[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]





                               BEFORE THE

                            SUBCOMMITTEE ON

                                 OF THE


                     U.S. HOUSE OF REPRESENTATIVES


                             SECOND SESSION


                              MAY 11, 2010


       Printed for the use of the Committee on Financial Services

                           Serial No. 111-132

58-042                    WASHINGTON : 2009
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                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
WM. LACY CLAY, Missouri                  Virginia
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES WILSON, Ohio                 KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
JOHN ADLER, New Jersey
JIM HIMES, Connecticut

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
              Subcommittee on Oversight and Investigations

                     DENNIS MOORE, Kansas, Chairman

STEPHEN F. LYNCH, Massachusetts      JUDY BIGGERT, Illinois
RON KLEIN, Florida                   PATRICK T. McHENRY, North Carolina
JACKIE SPEIER, California            RON PAUL, Texas
GWEN MOORE, Wisconsin                MICHELE BACHMANN, Minnesota
JOHN ADLER, New Jersey               CHRISTOPHER LEE, New York
MARY JO KILROY, Ohio                 ERIK PAULSEN, Minnesota
                            C O N T E N T S

Hearing held on:
    May 11, 2010.................................................     1
    May 11, 2010.................................................    27

                         Tuesday, May 11, 2010

Atkins, Hon. Paul, Member, Congressional Oversight Panel, and 
  former Securities and Exchange Commissioner....................    14
Jarrow, Robert A., Ronald P. and Susan E. Lynch Professor of 
  Investment Management and Professor of Finance and Economics, 
  The Johnson School, Cornell University.........................    16
Miller, David N., Chief Investment Officer, Office of Financial 
  Stability, U.S. Department of the Treasury.....................     4
Puvalowski, Kevin R. Deputy Special Inspector General, Office of 
  the Special Inspector General for TARP (SIGTARP)...............    12
Wilson, Linus, Assistant Professor of Finance, B.I. Moody III 
  College of Business, University of Louisiana at Lafayette......    17


Prepared statements:
    Moore, Hon. Dennis...........................................    28
    Atkins, Hon. Paul............................................    32
    Jarrow, Robert A.............................................    37
    Miller, David N..............................................    52
    Puvalowski, Kevin R..........................................    61
    Wilson, Linus................................................   138

              Additional Material Submitted for the Record

Moore, Hon. Dennis:
    United States Department of the Treasury, Office of Financial 
      Stability, ``Warrant Disposition Report''..................   145
    Congressional Research Service report entitled, ``Government 
      Interventions in Response to Financial Turmoil,'' dated 
      February 1, 2010...........................................   201
Atkins, Hon. Paul:
    List of field hearings held by the Congressional Oversight 
      Panel......................................................   245

                      TARP OVERSIGHT: AN UPDATE ON

                        WARRANT REPURCHASES AND

                         BENEFITS TO TAXPAYERS


                         Tuesday, May 11, 2010

             U.S. House of Representatives,
                          Subcommittee on Oversight
                                and Investigations,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 11 a.m., in 
room 2128, Longworth House Office Building, Hon. Dennis Moore 
[chairman of the subcommittee] presiding.
    Members present: Representatives Moore of Kansas, Adler; 
and Biggert.
    Chairman Moore of Kansas. This hearing of the Subcommittee 
on Oversight and Investigations of the House Financial Services 
Committee will come to order. Our hearing this morning is 
entitled, ``TARP Oversight: An Update on Warrant Repurchases 
and Benefits to Taxpayers.''
    This is our 10th Oversight and Investigations hearing this 
Congress, and our 4th focused on our top priority, TARP 
oversight. Today's hearing is a follow-up to our first TARP 
warrants hearing last July. We will begin this hearing with 
members' opening statements, up to 10 minutes per side, and 
then we will hear testimony from our witnesses.
    For each witness panel, members will each have up to 5 
minutes to question our witnesses. The Chair advises our 
witnesses to please keep their opening statements to 5 minutes 
to keep things moving so we can get to members' questions. 
Also, any unanswered questions can always be followed up in 
writing for the record.
    Without objection, all members' opening statements will be 
made part of the record. I now recognize myself for up to 5 
minutes for an opening statement.
    Leading up to our first TARP oversight hearing focused on 
the issues of warrant repurchases last July, there were a 
number of concerns raised that taxpayers were not seeing 
maximum returns on their investment. I wrote a letter to 
Secretary Geithner last June expressing that, ``I am concerned 
with recent reports that financial institutions that received 
TARP funds are lobbying to buy back warrants the U.S. 
Government received for providing taxpayer assistance at a 
reduced or minimal value. I strongly urge you to utilize your 
authority to maximize the best deal for taxpayers.''
    I copied on that letter our TARP oversight entities, 
including the Congressional Oversight Panel (COP) and SIGTARP. 
Within a few days, I received a response from both that they 
would investigate further.
    Before our July hearing, COP reported that at that time, 
taxpayers were receiving only 66 percent of warrants' value 
compared to their best estimate of their worth. With the 
mounting pressure from Members of Congress, the TARP oversight 
bodies, and the general public, I was pleased to learn the 
morning of our July hearing that Goldman Sachs announced they 
would buy back their warrants for $1.1 billion. That represents 
a 23 percent annualized return taxpayers received on the 
original $10 billion investment in the firm.
    At the hearing I said, ``That sounds pretty good, but is it 
good enough?'' Since that time, other large transactions 
include: Morgan Stanley agreeing to pay $950 million to 
repurchase their warrants; JPMorgan Chase auctioning their 
warrants for $950.3 million; and Bank of America auctioning 
their warrants for more than $1.5 billion.
    To answer my question from the July hearing, ``Are these 
returns enough'', I will read from the written testimony of our 
witnesses today.
    Professor Linus Wilson says, ``Oversight works.'' And that 
is a quote.
    Mr. Atkins, for the Congressional Oversight Panel says, 
``The Panel has been pleased to see that Treasury's performance 
in this area has improved dramatically since we first analyzed 
its original warrant dispositions.''
    Professor Robert Jarrow remarks, ``It is my belief that the 
Treasury's warrant repurchase program has been a success.''
    In SIGTARP's audit that we will discuss today, they write, 
``To its credit, Treasury has generally succeeded in negotiated 
prices from recipients for the warrants at or above its 
estimated composite value.''
    I will note that to the benefit of taxpayers, SIGTARP and 
COP rarely if ever hold back on being critical of various TARP 
programs and financial stability efforts, so those comments 
tell me that the program its really working pretty well.
    We should not lose sight of the forest for the trees, and 
before we focus on ways to improve this program, let me stress 
the TARP warrants program has worked and worked well, providing 
over $6 billion of additional returns for taxpayers, with 
billions more expected. And that is beyond the $181 billion 
repayments of the initial TARP investment. If you add the $14 
billion in total dividends, interest and distributions from 
TARP recipients today, taxpayers have received an additional 
$20 billion on top of the normal repayments.
    If Congress had enacted the Bush Administration's original 
3-page proposal for TARP, essentially a $7 billion blank check 
with no oversight and no strings attached, taxpayers would 
likely not have seen these additional returns today and would 
be left with the tab. But by authorizing the use of warrants, 
creating strong oversight entities like SIGTARP and COP, which 
have produced thousands of pages of oversight reports that are 
available online, and adding the requirement that taxpayers 
must eventually be fully repaid, TARP will have done its job to 
both stabilize the economy and fully protect taxpayers.
    And don't take my word for it. Consider what Professor 
David A. Walker from Georgetown University, a Republican 
witness at our Oversight and Investigations hearing last week, 
said, ``I believe that the TARP commitment was essential. It's 
my opinion that our economy would be rebounding much more 
slowly than it has if we had not implemented the TARP 
    While the TARP warrants have greatly benefited U.S. 
taxpayers, it is our duty to explore the program fully and 
ensure that it is as transparent and run as well as possible. 
For example, I hope we explore policy questions looking at the 
differences between the public auction and direct negotiations 
with Treasury. Is one option better than the other? How do we 
ensure there is consistency of outcomes over a subjective 
process in negotiating a fair value for the warrants? Also, how 
do TARP warrants work for smaller financial institutions 
compared to large ones?
    I look forward to hearing the testimony of all of our 
witnesses today as we continue working hard to provide tough 
oversight of TARP and to ensure taxpayers are fully protected.
    Chairman Moore of Kansas. I now recognize for 5 minutes the 
ranking member of the subcommittee and my colleague from 
Illinois, Ranking Member Judy Biggert.
    Mrs. Biggert. Thank you, Mr. Chairman, and thank you for 
holding this hearing which is a follow-up to our hearing last 
July. It is important that we continue to have hearings like 
this to ensure that taxpayers are getting the best return on 
their TARP investment. I have concerns that taxpayers may not 
be getting the best possible return, and some witnesses have 
noted that the Treasury lacks the internal controls needed to 
measure whether a high enough price was set for warrant 
repurchases or sales.
    I am also concerned that in addition to the 18 warrants 
Treasury holds in financial institutions that have exited TARP, 
Treasury still holds warrants for 237 companies that have yet 
to exit TARP. SIGTARP's April 20th quarterly report lists a 
number of companies that are late on their CPP dividend 
payments. EESA authorizes Treasury to appoint members to the 
boards of directors of such financial institutions.
    Does the Treasury plan to appoint government officials to 
these boards of directors of these delinquent financial 
institutions? I look forward to learning about Treasury's plans 
regarding these issues.
    And finally, I am concerned about the Administration's 
interpretation of the authority it thinks it has to use TARP 
funds. We have an auto bailout, a mortgage modification 
program, and potentially a small business program, all of which 
seem to stretch beyond the original intent of the use of TARP 
funds; and, coupled with AIG and the Fannie Mae and Freddie Mac 
bailouts, it caused a significant loss of TARP and taxpayers' 
    What is Treasury's justification for these activities?
    In addition, what is the Administration's plan to end this 
program, end bailouts, including that of Fannie Mae and Freddie 
Mac, and what is the exit strategy and what is the timeline? We 
need to put an end to the government picking winners and losers 
in the marketplace, which has facilitated unfair competition--
competitive advantages for some businesses and completely 
abandoned others.
    So I look forward to hearing from today's witnesses and I 
yield back the balance of my time.
    Chairman Moore of Kansas. Thank you to our ranking member.
    I am pleased to introduce our first witness this morning. 
Mr. David Miller is the Chief Investment Officer for the Office 
of Financial Stability in the Treasury Department. Without 
objection, sir, your written statement will be made a part of 
the record.
    Mr. Miller, you are recognized for 5 minutes.


