designed its programs, consistent with EESA, to protect the taxpayer and to provide positive return on investments to the maximum extent possible. For example, under the CPP, Treasury will purchase up to $250 billion of senior preferred shares on standardized terms, including a 5 percent dividend for 5 years, which then increases to 9 percent. The government will not only own shares which we expect to yield a reasonable return, but will also receive warrants for common shares in participating institutions. These warrants allow the taxpayer to benefit from any appreciation in the market value of the institution.

When measured on an accrual basis, the value of the preferred stock is at or near par. Furthermore, Treasury has already started receiving required dividend payments. On a mark-to-market basis, the value of some preferred stock may be judged lower when compared to the date of purchase as equity markets have experienced pressure since the program began. In addition to preferred stock, Treasury also received warrants in the institutions it has invested in to provide further value and protection to taxpayers (other than community development organizations which are exempt from warrant requirements). These warrants also have positive value. Treasury is investing in banks of all sizes around the country to help stabilize the financial system and get credit flowing to our communities. Treasury is not making these investments for short-term gains ¡V we are not day traders. Over time, Treasury believes the taxpayers will be protected by ensuring the stability of the financial system and by earning a return on these investments when they are eventually liquidated.

Question 6: What is Treasury doing to help the American family?

Answer:

Every aspect of the implementation of the financial rescue package has a single purpose ¡V to stabilize the financial system so it can support the financing needs of the American people, as consumers and as owners and employees of businesses. American families rely on the services provided by a wide array of sound financial institutions and financial markets, such as savings and investment for retirement (e.g., 401k accounts), and access to affordable credit for education, business development, and even daily necessities. For example, when financial institutions fail and when various credit markets don’ t function, every American household is impacted. A bank failure can suspend or end access to basic financial services in a community, and create enormous anxiety among individuals. As the commercial paper market came under pressure, small and large businesses had difficulty raising money to meet basic needs such as making payroll or purchasing inventory. Consumer credit relies on the securitization market, which froze this year, increasing the costs of credit cards, car loans, and student loans.

All of the steps that Treasury has taken, alone and in coordination with the regulators, are benefiting Americans because they have prevented a further deterioration of the financial system. The problems facing the financial sectors here and abroad arose over a number of years and it will take time for the restoration of normal financial markets. There is no single action the federal government can take to end the financial market turmoil and the economic downturn, but Treasury is confident that we are pursuing the right strategy to stabilize the financial system and support the flow of credit to our economy. The TARP is just one of many policy measures that Treasury has taken to restore the liquidity and capital necessary to support economic growth, protect the savings of millions of individuals and restore the flow of credit to consumers and businesses. In addition, the measures we are taking are allowing the process of financial intermediation to continue- which means that banks and financial institutions can play their vital role in the economy, including providing savings, retirement and lending services. Some of the specific programs we have established to directly help American families are:

Term Asset Backed Securities Lending Facility: Consumer credit is critical for many households as they consider purchasing a car, new appliances, or other big ticket items. Like other forms of credit, the availability of affordable consumer credit depends on ready access to a liquid and affordable secondary market ¡V in this case, the asset backed credit market. Recent credit market stresses essentially brought this market to a halt in October 2008. As a result, millions of Americans cannot find affordable financing for
their basic credit needs. And credit card rates are climbing, making it more expensive for families to finance everyday purchases. The Federal Reserve and the Treasury announced an aggressive program to support the normalization of credit markets and the availability of affordable consumer credit to support economic recovery. Treasury will invest $20 billion in a Federal Reserve facility that will provide liquidity to issuers of consumer asset backed paper, enabling a broad range of institutions to step up their lending, and enabling borrowers to have access to lower-cost consumer finance (auto loans, credit cards, student loans) and small business loans. The facility may be expanded over time and eligible asset classes may be expanded later to include other assets, such as commercial mortgage-backed securities, non-agency residential mortgage backed securities or other asset classes.

Guarantee for Money Market Mutual Funds: In September 2008, after a money market mutual fund ‘broke the buck’ for only the second time in history, Treasury established a temporary Guarantee Program for Money Market Mutual Funds. The program will help protect the savings and pensions of individuals, as well as institutional investors.

Fannie Mae and Freddie Mac: The housing correction has been at the root of the crisis.

