[JPRT, 111th Congress]
[From the U.S. Government Publishing Office]
CONGRESSIONAL OVERSIGHT PANEL
JUNE OVERSIGHT REPORT
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STRESS TESTING AND
SHORING UP BANK CAPITAL
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
June 9, 2009.--Ordered to be printed
Submitted under Section 125(b)(1) of Title 1 of the Emergency Economic
Stabilization Act of 2008, Pub. L. No. 110-343
CONGRESSIONAL OVERSIGHT PANEL JUNE OVERSIGHT REPORT
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CONGRESSIONAL OVERSIGHT PANEL
JUNE OVERSIGHT REPORT
__________
STRESS TESTING AND
SHORING UP BANK CAPITAL
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
June 9, 2009.--Ordered to be printed
Submitted under Section 125(b)(1) of Title 1 of the Emergency Economic
Stabilization Act of 2008, Pub. L. No. 110-343
C O N T E N T S
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Page
Executive Summary................................................ 3
Section One: Stress Testing and Shoring Up Bank Capital.......... 6
A. Overview.................................................. 6
B. The Stress Tests.......................................... 13
C. Immediate Impact of the Stress Tests...................... 27
D. A Comment on the Supervisory Process...................... 29
E. Specific Limitations of the Stress Tests.................. 30
F. Independent Analysis of Stress Tests...................... 31
G. Next Steps................................................ 35
H. Issues.................................................... 38
I. Recommendations........................................... 48
J. Conclusions............................................... 49
K. Tables.................................................... 50
Annex to Section One: The Supervisory Capital Assessment
Program:
An Appraisal................................................. 57
Section Two: Additional Views.................................... 117
Section Three: Correspondence With Treasury Update............... 131
Section Four: TARP Updates Since Last Report..................... 132
Section Five: Oversight Activities............................... 149
Section Six: About the Congressional Oversight Panel............. 151
Appendices:......................................................
Appendix I: Letter from Chair Elizabeth Warren to Federal Reserve
Chairman Ben Bernanke Regarding the Capital Assistance Program,
dated May 11, 2009............................................. 152
Appendix II: Letter from Chair Elizabeth Warren to Secretary
Timothy Geithner regarding the possibility of the Secretary
appearing before a panel hearing in June, dated May 12, 2009... 159
Appendix III: Letter from Chair Elizabeth Warren to Secretary
Timothy Geithner and Federal Reserve Chairman Ben Bernanke
regarding the Acquisition of Merrill Lynch by Bank of America,
dated May 19, 2009............................................. 161
Appendix IV: Letter from Chair Elizabeth Warren to Secretary
Timothy Geithner regarding the Temporary Guarantee Program,
dated May 26, 2009............................................. 164
JUNE OVERSIGHT REPORT
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June 9, 2009.--Ordered to be printed
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EXECUTIVE SUMMARY *
Across the country, many American families have taken a
hard look at their finances. They have considered how they
would manage if the economy took a turn for the worse, if
someone were laid off, if their homes plummeted in value, or if
the retirement funds they had been counting on shrunk even
more. If circumstances get worse, how would they make ends
meet? These families have examined their resources to figure
out if they could weather more difficult times--and what they
could do now to be better prepared. In much the same spirit,
federal banking regulators recently undertook ``stress tests''
to examine the ability of banks to ride out the financial
storm, particularly if the economy gets worse.
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* The Panel adopted this report with a unanimous 5-0 vote on June
8, 2009.
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Treasury recognized the importance of understanding banks'
ability to remain well capitalized if the recession proved
worse than expected. Thus, Treasury and the Federal Reserve
announced the Supervisory Capital Assessment Program (SCAP) to
conduct reviews or ``stress tests'' of the nineteen largest
BHCs. Together these nineteen companies hold two-thirds of
domestic BHC assets. As described by Treasury, the program is
intended to ensure the continued ability of U.S. financial
institutions to lend to creditworthy borrowers in the event of
a weaker-than-expected economic environment and larger-than-
estimated losses.
The Emergency Economic Stabilization Act of 2008 (EESA) \1\
specifically requires the Congressional Oversight Panel to
examine the Secretary of the Treasury's use of his authority,
the impact of the Troubled Asset Relief Program (TARP) on the
financial markets and financial institutions, and the extent to
which the information made available on transactions under the
TARP has contributed to market transparency. In this report,
the Panel examines the steps Treasury has taken to assess the
financial health of the nation's largest banks, the impact of
these steps on the financial markets, and the extent to which
these steps have contributed to market transparency.
Understanding the recently completed stress tests helps shed
light on the assumptions Treasury makes as it uses its
authority under EESA. As Treasury uses the results of these
tests to determine what additional assistance it might provide
to financial institutions, the tests also help determine the
effectiveness of the TARP in minimizing long-term costs to the
taxpayers and maximizing taxpayer benefits, thus responding to
another key mandate of the Panel.
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\1\ Emergency Economic Stabilization Act of 2008 (EESA), Pub. L.
No. 110-343 (hereinafter ``EESA'').
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As part of their regular responsibilities, bank examiners
determine whether the banks they supervise have adequate
capital to see them through economic reversals. Typically,
these bank supervisory examination results are kept strictly
confidential. The stress tests built on the existing regulatory
capital requirements, but, because the stress tests were
undertaken in order to restore confidence in the banking
system, they included an unprecedented release of information.
The stress tests were conducted using two scenarios: one
test based upon a consensus set of economic projections and
another test using projections based on more adverse economic
conditions. The only results that have been released are those
based on the adverse scenario. These test results revealed that
nine of the nineteen banks tested already hold sufficient
capital to operate through 2010 under the projected adverse
scenario; those banks will not be required to raise additional
capital. Ten of the nineteen banks were found to need
additional capital totaling nearly $75 billion in order to
weather a more adverse economic scenario. Those banks that need
additional capital were required to present a plan to Treasury
by June 8, 2009, outlining their plans to raise additional
capital. All additional capital required under the stress tests
must be raised by November 9, 2009, six months after the
announcement of the stress test results. Some BHCs have already
successfully raised billions in additional capital.
Like the case of the family conducting its own stress test
of personal finances, the usefulness of the bank stress test
results depends upon the methods used and the assumptions that
went into conducting the examinations. To help assess the
stress tests, the panel engaged two internationally renowned
experts in risk analysis, Professor Eric Talley and Professor
Johan Walden, to review the stress test methodology.
Based on the available information, the professors found
that the Federal Reserve used a conservative and reasonable
model to test the banks, and that the model provides helpful
information about the possible risks faced by BHCs and a
constructive way to address those risks. The criteria used for
assessing risk, and the assumptions used in calibrating the
more adverse case, have typically erred on the side of caution
and avoided many of the more dangerous simplifications present
in some risk modeling.
The professors also raised some serious concerns. They
noted that there remain unanswered questions about the details
of the stress tests. Without this information, it is not
possible for anyone to replicate the tests to determine how
robust they are or to vary the assumptions to see whether
different projections might yield very different results. There
are key questions surrounding how the calculations were
tailored for each institution and questions about the quality
of the self-reported data. It is also important to note that
the stress test scenarios made projections only through 2010.
While this time frame avoids the greater uncertainty associated
with any projection further in the future, it may fail to
capture substantial risks further out on the horizon. Based on
the testimony by Deutsche Bank at the Panel's May field
hearing, the projected rise in the defaults of commercial real
estate loans after 2010 raise concerns.
In evaluating the useful information provided by the stress
tests, as well as the remaining questions, the Panel offers
several recommendations for consideration moving forward:
The unemployment rate climbed to 9.4 percent in
May, bringing the average unemployment rate for 2009 to 8.5
percent. If the monthly rate continues to increase during the
remainder of this year, it will likely exceed the 2009 average
of 8.9 percent assumed under the more adverse scenario,
suggesting that the stress tests should be repeated should that
occur.
Stress testing should also be repeated so long as
banks continue to hold large amounts of toxic assets on their
books.
Between formal tests conducted by the regulators,
banks should be required to run internal stress tests and
should share the results with regulators.
Regulators should have the ability to use stress
tests in the future when they believe that doing so would help
to promote a healthy banking system.
The Federal Reserve Board should be commended for releasing
an unprecedented amount of bank supervisory information, but
additional transparency would be helpful both to assess the
strength of the banks and to restore confidence in the banking
system. The Panel recommends that the Federal Reserve Board
release more information on the results of the tests, including
results under the baseline scenario. The Federal Reserve Board
should also release more details about the test methodology so
that analysts can replicate the tests under different economic
assumptions or apply the tests to other financial institutions.
Transparency will also be critical as financial institutions
seek to repay their TARP loans, both to assess the strength of
these institutions and to assure that the process by which
these loans are repaid is fair.
Finally, the Panel cautions that banks should not be forced
into counterproductive ``fire sales'' of assets that will
ultimately require the investment of even more taxpayer money.
The need for strengthening the banks through capital increases
must be tempered by sufficient flexibility to permit the banks
to realize full value for their assets.
SECTION ONE: STRESS TESTING AND SHORING UP BANK CAPITAL
A. Overview
The stress test is one of the two core parts of Treasury's
Capital Assistance Program (CAP). It lays the foundation for
the second part of the CAP, the infusion of TARP funds to
support some of the nation's largest financial institutions
``as a bridge to private capital in the future.'' \2\ The
publication of the results of the stress tests involves a rare
release of supervisory information by the Federal Reserve
Board. EESA specifically requires the Panel to,
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\2\ U.S. Department of the Treasury, Treasury White Paper: The
Capital Assistance Program and its Role in the Financial Stability
Plan, at 2 (online at www.treasury.gov/press/releases/reports/
tg40_capwhitepaper.pdf) (accessed May 15, 2009) (hereinafter ``CAP
White Paper'').
Examine [the] use by the Secretary [of the Treasury]
of authority under this Act . . . [t]he impact of
purchases made under the Act on the financial markets,
and financial institutions, and [t]he extent to which
the information made available on transactions under
the [TARP] has contributed to market transparency.\3\
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\3\ EESA, supra note 1, at Sec. 125(1)(A)(i)-(iii).
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1. INTRODUCTION
A banking organization's capital is its economic
foundation. It serves as a cushion against losses and limits a
bank's ability to grow, including by limiting the degree to
which a bank can lend, how many deposits it can take, and how
it can otherwise raise funds in the capital markets. The
strength of a bank's capital is a barometer of its health, and
decreases in the strength of its capital or uncertainty about
that strength can affect the willingness of other financial
institutions to deal with it. When an individual bank's capital
is seriously depleted, it can fail. Bank failures and
uncertainty about the soundness of other banks can spread
financial contagion across a national financial system,
freezing lending, fostering uncertainty in the capital markets,
and perhaps even threatening the deposits of ordinary citizens,
although, in the United States, the deposit insurance system
managed by the Federal Deposit Insurance Corporation (FDIC)
protects against that threat.\4\ A bank's ability to lend is
directly related to its capital strength.\5\ While government
intervention has the potential to stabilize the system by
shoring up bank capital, it can also risk further scaring away
private capital by creating new forms of risk and
uncertainty.\6\
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\4\ Deposit insurance--currently set at $250,000 per account--
greatly reduces the risk of loss of deposits by individuals in banks
operating in the United States.
\5\ Congressional Oversight Panel, Testimony of Vice-President of
the Federal Reserve Bank of New York (FRBNY) Til Schuermann, Hearing on
the Impact of Economic Recovery Efforts on Corporate and Commercial
Real Estate Lending, at 2 (May 28, 2009) (online at cop.senate.gov/
documents/testimony-052809-schuermann.pdf).
\6\ Once the solvency of a bank is in question, private investors
may fear that government interference will dilute private capital or
that the government will pay below-market prices for assets. That, in
turn, can have a chilling effect on a bank's ability to attract private
capital. Perhaps in order to mitigate that chilling effect, Treasury
has signaled its intention: (1) to divest itself of the ownership
stakes it may acquire in any private firm as quickly as practical; and
(2) to exert minimal influence on day-to-day operations even if in a
position to do so. See U.S. Department of the Treasury, Statement from
Treasury Secretary Timothy Geithner Regarding the Treasury Capital
Assistance Program and the Supervisory Capital Assessment Program (May
7, 2009) (online at www.ustreas.gov/press/releases/tg123.htm).
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The danger of financial contagion surfaced early in the
financial crisis. During 2008, two large banking institutions,
IndyMac Bank ($32.01 billion in assets) \7\ and Washington
Mutual Savings and Loan ($307 billion) \8\ were taken over by
federal regulators, and three other banking institutions,
Wachovia Bank ($812.4 billion),\9\ the nation's fourth largest
commercial bank, National City Corporation ($143.7
billion),\10\ and Countrywide Financial Corporation ($211
billion) \11\ were in danger of failing when they were taken
over by other institutions at the behest of the regulators.\12\
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\7\ Federal Deposit Insurance Corporation, FDIC Establishes IndyMac
Federal Bank, FSB as Successor to IndyMac Bank, F.S.B., Pasadena,
California (July 11, 2008) (online at www.fdic.gov/news/news/press/
2008/pr08056.html).
\8\ Federal Deposit Insurance Corporation, JPMorgan Chase Acquires
Banking Operations of Washington Mutual (Sept. 25, 2008) (online at
www.fdic.gov/news//news/press/2008/pr08085.html).
\9\ Wachovia Corporation, Form 8-K (Oct. 10, 2008) (online at
www.sec.gov/Archives/edgar/data/36995/000119312508209190/d8k.htm).
\10\ PNC Financial Services Group, Inc., Form S-4 (Nov. 11, 2008)
(online at www.sec.gov/Archives/edgar/data/713676/000095012308014864/
y72384sv4.htm).
\11\ Countrywide Financial Corporation, Form 10-K (Feb. 29, 2008)
(online at www.sec.gov/Archives/edgar/data/25191/000104746908002104/
a2182824z10-k.htm) (latest asset report available).
\12\ This was in addition to the government-engineered takeover of
the investment bank Bear Stearns by JPMorgan Chase & Co., the
government-engineered takeover of Merrill Lynch by Bank of America, and
the rescue of the American International Group (AIG) by the Federal
Reserve Board and Treasury. PNC used $7.7 billion in Capital Purchase
Program (CPP) funds to aid in financing its acquisition of National
City Corporation. PNC Financial Services Group, Inc., Form 8-K (Oct.
24, 2008) (online at www.pnc.com/webapp/unsec/Requester?resource=/wcm/
resources/file/eb0fc043072db70/IR_8K_102408_NCC_Announce.pdf).
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Within two weeks after the passage of EESA, Treasury began
to make direct capital transfers ``to stabilize the financial
system by providing capital to viable financial institutions of
all sizes throughout the nation.'' The transfers were made
through various TARP programs created under the authority of
the EESA. As of June 3, $199.4 billion had been transferred to
436 banks under the TARP's Capital Purchase Program (CPP).\13\
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\13\ U.S. Department of the Treasury, Troubled Asset Relief Program
Transactions Report for Period Ending June 3, 2009 (June 5, 2009)
(online at www.financialstability.gov/docs/transaction-reports/
transactions-report-060509.pdf) (hereinafter ``June 5 TARP Transactions
Report''). An additional $69.8 billion was transferred under the TARP
to rescue AIG.
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Two institutions, Citigroup and Bank of America, have
received additional support outside of the CPP. Through the
Targeted Investment Program (TIP), Treasury purchased from
Citigroup $20 billion in preferred shares, as well as a warrant
to purchase common stock. Treasury and the FDIC also guaranteed
a pool of $306 billion of loans and securities.\14\ Bank of
America also received capital and guarantees under the TIP. It
received $20 billion in capital in exchange for preferred stock
and a warrant. Treasury and the FDIC agreed to guarantee a pool
of $118 billion in loans, in exchange for preferred stock.\15\
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\14\ U.S. Department of the Treasury, Joint Statement by Treasury,
Federal Reserve and the FDIC on Citigroup (Nov. 23, 2008) (online at
www.treas.gov/press/releases/hp1287.htm).
\15\ Board of Governors of the Federal Reserve System, Treasury,
Federal Reserve, and the FDIC Provide Assistance to Bank of America
(Jan. 16, 2009) (online at www.federalreserve.gov/newsevents/press/
bcreg/20090116a.htm).
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In early February, Treasury and the Federal Reserve Board
announced an accelerated effort to conduct comprehensive and
simultaneous reviews of the nation's 19 largest BHCs \16\--
those with more than $100 billion in assets--to determine their
ability to remain well capitalized if the recession led to
deeper than expected losses in the face of the nation's
increasing economic difficulties. The effort, formally called
the SCAP, is referred to more informally as the ``stress
tests.'' It is part of the broader CAP that is to be a primary
mechanism for direct capital assistance to the nation's largest
BHCs for the remainder of the financial crisis.
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\16\ A BHC is essentially a corporation that owns one or more
banks, but does not itself carry out the functions of a bank. The
advantage of this type of structure is that it allows the BHC to raise
capital more easily through, for instance, public offerings. Although
Federal Reserve Board regulations refer formally to BHCs as ``banking
organizations,'' the Federal Reserve Board uses the less formal
designation in the document relating to the SCAP, as does this report.
See 12 CFR Part 225, at Appendix A Sec. 1.
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While federal bank supervisors enforce various capital
requirements even in times of economic growth,\17\ SCAP
represents a special supervisory exercise tailored to the
current crisis. The term ``stress test'' itself sums up the
government's objective--to create a set of economic and
operating assumptions to see how much ``stress'' the
assumptions would place on each BHC's capital position if they
came to pass. The tests were designed to:
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\17\ A corporation's capital consists simply of the amount by which
the value of its assets exceeds the value of its obligations. See Annex
to Section One of this report. Specific capital requirements for banks,
insurance companies, securities broker-dealers, and other regulated
industries fix a level of capital above that simple margin to create a
level of safety to help ensure that the regulated companies can meet
their obligations and avoid failures that spill over into the economic
system.
evaluat[e] expected losses and [whether the stress-
tested BHCs have] the resources to absorb those losses
if economic conditions were to be more adverse than
generally expected [,] . . . determine whether an
additional capital buffer today, particularly one that
strengthens the composition of capital, is needed for
the banking organization to comfortably absorb losses
and continue lending even in a more adverse
environment.\18\
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\18\ CAP White Paper, supra note 2, at 2.
BHCs in need of a buffer have six months to raise the necessary
capital; the capital can in some cases come from additional
TARP investments made under the CAP.
The results of the stress tests were released in early May.
The Panel is devoting its June report to the details and
results of the tests for several reasons. The first is the
crucial one: the weaknesses of America's large banks, among
other things, are at the core of the financial crisis and the
breakdown in lending that was the immediate result of the
crisis; while some believe that government policies contributed
to the crisis, it is critical that government policies to deal
with this weakness are soundly conceived and well-executed.
There are several additional reasons to examine the stress
tests. These include the perspective they provide on the manner
in which the government is dealing with the country's major
lending institutions, as well as the information they have
generated about the condition of the BHCs themselves at a time
when economic conditions continue to deteriorate.
Thus, the report sets out the way the stress tests work and
the assumptions on which they rest, evaluates those assumptions
and the models used to conduct the tests, seeks to understand
the stress test results, and makes recommendations about the
future of the testing process.
2. BACKGROUND
a. Capital requirements
Capital requirements exist to protect against bank
insolvency and to reduce systemic risk. By enforcing these
requirements, regulators: (1) ensure that banks have adequate
capital to weather unexpected losses; (2) counteract market
pressures on banks to take excessive risks; (3) promote
confidence among bank investors, creditors, and counterparties;
and (4) minimize the scale and length of economic downturns.
Capital requirements also protect against what is called
``moral hazard,'' that is, the risk that a bank will take undue
risks because it believes any benefits will go to the BHC
executives and shareholders and any losses it suffers will be
covered either by deposit insurance or by the notion that the
institution will be supported with government funds rather than
allowed to fail.\19\
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\19\ Minimum capital ratios are used by banking regulators to
assign banks to one of five categories: (1) well capitalized; (2)
adequately capitalized; (3) undercapitalized; (4) seriously
undercapitalized; and (5) critically undercapitalized. Under banking
regulations, insured depository institutions falling in the last three
categories are subject to a variety of ``prompt corrective actions.''
However, BHCs are not currently subject to the prompt corrective action
regimen.
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Because the stress tests focus on the adequacy of BHC
capital, a short look at how BHC capital works is appropriate.
A BHC's capital is generally measured as the ratio of specified
core (tier 1) and supplementary (tier 2) capital elements on
the firm's consolidated balance sheet to its total assets. To
compute the tier 1 ratio, for instance, the firm's tier 1
capital elements are included in the numerator and the ``risk-
weighted'' value of its assets are included in the denominator.
For this purpose, tier 1 (core) capital is the sum of the
following capital elements: (1) common stockholders' equity;
(2) perpetual preferred stock; (3) senior perpetual preferred
stock issued by Treasury under the TARP; (4) certain minority
interests in other banks; (5) qualifying trust preferred
securities; and (6) a limited amount of other securities. Tier
2 (supplementary) capital is made up of the following capital
elements: (1) the amount of certain reserves established
against losses; (2) perpetual cumulative or non-cumulative
preferred stock; (3) certain types of convertible securities;
(4) certain types of long-, medium-, and short-term debt
securities; and (5) a percentage of unrealized gains from
certain investment assets.
The SCAP capital buffer includes a four percent tier 1
common capital ratio. Federal Reserve Board rules do not
specifically define tier 1 common capital, but this is the
element of tier 1 capital that is voting common stockholders'
equity (i.e., it excludes qualifying trust and perpetual
preferred stock, and qualifying minority interests). The
supervisors have encouraged BHCs to hold as much of their tier
1 capital in the form of common shareholder equity as possible
as this is the ``most desirable capital element from a
supervisory standpoint.'' \20\
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\20\ Board of Governors of the Federal Reserve System, BHC
Supervision Manual, at 4060.3.2.1.1.3, 1281 (Jan. 2008) (online at
www.federalreserve.gov/boarddocs/SupManual/bhc/200807/bhc0708.pdf).
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The risk-weighted assets of an institution, which form the
denominator of the capital ratio, represent the value of the
institution's assets, adjusted in some cases to reflect
possibilities that the assets will lose value after the
computation is made. For example, cash is assigned no risk
``haircut,'' because its face value cannot vary. Similar
adjustments are made for certain portions of an institution's
capital elements.\21\
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\21\ See 12 CFR Part 225, at Appendix A III.C, Appendix E, Appendix
G.
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General regulatory rules require a BHC to have a tier 1
capital ratio of four percent, and a total (tier 1 plus tier 2)
capital ratio of eight percent of the holding company's risk-
weighted assets.\22\
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\22\ See 12 CFR Part 225, at Appendix A IV.A. BHCs are also
required to maintain a leverage ratio of three percent of tier 1
capital to total capital.
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b. Efforts to shore up bank capital under the TARP
The initial method chosen by Treasury to shore up bank
capital emphasized the direct transfer of TARP funds to BHCs in
exchange for preferred stock. A special change in banking
regulations permits preferred stock purchased under the TARP to
count as tier 1 capital.\23\ It does not, however, count as
tier 1 common capital, which the banking regulators are looking
to bolster through the stress tests.\24\
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\23\ Board of Governors of the Federal Reserve System, Capital
Adequacy Guidelines: Treatment of Perpetual Preferred Stock Issued to
the United States Treasury Under the Emergency Economic Stabilization
Act of 2008, 74 Fed. Reg. 26081 (June 1, 2009) (final rule) (online at
edocket.access.gpo.gov/2009/pdf/E9-12628.pdf).
\24\ Board of Governors of the Federal Reserve System, The
Supervisory Capital Assessment Program: Overview of Results, at 2 (May
7, 2009) (online at www.federalreserve.gov/newsevents/press/bcreg/
bcreg20090507a1.pdf) (hereinafter ``SCAP Results'').
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The first set of programs--the CPP, the Systemically
Significant Failing Institutions (SSFI) program, and the TIP--
followed that model. While the CPP was described as the
``Healthy Banks Program,'' it was in fact targeted at a broader
range of banks. In contrast, the SSFI program and the TIP
targeted institutions in financial distress.\25\
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\25\ In addition to equity purchases, which are designed to shore
up the capital position of troubled institutions, Treasury's strategy
includes programs that directly address the assets affecting bank
balance sheets. One of the primary reasons banks are currently
constrained in their ability to lend to creditworthy borrowers is that
they have a number of assets on their books that have lost, or could
lose, substantial value. In effect, they are conserving funds to cover
these losses (and thereby limiting the availability of credit in the
economy). The Public-Private Investment Program (PPIP) is basically
designed to get these bad or ``toxic'' assets off the banks'' balance
sheets. Under the program, a number of investment funds will be created
with a combination of TARP funds and private capital; these funds will
then buy existing, bad assets from banks. There will be two kinds of
investment funds under PPIP: one backed by FDIC guarantees that will
purchase legacy loans; another that will be able to borrow from the
Federal Reserve Board in order to purchase legacy securities. The FDIC
recently announced it would postpone the implementation of the legacy
loans program, and it is not yet clear when this program will be put
into effect. Federal Deposit Insurance Corporation, FDIC Statement on
the Status of the Legacy Loans Program (June 3, 2009) (online at
www.fdic.gov/news/news/press/2009/pr09084.html) (hereinafter ``FDIC
Loans Program Statement''). Another part of Treasury's strategy is the
Term Asset-Backed Securities Loan Facility (TALF), a joint program
between Treasury and the Federal Reserve Board. Through the TALF, the
Federal Reserve Board provides loans to investors that are secured by
newly-issued, asset-backed securities (that are surrendered to the
Federal Reserve Board if the borrower defaults). In case of default,
Treasury buys the surrendered securities from the Federal Reserve
Board, in effect guaranteeing a certain amount of losses the Federal
Reserve Board potentially faces.
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In February 2009, Secretary of the Treasury Geithner
introduced the CAP as a key component of the new
Administration's Financial Stability Plan.\26\ The CAP has two
fundamental components. The CAP introduces a new, additional
mechanism for Treasury to make capital infusions. In exchange
for capital injections through the CPP, Treasury generally
receives preferred stock and warrants to purchase common stock.
In exchange for capital injections through the CAP, Treasury
will receive mandatory convertible preferred securities (i.e.,
securities that the recipient bank can convert into common
equity), as well as warrants to buy additional common stock of
the institution receiving the infusion.\27\ Through conversion,
recipient banks will be able to increase their tier 1 common
capital position as necessary if economic conditions
deteriorate. The ability to convert preferred stock to common
equity is intended to help institutions weather continued
turbulence, but it also increases taxpayer risk without adding
any new capital to the banks, since the conversion is
essentially a reorganization of a BHC's capital structure
moving the former preferred stockholders to a lower priority of
payment in the event the BHC is liquidated.
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\26\ U.S. Department of the Treasury, Fact Sheet: Financial
Stability Plan (online at www.financialstability.gov/docs/fact-
sheet.pdf) (accessed May 15, 2009) (hereinafter ``Financial Stability
Plan Fact Sheet''); U.S. Department of the Treasury, U.S. Treasury
Releases Terms of Capital Assistance Program (Feb. 25, 2009) (online at
www.ustreas.gov/press/releases/tg40.htm).
\27\ Financial Stability Plan Fact Sheet, supra note 26, at 3. The
issuance of warrants to purchase common stock in any financial
institution receiving assistance under the TARP is required by EESA,
supra note 1, at 114(d).
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The other component of the CAP, and the basis upon which
decisions regarding the need for capital infusions will be
made, is the stress tests under the SCAP. The stress tests are
essential to the CAP because they allow regulators to determine
which institutions may need additional capital over the next
two year period and require the institutions that may need more
capital to obtain that capital now. Equally important, they
increase the level and composition of the capital required,
building banks' capital buffers ``to ensure the continued
ability of U.S. financial institutions to lend to creditworthy
borrowers in the face of a weaker than expected economic
environment and larger than expected potential losses.'' \28\
---------------------------------------------------------------------------
\28\ CAP White Paper, supra note 2, at 1.
---------------------------------------------------------------------------
The stated purpose of CPP infusions is to build up the
capital bases of BHCs so they can continue lending.\29\ CAP
infusions are specifically aimed at increasing capital
buffers--in some cases beyond existing regulatory
requirements--to safeguard against worse-than-expected economic
conditions.\30\ It is not yet clear, however, exactly how that
more focused objective will affect Treasury's criteria for
selecting recipients of infusions under the CAP.\31\
Nonetheless, what is clear is that Treasury is no longer
applying the same approach toward all BHCs (or at least those
not in danger of imminent collapse), as it did in its initial
rounds of CPP infusions. Instead, Treasury is seeking to
distinguish BHCs with weak capital positions from BHCs with
strong capital positions so that it can tailor its actions
accordingly.