    Mr. Miller. Chairman Moore, Ranking Member Biggert, thank 
you for the opportunity to testify before you today regarding 
warrants received in connection with the Troubled Asset Relief 
Program. The Emergency Economic Stabilization Act of 2008 
mandates that Treasury, with certain exceptions, receive 
warrants in connection with the purchase of troubled assets. 
These warrants provide taxpayers with an additional potential 
return on the Federal Government's investment.
    I will focus my testimony today on TARP's warrant 
disposition process, and I will highlight our consistency, 
commitment to transparency, and successful results on behalf of 
    Of the $245 billion that was invested in financial 
institutions, $177 billion, or 72 percent, has been returned to 
pay down the deficit, and taxpayers have earned a modest profit 
on those investments, including more than $6 billion in warrant 
proceeds. These proceeds consist of approximately $3 billion 
from repurchases by issuers at agreed-upon fair market values 
and approximately $3 billion through public auctions. For these 
44 institutions, Treasury received an absolute return of 4 
percent on its investment from dividends and an added 5 percent 
return from warrant sales, for a total absolute return of 9 
    At this time, I will discuss our process for warrant 
valuation and disposition. Upon redemption of preferred stock 
issued to Treasury, a financial institution has a contractual 
right to repurchase its warrants held by Treasury at a mutually 
agreed upon price representing fair market value. Determining 
fair market value is challenging, especially given the limited 
comparable market data for long dated warrants. As a result, 
Treasury devised a comprehensive process to evaluate repurchase 
bids from financial institutions. Market quotations, 
comparables, independent third-party valuations and model 
valuations are the three primary valuation methods.
    Treasury aggregates the data from internal and external 
valuation sources to determine an estimated fair market 
valuation range. The Office of Financial Stability has 
maintained a consistent valuation process to treat each 
financial institution fairly and similarly.
    Treasury contracted Dr. Robert Jarrow, finance professor at 
Cornell University and noted options expert, to review 
Treasury's warrant valuation process. Dr. Jarrow concluded that 
Treasury's valuation methodology is fair to participating banks 
and taxpayers and consistent with industry best practice and 
the highest academic standards.
    Treasury has managed a transparent warrant disposition 
process. Treasury has published information on all CPP 
transactions, including investments, repayments, warrant 
repurchases, and auctions on financialstability.gov.
    This past January, Treasury released the Warrant 
Disposition Report. This report provides extensive analysis for 
each warrant repurchase and auction. We note that the SIGTARP 
audit release this week concluded that Treasury has 
successfully negotiated prices that were at or above Treasury's 
estimated range of fair value. This report also described 
Treasury's valuation methodology and it did not suggest any 
modifications. However, SIGTARP made recommendations regarding 
documentation of the negotiation process and ensuring that 
consistent information be provided to issuers seeking to 
repurchase their warrants.
    Treasury is carefully reviewing these recommendations and 
will make appropriate changes to its procedures.
    Throughout the warrant process, Treasury remains committed 
to providing the public with comprehensive detail and 
informative analysis.
    Following the repayment, a bank may notify Treasury that it 
does not intend to repurchase its warrants or it may not agree 
with Treasury on a price. As a result, Treasury has sold these 
warrants through public auctions. The warrant auctions have 
successfully attracted many bidders and have been 
oversubscribed multiple times. This has resulted in clearing 
prices in excess of the reserve price set by Treasury.
    These auctions have created a legitimate market, with 
abundant information and significant participation to determine 
a fair market value. Since auction warrants have achieved 
stable aftermarket prices, we believe the Treasury has received 
fair value.
    Implied volatility is one metric for measuring warrant 
disposition value. Generally, the higher the implied 
volatility, the greater the value Treasury receives. On 
average, Treasury has received better pricing, or higher 
implied volatility, for negotiated transactions than for 
auctions. In addition, the size of the warrant disposition has 
impacted the price Treasury has received. Treasury found that 
smaller warrant positions received, on average, a lower implied 
volatility. This differential is from a number of factors, 
including a larger liquidity discount and relatively higher 
transaction cost that would be incurred for smaller position 
    Treasury intends to continue to execute a comprehensive and 
transparent process which achieves fair market values and 
protects taxpayer interests. This program has been extremely 
successful and Treasury will continue to strive for optimum 
results on behalf of taxpayers.
    I look forward to answering your questions. Thank you.
    [The prepared statement of Mr. Miller can be found on page 
52 of the appendix.]
    Chairman Moore of Kansas. Thank you, sir, for your 
    I now recognize myself for 5 minutes for questions.
    First, Mr. Miller, let me commend you, Assistant Secretary 
Allison, Secretary Geithner, and the entire team at Treasury 
for the work that you do, especially as we review the success 
we have seen with the TARP warrants program.
    Before I focus on TARP warrants, I have a letter addressed 
to Secretary Geithner that I just signed today, discussing 
several items relating to TARP, but also my desire that 
Treasury redouble its effort and try to translate the success 
we have seen in the TARP warrants program to improvements in 
foreclosure mitigation.
    Will you be sure the Secretary receives this letter and 
responds in a timely manner, Mr. Miller?
    Mr. Miller. I will.
    Chairman Moore of Kansas. Thank you.
    Mr. Miller, I don't think it is a surprise that the 
negotiations with Morgan Stanley, as reported by SIGTARP, were 
difficult and not clear-cut. Major negotiations are rarely 
straightforward, and I am glad Treasury was able to obtain an 
additional $50 million more than the Warrant Committee 
originally approved.
    Will you discuss generally how difficult these decisions 
and negotiations are and what factors does Treasury consider 
when seeking maximum return for taxpayers?
    Mr. Miller. Thank you for the question.
    As I highlighted in my written testimony, there is a lot of 
uncertainty about the value of these warrants, particularly 
prior to launching the first auctions. Because there are no 
market prices, we employ a multipronged strategy which looks at 
market prices, looks at model valuation, and we also have a 
third-party independent contractor.
    When we create this range of valuation, there is still no 
single point estimate that one can nail down as the exact 
value. It is a range. There is uncertainty. We take this 
valuation after a lot of discussion and create a range. When we 
enter into the negotiation process, we have an idea of this 
range, and often some banks are way off, which requires a lot 
of conversations to explain how we arrive at the process and 
the inputs that go into it.
    The valuation ranges are highly sensitive to the inputs 
that go in. So it is quite important that we do have a 
discussion with the issuers if they want to repay. Some are 
more sophisticated. Larger banks tend to be more sophisticated 
than the smaller banks.
    Also, reasonable people can disagree about these inputs, 
which is why we use more than just our model. We like to go out 
to the marketplace and get a sense of where things trade. I 
also think the negotiation process is quite dynamic. It is 
going to be unique to each issuer, and one can't follow exactly 
a checklist of exactly the same information, the same schedule 
of conversations, because we are trying to get the best value 
for taxpayers.
    And I think the point regarding how have we done in these 
negotiations, again, what we are always thinking about is can 
we get a price that is as good as or better than what we would 
be able to sell these in the marketplace, understanding that 
there is no quote that we can look at, but getting a sense of 
what we can sell it for.
    Chairman Moore of Kansas. Thank you, Mr. Miller.
    Mr. Atkins from COP, on our second panel, points out that 
in their estimate, auctions yield 110 cents on the dollar, 
while direct negotiations with Treasury yield 93 cents on the 
dollar. But Professor Jarrow points out the added cost by 
setting up an auction, so the advantages may not be as clear-
    Does Treasury have a preference between auctions or direct 
negotiations? And what considerations are made by Treasury in 
this regard, sir?
    Mr. Miller. Thanks for the question.
    We have looked at the comparison between our results from 
auctions and negotiations. And what we found--since we only do 
auctions for positions greater than $5 million, which is the 
threshold to list them on the New York Stock Exchange--is that 
on average, we have actually gotten 35 percent volatility for 
the negotiated warrants versus 33 percent at auction on the 
auction warrants, which suggests that we are doing slightly 
better in the negotiations, on average.
    We don't have a preference, contractually, in the CPP 
preferred stock agreement. The banks have a right to repurchase 
the warrants under this program where we have to agree on fair 
market. We believe there are certainly cases where we can do 
better than what something would be sold for in the 
marketplace. I think as we released in our January report, 
putting all the detail out on the negotiated transactions as 
well as the first three warrant auctions, that we have done so.
    Chairman Moore of Kansas. Thank you, sir. And I have a 
couple of additional questions, but my time is just about out. 
So we will submit those in writing and ask if you would respond 
to those, sir.
    Mr. Miller. Thank you.
    Chairman Moore of Kansas. At this time, I will recognize 
the ranking member for questions.
    Mrs. Biggert. Thank you, Mr. Chairman.
    Mr. Miller, does the Treasury Department have plans to 
place members on the boards of directors of the financial 
institutions that participated in the capital purchase programs 
but have missed the dividend payments? I think it was up by the 
time--the sixth quarter, you are supposed to put in two members 
of the board of directors?
    Mr. Miller. Thanks for that question.
    Just to step back, I think you are referring correctly to 
the Capital Purchase Program. If an institution misses its 
dividend payment for six quarters, Treasury has the right to 
nominate someone for the board of directors. There have been a 
number of firms that have missed their dividend payments for 
several quarters. We have not yet had one miss it for six, 
although we are currently considering our options.
    This is a standard covenant in many financial agreements 
that if the bank does miss dividends, the owner of that 
security would have certain rights. But as far as putting 
government officials on the boards, we are not considering 
doing that.
    Mrs. Biggert. So it would be just--who would you put on the 
    Mr. Miller. We are precluded from actually having a 
government official, the legal interpretation is, but we would 
consider, as we have done in other cases with larger 
investments, looking for independent board members to provide 
an independent voice.
    Mrs. Biggert. In regard to the legality of the foreclosure 
mitigation program, HEMP, the Treasury Department has cited an 
internal legal memorandum that explains the authority for 
Treasury to fund HEMP with TARP funds. The most recent COP 
report, however, explains that the Treasury Department has 
asserted the attorney-client privilege over this memorandum.
    Why wouldn't the Treasury Department simply disclose the 
memo describing its authority to fund HEMP through TARP? 
Shouldn't this be made available to the members of this 
committee? I know that portions of it have been made available, 
and with at least $50 billion of money, taxpayer money on the 