One of the most important things Treasury can do to mitigate foreclosures and progress through the housing correction is to reduce the cost of mortgage finance, so more families can afford to buy a home, and so homeowners can refinance into more affordable mortgages. Treasury took strong actions in 2008 to stabilize and strengthen Fannie Mae and Freddie Mac, and prevent the collapse of two institutions with $5.4 trillion in debt and mortgage-backed securities held by investors and financial institutions throughout the United States and the world. The systemic importance of these two enterprises, and the systemic impact of a collapse of either, cannot be overstated. Treasury’s efforts to stabilize them by effectively guaranteeing their debt has increased the flow of mortgage credit and insulated mortgage rates from the rapid increases and fluctuations in the cost of other credit. Recently, the Federal Reserve announced that it will purchase $100 billion in GSE debt and half a trillion dollars in GSE mortgage backed securities, which should have a strongly positive impact on the cost of mortgage finance. Treasury continues to look for additional ways to make mortgage credit more affordable, which will stimulate home purchases, help to stabilize prices and end this housing correction.

HOPE NOW: October 2007, Treasury helped establish the HOPE NOW Alliance, a coalition of mortgage servicers, investors and counselors, to help struggling homeowners avoid preventable foreclosures. HOPE NOW estimates that roughly 2.9 million homeowners have been helped by the industry since July 2007; the industry is now helping more than 200,000 homeowners a month avoid foreclosure. In addition, Treasury worked with HOPE NOW and the ASF to develop a fast-track loan modification program to modify loans of subprime ARM borrowers facing unaffordable rate resets.

Streamlined Loan Modification Program: On November 11, 2008, Treasury joined with the FHFA, the GSEs, and HOPE NOW to announce a major streamlined loan modification program to move struggling homeowners into affordable mortgages. The program, implemented on December 15, creates sustainable monthly mortgage payments by targeting a benchmark ratio of housing payments to monthly gross household income (38%). Additionally, on November 20, 2008, Fannie Mae and Freddie Mac announced that they would suspend foreclosure sales and cease evictions of owner-occupied homes to allow time for implementation of the modification program.

Question 7: Is Treasury imposing reforms on financial institutions that are taking taxpayer money?

Answer:

The CPP is a voluntary program for viable institutions. The program was designed to be attractive to financial institutions of all sizes as a mechanism to increase capital in the financial system while also protecting the taxpayer. Treasury established strict executive compensation requirements on all participating institutions, as per the requirements set out in the EESA. Treasury barred any increase in dividends for 3 years and restricted share repurchases. Increasing dividends or buying back shares would undermine our policy objective by taking capital out of the financial system. In addition, Treasury is taking warrants in participating institutions so that taxpayers benefit from any appreciation in the value of these firms’ stock.

Under the Systemically Significant Failing Institution program, additional terms and conditions were established for AIG. As a condition of extending an $85 billion line of credit to AIG, the Fed required a change in management at AIG. Also as a condition for Treasury assistance under TARP, AIG must meet stringent executive compensation, corporate expenses and lobbying restrictions.

Treasury is committed to rigorous oversight of the restrictions pertaining to executive compensation and is continuing to develop a comprehensive compliance program to ensure that institutions adhere to executive compensation provisions.

Question 8: How is Treasury deciding which institutions receive the money?

Answer:

All information about the terms and conditions of the CPP, including the formal application process and forms, is publically available on the Treasury website, as well as on the websites of all the primary federal regulators.

Institutions: The Capital Purchase Program is available to a broad array of private and publically held- financial institutions of all sizes- including qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies. The program is designed for healthy banks ¡V banks that are considered viable without government investment. It is designed to have attractive terms to encourage healthy banks to participate; they are best positioned to increase the flow of credit in their communities.

Terms: The terms for this program are the same for all institutions. Treasury issued a term sheet for publically held banks and followed with term sheet for private depositories. The minimum subscription amount available to a participating institution is 1 percent of risk-weighted assets. The maximum subscription amount in this program is the lesser of $25 billion or 3 percent of risk-weighted assets. Treasury also created a standard investment agreement for all banks, regardless of size.

Application Process: There is one common application form that all qualified and interested financial institutions used to submit to their primary regulator ¡V the Federal Reserve, the FDIC, the OCC or the OTS. This common application form is available on the websites of all the regulatory agencies.

