Introduction

After the United States House of Representatives failed on Monday, September 29, 2008, to pass the proposed Emergency Economic Stabilization Act of 2008 (the “Act”), the Senate in the evening on Wednesday, October 1, 2008, passed an amended version of the Act that includes provisions designed to make the legislation more appealing to House members. The primary goal of the Act is to establish the Troubled Asset Relief Program (the “TARP”), a $700 billion program to buy mortgage loans and other assets from financial institutions to help thaw the credit freeze that is threatening the stability of the financial system in the United States. In addition to provisions previously worked into the legislation proposed by the Treasury Department designed to ensure taxpayer protection and reimbursement, strong independent oversight and assistance to homeowners and foreclosure prevention, the revised Senate version temporarily raises the limit on federal deposit insurance to $250,000 from $100,000 and incorporates additional measures such as a two-year extension of certain tax breaks designed to appeal to House Republicans. The House of Representatives is expected to vote on the amended Act on Friday, October 3, 2008.

The Details

The following is a summary of the main provisions of the Act. Specific implementation of the program is subject in large part to the discretion of the Secretary of the Treasury (the “Secretary”) and the regulations and guidelines that may be issued by the Secretary.

  • Establishment of TARP; Treasury Authority to Purchase Troubled Assets. The Secretary is granted the authority to spend up to $700 billion to purchase troubled assets from financial institutions on terms and conditions that are satisfactory to the Secretary and in accordance with the policies and procedures of the Act.

Graduated Authorization. The Secretary’s authority to purchase troubled assets is initially limited to $250 billion outstanding at any one time. Upon delivery of a certification of need by the President of the United States to Congress, that limit will be raised to $350 billion. An additional $350 billion may be used only if the President transmits a written report to Congress detailing the Secretary’s plan for the use of the remaining funds and Congress does not reject the request within 15 days.

Program Guidelines. The Secretary is required to issue program guidelines by the earlier of (1) two business days after the first purchase of a troubled asset under the TARP and (2) 45 days after the enactment of the Act. These guidelines are required to address mechanisms for purchasing troubled assets, methods for pricing troubled assets, procedures for selecting asset managers and criteria for identifying troubled assets.

  • Key Definitions in the Act.

Troubled assets” means (A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that were originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and (B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.

Financial institutions” means any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the United States or any State, territory, or possession of the United States, the District of Columbia, Commonwealth of Puerto Rico, Commonwealth of Northern Mariana Islands, Guam, American Samoa, or the United States Virgin Islands, and having significant operations in the United States, but excluding any central bank of, or institution owned by, a foreign government.

  • Goals. The stated goals of the Act are:

(1) to provide immediate authority and facilities that the Secretary 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 home ownership and promotes jobs and economic growth;

(C) maximizes overall returns to the taxpayers of the United States; and

(D) provides public accountability for the exercise of such authority.

  • Insurance of Troubled Assets. If the Secretary exercises its authority to establish the TARP, the Secretary will be required to also establish a program that permits financial institutions to obtain guarantees of the timely payment of principal and interest on troubled assets. The Secretary will be required to establish the terms of such guarantees as well as the appropriate premiums, which shall be set at a level necessary to create reserves sufficient to meet anticipated claims. The $700 billion purchase authority will be reduced by the total amount of the guaranteed obligations (but will be credited by the amount of insurance premiums collected).
  • Grant of Equity in Participating Seller: In order to provide additional protection to the taxpayers against losses from the sale of assets by the Secretary and the administrative costs of administering the TARP, the Secretary may not purchase troubled assets from any institution unless (1) if such institution is publicly traded, the Secretary receives warrants to receive non-voting common or preferred stock in such institution or (2) if such institution is not publicly traded, the Secretary receives a senior debt instrument from such financial institution. The contingent shares are required to contain market standard anti-dilution provisions to protect their value from stock splits and other reorganizations and recapitalizations. The other terms and amounts of the warrants and debt instruments are left to the Secretary’s judgment. The Secretary is required to establish de minimis exceptions to these requirements based on the size of the cumulative amount of assets purchased from an institution under the program, not to exceed $100 million.
  • Executive Compensation. If the Secretary buys troubled assets directly from an institution and as a result has taken a meaningful equity or debt interest in the selling institution, the Secretary must require that the institution “meet appropriate standards for executive compensation and corporate governance,” including limits on compensation to exclude incentives for senior executive officers (generally the five highest paid executives) to take unnecessary and excessive risks, a claw-back provision for incentive compensation to senior executive officers that is later proven to be materially inaccurate and a prohibition on golden parachute severance payments to senior executive officers while the Treasury owns an equity or debt position in the company.

If the Secretary buys assets from an institution at an auction and the aggregate purchases from such institution exceed $300 million, the Secretary must prohibit the institution from entering into any golden parachute type severance agreements.

  • 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, including the right to sell or enter into other transactions in regard to any troubled asset. Revenues from the sale of troubled assets are required to be paid to the Treasury for reduction of the public debt.
  • General Asset Management. The Act gives the Secretary the authority to engage financial institutions to act as financial agents of the Federal government and such institutions may perform such reasonable duties related to this as is required. The Act specifically provides that the FDIC is eligible and should be considered in the selection of asset managers for residential mortgage loans and residential mortgage-backed securities.
  • Assistance to Homeowners. 