line, I think that this committee and the Congress deserve at 
least a Treasury memo explaining the legality of funding this 
    It seems to me that the thing originally about TARP was 
that the money that would come back was going to go into the 
fund to pay back the deficit, to pay back the debt, rather than 
to fund other programs.
    Mr. Miller. The housing program--and you have raised some 
important questions--is not something that I have 
responsibility for, so I would be happy to take those questions 
back to Treasury.
    Mrs. Biggert. Would you take that back, so we can get an 
answer in writing?
    Mr. Miller. Sure.
    Mrs. Biggert. Thank you.
    The SIGTARP has issued an audit that was critical of the 
method the Treasury used to document its warrant negotiations, 
and I think the chairman addressed this a little bit, but they 
cited the lack of any internal controls in the negotiation 
    What are the internal controls?
    Mr. Miller. I would be happy to discuss a little more about 
the report, because we have gotten a chance to review it.
    First, we feel we have quite robust controls, as far as we 
have something called the Warrant Committee where staff 
prepares memos to review the valuation, all the three methods. 
That committee will meet and discuss it and ultimately provide 
a recommendation to the Assistant Secretary for Financial 
Stability, Herb Allison. He may accept or reject that 
recommendation, but there is a lot of interaction along the 
    As far as the negotiation process, we--again, each 
negotiation is dynamic. We are currently reviewing the 
recommendations made by the SIGTARP which really entail better 
documentation of the negotiation process, and it is something 
we are certainly--
    Mrs. Biggert. Would this include testing of whether 
Treasury was able to acquire a favorable warrant sale price or 
whether the taxpayer lost money on the negotiations?
    Mr. Miller. I think we certainly look at it--it is very 
hard to make a comparison, as valuations done solely by model 
are going to be subjective. People will have different views, 
which is why we use multiple inputs. You can't both do a 
negotiation, if successful, and sell them into the market. And 
so you don't have a perfect market price.
    But we do evaluate very closely what price we receive, and 
if we believe that will be better than what we get in the 
market price. So that is what guides our negotiating. And we 
have been very consistent in how we apply our valuations, 
although each negotiation is going to be different.
    Mrs. Biggert. But isn't SIGTARP wanting to have testing to 
see the result?
    Mr. Miller. I believe the focus of his report was really 
two areas. And again, I think we are always supportive of our 
oversight bodies helping us to improve the process. The first 
one is regarding our Warrant Committee and the minutes that are 
taken. And just to provide a little context, the committee 
minutes itself detail who is present, the recommendation made, 
the date, and the time. Attached to that committee minutes is a 
detailed memo that goes through how we arrive at our valuation 
ranges, and really is the basis for discussion of that 
committee meeting. So it is quite a lot of detail.
    However, the SIGTARP noted that it was a little bit 
difficult in the audit of that to find out exactly the key 
decision point, so we are certainly going to review that and 
look to add more information so it is easier to follow along.
    Mrs. Biggert. Thank you.
    Chairman Moore of Kansas. We don't have any other members 
present besides myself and the ranking member, so I think we 
have agreed that we would like to each have up to 5 additional 
minutes for additional questions, if you would, sir. And I 
thank the ranking member for her agreement.
    We learned a lot from the report Treasury released in 
January on the warrants program. Is that something Treasury 
could release semiannually? And before you respond, Mr. Miller, 
have the recommendations and oversight provided by SIGTARP, 
COP, GAO, and Congress been helpful over the past year-and-a-
half in improving the administration of TARP and our mutual 
goal of stabilizing our economy while trying to fully protect 
    Mr. Miller. I will take the first one first. The report was 
certainly something that we had always wanted to do. Leading up 
until January, we certainly were concerned about releasing too 
much information too early because we were concerned that the 
banks that we negotiate with would take advantage of it and 
that could potentially hurt taxpayer returns.
    As we were able to successfully launch the auctions, we 
felt very comfortable that if we could not reach an agreement 
with the bank, we had an extremely viable alternative to sell 
them in the marketplace, so we did not have to in any way lower 
our standards or accept prices that we did not think were fair. 
So once we did that, we felt comfortable releasing a report. We 
certainly plan to release additional reports like that going 
    Chairman Moore of Kansas. Thank you, sir.
    And finally, Mr. Miller, Professor Wilson raises concerns 
with regard to the proposed small business lending fund and 
small firms being able to get rid of their warrant without any 
benefits to taxpayers. Would you discuss this issue generally 
of how TARP warrants relate to small and big firms? And I have 
said throughout financial regulatory reform that responsible 
community banks should not be subject to enhanced scrutiny. The 
new oversight system should focus on the Wall Street banks and 
nonbanks, like mortgage brokers, that did the most damage.
    Should we focus on the larger institutions to achieve the 
maximum gains for taxpayers?
    Mr. Miller. First, with regards to what is known as the 
SBLF, the Small Business Lending Fund, that is in a proposal 
stage. The Administration put forth a proposal which is meant 
to allow banks to get attractive capital so that they could 
increase their small business lending. That is still in the 
design phase, and I understand it is still with Members of 
    With regards to the warrants, it makes no indication--we 
certainly have not indicated that we would cancel any warrants, 
so I am not sure where that view is coming from. That was never 
an intention.
    Regarding small and large institutions, I think clearly the 
bulk of the dollars went to the largest institutions. Those are 
also the institutions that have repaid the lion's shares of the 
$177 billion that has been repaid to date.
    The 650 or so remaining institutions in the Capital 
Purchase Program are small institutions. We still treat them 
equally. They are certainly more difficult to value the 
warrants. Many of them are private institutions which don't 
have warrants that are the ones we are talking about today. But 
the smallest ones certainly trade differently if we were to 
sell them into the market, so that is a challenge we are 
certainly working through as we go forward in the best way to 
monetize those if we don't reach agreement on repurchase as 
these banks continue to repay.
    Chairman Moore of Kansas. Thank you, sir.
    And the Chair now recognizes again the ranking member for 
up to 5 minutes.
    Mrs. Biggert. Thank you, Mr. Chairman.
    Just going back a little bit to the previous question that 
I had, I think that SIGTARP found that unless there are 
sufficient internal controls and documentation--and I am glad 
to hear that they are going to do more of that because, really, 
fairly or unfairly, the criticism of the third parties, it is 
really subjecting themselves to the fact that they can be 
criticized for picking winners and losers unless there is 
that--that the price can be properly scrutinized, even though 
it is after the fact of the negotiation, and to ensure that 
taxpayers receive top value for their investments. Would you 
agree with that?
    Mr. Miller. I think analysis of the value we are getting is 
absolutely important, and we welcome that. We do our own, and 
we welcome others to do so as well. But I would also add that 
these ultimate model valuations that people would use to test 
are highly sensitive to the volatility, which is one of the 
major inputs into determining that value, and so can be used, 
really, any result sum, if they were wanting to get to a number 
that was either very high or very low. What we are trying to do 
is find fair market value; what would the market pay for this? 
And so that is a slightly different process than some might go 
    We have seen a number of reports out in the press where 
people will make sort of outrageous claims that we could have 
gotten ``X,'' but they can't substantiate it.
    Mrs. Biggert. So what is the Administration's plan, 
including the time-lining for ending the TARP program? And when 
will this be revealed to us?
    Mr. Miller. That is a very important question. And I think, 
as you know, the authority to make new investments expires on 
October 3rd of this year. We have also already wound down a 
number of programs, the Asset Guarantee Program, the Target 
Investment Program. The Capital Purchase Program ceased making 
new investments in December of last year, and we have already 
seen a huge amount of repayment which we are very encouraged 
    I think the principle is clearly that we are reluctant 
holders of these securities and will look to monetize them as 
soon as is practicable, but taking into consideration, 
certainly, the prices we could get, financial stability 
overall. But again, we are working towards that, but we are 
doing it prudently and sensibly.
    Mrs. Biggert. One last question, Mr. Miller. If ever 
implemented, do you know where the funding for the 
Administration's proposed small business lending fund will come 
from? I think that the first proposal was for $30 million--a 
$30 billion fund to come from TARP. I understand that a revised 
plan has been issued, but it is silent on how the program is to 
be funded. And some people say that this is nothing but TARP II 
without any potential benefit or payback to the taxpayer.
    Mr. Miller. I don't know the status, as well. I know 
initially it was proposed to come out of TARP. There were good 
reasons why it should not be part of TARP; namely, over time, 
the stigma associated with banks taking TARP money became quite 
difficult, and they were concerned about some of the issues, 
both stigma and some of the restrictions that came with it. And 
that was really hurting the system overall for small banks that 
may benefit from that capital and be able to lend more. But I 
don't have a view on certainly which would be a better way to 
fund it, and I don't know the status of it.
    Mrs. Biggert. Is there a projection of losses? I think some 
people have said $8.4 billion or 28 percent of the fund?
    Mr. Miller. Depending on how it ends up getting structured, 
there have been a number of estimates that show varying degrees 
of subsidy or loss.
    Clearly, if you are giving capital that may be below market 
rate to encourage banks to take that capital, it is not going 
to be 100 cents on the dollar, if you will; there will be a 
subsidy. But I don't think there is a final estimate of that 
for the Small Business Lending Program.
    Mrs. Biggert. Thank you. I yield back.
    Chairman Moore of Kansas. Thank you.
    And thank you, Mr. Miller, for your service and your 
testimony here today. You are now excused, and I will invite 
the second panel of witnesses to please take your seats. Thank 
you sir.
    I am pleased to introduce our second panel of witnesses. 
First, we have Mr. Kevin Puvalowski, Deputy Special Inspector 
General for TARP.
    Second--while we normally have Professor Elizabeth Warren 
testify on behalf of the Congressional Oversight Panel on 
TARP--we are pleased to have a Republican appointee, the 
Honorable Paul Atkins, and a former Security and Exchange 
Commissioner represent COP today.
    Next, we will hear from Professor Robert Jarrow, the Ronald 
P. and Susan E. Lynch professor of investment management and 
professor of finance and economics at the Johnson School of 
Cornell University.
    And finally, we will hear from Professor Linus Wilson, 
assistant professor of finance, B.I. Moody III College of 
Business at the University of Louisiana at Lafayette.
    Without objection, the witnesses' statements will be made a 
part of the record.
    Mr. Puvalowski, you are recognized, sir, for 5 minutes.