Evaluation Process: Treasury worked closely with the banking regulators to establish a standardized evaluation process; this means that all regulators use the same standards to review all applications to ensure consistency. Once a Federal regulator has reviewed an application, it will take one of the following three actions:

1. For applications the regulator does not recommend, it may encourage the institution to withdraw the application.

2. For applications the regulator strongly believes should be included in the program, it directly sends the application and its recommendation to the TARP Investment Committee at the Treasury Department.

3. For cases that are less clear, the regulator will forward the application to a Regulatory Council, made up of senior representatives of the four banking regulators for a joint review and recommendation. Treasury is an observer on the Council. The Regulatory Council will make a joint recommendation of either withdrawal or approval.

The Treasury TARP Investment Committee reviews all recommendations from the regulators and recommendations for CPP investment are made based on all of the information received from the above process. The Investment Committee gives considerable weight to the recommendations of the banking regulators. In some cases, the Committee will send the application back to the primary regulator for additional information, or even remand it to the Regulatory Council for further review. At the end of the evaluation process, Treasury notifies all approved institutions.

Institutions then have 30 days to complete the required documents before Treasury funds the transaction. All completed transactions will be publicly announced within 2 business days of execution, as required by the law. Treasury will not, however, announce any applications that are withdrawn or denied.

Treasury’s investment committee includes senior officials on financial markets, economic policy, financial institutions, and financial stability, as well as the Chief Investment Officer for the TARP. For SSFI and other programs, Treasury makes the decision on a case-by-case basis. The goal of TARP is to stabilize the financial system and restore confidence in and of financial institutions, enabling credit to flow to consumers and businesses. In March of 2008, Treasury published an extensive Blueprint for a Modernized Regulatory Structure that proposes a framework and many specific recommendations for reforming our financial regulatory system. Our current system is a patchwork quilt that developed over many decades and is not optimal for our complex financial system today. Treasury is using TARP to stabilize the financial system today, while regulatory modernization will likely take several years to complete.

Question 9: What is the scope of Treasury’s statutory authority?

Answer:

The Emergency Economic Stabilization Act of 2008 (EESA) was enacted by Congress and signed by the President with the stated purposes (1) to immediately provide authority and facilities that the Secretary of the Treasury can use to restore liquidity and stability to the financial system of the United States; and (2) to ensure that such authority and such facilities are used in a manner that (A) protects home values, college funds, retirement accounts, and life savings: (B) preserves homeownership and promotes jobs and economic growth; (C) maximizes overall returns to the taxpayers of the United States; and, (D) provides public accountability forthe exercise of such authority.1 In order to achieve these purposes, Congress provided broad authority to the Secretary of the Treasury to establish the Troubled Asset Relief Program to purchase, and to make and fund commitments to purchase, troubled assets from any financial

[1 Emergency Economic Stabilization Act of 2008 (EESA), Sec. 2.] institution, on terms and conditions determined by the Secretary in accordance with EESA and applicable policies and procedures.

Recognizing the severity of the economic challenges facing the U.S. financial system, Congress incorporated a broad definition of financial institutions which covers any institution established and regulated in the United States or its territories and which has significant operations in the Unites States; the definition of financial institutions includes, but by its express terms is not limited to, banks, savings associations, credit unions, security broker or dealers and insurance companies.[2 EESA Sec. 3(5)] The definition of troubled asset provides authority to the Secretary, in consultation with the Chairman of the Board of Governors of the Federal Reserve System, to define a troubled asset as any financial instrument the purchase of which is necessary to promote financial market stability.[3 EESA Sec. 3(9)]

In exercising this authority, Treasury is limited by a series of requirements and directions set out in EESA. These requirements, which are found in a variety of sections of EESA including sections 101, 103, 104, 105, 107, 108, 109, 110, 111, 113, 115, 121, and 125, encompass, among other things, requirements related to transactions, conflicts of interest, executive compensation, maximizing taxpayers returns, reporting, oversight, and coordination.

Treasury is working on developing an insurance program under section 102. Treasury will submit a report on Dec. 31, 2008 regarding the status of that program.

Question 10: Is Treasury looking ahead?

