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





                     CONGRESSIONAL OVERSIGHT PANEL

                        JULY OVERSIGHT REPORT *

                               ----------                              



      TARP REPAYMENTS, INCLUDING THE REPURCHASE OF STOCK WARRANTS

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



                 July 10, 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

                        JULY OVERSIGHT REPORT *

                               __________



      TARP REPAYMENTS, INCLUDING THE REPURCHASE OF STOCK WARRANTS


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



                 July 10, 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



                  U.S. GOVERNMENT PRINTING OFFICE
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                     CONGRESSIONAL OVERSIGHT PANEL
                             Panel Members
                        Elizabeth Warren, Chair
                            Sen. John Sununu
                          Rep. Jeb Hensarling
                           Richard H. Neiman
                             Damon Silvers


                            C O N T E N T S

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                                                                   Page
Executive Summary................................................     1
Section One:.....................................................     4
    A. Background................................................     4
    B. Understanding Warrants....................................     5
    C. Statutory and Contractual Provisions Governing Repurchase 
      and Warrants under TARP....................................     7
    D. Repayments of CPP and TIP Capital Investments.............    14
    E. Valuing TARP Warrants.....................................    16
    F. Alternatives for Disposing of TARP Warrants...............    23
    G. Issues....................................................    28
    H. Conclusion--Policy Choices and Trade-Offs.................    37
Annexes to Section One:
    ANNEX A: Technical Explanation of Warrant Valuation Methods..    39
    ANNEX B: Analysis of the Old National Bancorp Warrants.......    46
Section Two: Additional Views....................................    49
    A. Richard H. Neiman.........................................    49
    B. Congressman Jeb Hensarling................................    50
    H. John Sununu...............................................    59
Section Three: Correspondence with Treasury Update...............    61
Section Four: TARP Updates Since Last Report.....................    62
Section Five: Oversight Activities...............................    72
Section Six: About the Congressional Oversight Panel.............    74
Appendices:
    APPENDIX I: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY 
      TIMOTHY GEITHNER REQUESTING INFORMATION ON THE REPAYMENT OF 
      TARP ASSISTANCE, DATED JUNE 12, 2009.......................    75
    APPENDIX II: LETTER FROM SECRETARY TIMOTHY GEITHNER IN 
      RESPONSE TO CHAIR WARREN'S LETTER REQUESTING INFORMATION ON 
      THE REPAYMENT OF TARP ASSISTANCE, DATED JULY 1, 2009.......    79
    APPENDIX III: LETTER FROM CHAIR ELIZABETH WARREN AND PANEL 
      MEMBER RICHARD NEIMAN TO SECRETARY TIMOTHY GEITHNER 
      REQUESTING ASSISTANCE WITH THE PANEL'S OVERSIGHT OF FEDERAL 
      FORECLOSURE MITIGATION EFFORTS, DATED JUNE 29, 2009........    92
                                     

=======================================================================  
_______________________________________________________________________