---------------------------------------------------------------------------
\29\ U.S. Department of the Treasury, Treasury Releases March
Monthly Bank Lending Survey (May 15, 2009) (online at www.treas.gov/
press/releases/tg135.htm).
\30\ The bank supervisors will also require CAP applicants to
submit a plan for how they intend to use taxpayer funds. This
requirement did not exist for CPP infusions.
\31\ The Panel has called on Treasury to be clearer about its
criteria for selecting TARP recipients since its first report in
December 2008. See Congressional Oversight Panel, Questions About the
$700 Billion Emergency Economic Stabilization Funds, at 4-8 (Dec. 10,
2008) (online at cop.senate.gov/reports/library/report-121008-cop.cfm).
---------------------------------------------------------------------------
The key to the CAP is the effort to measure bank capital,
through the stress tests, and then to shore up that capital
before more is needed. It is to the stress tests themselves
that the report now turns.
B. The Stress Tests
1. PURPOSE
According to the bank supervisors, and in some cases only
after very large infusions of capital by the U.S. taxpayer,
most U.S. banks now have capital levels in excess of the
amounts required under banking rules, though in the case of
Citigroup and Bank of America among others, only after large
infusions of capital and even larger asset guarantees from the
federal government through the TARP.\32\ Nonetheless, the
realized and prospective losses created by the financial crisis
and the impact of the country's economic condition on banks'
revenues have substantially reduced, and are expected to
further reduce, the capital of some major banks. Falling
capital levels at major banks can lead to a broad loss of
confidence in bank solvency, particularly if there is a lack of
clear information as to the financial condition of the major
banks. Loss of confidence can become a self-fulfilling
prophecy, leading to the reluctance of banks to lend to one
another (a key component of the banking system's operation),
causing individual banks to tighten credit by cutting back on
lending in general, and forcing regulators to pump funds into
one bank or BHC after another on an ad hoc basis.
---------------------------------------------------------------------------
\32\ Board of Governors of the Federal Reserve System, The
Supervisory Capital Assessment: Design and Implementation, at 3 (Apr.
24, 2009) (online at www.federalreserve.gov/newsevents/speech/
bcreg20090424a1.pdf) (hereinafter ``SCAP Design Report''). Views that
major U.S. banks are not in fact well capitalized lie at the heart of
disputes about the health of the nation's financial system. These
disputes are discussed further in Part H of Section One of this report.
---------------------------------------------------------------------------
Treasury has described the stress testing program as a
response to these threats. First, it looks ahead, to build up
bank capital in advance to provide additional levels of
protection against future potential losses. Second, by
providing clear statements of the prospective condition of the
BHCs tested--a departure from the past practice of keeping
supervisory examination results strictly confidential--Treasury
sought to restore confidence in the nation's largest banking
organizations. Ultimately, stress testing has the potential to:
(1) establish confidence that BHCs with weaker capital
positions will be better equipped to weather future turbulence;
and (2) signal to the capital markets that some BHCs have
strong capital positions.
2. THE ENTITIES TESTED
The SCAP applied exclusively to the 19 largest BHCs.\33\
Treasury and the Federal Reserve Board state that they believe
that those institutions, which the agencies estimate hold
approximately two-thirds of domestic BHC assets and over one-
half of the loans in the U.S. banking system, must be strong if
the ``banking system [is] to play its role in supporting a
stronger, faster, and more sustainable economic recovery.''
\34\ (The regulators have announced that they do not intend to
conduct stress tests for smaller BHCs, stating in joint
comments on the results of the stress tests that ``smaller
financial institutions generally maintain capital levels,
especially common equity, well above regulatory capital
standards.'' Regulators should nevertheless continue to closely
monitor capital levels at the smaller institutions as part of
the supervisory process, especially in light of the failures of
small banks that have already occurred.\35\)
---------------------------------------------------------------------------
\33\ Id. at 1.
\34\ SCAP Results, supra note 24, at 5; SCAP Design Report, supra
note 32, at 4 (``This capital buffer should position the largest BHCs
to continue to play their critical role as intermediaries, even in a
more challenging economic environment.''). Among the BHCs subject to
the stress tests were several companies that had recently concluded
significant mergers or acquisitions, including acquisitions of troubled
institutions with the potential to impact the capital reserves of the
BHCs participating in the stress tests. This group included: (1) Bank
of America, which acquired Merrill Lynch in September 2008 and had
purchased Countrywide Financial earlier last year; (2) JPMorgan Chase,
which bought Bear Stearns and Washington Mutual; (3) Wells Fargo, which
currently holds Wachovia; and (4) PNC, which acquired National City
Bank.
\35\ See Parts C and H of Section One of this report; Robert B.
Albertson, Stress Test Consequences, Sandler O'Neill Partners (May 11,
2009) (online at www.sandleroneill.com/pdf/financials_051109.pdf)
(hereinafter ``Stress Test Consequences''). Fifty-one banks have failed
since September 2008. Federal Deposit Insurance Corporation, Failed
Bank List (June 4, 2009) (online at www.fdic.gov/bank/individual/
failed/banklist.html).
---------------------------------------------------------------------------
While the majority of institutions to whom stress tests
were applied are traditional BHCs, several others are not. Two
of the largest ones, Goldman Sachs and Morgan Stanley, are
investment banking organizations that became BHCs in September
2008, at the height of the financial crisis, in order to access
the increased capital that BHCs can obtain from the Federal
Reserve Banks. However, the primary activity of these companies
remains investment rather than commercial banking.\36\ The
credit card company American Express and the former financial
services arm of General Motors, GMAC, also converted to BHCs
for similar reasons in November and December of 2008,
respectively, and qualified for the stress tests based on their
total assets at the end of 2008.\37\ In addition, the insurance
company MetLife qualified as one of the largest BHCs, having
become a BHC in 2001.\38\ Of course, by becoming BHCs, these
institutions subjected themselves to the more stringent capital
requirements that apply to banks and to which they were not
previously subject.
---------------------------------------------------------------------------
\36\ Board of Governors of the Federal Reserve System, Press
Release (Sept. 21, 2008) (online at www.federalreserve.gov/newsevents/
press/bcreg/20080921a.htm) (approving the applications of Goldman Sachs
and Morgan Stanley to become BHCs).
\37\ Board of Governors of the Federal Reserve System, Press
Release (Nov. 10, 2008) (online at www.federalreserve.gov/newsevents/
press/orders/20081110a.htm) (approving the application of American
Express to become a BHC); Board of Governors of the Federal Reserve
System, Press Release (Dec. 24, 2008) (online at
www.federalreserve.gov/newsevents/press/orders/20081224a.htm)
(approving the application of GMAC to become a BHC).
\38\ Board of Governors of the Federal Reserve System, Order
Approving Formation of a Bank Holding Company and Determination on a
Financial Holding Company Election, at 7 (Feb. 12, 2001) (online at
www.federalreserve.gov/boarddocs/press/BHC/2001/20010212/
attachment.pdf).
---------------------------------------------------------------------------
The 19 BHCs taking part in the stress tests as part of the
CAP have already been the recipients of $217 billion in
assistance through various TARP programs. These include the
CPP, and, in the case of Citigroup and Bank of America, the
TIP, and, in the case of GMAC, the Automotive Industry
Financing Program,\39\ although it should be noted that there
are reports indicating that not all of them actively sought
such funds.\40\ (MetLife was the only BHC that participated in
the stress test that has not received TARP aid.) In addition,
Bank of America and Citigroup have received government
guarantees on pools of their assets--totaling up to $97.2
billion in the case of Bank of America and up to $244.8 billion
for Citigroup.\41\ A significant share of the preferred stock
that Treasury purchased in Citigroup is expected to be
converted to common equity in order to strengthen that
company's capital structure.\42\
---------------------------------------------------------------------------
\39\ See June 5 TARP Transactions Report, supra note 13. See also
Part J of Section Two of this report.
\40\ See, e.g., Damian Paletta, et al., At Moment of Truth, U.S.
Forced Big Bankers to Blink, Wall Street Journal (Oct. 15, 2008)
(online at online.wsj.com/article/SB122402486344034247.html).
\41\ U.S. Department of the Treasury, Summary of Terms: Eligible
Asset Guarantee (Jan. 15, 2009) (online at www.treas.gov/press/
releases/reports/011508bofatermsheet.pdf) (hereinafter ``Bank of
America Asset Guarantee'') (granting a $118 billion pool of Bank of
America assets a 90 percent federal guarantee of all losses over $10
billion, the first $10 billion in federal liability to be split 75/25
between Treasury and the FDIC and the remaining federal liability to be
borne by the Federal Reserve Board); U.S. Department of the Treasury,
Summary of Terms: Eligible Asset Guarantee (Nov. 23, 2008) (online at
www.treasury.gov/press/releases/reports/cititermsheet_112308.pdf)
(hereinafter ``Citigroup Asset Guarantee'') (granting a 90 percent
federal guarantee on all losses over $29 billion of a $306 billion pool
of Citigroup assets, with the first $5 billion of the cost of the
guarantee borne by Treasury, the next $10 billion by FDIC, and the
remainder by the Federal Reserve Board). See also 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) (hereinafter ``Final Citi Guarantee Terms'')
(reducing the size of the asset pool from $306 billion to $301
billion).
\42\ U.S. Department of the Treasury, Treasury Announces
Participation in Citigroup's Exchange Offering (Feb. 27, 2009) (online
at www.financialstability.gov/latest/tg41.html).
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3. HOW THE STRESS TESTS WORKED
a. Overview
The stress tests first estimated the losses that the 19
BHCs would likely suffer between now and the end of 2010 based
on specified economic assumptions, resulting from:
debtors defaulting on loans the BHCs had
made to them;
decreases in value in the securities the
BHCs held as investments;
(for the BHCs with large securities trading
businesses) losses on the trading of securities; \43\
and
---------------------------------------------------------------------------
\43\ These calculations included (under accepted accounting rules)
the results of other entities and businesses that the BHCs had recently
acquired.
---------------------------------------------------------------------------
the impact of revenues of falling
transactional volume on a fixed cost base, such as in
the credit card market.
The tests then projected how much capital each BHC would
have after absorbing the estimated losses, at the end of 2010.
It was at this point that the supervisors determined the need
for a capital buffer. If the test resulted in tier 1 capital
being less than six percent of risk-weighted assets, or tier 1
common capital being less than four percent for a particular
institution, that institution was required to obtain additional
capital by November 2009.\44\
---------------------------------------------------------------------------
\44\ U.S. Department of the Treasury, Joint Statement by Secretary
of the Treasury Timothy F. Geithner, Chairman of the Board of Governors
of the Federal Reserve System Ben S. Bernanke, Chairman of the Federal
Deposit Insurance Corporation Sheila Bair, and Comptroller of the
Currency John C. Dugan: The Treasury Capital Assistance Program and the
Supervisory Capital Assessment Program (May 6, 2009) (online at
www.ustreas.gov/press/releases/tg121.htm). The various general
components of capital are described supra.
---------------------------------------------------------------------------
The process builds on existing regulatory and accounting
requirements \45\ and does not introduce new measures of risk
or change the way banks' risk is measured. The tests were
affected only to a limited extent by new accounting rules.
Recent accounting guidance that allows more flexibility in
calculating the value of securities portfolios \46\ was not
taken into account in estimating losses. \47\ On the other
hand, accounting rules not yet in effect that will require off-
balance sheet assets (such as special-purpose vehicles formed
to securitize banks' assets) to be brought onto banks' balance
sheets were treated as already in effect, resulting in a more
conservative calculation.\48\
---------------------------------------------------------------------------
\45\ This issue is discussed supra in Part A of Section One of this
report. See also 12 CFR Part 225, at Appendix E Sec. 4(b)(3).
\46\ Financial Accounting Standards Board, Determining Fair Value
When the Volume and Level of Activity for the Assets or Liability Have
Significantly Decreased and Identifying Transactions That Are Not
Orderly (Apr. 9, 2009) (FSP FAS 157-4) (online at www.fasb.org/cs/
BlobServer ?blobcol=urldata &blobtable=MungoBlobs
&blobkey=id&blobwhere= 1175818748755 &blobheader= application%2Fpdf)
(hereinafter ``FASB Fair Value Staff Position''); Financial Accounting
Standards Board, Recognition and Presentation of Other-Than-Temporary
Impairments (Apr. 9, 2009) (FSP FAS 115-2 and FAS 124-2) (online at
www.fasb.org /cs/BlobServer ?blobcol=urldata &blobtable=
MungoBlobs&blobkey= id&blobwhere= 1175818748856 &blobheader=
application%2Fpdf).
\47\ The accounting guidance did affect the reduction in estimated
capital required for those BHCs whose first quarter performance
exceeded original estimates, but the aggregate impact of the accounting
change appears to be limited. See further discussion later in this
report, infra note 79.
\48\ Financial Accounting Standards Board, Briefing Document: FASB
Statement 140 and FIN 46 (May 18, 2009) (online at www.fasb.org/news/
051809_fas140_ and_ fin46r.shtml); SCAP Results, supra note 24, at 16.
---------------------------------------------------------------------------
In estimating the losses, the banking supervisors took a
``horizontal'' approach, with specialized teams of personnel
assessing losses with respect to the same asset classes across
all institutions, in order to ensure that comparable assets
were valued the same way (or that differences were consistently
and rationally applied) for each BHC.\49\
---------------------------------------------------------------------------
\49\ Id. at 4.
---------------------------------------------------------------------------
b. Economic assumptions
The process used two sets of economic assumptions to create
the scenarios against which BHCs were ``stress tested.'' These
were: a ``baseline'' scenario that assumed that economic
conditions during 2009 and 2010 would follow the February 2009
``consensus estimate'' of those conditions and a ``more
adverse'' scenario that assumed that those conditions would be
worse.
The two scenarios used different assumptions for the
following macroeconomic metrics: real Gross Domestic Product
(GDP) growth, unemployment rate, and housing price changes.
FIGURE 1: ECONOMIC SCENARIOS: BASELINE AND MORE ADVERSE ALTERNATIVES
\50\
------------------------------------------------------------------------
2009 2010
------------------------------------------------------------------------
Real GDP Growth:
Average baseline \51\......................... -2.0 -2.1
Consensus Forecasts....................... -2.1 2.0
Blue Chip................................. -1.9 2.1
Survey of Professional Forecasters........ -2.0 2.2
Alternative more adverse...................... -3.3 0.5
Civilian unemployment rate: \52\
Average baseline.............................. 8.4 8.8
Consensus forecasts....................... 8.4 9.0
Blue Chip................................. 8.3 8.7
Survey of Professional Forecasters........ 8.4 8.8
Alternative more adverse...................... 8.9 10.3
House Prices: \53\
Baseline...................................... -14 -4
Alternative more adverse...................... -22 -7
------------------------------------------------------------------------
\50\ SCAP Design Report, supra note 32, at 6.
\51\ Baseline forecasts for real GDP growth and the unemployment rate
equal the average of the projections released by Consensus Forecasts,
Blue Chip, and Survey of Professional Forecasters in February.
\52\ Unemployment data is collected monthly; the rates used here are
projected averages for the year.
\53\ Percent change in the Case-Shiller 10-City Composite index from the
fourth quarter of the previous year to the fourth quarter of the year
indicated.
As noted above, the baseline scenario was based on
consensus economic forecasts available in February 2009, and
the adverse scenario was projected from that baseline. As
further discussed below, there was some criticism that both
sets of assumptions were too optimistic at the time, and there
was additional criticism when the economy deteriorated further
after the SCAP exercise began.\54\ The final SCAP results were
primarily reported on the basis of the ``more adverse''
scenario. While the Federal Reserve Board's paper on the
methodology of the SCAP states that ``[p]rojections under two
alternative scenarios allow for analysis of the sensitivity of
a firm's business to changes in economic conditions,'' \55\ it
is not clear whether, with only one set of data, there is
sufficient information for analysts to run their own models
based on alternative macroeconomic assumptions.
---------------------------------------------------------------------------
\54\ See, e.g., Ari Levy. `Stress Testing' for U.S. Banking
Industry May Not Live Up to Name, Bloomberg (Feb. 26, 2009) (online at
www.bloomberg. com/apps/news?pid=20601110&sid =a.DoUvyCa0cE); John W.
Schoen, Bank `Stress Test' Draws Fire From Critics, MSNBC (Apr. 24,
2009) (online at www.msnbc.msn.com/id/30368110); Nouriel Roubini,
Stress Testing the Stress Test Scenarios: Actual Macro Data Are Already
Worse than the More Adverse Scenario for 2009 in the Stress Tests. So
the Stress Tests Fail the Basic Criterion of Reality Check Even Before
They Are Concluded (Apr. 13, 2009) (online at www.rgemonitor.com/
roubini_ monitor/256382/stress_ testing_ the_ stress_ test_ scenarios_
actual_ macro_ data_ are_ already_ worse_ than_ the_ more_ adverse_
scenario_ for_ 2009_ in_ the_ stress_ tests_ so_ the_ stress_ tests_
fail_ the_ basic_ criterion_ of_ reality_ check_ even_ before_ they_
are_ concluded). See also Part H of Section One of this report.
\55\ SCAP Design Report, supra note 32, at 5.
---------------------------------------------------------------------------
While the stress tests assumed stronger BHC future earnings
than the International Monetary Fund (IMF) has projected, the
tests adopted loan loss assumptions that were more conservative
than those used in the IMF model.\56\ The differences between
various projections are summarized in Figure 2.
---------------------------------------------------------------------------
\56\ See generally Douglas J. Elliot, Implications of the Bank
Stress Tests, Brookings Institution, at 8-9 (May 11, 2009) (online at
brookings.edu//media/Files/rc/papers/2009/0511_ bank_ stress_ tests_
elliott/0511_ bank_ stress_ tests_ elliott.pdf).
FIGURE 2: ALTERNATIVE ECONOMIC ASSUMPTIONS
--------------------------------------------------------------------------------------------------------------------------------------------------------
Baseline More adverse IMF projections \57\ Current data \58\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Metric 2009 2010 2009 2010 2009 2010 (Most recent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
GDP Growth........................................................ -2.0 2.1 -3.3 0.5 -2.8 0.0 -5.7 \59\
Unemployment...................................................... 8.4 8.8 8.9 10.3 8.9 10.1 9.4 \60\
--------------------------------------------------------------------------------------------------------------------------------------------------------
\57\ International Monetary Fund, World Economic Outlook: Crisis and Recovery, at 65 (Apr. 2009) (online at www.imf.org/external/pubs/ft/weo/2009/01/pdf/
text.pdf).
\58\ Because the baseline and adverse scenarios are projected as annual averages, they are not directly comparable to monthly or quarterly data.
\59\ First quarter 2009, percent change from preceding quarter in chained 2000 dollars (preliminary figure). U.S. Department of Commerce, Bureau of
Economic Analysis, Gross Domestic Product, 1st quarter 2009 (preliminary) (May 29, 2009) (online at www.bea.gov/newsreleases/national/gdp/2009/
gdp109p.htm) (hereinafter ``Gross Domestic Product''). This figure is up from the 6.3 percent decline in the fourth quarter of 2008. Id.
\60\ U.S. Department of Labor, Bureau of Labor Statistics, The Employment Situation: May 2009 (June 5, 2009) (USDL 09-0588) (online at www.bls.gov/
news.release/pdf/empsit.pdf) (hereinafter ``Employment Situation''). This figure is the unemployment rate through April 2009, the last month for which
data is available. The year-to-date average unemployment rate stands at 8.5 percent. See id. at 10.
The stress-tested BHCs were told to adapt the scenarios'
macroeconomic assumptions to their specific business activities
when projecting their own losses and resources over 2009 and
2010. This process included adapting assumptions for housing
price changes to account for local conditions, and, where the
BHCs had international operations, adjusting the assumption
that international conditions would be as bad as those assumed
for the United States. In making these adaptations, the
institutions were encouraged to make additional appropriate
assumptions of macroeconomic conditions based on the three
governing metrics, and several BHCs developed their own
assumptions as to interest rates, yield curves, etc.
c. Loan loss projections
The BHCs were instructed by the supervisors to estimate
losses from failure to pay obligations through the end of 2012
for 12 separate loan categories,\61\ based on the value of the
loans shown on the BHCs' books at the end of 2008. Accounting
and banking rules require that banks carry loans on their books
at their unpaid principal amount, reduced by a percentage
reflecting the credit history of the borrower and the general
risk of nonpayment for loans of the particular type. The
remaining principal amount, less these provisions, is the
amount that a BHC shows as assets on its balance sheet. Loans
are not ``marked-to-market,'' that is, they are not revalued by
estimating what a BHC could receive for those loans if it sold
them. Thus, the losses the BHCs were required to estimate were
losses arising from borrowers' failure to pay their
obligations, not losses arising from a drop in market value of
existing loans, and the use of a different valuation method for
these loans might have resulted in a rather different estimate
of the required capital buffer.\62\
---------------------------------------------------------------------------
\61\ These categories were: first lien (1) prime, (2) Alt-A, and
(3) subprime mortgages; (4) closed-end junior liens; (5) home equity
lines of credit; (6) commercial & industrial loans; commercial real
estate (7) construction, (8) multifamily, and (9) non-farm, non
residential loans; (10) credit card loans; (11) other consumer loans;
and (12) other loans. SCAP Design Report, supra note 32, at 18.
\62\ See Part H of Section One of this report.
---------------------------------------------------------------------------
With respect to this method of valuation of loans, see
commentary in the Panel's April Oversight Report:
Treasury has not explained its assumption that the
proper values for these assets are their book values--
in the case, for example, of land or whole mortgages--
and more than their ``mark-to-market'' value in the
case of ABSs, CDOs, and like securities; if values fall
below those floors, the banks involved may be insolvent
in any event.\63\
---------------------------------------------------------------------------
\63\ Congressional Oversight Panel, April Oversight Report:
Assessing Treasury's Strategy: Six Months of TARP, at 75 (Apr. 7, 2009)
(online at cop.senate.gov/reports/library/report-040709-cop.cfm)
(hereinafter ``Panel April Oversight Report'').
In assessing their loan losses, the BHCs were told to add
to their loan inventory potential additional loans that could
result from the drawing down of existing credit lines by
borrowers, and to add to their balance sheets liabilities held
in ``special purpose vehicles'' (SPVs) that had previously been
excluded from capital calculations and that might have to be
taken back onto the balance sheets in a stressed economic
environment or due to accounting changes.\64\ It should be
noted that the unanticipated on-boarding of off-balance sheet
assets played a significant role in the current financial
crisis,\65\ and with consumer defaults rising, on-boarding SPVs
might be expected to account for a large proportion of
estimated losses. The proportion of estimated losses due to on-
boarding SPVs was not disclosed by the supervisors.
---------------------------------------------------------------------------
\64\ SCAP Results, supra note 24.
\65\ See, e.g. Citigroup Inc., Citigroup's 2008 Annual Report on
Form 10-K, at 6-18 (online at www.citigroup.com/citi/fin/data/
k08c.pdf?ieNocache=677).
---------------------------------------------------------------------------
Against this expanded loan inventory, BHCs were required to
estimate their losses in each of the 12 loan categories under
both scenarios. The banking supervisors provided the BHCs with
a range of indicative two-year cumulative loss rates for each
category and each scenario to guide their projections. For
example, the supervisors provided an indicative loan loss rate
of 7-8.5 percent for first lien mortgages in the more adverse
scenario. The BHCs adapted this guidance to their particular
situations to estimate the loan losses they would suffer in
each category of loans under each scenario. These estimates
were provided to supervisors. In addition, the BHCs were
required to provide granular data about the particular
characteristics of their portfolios (such as underwriting
practices, FICO scores and refreshed LTV information) so that
the supervisors could assess the reasonableness of the BHCs'
loan loss estimates. BHCs were permitted to predict loss rates
outside the indicative ranges if they could provide strong
supporting evidence for the deviation, especially if their loan
loss estimate fell below the range minimum. Therefore, in
certain categories and scenarios some BHCs estimated that their
loan loss rates would be above the indicative range, while
others ended up making estimates that fell below the range.
Using the data presented by the BHCs, the supervisors made
their own estimates of loan losses on an asset-class-by-asset-
class basis, comparing loss projections for similar asset
classes across institutions so that, for example, losses with
respect to subprime loans in a particular area originated in a
particular period would be estimated at the same rate for
different BHCs, even if those BHCs' own estimates differed.
Therefore, a divergence in loss rates between BHCs in a given
category of loans should indicate differences in portfolios,
not differences in the BHCs' own estimates. Each BHC's loss
estimates ultimately relied on portfolio-specific data
regarding past performance, origination year, borrower
characteristics and geographic distribution. These differences
led to significant variation between BHCs in the ultimate loan
loss estimates used by supervisors. For example, Capital One's
estimated loss rate for first lien mortgages was 10.7 percent
and BB&T Corporation's rate was 4.5 percent.\66\
---------------------------------------------------------------------------
\66\ SCAP Results, supra note 24, at 21, 23.
---------------------------------------------------------------------------
d. Projections of losses on securities
The BHCs were also required to estimate the losses that
their securities portfolios would suffer through 2010 under
both economic scenarios.
The way securities are valued on a BHC's balance sheet
differs from the way loans are treated and depends on what the
BHC intends to do with those securities. Securities may be
categorized as: (1) ``held to maturity'' (HTM); (2) trading,
that is, held for sale in the near future; or (3) ``available
for sale'' (AFS). Securities held to maturity are carried on
the BHC's balance sheet at ``amortized'' cost (roughly,
principal minus repayments), with that value further reduced if
the value of the security is considered subject to ``other than
temporary impairment'' (OTTI). Securities available for sale or
in the trading portfolio are carried at ``fair value,'' which
means market value if there is a trading market for them, or at
a value estimated by the BHC if there is not.\67\
---------------------------------------------------------------------------
\67\ ``Fair value'' is established in accordance with accounting
rules. Where there is a market for the securities, that market value is
used. Where the market is illiquid, the rules permit the owner to use
other inputs to establish a price for its securities, taking into
account current market pricing and conditions. In the recent market
turmoil, the need to take market conditions into account in creating
valuation models for their securities meant that some institutions had
to realize significant losses on their portfolios of securities such as
mortgage-backed ABSs, even though those securities were still
continuing to generate cash flow. In response to this situation, the
accounting authorities released guidance in April 2009, that permitted
more flexibility in the valuation of securities for which there was no
liquid market. FASB Fair Value Staff Position, supra note 46. This
guidance applied to financial statements for periods after June 15,
2009, with an early-adoption provision for periods ending no earlier
than March 15, 2009. Thus, the BHCs' financial statements for the year
ending December 31, 2008, were not affected by the April FASB guidance.
---------------------------------------------------------------------------
All 19 BHCs were instructed to estimate possible impairment
with respect to net unrealized losses on securities that they
categorized as held to maturity and securities that they
classified as available for sale under both scenarios. For this
analysis, securities carried at fair value were marked to
market as of December 31, 2008. Since a loss from impairment
when a security is marked down is recorded on the BHC's income
statement as a charge to income, the BHCs were also told to
estimate the decrease in income that would result from these
devaluations.\68\
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\68\ SCAP Design Report, supra note 32, at 8. In deciding which
securities should be treated as having suffered an OTTI and thus need
to be revalued at fair value as of December 31, 2008, the supervisors
took a conservative approach in the more adverse scenario, in that BHCs
were required to take into account the possibility that in adverse
economic conditions they might not be able to hold all their HTM
securities until they matured, and may need to sell them before
recovery of their cost basis. The total impact of this requirement was
small, as most HTM securities in the BHCs' portfolios were low-risk
Treasury securities and the like, but this approach illustrates the
conservative approach taken by the supervisors.
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The recent FASB guidance on establishing ``fair value'' in
illiquid markets, which gave BHCs greater flexibility in
valuing securities, was not taken into account in estimating
losses under the more adverse scenario in order to reflect
greater uncertainty about realizable losses in stressful
conditions.\69\ (The FASB guidance was taken into account in
estimating losses in the baseline scenario, but the baseline
scenario results were not published.) \70\
---------------------------------------------------------------------------
\69\ Critics have argued that the principal effect of the FASB rule
change would be to allow BHCs to simply avoid recording decreases in
the value of their assets, undermining investor confidence and perhaps
prolonging the crisis. See, e.g., House Committee on Financial
Services, Subcommittee on Capital Markets, Insurance and Government
Sponsored Enterprises, Testimony of Executive Director of the Center
for Audit Quality Cynthia Fornelli, Mark-to-Market Accounting: Problems
and Implications, 111th Cong. (Mar. 12, 2009) (online at www.house.gov/
apps/list/hearing/financialsvcs_dem/fornelli031209.pdf). In other
words, the rule change may allow BHCs that are actually insolvent to
continue operating, a situation analogous to Japan's elimination of
mark-to-market accounting early in its so-called ``Lost Decade.'' Id.