Answer:

Yes. Treasury is actively engaged in developing additional programs to strengthen our financial system so that credit flows to our communities. Treasury believes that the new authorities Congress provided in October dramatically expanded the tools available to address the needs of our system. We have made significant progress, but there is no single action the federal government can take to end the financial market turmoil and the economic downturn. We are confident that we are pursuing the right strategy to stabilize the financial system and support the flow of credit to our economy.

TARP: 12-31-08, GAO Report

Copy of Complete Report TARP Report (PDF) can be obtained here.

TROUBLED ASSET RELIEF PROGRAM

Additional Actions Needed to Better Ensure Integrity, Accountability, and Transparency

On October 3, 2008, the Emergency Economic Stabilization Act was signed into law. The act established the Office of Financial Stability (OFS) within the Department of the Treasury (Treasury) and authorized the Troubled Asset Relief Program (TARP). Every 60 days, the U.S. Comptroller General is required to report on a variety of areas associated with oversight of TARP. This report reviews (1) the activities that have been undertaken through TARP as of November 25, 2008; (2) the structure of OFS, its use of contractors, and its system of internal controls; and (3) preliminary indicators of TARP’s performance. GAO reviewed documents related to TARP, including contracts, agreements, guidance, and rules. GAO also met with OFS, contractors, federal agencies, and officials from some participating institutions. GAO plans to continue to monitor these and other issues including future and ongoing capital purchases, other transactions undertaken as part of TARP (e.g., capital purchases in Citigroup and American International Group), and the status of other aspects of TARP.

What GAO Recommends

Treasury generally agreed with GAO’s recommendations, but had a different perspective on the need to monitor how participating institutions are spending CPP funds. GAO believes that monitoring aggregate information across the participants would help ensure an appropriate level of transparency and accountability.

Treasury has taken a number of steps to stabilize U.S. financial markets and the banking system, including injecting billions of dollars in financial institutions. Through the capital purchase program (CPP)—a preferred stock and warrant purchase program—Treasury provided more than $150 billion in capital to 52 institutions as of November 25, 2008. GAO recognizes that TARP has existed for less than 60 days and that a new program of such magnitude faces many challenges, especially in this current uncertain economic climate. However, Treasury has yet to address a number of critical issues, including determining how it will ensure that CPP is achieving its intended goals and monitoring compliance with limitations on executive compensation and dividend payments. Moreover, further actions are needed to formalize transition planning efforts and establish an effective management structure and an essential system of internal control. To help ensure the program’s integrity, accountability, and transparency, GAO recommends that Treasury

• work with the bank regulators to establish a systematic means of determining and reporting in a timely manner whether financial institutions’ activities are generally consistent with the purposes of CPP and help ensure an appropriate level of accountability and transparency;

• develop a means to ensure that institutions participating in CPP comply with key program requirements (e.g., executive compensation, dividend payments, and the repurchase of stock);

• formalize the existing communication strategy to ensure that external stakeholders, including Congress, are informed about the program’s current strategy and activities and understand the rationale for changes in this strategy to avoid information gaps and surprises;

• facilitate a smooth transition to the new administration by building on and formalizing ongoing activities, including ensuring that key OFS leadership positions are filled during and after the transition;

• expedite OFS’s hiring efforts to ensure that Treasury has the personnel needed to carry out and oversee TARP;

• ensure that sufficient personnel are assigned and properly trained to oversee the performance of all contractors, especially for Contracts priced on a time and materials basis, and move toward fixed-price arrangements whenever possible;

• continue to develop a comprehensive system of internal control over TARP, including policies, procedures, and guidance that are robust enough to protect taxpayers interests and ensure that the program objectives are being met;

• issue final regulations on conflicts of interest quickly and review and renegotiate mitigation plans to enhance specificity and compliance; and

• institute a system to effectively manage and monitor the mitigation of conflicts of interest.

It is too soon to determine whether the program is having the intended effect on credit and financial markets. Moreover, given that U.S. regulators as well as foreign governments are continuing to take a variety of actions aimed at stabilizing markets and the economy, separately evaluating the impact of Treasury’s efforts under TARP will be difficult. Nevertheless, GAO has identified a number of preliminary indicators that when viewed collectively should signal whether TARP as well as other related programs may be functioning as intended. Among these preliminary indicators are trends in interest rate spreads, mortgage rates, mortgage originations, and foreclosures.

Treasury has operated on parallel tracks in implementing the act