Emergency Economic Stabilization Act of 2008 Troubled Asset Relief Program
The Emergency Economic Stabilization Act of 2008 (the “Act”) was signed into law on October 3, 2008 after a tumultuous week in Congress. The center of this legislation is the Troubled Asset Relief Program (“TARP”), the most significant economic intervention by the federal government in the financial system since the Great Depression. In order to restore liquidity and stability to the financial system, the Secretary of the Treasury (the “Secretary”) is authorized under the Act to purchase residential and commercial mortgage loans and mortgage-backed securities or other related obligations that were originated or issued on or before March 14, 2008 (“troubled assets”) from financial institutions including, but not limited to, banks, savings associations, credit unions, security brokers or dealers, and insurance companies established and regulated under the laws of the U.S. or any state, territory, or possession of the U.S. that have significant operations in the U.S. (excluding any central bank of, or institution owned by, a foreign government) and from foreign financial authorities and central banks that hold troubled assets as a result of extending financing to such financial institutions that have failed or defaulted on such financing. The Secretary is required to establish program guidelines no later than November 16, 2008, including mechanisms for purchasing troubled assets and methods for pricing and valuing such assets. By establishing a price discovery mechanism, it is expected that private capital, as well as government funds, will reenter the market, restoring the flow of capital to consumers and businesses and easing the credit crunch. By permitting the Secretary to purchase and remove troubled assets from a financial institution’s balance sheet, it is expected that such a financial institution will be in a better position to raise capital and obtain credit from other financial institutions.
In implementing the TARP, the Secretary is required to consider, among other factors, protecting the interests of taxpayers by maximizing overall returns and minimizing the impact on the national debt, providing stability and preventing disruption to the financial markets, helping families keep their homes, and ensuring that all financial institutions are eligible to take part in the program. The Secretary is required to use the authority under the Act to minimize any potential long-term negative impact on taxpayers, taking into account direct outlays made under the program, potential long-term returns on troubled assets purchased, and the overall economic benefits of the program, including improvements in economic activity and the availability of credit, the impact on savings and pensions, and reductions of losses to the federal government. To further these goals, the Secretary may hold assets to maturity or for resale at such time as the Secretary determines that the market is optimal for selling such assets at a price the Secretary determines will maximize return on investment for the federal government. If there is a shortfall on the net amount within the TARP five years after the enactment of the Act, the President is required to submit a legislative proposal to recoup such a shortfall from the financial industry in order to ensure that the TARP does not add to the deficit or national debt. In addition to establishing the TARP, the Secretary is required by the Act to establish a program to guarantee troubled assets of financial institutions, although the Secretary is not required to use this program.
The Secretary’s authority to purchase and insure troubled assets will terminate on December 31, 2009, unless extended through October 3, 2010 upon certification by the Secretary to Congress including a justification of why the extension is necessary and the expected cost to the taxpayers of such an extension. Initially, the maximum amount of troubled assets purchases by the Secretary is limited to $250 billion outstanding at any one time. Upon notification of Congress by the President, such limit is increased to $350 billion. The Secretary will be authorized to purchase a maximum of $700 billion of troubled assets outstanding at any one time unless, after the President sends Congress a written report regarding the Secretary’s plan to exercise such authority, Congress enacts a joint resolution disapproving the Secretary’s plan with respect to such additional amount. The amount of troubled assets purchased by the Secretary that are outstanding at any one time will be determined by aggregating the purchase prices of all troubled assets held. The Secretary will fund the costs of the program by issuing Treasury securities.
evenues and sales proceeds from troubled assets will be paid into the general fund of the Treasury. The TARP will be implemented under the newly created Office of Financial Stability within the Office of Domestic Finance of the Department of the Treasury. Significant oversight has been built into the Act. The Secretary’s actions with respect to the TARP will be subject to judicial review and final actions shall be held unlawful and set aside if they are found to be arbitrary, capricious, an abuse of discretion or are not in accordance with law. The key provisions of the Act are summarized below and are further detailed in a chart attached to this update.