However, this debate largely turns on the question of whether the
fundamental problem facing the financial system is one of liquidity or
valuation.
\70\ SCAP Design Report, supra note 32, at 14.
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BHCs with trading securities of $100 billion or more--Bank
of America, Citigroup, Goldman Sachs, JP Morgan Chase, and
Morgan Stanley--were asked to provide projections of trading-
related losses for the more adverse scenario, including losses
from their ``counterparty'' exposure risk with regard to credit
default swap and similar transactions. To calculate these
losses, the BHCs conducted a stress test of their trading book
positions and counterparty exposures as of market close on
February 20, 2009. BHCs were told to disclose the positions
that they included in this analysis, the risk factors that were
stressed, and the changes in variables that they used (such as
changes in interest rates, spreads, exchange rates, etc.).\71\
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\71\ The estimates of losses took into account the severe market
stresses that occurred between June 30, 2008 and December 31, 2008.
This process goes beyond usual mark-to-market rules and, in requiring
the use of data from the most stressed markets in recent decades, might
be termed ``mark to mayhem.''
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As with estimates of loan losses, the supervisors made
their ultimate estimates of losses from securities portfolios
using the estimates provided by the BHCs and applying
``horizontal testing'' across asset classes to ensure
consistency.
e. Resources available to absorb losses
In addition to drawing on their capital, banks can absorb
losses with offsetting income and loss reserves set up
precisely for that purpose. The tests ``stressed'' both items.
The BHCs were instructed to project the main components of
their ``pre-provision net revenue'' (PPNR), which is net
interest income plus non-interest income minus non-interest
expense, under both economic scenarios. The stress test review
required BHCs to explain in detail the assumptions they made in
computing PPNR, especially if those assumptions included an
increase in business, and any projections in excess of 2008
levels required strong supporting evidence.
A bank sets aside reserves in a current period to absorb
anticipated future loan losses so that those losses do not
affect overall capital in the future period. The BHCs were
instructed to estimate the resources they would have available
to absorb projected losses. This would include the revenue that
they earned in 2009 and 2010, the reserves that they had set
aside for losses at the end of 2008, and any additions to those
reserves projected to be made during 2009 and 2010. They were
then asked to estimate the portion of the year-end 2008
reserves that they would need to absorb credit losses on their
loan portfolio under each scenario while still ending up on
December 31, 2010, with sufficient reserves in light of their
loan portfolio on that date to absorb future losses at an
elevated (that is, stressed) rate. To the extent additional
reserves would likely be needed, income available to absorb
losses (i.e., PPNR) was reduced accordingly.
f. Adjustments
At the end of the first stage of the stress testing, the
supervisors translated the gains and losses they projected for
each BHC into changes in that BHC's projected capital levels.
These amounts were first calculated on the basis of the
BHCs' results to December 31, 2008. As discussed in more detail
below, the initial results suggested that the aggregate capital
needed for the 19 BHCs to reach capital buffer targets in the
more adverse scenario would be $185 billion, ``much of which''
would have to be in the form of tier 1 common capital.\72\
---------------------------------------------------------------------------
\72\ The summary of SCAP results does not specify the amounts of
tier 1 common and other tier 1 capital that comprise each holding
company's required buffer. The release says simply that:
[c]apital needs are mainly in the form of tier 1 common capital,
which reflects the fact that while many institutions have a sufficient
amount of capital, they need to take steps to improve the quality of
that capital . . . For ten of the participating BHCs, supervisors
expect these firms to raise additional capital or change the
composition of their capital. As noted above, much of this need is for
additional tier 1 common. For all of these firms, a raise of new common
equity of the amount indicated would be sufficient to ensure they will
also have at least a six percent tier 1 ratio at the end of 2010.
SCAP Results, supra note 24, at 16, 17.
---------------------------------------------------------------------------
The final calculation of the capital buffers reflected the
effects of acquisitions, new capital raised, and operating
performance in the first three months of 2009. These
adjustments were substantial, and reflected actions taken by
some BHCs prior to the conclusion of the stress tests to raise
capital by selling subsidiaries or businesses, converting
preferred stock into common stock or issuing common shares,
and, to a lesser extent, strong operating results generated by
some BHCs during the first quarter.\73\ Where a BHC's first
quarter performance exceeded the supervisors' estimate of PPNR
for that period, the amount by which it exceeded estimates was
added to the estimate of resources available to absorb losses,
thus decreasing the required capital buffer.\74\ The impact of
``Capital Actions and Effects of Q1 Results'' is presented on a
net basis for each BHC, so it is not possible to see the
specific effect of each of these actions or results on a BHC's
capital or even whether a particular BHC experienced an
adjustment because of its operating results.\75\ For the 19
BHCs, the total impact of Q1 2009 adjustments was to reduce the
capital buffer needed by $110 billion, $87.1 billion of which
was attributable to Citigroup, Inc.\76\
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\73\ Federal Reserve Board officials have informed Panel staff that
the aggregate impact of all first quarter 2009 PPNR on the required
capital buffer was only $20 billion.
\74\ Id.
\75\ See Part H of Section One of this report.
\76\ This issue is discussed infra in Part B of Section One of this
report.
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The adjustments for the additional three months reflects
certain accounting changes adopted in April 2009, to provide
flexibility as to the ``fair value'' that must be assigned to
securities for which no liquid market exists (for example,
asset-backed securities for which there is no market, or over-
the-counter credit default swaps). Seven BHCs adopted these
accounting changes for their first quarter financial
statements.\77\ Some securities that those BHCs had been
carrying on their books at ``fair value'' were revalued at a
higher price in light of the accounting changes, and the
increase in these values was recognized as income. On the other
hand, some liabilities of those BHCs were also revalued as a
result of the accounting change, and the increase in these
liabilities decreased the BHCs' income. Where a BHC's income
for the first quarter of 2009 exceeded the supervisors'
original estimates for its revenues, as discussed above,\78\
these revaluation-related increases (or decreases) would have
decreased (or increased) the amount of the capital buffer
required. It is not possible to quantify the impact of these
changes on the basis of the information published, however.
Because adjustments to the required capital buffer resulting
from first quarter performance are presented on a net basis,
reflecting both revenues and capital actions, it is not
possible to identify which BHCs had their buffer requirement
reduced due to first quarter performance, and thus whether any
members of that group of BHCs adopted the accounting guidance.
It appears that the maximum possible impact of the accounting
changes on required capital buffers would have been
approximately $5.6 billion.\79\
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\77\ These BHCs are: Bank of America, Bank of New York Mellon,
Citigroup, JPMorgan Chase, PNC, U.S. Bancorp, and Wells Fargo. The 19
BHCs tested report to the Securities and Exchange Commission (SEC) and
thus their financial statements are publicly available.
\78\ This issue is discussed infra in Part B of Section One of this
report.
\79\ Based on SEC filings by the BHCs, which do not present such
data in a standardized form, the possible aggregate impact on required
capital buffer ranges from an increase of approximately $240 million
(if only the BHCs that recognized losses resulting from the accounting
change were allowed adjustments due to first quarter performance) to a
decrease of approximately $5.6 billion (if only the BHCs that
recognized income from accounting changes were allowed such
adjustments. Of the latter figure, approximately $5 billion relates to
Wells Fargo alone. It should be noted that because the FASB guidance
was not taken into account in estimating losses under the more adverse
scenario (which was the only scenario for which results were reported),
the impact of the FASB guidance is limited to this measure alone (the
increased resources available to absorb losses) and only to the BHCs
whose PPNR for the first quarter of 2009 exceeded the supervisors'
estimates.
---------------------------------------------------------------------------
While several BHCs published income statements for the
first quarter of 2009 that included as revenue credit value
adjustments (CVA) resulting from the revaluation of their own
debt, this ephemeral ``revenue'' was not included in the
calculation of the PPNR available to absorb losses.\80\
---------------------------------------------------------------------------
\80\ Revenue from such CVAs is routinely excluded from the
calculation of tier 1 capital. See generally 12 CFR part 225, at
Appendix A Sec. II.
---------------------------------------------------------------------------
g. Calculation of the SCAP buffer
After making the adjustments just described, the
supervisors computed the additional amount, if any, required so
that the BHCs would reach the capital buffer ratio of six
percent tier 1 capital and four percent tier 1 common capital.
The computation began with measures of these capital elements
at December 31, 2008, calculated in accordance with Federal
Reserve Board rules.\81\ Using the loss and revenue estimates
discussed above, the supervisors calculated the necessary
capital buffer. In doing so, they examined a range of capital
metrics and factors, including tier 1 common and overall
capital, and including the composition of capital. The initial
assessment of capital need (relating to the BHCs' capital
position as of December 31, 2008) was communicated to the BHCs
in late April.
---------------------------------------------------------------------------
\81\ This calculation starts with shareholders' capital adjusted to
remove certain accounting adjustments that may obscure the true value
of shareholder equity. See 12 CFR part 225, Appendix A Sec. II.
---------------------------------------------------------------------------
As discussed below, Treasury released the results of the
stress tests on May 7, 2009. The reason for the time lag
between communication to the banks and release of the results
publicly may have been due to the need to check for errors,
omissions, and double counting, but the Panel has not had
access to documents that would establish this fact. Nor is it
possible to tell whether, or to what extent, the numbers
communicated to the banks in late April differed from those
released publicly.
4. RESULTS OF THE STRESS TESTS
On May 7, 2009, Treasury released the results of the stress
tests.\82\ (The results released dealt only with the impact of
the ``more adverse'' economic scenario, not the baseline
scenario.) Those results showed that ten of the 19 BHCs
required additional capital to weather a ``more adverse''
economic scenario and that nine of the 19 BHCs already held a
sufficient capital buffer and would not be required to raise
additional capital as a result of the stress test.\83\
---------------------------------------------------------------------------
\82\ SCAP Results, supra note 24.
\83\ These nine banks are American Express, BB&T, Bank of New York
Mellon, Capital One, Goldman Sachs, J.P. Morgan Chase, MetLife, State
Street, and USB.
---------------------------------------------------------------------------
The results estimated that in aggregate the 19 BHCs
included in the SCAP would incur approximately $600 billion of
additional losses by the end of 2010.\84\ Residential mortgage
and consumer loans accounted for $322 billion, or 53.7 percent,
of this $600 billion.\85\
---------------------------------------------------------------------------
\84\ SCAP Results, supra note 24, at 3. This $600 billion is in
addition to losses recorded on the banks' balance sheets in the six
quarters ending December 31, 2008.
\85\ SCAP Results, supra note 24, at 6.
---------------------------------------------------------------------------
The ten BHCs requiring capital are: Bank of America ($33.9
billion), Citigroup ($5.5 billion), Fifth Third Bancorp ($1.1
billion), GMAC ($11.5 billion), KeyCorp ($1.8 billion), Morgan
Stanley ($1.8 billion), PNC ($600 million), Regions Financial
Corporation ($2.5 billion), SunTrust ($2.2 billion), and Wells
Fargo & Company ($13.7 billion).\86\ These BHCs must raise the
capital by November 9, 2009, six months after the announcement
of the test results, and they must submit a capital plan to
their supervisors in early June outlining how they will do so.
---------------------------------------------------------------------------
\86\ SCAP Results, supra note 24, at 9.
---------------------------------------------------------------------------
The supervisors broke BHCs' assets into categories, or
``buckets,'' and disclosed the BHCs' estimated losses for each
bucket. Besides first lien mortgages, the other buckets were
second/junior lien mortgages, commercial and industrial loans,
commercial real estate loans, credit card loans, securities
(AFS and HTM), trading and counterparty, and other, which
included ``other consumer and non-consumer loans and
miscellaneous commitments and obligations.'' \87\
---------------------------------------------------------------------------
\87\ SCAP Results, supra note 24, at 10. The BHCs expected losses
were actually calculated more granularly. The supervisors estimated BHC
loan losses for 12 categories of loans and multiple categories of
securities. The eight buckets that were disclosed were netted figures
for some of these smaller categories.
---------------------------------------------------------------------------
Loss estimates within each bucket varied significantly
between the BHCs. For example, as noted above, BB&T's estimated
loss rate on first lien mortgages through the end of 2010 was
4.5 percent, while Capital One was estimated to have a 10.7
percent loss rate. This translated into an estimated loss for
BB&T on first lien mortgages of $1.1 billion, while Capital One
was estimated to have a $1.8 billion loss on its first lien
book.\88\ The median loss rate on first lien mortgages for all
19 participants was eight percent.\89\ The Federal Reserve
Board explained that such variations reflected ``substantial
differences in the portfolios across the BHCs, by borrower
characteristics such as FICO scores, and loan characteristics
such as loan-to-value ratio, year of origination, and
geography.'' \90\ An element of judgment was necessary in
determining these loss rates. It allowed the testing, for
example, to reflect local conditions with greater accuracy.
However, because of the judgment involved, the calculations
cannot be reviewed or replicated. This diminishes the
reliability of the tests and the confidence that the public is
able to place in them.
---------------------------------------------------------------------------
\88\ SCAP Results, supra note 24, at 9.
\89\ SCAP Results, supra note 24, at 10.
\90\ SCAP Results, supra note 24, at 10.
---------------------------------------------------------------------------
The original testing measured capital levels as of the end
of 2008. Since that time, a number of BHCs have taken steps
that have increased their capital, and thus, as discussed
above, decreased the amount of capital buffer that they must
raise. As of the end of 2008, the 19 BHCs would have had to
have raised a total of $185 billion in capital. As a result of
capital actions and the results of Q1 2009 results, this figure
decreased by $110.4 billion, to a total of $74.6 billion.\91\
By far the largest portion of this decrease is attributable to
Citigroup, whose required capital buffer was reduced from $92.6
billion to $5.5 billion.\92\ The most important factor in the
abrupt change in Citigroup's adjustment was a $58.1 billion
preferred stock exchange offer announced on February 27, 2009.
This exchange offer involves conversion of up to $27.5 billion
in Citigroup preferred stock held by Treasury into Citigroup
common stock \93\ (increasing Treasury's ownership in Citigroup
to 36 percent).\94\ It also includes two pending sales of
operating subsidiaries of Citigroup. In addition, Citigroup has
sold a Japanese subsidiary \95\ and announced a brokerage
venture for Salomon Smith Barney, for which Citigroup will book
a gain.\96\
---------------------------------------------------------------------------
\91\ SCAP Results, supra note 24, at 9.
\92\ SCAP Results, supra note 24, at 9.
\93\ SCAP Results, supra note 24, at 9; Citigroup Inc., Form 8-K
(Feb. 27, 2009) (online at www.sec.gov/Archives/edgar/data/831001/
000095010309000421/dp12698_8k.htm).
\94\ Citigroup Inc., Citi To Exchange Preferred Securities for
Common, Increasing Tangible Common Equity to as Much as $81 Billion
(Feb. 27, 2009) (online at www.sec.gov/Archives/edgar/data/831001/
000095010309000421/dp12698_ex9901.htm). Citigroup did not receive any
additional government funds as the result of the conversion.
\95\1A Citigroup Inc., Form 8-K (May 1, 2009) (online at
www.sec.gov/Archives/edgar/data/831001/000095014209000583/
form8k_050109.htm).
\96\ Citigroup Inc., Morgan Stanley and Citi To Form Industry-
Leading Wealth Management Business Through Joint Venture (Jan. 13,
2009) (online at www.sec.gov/Archives/edgar/data/831001/
000095010309000089/dp12289_ex9901.htm).
---------------------------------------------------------------------------
This unprecedented exercise reported that nine of the top
19 BHCs were adequately capitalized to withstand a serious
downturn in the economy over the next two years. It further
reported to the remaining banks a quantifiable amount of
capital that they needed to raise to remain well capitalized
during this potential downturn.
C. Immediate Impact of the Stress Tests
The stress tests appeared to have an immediate impact on
financial markets and public confidence.\97\
---------------------------------------------------------------------------
\97\ Various measures show the impact of the tests on the markets.
CDS prices show that the price of protecting against default in the
large banks fell after the results of the tests were released. Alistair
Barr and Ronald D. Orol, B. of A., Citi are Stress-Test Winners, CDS
Prices Suggest, MarketWatch (May 8, 2009) (online at
www.marketwatch.com/story/b-of-a-citi-are-stress-test-winners-group-
says?dist=TQP_Mod_mktwN) (``The cost of protecting against a default by
Citigroup and Bank of America dropped by more than a third this week,
as news of the stress-test results leaked out, according to Credit
Derivatives Research. The cost of default protection on other banks and
investment banks, including Morgan Stanley and Goldman Sachs has also
fallen a lot this week, the research firm said.''). Short interest in
the 19 banks fell by 20 percent from May 7, 2009 through May 29, 2009.
DataExplorers, Update: Stress Test for US Financials (May 29, 2009)
(online at dataexplorers.com/sites/default/files/
Sector%20Focus%20Bank%20Stress%20Test%20-
%20Update%20May%2029%202009.pdf).
Media reports reflect that many felt a general sense of relief on
seeing the results. See e.g., After the Financial Stress Tests: Relief
But Still Some Uncertainty, CNBC (May 8, 2009) (online at www.cnbc.com/
id/30640189); Jim Puzzanghera and E. Scott Reckard, Bank `Stress Test'
Results Hint at Economic Recovery, Los Angeles Times (May 8, 2009)
(online at www.latimes.com/business/la-fi-stress-tests8-
2009may08,0,6880257.story).
---------------------------------------------------------------------------
As soon as the results of the stress tests were announced,
the BHCs began raising capital to meet shortfalls. The 19 BHCs
have raised or publicly announced plans for raising $48.2
billion in new debt and equity. Treasury has claimed that, in
total, $56 billion in capital-raising was planned as of May
20.\98\ Debt and equity issuances reported for each BHC so far
are set out in part K of Section One of this report.
---------------------------------------------------------------------------
\98\ Senate Committee on Banking, Housing, and Urban Affairs,
Testimony of Secretary Geithner, Oversight of the Troubled Asset Relief
Program, 111th Cong. (May 20, 2009) (online at banking.senate.gov/
public/index.cfm?FuseAction=Hearings.Testimony&Hearing_ID =64feeb1d-
f2c3-4f11-a298-800be9bd360d&Witness_ID=ae7c9f56-f16f-4b3c-b4e7-
b5919e3ccd7c) (hereinafter ``Geithner Testimony''). The $8 billion
difference is the result of Treasury using a more lenient standard to
decide whether a fund has been ``planned'' yet.
---------------------------------------------------------------------------
Though the official results were released on Thursday, May
7, 2009, the results for many of the BHCs were reported in the
press prior to that date. By early that week, the public knew
that ten of the 19 BHCs would be required to raise additional
capital.\99\ It also knew the amount of capital required to be
raised for some of the BHCs. However, there appears to have
been some confusion surrounding the reported numbers. Federal
Reserve Board officials have told the Panel that some of the
reports revealed only the preliminary required capital, before
it was adjusted for the effect of capital actions and 2009
first quarter results. The officials further suggested that, as
a result of changes in the figures when the official results
were released, many commentators mistakenly believed that the
delay in the release was the result of negotiations with the
BHCs.\100\ To gain a better understanding of the stress tests,
on March 30, the Panel requested that Treasury provide the
Panel with documents related to Treasury's work on the stress
tests. On May 11, the Panel made a similar request of the
Federal Reserve Board. The Panel followed up with Treasury to
reiterate its need for access to the documents on May 26. On
June 5, Treasury made available to Panel staff a number of
documents related to the stress tests. On June 8, the Federal
Reserve made additional documents available. Panel staff is
reviewing the documents and expects to see more documents; the
meaning of the documents reviewed to date remains unclear. The
Panel expects to include information resulting from that review
in a future report or update where appropriate.
---------------------------------------------------------------------------
\99\ Damian Paletta and Deborah Solomon, More Banks Will Need
Capital, Wall Street Journal (May 5, 2009) (online at online.wsj.com/
article/SB124148189109785317.html).
\100\ Arianna Huffington, The Stress Tests Fail the Smell Test,
Huffington Post (May 5, 2009) (online at www.huffingtonpost.com/
arianna-huffington/the-stress-tests-fail-the_b_196350.html).
---------------------------------------------------------------------------
Although the SCAP involved only the nation's 19 largest
BHCs, it spurred the private evaluation of smaller
institutions. An analysis performed for the Financial Times
showed that 7,900 U.S. small and medium sized banks would need
to raise $24 billion in capital to achieve the capital buffer
levels required of large BHCs in the SCAP.\101\ The firm that
conducted this analysis stated that it expects that the stress
test's methodology and capital adequacy focus will migrate to
the broader U.S. banking system.\102\
---------------------------------------------------------------------------
\101\ Saskia Scholtes, et al., Smaller US Banks Need Additional
$24bn, Financial Times (May 17, 2009) (online at www.ft.com/cms/s/0/
79c47ffa-4306-11de-b793-0014feabdc0,dwp_uuid=ffa475a0-f3ff-11dc-aaad-
0000779fd2ac.html) (hereinafter ``Financial Times Study'') (The
Financial Times-commissioned study used metrics that differed from the
SCAP in two ways: (1) it did not adjust for first quarter performance;
and (2) it was not able to estimate loss rates with the same degree of
individualized precision as the regulators).
\102\ Stress Test Consequences, supra note 35.
---------------------------------------------------------------------------
D. A Comment on the Supervisory Process
The stress tests involved the submission of material by the
19 BHCs estimating their loss, income, and resource figures for
the test period. The banking supervisors evaluated the quality
of the BHCs' submissions and made their own estimates of losses
and resources to absorb those losses. As part of that process,
supervisors used supporting information provided by the BHCs,
as well as the supervisors' own knowledge and supervisory
information. Supervisors also included their own independent
benchmarks, such as the indicative loan loss rates discussed
above.
The supervisory teams performing the tests involved more
than 150 examiners from the Federal Reserve Board, the Federal
Reserve Banks, the Office of the Comptroller of the Currency
(OCC), and the FDIC. Additionally, specialist teams were
assigned to examine loss projections for specific asset classes
across all the BHCs. This ensured that the same or similar
assets would be valued the same way in the projections for each
institution, and that counterparty risk, revenue projections,
and loan loss would be treated consistently across
institutions. The BHCs had several thousand people working to
produce the raw data that informed the stress tests. Additional
advisory groups provided assistance with accounting, regulatory
capital, and financial and macroeconomic modeling.
The supervisory process, by its nature, always involves
constant interaction between the supervisor and the regulated
entity, and the SCAP process was no exception. The supervisors
presented the BHCs with indicative guidelines for loan loss
rates, but the BHCs were able to use alternative measures if
they could prove to the supervisors (with adequate
documentation) that the alternative was more appropriate. The
supervisors alone, however, decided whether the loan loss rates
used were appropriate. (The supervisors found some BHCs'
submissions to be of a higher quality than others, and, after
the supervisors had presented the BHCs with their initial
estimates, some BHCs presented the supervisors with more
detailed information in order to correct errors and double-
counting that had been reflected in their results.)
While SCAP in some ways represents a new and tougher
approach by federal regulators, it does not constitute a
genuine break from past supervision methods and tactics, and
was not intended to be. The fact that regulators did not
identify emerging systemic risks prior to the crisis
underscores the importance of scrutiny toward the supervisory
role generally and the recent round of stress testing.
E. Specific Limitations of the Stress Tests
Any evaluation of the stress tests must start with both
what the tests are and what they are not. Supervisors have
always regarded regulatory capital as a baseline measure and
have required additional capital (or changes in capital
composition) for particular institutions when the situation
warranted. The stress tests operate under this premise but they
are also a unique, cross-institution exercise. They are not a
regulatory examination of the 19 BHCs, focused on capital
adequacy, and do not test the BHCs' overall safety and
soundness, as would a regular examination. In this and in more
granular ways, the SCAP builds from a starting point of
existing bank supervision and conclusions about the health of
the institutions at issue.
It is logical, in view of such a starting point, that the
supervisors relied on raw data that were produced by the BHCs
themselves. For example, the stress tests estimated the losses
that might occur on first lien mortgages held by each BHC but
did not test whether the BHC held the total amount of mortgages
that it said it did, or whether it actually had enforceable
liens on them.\103\ The tests were not re-audits or re-
examinations; they relied on BHC-generated figures whose
assumptions were tests only. Thus, to a significant extent, the
stress tests rely on the accuracy of the audit and examination
process, and the integrity and soundness of the judgments and
internal processes of the participating BHCs.\104\
---------------------------------------------------------------------------
\103\ Such matters would be covered by the regular audit and
examination processes.
\104\ In its April report, the Panel noted that the success of the
Reconstruction Finance Corporation in stabilizing the U.S. banking
system during the Great Depression has since been attributed in large
part to the forced write-downs of bank assets to realistic values as
determined by the RFC. Panel April Oversight Report, supra note 63, at
40. Similarly, the Panel noted that Japan did not emerge from its
``Lost Decade'' until it began to rigorously examine the valuation of
bank assets in 2002, as part of a broader plan of uncovering the true
health of the financial system. Panel April Oversight Report, supra
note 63, at 57-58.
---------------------------------------------------------------------------
The stress test results are presented as the estimates of
the supervisors, not those of the institutions tested. The
Federal Reserve Board emphasizes that those institutions or
other outside analysts might have produced very different
estimates, even using a similar set of economic
assumptions.\105\
---------------------------------------------------------------------------
\105\ For example, Bank of America argues that its internal
projections show that the supervisors underestimated its future income
over the next two years while, in many cases, overestimating its loan
losses. Bank of America Corp., Stress Test: Bank of America Would Need
$33.9 Billion More in Tier 1 Common (May 7, 2009) (online at
investor.bankofamerica.com/phoenix.zhtml?c=71595&p=irol-
newsArticle&ID=1286200&highlight=).
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F. Independent Analysis of Stress Tests
The Panel asked Professors Eric Talley and Johan Walden to
review the stress test methodology. Professor Talley is a
Professor of Law and the U.C. Berkeley School of Law (Boalt
Hall), and Co-Director, the Berkeley Center for Law, Business,
and the Economy; he has been a Visiting Professor of Law at the
Harvard Law School during the 2008-2009 academic year.
Professor Walden is a Professor in the Haas Finance Group of
the U.C. Berkeley Haas School of Business. Both are recognized
experts in finance, asset pricing, economic analysis of risk,
and economic analysis of law. Their report, ``The Supervisory
Capital Assessment Program: An Appraisal'' (the Appraisal),
dated June 2009, is attached as Annex to Section One.
The Appraisal contains an overview of the dominant
approaches in the finance literature for measuring risk using
statistical models, attempting to understand and situate the
approach used by the Federal Reserve Board. It examines the
relative strengths and weaknesses of each model, as well as the
systemic issue of model uncertainty, resulting from the fact
that there is no single consensus approach to measuring
financial risk from multiple sources. In this process, the
Appraisal also highlights a number of statistical measures for
quantifying risk from single sources, noting their usefulness
in developing models.
These models include: the Capital Adequacy Ratio (which
measures the ratio of a bank's equity capital to the risk-
weighted value of its assets), Value at Risk (VaR) (which
captures the probability of losses exceeding some specified
threshold), and the Expected Shortfall (which measures the
expected amount of losses in the event that losses exceed the
VaR threshold).\106\ While acknowledging the merits of such
summary statistical measures, the Appraisal points out that
these measurements classify risk quite roughly and may neglect
co-movement among assets, two factors that greatly reduce the
amount of information contained in the final number.
---------------------------------------------------------------------------
\106\ Also included are Standard Deviation and Mean Absolute
Deviation (statistics commonly used to measure risk).
---------------------------------------------------------------------------
After discussing the methods of evaluating single-source
risk, the Appraisal treats the problem of calculating a
portfolio of risks, highlighting three dominant approaches
within the finance literature: Merton models (in which
companies default at the maturity of a debt when their total
asset value is less than the face value of the debt), First
Passage models (in which a company defaults if its asset value
drops below a specified default trigger at any time before
maturity), and Reduced Form models (which rely completely on
empirical data to model default dependencies between firms in
discrete periods of time).
On the basis of the conceptual and mathematical analyses
that it reflects, the Appraisal makes a number of points about
the stress tests. At the outset, it states that:
Based largely on information collected through public
document review and conference calls with
representatives from the Federal Reserve and the
Treasury Department, and taking into account the
enormity of the task within a short time horizon, we
conclude that the Fed's risk modeling approach has, on
the whole, been a reasonable and conservative one . . .