Foreclosure Mitigation. If the Secretary acquires troubled assets that are secured by residential real estate, the Secretary must implement a plan that seeks to maximize assistance for homeowners and use the authority of the Secretary to encourage the servicers of the underlying mortgages to take advantage of the HOPE for Homeowners Program1 or other available programs to minimize foreclosures. The Secretary may use loan guarantees and credit enhancements to facilitate loan modifications to prevent avoidable foreclosures.

Coordination With Other Federal Entities. The Secretary is also required to coordinate with other federal entities to identify opportunities for the acquisition of classes of troubled assets that will improve the ability of the Secretary to modify and restructure troubled residential mortgage loans.

Obligations Imposed on Other Federal Entities. All federal entities that hold mortgage and mortgage-backed securities secured by residential real estate are required to implement a plan that seeks to maximize assistance for homeowners and use their authority to encourage the servicers of the underlying mortgages, and considering the net present value to the taxpayer, to take advantage of the HOPE for Homeowners Program or other available programs to minimize foreclosures.

  • Market Transparency. To facilitate market transparency, the Secretary is required to make available to the public, in electronic form, a description, amounts, and pricing of assets acquired under this Act within two business days of purchase, trade, or other disposition.
  • Independent Oversight; Audits. The Act provides for a number of levels of independent oversight of Treasury’s implementation of the TARP.

Financial Stability Oversight Board. This board is comprised of the Chairman of the Board of Governors of the Federal Reserve System, the Secretary of the Treasury, the Director of the Federal Home Finance Agency, the Chairman of the Securities and Exchange Commission, and the Secretary of Housing and Urban Development. This board is responsible for:

(1) reviewing the exercise of authority under any program developed under the Act, including the designation of asset classes to be purchased, and plans for the structure of vehicles used to purchase troubled assets and the effect of such actions in assisting American families in preserving home ownership, stabilizing financial markets and protecting taxpayers;

(2) making recommendations, as appropriate, to the Secretary regarding use of its authority under the Act; and

(3) reporting any suspected fraud, misrepresentation, or malfeasance to the Special Inspector General for the Troubled Asset Relief Program or the Attorney General of the United States.

Credit Review Committee. The Financial Stability Oversight Board may appoint a credit review committee for the purpose of evaluating the Secretary’s exercise of its purchase rights under the Act.

Congressional Oversight Committee. This five member committee is comprised of one member appointed by the Speaker of the House of Representatives, one member appointed by the minority leader of the House of Representatives, one member appointed by the majority leader of the Senate, one member appointed by the minority leader of the Senate and one member appointed by the Speaker of the House of Representatives and the majority leader of the Senate, after consultation with the minority leader of the Senate and the minority leader of the House of Representatives. The Oversight Committee is required to review the current state of the financial markets and the regulatory system and submit reports to Congress on the use by the Secretary of authority under the Act, the impact of purchases made under the Act on the financial markets, the effectiveness of foreclosure mitigation efforts, and the effectiveness of the program from the standpoint of minimizing long-term costs to the taxpayers.

Comptroller General. The Comptroller General is required to commence ongoing oversight of the activities and performance of the TARP and the agents and representatives of the TARP, particularly those involving foreclosure mitigation, cost reduction, whether it has provided stability to the financial system and whether it has protected taxpayers.

Audits. The TARP is required to prepare annual audited financial statements to be delivered to Congress and audited by the Comptroller General.

  • Reports to Congress.

Monthly Reports. The Secretary is required to report back to Congress 60 days after the first exercise of power under the Act and every 30 days thereafter with a detailed financial report of the actions taken during such period.

Tranche Reports. The Secretary is required to deliver a report within seven days after the purchase of, or commitment to purchase, each increment of $50 billion of troubled assets. Such report is required to contain detailed information about the pricing of the assets purchased, a justification of such pricing and a description of the impact of the exercise of such authority on the financial system.

Regulatory Modernization Report. The Secretary is required to submit a report prior to April 9, 2009 analyzing the then-current state of the regulatory system and its effectiveness in overseeing participants in the financial markets.

Comptroller General. The Comptroller General is required to issue reports to Congress every 60 days on the activities and performance of the TARP.

  • Termination of Program. The authority to purchase assets is scheduled to terminate on December 31, 2009. The termination date does not apply to the right of the Secretary to manage troubled assets it acquired prior to the termination date. The Secretary may extend the relief program to the date that is two years after the date of enactment of the Act by delivering a certification to Congress that includes an explanation of why the extension is necessary to assist American families and stabilize financial markets.
  • Mark-to-Market Accounting. The Securities and Exchange Commission is given the authority under the securities laws to suspend, by rule, regulation, or order, the application of mark-to-market accounting for any issuer or with respect to any class or category of transaction if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors.

