In a major departure from the initial procedure established to distribute federal emergency money to U.S. financial institutions, Secretary of the Treasury Henry M. Paulson Jr. announced on November 12th that the Treasury Department (“Treasury”) no longer intends to purchase troubled assets from financial institutions. Instead, Treasury will purchase equity stakes similar to the recent purchase of preferred shares in several large U.S. banks. Consistent with this approach, on November 17th Treasury released its term sheet for requests by non-public qualified financial institutions (“QFIs”) for a Treasury investment.1 Non-public QFIs are essentially privately held depository institutions and private bank or thrift holding companies. It is not clear, however, when and the extent to which this new program will be funded.2

This client alert reviews recent developments in the Treasury’s TARP program and discusses several of the developments that may be of interest to insurance companies.

Initial Steps: Troubled Asset Relief Program or “TARP.” On October 3, 2008, Congress enacted the Emergency Economic Stabilization Act of 2008 (the “Act”). The Act directed Treasury to establish the Troubled Asset Relief Program (“TARP”). Under TARP, Treasury was authorized to purchase mortgage-backed and certain other “troubled” assets from eligible financial institutions in order to infuse capital into the U.S. financial system. The financial institutions eligible for TARP funds were defined by Congress in the Act to include insurance companies.3

Shift in Focus: Treasury’s Capital Purchase Program. The credit crunch and the resulting global financial crisis have evolved quickly and the actions Treasury has taken to mitigate the impact of the crisis on U.S. businesses and consumers have been similarly evolutionary. Treasury officials reportedly concluded even before the ink on the Act was dry that direct investment of capital into U.S. financial institutions would be more effective than indirect infusions through the purchase of troubled assets.4 On October 14th, Treasury announced the Capital Purchase Program (“CPP”) under TARP as a method to purchase direct equity stakes in large publicly held federally regulated banking institutions.5

Notably, Treasury narrowed the scope of the financial institutions eligible to participate in the Capital Purchase Program from the broad definition of “financial institutions” contained in the Act. CPP funds are currently available only to banks, savings associations, bank holding companies, and savings and loan holding companies that engage solely or predominately in activities that are permissible for financial holding companies.6 An insurance company could access CPP funds only if it were a part of a financial holding company7 or a savings and loan holding company. The first round of distributing the CPP funds ended on November 14th. From the initial nine large banks that received CPP funds, the program has reportedly grown to approximately 50.8

As has been widely reported over the past several days, numerous non-bank financial institutions have considered converting into a bank holding company or a savings and loan holding company in order to tap into CPP funds. American Express and CIT Financial, for example, reportedly have applied for bank holding company status. The Federal Reserve processed American Express’ application on an expedited basis and approved it on November 10, 2008.9

Most recently, insurance companies have taken steps to be eligible to participate in the Capital Purchase Program. At least three, possibly more, insurance companies are reported to be in the process of purchasing thrifts in order to become savings and loan holding companies and be eligible to participate in the Capital Purchase Program.10 Becoming a holding company also provides access to additional federal funds under the liquidity facilities that the Federal Reserve has established to support banks, money market funds, and commercial paper issuers; banks that holding companies own are members of the Federal Reserve System and can also borrow directly from the Federal Reserve discount window. However, not all entities can easily convert into bank holding companies or savings and loan holding companies, and furthermore, it may not be desirable to acquire such status.11

Further Shift in the TARP Focus: Treasury Curtails Further Purchase of Troubled Assets. Last week, on November 12th, Treasury announced that it was abandoning its original strategy of purchasing troubled assets in pursuit of other strategies that are expected to have a faster effect on the financial system and more quickly spur lending at financial institutions. Citing to the difficulty of implementing the financial rescue plan as initially proposed, Treasury Secretary Paulson described a possible expanded approach to capitalizing financial institutions not initially included in the Program. Mr. Paulson identified three new priorities for spending the remaining TARP funds: (i) stabilizing the financial system generally so that banks and other financial institutions that are critical to the provision of credit can support economic recovery; (ii) reviving the asset securitization market; and (iii) reducing the risk of mortgage foreclosures.

Likelihood of Insurance Companies Participating in Future Rounds of CPP. Because insurance companies are not federally regulated, it is unclear whether the Treasury would include insurance companies in coming rounds of CPP fund allocations, if they are forthcoming.12 In any case, the financial crisis and industry and government responses will likely continue to evolve rapidly and in unexpected ways. The recent developments discussed in this alert regarding insurance companies and their willingness to become subject to federal regulation in order to obtain access to funds under the Treasury’s Capital Purchase Program illustrate a critically important question looming for the insurance industry generally — that is, the possible federalization of insurance company regulation.