For example, the macro-economic scenarios they
hypothesized under the adverse case appear relatively
extreme by historical standards, and the (purportedly
one-time) sizing of the capital buffer was made
relatively stringent. Moreover, the general approach
undertaken here appears to have avoided some of the
more dangerous simplifications manifest in certain
types of risk modeling . . . On the whole, then, our
assessment is that the SCAP stress tests have provided
valuable information to the public.\107\
---------------------------------------------------------------------------
\107\ See Annex to Section One of this report, at 2, 5.
---------------------------------------------------------------------------
The authors note that:
We warn the Panel that our knowledge of the Fed's
program is based largely on the same information
possessed by the panel, consisting of two reports, the
first (describing methodology) was issued on April 24,
and the second (describing results) was issued on May
7. Beyond these reports, we were privy to a number of
conference calls involving the Federal Reserve (twice)
and the Treasury department (once).\108\
---------------------------------------------------------------------------
\108\ Id. at 17.
The Appraisal begins by explaining that in evaluating any
model of risk assessment . . . it is more constructive to use
four criteria:
1. Intuitiveness: From a practical perspective, given the
complexity of the problem and the limited time frame with which
to accomplish it, does the risk model employed appear to make
intuitive sense?
2. Robustness: Do the results continue to hold across
alternative model and/or parametric specifications?
3. Transparency: Are both the structure of the risk model
and the data inputs clear and transparent to outsiders? If the
model is a hybrid of multiple risk models, how clear is the
hybridization process?
4. Replicability: Is it possible for a third party to gain
access to the same data, and to replicate the results within
conventional standards of error?
The authors note that the first two of these criteria
relate to internal design considerations,\109\ while the third
and fourth criteria, in contrast, bear on how well the Federal
Reserve Board's approach might be evaluated by outsiders.\110\
The Appraisal notes a number of sound elements in the SCAP's
design. It states that:
---------------------------------------------------------------------------
\109\ Id. at 18. ``The multiple approaches to financial risk
modeling, along with the special circumstances under which the SCAP was
implemented make the first [criterion] extremely important. Due to the
current high uncertainty in capital markets, and the attendant hazards
of model risk, the second [criterion] is also relatively crucial.''
\110\ Id. (``The third [criterion] encapsulates what is, in a
sense, a minimal condition on observability that need be met; that is,
so long as one presumes the competence and good faith of Fed
researchers, satisfying the transparency [criterion] is tantamount to
understanding the material steps undertaken in the enterprise. The
fourth criterion--replicability--is a more stringent condition than
transparency, effectively requiring that an outsider be able to
directly verify the Fed's conclusions. It should be noted, however,
that this criterion may be more difficult to satisfy for a program such
as SCAP, due to confidentiality issues within the BHCs being studied.
We believe, nevertheless, that the third and fourth [criteria] are
material considerations, particularly given the high level of market
uncertainty, the magnitude of resources at issue, and the failure of
state-of-the-art models to capture the market's risk in 2008.'')
---------------------------------------------------------------------------
``The choice of a two year time horizon does
not, ipso facto, give us cause for concern (though it
may necessarily require updating on a going-forward
basis)''; \111\
---------------------------------------------------------------------------
\111\ Id. at 19.
---------------------------------------------------------------------------
``Using econometric models that relate loss
rates to differing macroeconomic scenarios (baseline
and more adverse) is a sensible way to characterize
loss exposure''; \112\
---------------------------------------------------------------------------
\112\ Id. at 26.
---------------------------------------------------------------------------
``Assembl[ing] projections from multiple
methodological approaches . . . helped to avoid some of
the most extreme problems associated with model risk'';
\113\
---------------------------------------------------------------------------
\113\ Id. at 34.
---------------------------------------------------------------------------
``It [was] clearly sensible for the Fed to
allow for tailoring of individual BHC's loss rates'';
\114\
---------------------------------------------------------------------------
\114\ Id.. at 29.
---------------------------------------------------------------------------
``The Fed's approach in specifying and
sizing the required SCAP capital buffer seems sensible,
transparent, and replicable [and] . . . within the time
and information constraints [in which] they operated,
the 6%/4% sizing was, at the very least, a defensible
first approximation.'' \115\
---------------------------------------------------------------------------
\115\ Id. at 31.
---------------------------------------------------------------------------
However, the Appraisal also states that ``the SCAP's design
and implementation do leave some open questions in our minds.''
\116\ The Appraisal's overriding concern is that, although the
stress tests involve a mix of quantitative (modeling) and
qualitative (judgments in application of modeling) elements, a
lack of transparency in the way the models were applied (even
illustratively) makes it impossible to replicate--and hence to
evaluate--the stress tests in any detail. For example, say the
authors, the Appraisal could only take a ``broad-brush
approach'' to the SCAP, because:
---------------------------------------------------------------------------
\116\ Id. at 5.
---------------------------------------------------------------------------
``The Fed evidently attempted to synthesize
numerous alternative macro-economic models . . . with
subjective judgments of experts across different
domains''; \117\
---------------------------------------------------------------------------
\117\ Id. at 3.
---------------------------------------------------------------------------
``The process by which the initial [loss
models] became tailored to each BHC appeared
analogously opaque.'' \118\
---------------------------------------------------------------------------
\118\ Id. at 6.
---------------------------------------------------------------------------
The ``Fed's stress test formulation (and
particularly the derivation of the adverse case) is
potentially subject to criticism as to transparency,
its replicability, and its robustness'' (for example,
in its omission of interest rate, wage and price
inflation, and exchange risk that ``play a significant
role in assessing not only prospective default risks
within asset classes but potentially also asset
valuations today'').\119\
---------------------------------------------------------------------------
\119\ Id. at 23. Federal Reserve Board staff has told a Panel staff
member that interest rate assumptions were ``built into'' the macro-
economic assumptions for the stress tests as well to the data banks
provided to the supervisors, that currency exchange risk was also built
into that data, and that inflation risk was now so low as to be
difficult to factor in.
---------------------------------------------------------------------------
``[T]here is effectively no way for a third
party to replicate (or even, evidently, selectively
audit) the [loss projections]'' used to conduct the
stress tests.\120\ The Appraisal continues: ``On the
basis of our interactions with them, we believe the Fed
staff to be both professionally competent and acting in
good faith. It may therefore be acceptable to take them
at their word. Nevertheless, given the fact that the
[loss ranges] constituted an important focal point for
the SCAP stress tests, the description of the process
did not permit us to pierce through their derivations
at anything more than a general level.'' \121\
---------------------------------------------------------------------------
\120\ Id. at 25.
\121\ Id. at 25-26.
---------------------------------------------------------------------------
``[T]he significant interaction required
between supervisors and the BHCs has the potential of
undermining the objectivity of the stress tests . . .
It may well be that the Fed's efforts [to bolster the
objectivity of the tests despite the necessary
supervisor-BHC interaction] were wholly successful . .
. but we are not in a position to either confirm or
reject this hypothesis. Indeed, when queried as to
whether it would be possible to walk us through one or
two examples of the tailoring process for specific (but
anonymous) BHCs, Fed researchers reported that such an
exercise was not practically feasible.'' \122\
---------------------------------------------------------------------------
\122\ Id. at 27-28.
---------------------------------------------------------------------------
``To the extent we have a concern [with the
Fed's approach in specifying and sizing the required
SCAP capital buffer] it likely is rooted in a more
general concern with . . . the appropriateness of a 2-
year time horizon for projecting required capital
buffers.'' \123\ This issue might have been dealt with
by:
---------------------------------------------------------------------------
\123\ Id. at 29. See also, Lucian Bebchuk, Near-Sighted Stress
Tests (May 20, 2009) (online at www.forbes.com/2009/05/20/stress-tests-
banking-opinions-contributors-maturity.html) (hereinafter ``Near-
Sighted Stress Tests'').
---------------------------------------------------------------------------
Conducting a longer-term stress test
(at least for long-maturing illiquid assets)
Quantifying the faction of illiquid
and highly risky assets with distant maturities
the BHCs as a group, and each BHC separate,
have; or
Revisiting the SCAP approach
periodically to reassess risk profiles of these
assets as they become more current.
The SCAP does not explore the
possibility that BHCs ``may be able to use
their own segmented corporate structure to
compartmentalize (and thus externalize) risk,
even if they have an adequate capital buffer in
the aggregate.'' \124\
---------------------------------------------------------------------------
\124\ Id. at 30.
---------------------------------------------------------------------------
G. Next Steps
1. CAPITAL-RAISING
The ten BHCs estimated to require a capital buffer were
required to give the supervisors a Capital Plan by June 8,
2009, explaining how they will raise equity capital. Their
options include: (1) selling stock to the markets or under the
CAP; \125\ (2) converting existing preferred stock (whether
privately held or issued under the CPP); or (3) selling assets.
Some of these options are preferable to others and result in
higher quality capital. Conversions of preferred to common
stock are the weakest option (as no new capital is added) and
new equity offerings for cash are the strongest. Asset sales
fall in between these options as they raise cash but diminish
earnings capacity. The plan must include dates by which the BHC
plans to take these actions, which must be completed by
November 9, 2009. The plans are not specifically required to
address plans to repay TARP funds. However, no bank can repay
its TARP capital if this would cause its capital levels to be
inconsistent with ``supervisory expectations.'' \126\ It is
unclear if these expectations will be the same as the capital
levels demanded by SCAP.
---------------------------------------------------------------------------
\125\ If there are future CAP transactions, the Panel will need to
consider a valuation exercise similar to that in the February report.
\126\ Board of Governors of the Federal Reserve System, Federal
Reserve Outlines Criteria It Will Use to Evaluate Applications to
Redeem U.S. Treasury Capital from Participants in Supervisory Capital
Assessment Program. (June 1, 2009) (online at www.federalreserve.gov/
newsevents/press/bcreg/2009bcreg.htm).
---------------------------------------------------------------------------
The most direct way for a BHC to increase its capital base
is to earn net income from its normal banking business and add
that income to its capital accounts. Estimated PPNR for 2009
and 2010 (as adjusted by reference to performance in the first
quarter of 2009) is already reflected in the SCAP calculation
and therefore BHCs cannot ``earn their way out'' of the capital
buffer requirements.\127\
---------------------------------------------------------------------------
\127\ To the extent that the BHCs' revenues are strong, however,
their ability to sell securities will of course be enhanced.
---------------------------------------------------------------------------
Next, a BHC can raise capital by selling assets, usually
businesses or branches. For example, Citigroup recently
announced that it expects to gain $2.5 billion in tangible
common equity through the sale of its Japanese securities
business.\128\ For its part, Bank of America sold nearly a
third of its stake in China's second largest bank.\129\
However, as discussed below, any sale risks a transaction at a
``fire sale'' price because the buyer knows that the selling
BHC must raise capital and is counting on the sale to do so.
---------------------------------------------------------------------------
\128\ Citigroup Inc., Citi to Sell Nikko Cordial Securities to
Sumitomo Mitsui Banking Corporation and to Forge Alliance with Sumitomo
Mitsui Financial Group (May 1, 2009) (online at www.citigroup.com/citi/
press/2009/090501a.htm).
\129\ Amy Or, BofA Raises US$7.3 Bln from CCB Share Sale to 4
Investors, Wall Street Journal (May 13, 2009) (online at
online.wsj.com/article/BT-CO-20090513-708215.html?mod=crnews).
---------------------------------------------------------------------------
A BHC can also raise funds through the sale of additional
common stock, the approach most in line with the requirements
of the supervisors following the stress tests. But the sale of
common stock is not without its own issues. First, existing
shareholders' interests will be diluted by the new sale--that
is, part of their investment will in effect be shared with the
new shareholders, diluting their proportional ownership of the
BHC and the value of their shares. Of course, that may be a
completely justified result, since, without an infusion of
billions of taxpayer dollars, the common stock of at least some
of these institutions would likely have become worthless.\130\
In addition, sale of a large block of shares to a single
investor may shift control, or at least reconfigure the
control, of the BHC in question.
---------------------------------------------------------------------------
\130\ Since warrant holders, including the holders of stock
options, are generally protected against dilution by the terms of the
warrants, a paradoxical result might be that the executives who were in
charge of the troubled institutions would incur far less loss (if stock
values recovered) than ordinary common shareholders. Thus, where bank
executives are compensated to any extent by the issuance of stock or
stock options, they may have a conflict of interest when deciding
whether common stock, rather than a sale of assets, should be part of
their BHC's capital plan.
---------------------------------------------------------------------------
Such sales of common stock may be made to investors in the
open market or in a private offering, or the BHC may rely on
the CAP and issue mandatory convertible preferred stock (which
will be treated as tier 1 common) to Treasury.
The BHCs may also convert preferred stock into common
stock, as Citibank is in the process of doing. This conversion
may include existing preferred stock issued to private parties
or the preferred stock issued to Treasury under the CPP. Since
this involves moving Treasury's assets to a more risky class of
securities, Treasury has stated that it expects such a
conversion to be accompanied by new capital raises or exchanges
of private capital securities into common equity.\131\
---------------------------------------------------------------------------
\131\ U.S. Department of the Treasury, FAQs on Capital Purchase
Program Repayment and Capital Assistance Program, at 3 (online at
www.financialstability.gov/docs/FAQ_ CPP-CAP.pdf) (accessed June 8,
2009) (hereinafter ``CPP FAQs'').
---------------------------------------------------------------------------
2. TARP REPAYMENT
Many banks, including the BHCs involved in the stress
tests, have indicated their desire to repay funds received
under TARP programs, and several smaller banks have already
done so.\132\ The Panel's next report will discuss certain
issues arising from the TARP repayment process in detail, but
it is worth discussing the interplay of the SCAP with TARP
repayment.
---------------------------------------------------------------------------
\132\ As of May 27, 20 banks have repaid the TARP funds they
received. Goldman Sachs, Morgan Stanley, BB&T, and JPMorgan, among
others, have announced their intentions to repay TARP funds as soon as
possible. Brian Wingfield, Banks Ready To Throw in the TARP, Forbes
(June 1, 2009) (online at www.forbes.com/2009/06/01/banking-tarp-fed-
business-beltway-tarp.html).
---------------------------------------------------------------------------
BHCs that do not need to raise additional equity capital
may be permitted to repay TARP funds. The Federal Reserve Board
has designed criteria that it will use to determine whether to
allow a BHC to repay TARP funds.\133\ BHC applications for
repayment must be first approved by the primary federal
supervisor before being sent to Treasury. A BHC that wishes to
repay funds must show that it can issue debt without relying on
TLGP. It must also show that it has access to the public equity
markets. Additional criteria that the Federal Reserve Board
will consider include the bank's ability to continue to act as
an intermediary for lending to families and businesses, its
ability to maintain appropriate capital levels, its ability to
``continue to serve as a source of financial and managerial
strength and support to its subsidiary bank(s) after the
redemption,'' and its ability to meet ``funding requirements
and obligations to counterparties'' while again lessening its
reliance on government funds and guarantees.\134\
---------------------------------------------------------------------------
\133\ Board of Governors of the Federal Reserve System, Press
Release (June 1, 2009) (online at www.federalreserve.gov/newsevents/
press/bcreg/20090601b.htm).
\134\ Id.
---------------------------------------------------------------------------
Since the announcement that BHCs will need to use new, non-
guaranteed capital to repay TARP funds, several BHCs have
issued non-guaranteed debt. However, these BHCs had to pay
relatively high interest rates on this debt.\135\ In addition
to repaying the preferred stock issued under the CPP, BHCs will
have to repurchase the warrants that were issued at the same
time.\136\ The price at which those warrants will be repaid has
already become a source of controversy with respect to non-
stress test banks.\137\ This issue is one which the Panel will
be paying close attention to in the near future.\138\
---------------------------------------------------------------------------
\135\ Since SCAP, the BHCs have raised $35 billion in stock and $13
billion in debt. The BHCs' notes ranged from 271 basis points over U.S.
Treasuries to 562 basis points over U.S. Treasuries. Compare the spread
on Citigroup's recent non-guaranteed debt offering, 8.765 percent ten-
year notes (562.5 basis points over U.S. Treasuries) with a Citigroup
debt offering prior to the financial crisis, 5.773 percent ten-year
notes (130 basis points over U.S. Treasuries). Citigroup Inc., Form FWP
(May 15, 2009) (online at www.sec.gov/Archives/edgar/data/831001/
000095012309008985/y77311fwfwp.htm); Citigroup Inc., Form FWP (Sept. 6,
2007) (online at www.sec.gov/Archives/edgar/data/831001/
000095012307012318/y39368afwp.htm). See Figure 5 for other recent BHC
debt issuances.
\136\ See, e.g., U.S. Department of the Treasury, Securities
Purchase Agreement Standard Terms, at 42 (Oct. 26, 2008) (online at
www.financialstability.gov/docs/agreements/BOA_ 10262008.pdf) (The
agreement contains terms setting up a direct repurchase by Treasury of
all bank securities based on a negotiated fair market value. These
terms cover the repurchase of warrants and do not specifically provide
for auctions to third parties as a method of pricing the repurchase.).
\137\ See, e.g., Old National Bancorp, Form 8-K (May 11, 2009)
(online at www1.snl.com/Cache/c7780441.htm) (first publicly-traded
company to finalize repurchase of its warrants from Treasury); Linus
Wilson, Valuing the First Negotiated Repurchase of the TARP Warrants,
Social Science Research Network (May 23, 2009) (online at
papers.ssrn.com/sol3/papers.cfm?abstract_ id=1404069) (arguing that,
based on economic models, that Treasury did not receive fair market
value for the Old National Bank warrants).
\138\ The effect on the projected capital buffers of potential
repayment of CPP infusions was apparently not taken into account in
computing whether an institution would require a capital buffer or the
size of that buffer.
---------------------------------------------------------------------------
H. Issues
1. THE CONTEXT AND PURPOSE OF THE STRESS TESTS
To date, $245 billion has been injected into the banking
system and an additional $69.8 billion into the American
International Group (AIG). After raising $75 billion more in
public or private funds, the nations' largest banking
institutions will be well capitalized enough to withstand
further economic difficulties, at least during 2009 and 2010.
It has to be noted that the $75 billion dollar figure rests on
existing taxpayer support of the banking system, and the SCAP
must be understood in this context. The stress tests' stated
purpose was to ensure that the BHCs were well capitalized
enough to withstand continued economic bad news and to continue
lending to qualified borrowers, but the subtext of the tests
was to calm the markets. The markets have been calmed, but it
must be understood that the underlying regulatory and legal
systems that permitted the financial crisis to occur have not
changed, and the current financial position of the BHCs relies
on massive amounts of government assistance, the impact of
which has not been clearly identified in the supervisors'
assessment of the BHCs' current and future financial viability.
The supervisors' releases indicate that infusions of funds
under the CAP may be necessary to make up any failure by the
ten institutions to raise the necessary capital in the private
market. But there are other forms of government assistance
whose impact on the tests was not made clear.
The loan guarantees provided by Treasury and the FDIC and
the availability of funds through the various liquidity
programs established by the Federal Reserve Board during the
early days of the crisis would appear to lower substantially
the cost of funds for the 19 BHCs, presumably increasing their
net income during the testing period. This raises the question
of how solid those earnings would be if the government programs
were removed or if external economic conditions caused the
Federal Reserve Board to tighten the money supply even
modestly.
2. ISSUES RELATING TO THE DESIGN OF THE STRESS TESTS
The stress tests are conducted within the bounds of the
current supervisory context and do not represent a new measure
or test of risk. They start with the amounts and values
projected by the tested institutions themselves. The extent to
which the supervisors delved deeply into the BHC-provided data
to verify its accuracy is unclear. This is not to question the
good faith of either the supervisors or the tested
institutions. But the experience of the last two years cannot
but cause some to question the adequacy of both the risk
management practices of many of the nation's largest financial
institutions and of the scope of the supervisory regime to
which those institutions were subjected. As one serious
example, the stress test reports assert that the 19 BHCs tested
are all well capitalized, but they do not discuss or rebut
claims by a number of respected economists that at least some
of the same banks are in fact insolvent.\139\
---------------------------------------------------------------------------
\139\ Nouriel Roubini, According to Press Reports the IMF May
Allegedly Be Increasing Its Estimate of Global Bank Losses to $4
Trillion, a Figure Consistent With Estimates by a Variety of
Independent Bank Analysts, RGE Monitor (Apr 10, 2009) (online at
www.rgemonitor.com/roubini-monitor/256364/according
_to_press_reports_the _imf_may_allegedly_be _increasing_its_estimate_of
_global_bank_losses__to _4_trillion_a_figure_
_consistent_with_estimates_by _a__variety_of_independent
_bank_analysts).
---------------------------------------------------------------------------
Reliance on the present system may well be understandable
in view of the short time frame within which the tests had to
be done, but the time pressures could have been mitigated by a
rolling set of tests adjusted for operating results and changes
in economic assumptions. Failure to do so may be seen as
limiting the usefulness of the tests.
A number of issues with the modeling techniques used in the
stress tests were noted by Professors Talley and Walden in
their report. These include a lack of sensitivity to the
ownership structure of BHCs, the exclusion of a number of
micro- and macroeconomic factors (such as interest rates and
inflation), and the use of the relatively short time horizon of
two years. In their opinion, these factors might have affected
the results of the stress tests.\140\
---------------------------------------------------------------------------
\140\ See Annex to Section One of this report, at 23, 33, 34.
---------------------------------------------------------------------------
When the two alternative economic scenarios were announced,
commentators immediately criticized the scenarios for
insufficient ``harshness.'' \141\ They stated that the baseline
scenario especially was too optimistic in light of an economy
that at that time was deteriorating rapidly and beginning to
follow the path of the more adverse scenario.\142\ Nouriel
Roubini, for example, has suggested that policymakers ``used
assumptions for the macro variables in 2009 and 2010 [for] both
the baseline and more adverse scenarios that are so optimistic
that actual data for 2009 are already worse than the adverse
scenario.'' \143\ He has challenged the GDP, unemployment, and
home prices assumptions in both the baseline and adverse
scenarios.\144\ The OECD released baseline real GDP and
unemployment projections that were equal to the SCAP's more
adverse scenario assumptions.\145\ On the other hand, some
comparisons suggest that the assumptions are appropriate. In
their review of the stress test methodology, Professors Talley
and Walden state that, ``[t]he criteria used for assessing
risk, and the assumptions [the Federal Reserve Board] made in
calibrating the more adverse case have typically erred on the
side of caution.'' \146\ In the end, it is not clear that we
know whether the economic assumptions were harsh enough or what
the BHCs' capital needs would be if the economy continued along
the path it appeared to be following in February.
---------------------------------------------------------------------------
\141\ See generally Douglas J. Elliott, Bank Stress Test Results,
Brookings (May 18, 2009) (online at www.brookings.edu/opinions/2009/
0512_ stress_ test_ results elliott.aspx); Paul Krugman, Stressing the
Positive, New York Times (May 7, 2008) (online at www.nytimes.com/2009/
05/08/opinion/08krugman.html) (``The regulators didn't have the
resources to make a really careful assessment of the banks' assets, and
in any case they allowed the banks to bargain over what the results
would say. A rigorous audit it wasn't.''); Nouriel Roubini, Ten Reasons
Why the Stress Tests Are ``Schmess'' Tests and Why the Current Muddle-
Through Approach to the Banking Crisis May Not Succeed, RGE Monitor
(May 8, 2009) (online at www.rgemonitor.com/roubini-monitor/256694/ten_
reasons_ why_ the_ stress_ tests_ are_ schmess_ tests_and_ why_ the_
current_ muddle-through_ approach _ to_ the_ banking_ crisis_ may_ not_
succeed) (hereinafter ``Roubini Article''); Edmund L. Andrews and Eric
Dash, Government Offers Details of Bank Stress Test, New York Times
(Feb. 25, 2009) (online at www.nytimes.com/2009/02/26/business/economy/
26banks.html) (hereinafter ``Andrews and Dash Article'').
\142\ Unemployment rose to 9.4 percent in April 2009. Employment
Situation, supra note 60. GDP fell 5.9 percent in the first quarter of
2009 from the previous quarter. Gross Domestic Product, supra note 59.
\143\ Roubini Article, supra note 141; Andrews and Dash Article,
supra note 141.
\144\ Id.
\145\ Organization for Economic Cooperation and Development, OECD
Economic Outlook Interim Report, at 68 (Mar. 2009) (online at
www.oecd.org/dataoecd/18/1/42443150.pdf).
\146\ See Annex to Section One of this report.
---------------------------------------------------------------------------
The ability to extrapolate the data by those wishing to
modify the model to use their own macroeconomic assumptions is
somewhat limited. Treasury officials informed the staff of the
Panel that sufficient data would be available such that private
analysts would be able to build on the results disclosed,
substituting their own assumptions with respect to the
direction of the economy, and working out for themselves what
the capital needs of the BHCs would be under even more adverse
conditions. The publicly announced results of the SCAP focused
only on the more adverse scenario. The model may be
replicated,\147\ but it is not clear that private analysts
could use these data to build their own models or to test the
strength of the supervisors' modeling. Without the ability to
replicate and re-test, the robustness of the model remains in
question.
---------------------------------------------------------------------------
\147\ Stress Test Consequences, supra note 35.
---------------------------------------------------------------------------
Professor Lucian Bebchuk, among others, has argued that the
failure to take into account mark-to-market values for ``toxic
assets,'' necessarily undervalues bank liabilities to the
extent that those liabilities result in losses after 2010.\148\
This point is also echoed in the report from Professors Talley
and Walden.\149\ Professor Bebchuk notes that the total
estimate of potential bank losses published by the supervisors
is as much as $600 billion and that no attempt has been made
``to come up with a precise estimate of the extent to which, at
the end of 2010, the economic value of the troubled assets will
fall below [their] face value.'' \150\ Bebchuk acknowledges the
Federal Reserve Board's recognition of this problem, but he
responds that:
---------------------------------------------------------------------------
\148\ Near-Sighted Stress Tests, supra note 123.
\149\ See Annex to Section One of this report.
\150\ Near-Sighted Stress Tests, supra note 123.
To get a full picture of the banks' situation, bank
supervisors should estimate also the decline in the
economic value of banks' positions with longer
maturities. Only then will the stress tests be able to
deliver reliable figures for the additional capital
necessary to make the banking sector healthy and
vigorous.\151\
---------------------------------------------------------------------------
\151\ Near-Sighted Stress Tests, supra note 123.
This approach suggests a useful insight about what the
stress tests do and do not do. Their purpose is to compute the
amounts necessary, within the framework of existing supervisory
and risk management techniques, to keep BHCs well capitalized
for two years if a specified set of economic assumptions is
borne out. What they do not do is to compute the point at which
BHCs will be stressed beyond the breaking point--even under the
supervisors' view that BHCs are now well capitalized--based on
their current balance sheets. For example, banks hold $1.068
trillion in core commercial real estate (CRE) loans.\152\ A
recent study commissioned by Deutsche Bank suggests that the
majority of losses on CRE loans will not affect bank balance
sheets for several more years when poorly underwritten CRE
loans made in the easy credit years (e.g., 2005-2007) will
reach maturity and will in many instances fail to qualify for
refinancing:
---------------------------------------------------------------------------
\152\ Core CRE does not include construction, multi-family, or farm
loans.
FIGURE 3: ESTIMATE OF CORE CRE LOANS NOT QUALIFYING FOR REFINANCE, 2009-18 \153\
----------------------------------------------------------------------------------------------------------------
Maturing loans Loans not qualifying for refinance
----------------------------------------------------------------------------------------------------------------
Balance (dollars Balance (dollars
Maturing year # in billions) # in billions) %(#) %($)
----------------------------------------------------------------------------------------------------------------
2009........................ 2,556 18.1 923 8.0 36.1 44.0
2010........................ 3,053 33.0 1,375 21.1 45.0 63.9
2011........................ 4,443 42.6 2,510 29.0 56.5 68.2
2012........................ 4,340 56.3 2,675 43.7 61.6 77.6
2013........................ 5,051 39.1 2,635 25.2 52.2 64.5
2014........................ 4,898 47.8 2,986 33.2 61.0 69.6
2015........................ 8,807 89.0 5,587 60.9 63.4 68.5
2016........................ 10,331 123.9 6,295 88.8 60.9 71.7
2017........................ 9,598 127.4 5,827 94.7 60.7 74.3
2018........................ 895 4.2 108 1.4 12.1 33.7
-----------------------------------------------------------------------------------
Total................... 53,972 581,542,418,727 30,921 406,163,154,040 57.3 69.8
----------------------------------------------------------------------------------------------------------------
\153\ This data is used with permission of Deutsche Bank and was originally compiled in a different form for a
Deutsche Bank special report. See Richard Parkus and Jing An, The Future Refinancing Crisis in Commercial Real
Estate, at 3-4 (Apr. 23, 2009) (online at cop.senate.gov/documents/report-042309-parkus.pdf). This report was
also submitted as written testimony for the Panel's May 28, 2009 hearing on Impact of Financial Recovery
Efforts on Corporate and Commercial Real Estate Lending in New York.