    Mr. Puvalowski. Chairman Moore, Ranking Member Biggert, and 
members of the committee, it is a privilege and an honor to 
testify today concerning SIGTARP's audit of Treasury's warrant 
disposition process which is being released today before this 
    The audit, which focuses on the process and procedure that 
Treasury uses to sell warrants that it obtained through TARP, 
was intended to complement the Congressional Oversight Panel's 
July 2009 report that examined the warrant valuation 
methodologies themselves.
    To its credit, Treasury has generally succeeded in 
negotiating prices for warrants at or above its internal 
estimated values. Our audit, however, identified two 
significant problems in Treasury's warrant disposition process 
that have led to failures in transparency and consistency that, 
if left unaddressed, could result in significant harm to the 
    The first deficiency is that Treasury does not sufficiently 
document important parts of the negotiation process. Treasury, 
for example, lacks detailed documentation supporting the 
decisions of the Warrant Committee, the committee that reviews 
TARP recipients' offers. Significantly, committee minutes 
generally do not reflect the factors considered by the members 
when making determinations whether to accept a bank's offer or 
their justifications or explanations for their decisions. Even 
more troubling, Treasury does not document the substance of its 
conversations with recipient institutions when it negotiates 
warrant repurchases, making it extremely difficult, if not 
impossible, to determine what actually happened.
    This lack of documentation significantly limits the ability 
to test the consistency of Treasury's decision-making. Memories 
fade, Treasury officials leave office, and with the passage of 
time and the occurrence of intervening negotiations, different 
parties to a meeting or a conversation may have different 
recollections of what occurred.
    When a committee decision or a brief telephone conversation 
can mean the difference of tens of millions of dollars for 
taxpayers, it is a basic and fundamental element of 
transparency and accountability that the substance of that 
meeting or call be recorded contemporaneously.
    SIGTARP was unable, for example, to determine with 
certainty what occurred during a key telephone conversation 
between Treasury and Morgan Stanley, a conversation that 
resulted in a $50 million swing for the taxpayer. Treasury 
failed to document the call, and the recollection of the 
participants as to what happened during that call differed very 
    The second significant deficiency is that Treasury does not 
have established guidelines or internal controls over how the 
negotiations proceed, and, in particular, as to how much 
information is shared with recipient institutions about the 
price Treasury is likely to accept for the repurchase of its 
    Descriptions provided to SIGTARP by several of the banks 
that engaged in negotiations with Treasury confirmed that 
Treasury was willing, for some banks, to provide clear 
indications as to what price it was prepared to sell the 
warrants. For other banks, Treasury was unwilling to share 
similar details.
    Indeed, as detailed in the audit, the amount of information 
provided, the circumstances of what information would be 
provided, and the results of the negotiations were all over the 
    While there may well be good reasons for treating different 
institutions differently in the context of the negotiation, 
because Treasury does not document the negotiations with 
financial institutions, and because there are no established 
guidelines or criteria for what information is shared or when 
it will be shared, it is impossible to determine with 
certainty, after the fact, whether the difference in the 
sharing information was justified or consistently applied, or 
if those different approaches were, in the final analysis, good 
or bad for taxpayers.
    Until Treasury addresses these deficiencies, it risks 
subjecting itself once again, fairly or unfairly, to criticism 
from third parties that through TARP, it is favoring some 
institutions over others, picking winners and losers, 
irrespective of whether, in fact, it had legitimate reasons to 
take the negotiating positions that it did.
    To address these deficiencies, SIGTARP's audit recommends 
that: one, Treasury should ensure that more detail is captured 
by the Warrant Committee meeting minutes; two, Treasury should 
document in detail, contemporaneously, the substance of all 
communications with recipients concerning warrant repurchases; 
and three, Treasury should develop and follow guidelines and 
internal controls concerning how negotiations will be pursued, 
including the degree and nature of information to be shared 
with repurchasing institutions concerning Treasury's valuation 
of the warrants.
    We await Treasury's formal response to these 
    Chairman Moore, Ranking Member Biggert, I want to thank you 
again for this opportunity to appear before you today, and I am 
pleased to answer any questions that you may have.
    [The prepared statement of Mr. Puvalowski can be found on 
page 61 of the appendix.]
    Chairman Moore of Kansas. Thank you Mr. Puvalowski. I 
appreciate your testimony.
    And the Chair will next recognize Mr. Atkins. You are 
recognized, sir, for up to 5 minutes.


