On Friday October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA” or the “Act”). The EESA was the result of a bipartisan deal reached after the U.S. House of Representatives on Monday, September 29, 2008, failed to pass legislation dealing with the Treasury’s proposed $700 billion bailout for the financial services sector to restart bank lending and unfreeze the financial services markets. The stated purposes of the EESA are: (i) to immediately provide the Secretary of the Treasury (the “Secretary”) with the authority and facilities to restore liquidity and stability to the financial systems of the United States; and (ii) to ensure that such authority and facilities are used in a manner that protects home values, college funds, retirement accounts, and life savings; preserves homeownership and promotes jobs and economic growth; maximizes overall returns to the taxpayers of the United States; and provides public accountability for the exercise of such authority. The authority granted under the EESA will terminate on December 31, 2009, except it may be extended upon submission of a written certification to Congress by the Secretary explaining why such extension is necessary.
The EESA is divided into three parts: Title I – Troubled Assets Relief Program (“TARP”); Title II – Budget Related Provisions; and Title III – Tax Provisions. This Alert only focuses on the key provisions of Title I.
Availability of Funds Under the EESA – The EESA provides for $250 billion to be immediately available to the Secretary. Another $100 billion will be available to the Secretary upon receipt by the Congress of a written certification from the President. Finally, an additional $350 billion will become available if, after the written certification mentioned above, the President transmits to Congress a written report detailing the Secretary’s plan for the use of such additional funds and Congress does not object by way of enacting a joint resolution within 15 days.
Establishment of TARP – The heart of the EESA is the establishment of the TARP which allows the Secretary to purchase, or make and fund commitments to purchase, troubled assets from any financial institution, on such terms and conditions as are determined by the Secretary, and in accordance with the EESA and the policies and procedures developed by the Secretary.
- Key Definitions:
- “Financial Institutions” – The EESA defines the term ‘financial institution” broadly to include any institution, including but is 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 and having significant operations in the United States, but excluding any central bank of, or institution owned by, a foreign government.
- “Troubled Assets” – The EESA also defines “troubled assets” as: (i) 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 that it promotes financial market stability, subject to terms and conditions approved by the Secretary; and (ii) other financial instruments 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.
Other Parties – It appears that the Treasury can also purchase assets from pension plans, local governments and banks that serve low and middle-income populations and other underserved communities.
Guidelines – The Secretary is required to issue guidelines for the TARP by the earlier of: (i) two business days after the first purchase of troubled assets under the program; and (ii) 45 days after the enactment of the EESA. Such guidelines must address mechanisms for purchasing troubled assets, methods for pricing troubled assets, procedures for selecting asset managers, and criteria for identifying troubled assets for purchase.
Management/Sale of Troubled Assets – The Secretary has the authority to manage troubled assets so as to minimize the cost to the taxpayers, and that includes selling the troubled assets, and entering into securities loans, repurchase transactions, or other financial transactions regarding, any troubled assets purchased under the EESA. Any revenues obtained by the Department of the Treasury from the transactions under the EESA shall be paid into the general fund of the Treasury for the reduction of the public debt.
Insurance Program – If the Secretary establishes the TARP, then the Secretary is required to establish a program to guarantee troubled assets originated or issued prior to March 14, 2008, which includes mortgage-backed securities. The Secretary shall establish the terms of such guarantees and the appropriate premiums. The Secretary’s $700 billion purchase authority under the TARP will be reduced by any amount of obligations guaranteed under this program. However, such reduction will be reduced by the amount of insurance premiums collected. The premiums are to be set at a level necessary to create reserves sufficient to meet anticipated claims and to ensure taxpayers are fully protected.
Prevention of Unjust Enrichment – The EESA requires the Secretary to prevent the unjust enrichment of financial institutions participating in the program by preventing the sale of a troubled asset to the Secretary at a higher price than what the financial institution paid for it. However, this prohibition does not apply to assets acquired in a merger or acquisition, or a purchase of assets from a financial institution in conservatorship or receivership, or that has initiated a federal bankruptcy proceeding.
Taxpayer Protections – The Secretary is directed to use his authority under the Act to minimize any potential long-term negative impact on the taxpayer, taking into account the direct outlays, potential long-term returns on assets purchased, and the overall economic benefits of the program. In carrying out the duties described above the Secretary is required to: (i) hold the assets to maturity or for resale until such time as the Secretary determines that the market is optimal for selling such assets, in order to maximize the value for taxpayers; and (ii) sell such assets at a price that the Secretary determines will maximize the return on investment for the Federal Government.
- When making purchases under the TARP the Secretary is required to use market mechanisms including auctions or reverse auctions, where appropriate to minimize costs. The Secretary is also authorized to make direct purchases if he determines that use of a market mechanism is not feasible or appropriate and the purposes of the EESA are best met through direct purchases.
