On February 10, 2009, Treasury Secretary Geithner released an outline of the Obama Administration’s “Financial Stability Plan” (“FSP”), which is designed to resolve the existing problems in credit markets and the banking industry. The FSP consists of a number of initiatives, which are summarized below:
I. Financial Stability Trust
According to the Treasury Department, the Financial Stability Trust involves a “forward looking assessment of what banks need to keep lending even through a severe economic downturn.” The components of the initiative are as follows:
- Increased Transparency; Stress Test. The initiative involves (i) a review of accounting standards by regulators and accounting boards in an effort to improve disclosure by depository institutions, (ii) efforts to have federal banking regulators better coordinate to realistically assess exposures on balance sheets of depository institutions, (iii) a “stress test” that involves an assessment of whether major financial institutions have the capital necessary to continue lending and absorb potential losses in a more severe economic decline than projected and (iv) a mandatory coordinated supervisory review process for all depository institutions with assets of $100 billion or more.
- Capital Assistance Program. Institutions that have undergone a stress test can qualify for capital funds provided by the Treasury Department to “help absorb losses and serve as a bridge to receiving increased private capital.” The capital buffer is intended to operate as a form of “contingent equity” to ensure capital strength and preserve lending in a worse than expected economic downturn. The equity will be in the form of an investment by Treasury in a preferred convertible security that can be converted to common equity if necessary. The security will carry a dividend to be determined and a conversion price set at a “modest discount” from the institution’s stock price as of February 9, 2008. Institutions with less than $100 billion in assets will also be eligible for this program after a supervisory review.
- Separate Trust. Securities held by Treasury under the capital buffer program will be placed in a separate entity – the Financial Stability Trust, which will manage the U.S. government’s investments in U.S. financial institutions.
II. Public-Private Investment Fund. Rather than deploying a government “good bank/bad bank” approach, Treasury, the Federal Reserve Board and the FDIC intend to create a “Public-Private Investment Fund.” That fund will include a public/private financing arm designed to raise funds to purchase so-called “toxic” assets from financial institutions. The public/private approach is intended to minimize government funding and involve private sector input in determining the price for troubled and illiquid assets.
III. Consumers and Business Lending Initiative. A joint Treasury/Federal Reserve Board initiative, of up to $1 trillion, will broaden and expand the resources of the Federal Reserve’s previously announced Term Asset-Backed Securities Loan Facility. The Consumer and Business Lending Initiative, which will finance private purchases of loans, is intended to free up secondary markets to facilitate the free flow of credit and lower rates for auto, small business, credit card and other loans. The initial reach of the Term Asset-Backed Securities Loan Facility will be expanded to include commercial mortgage backed securities.
IV. Enhanced Accountability Measures. The FSP will include enhanced conditions for firms receiving capital assistance. Treasury materials indicate that those conditions will not be imposed retroactively. Conditions include (i) submission of a plan during the application process that shows how the capital funds will be used to strengthen lending capacity, (ii) a requirement for recipients of exceptional assistance or capital buffer assistance to demonstrate how the capital that they receive enables them to preserve or generate new lending, (iii) monthly reporting requirements on the use of capital funds in lending operations, and (iv) disclosure of the recipient’s reports on a new Treasury website, financialstability.gov. Recipients of capital investments will also be required to participate in a mortgage foreclosure mitigation program, and be subject to restrictions on paying dividends, repurchasing stock and engaging in cash mergers until the Treasury investment is repaid. Executive compensation will be subject to previously announced limitations and accountability requirements.
V. Housing Support on Foreclosure Prevention. Part of the FSP involves efforts to support housing and prevent foreclosures. Such efforts include (i) a continuation of the efforts of the Federal Reserve Board to keep interest rates low and purchase mortgage-backed securities to free up mortgage lending markets, (ii) allocation of $50 billion to prevent avoidable foreclosures and (iii) required participation in a foreclosure mitigation program by recipients of Treasury capital support.
VI. Small Business and Community Lending Initiatives. Treasury and the Small Business Administration (“SBA”) intend to announce a program designed to arrest the decline in SBA lending. The program will involve (i) the use of Consumer and Business Lending Initiative funds to finance the purchase of AAA-rated SBA loans in order to unfreeze secondary markets, (ii) securing legislation designed to increase the government’s guarantees of SBA loans and (iii) implementing speedier and less burdensome processing of loan applications.