    Mr. Atkins. Thank you very much, Chairman Moore, Ranking 
Member Biggert, and distinguished members of this subcommittee. 
My name is Paul Atkins. I am a member of the Congressional 
Oversight Panel, and I appreciate very much this opportunity to 
testify about the Congressional Oversight Panel's work 
assessing the performance of the Treasury Department in 
managing and disposing of stock warrants that it has acquired 
in conjunction with the Troubled Asset Relief Program. I should 
note that the views expressed today in this testimony are my 
own. I will do my best to try to convey the Panel's views, but 
my statements cannot always reflect the opinions of our five 
very diverse thinkers.
    The Panel is charged by statute to review the current state 
of the financial markets and the financial regulatory system 
and provide monthly reports to Congress assessing the 
effectiveness of Treasury's implementation of the TARP, 
including its disposition of stock warrants.
    When Congress authorized the commitment of $700 billion to 
rescue the financial system, it also required that taxpayers 
participate in the upside if assisted financial institutions 
returned to profitability. This is achieved through Treasury's 
receipt of warrants to purchase common stock, or other 
securities, from the banks party to any transaction in which 
those banks received TARP capital, mainly through what is 
called the Capital Purchase Program or CPP.
    In May of 2009, CPP-assisted banks began to repay their 
TARP assistance. The Oversight Panel in July 2009 evaluated the 
prices that Treasury negotiated for; at that time, 11 banks had 
purchased their warrants. We used the industry standard Black 
Scholes option pricing model adjusted to reflect the particular 
characteristics of the warrants that Treasury received under 
the CPP, and specifically the dividend yield and the 10-year 
duration. The Panel's analysis concluded that Treasury had 
received approximately 66 percent of our best estimate of the 
value of TARP warrants for these banks.
    However, we acknowledged as well that these repurchases 
represented less than one-quarter of 1 percent of our best 
estimate of the value of all the CPP warrants that Treasury had 
acquired as of that time.
    We also knew that Treasury's own valuation of warrants of 
these smaller banks incorporated an adjustment for the likely 
relative illiquidity of a stock of these banks, a step that the 
Panel did not apply because of the subjectivity of that 
particular factor.
    The July report recommended that Treasury give serious 
consideration to employing auctions to dispose of warrants 
rather than relying heavily upon one-to-one negotiations with 
individual banks. Using a public auction for warrant 
repurchases would leave no room for speculation that Treasury 
either was too tough or too easy on a TARP recipient 
institution, while allowing banks to repurchase their warrants 
in competition with other market participants. The report noted 
the need for greater transparency in the Treasury warrant 
valuation and negotiation process and called for Treasury to 
publish periodic reports that provide details on the value 
determinations for the warrants that are being sold.
    I should note that committee member Jeb Hensarling, at that 
time a member of the Oversight Panel, emphasized in particular 
his unease with Treasury's lack of disclosure. And I should 
also express my own concern with Treasury's lack of openness in 
its dealings with the public and with the Oversight Panel, as 
Representative Biggert raised.
    The opinion that you mentioned, Representative Biggert, was 
addressed to me in my capacity as an Oversight Panel member, 
and as far as I am concerned, it is a public document. Treasury 
should not attempt to assert an inapplicable privilege to keep 
information submitted to a congressional oversight body out of 
the public domain.
    In addition to the warrants received under the Capital 
Purchase Program and the Targeted Investment Program, Treasury 
also receives stock warrants in conjunction with the Auto 
Industry Financing Program. Warrants received as part of the 
initial assistance to General Motors and Chrysler were 
extinguished as part of the credit bid process in bankruptcy. 
As in the case of other private institutions, the warrants that 
Treasury received in relation to GMAC for a variety of 
preferred securities were immediately exercised on the 
investment date.
    So in summary, the Oversight Panel is pleased to see that 
Treasury's performance in this area has improved dramatically 
since we first analyzed its initial warrant dispositions. The 
use of public auctions have clearly allowed for taxpayers to 
receive a solid return on their investments in these 
institutions and the transparency provided by public auctions 
allows transactions to take place in full public view. The 
panelists urge the Department to continue publishing the 
details of its internal valuations for each warrant disposition 
transaction, as it did most recently in January this year.
    The Panel has also urged Treasury to provide more assurance 
that it is achieving consistency in the negotiated warrant sale 
price process.
    The issues of transparency and consistency of outcomes will 
each become more important as Treasury moves to dispose of the 
warrants for the many remaining TARP-assisted small banks whose 
stocks are thinly traded. Taxpayers expect and deserve no less 
for the integrity of the process.
    Thank you very much Mr. Chairman.
    [The prepared statement of Mr. Atkins can be found on page 
32 of the appendix.]
    Chairman Moore of Kansas. Thank you, Mr. Atkins, for your 
    The Chair next recognizes Professor Robert Jarrow. Sir, you 
are recognized for 5 minutes.


