[JPRT, 111th Congress]
[From the U.S. Government Publishing Office]




                                     


                     CONGRESSIONAL OVERSIGHT PANEL
                      FEBRUARY OVERSIGHT REPORT *

                               ----------                              

                    VALUING TREASURY'S ACQUISITIONS

[GRAPHIC] [TIFF OMITTED] TONGRESS.#13


                February 6, 2009.--Ordered to be printed

    * Submitted under Section 125(b)(1) of Title I of the Emergency 
        Economic Stabilization Act of 2008, Pub. L. No. 110-343

        CONGRESSIONAL OVERSIGHT PANEL FEBRUARY OVERSIGHT REPORT

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                     CONGRESSIONAL OVERSIGHT PANEL

                      FEBRUARY OVERSIGHT REPORT *

                               __________

                    VALUING TREASURY'S ACQUISITIONS

[GRAPHIC] [TIFF OMITTED] TONGRESS.#13


                February 6, 2009.--Ordered to be printed

    * Submitted under Section 125(b)(1) of Title I of the Emergency 
        Economic Stabilization Act of 2008, Pub. L. No. 110-343
                     CONGRESSIONAL OVERSIGHT PANEL
                             Panel Members
                        Elizabeth Warren, Chair
                            Sen. John Sununu
                          Rep. Jeb Hensarling
                           Richard H. Neiman
                             Damon Silvers


                            C O N T E N T S

                              ----------                              
                                                                   Page
Executive Summary................................................     1
Valuing TARP Acquisitions........................................     4
Treasury Department Updates Since Prior Report...................    11
Oversight Activities.............................................    14
Future Oversight Activities......................................    15
About the Congressional Oversight Panel..........................    16
Appendix I: Letter from Mr. Lawrence Summers to Congressional 
  Leadership, dated January 15, 2009.............................    17
Appendix II: Letter from Congressional Oversight Panel Chair 
  Elizabeth Warren to Treasury Secretary Mr. Timothy Geithner, 
  dated January 28, 2009.........................................    20
Appendix III: Report of the Advisory Committee on Finance and 
  Valuation to the Congressional Oversight Panel.................    22
Appendix IV: Summary of the Legal Report to the Congressional 
  Oversight Panel for Economic Stabilization concerning the TARP 
  Investments in Financial Institutions..........................    34
Appendix V: Link to Valuation Report of Duff & Phelps to the 
  Congressional Oversight Panel..................................    45





======================================================================



 
                       FEBRUARY OVERSIGHT REPORT

                                _______
                                

                February 6, 2009.--Ordered to be printed

                                _______
                                

                           EXECUTIVE SUMMARY

    A central question surrounding the Troubled Asset Relief 
Program (TARP) is whether the U.S. Department of the Treasury's 
(Treasury) policy of injecting cash into financial institutions 
has resulted in a fair deal for taxpayers. The focus of this 
report is a financial valuation study of the terms of 
Treasury's program to invest capital in financial institutions. 
The report was commissioned as part of the Congressional 
Oversight Panel's continuing investigation into the terms of 
the TARP. The report was conducted for the Panel by its 
Advisory Committee on Finance and Valuation (Advisory 
Committee) and by the international valuation firm, Duff & 
Phelps Corporation; the Advisory Committee's report is attached 
to this report and the longer complete Duff & Phelps valuation 
report is posted on the Panel's website.\1\ The valuation 
report was enhanced by an accompanying legal analysis of the 
terms of the TARP transactions, which is also attached to this 
report.
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    \1\ Congressional Oversight Panel (online at cop.senate.gov).
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    The valuation report concludes that Treasury paid 
substantially more for the assets it purchased under the TARP 
than their then-current market value. The use of a one-size-
fits-all investment policy,\2\ rather than the use of risk-
based pricing more commonly used in market transactions, 
underlies the magnitude of the discount. A number of reasons 
for this result have been suggested. The Panel has not 
determined whether these reasons are valid or whether they 
justify the large subsidy that was created. In addition, the 
Panel has not made judgments about whether the decision-making 
underlying these investments was sound. The rationale for the 
Treasury's approach and the impact of this disparity will be 
subjects for the Panel's continued study and consideration. It 
is important, however, for the public to understand that in 
many cases Treasury received far less value in stocks and 
warrants than the money it injected into financial 
institutions.
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    \2\ That policy includes creation of a uniform capital infusion 
program, acceptance of a limit on the marketability of the securities 
Treasury received, and terms that encourage institutions to replenish 
their private capital.
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    The legal analysis concludes that the documentation for the 
investments was standardized. The use of standardized documents 
likely contributed to Treasury's ability to obtain speed of 
execution and wide participation, but it meant Treasury could 
not address differences in credit quality among various capital 
infusion recipients through variations in contractual terms 
governing the investments or impose specific requirements on a 
particular recipient that might help insure stability and 
soundness.
    The February report also provides an update on the Panel's 
previous work, as well as a review of the key actions and 
changes at Treasury regarding the TARP since the Panel's last 
report. In its initial report, on December 10, 2008, the Panel 
asked ten questions about the TARP and a series of sub-
questions on the strategy, goals, methods, and operations of 
the program. In its next report, issued on January 9, 2009, the 
Panel analyzed Treasury's response to the Panel's questions and 
highlighted four specific areas where Treasury most needed to 
provide additional information:

    (1) Bank Accountability. The Panel pressed Treasury to 
collect and disclose additional information about how TARP-
recipient banks are using taxpayer funds and to establish 
reporting requirements, formal usage guidelines, or additional 
benchmarks for the conduct of TARP recipients as a condition of 
taxpayer support.

    (2) Transparency and Asset Evaluation. The Panel emphasized 
the need for Treasury to ensure transparency both in the 
process of selecting TARP recipients and the relationship 
between an institution's receipt of TARP funds and the value of 
its assets in order to increase TARP accountability and 
confidence in the markets.

    (3) Foreclosures. The Panel pressed Treasury to follow 
Congress's express mandate in Sec. Sec. 109-110 of the 
Emergency Economic Stabilization Act of 2008 (EESA) to increase 
federal assistance to homeowners in danger of losing their 
homes and make further efforts to reduce foreclosures.

    (4) Strategy. The Panel repeated its concern about 
Treasury's shifting explanations of its strategy for using TARP 
funds and called for Treasury to develop and follow a coherent 
strategy for the future use of TARP funds.

    The Panel remains committed to its ongoing oversight role 
and will continue to seek answers to the questions presented in 
its previous reports. While the Panel recognizes that Treasury 
is in the midst of a transition of personnel and policies, it 
believes that the Panel's initial questions and areas of 
concern maintain their importance and will help Treasury as it 
reshapes its policies and continues to administer the TARP.
    To that end, the Panel wrote a letter to Treasury on 
January 28, 2009, reiterating its requests for answers and 
asking for further response by February 18, 2009.\3\ The Panel 
expects to discuss Treasury's responses in its March report to 
Congress.
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    \3\ See Appendix II, infra.
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    In addition to following the issues raised thus far, the 
Panel will focus on home mortgage foreclosures in its next 
report. We will continue to engage the public through hearings 
and a public participation and comment process, as well as 
required monthly reports.

                       VALUING TARP ACQUISITIONS

    In October 2008, Treasury abandoned its original strategy 
of purchasing ``troubled'' mortgage and other assets from the 
nation's financial institutions, deciding instead to invest 
money directly into those institutions.\4\ The Panel made clear 
in its first report to Congress and the public, on December 10, 
2008, that it wanted to know if ``the public is receiving a 
fair deal'' under the TARP in general and for those investments 
in particular. It explained that:
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    \4\ U.S. Department of the Treasury, Statement by Secretary Henry 
M. Paulson, Jr. on Actions to Protect the U.S. Economy (Oct. 14, 2008) 
(online at www.treasury.gov/press/releases/hp1205.htm).

          [A] critical aspect of [the Panel's] mission is to 
        determine whether the United States government has 
        received assets comparable to its expenditures under 
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        the Emergency Economic Stabilization Act of 2008.

    The Panel's review of the ten largest TARP investments the 
Treasury made during 2008 raises substantial doubts about 
whether the government received assets comparable to its 
expenditures.\5\ The Panel's analysis does not explore whether 
these investments were the best means of achieving broader 
policy goals.
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    \5\ This valuation analysis does not include the approximately $24 
billion in loans to General Motors, Chrysler, Chrysler Financial, and 
GMAC made as part of the Automotive Industry Finance Program.
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    Valuation of the transactions is critical because then-
Treasury Secretary Henry Paulson assured the public that the 
investments of TARP money were sound, given in return for full 
value: ``This is an investment, not an expenditure, and there 
is no reason to expect this program will cost taxpayers 
anything.'' \6\ In December, he reiterated the point, ``When 
measured on an accrual basis, the value of the preferred stock 
is at or near par.'' \7\ This means, in effect, that for every 
$100 Treasury invested in these companies, it received stock 
and warrants valued at about $100.
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    \6\ U.S. Department of the Treasury, Statement by Secretary Henry 
M. Paulson, Jr. on Capital Purchase Program (Oct. 20, 2008) (online at 
www.treas.gov/press/releases/hp1223.htm).
    \7\ U.S. Department of the Treasury, Responses to Questions of the 
First Report of the Congressional Oversight Panel for Economic 
Stabilization (Dec. 30, 2008).
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    As discussed in greater detail in the remainder of this 
section, an extensive valuation analysis of the ten 
transactions that was commissioned by the Panel concluded that:

     In the eight transactions which were made under 
the investment program for healthy banks, for each $100 spent, 
Treasury received assets worth approximately $78.

     In the two transactions which were made under 
programs for riskier banks, for each $100 spent, the Treasury 
received assets worth approximately $41.

     Overall, in the ten transactions, for each $100 
spent, the Treasury received assets worth approximately $66.

     Extrapolating these results using appropriate 
weighting to all capital purchases made in 2008 under TARP, 
Treasury paid $254 billion, for which it received assets worth 
approximately $176 billion, a shortfall of $78 billion.

    Three programs have been used by the Treasury to infuse 
capital directly into American financial institutions under 
TARP. The Capital Purchase Program (CPP), created in October 
2008 has the most widespread bank participation.\8\ This 
program was intended for healthy banks: those that are sound 
and not in need of government subsidization. While a total of 
317 financial institutions have received a total of $194 
billion under the CPP as of January 23, 2009, eight large early 
investments represent $124 billion, or 64 percent of the total. 
The eight were: Bank of America Corporation, Citigroup, Inc., 
JPMorgan Chase & Co., Morgan Stanley, Goldman Sachs Group, 
Inc., PNC Financial Services Group, U.S. Bancorp, and Wells 
Fargo & Company. In addition, the Systemically Significant 
Failing Institutions Program (SSFI Program), launched in 
November 2008,\9\ and the Targeted Investment Program (TIP), 
launched in January 2009,\10\ were created to deal with 
financial institutions that were in financial distress. Only 
American International Group (AIG) received money under the 
SSFI Program. After receiving money as a ``healthy bank,'' six 
weeks later Citigroup received a second infusion of TARP funds, 
an infusion that was ultimately included as part of the as yet 
uncreated TIP.\11\
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    \8\ U.S. Department of the Treasury, Treasury Announces TARP 
Capital Purchase Program Description (Oct. 14, 2008) (online at 
www.treas.gov/press/releases/hp1207.htm).
    \9\ U.S. Department of the Treasury, Treasury to Invest in AIG 
Restructuring Under the Emergency Economic Stabilization Act (Nov. 10, 
2008) (online at www.treasury.gov/press/releases/hp1261.htm).
    \10\ U.S. Department of the Treasury, Treasury Releases Guidelines 
for Targeted Investment Program (Jan. 2, 2009) (online at 
www.treasury.gov/press/releases/hp1338.htm).
    \11\ Id. Treasury made it clear retroactively when it announced the 
TIP guidelines that its November 23 investment in Citigroup fell under 
TIP. Id. See also U.S. Department of the Treasury, Joint Statement by 
Treasury, Federal Reserve and the FDIC on Citigroup (Nov. 23, 2008) 
(online at www.treasury.gov/press/releases/hp1287.htm). Treasury used 
TIP again in January 2009 to make additional investments in Bank of 
America. U.S. Department of the Treasury, Treasury, Federal Reserve and 
the FDIC Provide Assistance to Bank of America (Jan. 16, 2008) (online 
at www.treas.gov/press/releases/hp1356.htm).
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    Under these three programs, Treasury made cash investments 
in designated financial institutions in return for a 
combination of preferred stock \12\ and warrants \13\ to 
purchase common stock of those institutions. The terms differed 
for each of the three programs--CPP, SSFI, and TIP--but they 
all involved the purchase of portions of the institutions.
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    \12\ The preferred stock in the CPP investments paid a dividend of 
5 percent for five years and 9 percent thereafter; it was so-called 
``perpetual preferred'' (that is, it did not have a fixed term), 
although it could be redeemed by the issuer under certain conditions. 
Preferred stock is a form of security that lies halfway between a 
corporation's common stock and its formal debt. The preferred stock 
bears a fixed dividend rate that is payable out of earnings, it must 
receive its dividend before any dividends can be paid to common 
shareholders, and its dividend rights are often cumulative (as was the 
case with the Treasury investments), which means that if a dividend is 
missed, the holder of the preferred stock has a right to receive the 
missed dividend as part of its payment in future years. In a 
liquidation, the preferred shareholders must be paid before any amount 
can be paid to the common shareholders, but preferred shareholders 
themselves cannot receive any funds if there is not enough first to pay 
all of the corporation's creditors.
    \13\ The warrants allowed the Treasury to buy common stock of each 
institution for an additional amount--called the ``exercise price''--
that was calculated so that Treasury benefit if the value of the common 
stock increased. The exercise price for the Treasury warrants is the 
average trading price of a share of the institution's stock for the 20 
days prior to the selection of the institution for the CPP, and the 
shares that could be purchased were set at 15 percent of the face value 
of the Treasury's preferred stock investment. (So that if the Treasury 
made a $100 billion investment, the warrants would permit it to 
purchase $15 billion of common stock.) The warrant values differed for 
the other two programs, but the principle remained the same.
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    To determine whether the Treasury received its money's 
worth in these transactions, the Panel commissioned a detailed 
valuation project in December 2008. The project and its 
methodology were designed by an Advisory Committee on Finance 
and Valuation, composed of Adam M. Blumenthal, a former First 
Deputy Comptroller of the City of New York, Professor William 
N. Goetzmann of Yale University and Professor Deborah J. Lucas 
of Northwestern University.\14\ After a competitive bidding 
process, the Committee recommended the international valuation 
firm Duff & Phelps to work with it to implement the project 
design and to perform the actual valuation.
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    \14\ Mr. Blumenthal is now the Managing General Partner of Blue 
Wolf Capital Management in New York. Professor Goetzmann is Edwin J. 
Beinecke Professor of Finance and Management Studies and Director of 
the International Center for Finance at the Yale School of Management. 
Professor Lucas is Donald C. Clarke HSBC Professor of Consumer Finance 
at the Kellogg School of Management at Northwestern University. Both 
Professor Goetzmann and Professor Lucas are Research Associates of the 
National Bureau of Economic Research.
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    To reach a conclusion about each of Treasury's investments, 
it is necessary to compare the amount of the government 
investment with the value of the preferred stock and the 
warrants it received in return in each transaction. The task is 
made more difficult because none of the securities is publicly-
traded. Instead, the valuation analysis assumed that 
``securities similar to those issued under the TARP were 
trading in the capital markets at fair values.'' \15\ The 
valuations employed multiple approaches in order to cross-check 
and validate the results.\16\ Value was estimated for each 
security as of the time immediately following the announcement 
by Treasury of its purchase. This valuation approach takes into 
account investors' perceptions about how the TARP investment 
and other government programs announced concurrently affected 
the value of the institutions. The valuation report itself was 
based solely on publicly available information.
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    \15\ Adam M. Blumenthal, William N. Goetzmann, and Deborah J. 
Lucas, Report to the Congressional Oversight Panel on the Emergency 
Economic Stabilization Act of 2008, at 7 (Feb. 4, 2009) (hereinafter 
``Advisory Committee Report''). The Advisory Committee Report is 
attached as Appendix III to this report.
    \16\ The valuation methods are summarized on pages 7-10 of the 
Advisory Committee Report. The complete valuation report conducted by 
Duff & Phelps, which runs to some 697 pages, has been posted on the 
Panel's web site, www.cop.senate.gov, and a link to the report is 
attached as Appendix V to this report.
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    The ten largest investment transactions made under the 
three programs through November 2008 are listed in the 
following table.\17\
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    \17\ Advisory Committee Report, supra note 15, at 2.

