TARP
On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 ("Act"), which has few if any precedents in scope, national attention, and potential impact on the US economy, especially with regard to the real estate market.
Title I of the Act, the Troubled Assets Relief Program ("TARP"), has drawn the most attention. It grants broad authority to the Secretary of the Treasury ("Secretary") to restore liquidity and stability to the United States financial system, including the notable authority to spend up to $700 billion to purchase troubled assets.
The key feature of the TARP is the Secretary's authority to purchase troubled assets from any Financial Institution. In exercising this authority, the Secretary is required to take into account protection of the interests of taxpayers, stability of the financial markets, preservation of homeownership, the long-term viability of the Financial Institution, participation of all Financial Institutions regardless of size or other characteristics, assistance to retirement plans that hold troubled assets and the needs of local communities.
Key Definitions
"Financial Institution" 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."
"Troubled Assets" are "(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 upon transmittal of such determination, in writing, to the appropriate committees of Congress."
Asset Purchase Guidelines And Management Of Assets
The Secretary must publish program guidelines by November 14, or sooner if he buys troubled assets before that date, describing the mechanisms for purchasing troubled assets, methods for pricing and valuing troubled assets, procedures for selecting asset managers, and criteria for identifying troubled assets for purchase.
The Act provides that no troubled asset may be purchased at a higher price than the price the seller paid for it (unless the troubled asset was acquired from the Financial Institution under receivership, conservatorship or bankruptcy), to avoid unjust enrichment of Financial Institutions. Under the Act, the Secretary must make purchases at the lowest price that he determines to be consistent with the purposes of this Act and he must ensure that prices paid for assets are reasonable and reflect the underlying value of the asset.
The Secretary is authorized to manage troubled assets purchased under this Act and to sell or enter into securities, loans, repurchase transactions, or other financial transactions with respect to any troubled asset purchased under the Act. The proceeds of such transactions will be paid into the general fund of the Treasury for reduction of the public debt.
Once the Secretary establishes the program, he is also required to establish a guarantee program for the payment of principal and interest of the troubled assets. This guarantee program is available to Financial Institutions as an alternative to the purchase program. Any Financial Institution may request a guarantee and will be charged premium payments. The premium payments will be deposited into the Troubled Assets Insurance Financing Fund and payments will be made from the fund to fulfill obligations under the guarantees. The ability of the Secretary to purchase troubled assets will be reduced by an amount equal to the difference of the total outstanding guaranteed obligations and the balance in the Troubled Assets Insurance Financing Fund. Since this guarantee program was not contained in the Secretary's original proposal, it remains to be seen how vigorously the Secretary will implement the guarantee program.
Wasting no time, yesterday the Secretary requested proposals to act as financial agents, to act as custodians for securities, accountants, auction managers, and to manage securities and whole loans. In addition, the Secretary yesterday set out the process for selecting portfolio asset managers , providing that separate managers will handle securities (which include Prime, Alt-A, and Subprime residential mortgage backed securities (MBS), commercial MBS, and MBS collateralized debt obligations) and whole loans (which include residential first mortgages, home equity loans, second liens, and commercial mortgage loans). The Secretary warned that the process (which in sequence is likely to be request for proposals published on the Treasury website, written proposals, Treasury review, Treasury's narrowing the field of candidates, with possible further questions and perhaps face to face meetings, and then contract negotiation) is likely to occur very quickly due to the exigent circumstances. Yesterday, the Secretary also named Assistant Secretary for International Economics and Development Neel Kashkari to head the program.
Various Kinds Of Oversight
The Federal Reserve Chairman, the Secretary, the Director of the Federal Housing Finance Agency, the Chairman of the Securities Exchange Commission, and the Secretary of Housing and Urban Development will act as a board under the Act (i) to review the exercise of authority under the Act; (ii) to make recommendations to the Secretary regarding use of the authority under the Act, and (iii) to report any suspected fraud, misrepresentation, or malfeasance to the Special Inspector General for the Troubled Assets Relief Program or the Attorney General of the United States. The Comptroller General of the United States is given the authority to monitor the activities and performance of TARP and of any agents and representatives of TARP, including vehicles established by the Secretary under this Act. A new Special Inspector General for the Troubled Asset Relief Program is to be appointed by the President, with the advice and consent of the Senate, to conduct, supervise, and coordinate audits and investigations of (x) the purchase, management, and sale of the troubled assets by the Secretary; (y) any program established by the Secretary; and (z) the management by the Secretary of any such program.
With regard to judicial review, judges are limited to determining if the Secretary acted in an arbitrary or capricious manner, abused his discretion or acted otherwise not in accordance with law. No injunctive relief is permitted with respect to purchases of troubled assets, insurance of troubled assets, management of troubled assets or foreclosure mitigation efforts. Unless expressly provided in a written contract with the Secretary, no Financial Institution may bring an action or claim against the Secretary.