    Mr. Jarrow. Good morning. I would first like to thank the 
committee for my invitation to testify.
    Some relevant background on myself. I am an expert on risk 
management modeling and implementation. I wrote the first 
textbook on option valuation over 25 years ago. And since that 
time, I have continued to do research in this area. My models 
are currently used by the financial industry to value and to 
hedge both interest rate and credit derivatives. I have 
extensive consulting experience implementing derivative models, 
in practice.
    I was engaged as an independent contractor by the U.S. 
Treasury during the summer of 2009 to audit their warrant 
valuation procedure. A summary of my valuation is available on 
the Treasury's Web site.
    It is my belief that the Treasury's warrant repurchase 
program has been a success. It has generated sales fair to both 
U.S. citizens and to the banks and the TARP program. The 
Treasury warrants repurchase process is well constructed, 
containing two components, a negotiated repurchase and/or an 
auction sale to third parties.
    In the negotiation process, the Treasury determines a 
warrant's fair price using the judgment of Treasury's internal 
experts in conjunction with three different price estimates, 
quotes from market participants, third-party valuations, and an 
internal model.
    The Treasury's internal valuation model is based on best 
industry practice and the highest academic standards.
    Early in the warrant repurchase program, in the summer of 
2009, criticism of the Treasury's fair valuations appeared in 
the financial press and in the July 2009 Congressional 
Oversight Panel report. This criticism was unjustified because 
it was based on price estimates obtained from poor model 
    Since that time, the Treasury's valuations have converged 
to those of their critics. This convergence was due to changing 
market conditions. It was not due to a modification of the 
Treasury's methodology, except perhaps for the reduced use of a 
liquidity discount.
    Let me explain these statements in slightly more detail. As 
it is well known, the top warrants are American-type call 
options on a bank's common stock with a 10-year maturity date. 
Valuing these warrants is a complex exercise involving the 
modeling of stock prices, stock price volatilities, dividends, 
and interest rates over the next 10 years.
    Industry best practice is to use a modified Black Scholes 
model which assumes very simple evolutions for these 
    The crucial input is a stock price volatility used. The 
correct volatility input should be a forecast of the average 
stock price volatility over the next 10 years, and this is a 
very difficult quantity to estimate.
    The early criticism of the Treasury's valuation estimates 
was mostly based on disagreements concerning this input. The 
correct approach is the one used by the Treasury and not that 
of the critics.
    Since the early warrant repurchases in the summer of 2009, 
the stock market's volatility has declined. This decline in 
volatilities has caused the differences between the stock price 
volatility inputs of the critics and the Treasury to narrow, 
resulting in more similar warrant valuations.
    As is typical of most option pricing techniques, the Black 
Scholes model also assumes that markets are frictionless, with 
no transactions cost and with infinite market liquidity.
    Obviously, these assumptions are not satisfied for large 
sales of nontraded warrants. In this case, a liquidity discount 
is appropriate.
    In the early repurchase of TARP warrants, the Treasury 
applied such a liquidity discount. As market conditions 
stabilized, liquidity discounts were less necessary in 
subsequent warrant sales. The critics' valuation estimates 
never included such a liquidity discount. This was the second 
important difference.
    I am running out of time. I am used to lecturing.
    I will conclude my testimony here, and I welcome questions 
from the committee.
    [The prepared statement of Professor Jarrow can be found on 
page 37 of the appendix.]
    Chairman Moore of Kansas. Thank you, sir, very much, for 
your testimony.
    The Chair next recognizes Professor Linus Wilson.
    And I will remind each of the witnesses that your testimony 
will be received into the record. Thank you.
    Mr. Wilson.