As the report explains, the high percentage of loans not
qualifying for refinancing, and hence in danger of default
without significant injections of new equity, is attributable
to the combined effects of stricter underwriting standards,
steep declines in property values, and reduced income streams
to finance the loans because of lower rents and increased
vacancies.\154\ The findings are based on quantitative data for
commercial mortgage-backed securities (CMBS), which constitute
25 percent of the core CRE market. While the authors of the
report state that there was insufficient data to perform a
detailed study in the larger non-CMBS sector, the authors say
they expect a similar if not higher level of maturity defaults
on non-securitized CRE bank portfolio loans because portfolio
loans typically have shorter maturities (which would not allow
sufficient time for property values to recover from their
present depressed levels) and higher risk profiles than
CMBS.\155\ As another hearing witness explained, however, it is
possible that a higher proportion of maturity defaults can be
avoided in the non-CMBS sector because banks face fewer legal
and practical obstacles in attempting workouts with their
borrowers.\156\ The extent to which the stress tests, which
were never intended to look more than two or three years in the
future, fully grapple with the prospect of massive future CRE
loan defaults is uncertain.\157\
---------------------------------------------------------------------------
\154\ Id. at 11.
\155\ See Congressional Oversight Panel, Oral Testimony of Richard
Parkus, Hearing on Corporate and Commercial Real Estate Lending (May
28, 2009) (hereinafter ``Oral Testimony of Richard Parkus'').
\156\ See Congressional Oversight Panel, Oral Testimony of Kevin
Pearson, Hearing on Corporate and Commercial Real Estate Lending (May
28, 2009).
\157\ At the Panel's hearing in New York on May 28, 2009, there was
disagreement among Panel witnesses as to whether the stress tests' use
of a three-year analysis was sufficient to account for the future
strains on bank balance sheets attributable to a balloon in expected
maturity defaults for CRE loans. See Oral Testimony of Richard Parkus,
supra note 155 (``I do, however, understand the timeframe for the
stress test was, I believe, three years. And that, if that is the case,
that would, in my view, be fairly short, as many of the mortgages we
are looking at do not mature for quite a while.''); Congressional
Oversight Panel, Oral Testimony of Federal Reserve Bank of New York
Vice President of Bank Supervision Til Schuermann, Hearing on Corporate
and Commercial Real Estate Lending (May 28, 2009) (``For sure, there
are going to be some of the losses that will occur after this horizon,
but I think I feel comfortable that a sizable portion of the commercial
real estate exposure was, in fact, taken into account in the stress
test.'').
---------------------------------------------------------------------------
Several of the institutions tested were not traditional
banking enterprises, and yet, by choosing to become BHCs, have
become subject to the higher capital requirements of banks and
the assumptions and analysis of risk that underlie those
requirements. Is this appropriate, or should certain BHCs be
subjected to alternative measures of regulatory capital or be
assessed for risk using different tests? One issue (discussed
above in ``Specific Limitations of the Stress Tests'') is that
the accuracy of the input (the data on which the tests were
performed) depended on prior supervisory examinations; in the
present climate the nature of those examinations has itself
been questioned, and the stress testing may ultimately improve
the examinations themselves. The supervisors noted that, in
some cases, data initially presented were inaccurate or
resulted in double counting and that data was corrected and
resubmitted. As noted above, no full re-examination of the
tested BHCs was possible in the time period in which the test
occurred, but that fact necessarily places some limitation on
the tests' results.
3. ISSUES RELATING TO THE PROCESS AND IMPLEMENTATION
The primary issue identified by Professors Talley and
Walden with the stress test process is the program's lack of
``transparency to outsiders and replicability of its results.''
They state that it would be ``virtually impossible for the
third parties to replicate the SCAP's conclusions, or even
major sub-components of it.'' As a result, while they express
the utmost trust in the Federal Reserve Board's assessment,
they are ultimately unable to confirm any of its
conclusions.\158\
---------------------------------------------------------------------------
\158\ See Annex to Section One of this report, at 34.
---------------------------------------------------------------------------
The supervisors informed the staff of the Panel that there
was no ``negotiation'' of the results of the SCAP and that the
BHCs were merely informed of the supervisors' estimates, with
adjustments arising only from the specified first quarter
adjustments and clear errors and omissions. The range of the
adjustments permitted, however, and the lack of a full
explanation of those adjustments necessarily raise questions in
this regard. For example, it is unclear how large an effect
accounting changes had on the BHCs' first quarter
earnings,\159\ and how much of the resulting earnings
improvements flowed through to the adjustments that were made
with respect to the capital buffer by reason of earnings
improvements. This leads to questions regarding whether the
process could have been better handled and whether there should
have been more transparency and clearer communication as to
what exactly was communicated to the BHCs, which BHCs were
affected, and which numbers were being adjusted.
---------------------------------------------------------------------------
\159\ For further discussion of the impact of the recent accounting
changes, see supra note 80.
---------------------------------------------------------------------------
Securities trading portfolios were specifically
``stressed'' only for the five BHCs that were the largest
traders (this is, for those with trading accounts of $100
billion or more). That process showed very large estimated
losses in the securities trading portfolios of the five BHCs
for which the exercise was conducted. Given the size of those
losses, the way the stress tests take into account estimated
securities trading losses of the BHCs with trading accounts of
less than $100 billion is unclear, and it is thus difficult to
tell how or if those losses have been appropriately accounted
for.
4. THE IMPACT OF Q1 ADJUSTMENTS
Adjustments were presented on a net basis, and thus it is
not possible to see how much of the $110 billion reduction in
capital buffer produced by the first quarter adjustments was
due to sales of assets and conversions of preferred securities
and other capital actions and how much was due to ``strong
PPNR.'' \160\ This approach undercuts the transparency of the
process. It is also important because many commentators do not
believe that the strong earnings of the first quarter are
likely to be repeated. Knowing how much of the first quarter
adjustments were due to earnings would assist independent
analysts in running their own versions of the stress tests.
---------------------------------------------------------------------------
\160\ SCAP Results, supra note 24.
---------------------------------------------------------------------------
5. PRESENTATION OF DATA
While 12 categories of assets were measured, only eight
categories of assets were reported out in the SCAP results, and
some assets were grouped together. For example, estimated
losses on ``First Lien Mortgages'' are reported in aggregate,
while first lien mortgages were divided into prime, Alt-A, and
sub-prime for the purposes of estimation. Estimated losses in
the various categories of securities are also aggregated
together. It is possible that significant information is
obscured by the aggregation of data, and since the public knew
that 12 categories of assets were being measured, some
expectation of obtaining this information had been raised. This
aggregation prevented the public from fully replicating the
tests or from comparing the results of the testing on the 19
banks, or other banks, with different variables.\161\ Neither
Treasury nor the supervisors have explained why this
information was not made available.
---------------------------------------------------------------------------
\161\ The Wall Street Journal and the Financial Times both applied
the SCAP methodology to small- and mid-size banks. However, they could
not exactly replicate the testing. Financial Times Study, supra note
101; Maurice Tamman and David Enrich, Local Banks Face Big Losses, Wall
Street Journal (May 19, 2009) (online at online.wsj.com/article/
SB124269114847832587.html).
---------------------------------------------------------------------------
Because results are presented on the ``more adverse''
scenario alone, the ability to extrapolate results from a
single set of data is impaired. Even though the ``baseline''
scenario was likely too optimistic, publishing the results from
that scenario would have improved transparency and enabled
private analysts, who can play an important role in the way
information is used, to present their own predictions and
analyses.
6. SHOULD STRESS TESTING BE REPEATED?
As discussed above, Treasury conducted a one-time stress
test on the 19 largest U.S. BHCs under the CAP. While Treasury
intended the CAP to ensure that BHCs have adequate capital
cushions to weather worse-than-anticipated economic conditions
in the short-term, it is uncertain whether Treasury will
conduct any future stress testing during or after the current
crisis. It is uncertain whether this expanded form of stress
testing will or should become a permanent fixture of the
financial regulatory system. While Treasury has created capital
cushion requirements through year-end 2010 under the CAP, it
has not required fundamental or permanent changes in capital
adequacy requirements or general regulatory processes.
There are advantages and disadvantages of more permanent
use of stress testing. On one hand, regular stress testing of
large banks may enable regulators to: (1) limit the sorts of
risk-taking that contributed to the current crisis; and (2)
counterbalance the heightened moral hazard that the government,
through TARP, has created for too-large-to-fail
institutions.\162\ Moreover, the one-time nature of the stress
tests is difficult to understand in light of how rapidly, and
sometimes radically, the fortunes of banking institutions have
changed over the past two years. These rapid changes led to
some institutions requiring multiple capital infusions. For
example, both Citigroup and Bank of America, after
participating in the initial round of CPP investments, received
emergency capital infusions and asset guarantees which were
eventually allocated to the TIP program.\163\ Given the
questions raised about the economic assumptions incorporated
into the baseline and adverse scenarios of the stress tests and
about the continuing uncertainty around the value and terms for
write-down of many bank assets, a strong case can be made for
six-month repetitions of the stress tests for the next few
years.
---------------------------------------------------------------------------
\162\ See Sebastian Mallaby, Stress Tests Forever, Washington Post
(May 9, 2009) (online at www.washingtonpost.com/wp-dyn/content/article/
2009/05/07/AR2009050703538.html).
\163\ For more information, see Panel's January and February
reports. Congressional Oversight Panel, Accountability for the Troubled
Asset Relief Program (Jan. 9, 2009) (online at cop.senate.gov/reports/
library/report-010909-cop.cfm); Congressional Oversight Panel, Valuing
Treasury's Acquisitions (Feb. 6, 2009) (online at cop.senate.gov/
reports/library/report-020609-cop.cfm).
---------------------------------------------------------------------------
While comprehensive internal stress testing existed at
banks here and abroad even before the onset of the current
crisis,\164\ there is a justified skepticism about the
sufficiency of bank risk management programs. In particular,
internal testing lacks public transparency and accountability,
which are especially important in the case of too-big-to-fail
institutions because of the government's recent interventions.
Additionally, bank executives can continue to take excessive
risks in the future--as they did prior to the current crisis--
regardless of whether or how they engage in internal stress
testing. Transparency, which the Federal Reserve Board has
stated is justified to restore confidence in the banking
system, would also be missing if stress testing were conducted
within the context of the normal supervisory process where
results are not made public, but stress tests as part of
regular examinations still have merit in and of themselves.
---------------------------------------------------------------------------
\164\ See Bank for International Settlements (BIS), Stress Testing
at Major Financial Institutions: Survey Results and Practice, at 2
(Jan. 2005) (online at www.bis.org/publ/cgfs24.pdf) (noting that stress
testing is ``becoming an integral part of the risk management
frameworks of banks and securities firms'' and that it ``benefits from
its flexibility, comprehensibility and the onus that it puts on
management to discuss the risks that a firm is currently running.'').
---------------------------------------------------------------------------
Regular government stress testing may lose support as time
passes because of debates over: (1) methodologies; (2)
government capacity and resources; and (3) the perception of
negotiation between banks and their regulators.\165\
---------------------------------------------------------------------------
\165\ Stress testing under the CAP raised considerable concerns
among observers. See, e.g., discussion earlier in this report, supra
note 141.
---------------------------------------------------------------------------
7. SHOULD STRESS TESTING BE EXPANDED TO A WIDER RANGE OF BANKS?
Since the passage of EESA in October 2008, Treasury has
devoted a great deal of attention and resources to so-called
too-large-to-fail institutions. The health of these
institutions has considerable bearing on the financial system
because of the enormous value of their combined assets and the
breadth of their transactions involving other institutions and
private citizens. Moreover, while these institutions have
complex structures and, in some cases, branches and business
ventures across the globe, efforts to stabilize too-big-to-fail
institutions may require fewer human resources overall than
efforts to conduct a similar exercise for a far larger number
of institutions ranging in size from just under $100 billion in
assets to the comparatively very small capitalization of some
community banks. Moreover, the events of the financial crisis
necessarily caused Treasury and the Federal Reserve Board to
devote particularly heavy focus to large institutions.
Nonetheless, Treasury has provided capital infusions under
the TARP to a wider range of institutions over the time since
the passage of EESA. By focusing on small institutions in
addition to large ones, Treasury has sought to: (1) minimize
line-drawing problems inherent in providing capital infusions
to only the largest institutions; (2) expand the geographic
reach of its efforts; (3) increase the overall breadth of its
stabilizing influences; and (4) respond to concerns among
taxpayers that TARP targeted only Wall Street, not Main Street.
Despite Treasury's overall strategy to include banks of all
sizes in its stabilization programs, Treasury and the Federal
Reserve Board chose not to include even a sample of smaller
banks in stress testing (even though those banks are eligible
for infusions under the CAP).\166\ BHCs not included in the
stress tests are responsible for one-third of the assets and
close to half of the loans in the US banking system.\167\ While
the federal government's capacity may be strained by conducting
stress tests on as many institutions as it has given capital
infusions, such an approach could: (1) have the same general
benefits as other efforts toward smaller banks, as discussed in
the preceding paragraph; and (2) expand the reach and potential
benefits of the stress tests generally.
---------------------------------------------------------------------------
\166\ Financial Stability Plan Fact Sheet, supra note 26.
\167\ SCAP Design Report, supra note 32, at 1.
---------------------------------------------------------------------------
With the first round of stress testing complete, Treasury
should explain whether it intends to conduct stress tests on
additional institutions in the future. If it does not intend to
do so, Treasury should explain more fully why it chose to make
capital infusions available to smaller institutions under the
CPP, CAP, and other programs but not to include those
institutions in stress testing, and therefore not require the
same additional capital buffer of medium and smaller
institutions.
8. ISSUES REGARDING CAPITAL-RAISING AND RELATED ISSUES
The BHCs needing to establish an additional regulatory
capital buffer must present a plan to their supervisors by June
8 and complete the elements of that plan by November 9. This
may have the impact of limiting their bargaining power with
respect to asset dispositions as potential counterparties know
that the seller has to raise funds in a ``fire sale.'' For
example, Bank of America's sale of part of its holding in China
Construction Bank was effected at a high 14 percent discount to
CCB's market price. The supervisors may need to exercise
flexibility in oversight of the BHCs' capital plans in order to
make sure they are permitted to get the best price possible in
the sales of assets and their own securities.
It is unclear what the impact of the stress tests will be
on the PPIP program.\168\ To the extent the stress test may
have been built on unrealistic values for toxic assets, they
will have created a disincentive to sell those assets at market
prices, decreasing the likelihood of PPIP achieving its stated
goals.\169\ On the other hand, to the extent the stress tests
have accurately revealed that some banks are healthy, they may
be more likely to sell toxic assets to the PPIP program at
realistic prices. If PPIP ends up setting inflated prices for
toxic assets, it is harder to assess what effect the stress
tests will have on PPIP.
---------------------------------------------------------------------------
\168\ U.S. Department of Treasury, White Paper: Public Private
Investment Program (Mar. 23, 2009) (online at www.treas.gov/press/
releases/reports/ppip_ whitepaper_ 032309.pdf). PPIP targets so-called
``toxic assets''--the troubled loans and securities on banks'' balance
sheets. The immediate goal is to use a combination of private and
public capital to buy ``toxic assets.'' The intended result is to
improve liquidity and promote bank lending.
\169\ U.S Banks Have $168 Billion Reason to Avoid PPIP, Bloomberg
(May 29, 2009) (online at www.bloomberg.com/apps/
news?pid=20601208&sid=aa5Joz86_ K6w&refer=finance).
---------------------------------------------------------------------------
The SCAP did not take into account the possibility of
repayment of TARP funds. Only banks that do not need CAP funds
will be permitted to repay CPP funds,\170\ and they will only
be permitted to do so once they have proved they can issue debt
securities without a government guarantee and with the approval
of their supervisors. However, repayment will necessarily have
an impact on the capital of BHCs that repay TARP funds, and it
might be argued that more attention should be paid to the
danger of driving down capital after so much effort has been
expended in shoring it up.
---------------------------------------------------------------------------
\170\ CPP FAQs, supra note 131.
---------------------------------------------------------------------------
9. ISSUES RELATING TO THE BANKS NOT TESTED
The selection of the 19 largest BHCs, and not others, for
the stress tests may distort the BHC marketplace in a few ways.
First, by verifying that these 19 BHCs are healthy, the stress
tests may provide them with a competitive advantage against
smaller banks whose viability has not been confirmed. Second,
the market might interpret the selection of these 19 largest
BHCs as an indication that the supervisors consider them ``too
big to fail.'' Both effects could lead to market participants
favoring the tested BHCs against smaller competitors,
distorting the marketplace.
I. Recommendations
If economic conditions continue to worsen, raising
the possibility that the ``more adverse'' scenario may be met
or exceeded, the stress tests of the 19 BHCs should be repeated
under the more difficult economic assumptions, looking forward
at least two years.\171\ It should be noted that as of June 5,
2009, the unemployment rate for May had climbed to 9.4 percent
\172\ and the average for the first five months of 2009 had
reached 8.5 percent, compared with the assumed 2009 average of
8.9 percent under the more adverse scenario. We recommend that
Treasury publicly track the status of its stress test macro-
economic assumptions (unemployment, GDP, and housing prices)
and repeat the stress test if the adverse scenario assumptions
have been exceeded.
---------------------------------------------------------------------------
\171\ Additional stress tests that consider more alternatives--
longer periods of time, more adverse conditions--would permit experts
to evaluate the robustness of the tests and, if the results remain
strong, to develop more confidence in the strength of the financial
institutions tested.
\172\ Employment Situation, supra note 60.
---------------------------------------------------------------------------
Stress testing should be a regular feature of the
19 BHC's examination cycle so long as an appreciable amount of
toxic assets remain on their books, economic conditions do not
substantially improve, or both. Public disclosure of the main
results of such tests should continue to be a part of this
process. Between supervisory stress tests, the BHCs should be
required to run the stress tests themselves, according to
supervisory guidance, and to submit the results as part of
their ongoing supervisory examinations. Additionally,
regulators should use stress tests on an ad hoc basis for all
banks or BHCs where circumstances, including the bank's
business mix, dictate.
More information should be released with respect
to the results of the stress tests. More granular information
on estimated losses by sub-categories (e.g., the 12 loan
categories that were administered versus the eight that were
released) should be disclosed. The components of the first
quarter adjustments should be disclosed, showing more clearly
the impact of capital actions and revenue. Additional
information will improve transparency of the process and
increase confidence in the robustness of the tests.
The results of the stress tests under the
``baseline'' economic scenario should be released or Treasury
should explain why they were not released.
The CPP repayment process should be more
transparent, and information should be available to the public
with respect to eligibility for repayment, the approval
process, and the process for valuation and repurchase of
warrants. Treasury should also make clear how it proposes to
use repaid TARP funds. The relationship of the SCAP results to
CPP repurchase must be completely transparent.
Capital weaknesses must be addressed. At the same
time, supervisors should be aware of the business needs of the
BHCs. The supervisors should be encouraged to exercise
discretion and flexibility in oversight of the capital plans of
the BHCs required to raise a SCAP buffer. In particular,
supervisors should be sensitive to the need of BHCs to be able
to time capital-raising and asset dispositions in response to
market conditions and not to be forced into uneconomic
transactions in order to meet inflexible timetables. This
discretion, however, should not be used as an excuse to avoid
the pressing need to address capital weaknesses.
J. Conclusions
The three-month stress testing of the nation's largest BHCs
was an unprecedented cross-supervisor effort, conducted in the
midst of a financial crisis and deteriorating national and
international economic condition; the effort involved on the
part of the more than 150 experts involved is highly
commendable. It is also extremely encouraging that the Federal
Reserve Board has been willing to make public information
involving the tests on an almost unprecedented (although
unfortunately incomplete) scale.
The tests must be placed in context. They were conducted
solely within the present supervisory context and are based on
the principle that the supervisors can require capital in
excess of the regulatory baseline when either bank or economic
conditions dictate. They are not a thorough re-examination of
the banks involved (although they are based on the results of
prior examinations), and they rely on a combination of bank
data, modeling based on particular economic assumptions, and
qualitative judgments of the experienced examiners involved,
many of whose conclusions have not been made public.
Independent experts asked by the Panel to review the stress
tests found the economic modeling used to conduct them to be
generally soundly conceived and conservative, based on the
limited information available to those experts. And the
addition of capital to ten of the tested BHCs is certainly a
good step forward. Moreover, the stress-testing regimen can be
valuable if it is firmly instituted by the supervisors
themselves for future periods and is repeated by the
supervisors if bank or economic conditions worsen to a greater
degree than assumed in the stress test modeling.
All the same, the stress tests should not be taken for more
than they are. As indicated above, they were conducted within
the present supervisory context only, and they are a temporary
two-year projection of a one-time capital buffer that need not
be rebuilt. They do not model BHC performance under ``worst
case'' scenarios, and as a result they do not project the
capital necessary to prevent banks from being stressed to near
the breaking point. Most important, for some observers, they do
not address the question whether the values shown on bank
balance sheets for certain classes of assets are too high; by
restricting themselves to a two-year time frame, their
conclusions thus do not take into account the possibility that
the asset values assumed (particularly for so-called toxic
assets) may undervalue bank liabilities to the extent that
those liabilities result in losses after 2010.
The short-term effect of the stress tests was positive, and
the financial markets have calmed to some extent. The Panel
concludes that it would be as much a mistake to dismiss the
stress tests as it would be to assign them greater value than
they merit or in fact that the supervisors claim for them. The
fact that the holding companies have added certain amounts of
capital on certain assumptions does not mean that the financial
crisis is over or that the holding companies are now free from
the risk of the sort of crisis-laden conditions many found
themselves experiencing during 2008 and early 2009. While no
one should gainsay the potentially positive results of the
tests, it would be equally unwise to think that those results
reflect a diagnosis of all of the potential weaknesses or
create a necessarily sufficient buffer against future reverses
for the banking system.
K. Tables
FIGURE 4: BHCS SUBJECT TO THE STRESS TEST
----------------------------------------------------------------------------------------------------------------
Total BHC TARP capital
assets \173\ injections to Other significant
(as of 3/31/ BHC \174\ (to entities in BHC /
Name of BHC Primary location 2009) date) major recent
(dollars in (dollars in acquisitions
billions) billions)
----------------------------------------------------------------------------------------------------------------
Bank of American Corporation...... Charlotte, NC........ 2,323.0 45.0 Merrill Lynch
Countrywide
JPMorgan Chase & Co............... New York, NY......... 2,079.0 25.0 Bear Stearns
Washington Mutual
Citigroup, Inc.................... New York, NY......... 1,823.0 45.0
Wells Fargo & Company............. San Francisco, CA.... 1,286.0 25.0 Wachovia
The Goldman Sachs Group, Inc...... New York, NY......... 926.0 10.0
Morgan Stanley.................... New York, NY......... 626.0 10.0
MetLife, Inc...................... New York, NY......... 491.0 0.0
PNC Financial Services Group, Inc. Pittsburgh, PA....... 286.0 7.6 National City
U.S. Bancorp...................... Minneapolis, MN...... 264.0 6.6
The Bank of New York Mellon....... New York, NY......... 204.0 3.0
GMAC LLC.......................... Detroit, MI.......... 180.0 13.4
SunTrust Banks, Inc............... Atlanta, GA.......... 179.0 4.9
Capital One Financial Corporation. McLean, VA........... 177.0 3.6
State Street Corporation.......... Boston, MA........... 145.0 2.0
BB&T Corporation.................. Winston-Salem, NC.... 143.0 3.1
Regions Financial Corporation..... Birmingham, AL....... 142.0 3.5
American Express Company.......... New York, NY......... 120.0 3.4
Fifth Third Bancorp............... Cincinnati, OH....... 119.0 3.4
KeyCorp........................... Cleveland, OH........ 98.0 2.5
----------------------------------------------------------------------------------------------------------------
\173\ National Information Center, Top 50 Bank Holding Companies Summary Page (online at www.ffiec.gov/nicpubweb/
nicweb/Top50Form.aspx) (accessed June 5, 2009). This web site compiles data on total BHC assets based on BHCs'
quarterly Consolidated Financial Statements (FR Y-9C) and ranks BHCs by total assets on a quarterly basis. The
data used in this chart comes from the most recent financial statements, which include information through
March 31, 2009. One bank that qualified for the stress tests because it held over $100 billion in total assets
as of December 31, 2009--KeyCorp--no longer holds assets exceeding $100 billion. GMAC received an exemption
from filing a FR Y-9C form for the first quarter of 2009. See Board of Governors of the Federal Reserve
System, Letter to David J. DeBrunner (Apr. 13, 2009) (online at www.federalreserve.gov/boarddocs/legalint/BHC_
ChangeInControl/2009/20090413a.pdf). Data on GMAC's total assets was taken from the company's quarterly 10-Q
filed with the SEC. See GMAC LLC, Form 10-Q (online at www.sec.gov/Archives/edgar/data/40729/
000119312509105735/d10q.htm) (accessed May 19, 2009).
\174\ June 5 TARP Transactions Report, supra note 13.
FIGURE 5: CAPITAL-RAISING TO DATE
----------------------------------------------------------------------------------------------------------------
Company Equity Debt SCAP requirements
----------------------------------------------------------------------------------------------------------------
American Express Co.................. $500 million in stock $3.0 billion of non-
\175\. guaranteed five- and
ten-year notes \176\.
Bank of America Corp................. $20.8 billion in stock $33.9 billion
\177\.
BB&T Corp............................ $1.5 billion in stock
\178\.
The Bank of New York Mellon Corp..... $1.2 billion in stock
\179\.
Capital One Financial Corp........... $1.6 billion in stock $1 billion of non-
\180\. guaranteed five-year
notes \181\.
Citigroup, Inc....................... $2 billion of non- $5.5 billion
guaranteed ten-year
notes \182\.
Fifth Third Bancorp.................. $1.1 billion
GMAC LLC............................. $11.5 billion
Goldman Sachs Group Inc..............
JPMorgan Chase & Co.................. $5.0 billion in stock $2.5 billion of five-
\183\. year notes \184\.
KeyCorp.............................. $750 million in stock $1.8 billion
\185\.
MetLife Inc..........................
Morgan Stanley....................... $6.2 billion in stock $4 billion of five and $1.8 billion
\186\. ten-year notes \187\.
PNC Financial Services Group Inc..... $600 million in stock $600 million
\188\.
Regions Financial Corp............... $1.9 billion in stock $2.5 billion
\189\.
State Street Corp.................... $2.0 billion in stock $500 million of five-
\190\. year, senior notes
\191\.
SunTrust Banks, Inc.................. $1.4 billion in stock $2.2 billion
\192\.
U.S. Bancorp......................... $2.4 billion \193\.....
Wells Fargo & Co..................... $8.6 billion in stock $13.7 billion
\194\.
--------------------------------------------------------------------------
$54.5 billion.......... $13 billion............ $ 67.5 billion
----------------------------------------------------------------------------------------------------------------
\175\ American Express Co., Form 8-K (June 1, 2009) (online at www.sec.gov/Archives/edgar/data/4962/
000093041309003114/c57844_ ex1.htm).
\176\ $1.25 billion of 7.25 percent five-year notes (527 basis points over U.S. Treasuries) and $1.75 billion of
8.125 percent ten year notes (502 basis points over U.S. Treasuries). American Express Co., Form 8-K (May 20,
2009) (online at www.sec.gov/Archives/edgar/data/4962/000093041309002795/c57673_ 8k.htm)
\177\ Bank of America, Form 8-K (May 27, 2009) (online at www.sec.gov/Archives/edgar/data/4962/
000093041309003114/c57844_ ex1.htm).
\178\ BB&T Corp, Form 8-K (May 12, 2009) (online at www.sec.gov/Archives/edgar/data/92230/000119312509114095/
d8k.htm).
\179\ Bank of New York Mellon Corp., Form 8-K (May 12, 2009) (online at www.sec.gov/Archives/edgar/data/1390777/
000095012309008628/y77159e8vk.htm).
\180\ Capital One Financial Corp., Form 8-K (May 11, 2009) (online at www.sec.gov/Archives/edgar/data/927628/
000119312509107460/d8k.htm).
\181\ 7.494 percent five-year notes (540 basis points over U.S. Treasuries). One Financial Corp., Form FWP (May
20, 2009) (online at www.sec.gov/Archives/edgar/data/927628/000119312509115052/dfwp.htm).
\182\ 8.765 percent ten-year notes (562.5 basis points over U.S. Treasuries). Citigroup Inc.q, Form FWP (May 15,
2009) (online at www.sec.gov/Archives/edgar/data/831001/000095012309008985/y77311fwfwp.htm).