The Securities and Exchange Commission, in consultation with the Board of Governors of the Federal Reserve System and the Secretary, is also required to conduct a study on mark-to-market accounting standards, as such standards are applicable to financial institutions. Such study must include consideration of (1) the impact of such accounting on bank failures in 2008; (2) the advisability and feasibility of modifications to such standards; and (3) alternative accounting standards.

The Securities and Exchange Commission is required to submit to Congress a report of such study before the end of the 90-day period beginning on the date of the enactment of the Act containing its findings and determinations, including such administrative and legislative recommendations as the Commission determines appropriate.

  • Tax Provisions. The Act provides that certain banking and financial institutions will recognize ordinary gain or loss (rather than capital gain or loss) when they sell preferred stock of Fannie Mae or Freddie Mac. Since most of these institutions will recognize losses (rather than gains) and U.S. corporations may use capital losses only to offset capital gains (but are unrestricted on their ability to use ordinary losses), this provision is beneficial to these institutions and will permit them to use the losses from the sale of the preferred stock to offset their ordinary business income. The new rule applies to the preferred stock that was held by these institutions on September 6, 2008 or that was sold or exchanged by these institutions on or after January 1, 2008 and before September 7, 2008.

The Act also extends the current exclusion from cancellation of indebtedness income on qualified principal residence indebtedness ("QPRI") for an additional three years, until December 31, 2012. Thus, homeowners will be permitted to exclude from gross income (and not pay tax on) QPRI that is forgiven on or before December 31, 2012 where such forgiveness is related to a decline in value of the residence or to the financial condition of the homeowner. QPRI is indebtedness of up to $2 million ($1 million for married couples filing separately) secured by the principal residence of the homeowner and incurred in acquiring, constructing or substantially improving the homeowner’s principal residence.

Finally, the Act provides that in the case of an employer that transfers assets with a value in excess of $300 million pursuant to the TARP, (1) the employer will not be permitted to claim a federal income tax deduction for executive remuneration attributable to services performed by its CEO, CFO and three other highest compensated officers to the extent such remuneration exceeds $500,000 per person for any taxable year during which the Act is effective; and (2) the employer will not be permitted to claim a federal income tax deduction for severance payments made with respect to severances occurring in any taxable year during which the Act is effective to its CEO, CFO and three other highest compensated officers in excess of the executive’s average W-2 compensation for the five preceding tax years. The executive will also be subject to a 20% excise tax on the excess amount.

  • Temporary Increase in FDIC Insurance Coverage. Effective only during the period beginning on the date of enactment of the Act and ending on December 31, 2009, (i) the cap on insurance coverage provided by the FDIC will be raised to $250,000 from $100,000 and (ii) the Board of Directors of the FDIC may request from the Secretary, and the Secretary is required to approve, a loan or loans in the amount necessary to carry out clause (i) without regard to current borrowing limitations. Additionally, the Act provides that the Board of Directors of the FDIC may not take the increased cap on coverage into consideration when setting assessment rates on member institutions.

Additional Provisions

In an effort to make the Act more appealing to the House Republicans, additional provisions unrelated to the TARP have been included in the legislation such as (i) adding temporary tax relief for areas damaged by 2008 Midwestern severe storms, tornados, and flooding, (ii) extending alternative minimum tax relief, (iii) extending certain additional expiring tax breaks such as the exclusion of active financing income from “Subpart F income” through 2009 and (iv) extending certain alternative energy credits such as solar panels, fuel cells and microturbines. In addition, the Act extends the look-through rule of Section 954(c)(6) of the Internal Revenue Code of 1986, as amended (the “Code”) through 2009. Section 954(c)(6) excludes certain payments (interest, dividends, rents and royalties) between commonly controlled foreign corporations (CFCs) from current inclusion under Subpart F of the Code.

The revenue raising section of the Act includes provisions that (i) require brokers to report to the IRS the adjusted basis of securities, such as stock, debt, commodities, derivatives and other items as specified by Treasury that are sold by their customers, (ii) subject compensation deferred by executives under nonqualified deferred compensation plans maintained in certain offshore tax havens to income taxation when such compensation vests (rather than upon receipt), and (iii) extend the 0.2% Federal Unemployment Tax Act (FUTA) surtax through 2009.

Significant Proposals That Were not Adopted

The following is a list of the major proposals that were not included in the final legislation:

  • Proposal to amend Bankruptcy Code to permit “cram-down.” The initial proposal by the House of Representatives included a provision that would 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.
  • Proposal to transfer a percentage of profits into various housing funds. The initial proposal by the Senate required that 20% of the profit from the sale of any asset be used into the Housing Trust Fund (65% of such amount) and the Capital Magnet Fund (the remaining 35%)2.
  • Proposal to give investors access to proxy and non-binding vote on executive compensation. The initial House proposal included a requirement that financial institutions that participate in the relief program revise their corporate governance provisions to grant equity holders certain rights to nominate members of the board of directors and to allow shareholders the opportunity to cast a non-binding vote on executive compensation.

To read the full text of the bill, go to the following link: http://www.house.gov/apps/list/press/financialsvcs_dem/essabill.pdf