                                     SUMMARY OF ESTIMATED VALUE CONCLUSIONS
                                              [Dollars in billions]
----------------------------------------------------------------------------------------------------------------
                                                                                Total estimated value
                                                                    --------------------------------------------
        Purchase program participant          Valuation      Face                            Subsidy
                                                 date       value       Value  ---------------------------------
                                                                                       Percent             $
----------------------------------------------------------------------------------------------------------------
Capital Purchase Program:
    Bank of America Corporation............     10/14/08      $15.0      $12.5              17             $2.6
    Citigroup, Inc.........................     10/14/08       25.0       15.5              38              9.5
    JPMorgan Chase & Co....................     10/14/08       25.0       20.6              18              4.4
    Morgan Stanley.........................     10/14/08       10.0        5.8              42              4.2
    The Goldman Sachs Group, Inc...........     10/14/08       10.0        7.5              25              2.5
    The PNC Financial Services Group.......     10/24/08        7.6        5.5              27              2.1
    U.S. Bancorp...........................     11/03/08        6.6        6.3               5              0.3
    Wells Fargo & Company..................     10/14/08       25.0       23.2               7              1.8
                                                         -------------------------------------------------------
        Subtotal...........................  ...........      124.2       96.9              22             27.3
        311 Other Transactions\1\..........  ...........       70.0       54.6              22             15.4
SSFI & TIP:
    American International Group, Inc......     11/10/08       40.0       14.8              63             25.2
    Citigroup, Inc.........................     11/24/08       20.0       10.0              50             10.0
                                                         -------------------------------------------------------
        Subtotal...........................  ...........       60.0       24.8              59             35.2
                                                         -------------------------------------------------------
            Total..........................  ...........      254.2      176.2              31            78.0
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\1\ Extrapolates 22% subsidy rate from 8 studied CPP investments. See discussion in Part II.

    This valuation analysis bears some similarities to an 
earlier valuation by the Congressional Budget Office (CBO). The 
report, titled The Troubled Asset Relief Program: Report on 
Transactions Through December 31, 2008, was released in January 
2009. The CBO report focused on utilizing procedures similar to 
the Federal Credit Reform Act (FCRA) to assess the budgetary 
impact of all TARP transactions on the federal debt and 
deficit, which can be interpreted as a cost and thus a subsidy 
rate. By comparison, the Duff & Phelps report provides 
extensive, detailed company-by-company information for all 
major CPP participants. While both reports conclude that the 
fair market value of the securities received by Treasury was 
less than what was paid, the much deeper focus in the Duff & 
Phelps report provides the detailed information necessary to 
inform the public policy debate surrounding the future of the 
TARP. The Duff & Phelps report includes multiple valuation 
methods, an evaluation of similar private transactions, and an 
exploration of some of the reasoning behind the varied 
subsidies, including between the different programs and even 
between CPP participants. While the report itself does not draw 
any conclusions as to the validity of Treasury's decisions or 
any particular goals, the information will be extremely 
valuable to policy makers in drawing their own conclusions.\18\
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    \18\ Like the Duff & Phelps report, the CBO report uses only 
publicly available information to value capital purchases. Advisory 
Committee Report, supra note 15, at 7-10; Congressional Budget Office, 
The Troubled Asset Relief Program: Report on Transactions Through 
December 31, 2008, at 4-5 (Jan. 16, 2009).
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    In addition to a direct investigation of the market value 
of the transactions, the Panel's earlier reports suggested that 
additional information about the value of the TARP transactions 
could be derived by comparing those transactions to three large 
transactions involving private sector investors that were 
undertaken in the same time period: the purchase by Berkshire 
Hathaway of an interest in Goldman Sachs, announced in 
September 2008, the investment by Mitsubishi in Morgan Stanley, 
also announced in September 2008, and an investment by Qatar 
Holding LLC and entities representing the beneficial interests 
of HH Sheik Mansour Bin Zayed Al Nahyan, a member of the Royal 
Family of Abu Dhabi (Abu Dhabi) in Barclays PLC, announced in 
late October 2008.\19\ The Advisory Committee and Duff & Phelps 
concluded that these transactions could not be used to make a 
direct comparison with the TARP investments. But by applying 
the same methodology to three major investments by private 
investors in financial institutions which occurred near the 
same time as the Treasury investments (the $5 billion 
investment by Berkshire Hathaway in Goldman Sachs, the $9 
billion investment by Mitsubishi in Morgan Stanley and the K7 
billion investment by Qatar Holding and Abu Dhabi and in 
Barclays), the valuation report concludes that, unlike 
Treasury, private investors received securities with a fair 
market value as of the valuation dates of at least as much as 
they invested, and in some cases, worth substantially more.
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    \19\ Advisory Committee Report, supra note 15, at 10.

     For each $100 Berkshire Hathaway invested in 
Goldman Sachs, it received securities with a fair market value 
---------------------------------------------------------------------------
of $110.

     For each $100 Qatar Holding and Abu Dhabi invested 
in Barclays, they received securities with a fair market value 
of $123.

     For each $100 Mitsubishi invested in Morgan 
Stanley, it received securities with a fair market value of 
$91.

    The way Treasury structured the CPP, SSFI Program, and TIP 
transactions was certain to create significant subsidies. 
Treasury's emphasis on uniformity, marketability, and use of 
call options in structuring TARP investments helped produce a 
situation in which Treasury paid substantially more for its 
TARP investments than their then-current market value. The 
decision to model the far riskier investments under the TIP and 
SSFI Program closely on the CPP transactions also effectively 
guaranteed that a substantial subsidy would exist for these 
riskier institutions. Because Treasury decided to make all 
healthy bank purchases on precisely the same terms, stronger 
institutions received a smaller subsidy, while weaker 
institutions received more substantial subsidies.
    Two other structural factors contributed to the discount 
factor. First, companies have the ability to call the preferred 
stock at par; this option, which is not typical of publicly 
traded preferreds, decreased the value of the securities 
received by Treasury, particularly in the stronger 
institutions; this call feature may have reflected an attempt 
to limit the amount of time taxpayer funds are outstanding.\20\ 
In addition, while the preferred stock and warrants could be 
registered for resale at the Treasury's request, liquidating 
such a large position would entail substantial cost. The likely 
costs inherent in such a liquidation also contributed to the 
discount.
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    \20\ The ability of a recipient of TARP assistance to call at par 
the preferred stock it has issued to Treasury accounts for slightly 
less than one-third of the total subsidy involved in the TARP 
transactions valued and slightly less than one-half of the subsidy in 
the CPP transactions alone. The liquidation costs associated with the 
preferred stock and warrants Treasury received accounted for about 20 
percent of the total subsidy, or about a quarter of the subsidy in the 
CPP transactions alone. Looking at the benchmark transactions, private 
sector investors were, in those cases, able to offset this discount 
through a combination of higher interest rate, by taking more shares, 
or by insisting on other terms that balanced the impact of the market 
overhang.
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    In addition, the legal analysis \21\ prepared for the Panel 
noted that for the CPP transactions: (i) Treasury will receive 
no premium if the issuer optionally redeems the preferred 
shares, (ii) the warrants and common stock held by Treasury can 
be repurchased, albeit at their then-fair market value, if the 
preferred stock is either redeemed or transferred, and (iii) 
the number of warrants held by Treasury are subject to an 
automatic 50 percent reduction if the subject institution sells 
equity equal in amount to Treasury's investment and qualifying 
as Tier I capital. Treasury appears to have decided to be a 
passive investor in each of the institutions in which it 
invests, choosing not to receive either voting rights or seats 
on an institution's board of directors if it converts its 
warrants to common stock, and with a few exceptions no special 
covenants are imposed on the institutions that receive capital 
infusions. This can be contrasted with the more activist 
approach taken by the U.K. government in its investments in 
banks. (The legal analysis does note that, in some respects, 
Treasury did obtain better terms than were reflected in the 
Berkshire Hathaway investment in Goldman Sachs, but that those 
more favorable terms did not affect value.)
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    \21\ The legal analysis was prepared by Timothy G. Massad, Esq., a 
New York City corporate lawyer with close to 25 years' experience, who 
took an unpaid leave of absence from his law firm to serve as special 
legal advisor to the Panel on a pro bono basis. Catherina Celosse, Esq. 
acted as counsel for the Panel in the development of the legal 
analysis.
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    Additional observations in the legal analysis are also 
important. The analysis notes that the standard terms of the 
investments used in the CPP were generally within the range of 
what would be customary in a commercial transaction between a 
large financial institution and a large investor. The terms of 
the documents include a number of provisions that appear to be 
designed to encourage replacement of the Treasury investment 
with private capital quickly. In addition, there were no 
provisions in the CPP investment that restricted operations or 
business practices of the recipients, restricted or required 
reporting of use of funds,\22\ or were directed at specific 
public policy objectives of EESA.\23\ (The CPP, SSFI Program, 
and TIP forms do contain a ``highly unusual provision . . . 
favorable to Treasury'' that allow Treasury unilaterally to 
amend any provision of the relevant agreements if necessary to 
comply with any new or amended federal statutes; the impact of 
this provision is not included in the valuations in any way and 
is, in any event, extremely difficult to assess.) \24\
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    \22\ The lack of such reporting requirements is especially hard to 
understand.
    \23\ Timothy G. Massad, Summary of the Legal Report to the 
Congressional Oversight Panel for Economic Stabilization Concerning the 
TARP Investments in Financial Institutions, at 8 (Feb. 4, 2009) 
(hereinafter ``Legal Analysis''). The Legal Analysis is attached as 
Appendix IV to this report.
    \24\ Id. at 11.
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    By paying the same price, regardless of the financial 
condition of the bank, Treasury ensured that weaker 
institutions would necessarily be subsidized more heavily. It 
may have wished to avoid the risk that more stringent CPP terms 
for some institutions would signal Treasury knowledge of 
adverse circumstances at those institutions. It is also 
possible that Treasury wanted to avoid the risk that failure of 
a weak bank could bring down stronger banks. The Panel has not 
determined whether these objectives have been met or whether 
they justified the large subsidy that was created. The Panel 
expects to address these broader policy objectives in its 
future work.
    Investments in AIG under the SSFI Program and the second 
Citigroup investment involved significantly larger subsidy 
levels than were seen in the CPP institutions. The reason is 
that, despite the higher risk, Treasury modeled these 
investments closely on the CPP investments that had been 
designed for healthy banks. In the AIG transaction, Treasury 
already held warrants for 79.9 percent of the equity of AIG as 
the result of a loan provided to AIG by the Federal Reserve 
Bank of New York earlier in 2008; the proceeds of the TARP 
investment in AIG were used to repay part of that loan. The 
multiple loans and investments by parts of the federal 
government in AIG have helped keep it out of bankruptcy. The 
Advisory Committee and Duff & Phelps looked only at the 
discount to face value that the Treasury took as a result of 
its TARP investment, although they recognize that that 
investment was part of a broader strategy by the government to 
prop up the company. Even in the AIG case, however, the then-
Treasury Secretary insisted that the transactions were 
accompanied by ``significant taxpayer protections and 
conditions.'' \25\
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    \25\ U.S. Department of the Treasury, Remarks by Secretary Henry M. 
Paulson, Jr. on Financial Rescue Package and Economic Update (Nov. 12, 
2008) (online at www.treas.gov/press/releases/hp1265.htm).
---------------------------------------------------------------------------
    Similarly, while the first investment in Citigroup was made 
as part of the CPP for healthy banks, the second investment was 
made after the markets recognized that Citigroup was subject to 
a significantly increased level of risk. The second investment 
was originally made outside any particular TARP program, on a 
freestanding basis; when the TIP was subsequently created, on 
January 2, 2009, the second Citigroup investment was 
reclassified as part of the TIP, aimed at riskier institutions, 
in connection with other government interventions. The analysis 
in the valuation report and its appendices does not evaluate 
those other interventions (i.e., interventions other than the 
purchase of preferred stock and warrants). It focuses only on 
the value gap between the amount of capital provided by the 
Treasury in the second Citigroup investment, and the value of 
the securities the Treasury received in exchange.
    It is possible that the value of the investments made by 
Treasury may someday be worth more than the amount Treasury 
paid. It is also possible that they may be worth much less. 
This assessment demonstrates that the value received--including 
the market's estimate of its future worth--was considerably 
less at the time of the transaction than the amount paid by 
Treasury. It also demonstrates that the value on an 
institution-by-institution basis varied substantially.
    Treasury may have determined that granting the subsidies 
described above to a group of banks, regardless of their 
condition, on essentially the same terms was necessary, for one 
or more reasons, to preserve the integrity of the financial 
system. Whether the subsidy provided by Treasury to financial 
institutions represents a fair deal for the taxpayers is a 
subject for policy debate and judgment, not one that can be 
answered in a purely quantitative way.
    In its public statements about its TARP expenditures, 
Treasury did not describe the program in terms of 
subsidization, nor did it explain why some banks should be 
subsidized more than others. Instead, Treasury repeatedly 
described investments ``at or near par.'' The Panel recognizes 
that the prudence of spending taxpayer dollars in this way may 
be the subject of disagreement among both experts and the 
public, but the Panel believes that if TARP is to garner 
credibility and public support, a clear explanation of the 
economic transaction and the reasoning behind any such 
expenditure of funds must be made clear to the public.
    The Panel will continue to investigate how Treasury spends 
taxpayer funds and whether these expenditures are helping the 
economy.

