After the Treasury Department’s announcement of its bailout plan gave financial markets a temporary lift last week, the details and scope of the program began to take shape over the weekend. While both the White House and Congress welcomed the proposal to move up to $700 billion worth of distressed real estate debt into a government portfolio, their differences began to materialize as they began writing the actual legislation necessary to implement the plan. On Saturday, the White House sent Congress a 3-page draft of the proposed legislation. Congress responded on Monday with a 44-page “discussion draft” produced by the Senate and a 42-page “discussion draft” produced by the House of Representatives. Designated by the House of Representatives as the Troubled Asset Relief Program or “TARP,” these legislative proposals have, quite understandably, attracted a significant amount of attention in the press, and have already begun to generate a healthy debate. This memorandum will identify and summarize the highlights of the proposals that have been made to date. We expect that there will be many changes made before this legislation is finalized and we will keep you apprised of those changes as they unfold.
The White House Proposal
The Treasury Department and the White House prepared a relatively simple version of the proposed legislation (the “Proposed Act”), which concentrated all of the authority to implement the plan in the hands of the Secretary of the Treasury (the “Secretary”). Highlights of the proposal include the following:
- Treasury Authority to Purchase Troubled Assets. The Secretary is granted the authority to purchase troubled assets from financial institutions.
- Goals. Stated goals of the Act are to (1) provide stability and prevent disruption to the financial markets and banking systems and (2) protect the taxpayer.
- General Asset Management. The Act gives the Secretary the authority to engage financial institutions to act as agents of the United States in assisting the Treasury Department in performing its duties under the Act. Treasury may, at its discretion, sell assets or hold them to maturity. Proceeds from the liquidation of any assets will be returned to Treasury's general fund.
- Revolving Facility. The maximum amount available to the Secretary for the relief program will be $700 Billion, at any one time. This means that proceeds from the sale of loans could be used to acquire more assets at a later date.
- Purchase Price. Noticeably missing from both the White House and Congressional versions of the bill is any limitation on the purchase price that may be paid to acquire troubled assets.
- Reporting to Congress. The Secretary is required to report back to Congress within 3 months of the first exercise of authority under the Act and semi-annually thereafter.
- Exercise of Rights Under Purchased Loans. The Act grants the Secretary the right to exercise all rights received in connection with its purchase of a troubled asset, but gives no specific guidance as to the manner in which those rights should be exercised.
- Restrictions on Review. Decisions made by the Treasury Department are non-reviewable by any court of law or any administrative agency.
- Termination of Program. The authority to purchase assets is scheduled to terminate two years after its effective date.
- Key Definitions.
- “Troubled assets” means (1) residential or commercial mortgages and any securities or other obligations based on or related to such mortgages, that in each case were originated or issued on or before September 17, 2008 and (2) upon the determination of the Secretary in consultation with the Chairman of the Board of Governors of the Federal Reserve, any other financial instrument, as is determined to be necessary to promote financial market stability.
- “Financial institutions” means a financial institution having headquarters in the United States.
The Congressional Proposals
The Congressional proposals concur with the basics of the White House draft, but they add a lot more detail to the terms of the program with specific emphasis on (1) taxpayer protections, (2) assistance to homeowners, (3) executive compensation, (4) independent oversight and (5) audits and more frequent reporting. The proposed legislation also contains provisions for bankruptcy law reform and the creation of insurance for money market funds.
Although there are differences between the proposals submitted by the Senate and the House of Representatives, their themes are consistent. The following summarizes and highlights the key provisions of the legislation proposed in Congress:
- Relief to Homeowners. In implementing the relief program the Secretary is required to maximize assistance to homeowners through the use of loan modifications, the HOPE for Homeowners Program1 and other available programs to prevent foreclosures. The Senate version of the bill requires the Secretary, to the extent practicable, to acquire sufficient interest in, or control of, mortgage pools so that it has sufficient authority to direct the loan modification process. The House version of the bill requires the Secretary to coordinate with the FDIC and other government entities to identify opportunities for the acquisitions of assets that will maximize the Secretary’s ability to improve the loan modification and restructuring process.
- Independent Oversight. The Senate proposal calls for the establishment of an “Emergency Oversight Board” that includes the Chairman of the Board of Governors of the Federal Reserve System, the chairperson of the Board of Directors of the FDIC, the chairperson of the SEC and two non-government employees “having appropriate financial expertise in both public and private sectors” (with one being appointed by the majority leadership of the House and the Senate and one being appointed by the minority leadership of the House and the Senate). The Emergency Oversight Board may also appoint a credit review committee to evaluate the exercise of the Secretary’s purchase authority and the assets acquired thereunder. The House proposal calls for the Comptroller General (a legislative branch position) to oversee the activities and performance of the relief program.
