On October 3, 2008, the President signed into law the Emergency Economic Stabilization Act of 2008 (the “Act”). Pursuant to the Act, the Secretary of the Treasury (“Treasury” or the “Secretary”) has been authorized to establish the Troubled Asset Relief Program (“TARP”) to purchase “troubled assets” from any “financial institution.”
The Act establishes a graduated authorization for the Secretary’s purchase of troubled assets under the Act, under which a maximum of up to $700 billion of purchases may be outstanding at any one time. Initially, the Secretary’s authority to purchase assets is set at $250 billion outstanding at any one time. This amount may be increased to $350 billion at any time upon Presidential certification to Congress of the need for additional funding.1 The remaining $350 billion may be used upon Presidential submission of a report detailing Treasury’s plan for the use of the additional funding unless Congress rejects the plan within 15 calendar days after its receipt of the report.
Because the Treasury’s authorization is set to amounts “outstanding at any one time,” TARP should operate as a revolving purchase facility, pursuant to which troubled assets that are sold or mature will create capacity for the purchase of additional troubled assets. As a result, the amount of liquidity ultimately provided by TARP may well exceed the actual amounts appropriated.
The Act authorizes the purchase of a wide range of assets from a wide range of institutions. Section 3(5) of the Act defines “financial institution” broadly as “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 . . . and having significant operations in the United States, but excluding any central bank of, or institution owned by, a foreign government.” Similarly, “troubled assets” is broadly defined in Section 3(9) of the Act as: “(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was 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 after transmittal of such determination, in writing, to the appropriate committees of Congress.”
The Act gives the Secretary broad discretion to determine the manner and circumstances under which Treasury purchases troubled assets. In exercising its authority under the Act, however, Treasury is required to take into consideration the following:
- Protecting the interests of taxpayers by maximizing overall returns and minimizing the impact on the national debt.
- Providing stability and preventing disruption to financial markets in order to limit the impact on the economy and protect American jobs, savings and retirement security.
- The need to help families keep their homes and to stabilize communities.
- In determining whether to engage in a direct purchase from an individual financial institution, the long-term viability of the financial institution in determining whether the purchase represents the most efficient use of funds under the Act.
- Ensuring that all financial institutions are eligible to participate in TARP, without discrimination based on size, geography, form of organization, or the size, type, and number of assets eligible for purchase under the Act.
- Providing financial assistance to certain smaller institutions affected by the federal take over of GSEs.
- The need to ensure stability for US public instrumentalities, such as counties and cities.
- Protecting retirement security by purchasing troubled assets held by eligible retirement plans.
- The utility of purchasing other real estate owned and instruments backed by mortgages on multifamily properties.
The Act mandates the use of market mechanisms in the purchase of troubled assets whenever possible, but provides the Secretary with a great deal of discretion in designing and implementing such mechanisms. Where the use of a market mechanism is not “feasible or appropriate,” the Act allows the Secretary to make direct purchases from an individual financial institution, so long as the Secretary pursues “additional measures to ensure that prices paid for assets are reasonable and reflect the underlying value of the asset.” The Act empowers Treasury to hold assets to maturity or to sell them at such time as Treasury determines.
In order to ensure market transparency, the Secretary is required to disclose to the public the description, amounts and pricing of assets acquired under the Act within two business days of the purchase, trade or other disposition of assets.
In implementing TARP, Treasury is required to take steps to prevent unjust enrichment of financial institutions participating in TARP by, among other things, preventing the sale of a troubled asset to Treasury at a higher price than the seller paid to purchase it.
The Act provides that TARP is to be administered through a newly created Office of Financial Stability within Treasury and is to be headed by an Assistant Secretary of the Treasury, a position currently being filled on an interim basis by Interim Assistant Secretary for Financial Stability Neel Kashkari. Under the Act, Treasury is obligated to publish program guidelines for TARP before the earlier of (i) the end of the twobusiness- day period beginning on the date of the first purchase of troubled assets pursuant to the Act or (ii) the end of the 45-day period beginning on the date of enactment of the Act (or November 17, 2008). Those guidelines are required to include the following:
- Mechanisms for purchasing troubled assets.
- Methods for pricing and valuing troubled assets.
- Procedures for selecting asset managers.
- Criteria for identifying troubled assets for purchases.
The Act also creates a Financial Stability Oversight Board (consisting of the Chairman of the Board of Governors of the Federal Reserve System, the Secretary, the Director of the Federal Housing Finance Agency, the Chairman of the SEC and the Secretary of Housing and Urban Development) to, among other things, review the exercise of authority under TARP and make recommendations to Treasury. In addition, certain reporting obligations are imposed on Treasury under the Act.
In connection with the establishment of TARP, the Act requires Treasury to issue regulations or guidelines necessary to address and manage or prohibit conflicts of interest arising under the Act (see our separate Alert on these matters).