 
                         JULY OVERSIGHT REPORT

                                _______
                                

                 July 10, 2009.--Ordered to be printed

                                _______
                                

                          EXECUTIVE SUMMARY *

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    \*\ The Panel adopted this report with a unanimous 5-0 vote on July 
10, 2009.
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    In late 2008, our economy faced an exceptional crisis, and 
Congress created the Troubled Asset Relief Program (TARP) in an 
effort to stabilize the financial system. Through the TARP, 
taxpayers invested billions of dollars in the nation's 
financial institutions.
    These actions imposed an enormous risk on taxpayers. If the 
TARP failed to stabilize the financial system, the entire 
economy could collapse. Even if the system stabilized after 
huge infusions of taxpayer funds, if some institutions were 
unable to recover taxpayers could be paying the debts for 
generations. While these risks were looming, then-Treasury 
Secretary Henry Paulson argued that TARP assistance could be 
used to rescue the economy and generate a profit for taxpayers. 
When Congress authorized the commitment of $700 billion to 
rescue the financial system, it decided that taxpayers should 
have the opportunity to share in a potential upside if the 
banks returned to profitability.
    The opportunity to profit from TARP investments comes 
through special securities called warrants. Banks that received 
financial assistance were required to give the government 
warrants for the future purchase of some of their common 
shares. Simply put, warrants are the right to buy shares of a 
company at a set price at some point in the future. For 
example, a warrant might allow Treasury to buy shares of a bank 
for ten dollars at any time in the next ten years. If the share 
price rises above ten dollars, Treasury could pay less than 
market value for the shares, then sell them and turn a profit. 
In this way, the banks were repaying the taxpayers for their 
investment by sharing some of their future profitability.
    Currently many banks want to exit the TARP program by 
repaying their financial assistance and repurchasing their 
warrants from Treasury. Treasury is permitting ten of the 
nation's largest bank holding companies--representing more than 
one third of the nation's banking assets--to repay the 
financial assistance they received eight months ago. Any exit 
from the TARP system implicates an important policy question: 
if the banks give up federal support prematurely, will the 
economy suffer as a result? The Panel has not reached a 
consensus on whether it is wise policy to release banks from 
the TARP program at this time, but our June report on the bank 
stress tests raised key questions about whether we know enough 
about the banks' overall health.
    As Treasury makes these decisions about repayment, it is 
the Panel's mandate to determine whether the taxpayer is 
receiving maximum benefit from the TARP. Because the warrants 
that accompanied TARP assistance represent the only opportunity 
for the taxpayer to participate directly in the increase in the 
share prices of banks made possible by public money, the price 
at which the warrants are sold is critical. To determine 
whether Treasury is valuing the warrants in a way that 
maximizes the taxpayers' investments in the financial 
institutions, it is necessary to determine how much the 
warrants are worth.
    The Panel uses the most widely-accepted mathematical model, 
presenting a detailed technical valuation of the warrants 
Treasury holds. The assumptions employed in the use of any 
model are crucial, and the report offers a range of estimates 
based on high, low and best estimate assumptions for certain 
key variables. The Panel was aided in its valuation efforts by 
three renowned finance experts, Professor Robert Merton, 
Professor Daniel Bergstresser, and Professor Victoria Ivashina, 
all of the Harvard Business School. The professors reviewed 
both the technical valuation model and the assumptions that 
were built into the model; they concluded that the approaches 
reported here were reasonable and that they produced reliable 
estimates.
    Eleven small banks have repurchased their warrants from 
Treasury for a total amount that the Panel estimates to be only 
66 percent of its best estimate of their value. If the warrants 
had been sold for their market value, taxpayers would have 
recovered $10 million more.
    Treasury has to date sold warrants only from smaller banks. 
In those sales, liquidity discounts are likely to be a major 
factor in a way that they are not likely to be for large 
publicly-traded institutions. If, however, liquidity discounts 
or any other rationales are accepted as a reason for taking 
only 66 percent of market value for the full group of warrants 
Treasury holds, the shortfall to taxpayers could be as much as 
$2.7 billion.
    It is possible that policymakers may conclude that other 
objectives should override the goal of maximizing taxpayer 
returns. For example, Treasury has said that it wants to allow 
banks to operate again without TARP assistance as soon as they 
are strong enough to do so.
    Because warrant valuation is a difficult task, the Panel 
explores the possibility that Treasury should leave it to the 
markets by selling the warrants in an open, public auction. 
This has the benefit of stopping any speculation about whether 
Treasury has been too tough or too easy on the banks that want 
to repurchase their own warrants. It also permits the banks to 
bid for their own warrants--in direct competition with 
outsiders.
    The report describes key provisions in the Treasury 
contracts with the banks and statutory provisions that govern 
warrant purchases. The Panel notes that Treasury is constrained 
in some ways by the provisions of the contracts governing the 
TARP investments in the banks.
    It should be noted that Treasury is just beginning its 
warrant repurchase program. Banks have bought back only a 
fraction of one percent of all warrants issued, and the prices 
paid thus far may not be representative of what is to come. As 
always, it is critical that Treasury make the process--the 
reason for its decisions, the way it arrives at its figures, 
and the exit strategy from or future use of the TARP--
absolutely transparent. If it fails to do so, the credibility 
of the decisions it makes and its stewardship of the TARP will 
be in jeopardy.
                              SECTION ONE