\183\ JPMorgan Chase & Co., Form 8-K (June 1, 2009) (online at www.sec.gov/Archives/edgar/data/19617/
000119312509122723/d8k.htm).
\184\ 4.696 percent five-year notes (271 basis points over U.S. Treasuries). JPMorgan Chase & Co., Form FWP (May
13, 2009) (online at www.sec.gov/Archives/edgar/data/19617/000001961709000793/fwp51309.htm).
\185\ Key Corp., Form 8-K (June 1, 2009) (online at www.sec.gov/Archives/edgar/data/19617/000119312509122723/
d8k.htm).
\186\ Initial offering of $4 billion. Morgan Stanley, Form 8-K (May 8, 2009) (online at www.sec.gov/Archives/
edgar/data/895421/000095010309001058/dp13415_ 8k.htm). Second offering of $2.2 billion. Morgan Stanley, Form 8-
K (June 1, 2009) (online at www.sec.gov/Archives/edgar/data/895421/000095010309001280/dp13673_ 8k.htm).
\187\ $2 billion of 6.0 percent five-year notes (385 basis points over U.S. Treasuries) and $2 billion of 7.3
percent ten-year notes (399 basis points over U.S. Treasuries). Morgan Stanley, Form FWP (May 8, 2009) (online
at www.sec.gov/Archives/edgar/data/895421/000090514809001909/efc9-0580_ formfwp.htm).
\188\ PNC Financial Service Group, Inc., Form 8-K (May 20, 2009) (online at www.sec.gov/Archives/edgar/data/
713676/000119312509119280/d8k.htm).
\189\ Regions Financial Corp., Form 8-K (May 20, 2009) (online at www.sec.gov/Archives/edgar/data/1281761/
000119312509115380/d8k.htm).
\190\ State Street Corp., Form 8-K (May 21, 2009) (online at www.sec.gov/Archives/edgar/data/93751/
000119312509116176/d8k.htm).
\191\ 4.3 percent five-year notes (196 basis points over U.S. Treasuries). State Street Corp., Form 8-K (May 22,
2009) (online at www.sec.gov/Archives/edgar/data/93751/000119312509117661/d8k.htm).
\192\ SunTrust Banks, Inc., Form 8-K (June 1, 2009) (online at www.sec.gov/Archives/edgar/data/750556/
000119312509121956/d8k.htm).
\193\ U.S. Bancorp., Form 8-K (May 11, 2009) (online at www.sec.gov/Archives/edgar/data/36104/000129993309002107/
htm_ 32711.htm).
\194\ Wells Fargo & Co., Form 8-K (May 8, 2009) (online at www.sec.gov/Archives/edgar/data/72971/
000089882209000287/wfc8k.htm).
FIGURE 6: BANKS THAT HAVE REPAID THEIR TARP FUNDS UNDER THE CPP AS OF MAY 29, 2009
----------------------------------------------------------------------------------------------------------------
Amount
CPP Repayment remaining to Does Treasury Warrant
Bank CPP Repayment amount repay still hold repurchase
date (dollars in (dollars in warrants? amount (dollars
millions) millions) in millions)
----------------------------------------------------------------------------------------------------------------
Washington Federal Inc........ 05/27/2009 200.0 0 Y
TCF Financial Corp............ 04/22/2009 361.2 0 Y
First Niagara Financial Group. 05/27/2009 184.0 0 Y
Iberiabank Corp............... 03/31/2009 90.0 0 N 1.2 (05/20/2009)
Bank of Marin Bancorp......... 03/31/2009 28.0 0 Y
Old National Bancorp.......... 03/31/2009 100.0 0 N 1.2 (05/08/2009)
Signature Bank................ 03/31/2009 120.0 0 Y
Sterling Bancshares, Inc...... 05/05/2009 125.2 0 Y
Berkshire Hills Bancorp, Inc.. 05/27/2009 40.0 0 Y
Alliance Financial Corporation 05/13/2009 26.9 0 Y
FirstMerit Corporation........ 04/22/2009 125.0 0 N 5.0 (05/27/2009)
Sun Bancorp, Inc.............. 04/08/2008 89.3 0 N 2.1 (05/27/2009)
Independent Bank Corp......... 04/22/2009 78.2 0 N 2.2 (05/27/2009)
Shore Bancshares, Inc......... 04/15/2009 25.0 0 Y
Somerset Hills Bancorp........ 05/20/2009 7.4 0 Y
SCBT Financial Corp........... 05/20/2009 64.8 0 Y
Texas Capital Bancshares, Inc. 05/13/2009 75.0 0 Y
Centra Financial Holdings, Inc/ 03/31/2009 15.0 0 N \195\ .8 (04/15/
Centra Bank, Inc. 2009)
First Mantowoc Bancorp, Inc... 05/27/09 12.0 0 N .6 (05/27/2009)
First ULB Corp................ 04/22/09 4.9 0 N .2 (04/22/2009)
Valley National Bancorp....... 06/03/09 75.0 225.0 Y
HF Financial Corp............. 06/03/09 25.0 0 Y
----------------------------------------------------------------------------------------------------------------
\195\ For certain privately held institutions such as this one, Treasury immediately exercised a warrant for
additional preferred shares. Upon exiting TARP, the institution repurchased those additional shares for the
total repurchase amount indicated.
Annex to Section One: The Supervisory Capital Assessment Program: An
Appraisal
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
SECTION TWO: ADDITIONAL VIEWS
A. REP. JEB HENSARLING
1. GENERAL PROGRAM OVERVIEW
As a member of the Congressional Oversight Panel (COP or
the panel) for the Troubled Asset Relief Program (TARP), it has
become evident to me that, unfortunately, the program is no
longer being utilized for its intended purposes of financial
stability and taxpayer protection. It is being used instead to
promote the economic, social and political agendas of the
current administration. As evidenced by TARP's financing of two
bankrupt auto makers, multiple capital infusions into
``healthy'' institutions, increased complexity for institutions
wishing to repay TARP, I have come to the conclusion that
Congress' original intent for financial stability and taxpayer
protection is no longer being respected and the program should
be unwound.
2. BACKGROUND AND THE CONGRESSIONAL OVERSIGHT PANEL'S STATUTORY
RESPONSIBILITIES
On October 3, 2008, Congress voted to enact and the
president signed into law the Emergency Economic Stabilization
Act of 2008 (EESA). The act provided the United States Treasury
with the authority to spend $700 billion to stabilize the U.S.
economy and prevent a systemic meltdown. The act also
established two bodies with broad oversight responsibilities:
the COP and the Financial Stability Oversight Board (FSOB). The
act placed audit responsibilities in the GAO and a Special
Inspector General for the Troubled Asset Relief Program
(SIGTARP).
While the oversight and audit organizations have some
overlapping responsibilities, only the COP is specifically
empowered to hold hearings, take testimony, receive evidence,
administer oaths to witnesses, and review official data, and is
required to write reports on the extent to which the
information on transactions has contributed to market
transparency.\196\
---------------------------------------------------------------------------
\196\ Congressional Research Service, Emergency Economic
Stabilization Act: Preliminary Analysis of Oversight Provisions (Nov.
20, 2008).
---------------------------------------------------------------------------
The EESA statute requires COP to accomplish the following,
through regular reports:
Oversee Treasury's TARP-related actions and
use of authority;
Assess the impact to stabilization of
financial markets and institutions of TARP spending;
Evaluate the extent to which TARP
information released adds to transparency; and
Ensure effective foreclosure mitigation
efforts in light of minimizing long-term taxpayer costs
and maximizing taxpayer benefits.
All are tremendous responsibilities. However, the American
people, through Congress, determined that each were necessary
and expressed confidence that the COP, as an organization and
an arm of Congress, was the right body to carry out the
assigned tasks.
It is no secret that I voted against EESA. However, as the
only sitting member of Congress on the COP, I have consistently
expressed my commitment to ensure that the TARP program works,
that decisions made are based on merit and not political
considerations, and most importantly, that the taxpayers are
protected. I respect the panel and each of its members and
staff; however, I fear that by choosing to focus much of its
work on issues not central to our mandate the panel has missed
critical opportunities to provide effective oversight.
The American people have long understood that when it comes
to government actions, sunshine is the best disinfectant. The
COP is supposed to ensure that the sun is always shining when
it comes to Treasury's actions and the use of TARP funds.
However, due to the panel's pursuit of interesting topics for
legislative and policy debates, taxpayers have not received
answers as to whether the TARP program works, how decisions are
being made or what the banks are doing with the taxpayers'
money. A number of anecdotes exist, but the panel has the
ability to establish the facts.
As I have said in the past, effective oversight begins with
a vigorous examination of those who administer the TARP.
Unfortunately, the panel has conducted only one hearing with a
Treasury official during its six-month existence. As a starting
point, I echo my call that the panel hold a hearing each month
with the Secretary of the Treasury or a senior designee with
TARP management responsibilities. If the Treasury refuses to
participate, the panel should hold its officials to account for
not participating. If the panel refuses to call regular
hearings with Treasury officials, the American public and
Congress should hold the panel to account for negligence.
Additionally, effective taxpayer accountability requires
that the panel question TARP recipients. To date, the panel has
questioned 3 institutions, representing 0.11 percent of total
TARP authorization, out of over 600 \197\ TARP recipients. None
of the major TARP recipients have been questioned in a public
hearing.
---------------------------------------------------------------------------
\197\ Total number of financial institutions participating in
Treasury's Capital Purchase Plan. See U.S. Department of the Treasury,
Seventh Tranche Report to Congress (June 3, 2009) (online at
www.financialstability.gov/docs/TrancheReports/7th_ Tranche-Report-
Appendix.pdf).
---------------------------------------------------------------------------
If presented with the opportunity, I believe the taxpayers
would pose the following types of questions to the TARP
recipients in a matter-of-fact, plainspoken American manner:
Did the financial stability of the economy require
that you accept TARP funds in the first place? Did your
business model, risk management techniques, compliance
protocols and underwriting standards threaten macroeconomic
stability?
If so, have you addressed those issues to ensure
that taxpayers won't be called upon once again to infuse
capital into your company? Please tell us what remedial actions
you took and why you think they will be effective.
If the financial stability of our economy did not
require a TARP infusion into your company, did Treasury
``force'' you to accept any TARP funds? If so, please tell us
what happened.
When can taxpayers expect you to repay the TARP
funds?
To achieve the goal of financial stability, do you
anticipate the need for additional TARP funds? If so, how much
and when will you need the additional TARP funds?
Has Treasury refused to permit you to repay all or
any part of your TARP funds in the name of financial stability?
If so, please tell us about your disagreement with Treasury.
We realize that money is fungible, but please tell
us what you did with your TARP funds.
Has Treasury or anyone from the government
``encouraged'' (or directed) you to (i) extend credit to any
person or entity or (ii) forgive or restructure any loan that
may run counter to the goal of your company's financial
stability?
Using the TARP funds your company has received as
leverage, has Treasury or anyone from the government
``assisted'' (or directed) you in managing the affairs of your
institution?
Did your receipt of TARP funds result in new
lending activity or increased lending activity?
While the COP has reviewed a number of historical
precedents and commented on various policies, including how
Iceland handled its banking crisis, the panel cannot tell the
American people what safeguards Treasury has in place to ensure
that TARP money is not being wasted or if TARP money is being
used in their best interest. The panel knows the answers to
ancillary questions regarding how Spain, Germany, and Italy
handled their banking crises, but the panel cannot answer
fundamental questions on how Treasury is handling the current
crisis. For example, the COP should ascertain how Treasury
measures success, how it will know when TARP funds are no
longer required, and what is Treasury's exit strategy. The
taxpayers deserve to know answers to these fundamental
questions, and it is the COP's duty to help provide them.
As SIGTARP discussed at length in its last report, TARP has
expanded a ``tremendous'' amount in scope, scale and
complexity.\198\ I am including analysis of and questions about
additional, key TARP-related issues upon which the panel has so
far failed to shed light. I have also provided a few
observations on the panel's June report.
---------------------------------------------------------------------------
\198\ Office of the Special Inspector General for the Troubled
Asset Relief Program, Quarterly Report to Congress (Apr. 21, 2009)
(online at www.sigtarp.gov/reports/congress/2009/April2009_ Quarterly_
Report_ to_ Congress.pdf) (hereinafter ``SIGTARP April Report'').
---------------------------------------------------------------------------
a. Investigation of Chrysler's and GM's Bankruptcy and Restructuring
Under the terms of the proposed Chrysler restructuring
plan, the Chrysler senior secured creditors will receive 29
cents on the dollar and the pension funds of the United Auto
Workers (UAW), each an unsecured creditor, will receive 43
cents on the dollar and a 55 percent equity ownership interest
in the ``new'' Chrysler, even though the claims of the senior
secured creditors are of a higher bankruptcy priority than the
claims of the UAW.\199\ The State of Indiana's pension funds,
one group of Chrysler's secured creditors, filed an appeal to
the Chrysler sale, causing the bankruptcy judge to freeze the
proceedings. In their filing, the funds stated, ``This attack
on the most fundamental of creditor rights has been funded,
orchestrated and controlled by Treasury, despite its complete
lack of statutory and constitutional authority to do so.''
\200\
---------------------------------------------------------------------------
\199\ Chad Bray and Alex P. Kellog, Court Affirms Chrysler Sale but
Puts Deal on Hold Until Monday, Wall Street Journal (June 3, 2009)
(online at online.wsj.com/article/
SB124423529553090069.html#mod=testMod).
\200\ Tiffany Kary, et al., Chrysler Says Indiana Pension Funds
Can't Win Appeal, Bloomberg (June 4, 2009) (online at
www.bloomberg.com/apps/news?pid=20601103&sid=aDSQ2KKXfDPI).
---------------------------------------------------------------------------
Under the terms of the proposed GM restructuring plan, the
United States and Canadian governments, the UAW pension funds
and the GM bondholders will receive an initial common equity
interest in GM of 72.5 percent, 17.5 percent and 10 percent,
respectively. The equity interest of the UAW pension funds and
the GM bondholders may increase (with an offsetting reduction
in each government's equity share) to up to 20 percent and 25
percent, respectively, upon the satisfaction of specific
conditions. The GM bondholders have been asked to swap $27
billion in debt for a 10-25 percent common equity interest in
GM, while the UAW has agreed to swap $20 billion in debt for a
17.5-20 percent common equity interest and $9 billion in
preferred stock and notes in GM.\201\ Apparently, even though
the bankruptcy claims of the UAW pension funds and the GM
bondholders are of the same priority, the UAW will receive a
disproportionately greater distribution than the GM bondholders
in the reorganization.
---------------------------------------------------------------------------
\201\ Peter Whoriskey, U.S. Gets Majority Stake in New GM,
Washington Post (June 1, 2009) (online at www.washingtonpost.com/wpdyn/
content/article/2009/05/31/AR2009053101959.html?sid=ST2009060100034).
---------------------------------------------------------------------------
Given the unorthodox reordering of the rights of the
Chrysler and GM creditors, a fundamental question arises as to
whether the Administration directed that TARP funds be used to
advance its policy and legislative objectives rather than to
stabilize the American economy as required by EESA. In other
words, did the Administration use any TARP funds as a carrot or
stick? The Administration should also inform the American
taxpayers regarding its proposed exit strategy from the
Chrysler, GM and other TARP investments and whether it plans to
reinvest such proceeds in other entities.
The panel has agreed to hold a public hearing on the
Chrysler and GM reorganizations. I commend the panel for this
oversight effort. An effective hearing will take place as soon
as possible in the nation's capitol and include senior Treasury
officials, auto company executives, union executives, TARP
recipient bondholders, and non-TARP recipient bondholders, to
name a few. In order to discharge its specific duties and
responsibilities under EESA in a professional and timely
manner, the panel should seek answers to the following
additional questions (among others):
Why would certain Chrysler and GM creditors agree
to accept less than what they were contractually owed and
entitled to receive under bankruptcy law? \202\
---------------------------------------------------------------------------
\202\ Thomas Lauria, a senior bankruptcy and reorganization
attorney with the international law firm White & Case LLP, who
represents a group of Chrysler creditors, recently stated on CNBC that
the Administration flagrantly violated constitutional principles by
trampling on the contractual rights of the Chrysler bondholders. This
is a serious charge by a seasoned and well respected attorney at a top-
tier law firm and should be investigated by the panel. See Thomas
Lauria, Interview: GM, Bonds & Beyond, CNBC (May 13, 2009) (online at
www.cnbc.com/id/15840232?video=1122734987&play=1); Thomas Lauria,
Interview: A Case of Gangster Government, CNBC (May 8, 2009) (online at
www.cnbc.com/id/15840232?video=1118369112&play=1); Thomas Lauria,
Interview: White House Bullying Bondholders?, CNBC (May 6, 2009)
(online at www.cnbc.com/id/15840232?video=1116040367&play=1).
---------------------------------------------------------------------------
Specifically, what is the legal and business
justification for preferring the claims of the UAW pension
funds over the claims of (i) the Chrysler senior secured
creditors since the claims of such creditors are of a higher
bankruptcy priority and should receive preferential treatment
under bankruptcy law, and (ii) the GM bondholders since the
claims of the UAW and the GM bondholders are of the same
bankruptcy priority (both unsecured) and should receive
identical (or at least substantially similar) treatment under
bankruptcy law?
Does it matter that some of the creditors were
also TARP recipients? TARP beneficiaries who were also secured
bondholders of Chrysler--including Citigroup, JP Morgan Chase,
Morgan Stanley, and Goldman Sachs--agreed to the swap of $6.9
billion in debt for just $2 billion in cash. Did these
institutions acquiesce with the knowledge that losses from
their Chrysler holdings may be replenished with TARP funds?
Were they pressured into doing so? How would the taxpayer know
whether or not Treasury channeled TARP funds through these
institutions as a backdoor way of financing the auto industry
and, indirectly, UAW claims? Were any of the GM bondholders
TARP recipients?
Why would TARP recipients (that by definition owe
substantial sums to the United States government) agree to
settle bankruptcy claims for less than the maximum amount
allowable under bankruptcy law?
Who authorized those decisions--the management of
each TARP recipient or Treasury acting as the de facto manager
of the TARP recipients--and what, if any, fiduciary duties were
violated?
If management of each such TARP recipient
voluntarily agreed to forgive part of its claim against
Chrysler and GM, as applicable, what was their legal basis for
making such a gift?
Why would TARP recipients agree to transfer part
of their bankruptcy claims to another creditor--the UAW--and
not use such amounts to repay their TARP loans?
Did the Administration ``reimburse'' Chrysler and
GM for any TARP funds transferred to the UAW?
Did the Administration choose to prefer one group
of employees--UAW members and their retiree benefits fund--over
other non-UAW employees whose pension funds invested in GM
bonds? Under such an approach the retirement plans of the UAW
employees would be enriched while the retirement plans of the
non-UAW employees would be diminished.
What message does this send to the financial
markets--should investors expect their contractual rights to be
ignored when dealing with the United States government? How
will the cases of GM and Chrysler affect future financings and
reorganizations?
What message does this send to non-UAW employees
whose pension funds invested in Chrysler and GM indebtedness--
you lose part of your retirement savings because your pension
fund does not have the special relationships of the UAW?
Is the Administration setting corporate policy
and/or running the day-to-day affairs of Chrysler and GM,
including the two reorganizations? If so, under what authority?
Did the Administration ``force'' Chrysler to
accept a deal with Fiat?
Have the Chrysler and GM boards of directors and
officers abandoned their fiduciary duties and acquiesced in the
management decisions made by the Administration?
Has the Administration appropriately discharged
its fiduciary duties in its role as the de facto manager of an
insolvent Chrysler and GM?
Will the United States government be open to suit
by private parties based upon the breach of its fiduciary
duties owed to Chrysler and GM and their shareholders and
creditors?
Should the panel recommend that SIGTARP, which
performs audits and investigations on abuse and fraud,
investigate any such inappropriate use of TARP funds?
What is the Administration's exit strategy
regarding the investment of TARP funds in Chrysler and GM?
On top of a bankruptcy that will give the UAW a sweeter
deal than comparable GM creditors, there is also the wider
concern that GM is becoming another black hole for taxpayer
dollars. The government will presumably receive a 72.5 percent
initial ownership stake in exchange for $50 billion of TARP
funds committed so far. Although the President has called the
government a ``reluctant'' shareholder that will ``take a
hands-off approach, and get out quickly,'' the Administration
has presented no exit strategy for its ownership, nor any plan
for recouping equity investments. In its latest baseline, the
Congressional Budget Office (CBO) estimated that the TARP auto
program carried about a 74 percent subsidy rate for the
taxpayer--a rate calculated before GM announced bankruptcy and
before loans were converted to what will amount to common
stock. Congress and the public still have little knowledge of
how the Administration will manage the automaker, how it
assesses risks of taxpayer losses, and a strategy to unwind its
investment. These issues will require rigorous and ongoing
investigation by the COP.
Regrettably, the consequences of these actions may not be
limited to Chrysler and GM but may resonate through and have a
chilling effect on the broader bond and capital markets. Once
investors realize that their contracts may not be respected by
the Administration, if they even agree to participate, they
will demand interest rate and other premiums to compensate for
the enhanced risk. Such expenses will be passed on to consumers
and will render American businesses at a competitive
disadvantage to their foreign counterparts. Following the well-
stumbled path of unintended consequences, two misguided
attempts perhaps to favor the UAW may cause other hard working
Americans to lose their jobs to business enterprises organized
in foreign countries that continue to respect the sanctity of a
contract. How can the Administration believe that its actions
in the Chrysler and GM reorganizations will go unnoticed by the
investment community? These ``technicalities'' may have not
garnered the attention of most Americans but they are front-
and-center issues with financial institutions and their counsel
and investors. How can an Administration that is beating the
drum with one hand to encourage financial institutions to
extend credit poke the same financial institutions in the eye
with the other hand? I suspect this lesson has not been lost on
the financial community and may serve as one of the reasons for
the community's tepid embrace of the TALF and PPIP programs.
b. Transparency of Bank of America's Acquisition of Merrill Lynch
Recently, reports have appeared to the effect that Treasury
``coerced'' Bank of America into purchasing Merrill Lynch even
though Bank of America's management concluded that the
transaction was not in the best interest of the bank and its
shareholder. In May the chair of the panel, Professor Elizabeth
Warren, sent a letter to Treasury Secretary Geithner requesting
his ``thoughts on the issue.'' In order to determine what
actually occurred, the panel should investigate whether
Treasury threatened to withhold TARP funds if Bank of America
withdrew from the acquisition, when any such threats were made
and if such actions impacted Bank of America's decision to
acquire Merrill Lynch.
c. TALF and PPIP
The COP's April report indicates a lack of participation by
potential investors in other government programs like the Term
Asset-Backed Securities Loan Facility (TALF) and the Public-
Private Investment Program (PPIP), due to the uncertainty
regarding changing terms and conditions of the programs.\203\
Although the Federal Reserve announced that requests for
participation in TALF increased $11.5 billion from last month,
the program had a rocky start and may pose a greater risk as it
brings on commercial and residential mortgage-backed securities
(MBS).\204\ The PPIP, which has not yet gone live, continues to
be a program in limbo, and the FDIC now says it will delay the
sale of legacy loans.\205\
---------------------------------------------------------------------------
\203\ Jody Shenn, Dudley's TALF Comments Add Signs of a PPIP Stall,
Bloomberg (June 5, 2009) (online at www.bloomberg.com/apps/
news?pid=newsarchive&sid=a2Wl7tAD6rEA).
\204\ Scott Lanman and Sarah Mulholland, Fed Says TALF Loan
Requests Increase to $11.5 Billion, Bloomberg (June 2, 2009) (online at
www.bloomberg.com/apps/news?pid=20601087&sid=aUonjouK30hU).
\205\ Margaret Chadbourn, FDIC Said to Delay PPIP Test Sale of
Distressed Loans, Bloomberg (June 2, 2009) (online at
www.bloomberg.com/apps/news?pid=20601103&sid=aVLm8N96tvV0&refer=us).
---------------------------------------------------------------------------
As we await further details and in order to discharge its
specific duties and responsibilities under EESA in a
professional and timely manner, the panel should address the
following inquiries:
How have these uncertainties--specifically
including the complex executive compensation rules, the
threatened ``outing'' of certain AIG employees and their
families, the alleged inequitable treatment of certain
creditors of Chrysler and GM, and the pending SIGTARP
investigations--affected the TALF and PPIP programs?
Why haven't hedge funds, private equity funds and
other investors embraced the TALF and PPIP programs as
anticipated by Treasury?
Has Treasury marketed these programs to passive
foreign investors and tax exempt organizations (as well as the
typical domestic investors) and what regulatory and other
burdens prohibit or limit the participation by such investors?
Are the tax laws written so as to encourage
passive foreign investors to invest in performing loans and
securities but discourage such investors from investing in
distressed loans and securities?
Why hasn't the panel called leaders in the
financial and investment communities to testify as to why they
consider the TALF and PPIP programs unattractive?
What do potential investors like and what do they
dislike, and why?
Is it possible to address the ``dislikes'' in a
reasonable and mutually beneficial manner?
Why have some investors abandoned their
participation in the programs after expressing initial
interest?
What legal and financial impediments exist?
What other impediments exist?
If Treasury is struggling to introduce market-
ready investment programs, why hasn't the panel offered its
assistance?
I am certainly not suggesting that hedge fund managers be
permitted to structure the programs de novo, but since Treasury
desperately needs private capital to arrest the financial
crisis it seems entirely appropriate for the panel to solicit
and consider the views of the targeted investor classes.
Treasury and the panel must remember that private sector
investors have limited capital to deploy and numerous
attractive opportunities to consider and will not chose to
invest in any Treasury program unless they expect to earn an
appropriate risk adjusted rate of return without excessive
administrative and regulatory burdens. These private sector
institutions owe a fiduciary duty to their investors (which
often include pension funds and university endowments) and
simply cannot allocate capital to off-market investments.
With the full knowledge that private dollars will not
participate unless they anticipate upside potential, the panel
should also ask Treasury to provide more detail on how it
assesses downside risk to the taxpayers of the TALF and PPIP
programs. SIGTARP, for example, has already made several
recommendations to Treasury on ways to reduce risk and the
potential for fraud in TALF and PPIP. It is extremely concerned
with the inclusion of legacy residential MBS in TALF, stating
the Treasury should screen individual securities, have more
stringent requirements for loans used as collateral, and
require higher haircuts for all MBS. In addition, SIGTARP
believes that PPIP is ``inherently vulnerable to fraud, waste
and abuse,'' including various conflicts of interests between
participants.\206\
---------------------------------------------------------------------------
\206\ SIGTARP April Report, supra note 198.
---------------------------------------------------------------------------
d. June COP Report
The report is fairly straightforward in that it focuses on
the mechanics of the recently completed stress tests. Although
I voted ``yes'' to the report, I offer the following questions
and observations.
i. Underlying Legal and Regulatory System. Increased
government involvement in our housing markets created
significant distortions and disruptions. This increased
involvement is contrary to the oft-repeated, now disproven
claims of proponents of expanded government control of our
economy that a ``wave'' of market deregulation over the last 20
years caused the current crisis. To the contrary, facts
indicate that there were at least five key factors which
contributed to financial crisis, at least four of which were a
direct result of government involvement. Those four factors--
highly accommodative monetary policy by the Federal Reserve,
continual federal policies designed to expand home ownership,
the congressionally-granted duopoly status of housing GSEs
Fannie Mae and Freddie Mac, and an anti-competitive government-
sanctioned credit rating oligopoly--are thoroughly discussed in
the Joint Dissenting Views to the COP's ``Special Report On
Regulatory Reform'' that I offered along with Senator John
Sununu along with a fifth factor (failures throughout the
mortgage securitization process that resulted in the
abandonment of sound underwriting practices).\207\ As such, a
thorough recitation of those points here would be redundant.
---------------------------------------------------------------------------
\207\ Congressional Oversight Panel, Special Report on Regulatory
Reform: Modernizing the American Financial Regulatory System:
Recommendations for Improving Oversight, Protecting Consumers, and
Ensuring Stability, at 54-89 (Jan. 29, 2009) (online at cop.senate.gov/
documents/cop-012909-report-regulatoryreform.pdf).