             TREASURY DEPARTMENT UPDATES SINCE PRIOR REPORT

    In the month since the Panel's last report, the second half 
of the TARP funds have been released, a new Administration has 
taken office, and a new Treasury Secretary, Timothy Geithner, 
has been sworn in. Since the new Administration began, Treasury 
has also extended additional assistance to financial 
institutions and announced new rules governing the conduct of 
recipients of TARP money.\26\ The Panel will continue to 
evaluate the terms and conditions of the new programs and will 
provide updates on the effectiveness of these efforts.
---------------------------------------------------------------------------
    \26\ The Panel appreciates the new administration's responsiveness 
to the concerns raised in its oversight reports as evidenced by 
National Economic Council Director Lawrence H. Summers' January 15, 
2009 letter to the Congressional leadership, see Appendix I infra, and 
its recent TARP initiatives discussed in this report.

     Second Tranche of TARP Funds Released. On January 
15, 2009, Congress voted to approve the release of the second 
$350 billion available from the October 2008 Emergency Economic 
Stabilization Act.\27\ As such, Treasury now has access to the 
full $700 billion spending authority contemplated in EESA.\28\
---------------------------------------------------------------------------
    \27\ Lori Montgomery and Paul Kane, Senate Votes to Release Bailout 
Funds to Obama, Washington Post (Jan. 16, 2009) (online at 
www.washingtonpost.com/wp-dyn/content/article/2009/01/15/
AR2009011504253.html).
    \28\ Emergency Economic Stabilization Act of 2008 (EESA), Pub. L. 
No. 110-343 at Sec. 115(a).

     New Transparency Initiatives. Treasury has 
announced new regulations governing disclosure and mitigation 
of conflicts of interest in its TARP contracting.\29\ In 
addition, Treasury has made public assurances that it will 
``publish a detailed description'' of its criteria and process 
for selecting TARP recipients.\30\ Treasury has also issued new 
guidelines that restrict contact between lobbyists and the 
Treasury officials who decide how to allocate TARP funds.\31\ 
Finally, Treasury has announced a new policy of publishing 
investment contracts within five to ten business days of all 
future TARP transactions,\32\ in addition to publishing 
additional information about past TARP transactions with 
financial institutions.\33\
---------------------------------------------------------------------------
    \29\ TARP Conflicts of Interest, Interim Rule, 74 Fed. Reg. 3431-
3436 (Jan. 21, 2009) (codified at 31 C.F.R. Sec. Sec. 31.200-31.218).
    \30\ Brady Dennis, Treasury Moves to Restrict Lobbyists from 
Influencing Bailout Program, Washington Post (Jan. 28, 2009) (online at 
www.washingtonpost.com/wp-dyn/content/article/2009/01/27/
AR2009012703500.html); U.S. Department of the Treasury, Treasury 
Secretary Opens Term with New Rules To Bolster Transparency, Limit 
Lobbyist Influence in Federal investment Decisions (Jan. 27, 2009) 
(online at www.ustreas.gov/press/releases/tg02.htm).
    \31\ Id.
    \32\ U.S. Department of the Treasury, Treasury Announces New Policy 
to Increase Transparency in Financial Stability Program (Jan. 28, 2009) 
(online at www.ustreas.gov/press/releases/ tg04.htm).
    \33\ See, e.g., David Enrich and Damian Paletta, Agreement Boosts 
Citi Oversight, Wall Street Journal (Jan. 29, 2009) (online at 
online.wsj.com/article/SB123318955291026821.html).

     Changing TARP Strategy. Secretary Geithner has 
indicated that future TARP strategy will incorporate additional 
conditions and an emphasis on homeowner assistance and 
unfreezing credit markets. New TARP funding will have ``tough 
conditions to protect the taxpayer and the necessary 
transparency to allow the American people to see how and where 
their money is being spent and the results those investments 
are delivering.'' \34\ Furthermore, Treasury will increase its 
emphasis on preventing foreclosures and freeing up credit for 
homeowners and small businesses.\35\
---------------------------------------------------------------------------
    \34\ Senate Committee on Finance, Testimony of Timothy F. Geithner, 
Hearing To Consider the Nomination of Timothy F. Geithner To Be 
Secretary of the Treasury, 111th Cong. (Jan. 21, 2009) (online at 
finance.senate.gov/hearings/testimony/2009test/012109tgtest.pdf).
    \35\ Id. See also Rebecca Christie, Summers Says TARP To Be `Very 
Different' Under Obama, Bloomberg (Jan. 25, 2009) (online at 
www.bloomberg.com/apps/news?pid= 20601068&sid=ayehJsUpnfGg); Andrew 
Ross Sorkin, Geithner Says TARP Would Force Banks To Lend More (Jan. 
23, 2009) (online at dealbook.blogs.nytimes.com/2009/01/23/geithner-
says-tarp-will-force-banks-to-lend-more/).

     Term Sheet for CPP investments in Subchapter S-
Corporations. On January 14, 2009, Treasury released a Summary 
of Terms under which S-Corporation financial institutions--
generally small, private banks--can apply for TARP capital 
infusions.\36\ Under these terms, Treasury limits dividend 
repayments and receives 7.7 percent interest for the first five 
years and then 13.8 percent interest for the next 25 years. In 
exchange for capital, Treasury will receive debt senior to any 
stock in the company.
---------------------------------------------------------------------------
    \36\ U.S. Department of the Treasury, TARP Capital Purchase Program 
(Jan. 14, 2009) (online at www.treas.gov/initiatives/eesa/docs/scorp-
term-sheet.pdf).

     Additional Executive Compensation Rules. On 
January 16, 2009, Treasury issued interim final rules for 
reporting and recordkeeping requirements under the executive 
compensation standards of the CPP.\37\ Treasury originally 
published executive compensation standards for CPP in October 
2008. The new rules require the CEOs of firms receiving funds 
under CPP to certify to TARP's Chief Compliance Officer on a 
regular basis that the institutions are complying with the 
applicable TARP rules governing executive compensation. 
Financial institutions are also required to maintain records to 
substantiate these certifications for at least six years 
following each certification and provide these records to the 
TARP Chief Compliance Officer upon request. Treasury made 
similar revisions to the executive compensation guidelines 
applicable to financial institutions participating in the SSFI 
Program. On February 4, 2009, Treasury issued stringent new 
guidelines governing executive compensation for future TARP 
recipients.\38\
---------------------------------------------------------------------------
    \37\ U.S. Department of the Treasury, Treasury Issues Additional 
Executive Compensation Rules Under TARP (Jan. 16, 2009) (online at 
www.treas.gov/press/releases/hp1364.htm).
    \38\ U.S. Department of the Treasury, Treasury Announces New 
Restrictions On Executive Compensation (Feb. 4, 2009) (online at http:/
/www.ustreas.gov/press/releases/tg15.htm).

     Investment in Chrysler Financial. In addition to 
the $22.4 billion already loaned out as part of TARP's 
Automotive Industry Financing Program (AIFP) in December 2008, 
on January 16, 2009, Treasury announced a plan to make a $1.5 
billion loan under the AIFP to a special purpose entity created 
by Chrysler Financial.\39\ The money will provide liquidity to 
Chrysler Financial's program to extend new consumer auto loans 
to Chrysler customers. The five-year loan will require Chrysler 
to pay Treasury interest equal to one month LIBOR plus 100 
basis points in the first year, and then one month LIBOR plus 
150 basis points in years two to five. The loan will be secured 
by a senior secured interest in a pool of newly originated 
consumer auto loans, and Chrysler Holding will serve as a 
guarantor for certain covenants of Chrysler Financial.
---------------------------------------------------------------------------
    \39\ U.S. Department of the Treasury, Treasury Announces TARP 
Investments in Chrysler Financial (Jan. 16, 2009) (online at 
www.treas.gov/press/releases/hp1362.htm); U.S. Department of the 
Treasury, Treasury Announces TARP Investment in GMAC (Dec. 29, 2008) 
(online at www.treasury.gov/press/releases/hp1335.htm); U.S. Department 
of the Treasury, Indicative Summary of Terms for Secured Term Loan 
Facility (Dec. 19, 2008) (Chrysler Term Sheet); U.S. Department of the 
Treasury, Indicative Summary of Terms for Secured Term Loan Facility 
(Dec. 19, 2008) (GM Term Sheet).

     Finalized Terms of Citigroup Guarantee Agreement. 
On January 16, 2009, Treasury, in conjunction with the Federal 
Reserve and the Federal Deposit Insurance Corporation (FDIC), 
finalized the terms of a guarantee agreement with 
Citigroup.\40\ The guarantee agreement was initially announced 
by Treasury on November 23, 2008. The agreement guarantees 
Citigroup against unusually large losses on an asset pool of 
$301 billion of loans and securities backed by residential and 
commercial real estate assets, which will remain on Citigroup's 
balance sheet.
    The guarantee is in place for ten years for residential 
assets and five years for nonresidential assets.\41\ Should 
there be losses on the pool, Citigroup will be responsible for 
up to the first $29 billion. Any additional losses will be 
split between Citigroup and the government, with Citigroup 
bearing 10 percent of the losses and the government bearing 90 
percent.
---------------------------------------------------------------------------
    \40\ U.S. Department of the Treasury, U.S. Government Finalizes 
Terms of Citi Guarantee Announced in November (Jan. 16, 2009) (online 
at www.treas.gov/press/releases/hp1358.htm).
    \41\ U.S. Department of the Treasury, Summary of Terms, (Nov. 23, 
2008) (online at www.treasury.gov/press/releases/reports/
cititermsheet_112308.pdf).

     Additional Assistance to Bank of America. On 
January 16, 2009, Treasury announced an agreement to provide 
Bank of America with a package of assistance in the form of 
guarantees, liquidity access, and capital under the TARP.\42\ 
Treasury and FDIC agreed to provide Bank of America protection 
against the possibility of unusually large losses on an asset 
pool of approximately $118 billion primarily composed of 
securities backed by residential and commercial real estate 
loans. The majority of these assets, which will remain on Bank 
of America's balance sheet, were acquired as the result of its 
merger with Merrill Lynch.
---------------------------------------------------------------------------
    \42\ U.S. Department of the Treasury, Treasury, Federal Reserve and 
the FDIC Provide Assistance to Bank of America (Jan. 16, 2009) (online 
at www.treas.gov/press/releases/hp1356.htm).
---------------------------------------------------------------------------
    In addition, Treasury announced it will invest $20 billion 
in Bank of America under the TIP. TIP was created to maintain 
investor confidence in financial institutions at risk of a loss 
due to market volatility. In exchange for its investment, Bank 
of America will issue Treasury preferred shares with an 8 
percent dividend.