- Reporting to Congress. The Secretary is required to report back to Congress on more frequent intervals than proposed by the White House. The Senate proposal is for monthly reporting (such reports to specifically include information on the number and types of loan modifications made and the number of foreclosures occurring). The House proposal is for an initial report on the 60th day after the first exercise of power under the Proposed Act and every 90 days thereafter.
- Interim Reporting; Market Transparency. To facilitate market transparency, the Secretary is required make public certain information about the assets held by, and the purchases and sales done for the benefit of, the relief program. The Senate proposal requires weekly reports while the House proposal requires reports within 48 hours of every purchase, sale or other disposition.
- Executive Compensation. In order to be eligible to sell assets through the relief program, the participating entities will be required to “meet appropriate standards for executive compensation,” including limits on compensation to exclude incentives for executives to take risks that the Secretary deems inappropriate or excessive and a claw-back provision for incentive compensation that is later proven to be inaccurate. There are also limitations on severance compensation to senior executives. Broad discretion is given to the Secretary to determine appropriate limits on compensation.
- Revisions to Bankruptcy Code. The Bankruptcy Code is amended to make certain mortgage borrower friendly amendments, including the following:
- amend Title 13 to permit a Bankruptcy Court to (1) reduce the secured balance of a mortgage loan (i.e., “cram-down”) and (2) reduce the interest rate on a mortgage loan; and
- amend Section 109(h) to allow for the waiver of the required bankruptcy counseling as a precondition to individual debtor’s filing for relief if the individual certifies that its primary residence is at risk of foreclosure.
- Money Market Insurance Fund. The Secretary is authorized to establish a program to provide guarantees or insurance to money market mutual funds similar to what the FDIC provides for bank depositors. The amount insured per account may not exceed the insurance provided by the FDIC for bank depositors.
- Key Definitions.
- “Troubled assets” means (1) residential or commercial mortgages and any securities or other obligations based on or related to such mortgages, that in each case were originated or issued on or before September 17, 2008 (the Senate version states before March 14, 2008) and (2) upon the determination of the Secretary in consultation with the Chairman of the Board of Governors of the Federal Reserve, any other financial instrument, as the Secretary determines necessary to promote financial market stability.
- “Financial institutions” means institutions, including banks, credit unions, broker dealer and insurance companies that have significant operations in the United States. The House version makes it clear that central banks of, or institutions owned by, a foreign government, are excluded.
Significant Differences Between the Senate and the House Bills
The following is a summary of the major differences between the Senate and House versions of the Proposed Act:
- Asset Management. The Senate version of the bill contemplates that the FDIC would be responsible for the management of all residential and residential mortgage backed securities. The House version, on the other hand, contemplates awarding contracts to asset managers, although the bill specifically states that the FDIC is eligible and should be considered in the selection of asset managers for whole loans.
- Extension of Termination Date. The Senate proposal gives the Secretary the right to extend the relief program beyond the two-year termination date by delivering a certification to Congress that includes an explanation as to why the extension is necessary to assist American families and stabilize financial markets.
- Grant of Equity in Participating Seller: The Senate’s proposal includes a requirement that Treasury obtain “contingent shares” in any institution wishing to sell assets through the program (or, if the institution is not publicly traded, to obtain senior contingent debt instruments) that will vest in favor of the US Treasury if it sells assets acquired from the related institution at a loss. The contingent shares will vest in an amount equal to 125% of the loss. The contingent shares are required to contain market standard anti-dilution provisions to protect Treasury from stock splits and other reorganizations and recapitalizations. While the House version also contains a reference to obtaining warrants or similar interests in the selling institution, the details of that requirement are left to the Secretary’s judgment.
- Changes to Corporate Governance. The House proposal includes a requirement that financial institutions that participate in the relief program must revise their corporate governance provisions to (1) grant equity holders representing three percent or more of the institution’s equity securities the right to nominate members of the board of directors in any proxy solicitation and shareholder vote that relates to the election of member of the board of directors, and (2) allow all shareholders the opportunity to cast a non-binding vote, in any annual proxy solicitation or shareholder vote, on executive compensation.
- Transfer of a Percentage of Profits. The Senate bill requires that 20% of the profit from the sale of any asset be deposited into the Housing Trust Fund (65% of such amount) and the Capital Magnet Fund (the remaining 35%)2. The remaining 80% of any profits are to be paid into the general fund of the United States Treasury for the reduction of public debt.
To read the full text of the Senate’s proposed bill click here, http://www.cwt.com/docs/AYO08B28_xml.pdf
To see the House of Representatives’ proposed bill click here, http://www.cwt.com/docs/TREAS_004_xml.pdf