    Ten of the nation's largest financial institutions, and 
some smaller institutions, have repaid the amounts they 
received under the TARP by redeeming the preferred shares 
Treasury received when the assistance was provided. Their 
redemption of the preferred shares entitles them to buy back 
the warrants to purchase their common shares that Treasury also 
received at that time.
    The preferred shares and pending warrant repayments raise 
important questions about the TARP:
           the extent to which repayment of TARP 
        assistance is yet appropriate, and if so, on what terms 
        and timing, in light of the still uncertain economic 
        recovery;
           the appropriate circumstances for repayment;
           the extent to which the relationship between 
        the strength of individual institutions and the 
        strength of the financial system should govern timing 
        of repayment;
           the price at which Treasury should dispose 
        of the warrants it holds, and the way it should do so;
           the statutory and contractual obligations 
        that affect Treasury's ability to set a price for 
        warrant repurchase;
           the fair market value of the warrants; and
           the policy considerations that should govern 
        the price that Treasury accepts for its warrants.
    In its past reports, the Panel examined questions about the 
policy, strategy and execution of the TARP's approach to bank 
assistance. This report begins an effort to evaluate the 
details of the exit strategy from the TARP that are emerging 
from the actions Treasury and the Federal Reserve Board are now 
taking.
    In doing so, the Panel recognizes that repayment of TARP 
assistance and disposition of TARP warrants raise different, 
albeit related, issues. The former is the foundation of the 
government strategy for stabilizing the nation's financial 
system. The warrants represent only 15 percent of the value of 
Treasury's investment in the banks that have received 
assistance (at the time of that investment). But Congress 
required institutions receiving TARP assistance to issue the 
warrants to permit the public to share in the increase in share 
values that investment of billions of dollars of the public's 
money made possible. Thus examination of issues relating to 
both repayment and warrants can shed light on Treasury's 
objectives and strategy during what appears to be a critical 
phase in the implementation of the TARP.