                          OVERSIGHT ACTIVITIES

    The Congressional Oversight Panel was established as part 
of EESA and formed on November 26, 2008. Since its 
establishment, the Panel has issued two oversight reports, as 
well as its Special Report on Regulatory Reform, which was 
issued on January 29, 2009.
    Since the release of the Panel's January oversight report, 
the following developments pertaining to the Panel's oversight 
of the TARP took place:

     In late January, the Panel received reports from 
experts it engaged to estimate the fair market value of the 
securities purchased by Treasury in its eight largest purchases 
under the CPP, and its investments in AIG and Citigroup outside 
the CPP. This report includes a discussion of their findings 
above and a more detailed summary in Appendix III and on the 
Panel's website.

     On January 28, 2009, Elizabeth Warren, Chair of 
the Panel, sent a letter to newly sworn-in Treasury Secretary 
Timothy Geithner requesting more complete answers to the 
questions the Panel posed regarding Treasury's TARP strategy 
and implementation.

     The Panel has received and reviewed more than 
3,500 messages with stories, comments, or suggestions through 
cop.senate.gov.

                      FUTURE OVERSIGHT ACTIVITIES


                            PUBLIC HEARINGS

    Following two successful public hearings, one in Clark 
County, Nevada in December on the housing crisis and one in 
Washington, DC in January on regulatory reform, the Panel will 
continue to hold hearings to shine light on the causes of the 
financial crisis, the administration of TARP, and the anxieties 
and challenges of ordinary Americans.

                            UPCOMING REPORTS

    In March 2009, the Panel will release its fourth TARP 
oversight report. The EESA aimed to stabilize the economy both 
through direct support of financial institutions and through 
encouraging foreclosure mitigation efforts. In the March 
report, the Panel will examine existing foreclosure mitigation 
efforts. The report will consider key areas including: the need 
for more detailed and comprehensive information about mortgage 
loan performance and loss mitigation efforts; the primary 
drivers in loan default, including affordability, negative 
equity and mortgage fraud; impediments to successful 
foreclosure mitigation efforts; and existing foreclosure 
programs and alternative approaches.
    That report will also update the public on the status of 
its TARP oversight activities. The Panel will continue to 
release oversight reports every 30 days.
    The Panel notes with great interest the release by the 
Government Accountability Office (GAO), on January 30, 2009, of 
a report titled Troubled Asset Relief Program: Status of Effort 
to Address Transparency and Accountability Issues. 
Independently agreeing with the Panel's unresolved concerns, 
GAO highlighted Treasury's continued need for action both to 
improve transparency and accountability in the TARP and to 
articulate and communicate a coherent overall strategy. The 
Panel intends to pursue these issues closely and to address 
them in future reports.
    The Panel also notes with approval the efforts of TARP 
Special Inspector General (SIG) Neil Barofsky to prompt TARP 
recipients to account for their use of taxpayer funds and 
satisfy the conditions and reporting requirements already in 
place. The Panel strongly calls on Treasury and the Office of 
Management and Budget to aid, rather than hinder, SIG 
Barofsky's investigation.

                PUBLIC PARTICIPATION AND COMMENT PROCESS

    The Panel encourages members of the public to visit its 
website at cop.senate.gov. The website provides information 
about the Panel and the text of the Panel's reports. In 
addition, concerned citizens can share their stories, concerns, 
and suggestions with the Panel through the website's comment 
feature. To date, the Panel has received more than 3,500 
comments, and the Panel looks forward to hearing more from the 
American people. By engaging in this dialogue, the Panel aims 
to enhance the quality of its ideas and advocacy.

                ABOUT THE CONGRESSIONAL OVERSIGHT PANEL

    In response to the escalating crisis, on October 3, 2008, 
Congress provided the U.S. Department of the Treasury with the 
authority to spend $700 billion to stabilize the U.S. economy, 
preserve home ownership, and promote economic growth. Congress 
created the Office of Financial Stabilization (OFS) within 
Treasury to implement a Troubled Asset Relief Program. At the 
same time, Congress created the Congressional Oversight Panel 
to ``review the current state of financial markets and the 
regulatory system.'' The Panel is empowered to hold hearings, 
review official data, and write reports on actions taken by 
Treasury and financial institutions and their effect on the 
economy. Through regular reports, the Panel must oversee 
Treasury's actions, assess the impact of spending to stabilize 
the economy, evaluate market transparency, ensure effective 
foreclosure mitigation efforts, and guarantee that Treasury's 
actions are in the best interests of the American people. In 
addition, Congress has instructed the Panel to produce a 
special report on regulatory reform that will analyze ``the 
current state of the regulatory system and its effectiveness at 
overseeing the participants in the financial system and 
protecting consumers.''
    On November 14, 2008, Senate Majority Leader Harry Reid and 
the Speaker of the House Nancy Pelosi appointed Richard H. 
Neiman, Superintendent of Banks for the State of New York, 
Damon Silvers, Associate General Counsel of the American 
Federation of Labor and Congress of Industrial Organizations 
(AFL-CIO), and Elizabeth Warren, Leo Gottlieb Professor of Law 
at Harvard Law School to the Panel. With the appointment on 
November 19 of Congressman Jeb Hensarling to the Panel by House 
Minority Leader John Boehner, the Panel had a quorum and met 
for the first time on November 26, 2008, electing Professor 
Warren as its chair. On December 16, 2008, Senate Minority 
Leader Mitch McConnell named Senator John E. Sununu to the 
Panel, completing the Panel's membership.
    In the production of this report, the Panel owes special 
thanks to our Advisory Committee of Adam M. Blumenthal, 
Professor William N. Goetzmann, and Professor Deborah J. Lucas, 
to Tim Massad and Catherina Celosse for their legal analysis, 
as well as to the hardworking staff at Duff & Phelps. The Panel 
also thanks Ting Yeh for his careful research support on this 
report.

     APPENDIX I: LETTER FROM MR. LAWRENCE SUMMERS TO CONGRESSIONAL 
                  LEADERSHIP, DATED JANUARY 15, 2009 

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[GRAPHIC] [TIFF OMITTED] T7178A.002

[GRAPHIC] [TIFF OMITTED] T7178A.003

APPENDIX II: LETTER FROM CONGRESSIONAL OVERSIGHT PANEL CHAIR ELIZABETH 
 WARREN TO TREASURY SECRETARY MR. TIMOTHY GEITHNER, DATED JANUARY 28, 
                                 2009 

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[GRAPHIC] [TIFF OMITTED] T7178A.005

APPENDIX III: REPORT OF THE ADVISORY COMMITTEE ON FINANCE AND VALUATION 
                  TO THE CONGRESSIONAL OVERSIGHT PANEL


   Report to Congressional Oversight Panel on the Emergency Economic 
                        Stablization Act of 2008

    Adam M. Blumenthal, Managing General Partner, Blue Wolf 
Capital Management.
    William N. Goetzmann, Edwin J. Beinecke, Professor of 
Finance and Management Studies and Director of the 
International Center for Finance at the Yale School of 
Management, and Research Associate of the National Bureau of 
Economic Research.
    Deborah J. Lucas, Donald C. Clarke, HSBC Professor of 
Consumer Finance at the Kellogg School of Management at 
Northwestern University, and Research Associate of the National 
Bureau of Economic Research.

                                SUMMARY

    A key question posed by the Congressional Oversight Panel 
for the Emergency Economic Stabilization Act of 2008 (``EESA'') 
is whether or not the investments in financial institutions 
made by the U.S. Department of the Treasury (``Treasury'') 
under the Troubled Asset Relief Program (``TARP'') represent a 
fair deal to taxpayers. To provide insight into that question, 
we compared the price paid by Treasury for these securities 
with the values implied by the open market for some of the 
largest investments made under the TARP.\1\
---------------------------------------------------------------------------
    \1\ The investments chosen represent the largest investments made 
in non-automotive financial institutions other than the second and 
third investments in Bank of America (of $10 billion and $20 billion) 
which occurred in January 2009, too recently to be included.

                                     SUMMARY OF ESTIMATED VALUE CONCLUSIONS
                                              [Dollars in billions]
----------------------------------------------------------------------------------------------------------------
                                                                                Total estimated value
                                                                    --------------------------------------------
        Purchase program participant          Valuation      Face                            Subsidy
                                                 date       value       Value  ---------------------------------
                                                                                       Percent             $
----------------------------------------------------------------------------------------------------------------
Capital Purchase Program:
    Bank of America Corporation............     10/14/08      $15.0      $12.5              17             $2.6
    Citigroup, Inc.........................     10/14/08       25.0       15.5              38              9.5
    JPMorgan Chase & Co....................     10/14/08       25.0       20.6              18              4.4
    Morgan Stanley.........................     10/14/08       10.0        5.8              42              4.2
    The Goldman Sachs Group, Inc...........     10/14/08       10.0        7.5              25              2.5
    The PNC Financial Services Group.......     10/24/08        7.6        5.5              27              2.1
    U.S. Bancorp...........................     11/03/08        6.6        6.3               5              0.3
    Wells Fargo & Company..................     10/14/08       25.0       23.2               7              1.8
                                                         -------------------------------------------------------
        Subtotal...........................                   124.2       96.9              22             27.3
                                                         -------------------------------------------------------
        311 Other Transactions*............                    70.0       54.6              22             15.4
SSFI & TIP:
    American International Group, Inc......     11/10/08       40.0       14.8              63             25.2
    Citigroup, Inc.........................     11/24/08       20.0       10.0              50             10.0
                                                         -------------------------------------------------------
        Subtotal...........................                    60.0       24.8              59             35.2
                                                         -------------------------------------------------------
            Total..........................                   254.2      176.2              31            78.0
----------------------------------------------------------------------------------------------------------------
* Extrapolates 22 subsidy rate from 8 studied CPP investments. See discussion below.


     Of the $184 billion of TARP funds analyzed, we 
estimate the securities received would have a fair market value 
of approximately $122 billion when Treasury announced its 
agreement to buy them.

     The eight purchases made under the TARP Capital 
Purchase Program, aimed at healthier banks, had a subsidy rate 
to those banks of 22%. The securities subsequently purchased 
from AIG and Citigroup under the Systemically Significant 
Failing Institutions Program and the Targeted Investment 
Program had a significantly higher subsidy rate of 59%.

     If one takes this discount for the investments 
made under the CPP and applies it to the entire $194 billion 
committed to capital purchases in financial institutions 
participating in that program, the total subsidy under the CPP 
would be approximately $43 billion.\2\ When added to the $35 
billion discount on $60 billion invested in AIG and in 
Citigroup outside of the CPP, we estimate that of the $254 
billion invested to date in securities of non-automotive 
financial institutions, and exclusive of the most recent Bank 
of America investment, the amount that represents a subsidy to 
those institutions is $78 billion.
---------------------------------------------------------------------------
    \2\ Treasury's subsequent investments under the CPP were to 
institutions that differed from those analyzed by Duff & Phelps in 
several important respects such as size and scope of activities, and 
the transactions took place under different market conditions. In 
extrapolating the costs, we did not attempt to evaluate the effect of 
these differences.

    A value was estimated for each security as of the time 
immediately following the announcement by Treasury of its 
purchase. This valuation approach takes into account investors' 
perceptions about how the TARP investment itself, and other 
government programs announced concurrently, affected value.
    Whether the subsidy provided by Treasury to financial 
institutions represents a fair deal for the taxpayers is a 
question for policy debate and judgment, not one that can be 
answered in a purely quantitative way. The Treasury Department 
has pointed out that the loss of wealth and diminution in asset 
values that would accompany failure of one or more major 
financial institutions could represent a far larger sum.
    A substantial portion of the subsidy under the CPP program 
can be attributed to the decision by Treasury to provide 
capital on the same terms to all participants. Treasury chose 
to offer ``one size fits all'' pricing in order to encourage 
all institutions to participate, and in so doing disregarded 
apparent differences in their financial condition. A 
consequence is that Treasury effectively offered weaker 
participants greater subsidies than it offered to stronger 
participants. For example, the analysis in the report suggests 
that Treasury received securities from Wells Fargo worth an 
estimated $23.2 billion as of the valuation date for its 
investment of $25.0 billion, or 93% of face value, while from 
Morgan Stanley, it received securities worth an estimated $5.8 
billion as of the valuation date for its investment of $10.0 
billion, or 58% of face value.
    The TIP and SSFI programs were intended to assist 
institutions under more stress than those participating in the 
CPP. Under these programs AIG and Citigroup received funds on 
terms that were only slightly more stringent than those offered 
to CPP participants, and the resulting subsidy rates were much 
higher in these two transactions. It is worth noting that at 
the time of these two investments, there were numerous 
government commitments to these institutions; we focused only 
on the value of the TARP investments.
    By applying the same methodology to three major investments 
by private investors in financial institutions which occurred 
in the same time frame as the Treasury investments (the $5 
billion investment by Berkshire Hathaway in The Goldman Sachs 
Group, the $9 billion investment by Mitsubishi in Morgan 
Stanley and the K7 billion investment by Abu Dhabi and Qatar 
Holding in Barclays plc), it was estimated that the private 
investors received securities with a fair market value as of 
the valuation dates of at least as much as they invested, and 
in some cases worth substantially more. (Berkshire Hathaway 
received Goldman Sachs securities with a fair market value of 
110% of the amount paid, Abu Dhabi and Qatar Holding received 
securities with a fair market value of 123% of the amount paid, 
and Mitsubishi received securities with a fair market value of 
91% of the amount paid.)
    Such comparisons are offered only as a benchmark. The 
question of whether Treasury could have negotiated investments 
that had comparable pricing and satisfied its public policy 
objectives at the same time is not one that the report can 
answer.