    Mr. Wilson. I am honored to be invited to appear before the 
subcommittee today. Thank you, Chairman Moore and Ranking 
Member Biggert.
    While I teach and conduct research and finance at the 
University of Louisiana at Lafayette, the views that are 
expressed today are my own and not necessarily the views of my 
university or the State of Louisiana.
    I received my doctorate of philosophy in economics at 
Oxford University in England in 2007. In addition to my other 
academic research in finance economics, I have written 14 
academic papers on the TARP warrants government plans to buy 
so-called toxic assets from banks, the effectiveness of various 
types of capital in encouraging bailed-out banks to make good 
loans, and the ``too-big-to-fail'' problem.
    Half of those papers on the bank bailouts have, to date, 
been accepted or appeared in peer-reviewed academic journals. 
We meet today on almost the 1-year anniversary of the first 
warrant transaction with Old National Bank Corp.
    Much to my surprise, my research into the Goldman Sachs 
warrants and the first warrant repurchase with Old National 
Bank garnered considerable interest.
    I argued that only through third-party sales and auctions 
could taxpayers hope to get the best prices. With pressure from 
this committee, the Congressional Oversight Panel, and me, 
Goldman Sachs announced its $1.1 billion repurchase of the 
taxpayers' warrants. That price was the closest price to my 
estimated fair market value of any bank up to that time. 
Several other very good negotiations for taxpayers followed.
    Yet one outlier among the big investment banks was Morgan 
Stanley, which repurchased the taxpayers' warrants for $950 
million, or $450 million less than the amount that I estimated 
for the Financial Times and Reuters.
    It is alleged in the SIGTARP report released today that the 
top Treasury official for the TARP, Herb Allison, a Wall Street 
veteran, told the chief financial officer of the Wall Street 
investment bank Morgan Stanley the minimum price which the 
Treasury would accept for the taxpayers' warrants.
    Homeowners don't want their real estate agents telling 
potential buyers what the minimum price is that they would 
accept for their house. Yet Mr. Allison, the taxpayers' agent, 
did just that, telling Morgan Stanley that he would accept $950 
million to prevent private investors from pricing these very 
valuable securities at auction.
    We need leadership in the U.S. Treasury that looks after 
taxpayers, not Wall Street investment bankers. Mr. Allison 
should be here to answer for these allegations made in the 
SIGTARP report.
    The first auctions were in December 2009. Before December 
2009, there were no traded options or warrants with expiration 
dates later than 2014. In December, taxpayers got higher prices 
than they were offered in negotiations. Since then, the auction 
and secondary market prices have increased in March, April, and 
May of 2010.
    In addition, we have seen that in-the-money warrants, like 
those of Morgan Stanley and Goldman Sachs, have traded at 
premiums to short-term options with higher implied volatilities 
than short-term options.
    We need to let markets, not backroom deals, price the big 
bank warrants. The Administration is asking Congress to give 
away taxpayers' warrants. The U.S. Treasury and the 
Administration today plan to squander a fair market value of 
warrants and preferred stock of approximately $3 billion by 
allowing almost 600 existing Capital Purchase Program 
recipients to cancel their warrants and convert their preferred 
stock in subordinated debt into the proposed small business 
lending fund.
    If we add in the subsidies to new banks entering the fund 
which are not in the CPP, the subsidy to small banks and their 
shareholders would increase by $5.5 billion. That is, for a $30 
billion fund, taxpayers should expect to lose $8.4 billion, or 
28 percent of their investment, on the day the typical 
investment is made into the fund.
    TARP was an emergency legislation enacted to stop a banking 
panic. I think policymakers can design better ways to stimulate 
growth through tax cuts, government spending or deficit 
reduction. Giving handouts to banks does not make any economic 
    I think taxpayers should be rewarded for the investments 
they have made.
    With the recovery in bank shares, the U.S. Treasury has 
collected $6.1 billion for the repurchases and auctions. I 
estimate that the fair market value that over 200 publicly 
traded banks and insurance company warrants, excluding AIG, 
which have not been sold prior to this hearing, were worth $4.1 
billion on March 31, 2010.
    Thank you for having me today. I look forward to your 
questions and perspectives.
    [The prepared statement of Professor Wilson can be found on 
page 138 of the appendix.]
    Chairman Moore of Kansas. Thank you, Professor Wilson, for 
your testimony. I will now recognize myself for up to 5 minutes 
for questions.
    Mr. Puvalowski and Mr. Atkins, since you represent SIGTARP 
and COP, would you discuss your views as to whether the 
Treasury Department has been receptive to criticisms and 
recommendations to improve the Tarp Warrants Program? And has 
their performance improved over time? Mr. Puvalowski or Mr. 
    Mr. Atkins. I think they have worked to try to increase 
their accountability and transparency and, as the SIGTARP's 
report and as the Congressional Oversight Panel's report from 
last year indicate, they have been making strides to that goal. 
Is it perfect yet? Probably not, but I think the transparency 
obviously is a thing that we want to try to achieve. Also, an 
equivalence of outcomes is ultimately the goal.
    Chairman Moore of Kansas. Thank you. Mr. Puvalowski?
    Mr. Puvalowski. One way in which Treasury has done a much 
better job over time is in terms of transparency. The 
Government Accountability Office, the Congressional Oversight 
Panel, and SIGTARP were all quite critical of Treasury in the 
early days of the warrant disposition process as to almost a 
complete lack of transparency. Treasury has done a pretty good 
job in responding to that criticism and the warrant report that 
was published in January was a significant step forward in 
terms of transparency in the program.
    With respect to SIGTARP's recommendations in the audit that 
was released today, they are, in our view, very 
straightforward, very commonsense recommendations--that the 
process be documented better, that communications between 
Treasury and the recipient institutions be documented better. 
Right now, they are not documented at all. And that Treasury 
have some guidelines as to how the negotiations take place. 
Treasury has not yet responded to those specific 
recommendations, so we look forward to getting the response, 
and we will report an update on that in our next quarterly 
    Chairman Moore of Kansas. Thank you, sir.
    Professor Jarrow, I appreciate your perspective as an 
authority on model evaluations. Will you go into more detail as 
to how difficult it is to value warrants and address issues 
that these warrants values decay over time. While models are 
valuable, we know they don't always work as we saw in the 
recent financial crisis. Should Treasury be careful not to rely 
on mathematical formulas too much to ensure maximum returns for 
taxpayers, sir?
    Mr. Jarrow. Thank you for that question. So let's start 
first with the models, the models are approximations to a 
complex reality. And as an approximation, they contain errors. 
You need judgment to adjust the model for these errors.
    Relying on a model alone to make judgments with respect to 
repurchase and sales would be a big mistake, especially for 
these financial instruments. They are what we call loan dated, 
they are what we call American type options. American type 
options are options that have a decision embedded within them 
to value them. You have to decide when over the 10 years you 
want to exercise the options. Those are very, very complex 
financial instruments and modeling them is correspondingly 
    Chairman Moore of Kansas. Thank you, sir. I would like to 
hear from each of you as to which provides the most value for 
taxpayers through the TARP Warrants Program, direct 
negotiations or options? And what public policy issue should 
Treasury and the Congress keep in mind as lessons from the use 
of these warrants and the TARP program. Professor Jarrow, we 
will start with you, sir.
    Mr. Jarrow. Thank you. One of the big issues in valuation 
is deciding what is called the amount of the liquidity 
discount. When you sell a large quantity of shares in the 
market, you don't get the price that you would get, you get a 
lower price than if you sold only a few shares and this 
liquidity discount is a key factor. When you do negotiation, 
you can avoid this market impact potentially. And secondly, 
when you do an auction, you have a third party cost you have to 
pay to the investment bank. So as a rule of thumb, you should 
always do negotiation first, and if negotiations fail, then I 
think having as an alternative an auction process is a very 
good idea.
    Chairman Moore of Kansas. Mr. Puvalowski, do you have any 
comments, sir?
    Mr. Puvalowski. The options that have taken place thus far 
did return a slightly better return just in terms of 
calculation investment return, but there haven't been enough 
options thus far to compare against the negotiated results, we 
haven't drawn a firm conclusion on that one way or the other.
    Mr. Atkins. And by definition, an auction obviously is a 
market price, it is better than any modeling price so that is 
ideally I think what we should strive for. It has been 
relatively easy with the big banks, as we get into the smaller 
banks it may get more problematic.
    Chairman Moore of Kansas. My time has expired, and I will 
have to yield now to the ranking member, please.
    Mrs. Biggert. Thank you, Mr. Chairman.
    Commissioner Atkins, a number of the Capital Purchase 
Program recipients have missed the dividend payments, it might 
not have reached six yet, but there is a whole list of those 
that have missed some of the payments. And after missing a 
sixth quarterly dividend payment, Treasury will have to place 
members on the board of directors of the financial institutions 
that participated, does this concern you?
    Mr. Atkins. Well, it does, obviously having the government 
even more involved in these sorts of private entities, we see 
it already with respect to GM, Chrysler, GMAC, and AIG. And I 
think the importance will be the process of choosing those 
particular directors by Treasury, how open and transparent a 
process it is, and what sort of direction those directors will 
    Mrs. Biggert. And do you have any concerns regarding the 
Treasury's small business lending fund? You know what the 
original proposal was for TARP, but the latest iteration 
doesn't specify how it will be funded.
    Mr. Atkins. Yes, I think you brought up a very good point. 
I think the reason why it is probably not clear how it will be 
funded is that I don't believe that it can be funded from TARP 
under the statute, which is one of the issues for HAMP and HARP 
as well, and I think one of the reasons I asked for Treasury 
for that opinion.
    Mrs. Biggert. I am glad you did bring that up. And that is 
why we want to probe further, and hopefully we will get a 
written response on that authority, thank you.
    Has the Congressional Oversight Panel adopted a budget?
    Mr. Atkins. Well, apparently, we have one, I haven't 
actually seen it. I understand it has $5 million or so, but the 
specifics I am not--
    Mrs. Biggert. How is it funded?
    Mr. Atkins. Apparently, the money comes through the Senate 
Rules Committee, from the Senate side.
    Mrs. Biggert. I am glad they are paying for it. I am sure 
it is the taxpayers, but wouldn't it make sense to adopt a 
budget where the taxpayers know how much is being spent, and 
not just the Senate?
    Mr. Atkins. I agree; I think transparency is good. 
Obviously, that is, I think in your bailiwick as Members of 
    Mrs. Biggert. If possible, can you or the COP staff provide 
this panel with a full list of congressional field hearings at 
which a member of the COP has testified since the Panel's 
creation? Are there a lot of field hearings?
    Mr. Atkins. There have probably been about half a dozen or 
so field hearings. There is one, in fact, up in New York today. 
I am sure we can get that to you.
    Mrs. Biggert. We would appreciate that. Then, given that 