Purchase of Troubled Assets
The Secretary is required to make purchases of troubled assets under the Act at the lowest price that the Secretary determines to be consistent with the purposes of the Act and to use market mechanisms, including auctions or reverse auctions where appropriate. If the Secretary determines that a market mechanism is not appropriate and that the purposes of the Act are best met by a direct purchase from a financial institution, the Secretary must pursue additional measures to ensure that the purchase price is reasonable and reflects the underlying value of the assets and must assess the longterm viability of such financial institutions and whether such a direct purchase represents the most efficient use of funds under the Act. To further market transparency, the Secretary must make available to the public a description, amounts, and pricing of all assets purchased within two business days of purchase, disposition, or trade.
Insurance of Troubled Assets
In addition to establishing the TARP, the Secretary is also required to establish a program to guarantee troubled assets originated or issued prior to March 14, 2008. The Secretary will collect premiums from financial institutions participating in the guarantee program in an amount determined by the Secretary that may vary based on the credit risk of the troubled asset. Premiums must be set at a level necessary to create reserves sufficient to meet anticipated claims and to ensure that taxpayers are fully protected. Troubled assets will be guaranteed in amounts not greater than 100% of the amount of the payment of principal and interest on such assets. Premiums will be held in a Troubled Assets Insurance Financing Fund. The Secretary’s purchase authority limits under the TARP will be reduced by an amount equal to the difference between the total outstanding guaranteed obligations and the balance of the Troubled Assets Insurance Financing Fund.
Receipt of Equity Interest
To cover losses and administrative costs of the program, and to give taxpayers an opportunity to recoup some of the government outlay, subject to certain de minimis exceptions, the Treasury will be required to receive warrants from publicly traded participating financial institutions or debt securities from participating financial institutions that are not publicly traded. Any warrants must contain anti-dilution provisions to protect the value of the securities.
The Secretary may use a streamlined process in awarding contracts under the Act and will issue regulations or guidelines to address conflicts of interest that may arise in connection with the hiring of contractors, advisors, and asset managers; the purchase and management of troubled assets; post-employment restrictions on employees; and any other potential conflict of interest.
A Financial Stability Oversight Board (composed of the Chairman of the Board of Governors of the Federal Reserve System, the Chairman of the SEC, the Director of the Federal Housing Finance Agency, the Secretary of Housing and Urban Development, and the Secretary of the Treasury) and myriad reporting requirements included throughout the Act are designed to ensure that taxpayers are adequately protected and that the purposes of the Act are being properly carried out. The Financial Stability Oversight Board has authority to review the exercise of authority under the program (including the appointment of financial agents, the designation of asset classes to be purchased, and plans for the structure of vehicles used to purchase troubled assets), make recommendations, report any suspected fraud or malfeasance to a Special Inspector General for TARP, and ensure the policies implemented are consistent with protecting taxpayers and in the economic interests of the federal government. The Financial Stability Oversight Board may appoint a Credit Review Committee to evaluate the exercise of the purchase authority and the assets acquired under the Act. In addition, a Congressional Oversight Panel is established to review the Secretary’s use of authority under the TARP, the current state of the financial markets and the regulatory system. This panel will be comprised of five experts appointed by designated members of Congress and will submit monthly reports to Congress.
A Special Inspector General for TARP appointed by the President is required to conduct audits and investigations of the purchase, management, and sale of assets by the Secretary under the Act and the guarantee program and to collect and report quarterly to certain Congressional committees. The Act also mandates that the Comptroller General oversee the program to ensure strong internal controls are in place and to conduct a study to determine the extent to which leverage was a factor behind the current financial crisis and the role of the SEC, the Federal Reserve Board and banking agencies relating thereto. The Comptroller General will report to Congress no less than every 60 days on the performance of the program, conduct an annual audit of the program, and report findings so that corrective action will be taken with respect to any identified deficiencies.
The TARP requires that to the extent residential mortgages, residential mortgage-backed securities, and other assets secured by residential real estate, including multifamily housing, are held, owned, or controlled by the Secretary or by a federal property manager, each will seek (and will collectively coordinate a plan to seek) to maximize assistance to homeowners and encourage servicers, considering net present value to the taxpayer, to take advantage of programs to minimize foreclosures including, with respect to the Secretary, consenting to reasonable requests for loss mitigation measures under existing investment contracts and, with respect to each federal property manager, loan modifications that may include reduction of interest rates, reduction of loan principal, and other similar modifications. For residential rental properties, modifications may include the continuation of existing government rental subsidies. Where the federal property manager is not the owner of a residential mortgage but has an interest in that mortgage, the federal property manager will encourage implementation by loan servicers of loan modifications and assist in facilitating such modifications. Federal property managers include the Federal Housing Finance Agency, as conservator of Freddie Mac and Fannie Mae, the FDIC with respect to such residential assets held by any bridge depository institution pursuant to section 11(n) of the Federal Deposit Insurance Act, and the Federal Reserve Board with respect to such residential assets held, owned, or controlled by a Federal Reserve bank with certain exceptions. These requirements under the Act do not supersede any other requirements imposed on the federal property managers under applicable law.