A. Introduction

    The U.S. Department of the Treasury (``Treasury'') used 
almost all of the $350 billion of taxpayer dollars provided to 
it to in the first installment of the the Troubled Asset Relief 
Program (``TARP'') created by the Emergency Economic 
Stabilization Act of 2008 (``EESA''). Of this amount, Treasury 
has spent, or committed to spend, approximately $310 billion to 
purchase preferred stock and warrants of financial 
institutions.
    Most of these purchases were made pursuant to a program 
developed by Treasury called the Capital Purchase Program 
(``CPP''). In addition, outside of the CPP, Treasury had 
invested an additional $60 billion in two financial 
institutions, Citigroup and AIG, through other programs as of 
the date of our study (an additional investment in Bank of 
America has since been announced, but we did not review it). 
The CPP, announced on October 14, 2008, was implemented through 
a series of Treasury cash investments in exchange for preferred 
shares and warrants from a broad range of financial companies. 
All participating institutions obtained essentially the same 
terms on the preferred shares (a 5% dividend, increasing to 9% 
after five years) and warrants to purchase common stock equal 
to 15% of the face value of the preferred investment, with the 
companies having the right to cancel half of these warrants 
under certain circumstances. Terms differed somewhat for non-
publicly traded institutions and for the investments outside of 
the CPP.
    Treasury allocated $250 billion of the funds under EESA to 
CPP. To date, it has spent or committed to spend $194 billion 
of that amount to purchase preferred stock and warrants of 319 
financial institutions under this program.
    In this report, we focus on the value of Treasury's 
investments in a set of the largest participants in the CPP 
program, and the value of Treasury's investments in Citigroup 
and AIG made under related programs. In order to provide 
information helpful in assessing whether the public is 
receiving a fair deal under the TARP program, we asked two 
questions in particular: (i) what was the fair market value of 
the preferred stock and warrants Treasury received in exchange 
for these cash infusions to financial institutions and (ii) how 
do these values compare to what was received in several 
privately negotiated transactions, including the earlier 
investment made by Warren Buffett's Berkshire Hathaway Inc. 
(``Berkshire Hathaway'') in The Goldman Sachs Group 
(``Goldman'') and the investment made by Mitsubishi UFJ 
Financial Group (``Mitsubishi'') in Morgan Stanley, two of the 
institutions that received TARP funds, and by Qatar Holdings 
and other middle eastern entities in Barclays plc 
(``Barclays'') at the end of October 2008.
    To answer these questions, on the Panel's behalf, we 
designed the scope and methodology for a valuation project and 
selected Duff & Phelps (``D&P''), one of the largest valuation 
firms in the world, to conduct a rigorous valuation study 
implementing that plan. D&P frequently conducts arm's-length, 
independent valuations of securities like the TARP investments 
for which no active trading market exists. We directed D&P to 
provide an analysis of the likely fair market value of the 
securities received by Treasury in the ten largest investments 
made under the TARP. Given the particular details of Treasury's 
investments and the desire to comprehensively review how they 
relate to publicly traded securities as well as to comparable 
private investments, we judged that the professional experience 
and judgment of a major firm such as D&P would most effectively 
interpret market information and yield reliable, quantitative 
answers. In the sections that follow, we describe the scope, 
methodology and conditions of the D&P analysis, and summarize 
their basic findings. We then apply the estimates made by D&P 
to the question posed by the Panel.

B. Process

    Immediately after the Congressional Oversight Panel was 
formed, the Panel created an Advisory Committee on Finance and 
Valuation to create a valuation study. The members of the 
Advisory Committee are: Adam M. Blumenthal, Managing General 
Partner of Blue Wolf Capital Management and Former First Deputy 
Comptroller of the City of New York; Professor William N. 
Goetzmann, Edwin J. Beinecke Professor of Finance and 
Management Studies and Director of the International Center for 
Finance at the Yale School of Management, and Research 
Associate of the National Bureau of Economic Research; and 
Professor Deborah J. Lucas, Donald C. Clarke HSBC Professor of 
Consumer Finance at the Kellogg School of Management at 
Northwestern University, and Research Associate of the National 
Bureau of Economic Research, and the former Chief Economist of 
the Congressional Budget Office.
    Members of the Advisory Committee created a detailed scope 
for the valuation project, and identified and interviewed or 
had discussions with five firms who were considered as 
candidates to perform the valuation work. The Advisory 
Committee recommended the selection of Duff & Phelps, LLC 
(D&P), one of the largest valuation firms in the world, based 
on a number of factors. D&P and the Advisory Committee then 
designed a methodology to be used to implement the project 
design. The Advisory Committee periodically reviewed with D&P 
their application of the valuation methodologies and the 
assumptions underlying them.

C. Scope

    The valuation project was designed to provide an estimate 
of the fair market value of the securities purchased by 
Treasury in its eight largest purchases under the CPP, and its 
investments in AIG and Citigroup outside the CPP. The Panel 
focused on these investments because they were among the 
largest commitments made under the TARP.\3\ Collectively, they 
represent a total expenditure of $184 billion, or 53% of the 
first $350 billion authorized by Congress for the TARP.
---------------------------------------------------------------------------
    \3\ The additional $20 billion investment in Bank of America on 
January 16, 2009 occurred too late to be included in the valuation 
report.
---------------------------------------------------------------------------
    The scope called for D&P to take into account in its 
analysis only information that was publicly available. They 
were asked what an arm's-length investor would pay for the 
securities. This presupposed that an investor would not have 
access to material nonpublic information, but would have 
comprehensive access to public filings, analyst reports, and 
trading information on all of the publicly traded securities 
issued by the companies. Importantly, by basing estimates on 
the market price immediately following the announcement by 
Treasury of a purchase, the valuation takes into account 
investors' perceptions about how the intervention itself 
affects value going forward.
    The scope also called for the firm to take into account 
major privately negotiated investments that occurred around the 
same time as the TARP investments under consideration, in 
particular, investments by Warren Buffet's Berkshire Hathaway 
in Goldman Sachs, by Mitsubishi in Morgan Stanley, and by Qatar 
Holding and Abu Dhabi in Barclays, all of which occurred in 
September and October of 2008.
    The scope specifically excludes any effort to place a value 
on the policy objectives of Treasury in making these 
investments, apart from those reflected directly in security 
prices. It also excludes consideration of any indirect effects 
of the purchases on other governmental or private interests. 
For instance, interdependencies between institutions may mean 
that helping one enhances the value of others, as was thought 
to be important with AIG. Those objectives, as well as the 
broader implications for the financial system and the economy, 
obviously must be considered in the policy debate on whether 
the TARP investments were a good use of public funds, but they 
are outside the scope of the valuation analysis, which 
addresses only the subsidies to the institutions as measured by 
the difference between the prices paid for the securities and 
estimated fair market values.
    We do not attempt to value other broad financial 
interventions which Treasury, the Federal Reserve Bank, the 
FDIC, or other government affiliated entities made in the 
financial markets, in some cases simultaneously or in close 
proximity to the TARP investments. We also do not value other 
government investments in the same companies. For example, at 
the time of the TARP investment, Treasury already owned 79.9% 
of AIG, as the result of a prior loan to AIG by the Federal 
Reserve Bank of New York, and the proceeds of the AIG loan were 
used to repay part of the Fed's loan to AIG. In this case, we 
valued the TARP securities, not the Fed's loan, or the 
government's pre-existing equity interest in AIG.
    The scope includes only the value of the securities at the 
time of the announcement of the investment. As such, it does 
not consider their current market value, which may be 
considerably different than the values reported.
    Finally, the scope provides for an estimate of the subsidy 
received by each institution as a whole, but it does not cover 
how the subsidy will be divided among different classes of 
stakeholders (e.g., stock holders, bond holders, employees, 
suppliers and customers).

D. Methodology

    The methodology used in the valuation report is discussed 
below and is described at much greater length in D&P's report. 
The Advisory Committee and D&P developed a general approach, 
which was to evaluate the preferred shares and the warrants 
obtained by Treasury separately, company by company. 
Recognizing that any single valuation approach might provide a 
limited perspective on the factors influencing the value of the 
securities, the Advisory Committee asked D&P to consider 
multiple methods that offered a means to cross-validate their 
estimates. All of these approaches rely on some basic 
assumptions, the most important of which is that the prices for 
securities similar to those issued under the TARP were trading 
in the capital markets at fair values, which as defined by D&P 
is ``the price at which they would change hands between a 
willing buyer and a willing seller when neither is acting under 
compulsion and when both have a reasonable knowledge of the 
relevant facts.'' Despite the turmoil in the capital markets, 
the Advisory Committee believes, and D&P confirmed through 
analysis, that there was sufficient liquidity and market volume 
in the trading of securities at that time to rely on market 
pricing for analysis. D&P was not asked to consider whether 
these market prices were consistent with other notions of 
fundamental economic value. D&P's results are provided as a 
range of values. The midpoints of those ranges were selected as 
representative values for this report.

E. Preferred stock valuation

    Preferred shares are legally a type of equity, but they 
have several characteristics that are similar to bonds. They 
are senior in priority to the common shares of a company, but 
junior to the debt of the firm. The preferred shares issued 
under CPP are non-voting securities which provide for a 5% 
dividend for a five-year period and a 9% dividend in perpetuity 
thereafter. A company can choose not to pay a preferred 
dividend without declaring bankruptcy, but the dividends on the 
preferred shares issued by bank holding companies under CPP are 
cumulative, meaning that any missed dividends must be paid in 
full before common stockholders can receive dividends. The 
preferred shares are callable under certain conditions 
described in full in D&P's report.
    As a check on the robustness of the estimates, D&P used 
several methodologies to value the preferred stock issued in 
the investments: two based on the market values of different 
types of comparable publicly traded securities and one using a 
contingent claims analysis approach.
            (i) Discounted Cash Flow Analysis Using Market Yields 
                    (``Yield-Based Discounted Cash Flow Approach'')
    This approach involves estimating the future expected cash 
flows (dividend payments and return of principal) on the 
preferred securities, and discounting those projected cash 
flows at a market yield derived from the prices of comparable 
securities. Finding the appropriate discount rate involved 
analyzing the yields of the publicly traded preferred stock and 
debt securities of each institution based on transaction prices 
in the days following Treasury's announcement of the 
investments. In those instances where sufficiently liquid 
preferred securities were available for comparison, D&P used 
them as the primary basis for determining a discount rate. In 
either case, D&P then systematically adjusted yields to take 
into account the differences between the terms of the CPP 
preferred shares and the terms of the publicly traded 
securities. Adjustments were made for the call options, the 
cumulative dividend, and other factors.
            (ii) Discounted Cash Flow Analysis Using Risk Adjusted 
                    Survival Probabilities Derived from CDS Spreads 
                    (``CDS-Based Discounted Cash Flow Approach'')
    Like the yield-based method, this approach is based on 
future contractual cash flows adjusted for expected losses, a 
risk premium, and the time value of money. In this case, the 
adjustments are based on information about default and the 
price of credit risk implied by the premiums charged on credit 
default swaps (``CDS''). Values estimated in this manner were 
compared to those derived from the Yield-Based Discounted Cash 
Flow Approach. An advantage of the CDS prices is that they are 
generally determined in a more liquid market, and thus they may 
better capture the market assessment of risk. However, CDS 
prices reflect the market's required return on debt securities, 
not on preferred shares, and thus valuation requires an 
adjustment for the differences between the two types of 
securities. Because of the difficulty of determining the 
appropriate adjustment, this method was used primarily as a 
check on whether the other two approaches were generating 
reasonable estimates of value.
            (iii) Contingent Claims Analysis
    This methodology is distinctly different from the yield-
based approaches. It relies on a probabilistic model of how the 
firm's asset value, and therefore, its ability to pay 
claimants, evolves over time. The model is calibrated using 
data on stock prices and their volatility, and on the book 
value of debt. Preferred shares are assumed to receive dividend 
payments as long as the solvency condition is satisfied, but to 
recover little or nothing in bankruptcy. Default occurs when 
assets drop below a trigger point based on debt outstanding. 
The value of the preferred shares is based on the discounted 
present value of dividends and any return of principal, 
averaged over simulations of a large number of possible time 
paths of a firm's asset value.
    This mathematical framework is used in the private sector 
for credit risk modeling and has also been used in a government 
context for the valuation of government guarantees. This 
approach allows for sensitivity analysis of the quantitative 
importance of various assumptions. The results of the 
contingent claims analysis are consistent with the yield-based 
approaches, and in addition, make apparent the sensitivity of 
estimated value to assumptions about the volatility of the 
firm's underlying assets and the events that trigger 
bankruptcy.