                             A. Background

    Between October 14, 2008 and June 26, 2009, Treasury 
injected more than $240 billion into over 600 of the nation's 
bank holding companies (BHCs) and independent banking 
institutions through the TARP in exchange for preferred shares 
and warrants to buy common shares of each institution 
involved.\1\ These capital injections appear to have 
contributed to stabilizing, or at least softening, last year's 
severe downturn in the U.S. financial system, although as the 
Panel has noted elsewhere, it is not entirely clear what 
positive effects TARP assistance has had on the availability or 
terms of credit.\2\
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    \1\ U.S. Department of the Treasury, TARP Transactions Report for 
the Period Ending June 30, 2009 (July 2, 2009) (online at 
www.financialstability.gov/docs/transaction-reports/transactions-
report_070209.pdf) (hereinafter ``July 2 TARP Transactions Report''). 
The injections were part of Treasury's Capital Purchase Program (the 
``CPP''), except for two $20 billion transactions that were part of 
Treasury's Targeted Investment Program (the ``TIP'').
    \2\ See Congressional Oversight Panel, April Oversight Report: 
Assessing Treasury's Strategy: Six Months of TARP at 27-35 (April 7, 
2009) (online at cop.senate.gov/documents/cop-040709-report.pdf) 
(hereinafter ``Panel April Report''); Congressional Oversight Panel, 
May Oversight Report: Reviving Lending to Small Businesses and Families 
and the Impact of the TALF (May 7, 2009) (online at cop.senate.gov/
documents/cop-050709-report.pdf) (hereinafter ``Panel May Report''); 
Congressional Oversight Panel, June Oversight Report: Stress Testing 
and Shoring Up Bank Capital at 135-139 (June 9, 2009) (online at 
cop.senate.gov/documents/cop-060909-report.pdf) (hereinafter ``Panel 
June Report'').
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    During the winter and spring of this year, the Federal 
Reserve Board oversaw the Supervisory Capital Assessment 
Program (the ``stress tests'' or ``SCAP'') that was the subject 
of the Panel's June report.\3\ The stress tests' results, 
released on May 7, 2009, determined that ten of the nation's 
nineteen largest BHCs must raise an additional capital buffer 
totaling $74.6 billion in all, to meet capital requirements 
that the Federal Reserve Board has set in light of current 
economic conditions.\4\
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    \3\ Id, at 6-56.
    \4\ Board of Governors of the Federal Reserve System, The 
Supervisory Capital Assessment Program: Overview of Results (May 7, 
2009) (online at http://www.federalreserve.gov/newsevents/press/bcreg/
bcreg20090507a1.pdf).
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    On June 17, ten of the nation's largest BHCs repaid the 
TARP capital infusions they received eight months ago, spending 
a total of $68.2 billion to redeem their preferred shares from 
Treasury (with the approval of Treasury and the Federal Reserve 
Board). The institutions, and amounts repaid, included: 
JPMorgan Chase ($25 billion), Morgan Stanley ($10 billion), 
Goldman Sachs ($10 billion), US Bancorp ($6.6 billion), Capital 
One Financial ($3.5 billion), American Express ($3.4 billion), 
BB&T ($3.1 billion), Bank of New York Mellon ($3 billion), 
State Street ($2 billion), and Northern Trust ($1.6 billion). 
In addition, as of July 2, 2009, repayments have been made by 
22 small and private banks, for a total of $1.9 billion. All 
told, $70.2 billion in Capital Purchase Program (CPP) 
assistance has been repaid. The systemic risks posed by BHCs 
with $100 billion or more in assets are different than those 
posed by other BHCs or smaller community banks, but the issues 
raised in this report--the relationship of the return of 
capital assistance to the size and health of a bank, the 
policies that should govern approval of return of assistance, 
and the value of the warrants held by Treasury in the bank, 
apply equally to both.
    In May 2009, Treasury issued ``FAQs on Capital Purchase 
Program Repayment,'' which included a general statement of the 
policy used in determining whether to approve TARP repayments; 
on June 1, 2009, the Federal Reserve Board issued more detailed 
guidelines on the criteria for approval for the stress-tested 
BHCs.\5\
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    \5\ See infra note 25.
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                       B. Understanding Warrants