---------------------------------------------------------------------------
ii. Further Information on Counterparty Risk. The current
COP report gives a broad overview of how bank holding companies
(BHCs) provided estimates of counterparty losses, potentially
occurring from deterioration in the credit markets, under the
two stress test scenarios. But the fact remains that there is
still a considerable amount of uncertainty about the inputs
used to stress test counterparty agreements like credit default
swaps and similarly-structured products. The panel neglects to
provide much detail beyond what the Federal Reserve's SCAP
``Design and Implementation'' presents in its white paper. What
was the interaction like between the BHCs, who ran the tests,
and the Federal Reserve, who supervised them? Was the Fed able
to validate counterparty data? There is also little discussion
of disparate data among BHCs, and how the Federal Reserve
rationalized what is a complicated framework with
interdependent assumptions on the risks of default. If the
financial institutions already have counterparty data available
to reasonably assess losses, were another set of market shocks
to occur, why is there still so much uncertainty about systemic
risk? Is there any way for the Federal Reserve to separate the
potential losses from agreements like credit default swaps from
other potential trading losses? Information that addresses
these questions would enable COP to fulfill its responsibility
of assessing how effective TARP funds have been in stabilizing
financial markets.
iii. Application of the Mark-to-Market Rules. Was the
methodology applied to the ``more adverse'' scenario too
conservative? That is, if the newly relaxed mark-to-market
rules were applied to the ``more adverse'' scenario by how much
would the additional capital requirements have dropped? A
lesser capital requirement would decrease the likelihood that
the BHCs would have to raise equity capital by (i) selling
stock in the market or under CAP, (ii) converting preferred
stock (whether privately held or issued under the CPP) into
common stock, or (iii) selling assets. No such alternative is
in the best interests of the taxpayers or the BHCs and, as
such, should be avoided unless necessary and appropriate.
Perhaps prudent underwriting necessitates the use of the old
mark-to-market rules under the theory ABS securities will
continue to be worth far less than their face values. The panel
should continue to investigate by how much the additional
capital requirements would have dropped if the recently
modified mark-to-market rules were applied to the ``more
adverse'' scenario.
iv. ``Negotiation'' of Stress Tests. The report raises the
question as to whether the stress test results were
``negotiated'' between the BHCs and their supervisors. The
report notes that the supervisors informed the staff of the
panel that there was no ``negotiation'' of the results except
with respect to specific first quarter adjustments and clear
errors and omissions.
The report also asks if the process could have been better
handled in a more transparent manner. Although such inquiry is
no doubt appropriate, absent evidence to the contrary, I think
it might be counterproductive to dig aggressively into the
discussions between the BHCs and their supervisors because such
discussions were no doubt candid and may have indeed resulted
in lower capital requirements for specific institutions. It's
naive to think otherwise. It does not follow, however, that the
regulators were persuaded to recommend inappropriately low
additional capital requirements for any institution. Regulated
entities and their supervisors typically discuss (and argue) at
length the results of an examination or audit. Through this
back-and-forth process each side presents its case and
advocates the merits of its position. The regulated entity
works to assist the regulator in better understanding how the
applicable regulations should apply to its business, financial
position and operating results, and the regulator argues in
support of its application of the regulations to the regulated
entity. This process is critical for the regulators because
they are generally significantly outnumbered by the employees
of the regulated entities. Regulated entities and their
supervisors must have an open line of communication that
permits each to speak frankly. Such interaction and exchange of
ideas between a regulated entity and its supervisor by no means
implies that the regulated entity acted in an inappropriate
manner or that the regulator conceded an issue that is not in
the best interest of the taxpayers. If credible evidence
develops to the contrary the panel should promptly investigate,
otherwise any investigation will most likely yield only the
obvious: the supervisors presented their results to the BHCs;
the BHCs commented on any inconsistencies, errors and omission;
the supervisors made any modifications to their reports that
they considered appropriate in their sole and absolute
discretion; and the results were released.
v. CMBS. I continue to receive less than enthusiastic
reports regarding the commercial real estate market. If all
commercial real estate loans and CMBSs were marked-to-market
the additional capital requirement could jump dramatically. The
supervisors should diligently monitor these loans and
securities.
vi. Government Intervention, Exit Strategy and Related
Issues. The following sentences were included in a draft
version of the June report, but were not included in the final
report. They are important issues to consider in the context of
TARP's effectiveness, and I have included them below:
``To the extent that BHCs rely on CAP funds in meeting
their capital buffer needs, all the issues involved in
government ownership of companies' common stock are raised.
Promised Treasury guidance as to the corporate governance
principles that will be followed does not yet seem to have been
published, and will be crucial.''
``Since government intervention in the markets causes
uncertainty, and may make investors less likely to participate
in capital raising by the BHCs, the Administration should be as
transparent as possible with respect to policy issues regarding
intervention.''
``Treasury should publish the corporate governance policies
or guidelines which it will follow as a shareholder in
institutions requiring CAP funding.''
In addition, and in order to discharge its specific duties
and responsibilities under EESA in a professional and timely
manner, the panel should investigate the following related
issues (among others):
What is Treasury's exit strategy with respect to
each TARP investment? Treasury should specify its exit strategy
on an entity-by-entity basis with a time line and in sufficient
detail.
What TARP investments does Treasury expect to hold
at the end of 2009 and each of the next five years? Treasury
should specify on an entity-by-entity basis and in sufficient
detail.
Does Treasury anticipate that it will need to make
additional investments in any of the current TARP recipients or
any other entity? If so, in what amount, in what form, for what
entity and for what purpose?
Does Treasury anticipate that it will reinvest any
repaid TARP funds, that is, is TARP a revolving credit/
investment facility?
Will Treasury remain a passive investor or will it
undertake to designate the directors and officers of the TARP
recipients and in substance exercise day-to-day control over
the management and affairs of such entities?
Will Treasury timely announce its decision to act
in a passive or active manner with respect to the TARP
recipients so as to lessen the uncertainty regarding the large
block of shares held by the public sector?
Will Treasury follow and respect applicable state
corporate and federal and state securities law?
If the government acts as the de facto management
of any TARP recipient will it be liable to suit as a
controlling person and subject to all applicable federal and
state corporate, securities and other rules and regulations?
What are the consequences of the United States
government serving as the de facto manager of Chrysler, GM and
the largest financial institutions?
Will the government mandate which cars will be
built and which borrowers will qualify for loans?
How will ``non-subsidized'' businesses compete
with TARP recipients whose government shareholder may literally
print money?
Will TARP recipients receive favorable government
contracts or other direct or indirect subsidies the award of
which is not based upon objective and transparent criteria?
Will TARP recipients promptly disclose all
contractual arrangements (oral or written) between each TARP
recipient and the government, together with a detailed
description of the contract, its purpose, the transparent and
open competitive bidding process undertaken and the arm's
length and market directed nature of the contract?
Will TARP recipients be able to obtain private or
public credit or enter into other contractual arrangements at
favorable rates because of the implicit governmental guarantee
of such indebtedness and contracts?
Will any such subsidies violate U.S. law or the
laws of any foreign jurisdiction?
How may all aspects of the relationship between
each TARP recipient and the government be made more
transparent, accountable and beyond reproach?
What are the best practices the government should
adopt with respect to its role as the sole TARP investor?
Will employees (and members of their immediate
families) of the government that work with or supervise any
TARP recipients be barred from seeking employment or serving as
a director with TARP recipients or from working with any public
policy shop, law firm or other organization that represents any
TARP recipients for a period of, say, at least five-years
following the departure from government service of such
employee?
Will governmental employees (and members of their
immediate families) be barred from serving as directors,
managers or employees of any TARP recipient during their
government service?
What corporate governance, compliance, risk
management and internal control protocols and procedures will
the government adopt with respect to its role as a creditor and
shareholder of the TARP recipients?
Will the government in its capacity as a
shareholder of each TARP recipient undertake to abide by all
insider trading, controlling shareholder and other applicable
rules and regulations?
Will the government exert disproportionate
influence over management relative to its actual ownership
interests in the TARP recipients?
How will Treasury resolve any conflict of interest
between its role as a creditor or equity holder in any TARP
recipient and as a supervising governmental authority for any
such TARP recipient?
Will the IRS, SEC, Federal Reserve, FDIC and other
governmental agencies be able to discharge their regulatory and
enforcement responsibilities with respect to each TARP
recipient without political influence?
Will management of the TARP recipients support the
government's slate of proposed directors and thus
disenfranchise the remaining shareholders under the proxy
rules?
If Treasury plans to sell its common stock to the
public what are the appropriate benchmarks that will trigger
such sales?
Should Treasury sell its shares in the market
(whereby the TARP recipients will not share in the proceeds,
but the TARP advances will be repaid) or should Treasury agree
to retain its stock and permit the TARP recipients to sell
newly issued shares to third-parties (whereby the TARP
recipients will retain the proceeds from the offering, but the
TARP advances will remain outstanding)?
SECTION THREE: CORRESPONDENCE WITH TREASURY UPDATE
On behalf of the Panel, Chair Elizabeth Warren sent a
letter on May 11, 2009 to Federal Reserve Board Chairman
Bernanke to request certain documents and information related
to the SCAP and to arrange a series of meetings to discuss
SCAP.\208\ Negotiations regarding the production of the
requested materials are ongoing.
---------------------------------------------------------------------------
\208\ See Appendix I of this report, infra.
---------------------------------------------------------------------------
On behalf of the Panel, Chair Elizabeth Warren sent a
letter to Secretary Geithner on May 12, 2009, inviting him to
testify before the Panel on Wednesday, June 17, 2009.\209\ The
Panel seeks to continue its public dialogue with Secretary
Geithner, which began with his first appearance before the
Panel on April 21, 2009. The letter specifically requests that
the Secretary appear before the Panel to discuss the results of
the stress tests and the questions the results raise concerning
methodology, repayment of TARP funds, and the next steps for
the use of TARP money.
---------------------------------------------------------------------------
\209\ See Appendix II of this report, infra.
---------------------------------------------------------------------------
On behalf of the Panel, Chair Elizabeth Warren sent a
letter on May 19, 2009 to Secretary Geithner and Chairman
Bernanke referencing public concern that Treasury and the Board
had applied strong pressure on Bank of America to complete its
acquisition of Merrill Lynch, despite Bank of America's
concerns about Merrill Lynch's deteriorating financial
state.\210\ The letter cites this episode as an example of the
conflicts of interest that can arise when the government acts
simultaneously as regulator, lender of last resort, and
shareholder. The letter concludes by soliciting Secretary
Geithner's and Chairman Bernanke's thoughts on how to manage
these inherent conflicts to ensure that similar episodes do not
undermine government efforts to stabilize the financial system
in the future.
---------------------------------------------------------------------------
\210\ See Appendix III of this report, infra.
---------------------------------------------------------------------------
On behalf of the Panel, Chair Elizabeth Warren sent a
letter on May 26, 2009, to Secretary Geithner requesting
information about Treasury's Temporary Guarantee Program for
Money Market Funds, which is funded by TARP.\211\ The Temporary
Guarantee Program uses assets of the Exchange Stabilization
Fund to guarantee the net asset value of shares of
participating money market mutual funds. The letter requests a
description of the program mechanics and an accounting of its
obligations and funding mechanisms.
---------------------------------------------------------------------------
\211\ See Appendix IV of this report, infra.
SECTION FOUR: TARP UPDATES SINCE LAST REPORT
In addition to the release of the stress test results on
May 7, 2009 (see Section One of this report), Treasury and the
Federal Reserve Board released data and made program
adjustments to a number of initiatives under the Financial
Stability Plan since the release of the Panel's last oversight
report.
A. AUTOMOTIVE INDUSTRY FINANCING PROGRAM (AIFP)
On June 1, 2009, a federal bankruptcy judge approved the
sale of the majority of Chrysler's assets to the Italian
automaker Fiat, clearing the way for the company to exit the
bankruptcy process. On the same day, General Motors (GM) filed
for chapter 11 bankruptcy following the approval of its revised
viability plan by the President's Auto Industry Task Force. The
Administration pledged to support GM through an expedited
chapter 11 proceeding with an additional public investment of
$30.1 billion under AIFP. The additional cash infusion will
raise the total U.S. investment in GM to $49.8 billion. In
return, the government will receive $8.8 billion in debt and
preferred stock, giving it a 60 percent ownership stake in the
new GM.
B. ADDITIONAL CPP INVESTMENT IN GMAC
On May 21, 2009, Treasury announced a $7.5 billion
preferred equity investment in GMAC. GMAC was one of ten banks
subjected to ``stress tests'' under the SCAP determined to be
in need of additional capital. Treasury mandated that the auto
lender raise $9.1 billion in new tier 1 capital within six
months. $3.5 billion of this investment will go toward
addressing the capital shortage. The remaining $4 billion will
be used to support new financing for Chrysler dealers and
customers, a condition of federal assistance. GMAC must submit
a plan for meeting the remainder of its capital needs to
Treasury by June 8. Treasury also announced its intention to
exercise the right to exchange an earlier $884 million loan to
GM for common equity interests in GMAC, giving the government a
35.4 percent equity interest in GMAC.
C. TERM ASSET-BACKED SECURITIES LOAN FACILITY (TALF)
The Federal Reserve Board approved the addition of legacy
commercial mortgage-backed securities (Legacy CMBS) to the
classes of assets eligible for TALF loans. Legacy CMBS are
those issued before January 1, 2009. Previously, the Board had
announced it would expand the range of acceptable TALF
collateral to include new CMBS (those issued after January 1,
2009) starting with the June 16 subscription date. Legacy CMBS
are expected to join TALF beginning with the subscription in
late July. The terms of TALF coverage of Legacy CMBS will
differ from those for other assets. The haircut (adjusted for
length of maturity) will be a standard 15 percent of par--the
face amount--of the Legacy CMBS financed. Because the haircut
is based on par value, it will increase with every dollar that
the Legacy CMBS are valued below par. Thus, the government
compensation for risk increases as its collateral loses value.
The interest rate carry (the amount that can be earned in
excess of the interest paid to the New York Fed) will be capped
at 90 percent; this is the first explicit ceiling on TALF
returns. The cap amounts to a second haircut of six to eight
percent.
On June 2, 2009, the Federal Reserve Bank of New York
offered its June TALF subscription on non-mortgage asset-backed
securities (ABS). In the two hours the facility was open, $11.5
billion in loans were requested. More than three quarters of
the funds were secured by assets backed by credit card debt
($6.2 billion) or auto loans ($3.3 billion). As a point of
comparison, there was a total of $10.6 billion in loans at the
May facility, $1.7 billion at the April facility and $4.7
billion at the March facility.
D. MAKING HOME AFFORDABLE PROGRAM (MHA)
On May 14, 2009, Secretary Geithner and Housing and Urban
Development (HUD) Secretary Shaun Donovan announced two new
program components intended to help homeowners obtain
modifications and stabilize property values in areas suffering
from home price declines.
1. Foreclosure Alternatives Program provides incentives for
servicers and borrowers to pursue short sales and deeds-in-lieu
(DIL) of foreclosure in cases where the borrower is generally
eligible for a MHA modification but is unable to complete the
process. The program aims to simplify and streamline the short
sale and deed-in-lieu process by providing a standard process
flow, minimum performance timeframes, and standard
documentation.
2. Home Price Decline Protection Incentives will provide
lenders additional incentives for modifications in areas where
home price declines have been most severe and there is concern
that the market has yet to bottom out. The program will provide
cash payments to lenders based on the rate of recent home price
declines in a local housing market, as well as the average cost
of a home in that market. The incentive payments on all
modified homes will help cover the incremental collateral loss
on those modifications that do not succeed.
Treasury also released a progress report on MHA. According
to the report, since MHA was announced in early March, 14
servicers, including the nation's five largest, had signed
contracts and begun modifications under MHA. The servicers had
extended offers on over 55,000 trial modifications and mailed
over 300,000 letters with information about trial modifications
to troubled borrowers.
E. PUBLIC-PRIVATE INVESTMENT PROGRAM (PPIP)
On June 3, 2009, the FDIC announced that the June pilot
auction of illiquid bank assets under the Legacy Loans Program
(LLP), one component of the Administration's two-part Public-
Private Investment Program (PPIP), would be postponed.
According to the FDIC, the auction was postponed because many
banks have been able to raise new capital without having to
contemplate selling bad assets through the LLP. The FDIC did
not state when the postponed auction would take place. A pilot
auction for receivership assets, those assets retained by the
FDIC from failed banks, is scheduled to take place in July.
F. CPP MONTHLY LENDING REPORT
Treasury released its first CPP Monthly Lending Report, a
survey of all CPP participants designed to provide insight into
their lending activities. The report captures three data points
on a monthly basis: average outstanding balances of consumer
loans, commercial loans, and total loans from all CPP
participants. This first report includes data from 500 banks
from February 2009 and March 2009. The report shows that the
total average outstanding loans for all CPP participants were
$5,279 billion in February 2009 and $5,237 billion in March
2009. The CPP Monthly Lending Report joins the Monthly Lending
and Intermediation Snapshot of the top 21 CPP participants
(launched in January) as Treasury's primary sources of public
data on lending trends and loans outstanding from CPP
institutions.
G. REPAYMENT OF TARP FUNDS
On June 1, 2009, the Federal Reserve Board released an
outline of the criteria it will use to evaluate applications to
redeem Treasury capital from the 19 BHCs that participated in
SCAP. The Board's primary requirements for approval are a
demonstration on the part of the BHC that it can access the
long-term debt markets without reliance on a guarantee from the
FDIC and the ability to successfully access public equity
markets. Among other things, a BHC must also demonstrate the
ability to maintain certain minimum capital levels and to serve
as a source of financial and managerial strength and support to
its subsidiary banks. Redemption approvals for an initial set
of BHCs are expected to be announced the week of June 8.
Applications will be evaluated periodically thereafter.
H. ADMINISTRATION PROPOSAL ON REGULATING OVER-THE-COUNTER (OTC)
DERIVATIVES
On May 13, 2009, the Obama Administration announced its
proposal for a comprehensive regulatory framework to cover all
OTC derivatives. In a letter to Congress, Secretary Geithner
identified the four broad objectives of the proposal: (1)
preventing activities in derivatives markets from posing risk
to the financial system; (2) promoting the efficiency and
transparency of those markets; (3) preventing market
manipulation, fraud, and other market abuses; and (4) ensuring
that OTC derivatives are not marketed inappropriately to
unsophisticated investors. The proposal requires legislative
action to amend the Commodity Exchange Act and enhance the
regulatory authority of the Commodity Futures Trading
Commission (CFTC) and the Securities and Exchange Commission
(SEC). Under the proposal, a new regulatory regime of OTC
derivatives would require the clearing of all standardized OTC
derivatives through regulated central counterparties, enhanced
supervision and regulation of firms who deal in OTC derivatives
by the CFTC and the SEC, and stricter recordkeeping and
recording requirements, including the movement of all
standardized trades onto regulated exchanges and regulated
electronic execution systems.
I. METRICS
The Panel's April oversight report highlighted a number of
metrics that the Panel and others, including Treasury, the
Government Accountability Office (GAO), Special Inspector
General for the Troubled Asset Relief Program (SIGTARP), and
the Financial Stability Oversight Board, consider useful in
assessing the effectiveness of the Administration's efforts to
restore financial stability and accomplish the goals of the
EESA. The Panel's May oversight report described some
significant movement that had occurred in a few of the
indicators in the time between the Panel's April and May
reports. This report highlights changes that have occurred in
several indicators since the release of the Panel's May report.
Interest Rate Spreads. Several key interest rate
spreads have dropped significantly in recent weeks, most
notably the 3-month and 1-month LIBOR-OIS spreads and the TED
spread. The Fed attributes the moderation of many of these
spreads to its lending programs as well as to the somewhat
improved general economic outlook.\212\
---------------------------------------------------------------------------
\212\ House Committee on the Budget, Testimony of Board of
Governors of the Federal Reserve System Chairman Ben S. Bernanke,
Challenges Facing the Economy: The View of the Federal Reserve, 111th
Cong. (June 3, 2009) (online at budget.house.gov/hearings/2009/
06.03.2009_ Bernanke_ Testimony.pdf).
FIGURE 7: INTEREST RATE SPREADS
------------------------------------------------------------------------
Current Percent change
Indicator spread (as of since last report
6/8/09) (5/7/09)
------------------------------------------------------------------------
3-Month LIBOR-OIS Spread \213\....... 0.41 -45.06
1-Month LIBOR-OIS Spread \214\....... -0.10 -45.02
TED Spread \215\ (in basis points)... 47.76 -38.67
Conventional Mortgage Rate Spread 1.57 -6.55
\216\...............................
Corporate AAA Bond Spread \217\...... 2.00 -15.25
Corporate BAA Bond Spread \218\...... 4.05 -21.51
Overnight AA Asset-backed Commercial 0.18 -35.71
Paper Interest Rate Spread \219\....
Overnight A2/P2 Nonfinancial 0.32 -23.81
Commercial Paper Interest Rate
Spread \220\........................
------------------------------------------------------------------------
\213\ 3-Mo LIBOR OIS Spread, Bloomberg (online at www.bloomberg.com/apps/
quote?ticker=.LOIS3:IND) (accessed June 8, 2009).
\214\ 1-Mo LIBOR OIS Spread, Bloomberg (online at www.bloomberg.com/apps/
quote?ticker=.LOIS1:IND) (accessed June 8, 2009).
\215\ TED Spread, Bloomberg (online at www.bloomberg.com/apps/
quote?ticker=.TEDSP:IND) (accessed June 8, 2009).
\216\ Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release H.15: Selected Interest Rates: Historical Data
(Instrument: Conventional Mortgages, Frequency: Weekly) (online at
www.federalreserve.gov/releases/h15/data/Weekly_ Thursday_ /H15_
MORTG_ NA.txt) (accessed June 8, 2009); Board of Governors of the
Federal Reserve System, Federal Reserve Statistical Release H.15:
Selected Interest Rates: Historical Data (Instrument: U.S. Government
Securities/Treasury Constant Maturities/Nominal 10-Year, Frequency:
Weekly) (online at www.federalreserve.gov/ releases/h15/data/Weekly_
Friday_ /H15_ TCMNOM_ Y10.txt) (accessed June 8, 2009) (hereinafter
``Fed H.15 10-Year Treasuries'').
\217\ Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release H.15: Selected Interest Rates: Historical Data
(Instrument: Corporate Bonds/Moody's Seasoned AAA, Frequency: Weekly)
(online at www.federalreserve.gov/ releases/h15/data/Weekly_ Friday_
H15_ AAA_ NA.txt) (accessed June 8, 2009); Fed H.15 10-Year
Treasuries, supra note 216.
\218\ Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release H.15: Selected Interest Rates: Historical Data
(Instrument: Corporate Bonds/Moody's Seasoned BAA, Frequency: Weekly)
(online at www.federalreserve.gov/releases/h15/data/Weekly_ Friday_ /
H15_ BAA_ NA.txt) (accessed June 8, 2009); Fed H.15 10-Year
Treasuries, supra note 216.
\219\ Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release: Commercial Paper Rates and Outstandings: Data
Download Program (Instrument: AA Asset-Backed Discount Rate,
Frequency: Daily) (online at www.federalreserve.gov/DataDownload/
Choose.aspx?rel=CP) (accessed June 8, 2009); Board of Governors of the
Federal Reserve System, Federal Reserve Statistical Release:
Commercial Paper Rates and Outstandings: Data Download Program
(Instrument: AA Nonfinancial Discount Rate, Frequency: Daily) (online
at www.federalreserve.gov/DataDownload/Choose.aspx?rel=CP) (accessed
June 8, 2009) (hereinafter ``Fed CP AA Nonfinancial Rate'').
\220\ Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release: Commercial Paper Rates and Outstandings: Data
Download Program (Instrument: A2/P2 Nonfinancial Discount Rate,
Frequency: Daily) (online at www.federalreserve.gov/DataDownload/
Choose.aspx?rel=CP) (accessed June 8, 2009); Fed CP AA Nonfinancial
Rate, supra note 219.
Commercial Paper Outstanding. Commercial paper
outstanding, a rough measure of short-term business debt, is an
indicator of the availability of credit for enterprises. Levels
of financial, nonfinancial, and asset-backed commercial paper
continued to decline in May, indicating a sustained tightening
of credit for businesses.
FIGURE 8: COMMERCIAL PAPER OUTSTANDING
------------------------------------------------------------------------
Current level
(as of 6/8/09) Percent change
Indicator (dollars since last
billions) report (5/7/09)
------------------------------------------------------------------------
Asset-Backed Commercial Paper 557.4 -10.55
Outstanding (seasonally adjusted)
\221\............................
Financial Commercial Paper 530.5 -10.80
Outstanding (seasonally adjusted)
\222\............................
Nonfinancial Commercial Paper 156.7 -2.85
Outstanding (seasonally adjusted)
\223\............................
------------------------------------------------------------------------
\221\ Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release: Commercial Paper Rates and Outstandings: Data
Download Program (Instrument: Asset-Backed Commercial Paper
Outstanding, Frequency: Weekly) (online at www.federalreserve.gov/
DataDownload/Choose.aspx?rel=CP) (accessed June 8, 2009).
\222\ Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release: Commercial Paper Rates and Outstandings: Data
Download Program (Instrument: Financial Commercial Paper Outstanding,
Frequency: Weekly) (online at www.federalreserve.gov/DataDownload/
Choose.aspx?rel=CP) (accessed June 8, 2009).
\223\ Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release: Commercial Paper Rates and Outstandings: Data
Download Program (Instrument: Nonfinancial Commercial Paper
Outstanding, Frequency: Weekly) (online at www.federalreserve.gov/
DataDownload/Choose.aspx?rel=CP) (accessed June 8, 2009).
Lending by the Largest TARP-recipient Banks.
Treasury's Monthly Lending and Intermediation Snapshot tracks
loan originations and average loan balances for the 21 largest
recipients of CPP funds across a variety of categories, ranging
from mortgage loans to commercial and industrial loans to
credit card lines. Originations increased across all categories
of bank lending in March when compared to February; \224\
however, Treasury notes that this could be due to the three
additional business days in March or to a seasonal increase in
loan activity in the closing days of a quarter. \225\ A
continued spike in refinancing activity is particularly
noteworthy. Changes in average loan balances were relatively
minor from February to March, with mortgage and other consumer
loan balances up modestly and home equity, credit card,
consumer and industrial loan, and commercial real estate loan
balances down over the period.\226\ The data below exclude
lending by two large CPP-recipient banks, PNC Bank and Wells
Fargo, because significant acquisitions by those banks since
last October make comparisons difficult.
---------------------------------------------------------------------------
\224\ U.S. Department of the Treasury, Treasury Department Monthly
Lending and Intermediation Snapshot Data for October 2008-March 2009
(May 15, 2009) (online at www.financialstability. gov/docs/surveys/
Snapshot_ Data_ March%202009.xls) (hereinafter ``Treasury Snapshot
March Summary Data'').
\225\ U.S. Department of the Treasury, Treasury Department Monthly
Lending and Intermediation Snapshot: March Summary Analysis (May 15,
2009) (online at www.financialstability.gov/docs/surveys/
SnapshotAnalysisMarch2009.pdf) (hereinafter ``Treasury March
Snapshot'').
\226\ Id.
FIGURE 9: LENDING BY THE LARGEST TARP-RECIPIENT BANKS
----------------------------------------------------------------------------------------------------------------
Most recent data
(March 2009) Percent change Percent change
Indicator (dollars in since february since october
billions) 2009 2008
----------------------------------------------------------------------------------------------------------------
Total Loan Originations................................ 220.2 30.80 0.91
Mortgage Refinancing................................... 53.1 11.04 183.04
Total Average Loan Balances............................ 3,390.2 -0.96 -0.95
----------------------------------------------------------------------------------------------------------------
Loans and Leases Outstanding of Domestically-
Chartered Banks. Weekly data from the Federal Reserve Board
track fluctuations among different categories of bank assets
and liabilities. The Federal Reserve Board data are useful in
that they separate out large domestic banks and small domestic
banks. Loans and leases outstanding for large and small
domestic banks have remained largely flat over the past month,
with both falling slightly.\227\ However, while total loans and
leases outstanding at large domestic banks have dropped by over
three percent since EESA was enacted, total loans and leases
outstanding at small domestic banks have increased by 1.37
percent over that time period.\228\
---------------------------------------------------------------------------
\227\ Board of Governors of the Federal Reserve System, Federal
Reserve Statistical Release H.8: Assets and Liabilities of Commercial
Banks in the United States: Historical Data (Instrument: Assets and
Liabilities of Large Domestically Chartered Commercial Banks in the
United States, Seasonally adjusted, adjusted for mergers, billions of
dollars) (online at www.federalreserve.gov/releases/h8/data.htm)
(accessed June 8, 2009).
\228\ Board of Governors of the Federal Reserve System, Federal
Reserve Statistical Release H.8: Assets and Liabilities of Commercial
Banks in the United States: Historical Data (Instrument: Assets and
Liabilities of Small Domestically Chartered Commercial Banks in the
United States, Seasonally adjusted, adjusted for mergers, billions of
dollars) (online at www.federalreserve.gov/releases/h8/data.htm)
(accessed June 8, 2009).