Limits on Executive Compensation
The Act imposes limits on the compensation of senior executive officers at financial institutions that participate in the TARP through a direct purchase of troubled assets where no bidding process or market prices are available and in which the Secretary receives a “meaningful” equity or debt position. The Act mandates that the Secretary require that such financial institutions meet appropriate standards for executive compensation and corporate governance for senior executive officers (the top five highly-paid executives of a public company and non-public company counterparts), including limits on compensation that exclude incentives to take unnecessary and excessive risks and a prohibition on golden parachutes, in each case during the period the Secretary holds equity or debt in the related financial institution, and provides for the recovery by the financial institution of any bonus or compensation based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate. In addition, where the Secretary has purchased in excess of $300 million of troubled assets (whether by auction or direct purchase), the Act prohibits golden parachutes with respect to any new employment contract with a senior executive officer in the event of an involuntary termination, bankruptcy filing, insolvency, or receivership and reduces tax deductions associated with compensation paid by such a participating financial institution to a covered executive (the chief executive officer or the chief financial officer or an executive who is one of the three highest compensated officers in that taxable year).
Exchange Stabilization Fund Reimbursement
The Act provides that the Secretary shall use TARP funds to reimburse the Exchange Stabilization Fund for any funds used for the Treasury Money Market Funds Guaranty Program for the money market mutual fund industry. The Act also prohibits any future use of the Exchange Stabilization Fund for the establishment of any guaranty program for the money market mutual fund industry.
The Act states that the SEC has the authority to suspend the application of Statement Number 157 of the Financial Accounting Standards Board for any issuer or class or category of transaction the SEC deems appropriate and is consistent with the protection of investors. The Act also requires the SEC, in consultation with the Federal Reserve Board and the Secretary, to conduct a study on mark-to-market accounting standards as provided in FAS 157 (accounting standards that many blame for fueling the current economic crisis) including its effects on a financial institution’s balance sheet, its impact on bank failures in 2008, its impact on the quality of financial information available, the process used in developing accounting standards, and the advisability of modifying the standards. We note that the SEC’s Office of the Chief Accountant and the staff of the Financial Accounting Standards Board clarified their views on fair value accounting in a release issued September 30, 2008.
Ordinary Loss on Sale of Certain Preferred Stock
Pursuant to the Act, gains or losses from the sale or exchange of any Federal National Mortgage Association or Federal Home Loan Mortgage Corporation preferred stock that was held by any applicable financial institution (as defined in the Act) on September 6, 2008 or sold or exchanged on or after January 1, 2008 but before September 7, 2008 shall be treated as ordinary income or loss.
Temporary Increase in Deposit Insurance
The Act provides for the increase until December 31, 2009 in the limit on federal deposit insurance to $250,000 from $100,000.
Taxation of Offshore Deferred Compensation
In provisions designed to apply to deferred compensation arrangements for advisors of offshore investment companies, the Act imposes current taxation on deferred compensation payable by certain foreign corporations and certain partnerships if that compensation is not subject to a substantial risk of forfeiture. Where the amount includible is not determinable, taxation is deferred until the amount becomes determinable, but the amount of tax imposed is then increased by the sum of (i) 20% of the amount of the compensation and (ii) interest for the period of income deferral. The new provision is applicable to compensation for services rendered after December 31, 2008 and transition rules apply for taxation of deferred compensation in respect of services rendered before January 1, 2009.
There remain many important details related to the process for carrying out the purposes of the Act that will need to be developed by the Treasury and its advisors. Dechert attorneys will continue to monitor the development of these processes and will be available to assist clients interested in selling assets to or buying assets from the TARP, serving as agents to the TARP, or otherwise participating in the TARP. For your reference, we have attached a chart highlighting certain key aspects of the Act.