By December 2, 2008, the Secretary must file his first monthly report with Congress describing his actions taken under TARP and expenses incurred, with financial statements, along with a Tranche Report for every $50 billion in troubled assets purchased, describing each of the transactions, the pricing mechanisms used, and the justification for the financial terms of the transactions.
Impact On Individual Homeowners
The Secretary is required to work with other federal entities that hold troubled assets to create a plan that seeks to minimize foreclosures for homeowners. The plan could use loan guarantees and credit enhancements to encourage loan modifications to prevent avoidable foreclosures. The Secretary will also encourage the servicers of the underlying mortgages to take advantage of the HOPE for Homeowners Program or other available programs to minimize foreclosures. Information regarding the HOPE for Homeowners Program can be found at www.hud.gov/fha/home080730.cfm .
Potential Upside For Taxpayers – Cost Of Financial Institutions' Sale Of Troubled Assets
As a condition for selling troubled assets to the Secretary, a publicly traded Financial Institution must provide the Secretary a warrant for the right to receive nonvoting common stock or preferred stock or even voting stock, as the Secretary determines appropriate (as to voting stock, however, the Secretary would agree not to exercise the voting power). The terms of the warrant must allow the Secretary to participate in any appreciation in the value of the Financial Institution realized by other equity holders. The warrant must also contain antidilution provisions to protect the value of the securities from market transactions such as stock splits, stock distributions, dividends, and mergers.
As a condition for selling troubled assets to the Secretary, a privately held Financial Institution must provide the Secretary a warrant for common or preferred stock or a senior debt instrument. The terms of the warrant must allow the Secretary to participate in any equity appreciation of the Financial Institution and, as to any senior debt instrument, must provide the Secretary a reasonable interest rate premium. The warrant must also contain antidilution provisions to protect the value of the securities from market transactions such as stock splits, stock distributions, dividends and mergers.
The Director of the Office of Management and Budget, in consultation with the Director of the Congressional Budget Office, will submit a report to the Congress five years after the enactment of the Act calculating the net amount within the Troubled Asset Relief Program. If there is a shortfall, the President will submit a legislative proposal that recoups from the financial industry an amount equal to the shortfall in order to ensure that the Troubled Asset Relief Program does not add to the deficit or national debt.
Limits On Executive Compensation And Corporate Governance – Another Cost Of Financial Institutions' Sale Of Troubled Assets
A Financial Institution that sells troubled assets to the Secretary under the Act in a direct purchase must meet "appropriate standards" for executive compensation and corporate governance if the Secretary makes a direct purchase of troubled assets from the institution where no bidding process or market prices are available and receives a "meaningful" equity or debt position in the institution as a result of the transaction. The "appropriate standards" will (and it appears that the Treasury has the authority to add others) restrict incentives that encourage senior executive officers to take "unnecessary and excessive risks," require "clawbacks", and prohibit "golden parachute" payments.
If a Financial Institution sells troubled assets to the Secretary under the Act in an auction purchase and the aggregate purchases (including any direct purchases) exceed $300 million, then that Financial Institution will be prohibited from establishing any new employment contract with a "senior executive officer" that provides a "golden parachute" payment in the event of an involuntary termination, bankruptcy filing, insolvency or receivership.
Where the aggregate purchase price for troubled assets purchased by the Secretary exceeds $300 million, various tax rules, including deductions of executive pay of more than $500,000 and certain severance payments, are altered for the participating Financial Institution.
New Fed And Treasury Actions To Boost Liquidity
As the events of the weekend and early this week demonstrate, the nation's and the world's economic problems go far beyond troubled mortgage loans and securities. The Federal Reserve announced today that it would establish a vehicle, the Commercial Paper Funding Facility ("CPFF"), to purchase three-month commercial paper, both unsecured and asset-backed, directly from issuers in an effort to unclog the stagnant commercial paper market . Bloomberg reported that activity in the commercial paper market hit a three-year low of $1.6 trillion last week, which presumably sparked the Federal Reserve's urgent action. In its announcement, the Federal Reserve noted that interest rates on long term commercial paper have risen dramatically and some CP is having to be refinanced on a daily basis. The commercial paper must be rated at least A1/P1/F1 by a major rating agency to be eligible for purchase. Unsecured commercial paper issuers will have to pay an upfront fee. The CPFF will cease purchasing activity on April 30, 2009.
For its part, last Friday, according to the Wall Street Journal, the Treasury also took steps to enhance major US corporations' liquidity, by permitting US corporations to borrow from foreign subsidiaries without incurring tax on the repatriated funds, for up to 60 days, three times a year (up from the previous 30 days, up to twice per year). This measure could help some US corporations with substantial cash overseas to avoid or reduce their dependence on the commercial paper market for their short term cash needs.
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