FIGURE 10: LOANS AND LEASES OUTSTANDING
----------------------------------------------------------------------------------------------------------------
Current level
(as of 6/8/09) Percent change Percent change since
Indicator (dollars in since last report ESSA signed into law
billions) (5/7/09) (10/3/08)
----------------------------------------------------------------------------------------------------------------
Large Domestic Banks--Total Loans and Leases..... 3984.8 -0.13 -3.32
Small Domestic Banks--Total Loans and Leases..... 2480.3 -0.14 1.37
----------------------------------------------------------------------------------------------------------------
Housing Indicators. Foreclosure filings stayed
relatively level from March to April, increasing by a modest
0.25 percent, while remaining markedly above the level of last
October. Housing prices, as illustrated by the S&P/Case-Shiller
Composite 20 Index, continued to dip in March. The index is
down over ten percent since October 2008.
FIGURE 11: HOUSING INDICATORS
----------------------------------------------------------------------------------------------------------------
Percent change
from data Percent change
Indicator Most recent available at time since October
monthly data of last report 2008
(5/7/09)
----------------------------------------------------------------------------------------------------------------
Monthly Foreclosure Filings \229\...................... 342,038 0.25 22.35
Housing Prices--S&P/Case-Shiller Composite 20 Index 141.35 -2.17 -10.02
\230\.................................................
----------------------------------------------------------------------------------------------------------------
\229\ RealtyTrac, Foreclosure Activity Press Releases (online at www.realtytrac.com//ContentManagement/
PressRelease.aspx) (accessed June 8, 2009).
\230\ Standard & Poor's, S&P/Case-Shiller Home Price Indices (Instrument: Seasonally Adjusted Composite 20
Index) (online at www2.standardandpoors.com/spf/pdf/index/SA_ CSHomePrice_ History_ 052619.xls) (accessed June
8, 2009).
J. FINANCIAL UPDATE
In its April oversight report, the Panel assembled a
summary of the resources the federal government has committed
to economic stabilization. The following provides: (1) an
updated accounting of the TARP, including a tally of dividend
income and repayments the program has received as of June 3,
2009; and (2) an update of the full federal resource commitment
as of June 3, 2009.
1. TARP
a. Costs: Expenditures and Commitments
Through an array of programs used to purchase preferred
shares in financial institutions, offer loans to small
businesses and auto companies, and leverage Federal Reserve
Board loans for facilities designed to restart secondary
securitization markets, Treasury has committed to spend $645.8
billion, leaving $54.2 billion available for new programs or
other needs.\231\ Of the $645.8 billion that Treasury has
committed to spend, $434.7 billion has already been allocated
and counted against the statutory $700 billion limit.\232\ This
includes purchases of preferred stock, warrants and/or debt
obligations under the CPP, TIP, SSFI Program, and AIFP
initiatives, a $20 billion loan to TALF LLC, the special
purpose vehicle used to guarantee Federal Reserve Board TALF
loans, and the $5 billion Citigroup asset guarantee already
exchanged for a guarantee fee composed of additional preferred
stock and warrants.\233\ Additionally, Treasury has allocated
$15.2 billion to the Home Affordable Modification Program, out
of a projected total program level of $50 billion, but has not
yet distributed any of these funds. Treasury will release its
next tranche report when transactions under TARP reach $450
billion.
---------------------------------------------------------------------------
\231\ EESA limits Treasury to $700 billion in purchasing authority
outstanding at any one time as calculated by the sum of the purchases
prices of all troubled assets held by Treasury. EESA, supra note 1, at
115(a)-(b).
\232\ U.S Department of the Treasury, Seventh Tranche Report to
Congress (June 3, 2009) (online at www.financialstability.gov/docs/
TrancheReports/7th_ Tranche-Report-Appendix.pdf).
\233\ June 5 TARP Transactions Report, supra note 13.
---------------------------------------------------------------------------
b. Income: Dividends and Repayments
Secretary Geithner's testimony to the Senate Banking
Committee on May 20 included Treasury's estimate of TARP funds
remaining for allocation as of May 18. Treasury provided two
figures, $98.7 billion and $123.7 billion,\234\ the later
including an estimated $25 billion in CPP investments that
Treasury expects recipients to repay or liquidate.\235\
Although describing this estimate as ``conservative,'' neither
Secretary Geithner nor Treasury has identified the institutions
that will supply these anticipated repayments, when they will
supply these repayments, or any methodological basis
underpinning this figure. The total amount of CPP repayments
currently stands at $1.772 billion.\236\
---------------------------------------------------------------------------
\234\ After these figures were provided to the Senate Committee on
Banking, Housing, and Urban Affairs, Treasury allocated an additional
$44.5 billion of TARP funds in loans to GM, GMAC, and Chrysler.
Including these allocations would bring Treasury's estimates to $54.2
billion and $79.2 billion, respectively.
\235\ Geithner Testimony, supra note 98.
\236\ June 5 TARP Transactions Report, supra note 13.
---------------------------------------------------------------------------
In addition, Treasury's investment in preferred stock
entitles it to dividend payments from the institutions in which
it invests, usually five percent per annum for the first five
years and nine percent per annum thereafter.\237\ Treasury has
not yet begun to officially report dividend payments on its
transaction reports.
---------------------------------------------------------------------------
\237\ See, e.g., U.S. Department of the Treasury, Bank of New York
Mellon, Securities Purchase Agreement: Standard Terms, at A-1 (Oct. 28,
2008) (Annex A).
---------------------------------------------------------------------------
c. TARP Accounting as of June 3, 2009
FIGURE 12: TARP ACCOUNTING (AS OF JUNE 3, 2009)
[Dollars in billions]
----------------------------------------------------------------------------------------------------------------
Announced Purchase Dividend
TARP Initiative funding price Repayments income
----------------------------------------------------------------------------------------------------------------
Total............................................... 645.8 \238\ 434.7 \239\ 1.8 \240\ 6.2
CPP............................................. 218.0 199.4 1.8 4.8
TIP............................................. 40.0 40.0 0 1.1
SSFI Program.................................... 70.0 69.8 0 0
AIFP............................................ 80.3 80.3 0 0.2
AGP............................................. 12.5 5.0 0 0.1
CAP............................................. TBD 0.0 0 0
TALF............................................ 80.0 20.0 0 0
PPIP............................................ 75.0 0.0 0 0
Supplier Support Program........................ 5.0 5.0 0 0
Unlocking SBA Lending........................... 15.0 0.0 0 0
HAMP............................................ 50.0 15.2 0 0
----------------------------------------------------------------------------------------------------------------
\238\ See June 5 TARP Transactions Report, supra note 13.
\239\ See June 5 TARP Transactions Report, supra note 13.
\240\ As of June 3, 2009. This information was passed on by Treasury officials to Panel staff.
2. OTHER FINANCIAL STABILITY EFFORTS
a. Federal Reserve Board, FDIC, and Other Programs
In addition to the more direct expenditures Treasury has
undertaken through TARP, the federal government has also
engaged in a much broader program directed at stabilizing the
U.S. financial system. Many of these programs explicitly
augment Treasury funds, like FDIC guarantees of securitization
of PPIF Legacy Loans or asset guarantees for Citigroup and Bank
of America, or operate in tandem with Treasury programs, such
as the interaction between PPIP and TALF. Other programs, like
the Federal Reserve Board's extension of credit through its
Sec. 13(3) facilities and special purpose vehicles or the
FDIC's Temporary Liquidity Guarantee Program, stand independent
of TARP and seek to accomplish different goals.
b. Total Financial Stability Resources as of June 3, 2009
Beginning in its April report, the Panel broadly classified
the resources that the federal government has devoted to
stabilizing the economy through a myriad of new programs and
initiatives, as outlays, loans, or guarantees. Although the
Panel has calculated the total value of these resources at over
$4 trillion, this would translate into the ultimate ``cost'' of
the stabilization effort only if: (1) assets do not appreciate;
(2) no dividends are received; no warrants are exercised, and
no TARP funds are repaid; (3) all loans default and are written
off; and (4) all guarantees are exercised and subsequently
written off.
FIGURE 13: FEDERAL GOVERNMENT FINANCIAL STABILITY EFFORT (AS OF JUNE 3, 2009)
----------------------------------------------------------------------------------------------------------------
Federal
Program Treasury Reserve FDIC Total
(TARP) Board
----------------------------------------------------------------------------------------------------------------
Total....................................................... 700 2,440.7 1,427.4 \243\ 4,568
.1
Outlays \241\........................................... 466.4 0 29.5 495.9
Loans................................................... 86.9 2123.7 0 2,210.6
Guarantees \242\........................................ 92.5 317 1,397.9 1,807.4
Uncommitted TARP Funds.................................. 54.2 0 0 54.2
----------------------------------------------------------------------------------------------------------------
AIG......................................................... 70 \245\ 112.5 0 182.5
Outlays................................................. 70 0 0 70
Loans................................................... 0 \246\ 112.5 0 112.5
Guarantees.............................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Bank of America............................................. 52.5 87.2 2.5 142.2
Outlays................................................. \247\ 45 0 0 45
Loans................................................... 0 0 0 0
Guarantees.............................................. \248\ 7.5 \249\ 87.2 \250\ 2.5 97.2
----------------------------------------------------------------------------------------------------------------
Citigroup................................................... 50 229.8 10 289.8
Outlays................................................. \251\ 45 0 0 45
Loans................................................... 0 0 0 0
Guarantees.............................................. \252\ 5 \253\ 229.8 \254\ 10 244.8
----------------------------------------------------------------------------------------------------------------
Capital Purchase Program (Other)............................ 168 0 0 168
Outlays................................................. \255\ 168 0 0 168
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Capital Assistance Program.................................. TBD TBD TBD \256\ TBD
----------------------------------------------------------------------------------------------------------------
TALF........................................................ 80 720 0 800
Outlays................................................. 0 0 0 0
Loans................................................... 0 \258\ 720 0 720
Guarantees.............................................. \257\ 80 0 0 80
----------------------------------------------------------------------------------------------------------------
PPIF (Loans) \259\.......................................... 50 0 600 650
Outlays................................................. 50 0 0 50
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 \260\ 600 600
----------------------------------------------------------------------------------------------------------------
PPIF (Securities) \261\..................................... 25 0 0 25
Outlays................................................. \262\ 10 0 0 10
Loans................................................... 15 0 0 15
Guarantees.............................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Home Affordable Modification Program........................ 50 0 0 \264\ 50
Outlays................................................. \263\ 50 0 0 50
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Automotive Industry Financing Plan.......................... 80.3 0 0 80.3
Outlays................................................. \265\ 13.4 0 0 13.4
Loans................................................... \266\ 66.9 0 0 66.9
Guarantees.............................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Auto Supplier Support Program............................... 5 0 0 5
Outlays................................................. \267\ 5 0 0 5
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Unlocking SBA Lending....................................... 15 0 0 15
Outlays................................................. \268\ 15 0 0 15
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Temporary Liquidity Guarantee Program....................... 0 0 785.4 785.4
Outlays................................................. 0 0 0 0
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 \269\ 785.4 785.4
----------------------------------------------------------------------------------------------------------------
Deposit Insurance Fund...................................... 0 0 29.5 29.5
Outlays................................................. 0 0 \270\ 29.5 29.5
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Other Federal Reserve Board Credit Expansion................ 0 1,291.2 0 1,291.2
Outlays................................................. 0 0 0 0
Loans................................................... 0 \271\ 1,291 0 1,291.2
.2
Guarantees.............................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
Uncommitted TARP Funds...................................... \272\ 54.2 0 0 54.2
----------------------------------------------------------------------------------------------------------------
\241\ The term ``outlays'' is used here to describe the use of Treasury funds under the TARP, which are broadly
classifiable as purchases of debt or equity securities (e.g., debentures, preferred stock, exercised warrants,
etc.). The outlays figures are based on: (1) Treasury's actual reported expenditures; and (2) Treasury's
anticipated funding levels as estimated by a variety of sources, including Treasury pronouncements and GAO
estimates. Anticipated funding levels are set at Treasury's discretion, have changed from initial
announcements, and are subject to further change. The outlays concept used here represents cash disbursements
and commitments to make cash disbursements and is not the same as budget outlays, which under EESA Sec. 123
are recorded on a ``credit reform'' basis.
\242\ While many of the guarantees may never be exercised or exercised only partially, the guarantee figures
included here represent the federal government's greatest possible financial exposure.
\243\ This figure differs substantially from the $2,476-2,976 billion range of ``Total Funds Subject to SIGTARP
Oversight'' reported during testimony before the Senate Finance Committee on March 31, 2009. Senate Committee
on Finance, Testimony of SIGTARP Neil Barofsky, TARP Oversight: A Six Month Update, 111th Cong. (Mar. 31,
2009) (online at finance.senate.gov/hearings/testimony/2009test/033109nbtest.pdf). SIGTARP's accounting,
designed to capture only those funds potentially under its oversight authority, is both less and more
inclusive than the Panel's, and thus the two are not directly comparable. Among the differences, SIGTARP does
not account for Federal Reserve Board credit extensions outside of the TALF or FDIC guarantees under the
Temporary Liquidity Guarantee Program and sets the maximum Federal Reserve Board guarantees under the TALF at
$1 trillion.
\244\ This number includes both investments in AIG under the SSFI program: a $40 billion investment made on
November 25, 2008, and a $30 billion investment made on April 17, 2009 (less a reduction of $165 million
representing bonuses paid to AIG Financial Products employees). June 5 TARP Transactions Report, supra note
13.
\245\ The value of loans extended by the Federal Reserve Board to AIG has been calculated according to a
different methodology from that used in previous Panel reports. Previously, this figure reflected the current
balance sheet value of credit extended to AIG and the Maiden Lane II and III SPVs. The Panel has replaced this
measurement of government exposure with the maximum amounts the Federal Reserve Board is authorized to loan,
as described below.
This number represents the total credit line the Federal Reserve Board is authorized to extend to AIG ($60
billion) and the maximum amount that the FRBNY is authorized to lend to the Maiden Lane II LLC ($22.5 billion)
and Maiden Lane III LLC ($30 billion) special purpose vehicles. See Board of Governors of the Federal Reserve
System, Federal Reserve Board and Treasury Department Announce Restructuring of Financial Support to AIG (Nov.
10, 2008) (online at www.federalreserve.gov/newsevents/press/other/20081110a.htm).
\246\ As of June 5, the value of loans outstanding to AIG stands at $84 billion. This includes $43 billion in
loans directly provided to AIG as well as $41 billion in the outstanding principal amount of loans extended to
special purpose vehicles (approximately $18 billion to Maiden Lane II and $23 billion to Maiden Lane III). See
Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release H.4.1: Factors Affecting
Reserve Balances (June 4, 2009) (online at www.federalreserve.gov/releases/h41/Current/) (hereinafter ``Fed
Balance Sheet June 4'').
\247\ June 5 TARP Transactions Report, supra note 13. This figure includes: (1) a $15 billion investment made by
Treasury on October 28, 2008 under the CPP; (2) a $10 billion investment made by Treasury on January 9, 2009
also under the CPP; and (3) a $20 billion investment made by Treasury under the TIP on January 16, 2009.
\248\ Bank of America Asset Guarantee, supra note 41 (granting a $118 billion pool of Bank of America assets a
90 percent federal guarantee of all losses over $10 billion, the first $10 billion in federal liability to be
split 75/25 between Treasury and the FDIC and the remaining federal liability to be borne by the Federal
Reserve Board).
\249\ Bank of America Asset Guarantee, supra note 41.
\250\ Bank of America Asset Guarantee, supra note 41.
\251\ June 5 TARP Transactions Report, supra note 13. This figure includes: (1) a $25 billion investment made by
Treasury under the CPP on October 28, 2008; and (2) a $20 billion investment made by Treasury under TIP on
December 31, 2008.
\252\ Citigroup Asset Guarantee, supra note 41 (granting a 90 percent federal guarantee on all losses over $29
billion of a $306 billion pool of Citigroup assets, with the first $5 billion of the cost of the guarantee
borne by Treasury, the next $10 billion by FDIC, and the remainder by the Federal Reserve). See also Final
Citi Guarantee Terms, supra note 41 (reducing the size of the asset pool from $306 billion to $301 billion).
\253\ Citigroup Asset Guarantee, supra note 41.
\254\ Citigroup Asset Guarantee, supra note 41.
\255\ This figure represents the $218 billion Treasury has anticipated spending under the CPP, minus the $50
billion investments in Citigroup ($25 billion) and Bank of America ($25 billion) identified above. This figure
does not account for anticipated repayments or redemptions of CPP investments, nor does it account for
dividend payments from CPP investments.
\256\ Funding levels for the CAP have not yet been announced but will likely constitute a significant portion of
the remaining $54.2 billion of TARP funds.
\257\ Geithner Testimony, supra note 98, at 1; June 5 TARP Transactions Report, supra note 13. This figure
represents: a $20 billion allocation to the TALF special purpose vehicle on March 3, 2009; Treasury's
announcement of an additional $35 billion dedicated to the TALF; and $25 billion dedicated to supporting TALF
loans to purchase legacy securities under the PPIP.
\258\ This number derives from the unofficial 1:10 ratio of the value of Treasury loan guarantees to the value
of Federal Reserve Board loans under the TALF. See Financial Stability Plan Fact Sheet, supra note 26
(describing the initial $20 billion Treasury contribution tied to $200 billion in Federal Reserve Board loans
and announcing potential expansion to a $100 billion Treasury contribution tied to $1 trillion in Federal
Reserve Board loans). Because Treasury is responsible for reimbursing the Federal Reserve Board for $80
billion of losses on its $800 billion in loans, the Federal Reserve Board's maximum potential exposure under
the TALF is $720 billion.
\259\ Because PPIP funding arrangements for loans and securities differ substantially, the Panel accounts for
them separately. Treasury has not formally announced either total program funding level or the allocation of
funding between the PPIP Legacy Loans Program and Legacy Securities Program. However, the FDIC recently
announced that it was postponing the implementation of the Legacy Loans program. See FDIC Loans Program
Statement, supra note 25. It is not yet clear whether this postponement will affect the allocation of TARP
funds for the LLP.
\260\ U.S. Department of the Treasury, Fact Sheet: Public-Private Investment Program, at 2 (Mar. 23, 2009)
(online at www.treas.gov/press/releases/reports/ppip_ fact_ sheet.pdf) (hereinafter ``Treasury PPIP Fact
Sheet'') (explaining that, for every $1 Treasury contributes in equity matching $1 of private contributions to
public-private asset pools created under the Legacy Loans Program, FDIC will guarantee up to $12 of financing
for the transaction to create a 6:1 debt to equity ratio). If Treasury ultimately allocates a smaller
proportion of funds to the Legacy Loans Program (i.e., less than $50 billion), the amount of FDIC loan
guarantees will be reduced proportionally.
\261\ In previous reports, the Panel projected that Treasury would split the $100 billion allocated to PPIP
evenly between legacy loans and legacy securities. However, it now appears that Treasury will allocate $25
billion to the TALF for legacy securities, implying that only $25 billion of TARP funds will be directly
allocated to PPIF Legacy Securities.
\262\ Treasury PPIP Fact Sheet, supra note 260, at 4-5 (outlining that, for each $1 of private investment into a
fund created under the Legacy Securities Program, Treasury will provide a matching $1 in equity to the
investment fund; a $1 loan to the fund; and, at Treasury's discretion, an additional loan up to $1). In the
absence of further Treasury guidance, this analysis assumes that Treasury will allocate funds for equity co-
investments and loans at a 1:1.5 ratio, a formula that estimates that Treasury will frequently exercise its
discretion to provide additional financing.
\263\ Government Accountability Office, Troubled Asset Relief Program: March 2009 Status of Efforts to Address
Transparency and Accountability Issues, at 55 (Mar. 31, 2009) (GAO09/504) (online at www.gao.gov/new.items/
d09504.pdf); Geithner Testimony, supra note 98. Of the $50 billion in announced TARP funding for this program,
only $15.2 billion has been allocated as of June 3, and no funds have yet been disbursed. See June 5 TARP
Transactions Report, supra note 13.
\264\ Fannie Mae and Freddie Mac, government-sponsored entities (GSEs) that were placed in conservatorship of
the Federal Housing Finance Agency on September 7, 2009, will also contribute up to $25 billion to the Making
Home Affordable Program, of which the HAMP is a key component. See U.S. Department of the Treasury, Making
Home Affordable: Updated Detailed Program Description (Mar. 4, 2009) (online at www.treas.gov/press/releases/
reports/housing_ fact_ sheet.pdf).
\265\ June 5 TARP Transactions Report, supra note 13. This figure represents Treasury's equity stake in GMAC.
\266\ June 5 TARP Transactions Report, supra note 13. Treasury's initial allocation to GM was effectively a
loan. Under the terms of the company's pending bankruptcy proceedings the $49.9 billion in debt obligations to
Treasury will be converted to a 60 percent stake in the restructured company and $8.8 billion in debt and
preferred stock. See U.S. Department of the Treasury, Fact Sheet: Obama Administration Auto Restructing
Initiatives, General Motors Restructing (May 31, 2009) (online at www.financialstability.gov/latest/05312009_
gm-factsheet.html). It is less clear how Treasury's $17 billion in loans to Chrysler will be affected by its
bankruptcy proceedings. It appears that approximately $9 billion lent before the Chrysler bankruptcy will be
converted to an eight percent equity stake, while $8 billion will be retained as first-lien debt. See U.S.
Department of the Treasury, Obama Administration Auto Restructuring Initiative, Chrysler-Fiat Alliance (Apr.
30, 2009) (online at www.financialstability.gov/latest/tg_043009.html).
\267\ June 5 TARP Transactions Report, supra note 13.
\268\ Geithner Testimony, supra note 98, at 15.
\269\ This figure represents the current maximum aggregate debt guarantees that could be made under the program,
which, in turn, is a function of the number and size of individual financial institutions participating.
$334.6 billion of debt subject to the guarantee has been issued to date, which represents about 43 percent of
the current cap. Federal Deposit Insurance Corporation, Monthly Reports on Debt Issuance under the Temporary
Liquidity Guarantee Program: Debt Issuance under Guarantee Program (May 20, 2009) (online at www.fdic.gov/
regulations/resources/TLGP/total_ issuance4-09.html).
\270\ This figure represents the FDIC's provision for losses to its deposit insurance fund attributable to bank
failures in the third and fourth quarters of 2008. See Federal Deposit Insurance Corporation, Chief Financial
Officer's (CFO) Report to the Board: DIF Income Statement (Fourth Quarter 2008) (online at www.fdic.gov/about/
strategic/corporate/cfo_ report_ 4qtr_ 08/income.html); Federal Deposit Insurance Corporation, Chief Financial
Officer's (CFO) Report to the Board: DIF Income Statement (Third Quarter 2008) (online at www.fdic.gov/about/
strategic/corporate/cfo_ report_ 3rdqtr_ 08/income.html). As of June 5, 2009, the FDIC had not yet released
first quarter 2009 data.
\271\ This figure is derived from adding the total credit the Federal Reserve Board has extended as of June 3,
2009 through the Term Auction Facility (Term Auction Credit), Discount Window (Primary Credit), Primary Dealer
Credit Facility (Primary Dealer and Other Broker-Dealer Credit), Central Bank Liquidity Swaps, loans
outstanding to Bear Stearns (Maiden Lane I LLC), GSE Debt (Federal Agency Debt Securities), the value of
Mortgage Backed Securities Issued by GSEs, Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity
Facility, and Commercial Paper Funding Facility LLC. See Fed Balance Sheet June 4, supra note 246. The level
of Federal Reserve Board lending under these facilities will fluctuate in response to market conditions and
independent of any federal policy decisions.
This calculation is slightly changed from previous reports. The Panel previously looked at the balance sheet
value of Federal Reserve Board holdings in Maiden Lane I LLC and the Commercial Paper Funding Facility; in
this report, the Panel calculates this figure as the outstanding principal amount of the loans extended to
these SPVs.
\272\ One potential use of uncommitted funds is Treasury's obligation to reimburse the Exchange Stabilization
Fund (ESF), currently valued at $50.5 billion. See U.S. Department of Treasury, Exchange Stabilization Fund,
Statement of Financial Position, as of April 30, 2009 (online at www.ustreas.gov/offices/international-affairs/
esf/esf-monthly-statement.pdf) (accessed June 5, 2009). Treasury must reimburse any use of the fund to
guarantee money market mutual funds from TARP money. See EESA, supra note 1, at Sec. 131. In September 2008,
Treasury opened its Temporary Guarantee Program for Money Mutual Funds, U. S. Department of Treasury, Treasury
Announces Temporary Guarantee Program for Money Market Mutual Funds (Sept. 29, 2008) (online at www.treas.gov/
press/releases/hp1161.htm). This program uses assets of the ESF to guarantee the net asset value of
participating money market mutual funds. Id. EESA Sec. 131 protected the ESF from incurring any losses from
the program by requiring that Treasury reimburse the ESF for any funds used in the exercise of the guarantees
under the program, which has been extended through September 18, 2009. U.S. Department of Treasury, Treasury
Announces Extension of Temporary Guarantee Program for Money Market Funds (Mar. 31, 2009) (online at
www.treas.gov/press/releases/tg76.htm).
SECTION FIVE: OVERSIGHT ACTIVITIES
The Congressional Oversight Panel was established as part
of EESA and formed on November 26, 2008. Since then, the Panel
has issued six 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 May oversight report, the
following developments pertaining to the Panel's oversight of
TARP took place:
The Panel held a hearing in New York City on May
28 entitled, ``The Impact of Economic Recovery Efforts on
Corporate and Commercial Real Estate Lending.'' Witnesses
representing banks, businesses, and the Federal Reserve Bank of
New York discussed the impact of the financial crisis on credit
availability for mid-market businesses that rely on commercial
and industrial loans and commercial real estate loans to
operate. Written testimony and video from the hearing can be
found on the Panel's website at http://cop.senate.gov/hearings/
library/hearing-052809-newyork.cfm.
At a Panel hearing on April 21, 2009, Secretary
Geithner pledged to arrange weekly Treasury briefings on TARP
activities for Panel staff. Based on the Secretary's pledge,
Panel staff has since received numerous briefings on topics
including the methodology and results of the stress tests,
lending data from CPP participants, and home ownership
programs.
The Panel and Treasury have reached agreement on a
protocol for Treasury's production of documents to the Panel.
Treasury has stated that it will begin production of requested
documents shortly, but no documents have been produced pursuant
to this protocol as of the date of this report. The Panel is in
the process of negotiating a similar protocol with the Federal
Reserve Board.
Upcoming Reports and Hearings
The Panel will release its next oversight report
in July. The report will provide an updated review of TARP
activities and continue to assess the program's overall
effectiveness. The report will also examine the terms of
repayment of TARP money, including the repurchasing of
warrants.
The Panel is currently working with Treasury to
find a date for Secretary Geithner to make his second
appearance at a Panel oversight hearing in June.
The Panel is planning a field hearing in Detroit
in early July to hear testimony on Treasury's administration of
the Automotive Industry Financing Program.
On May 20, 2009, the President signed into law the
Helping Families Save Their Homes Act of 2009 (P.L. 111-22).
Section 501 of the law requires the Panel to submit a special
report to Congress that provides an analysis of the state of
the commercial farm credit markets and considers the use of
farm loan restructuring as an alternative to foreclosure by
recipients of TARP assistance. To inform its composition of
this report, the Panel is planning a field hearing on farm
credit in the coming weeks.
SECTION SIX: ABOUT THE CONGRESSIONAL OVERSIGHT PANEL
In response to the escalating crisis, on October 3, 2008,
Congress provided 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 instructed the
Panel to produce a special report on regulatory reform that
analyzes ``the current state of the regulatory system and its
effectiveness at overseeing the participants in the financial
system and protecting consumers.'' The Panel issued this report
in January 2009.
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.
APPENDIX I: LETTER FROM CHAIR ELIZABETH WARREN TO FEDERAL RESERVE
CHAIRMAN BEN BERNANKE REGARDING THE CAPITAL ASSISTANCE PROGRAM, DATED
MAY 11, 2009
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
APPENDIX II: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY
GEITHNER REGARDING THE POSSIBILITY OF THE SECRETARY APPEARING BEFORE A
PANEL HEARING IN JUNE, DATED MAY 12, 2009
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APPENDIX III: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY
GEITHNER AND FEDERAL RESERVE CHAIRMAN BEN BERNANKE REGARDING THE
ACQUISITION OF MERRILL LYNCH BY BANK OF AMERICA, DATED MAY 19, 2009
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
APPENDIX IV: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY
GIETHNER REGARDING THE TEMPORARY GUARANTEE PROGRAM, DATED MAY 26, 2009
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]