- In addition:
- The EESA provides for taxpayer payback in the event the Treasury experiences losses in selling off the purchased assets. On October 3, 2013, the Director of the Office of Management and Budget (in consultation with the Director of the Congressional Budget Office) is required to submit a report to Congress on the net amount within the TARP. If there is a shortfall, the President is required to submit a legislative proposal that recoups from the financial industry an amount equal to the shortfall.
- The secretary may not purchase troubled assets unless it receives an ownership interest in the sellers of the purchased assets:
- Publicly traded institutions must grant the Secretary a warrant to receive nonvoting common stock or preferred stock, or voting stock with respect to which the Secretary agrees not to exercise voting power, as the Secretary deems appropriate.
- Any other institution must grant the Secretary a warrant for common or preferred stock, or a senior debt instrument.
- These contingent shares must provide for participation by the Secretary, for the benefit of taxpayers, in equity appreciation in the case of an equity security, or a reasonable interest rate premium in the case of a debt instrument. Warrants granted to the Secretary must also contain anti-dilution provisions of the type employed in capital market transactions, as determined by the Secretary.
- Exception – The Secretary is required to establish two exceptions to the provision described above: (i) a de minimus exception to the provision above at not more than $100 million; and (ii) an exception and appropriate alternative requirements for any institution that is legally prohibited from issuing securities and debt instruments.
Market Transparency – The Secretary is required to make available to the public in electronic form within two business days of purchase, trade or other disposition, a description of the amounts and pricing of troubled assets acquired under the TARP. The Treasury Department must also conduct an analysis of the public disclosures of financial institutions that sell assets into TARP. If such institutions’ disclosures are not adequate, the Treasury must make recommendations to the relevant regulators for additional disclosure requirements.
Executive Compensation – There are several provisions designed to rein in the executive compensation practices of participating financial institutions. These provisions were summarized in Reed Smith’s Financial Industry Alert 08-175 (October 9, 2008), available at http://www.reedsmith.com/_db/_documents/bull08175.pdf.
Oversight – The EESA provides for strong independent oversight. Such oversight includes:
- Establishment of the Financial Stability Oversight Board comprised of the Chairman of the Federal Reserve Board, the Secretary of the Treasury, the Director of the Federal Housing Finance Agency, the Chairman of the Securities and Exchange Commission (the “SEC”), and the Secretary of Housing and Urban Development. This body is responsible for reviewing the exercise of the Secretary’s authority under the EESA;
- Establishment of a Congressional Oversight Panel that is responsible for reviewing the current state of the financial markets and the regulatory system and submitting reports to Congress, including a report on regulatory reform by January 20, 2009;
- The establishment of a new Office of the Special Inspector General for TARP that is responsible for auditing and investigating the purchase, management, and sale of assets by the Secretary under the EESA; and
- Ongoing oversight by the Comptroller General.
Homeowner Protections – The EESA provides a number of protections for homeowners, including:
- Requiring Federal agencies that hold, own or control mortgages, mortgage-backed securities, and other assets secured by residential real estate, including multi-family housing, to implement plans that seek to maximize assistance for homeowners, using the agencies’ authority to encourage the servicers of underlying mortgages to take advantage of the HOPE for Homeowners Program or other available programs to minimize foreclosures. Such modifications may include reduction in interest rates, reduction of loan principal and other similar modifications; and
- The Secretary may use loan guarantees and credit enhancements to facilitate loan modifications.
Fannie Mae and Freddie Mac Stock –The EESA allows certain financial institutions or depository institution holding companies to treat as ordinary income or loss, the gains or losses on Fannie Mae and Freddie Mac preferred stock that was held on or before September 6, 2008, or was sold on or after January 1, 2008 and prior to September 7, 2008.
Judicial Review – Actions by the Secretary pursuant to the EESA shall not be set aside unless they are found to be arbitrary, capricious, an abuse of discretion, or not in accordance with law. The EESA also prohibits injunctions or other forms of equitable relief against the Secretary for his actions under the primary provisions of the EESA (Sections 101, 102, 106 and 109), other than for a violation of the Constitution. Finally, no action or claim may be brought against the Secretary by any institution participating in any program under the EESA except if the Secretary’s action is found to be arbitrary, capricious, an abuse of discretion or not in accordance with law.
Mark-to-Market Accounting – Mark-to-market accounting under FASB Statement Number 157 may be suspended by the SEC if it determines that it is necessary or in the public interest and consistent with the protection of investors. The SEC is also required to complete a study on mark-to-market accounting.
- The EESA temporarily increases the FDIC and NCUA insurance caps from $100,000 to $250,000, effective until December 31, 2009.
- The EESA also allows civil penalties for the misuse of the FDIC name and logo or for falsely representing FDIC insured status. The EESA also gives the banking agencies the necessary enforcement authority.
In the case of legislation, the devil is in the details. Thus, any assessment of the true impact will require review of the regulations, policies and procedures issued by the Secretary to implement the TARP.