large banks comprise a significant higher share of loans under 
$1 million, do you worry that the Administration's small 
business lending fund proposal to inject capital into the 
community banks will not have the desired effect of 
significantly increasing credit for small businesses?
    Mr. Atkins. Well, I think there is a big debate, in fact we 
are coming out with a report this week with respect to 
commercial lending. But I think there is a big debate as to 
whether it is demand or supply that is really affecting small 
business lending.
    Mrs. Biggert. Thank you.
    Professor Wilson, you compared the Treasury's first version 
of the small business lending fund to TARP 2, I think that is 
where it came from without any of the benefits to the taxpayers 
that TARP 1 had. Have you had an opportunity to examine the 
revised version of this program and how it would affect the 
Capital Purchase Program?
    Mr. Wilson. I was looking at the fact sheet that was put on 
whitehouse.gov, which I think was dated February 2nd--if there 
is a more recent version I haven't seen it, and I would love to 
look at it.
    Mrs. Biggert. Thank you.
    Mr. Wilson. I would also say my thoughts about the small 
business lending program, my research has shown that if you 
give banks preferred stock that is senior to common, and 
managers try to maximize the value of common stock, not 
preferred stock. So, in essence, preferred stock adds leverage 
to their incentives and doesn't have desired incentives for 
banks that are undercapitalized.
    Mrs. Biggert. It certainly didn't when they purchased 
Fannie and Freddie preferred stock, did it, as they were asked 
to do.
    Mr. Wilson. Yes. I don't think that the government programs 
have necessarily been as successful as people had hoped.
    Mrs. Biggert. Thank you, I yield back.
    Chairman Moore of Kansas. Thank you, Mr. Puvalowski, for 
showing your office's audit. What was the most troubling 
finding in your report? And if Treasury made only one change to 
improve the TARP warrants program what would that be, sir?
    Mr. Puvalowski. It would be the development of guidelines 
or criteria to put some framework around how the negotiation 
process is conducted. SIGTARP's audit identified very 
significant differences in how different banks were dealt with 
during the negotiation process, particularly with respect to 
how much information was provided to the institutions about 
Treasury's estimated value. Obviously, the negotiation process 
is a dynamic thing that requires some flexibility, but without 
some form of guideline or criteria, there is a real danger of 
arbitrariness of different banks being treated differently, of 
frankly just having one person, whether it is the analyst or 
assistant secretary or someone else at Treasury having a very 
significant discretion in terms of decisions that make the 
difference of tens of billions of dollars of taxpayer return.
    When a Wall Street bank goes out and decides to do a bare-
knuckled negotiation with a counterparty with one kind of party 
and a more accommodating approach with another counterparty 
that is business, that is what business is all about. Treasury 
is not a Wall Street bank. And when Treasury is administering a 
government program, it is fundamental to accountability, to 
transparency that there be some ground rules to make sure that 
banks are being treated the same.
    Chairman Moore of Kansas. Thank you, sir. Mr. Atkins, or 
other witnesses, what key change should Treasury focus on with 
respect to TARP warrants?
    Mr. Atkins. I would have to echo what Mr. Puvalowski has 
said. I think the potential allegations of favoritism or other 
things that might come up by disparate treatment of 
institutions need to be headed off before they happen. 
Obviously, there is a lot of cynicism in the public, and more 
openness and more documentation to be able to replicate the 
determinations as necessary.
    Chairman Moore of Kansas. Mr. Jarrow and Mr. Wilson, do 
either of you have any comments?
    Mr. Jarrow. I would just echo that transparency is a good. 
And I think the Treasury, at least from my perspective, has 
been very accommodating in regard to that, so I expect that 
they will continue to do so in the future.
    Chairman Moore of Kansas. Mr. Wilson?
    Mr. Wilson. I think the SIGTARP report reveals very 
interesting details about how different banks were treated in 
different ways. And the way that Treasury communicated its 
minimum prices to different banks, and not all banks were 
treated the same. So American Express was not told anything and 
we got the highest price that I have estimated as a percent of 
fair market value. Treasury thought that was a very high price 
    In contrast with Morgan Stanley, there was supposedly, 
according to the Morgan Stanley executive, there was a lot of 
communication about the minimum price they were willing to 
accept, and taxpayers lost between $375 million and $450,0000, 
whether you take my estimate at the time or my estimate after 
looking at the auction warrants. One of the things that we 
found from the auction warrants is that in-the-money warrants 
trade for a lot more than out-of-the-money warrants. And this 
is well-known in option markets; it is called the volatility 
smile. The volatility smile is working in the favor of the 
Treasury with American Express, Goldman Sachs, Morgan Stanley, 
but Morgan Stanley paid less than the implied volatility short-
term options or at-the-money option, but Goldman Sachs and 
Morgan Stanley paid significantly higher implied volatilities.
    Chairman Moore of Kansas. The Chair would next recognize 
Mrs. Biggert if you have questions for up to 5 minutes.
    Mrs. Biggert. Yes, thank you, Mr. Chairman.
    Mr. Puvalowski, when we were talking about how there is the 
auction and the negotiation, is there a third way to do this 
and with the third party valuations, or is that folded into the 
other two?
    Mr. Puvalowski. Part of Treasury's process is a series of 
steps, and the first is the negotiation process. The bank 
essentially gives its first offer, Treasury will assess that 
offer, and reject or accept it. If it is rejected, the bank has 
an opportunity to provide additional offers, sometimes there 
are multiple offers that are provided.
    If a price cannot be determined through that process, the 
parties do have the option of entering into an appraisal 
process where essentially each side would pick an appraiser, 
they would try to agree, if they couldn't agree a third 
appraiser would be selected. So there is a kind of intermediate 
step. The appraisal process has not been invoked in any case 
thus far. The banks would have to incur the cost of the 
appraisal, which is one of the reasons that has been 
identified, that the appraisal process hasn't happened thus 
far. So there is an intermediate step that is built into the 
process, but it has not yet been used.
    Mrs. Biggert. Thank you. You know the regulatory reform 
bill said in the Senate right now and soon to be the House 
again, I suppose the bills allow for a permanent government 
intervention into ``too-big-to-fail'' for any financial 
institution or business deemed a problem to the Federal 
regulators. Is there a moral hazard in making these programs 
permanent if the financial institutions, or any business thinks 
that if they make poor decisions, then the government will 
simply take over and taxpayers will pick up the tab, does this 
give businesses more or less the green light to engage in risky 
activities? This is a question for anybody who wants to answer.
    Mr. Atkins. Well, I can take a stab at that. I think there 
are certain aspects to that Senate bill as it is moving on the 
Floor that raise a lot of the concerns that you have mentioned, 
particularly the flexibility that is still within the 
government to determine who is systemically significant and 
make those determinations sort of a star chamber type of group 
that would make that determination, there is an appeal process 
and things like that. But I am not sure how that is going to 
work in practice and it is quite concerning, I think.
    Mrs. Biggert. Anybody else? Okay.
    Then Mr. Jarrow, in your testimony, you state that you 
believe that Treasury warrant repurchase program has been a 
success. In the interest of full disclosure, were you 
compensated for your warrant valuation consulting services to 
the Treasury?
    Mr. Jarrow. Yes, I was.
    Mrs. Biggert. Then having served as a consultant to the 
Treasury last year regarding the valuation of the TARP 
warrants, can you comment on SIGTARP's recent audit finding 
regarding the lack of documentation or internal controls? For 
example, how did we know that the Goldman warrant repurchases 
were the best deal for the taxpayer?
    Mr. Jarrow. I can't really comment on the transparency of 
the negotiation because that isn't what I was really looking 
at. I was looking at the process for the valuation and whether 
or not the internal models were good. And I found, and I 
concluded that the process itself was fair and the internal 
models were good.
    One way you could check to see whether or not the resulting 
sale was fair is to get market quotes before the fact and 
compare them to the ultimate sale, to have an internal model 
and to see whether or not the estimates that come out of the 
model are close to the sale. And on those latter criteria, I 
judge that to be quite good and therefore a success.
    Mrs. Biggert. Thank you. Let's see, I have a minute here.
    Professor Wilson, you said in your testimony that we should 
be contracting State ownership of the banking sector, not 
expanding it, and I couldn't agree more. Recently revised small 
business lending fund leaves open the possibility that Congress 
could still fund the program through TARP. What harm to the 
taxpayers could come from implementing this program?
    Mr. Wilson. Right now, we have made investments in over 700 
banks and other institutions. Most of those are preferred stock 
or subordinated debt. The subordinated debt lasts 30 years, 
preferred stock you never have to pay that back. So that the 
taxpayers to exit the TARP will eventually have to sell that or 
convince those institutions to pay that back. I believe that 
the institutions that have paid back early were most likely the 
ones to paid back early, they are also the most healthy 
    There are many institutions that have received preferred 
stock or subordinated debt that are not paying dividends or 
interest if it is subordinated debt. And last count, it was 82. 
Three of those have been restructured in bankruptcy and there 
may be more in the future. But it would be very hard to exit 
these preferred stock injections if we don't convince the banks 
to do that. And I think the adverse selection problem will be 
even worse if we are offering a 1 percent dividend to banks 
that have not participated in the Capital Purchase Program 
because we have really exhausted all the banks that are really 
willing to participate and only really desperate institutions 
would want to enter into government ownership.
    Mrs. Biggert. Thank you. Thank you, Mr. Chairman. I yield 
    Chairman Moore of Kansas. Thanks again to the ranking 
member. And again, I want to thank all of our witnesses for 
your testimony here today. Today's hearing was helpful in 
getting an update on where things stand for the United States 
taxpayers with respect for TARP and warrant repurchases. While 
it is good to celebrate the success of the TARP Warrants 
Program, this subcommittee will not and should not rest easy. 
We must keep pushing for greater transparency and 
accountability while maximizing return for taxpayers.
    I ask unanimous consent that the following reports be 
entered into the record: Exhibit 1, the Treasury Department's 
January TARP Warrant Disposition Report; and Exhibit 2, a CRS 
report, ``Government Interventions in Response to Financial 
Turmoil.'' Without objection, those 2 reports will be made a 
part of the record.
    The Chair notes that some members, whether they are here or 
not, may have additional questions for our witnesses which they 
may wish to submit in writing. Without objection, the hearing 
record will remain open for 30 days for members to submit 
written questions to these witnesses and to place their 
responses in the record. This hearing is adjourned, and again, 
I thank very much the witnesses who attended today to give 
their testimony.
    [Whereupon, at 12:21 p.m., the hearing was adjourned.]

                            A P P E N D I X

                              May 11, 2010