    A warrant is a security that permits the holder to buy a 
specified number of common shares (the ``underlying'' shares) 
at a specified price (the ``strike price'') on or before a 
specified date (the ``expiration''). With a couple of technical 
caveats,\6\ warrants can be considered a form of call option 
and are often issued as ``sweeteners'' with fixed-income 
securities, such as preferred shares or debt (much like 
employee stock options are used to enhance compensation 
packages). When warrants are issued, their strike price is 
usually set above the current share price; they generally have 
no value if exercised immediately because the holder could 
immediately buy shares on an exchange at a lower price. 
However, warrants may be traded on public or private markets, 
and they can be highly valued by investors who believe the 
share price of the issuing company is likely to rise above the 
strike price. Typically, prospective warrant investors will use 
mathematical models to calculate the value of warrants based on 
the probability of the share price rising above the warrant's 
strike price.
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    \6\ Including a warrant's potential dilutive effect and its balance 
sheet treatment, discussed infra.
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    When a holder exercises its rights under a warrants 
agreement, the company must issue new common shares. This 
necessarily has the effect of reducing the percentage of the 
company owned by existing shareholders (known as ``dilution''). 
The prospect of potential dilution means that the issuance of 
warrants tends to depress the trading price of the common 
shares to some extent.\7\
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    \7\ Such price declines reflect the potential for each share of 
common stock to represent less ownership control. Stock exchange rules 
temper the impact of this dilution by requiring shareholder votes in 
the event that the proposed issuance would increase the outstanding 
number of shares by more than 20 percent. See New York Stock Exchange, 
Listed Company Manual Sec. 312.03(c)(1); NASDAQ Stock Market, Equity 
Rules Sec. 5635(a)(1)(A).
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    When warrants are issued in conjunction with other 
securities, as in the CPP, and valued and traded separately 
from the preferred shares (i.e., they are ``detachable''),\8\ 
the issuer allocates a corresponding value as paid-in capital 
on its balance sheet.\9\ This value is based on the fair value 
of the securities relative to the fair value of the warrants at 
the time of issuance and does not change in subsequent 
financial statements.\10\
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    \8\ Financial Accounting Standards Board, Accounting for Derivative 
Instruments and Hedging Activities, 12, 16 (FAS No. 133) (June 1998) 
(as amended by FAS No. 155).
    \9\ Letter from James Kroeker, Securities and Exchange Commission, 
and Russell Golden, Financial Accounting Standards Board, to Assistant 
Secretary David G. Nason, U.S. Department of the Treasury (Oct. 24, 
2008) (online at financialstability.gov/docs/CPP/secfasbletter.pdf).
    \10\ When the warrants are exercised, the value allocated to the 
warrants is removed from the ``stock warrants outstanding'' account 
and, together with the cash received on exercise, credited to the stock 
account for par or stated value, with any excess over the par value 
being credited to the ``additional paid-in capital'' account. When 
warrants are reacquired, the amount paid in excess of the amount 
assigned to warrants at issuance is charged to retained earnings. If 
warrants are reacquired at a price less than the amount originally 
assigned to them, the difference is credited to additional paid-in 
capital.
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    When a company offers or sells securities, the transaction 
must be registered with the SEC under the Securities Act of 
1933,\11\ unless the transaction is exempt from registration. 
Private sales, such as the CPP transactions with Treasury, are 
exempt from registration. However, if the original holder 
wishes to have the ability to sell the warrants into the public 
markets (which is permitted in the case of the CPP warrants) 
the issuer must have agreed to register the public resale of 
the warrants.\12\
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    \11\ Securities Act of 1933, Pub. L. No. 73-22, Sec. 5 (codified at 
15 U.S.C. Sec. 77(a) et seq.).
    \12\ Securities Purchase Agreement, infra note 15 at Sec. 4.5(p).
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   C. Statutory and Contractual Provisions Governing Repurchase and 
                          Warrants Under TARP

