The new Financial Stability Plan announced by Secretary Geithner puts forward a broad description of how approximately $2 trillion will be spent, without any substantive details.
After a lot of criticism of how TARP has been implemented since last fall, and more delay than people expected, the Department of the Treasury has finally issued its revised TARP approach in a new Financial Stability Plan. The announced plan is aimed at encouraging the flow of credit and easing the stresses on U.S. financial institutions and markets.
The Financial Stability Plan has been described as the second stage in, and an overhaul of, the financial package implemented in 2008, which newly-installed Secretary Timothy Geithner described as “inadequate.” The plan may commit in excess of $2 trillion, from a combination of the remaining $350 billion in the Treasury’s original package, Federal Reserve funds and private-sector investments. The plan announced by the Treasury yesterday includes the following new programs and other initiatives:
Financial Stability Trust
- Stress Tests – The plan will require that all banks with consolidated assets exceeding $100 billion undergo a “carefully designed comprehensive stress test” to determine which banks are in need of funds but still healthy enough to lend. Any other bank seeking capital assistance (described below) also will need to undergo the stress test. Implementation will require coordination between various financial regulators – the Federal Reserve Board, the Federal Deposit Insurance Corp. (FDIC), the Office of Thrift Supervision (OTS), and the Office of the Comptroller of the Currency (OCC) – but the details of how it would work were not laid out.
- Capital Assistance Program (CAP) – The Plan includes a new round of capital injections into banks that undergo the comprehensive stress test and need a “capital buffer” to help absorb losses. The new capital infusions are intended to serve as a bridge to private investment. The proposal contemplates that the government would receive preferred stock convertible into common stock in participating financial institutions. The convertible preferred securities will carry a dividend to be specified later and a conversion price at a modest discount from the participating institution’s stock price as of February 9, 2009.
- Financial Stability Trust – Capital investments made by Treasury under the CAP will be placed in a separate Financial Stability Trust, which will be set up to manage the government’s investments in U.S. financial institutions.
Public-Private Investment Fund to Purchase Troubled Assets
The Treasury Department, along with the Federal Reserve and the FDIC, will start a public-private investment fund to help provide a market for financial firms’ troubled “legacy” assets. The Treasury intends to use public financing to leverage private capital, initially up to $500 billion, but potentially up to $1 trillion. The program’s goal would be to remove troubled assets from banks’ balance sheets and provide a market valuation tool for remaining similar assets, in order to free up lenders to lend, rather than hold onto, their capital. The Treasury noted that it will seek public input on the proposed program and that the details of the program will be solidified over the next few weeks. There was no indication of what criteria the market valuation tool would use.
Consumer and Business Lending Initiative
The Federal Reserve and the Treasury announced the expansion of the previously announced (but not yet implemented) Term Asset-Backed Securities Loan Facility (TALF), in order to spur lending outside of the banking system. The facility will be increased from the original $200 billion up to $1 trillion, to provide financing to private investors to increase lending and lower interest rates for credit card, auto, student, small-business, commercial mortgages, and other consumer and business loans. The government will limit purchases under the revamped TALF to newly packaged AAA loans. The initiative will expand the reach of the TALF to include commercial mortgagebacked securities, and the Treasury noted that it may be expanded later to include additional asset classes, such as residential mortgage-backed securities and assets collateralized by corporate debt.
Transparency, Accountability, Monitoring, and Conditions
In addition to the three new programs detailed above, the Treasury announced new standards for transparency, accountability, monitoring, and conditions in the Financial Stability Plan. The new standards will only apply going forward (not retroactively to previous TARP participants):
- Disclosure requirements – Recipients of “exceptional assistance” and recipients of “capital buffer assistance” under the CAP will be required to show how each dollar of capital received is enabling them to generate new lending. In particular, such recipients must (i) submit a plan detailing how they intend to use the capital (which plans will be made public following the government’s investment) and (ii) submit monthly reports detailing their lending activities, the categories of loans provided, and the lending environment in which they operate. The Treasury also intends to publish and update (at http://FinancialStability.gov) metrics showing the impact of the Financial Stability Plan on credit markets, all contracts under the Financial Stability Plan, details on the government’s investments, and information disclosed or reported by recipients to Treasury.
- Mortgage foreclosure mitigation – All recipients of capital investments under the CAP will be required to participate in mortgage foreclosure mitigation programs.
- Limitations on dividends, stock repurchases, and acquisitions – All banks that receive capital assistance under the CAP will be restricted from (i) paying quarterly common dividend payments in excess of $0.01 (for all banks receiving “exceptional assistance,” and for other banks unless approval for higher dividends is obtained); (ii) repurchasing shares; and (iii) pursuing cash acquisitions of healthy firms, subject in each case to approved exceptions, and in each case until the government’s investment is repaid.
- Limits on executive compensation – All CAP participating firms will be required to comply with the executive compensation restrictions announced on February 4, 2009, including those relating to the $500,000 cap on total annual compensation (plus restricted stock payable when the government’s investment is repaid), “say on pay” shareholder votes, and disclosure requirements applicable to luxury purchases.
- Prohibitions on political interference in investment decisions – The Treasury announced measures intended to ensure that lobbyists do not interfere with applications for, or distributions of, Financial Stability Plan funds.
New Program to Help Homeowners at Risk of Foreclosure
To the disappointment of several on Capitol Hill, including House Financial Services Chair Barney Frank (D-MA), Geithner’s comments revealed no details about the Treasury Department’s promised plan to restructure troubled mortgages and reduce the impact of the foreclosure crisis. The Treasury provided generic descriptions, including, among other things, (i) expansion of an ongoing effort by the Federal Reserve to reduce mortgage rates by spending up to $600 billion purchasing Government Sponsored Entity mortgage-backed securities and debt; (ii) committing $50 billion to prevent avoidable foreclosures of owner-occupied middle class homes; (iii) establishing loan modification guidelines and standards for government and private programs; and (iv) requiring all financial stability plan recipients to participate in foreclosure mitigation programs. But that was not enough for Frank, who commented that the $50 billion to prevent foreclosures “understates the amount that we will need” and asked for “assurance that, assuming this works as we hope it will, there will be more money available.” Frank also asked “institutions that hold or service mortgages to delay and stop any foreclosure proceedings” while waiting to learn the details of the Treasury’s foreclosure plan.
Small Business and Community Lending Initiative
Finally, later in the week, the Treasury and the Small Business Administration (SBA) are expected to announce a Small Business and Community Lending Initiative to stop the decline in SBA lending by, among other things, freeing up secondary markets for small business loans.
What is Next
We will continue to monitor developments as further details on the Financial Stability Plan and other programs become available. However, for now the markets seem underwhelmed as the critical questions remain unresolved – namely, how will the public-private partnership really work, and how will assets be valued. More details will be coming soon, but we expect to see the publicprivate partnership in the form of LLCs or other similar investment vehicles where the FDIC can cause the purchase price of bad assets to be better than public distress prices, and on the flip side, where the FDIC can enjoy any profits from a potential increase in value of those assets if the market turns. This is vastly different than the RTC model of the early 1990s where the government merely sold bad assets to investors (at an average of $0.31 per dollar of face value). The implementation will be critical as bankers look for rescue, and the Treasury and Capitol Hill look for banks to add liquidity to the markets.