F. Warrant valuation

    A warrant confers the right to acquire a share of stock 
from a company within a specified time period for a 
predetermined price, called the exercise price. Warrants allow 
an investor to participate in potential stock price increases 
since they generate a gain whenever share prices rise above the 
exercise price of the warrant.
    Treasury required each publicly held institution receiving 
an investment to issue warrants at an exercise price equal to 
the average trading price for the 20 days prior to the day of 
Treasury's approval of the institution's participation in the 
CPP. The number of common shares to be acquired was set at a 
number which, when multiplied by the exercise price, was equal 
to 15% of the total amount of Treasury's investment in the 
preferred shares. Thus, if Treasury invested $10 billion in the 
institution, Treasury would receive warrants for $1.5 billion 
of common stock. If the exercise price of the warrants was $15 
per share, then Treasury would receive warrants for 100 million 
shares. The warrants are subject to a reduction feature whereby 
half of the warrants may be cancelled by the issuing 
institution if it meets certain conditions involving sale of 
common stock to investors in private sector transactions prior 
to year-end 2009, a feature which should reduce the upside to 
Treasury. These warrants have a value independent of the 
preferred shares themselves. D&P valued the warrants using a 
widely used option pricing methodology, a Monte Carlo model, 
which allowed them to take into account the conditions of the 
warrant contract.
    Warrant values depend on a number of inputs, including the 
current stock price, the exercise price, the risk free rate of 
return, the expected future volatility of the stock price, the 
dividend yield on common stock, and the number of warrants 
issued in relation to the outstanding shares of stock and other 
features specific to the TARP offerings. The D&P valuation used 
the stock price of the company on the chosen date of valuation, 
a forward-looking set of short-term discount rates based upon 
the current Treasury yield curve, an estimation of volatility 
drawn from historical stock price fluctuations, as well as a 
comparison to volatilities implied by prevailing market prices 
of long-dated equity options and the appropriate ratio of 
exercised warrants to outstanding shares.
    In most instances, the value of the warrants was small 
relative to the value of the preferred stock itself.

G. Reduced marketability discount

    Under all of the methodologies, and for both preferred 
stocks and warrants, D&P applied a ``reduced marketability 
discount factor'' to reflect the fact that the large size of 
Treasury positions made them potentially costly to liquidate 
and hence less valuable. Based on academic and industry 
studies, they estimated this factor to be between 5% and 10% 
for the preferred stocks and between 5% and 20% for the 
warrants.

H. Comparable transactions

    Utilizing similar methodologies, D&P also analyzed three 
transactions which were concluded around the time of the TARP 
investments: the $5 billion Berkshire Hathaway investment in 
Goldman Sachs announced on September 23, 2008 and closed on 
October 1, 2008; the $9 billion Mitsubishi investment in Morgan 
Stanley, which was announced on September 22, 2008, amended, 
and then closed on October 13, 2008; and the K7 billion 
investment by Abu Dhabi and Qatar Holding in Barclays plc which 
was announced on October 31, 2008 and completed on November 27, 
2008. D&P estimated that Berkshire Hathaway received securities 
with a fair market value between 108% and 112% of the actual 
amount paid, based on prevailing market prices for similar 
securities; that Mitsubishi received securities with a fair 
market value between 88% to 94% of the amount paid; and that 
Qatar Holdings and Abu Dhabi received securities with a fair 
market value of between 122% to 125% of the amount paid.
    Stated differently, Berkshire Hathaway, Qatar Holding and 
Abu Dhabi paid less for their securities than what one would 
expect other investors to pay; all of the private investors 
received relatively more valuable securities for their 
investments than did Treasury.
    D&P concluded that this broad range of outcomes reflects 
unique circumstances at individual financial institutions, and 
in some cases contractual terms that severely limited 
marketability. In addition, there may also be some value 
accruing from Warren Buffett's reputation as a canny investor 
which enabled him sufficient leverage to purchase securities in 
Goldman Sachs at a significant discount to the prevailing 
market value of similar securities. Because of such special 
circumstances, they concluded that the individual transactions 
should not be taken as a benchmark for valuation of the TARP 
securities but rather as an indicator of the potential for 
investors to extract price concessions below prevailing market 
values in certain circumstances.
    The issue of whether the government could have obtained 
similar discounts from prevailing market values on similar 
securities remains a question for Treasury. The question also 
remains of whether, even if it could have negotiated a 
transaction benchmarked to these transactions, such a deal 
would have met policy objectives, but this question is outside 
of the scope of the valuation report. As a result, the D&P 
analysis uses public market trading data that assumes no 
positive strategic advantage that might accrue to a large 
shareholder. The analysis of comparable transactions does, 
however, provide information about the relative discounts that 
accrued to some other major private actors so that the Panel 
may understand their magnitude.

I. Conclusions of the valuation analysis

    The table below lists the TARP investments reviewed in the 
valuation showing institution, amount, date announced and the 
Treasury program under which the investment was made.

                          [Dollars in billions]
------------------------------------------------------------------------
          Purchase program participant                Date       Amount
------------------------------------------------------------------------
Capital Purchase Program:
    Bank of America Corporation.................     10/14/08      $15.0
    Citigroup, Inc..............................     10/14/08       25.0
    JPMorgan Chase & Co.........................     10/14/08       25.0
    Morgan Stanley..............................     10/14/08       10.0
    The Goldman Sachs Group, Inc................     10/14/08       10.0
    The PNC Financial Services Group............     10/24/08        7.6
    U.S. Bancorp................................     11/03/08        6.6
    Wells Fargo & Company.......................     10/14/08       25.0
                                                              ----------
        Subtotal................................  ...........      124.2
SSFI & TIP:
    American International Group, Inc...........     11/10/08       40.0
    Citigroup, Inc..............................     11/24/08       20.0
                                                              ----------
        Subtotal................................  ...........       60.0
                                                              ----------
            Total...............................  ...........      184.2
------------------------------------------------------------------------

    The next table shows D&P's estimates of the fair market 
value of each of the investments, in each case as of the 
respective dates the investments were announced. Taken as a 
whole, D&P concluded that the fair market value of the 
investments as of such dates, in the aggregate, was between 
$112 and $132 billion, or between 61% and 71% of the amount 
Treasury paid for them. Thus, of the total $184 billion 
invested in these transactions, between $53 and $73 billion 
represented overpayment relative to the estimated fair market 
value of the securities.

    (a) In the case of two of the eight largest investments 
under the CPP, U.S. Bancorp and Wells Fargo & Company, which 
the market deemed least risky, and for which Treasury paid 
$31.6 billion in the aggregate, D&P concluded that the fair 
market value of the investments was at or somewhat below the 
amount paid for them by Treasury, with a range of 87% to 99% of 
Treasury's cost. That is, D&P believes that a third party buyer 
would have paid between $27.6 billion and $31.3 billion for 
securities for which Treasury paid $31.6 billion.

    (b) In the case of the other six CPP investments, in Bank 
of America, JP Morgan Chase & Co., Goldman Sachs, the PNC 
Financial Services Group, Citigroup, and Morgan Stanley, which 
the market deemed riskier, D&P concluded that the fair market 
value of the investments was significantly below the price paid 
by Treasury, with a value range of 47% to 68% of face for 
Morgan Stanley, which bore the greatest discount, to 77% to 89% 
of face at Bank of America. In the aggregate for these six 
investments, for which Treasury paid $92.6 billion, D&P 
estimated a value range of $61.6 to $73.2 billion.

    (c) In the case of the $60 billion in investments outside 
the CPP program, consisting of the November investments in AIG 
under the SSFI program and in Citigroup under the TIP, D&P 
concluded that the government received value equal to between 
$22.5 and $27.1 billion, or 37% to 45% of the amount invested.

                                                         SUMMARY OF ESTIMATED VALUE CONCLUSIONS
                              [Dollars in billions. All values are after applicable discounts due to reduced marketability]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                     Total estimated       Duff & Phelps value range
                                                                                                         value*      -----------------------------------
                                                                  Valuation      Face              ------------------      Values        Percent of face
                  Purchase program participant                       date       value     Midpoint  Discount to face -----------------------------------
                                                                                                   ------------------
                                                                                                    Percent     $       Low      High     Low      High
--------------------------------------------------------------------------------------------------------------------------------------------------------
Capital Purchase Program:
    Bank of America Corporation................................     10/14/08      $15.0       12.5       17     $2.6    $11.6    $13.3       77       89
    Citigroup, Inc.............................................     10/14/08       25.0       15.5       38      9.5     14.2     16.8       57       67
    JPMorgan Chase & Co........................................     10/14/08       25.0       20.6       18      4.4     19.0     22.2       76       89
    Morgan Stanley.............................................     10/14/08       10.0        5.8       42      4.2      4.7      6.8       47       68
    The Goldman Sachs Group, Inc...............................     10/14/08       10.0        7.5       25      2.5      6.8      8.2       68       82
    The PNC Financial Services Group...........................     10/24/08        7.6        5.5       27      2.1      5.2      5.8       69       77
    U.S. Bancorp...............................................     11/03/08        6.6        6.3        5      0.3      5.9      6.7       89      102
    Wells Fargo & Company......................................     10/14/08       25.0       23.2        7      1.8     21.7     24.6       87       99
                                                                             ---------------------------------------------------------------------------
                            Subtotal                             ...........      124.2       96.9       22     27.3     89.2    104.5       72       84
SSFI & TIP:
    American International Group, Inc..........................     11/10/08       40.0       14.8       63     25.2     14.2     15.4       36       38
    Citigroup, Inc.............................................     11/24/08       20.0       10.0       50     10.0      8.3     11.7       41       59
                                                                             ---------------------------------------------------------------------------
    Subtotal...................................................  ...........       60.0       24.8       59     35.2     22.5     27.1       37       45
    Total......................................................  ...........      184.2      121.6       34     62.6    111.7    131.6       61      71
--------------------------------------------------------------------------------------------------------------------------------------------------------
* As of the respective valuation dates. Midpoint is midpoint of Duff & Phelps range.

J. Discussion

    There were significant differences in the risk of the 
institutions that received funds under the TARP, as evidenced 
by the very different yields on their securities that investors 
demanded in the capital markets and documented by D&P. In 
financial institutions which the markets judged to be 
relatively less risky, Treasury received securities with values 
slightly below what was paid for them. In institutions which 
the market viewed to have greater risk, the value of securities 
received by Treasury was further below fair market value.
    The Advisory Committee believes that this result is a 
consequence of the policy decision by Treasury to offer uniform 
terms under the CPP to all financial institutions irrespective 
of their relative financial condition. For firms with a 
relatively high probability of default, the 5% dividend rate on 
the preferred shares was substantially below their market cost 
of capital, whereas for the healthier firms, it offered a 
smaller advantage over market rates. Further, the option for an 
institution to extend the financing beyond the fifth year at a 
9% rate only had substantial value to the weaker institutions.
    A further benchmark for understanding the results of the 
valuation exercise is that the CPP facility was structured to 
be voluntary. To induce the relatively healthy financial 
institutions to participate, the terms for them had to be set 
so that they did not surrender more value than they received. 
The decision by Treasury to treat everyone equally led to the 
best institutions more or less breaking even and weaker 
entities benefiting from receiving financing on the same terms 
as their stronger peers.
    A potential reason to refrain from discriminating among 
TARP borrowers is the potential adverse effect on public 
expectations about particular institutions. Put simply, if the 
public thinks that Treasury knows something about a bank that 
the public does not know, the markets may interpret any signal 
from Treasury as a positive or negative indication about the 
health of the firm. Avoiding this type of signaling may have 
been a concern in crafting the program. On the other hand, as 
the report illustrates, the market was aware of the 
differential risk profile of these banks at the time the 
investments were made. To the extent that adverse signaling was 
a concern, risk-based pricing based only on public information 
may have been possible. However, proposing alternative 
mechanisms ex post is outside of the scope of this report.

K. Conclusion

    Our report concludes, based on analysis set forth in great 
detail in D&P's report, that the fair market value of the 
securities received was, in most cases, significantly less than 
what Treasury paid; and we identify the structural reasons in 
the program that led this to be true. We are not attempting in 
this report to answer the question of whether the investments 
were good or bad from a policy perspective, or whether Treasury 
will eventually recover its investment or even come out ahead. 
Whether they were of positive benefit to the nation requires an 
assessment of their effects on the functioning of the U.S. 
economy. Consequently, this involves a policy debate and 
requires an assessment as to whether these investments are part 
of a coherent strategy to achieve the objectives of EESA. The 
fundamental question is whether the actions taken by Treasury 
are working to stabilize financial markets and institutions and 
helping American families. This report provides information on 
the value conveyed to these institutions at the time of the 
intervention, which should be a useful input into a broader 
cost-benefit analysis of the TARP. We hope that by quantifying 
the cost of the initial largest investments made to date, we 
have made a contribution to that debate.