Section 109 of the Act specifies that to the extent Treasury acquires mortgages, mortgage backed securities and other assets secured by residential real estate, including multifamily housing, 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 Program or other available programs to minimize foreclosures. Treasury is also required to consent, where appropriate, to reasonable requests for loss mitigation measures, including term extensions, rate reductions and principal write downs.
Under Section 111 of the Act, any financial institution that sells troubled assets to the Secretary under the Act is required to agree to certain executive compensation standards. Please see our separate Alert for more information regarding the content and applicability of these executive compensation standards.
The Act prohibits Treasury from purchasing troubled assets unless Treasury receives warrants to purchase nonvoting common stock or preferred stock in a publicly traded institution or warrants to purchase common stock, preferred stock or a senior debt instrument in privately held institutions. The warrants are required to meet specified terms and conditions. The requirement to receive warrants does not apply to purchases of troubled assets from any one financial institution in a cumulative amount of not more than $100 million.
The Secretary’s authority to purchase or guarantee troubled assets will terminate on December 31, 2009. However, the Secretary can extend the authorization to expire not later than two years after the date of the Act’s enactment (or October 3, 2010) by written certification to Congress. The Secretary’s authority to continue to hold and manage purchased troubled assets, or to purchase or fund the purchase of an asset under a commitment entered into prior to the termination date referenced above, is not subject to this sunset provision.
To date, Treasury has not made any commitment to purchase troubled assets from any financial institution, nor has it made any public statements regarding how it intends to implement the asset purchase provisions of TARP. However, on October 13, 2008, Mr. Kashkari updated the public on Treasury’s efforts to date. In his speech at the Institute of International Bankers, Mr. Kashkari stated that Treasury had created seven policy teams to develop the elements of various parts of TARP. The seven teams are:
- Mortgage-backed Securities Purchase Program
- Whole Loan Purchase Program
- Insurance Program
- Equity Purchase Program
- Homeownership Preservation
- Executive Compensation
In support of its efforts, Treasury has hired an investment management consultant, a custodian, a legal adviser and an accounting firm to advise it in implementing TARP. Mr. Kashkari indicated in his speech that Treasury would also be seeking to retain securities asset managers to hold, manage and sell mortgagebacked securities purchased by Treasury under TARP and whole loan asset managers to hold, manage and sell whole loans purchased by Treasury under TARP and to work with servicers (presumably including seeking modifications where possible to prevent foreclosures).
As discussed in our other Alerts, Treasury has already moved forward on several of the areas covered by the policy teams referenced above. On October 14, 2008, the Secretary announced the creation of the Capital Purchase Program. Treasury also announced on October 14, 2008 that it was seeking public input on the potential establishment of an insurance program for troubled assets. In addition, Treasury has announced executive compensation standards and conflict of interest mitigation policies.
The structure and implementation of the troubled asset purchase programs is still unknown at this time. However, in implementing the authorities granted to it under the Act, Treasury faces a daunting task. The mortgage securities market is highly complex. Many loans have been packaged, divided and sold to completely different investor classes. It is unclear how Treasury will seek to acquire and modify mortgage securities that represent different parts of different asset classes. In doing so, Treasury will be required to strike a balance between different investor classes as some modifications will benefit certain investors at the expense of others.
How Treasury decides to intervene in the market is also unknown. Commentators have expressed concern that Treasury not overpay for troubled assets as doing so would inflate bank balance sheets as a result of unrealistic and unsustainable asset valuations. Others have expressed the opinion that Treasury will not have to acquire a significant amount of assets to bring order and liquidity to secondary markets. In their view, small purchases will go a long way to creating and maintaining healthy markets for these assets by establishing pricing mechanisms and providing liquidity to private market participants.
In addition, Treasury’s plans for the disposition of the assets it purchases and the warrants it acquires as a result are also unknown and likely to have a significant impact on markets. Many buyers of distressed assets may have unique opportunities to acquire asset pools from Treasury at favorable prices. In addition, hedge funds, mutual funds and other investors may be attracted to the warrants held by Treasury. Given the likely number of sellers of troubled assets, a wide range of publicly traded warrants in established companies may be available for purchase for the first time in decades.
The Act also does not directly address purchases of credit default swaps and similar derivative instruments which have received the lion’s share of the blame for triggering the current financial crisis. Treasury has not yet indicated any plan to intervene in the market for derivative securities. However, it seems likely that regulators will now move into these markets and demand greater public disclosure and regulation of these instruments. Commentators also have suggested that market participants establish a clearinghouse to organize and regularize trading of these derivative instruments and to mitigate counterparty risk. According to published reports, the Federal Reserve System has engaged in a number of exploratory discussions regarding the creation of such a clearinghouse.
While movement has occurred in a number of areas, there is still a lot of work to be done before the scope and contours of TARP are fully developed.