APPENDIX IV: SUMMARY OF THE LEGAL REPORT TO THE CONGRESSIONAL OVERSIGHT 
  PANEL FOR ECONOMIC STABILIZATION CONCERNING THE TARP INVESTMENTS IN 
                         FINANCIAL INSTITUTIONS


                           TIMOTHY G. MASSAD

A. Scope and methodology of legal report

    The Panel asked Timothy G. Massad, a corporate lawyer with 
a New York-based law firm for almost 25 years, including 17 as 
a partner, to prepare a legal analysis of the TARP investments. 
He specializes in corporate finance. Mr. Massad took a leave of 
absence from his firm in late December in order to serve as 
special legal advisor to the Panel on a pro bono basis and to 
prepare the report. Catherina Celosse acted as counsel for the 
Panel in the development of the legal report.
    The legal analysis focuses on the Capital Purchase Program 
(``CPP'') created by Treasury as a whole and the largest 
investments thereunder, as well as the AIG, second Citigroup 
and most recent Bank of America investment made outside of the 
CPP. The CPP was for healthy banks. The AIG investment in 
November 2008 was made under the Systemically Significant 
Failing Institutions (``SSFI'') program and the Citigroup and 
Bank of America investments were made under the Targeted 
Investment Program (``TIP''), which were programs for 
institutions in greater difficulty or at risk of failure.
    The legal analysis provides an explanation of the structure 
and terms of these investments. It also considers whether the 
terms received by Treasury were customary and consistent with 
market practice from a legal (but not a valuation) standpoint. 
There is a wide range of market practice, and terms vary 
depending on many factors including in particular the credit-
worthiness of the issuer, the relative strength of the parties 
and the preferences of investors. Opinions also vary as to what 
is customary, and the analysis cannot be reduced to a 
quantitative assessment as with the valuation analysis. While 
the legal analysis reviews the material terms of the agreements 
individually, an investment decision by a private investor to 
purchase securities of this type is usually made on the basis 
of the terms as a whole, and an investor's willingness to agree 
to a particular set of non-economic terms usually is greatly 
influenced by the attractiveness of the economic terms.
    In examining whether the terms were consistent with market 
practice, the analysis considers in particular the terms of a 
set of recent transactions agreed upon with the Panel. These 
include the investments by Berkshire Hathaway Inc. in The 
Goldman Sachs Group, Inc. (``Goldman Sachs'') and by Mitsubishi 
UFJ Financial Group (``Mitsubishi'') in Morgan Stanley in the 
fall of 2008, as well as four other investments in Citigroup, 
Merrill Lynch and Morgan Stanley that were made between late 
2007 and the fall of 2008 (the ``U.S. comparative 
transactions''). In addition, these transactions include the 
investments by the government of the United Kingdom in Royal 
Bank of Scotland and Lloyds TSB--HBOS in October 2008 (the 
``U.K. government investments'') and the investment in Barclays 
Bank PLC by Qatar Holdings and Sheikh Mansour of Abu Dhabi.
    The scope and methodology of the report was agreed upon 
with the Panel, including that the report would be based solely 
on review of publicly available information concerning the 
investments.
    As with the valuation analysis, the legal analysis does not 
address whether the investments were good or bad investments. 
Because they were investments by the government seeking to 
fulfill certain public policy purposes, that conclusion 
requires not only a consideration of the terms of the 
investments but also an evaluation of the public policy 
objectives and whether the investments contributed to achieving 
those objectives, matters which are beyond the scope of the 
legal report. The assessment of whether the terms were 
consistent with market practice is only intended to provide a 
benchmark. It is not intended to judge whether Treasury made 
the right public policy choices or suggest that public policy 
objectives should not influence those terms.
    The legal report does not consider the other actions that 
were taken by the U.S. government in response to the financial 
crisis concurrently with the making of these investments, 
including specific arrangements made with particular 
institutions that received TARP funds. Although these actions 
are relevant to evaluating the effectiveness of the investments 
from a policy standpoint, they are beyond the scope of the 
report.

B. Findings

    The summary below highlights some of the findings of the 
legal report.

    (i) Documentation of TARP Investments--Use of Standard 
Forms. Treasury created standard documentation for the CPP 
investments. In the transactions reviewed, there were no 
variations in terms from the standard forms other than those 
contemplated by the forms themselves, such as those related to 
size of the investment, number of shares issued and strike 
price of the warrants.
    Treasury created two sets of forms, one for publicly held 
qualified financial institutions or ``QFIs'' (the Public QFI 
forms) and one for non-publicly held qualified financial 
institutions excluding S corporations and mutual organizations 
(the Non-Public QFI forms). Of the total $194.2 billion 
invested as of January 23, 2009, approximately $1.7 billion has 
been invested in 90 institutions that are privately held or are 
community development institutions.
    Similarity to Berkshire Hathaway Papers. The CPP standard 
forms are quite similar to, and appear to have been based on, 
the papers used by Berkshire Hathaway for its investment in 
Goldman Sachs. The pricing-related terms (such as dividend 
rate, number and exercise price of warrants (including the 
warrant reduction feature discussed below) and optional 
redemption premium) of the Treasury agreements are not nearly 
as favorable to Treasury as the terms that Berkshire Hathaway 
received, as discussed in the valuation report. In most other 
areas the terms obtained by Treasury are as good as, and in 
some cases better than, those in the Berkshire Hathaway 
agreements (such as voting rights of the preferred stock, 
restrictions on dividends and stock repurchases, warrant anti-
dilution protection and exercise period, transfer restrictions, 
representations and warranties and amendments), although such 
other provisions generally are not as important to the average 
investor. One other area where the terms obtained by Treasury 
are not as good, though it could be thought of as a pricing-
related term, is the issuer's right to repurchase the warrants 
and underlying common shares at fair market value following 
redemption or transfer by Treasury of the preferred.
    Incentives to Replace Treasury Investment. In order to meet 
regulatory requirements, Treasury could not require the issuer 
to redeem the securities (that is, repay Treasury) at a fixed 
date. However, Treasury included a number of provisions, as 
discussed below, that appear to be designed to encourage the 
QFI to replace the Treasury investment with private capital, 
which was presumably one of Treasury's objectives. These 
include the dividend step-up provision, the lack of a premium 
on optional redemption and (in the Public QFI form) the QFI's 
right to reduce the number of warrants in certain circumstances 
and to repurchase the warrants and underlying common shares at 
fair market value once the preferred stock is redeemed or 
transferred. (The common stock dividend restrictions may also 
encourage replacement of the Treasury investment.) Some of 
these provisions have a negative impact on valuation as 
indicated by the valuation report; that is, they make the 
security less attractive to an average investor.
    Passive Investor Philosophy. The contracts generally 
provide for Treasury to be a passive investor. This is 
evidenced by providing for only limited voting rights, not 
having any board seats or board observers, agreeing not to 
exercise voting rights on common shares acquired under the 
warrants and (in the CPP investments) not imposing any 
covenants other than those that are customary for passive 
preferred stock investments. There are, for example, few 
covenants that restrict operations or that are directed at the 
public policy objectives of EESA. This approach can be 
contrasted with the more activist approach of the U.K. 
government as well as the approach taken by Treasury in the 
TARP loans made to the automotive companies, as discussed in 
the report.
    Consequences of Using Standard Forms. The legal analysis 
also considered the implications of Treasury's decision to 
structure the program by creating standard forms that were used 
for all transactions, which implications are relevant to the 
debate as to whether the investments were good policy choices. 
First, the design of the program enabled Treasury to avoid 
having to negotiate any of the terms with any institution, 
which would have required substantially more Treasury resources 
and many policy or credit choices. That would have made it 
difficult to complete as many transactions as quickly as 
Treasury did. The program design also may have contributed to a 
perception that the program was fair at least as among 
financial institutions that were deemed eligible. That may have 
encouraged participation. Speed of execution and wide 
participation were important Treasury objectives in October 
2008 when the program was launched. The absence of individually 
negotiated terms meant also that completed transactions did not 
suggest to the marketplace that, because of the inclusion of 
more restrictive terms in one case versus another, Treasury had 
determined that one institution was weaker than another; such 
signals could have in turn affected confidence in, or market 
prices of the securities of, particular institutions. Treasury 
also avoided subjecting itself to criticism for why it required 
or did not require particular terms for an institution. On the 
other hand, the program design meant that Treasury could not 
address differences in credit quality or risk among 
institutions, or in their need for capital, by varying the 
terms of each investment.\1\ Insofar as the standard terms were 
set for strong institutions, they may have been too lenient for 
weaker institutions. The program design also meant that 
Treasury could not impose specific requirements on a recipient 
to take certain actions that it deemed necessary for the 
stability or soundness of an institution (The Treasury view may 
have been that the government could use its power as a 
regulator to do so). It meant Treasury's only choice was to 
decide whether an institution was eligible and what the size of 
the investment would be within the range of 1-3% of risk-
weighted assets. A determination that an institution was not 
eligible had potentially harsh consequences for the 
institution.
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    \1\ In customary market practice, there are often differences in 
pricing-related terms as well as non-economic terms depending on the 
credit-worthiness of the issuer. In theory, Treasury could have 
incorporated a customized, risk-based approach to setting the dividend 
rate at least for large public companies, for example by reference to 
the yields on other publicly traded securities or credit default swap 
rates (or perhaps they could have varied the number of warrants taken), 
and still have maintained the general standardized terms of the 
documents. But this would have left the question of how to price the 
securities for less widely-traded institutions, and its effects on 
speed of execution and participation rates are impossible to know.
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    A major question for the policy debate is therefore whether 
the basic design of the program--provide capital to a large 
number of institutions by using standard terms designed for 
``healthy'' banks--made sense, because so many issues follow 
from the answer to that question.
    TIP/SSFI Investments. Treasury used the CPP forms with 
modifications for the TIP/SSFI investments. The CPP was a 
voluntary program for healthy banks; TIP and SSFI are for 
institutions experiencing more difficulty or at risk of 
failure. The two institutions funded under the TIP also 
received funds under CPP, and the TIP program was not created 
until months after the first investment now grouped under that 
program was announced. The Panel may wish to consider whether 
these various programs fit together into a coherent overall 
strategy.

    (ii) Basic Structure of the Investments. Treasury acquired 
preferred stock and warrants. In the CPP investments, Treasury 
purchased senior preferred stock in an amount equal to 1-3% of 
risk weighted assets of the institution but not more than $25 
billion. Risk-weighted assets are the total assets weighted for 
credit risk and are a measure used to determine adequacy of 
capital. The preferred stock qualified as Tier 1 capital, which 
is a core measure of capital for a financial institution, as a 
result of a contemporaneous regulatory change by the Federal 
Reserve Board. The structure of the investment was consistent 
with Treasury's goal of bolstering the capital of institutions, 
which had been depleted by, among other things, losses on 
mortgage-related assets.
    Priority of Preferred Stock. Preferred stock provides 
Treasury with priority over common stock as to payment of 
dividends and in liquidation. The TARP preferred stock pays 
dividends at a fixed rate, and the dividends are cumulative 
(except for banks that are not subsidiaries of bank holding 
companies), which means the dividends, even if not declared by 
the board of directors in a particular period, continue to 
accrue, thus enhancing the investor's return. Unpaid cumulative 
dividends also compound at the dividend rate then in effect, 
which is favorable to the investor. The preferred stock is 
senior, which insures that no other preferred stock can have a 
higher priority as to payment of dividends or in liquidation.
    Blank Check Preferred. Another reason preferred stock may 
have been attractive to Treasury and to the financial 
institutions seeking CPP funds is that many public corporations 
have what is known as ``blank-check preferred'' which allows 
the board of directors to issue preferred stock having the 
desired terms without having to obtain approval (in most cases) 
from common stockholders, thus facilitating a quick 
transaction.
    Stockholder approval can nevertheless be necessary pursuant 
to the rules of the national securities exchanges if the common 
shares underlying the warrants equal 20% or more of the total 
outstanding common shares. Treasury provided that in this case, 
the institution was not only required to get approval, but the 
exercise price of the warrants would decline if approval was 
not obtained quickly.
    Warrants--Basic Terms. In the CPP investments, Treasury 
received warrants to acquire common shares equal to 15% of the 
value of the preferred investment, which give it an opportunity 
to realize upside, without giving up its fixed return, if the 
common stock price of the institution increases. The exercise 
or strike price of the warrants was set at the current market 
price of the common stock. Sometimes, warrant exercise prices 
are set at a premium to current market price of the common 
stock, which would be less favorable to Treasury as it would 
require greater price appreciation in order to realize a gain. 
The warrants were immediately exercisable (subject to a 
reduction feature) and had a term of ten years, which 
potentially gives Treasury a long time to realize any gain.
    The Non-Public QFI form for the CPP program differs in that 
Treasury acquires a warrant for a preferred stock that pays a 
9% dividend, which it exercises immediately. There is no 
provision for reduction of warrants.
    Warrant Reduction. One unusual feature of the Public QFI 
forms is that the issuer is entitled to reduce the number of 
common shares which may be acquired on exercise of the warrants 
by 50% if it sells equity that qualifies as Tier 1 capital in 
an amount equal to Treasury's investment before December 31, 
2009. This feature could eliminate much of Treasury's upside 
with respect to the warrants. However, it may serve a public 
policy goal of creating an incentive for the issuer to raise 
capital which could be used to replace the Treasury investment 
(although actual redemption of the preferred is not required in 
order to reduce the warrants).
    Structure of TIP/SSFI Investments. The basic structures of 
the TIP/SSFI investments were similar to the CPP forms--
Treasury acquired nonconvertible senior preferred stock paying 
cumulative dividends as well as warrants. There were 
differences in pricing-related terms (such as dividend rates, 
numbers and exercise prices of warrants and absence of the 
warrant reduction feature found in the CPP investments) as well 
as in non-pricing terms as described below. Treasury has the 
unilateral power to change the dividend rate in the AIG 
transaction, which is highly unusual.
    Structures of Comparative Transactions. The basic structure 
of the CPP investments was quite similar to the Berkshire 
Hathaway investment in Goldman Sachs. Berkshire Hathaway 
purchased cumulative perpetual preferred stock paying a fixed 
dividend, plus warrants to acquire common stock that were 
exercisable for five years. The structures used in the other 
U.S. comparative transactions were somewhat different. 
Mitsubishi purchased noncumulative convertible preferred stock. 
Noncumulative dividends do not accrue if not paid. However, 
noncumulative perpetual preferred stock can be treated as Tier 
1 capital without limit. Convertible preferred stock gives the 
holder the right to convert into common stock at a price (and 
thus realize an upside that is tied to common stock price 
appreciation as with the warrant), although it must give up the 
fixed return of the preferred stock to do so. Two of the other 
U.S. comparative transactions also involved purchases of 
noncumulative convertible preferred stock. The other two U.S. 
comparative transactions involved sales of units in which the 
investor acquired common stock and trust preferred securities. 
These latter two investments are more complex transactions that 
have certain tax advantages for the issuers, although they also 
involve acquiring a combination of a fixed return and a 
potential to realize upside in the common stock price.
    The U.K. government transactions are quite different in 
structure. The U.K. banks made open offers to their existing 
shareholders to purchase ordinary shares (the equivalent of 
common shares), and the U.K. government agreed to purchase the 
ordinary shares to the extent existing shareholders did not 
take them up, and to buy preference shares that pay 
noncumulative dividends. Because few shareholders took up the 
offers, the U.K. government purchased almost all the ordinary 
shares offered. As a result, it owns 57.9% of one of the banks 
and 43.4% of the other. The Barclays transaction involved the 
sale of three securities: perpetual reserve capital instruments 
which pay a fixed return in cash or common shares, warrants for 
common stock and mandatorily convertible notes.

    (iii) Dividends. The dividend rate on the CPP investments 
increases from 5% to 9% per annum after five years. This 
creates the potential for higher returns, and it may also 
create an incentive for the issuer to redeem the preferred 
stock. The dividend rates in the TIP/SSFI investments are 
higher to begin with and do not increase.

    (iv) Redemption and Repurchase. In order for the preferred 
stock to be treated as Tier 1 capital for regulatory purposes, 
it must be perpetual; the issuer cannot be required to redeem 
it (that is, repay Treasury) at a fixed date or upon the 
occurrence of certain events. However, the CPP forms provide 
for redemption at the option of the issuer in the first three 
years if the issuer receives proceeds from a qualified equity 
offering (essentially a sale of equity securities constituting 
Tier 1 capital for cash) equaling at least 25% of the 
investment price. After three years, the issuer can redeem at 
any time. Redemption is at par (without a premium). The absence 
of a premium, and the fact that the issuer can redeem so early, 
is not advantageous to an investor who wishes to lock in a rate 
of return (and negatively impacts the valuation of the 
securities), but it may serve a public policy objective of 
encouraging institutions to replace Treasury investment with 
private capital.
    The CPP forms also give the issuer the right to repurchase 
the warrants and any common shares acquired upon exercise of 
the warrants at fair market value once the preferred shares are 
redeemed or transferred by Treasury. (Fair market value is 
determined initially by the issuer's board of directors but is 
subject to an appraisal process if Treasury disagrees.) This 
provision is very unusual and again negatively affects 
valuation, but it may serve the public policy objective of 
encouraging replacement of the Treasury investment. It may also 
reflect past experience in U.S. government bailouts, such as in 
the Chrysler bailout when, after Chrysler recovered and paid 
off the government loans, there was debate over whether the 
government should realize a profit on the warrants it received 
or give them back to Chrysler. The repurchase right sets up a 
procedure that may avoid a similar controversy.
    The TIP/SSFI investments contain redemption provisions at 
par and a repurchase right that are similar to the CPP forms.

    (v) Covenants. The Panel requested that the legal analysis 
review the covenants included in the TARP investments from the 
standpoint of not only what was found in the comparative 
transactions, but also from the standpoint of whether there 
were provisions that addressed the public policy purposes of 
the investments. The analysis noted that that there is a wide 
range of market practice in commercial transactions when it 
comes to covenants. Wellknown, seasoned investment grade 
issuers generally face lighter covenants when raising funds in 
normal circumstances than do less credit-worthy companies. 
Covenants may also vary depending on, among other things, the 
form of the investment, the context of the transaction and the 
leverage of the investor. There are generally fewer covenants 
in purchase agreements for equity securities as compared to 
loans and other debt financing arrangements, in part because 
there is a more practical remedy for a covenant violation in a 
debt financing (the investor can call a default and accelerate 
the debt) than in an equity investment.
    The analysis summarized the covenants in the TARP 
investments as follows. Whether the covenants in any particular 
area, including those pertaining to dividends, executive 
compensation, lending and use of proceeds, are appropriate or 
adequate is a matter for the policy debate. That debate should 
consider in particular whether covenants should be more 
restrictive if the economics of the investments provide less 
than fair value to Treasury, and whether the use of standard 
forms created an inherent risk of covenants that were too 
lenient for some, as discussed earlier.

    (a) Dividend Restrictions and Stock Repurchases. The TARP 
investments include restrictions which insure the priority of 
dividends on the preferred stock that are similar to those in 
the comparative transactions. This is a standard covenant in a 
preferred stock transaction. They also include a covenant that 
prohibits increases in the dividends on common stock, which is 
not as common (none of the U.S. comparative transactions or the 
Barclays transaction has such a restriction). By contrast, the 
U.K. government transactions and the TARP investments in the 
automotive companies prohibit all dividends on common shares. 
The TARP investments also restrict repurchases of common stock, 
which can be thought of as economically equivalent to a 
dividend payment in terms of the interests of the preferred 
stock investor. These covenants are subject to exceptions. The 
covenants regarding dividends and stock repurchases are more 
restrictive in the TIP/SSFI investments than in the CPP forms, 
in that dividends are prohibited in AIG's case for five years 
and limited to $0.01 per share per quarter for up to three 
years in the case of Bank of America and Citigroup.

    (b) Executive Compensation. The CPP forms contain a 
covenant implementing the executive compensation provisions of 
EESA but do not contain more detailed restrictions or any 
reporting requirements, though Treasury has recently published 
rules to require certain reports and certifications. The TIP/
SSFI investments contain slightly more restrictive executive 
compensation covenants (which apply to a larger group of 
executives and cover more payments) and related reporting 
requirements.

    (c) Lending/Foreclosure Mitigation/Use of Proceeds. Because 
the TARP investments were made with public funds to achieve 
certain policy objectives, one must consider whether there were 
covenants directed at those policy objectives. The CPP forms 
contain recitals--introductory language--that state that the 
QFI ``agrees to expand the flow of credit to U.S. consumers and 
businesses'' and agrees to work to ``modify the terms of 
residential mortgages to strengthen the health of the U.S. 
housing market.'' However, no specific covenants concerning 
these issues were included in the CPP investments. There are 
also no covenants in the CPP investments restricting use of the 
proceeds nor any requirements to report how the funds are used. 
There are no covenants requiring the issuer to take actions 
with respect to the problems that may have led to the need for 
the Treasury investment, such as covenants to develop a 
restructuring plan (as in the U.K. transactions and the 
automotive investments), to sell certain assets, to not engage 
in or limit particular types of business, etc.
    Except for the other matters noted below, there were 
generally no other covenants or provisions in the CPP 
investments that imposed restrictions on, or required changes 
to, operations or business practices or that were directed at 
the specific public policy objectives cited by Treasury for 
making the investments. The legal report notes that the use of 
standard forms meant Treasury could not include customized 
covenants that required particular institutions to take 
particular actions that Treasury felt were desirable to improve 
strength and stability. The legal report also speculates as to 
why Treasury chose not to include general covenants directed at 
policy objectives, which may have been because Treasury 
believed that it was more important to get large numbers of 
institutions to participate in the program and such covenants 
would have discouraged participation. It could also be because 
Treasury wished to be a passive investor and exercise its 
authority as a regulator rather than an investor (which passive 
approach, as noted earlier, was also evidenced by having only 
limited voting rights, not voting the warrant shares, and not 
having board seats or board observers). It could also be that 
Treasury believed contractual covenants cannot address the 
policy objectives effectively.
    The TIP/SSFI investments contain a few more restrictions. 
In the case of the AIG investment, the proceeds were applied 
directly to pay down loans provided by the Federal Reserve 
Board of New York. In the case of the second Citigroup and 
third Bank of America investments, there are no restrictions on 
use of the proceeds but there are reporting requirements 
concerning use of the proceeds. Citigroup also agreed to 
implement the FDIC's mortgage modification program with respect 
to certain assets. All three TIP/SSFI investments contain 
covenants that pertain to policies on lobbying, governmental 
ethics, political activity and corporate expenses. There are no 
covenants on lending. Although there are no other significant 
restrictions, the analysis noted that the credit agreement 
between the Federal Reserve Bank of New York and AIG imposes 
more restrictive covenants on AIG with respect to operation of 
its business. In addition, a trust for the benefit of Treasury 
holds almost 80% of the voting equity of AIG, which gives the 
trust the ability to direct management.
    The approach taken by Treasury can be contrasted with that 
taken by the U.K. government. The U.K. banks are required to 
maintain lending to the mortgage market and to small and medium 
enterprises at their respective 2007 levels, although this is 
subject to a caveat that appears to relieve them of any 
obligation to engage in uncommercial practices. The U.K. banks 
are also required to submit restructuring plans.
    Treasury's approach can also be contrasted with what 
Treasury did in the case of the loans to the automotive 
companies, where extensive covenants restricting the companies 
were included. These included prohibitions on all dividends, 
restrictions on executive compensation, restrictions on 
material transactions outside the ordinary course of business, 
a requirement to divest corporate aircraft, reporting 
requirements, and a requirement to develop a restructuring plan 
meeting certain public policy objectives.
    While it is more common to see restrictions of this sort in 
debt financings than in preferred stock investments, one could 
take the view that the use of preferred stock for the banking 
institution investments was driven by the need to satisfy 
capital requirements, not to realize higher equity returns, and 
should not dictate the covenant package. The differences 
between the covenants in the automotive loans (and AIG credit 
facility) on the one hand versus the banking institution 
investments on the other may have been driven more by the 
overall design of the program--that is, it was a voluntary 
program intended for large numbers of ``healthy'' banks, not a 
rescue of a single institution, and it was for institutions 
which the government already regulates.

    (d) Other. The CPP forms contain a limited right of access 
to information that relies on the information received by the 
U.S. government in its capacity as regulator. The Non-Public 
QFI forms contain restrictions on affiliate transactions.

    (vi) Voting and Control Rights. All the investments provide 
that the holders of the preferred stock have the right to vote 
on amendments to the charter and certain material transactions 
if their interests could be adversely affected. These are 
customary voting rights for preferred stock, and are contained 
in the four U.S. comparative transactions in which preferred 
stock was issued as well as in the U.K. government investments. 
In addition, the investments provide that if dividends are not 
paid for six quarterly periods (in the case of the CPP) or four 
quarterly periods (in the case of the TIP/SSFI investments), 
the holders of preferred stock have the right to elect two 
directors. This is a provision that is very frequently, but not 
always, included in preferred stock investments. For example, 
Mitsubishi obtained such right but Berkshire Hathaway did not, 
and it was included in one of the other two U.S. comparative 
transactions in which preferred stock was issued. In the U.K. 
government transactions, the preference shares also obtained 
additional voting rights upon a failure to pay dividends.
    Treasury agreed not to exercise voting rights with respect 
to any common shares acquired on exercise of the warrants. This 
is a very unusual term. However, it does not apply to any 
person to whom Treasury transfers the warrants (or underlying 
shares) and thus does not affect resale value of the warrants 
or underlying shares.
    In the U.K. government transactions, the government 
obtained the contractual right to designate two or three 
directors. Because the U.K. government ended up acquiring 58% 
and 43% of the common equity of the two banks in the open 
offers, it has the practical ability to designate the entire 
board of directors without the benefit of these contractual 
provisions. In one of the U.S. comparative transactions the 
investor acquired the right to designate a director.
    The legal analysis notes that although the voting rights 
obtained by Treasury in the TARP investments are customary for 
preferred stock investments, the issue of what type of voting 
rights, or influence over management, Treasury should have in 
an investment made with taxpayer funds raises public policy 
concerns that the Panel may wish to consider. Treasury may not 
have sought greater contractual rights of influence because of 
a view that the government should exercise influence as a 
regulator but not as a shareholder.

    (vii) Transfer Restrictions. Treasury did not agree to any 
contractual restrictions on its ability to transfer the 
preferred stock or the warrants, other than agreeing not to 
transfer more than 50% of the warrants during the warrant 
reduction period. There were transfer restrictions in all the 
U.S. comparative transactions, including a five year 
restriction in the case of the Berkshire Hathaway investment in 
Goldman Sachs. Treasury also received registration rights for 
public QFIs, which facilitates its ability to resell the 
securities because such rights enable it to do so in a public 
offering, and it can require the issuer to list the preferred 
stock on a national securities exchange. Registration rights 
were granted in only three of the U.S. comparative 
transactions.

    (viii) Representations and Warranties and Conditions to 
Closing. Treasury required the issuers to make far more 
extensive representations and warranties in the purchase 
agreements than was the case in the Berkshire Hathaway deal or 
the other U.S. comparative transactions. (Representations and 
warranties assist the parties to a transaction in performing 
due diligence and in allocating risk. If an inaccuracy is 
discovered prior to closing, Treasury would have a right not to 
purchase the securities; once the securities are purchased, 
Treasury may have a claim for damages but the value of this is 
limited since it would reduce the value of the issuer.) The 
Treasury forms also impose conditions to closing including 
receipt of legal opinions and officers certificates. Although 
these are not unusual and should not be difficult to meet, they 
are not always obtained by an investor and were not included in 
the Goldman-Berkshire Hathaway transaction, for example.

    (ix) Other. The CPP forms provide that Treasury has the 
unilateral right to amend any provision of the purchase 
agreement to the extent required to comply with any changes 
after the signing date in federal statutes. This is a highly 
unusual provision that is favorable to Treasury and could be 
used, for example, to remedy deficiencies in reporting 
requirements. It is also included in the TIP/SSFI investments.

     APPENDIX V: LINK TO VALUATION REPORT OF DUFF & PHELPS TO THE 
                     CONGRESSIONAL OVERSIGHT PANEL


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