    The Emergency Economic Stabilization Act of 2008 (EESA) 
authorizes Treasury to purchase financial instruments.\13\ 
Through the CPP and Targeted Investment Program (TIP), Treasury 
bought $203.2 billion and $40 billion, respectively, of 
preferred shares from financial institutions. Preferred shares 
entitle the holder to a fixed rate of dividend, and in that 
respect function somewhat like a loan to the institution. EESA 
also requires that any such purchase of financial instruments 
from financial institutions must be accompanied by the issuance 
to Treasury of warrants to purchase common shares of the 
institution, so that taxpayers can benefit from a rise in the 
price of the institution's shares, presumably reflecting the 
value of the assistance Treasury has provided.\14\
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    \13\ Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-
343 (online at frwebgate.access.gpo.gov/cgi-bin/
getdoc.cgi?dbname=110_cong_bills&docid=f:h1424enr.txt.pdf) (codified at 
12 U.S.C. Sec. 5201 et seq.) (hereinafter ``EESA''), as amended by Pub. 
L. No. 111-5, Sec. 7001 and Pub. L. No. 111-22, Sec. 403.
    \14\ EESA, supra note 13 Sec. 113(d)(2)(a) (codified at 12 U.S.C. 
Sec. 5223(d)(2)(A)) (``[The] terms and conditions of any warrant . . . 
shall . . . at a minimum, be designed . . . to provide for reasonable 
participation by the Secretary, for the benefit of taxpayers, in equity 
appreciation in the case of a warrant or other equity security . . . 
and to provide additional protection for the taxpayer against losses 
from sale of assets by the Secretary under [EESA] and the 
administration expenses of the TARP.''); EESA, supra note 13, 
Sec. 113(d)(1) (codified at 12 U.S.C. Sec. 5223(d)(1)) (providing that 
the warrants may be to purchase either nonvoting common stock, common 
stock with respect to which Treasury agrees not to exercise voting 
power, or preferred shares of any institution from which Treasury 
purchases financial instruments. If the institution involved is 
privately-held, the warrant may be ``for common or preferred stock or a 
senior debt institution from such institution.'').
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    The terms of the preferred shares and the warrants are 
governed both by statute and by individual contracts with each 
institution receiving assistance. Each bank's agreement with 
Treasury includes a Securities Purchase Agreement (SPA) and a 
Form of Warrant to Purchase Common Stock (Form of Warrant), 
which are attached to a Letter Agreement.\15\ These documents 
set out the detailed terms of each security.
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    \15\ The terms of these documents vary somewhat by institution 
type--public, private, S-corporation, mutual holding company, or mutual 
bank--but are substantially similar. See, e.g., U.S. Department of the 
Treasury, Securities Purchase Agreement: Standard Terms (online at 
www.financialstability.gov/docs/CPP/spa.pdf) (hereinafter ``Securities 
Purchase Agreement''); U.S. Department of the Treasury, Form of Warrant 
to Purchase Common Stock (online at www.financialstability.gov/docs/
CPP/warrant.pdf) (hereinafter ``Form of Warrant'').
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    The statute, the contracts, and Treasury policy interact to 
shape the terms of the preferred shares and warrants, including 
terms relating to their redemption or repurchase. The statutory 
provision regarding repurchases has been amended twice since 
EESA was enacted. As discussed in more detail below, initially 
the repayment of preferred shares and warrants was made 
somewhat difficult for banks. EESA was then amended to allow a 
bank to repay with the approval of its supervisor, and to 
mandate that Treasury liquidate the warrants on redemption of 
the preferred shares.\16\ In May 2009, EESA was further amended 
to provide Treasury with discretion as to whether to hold or 
liquidate the warrants upon a bank's redemption of the 
preferred shares. Because the contracts were entered into under 
the original statutory regime, Treasury has needed to adapt to 
the amendments. It has done so through both its policy and 
changes to the contracts. The end result, as described in this 
section, is a process created by a combination of the statute, 
contract, and policy. Under this process, a bank may redeem its 
preferred shares only with the approval of its supervisor, as 
required by EESA, after which it may repurchase its warrants at 
a price determined by a specific valuation procedure, as 
required by the contracts.
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    \16\ See infra notes 23 and text accompanying note 44; Section One 
Part C(2) of this report.
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                          1. PREFERRED SHARES

a. Terms of Preferred Shares

    The CPP preferred shares pay cumulative \17\ dividends of 
five percent per year for the first five years of the 
program.\18\ They are senior to the institution's common 
shares, have an equal preference to existing preferred shares, 
and are non-voting.\19\
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    \17\ A bank that is not a subsidiary of a holding company pays non-
cumulative dividends at the same rates. U.S. Department of the 
Treasury, TARP Capital Purchase Program Senior Preferred Stock and 
Warrants Summary of Senior Preferred Terms (online at www.treas.gov/
press/ releases/reports/document5hp1207.pdf) (hereinafter ``CPP Term 
Sheet'').
    \18\ In the sixth year, the dividends are raised to 9 percent. U.S. 
Department of the Treasury, Factsheet on Capital Purchase Program (Mar. 
17, 2009) (online at www.financialstability.gov/roadtostability/
CPPfactsheet.htm) (hereinafter ``CPP Factsheet'').
    \19\ The preferred stock do have ``class voting rights on (i) any 
authorization or issuance of shares ranking senior to the Senior 
Preferred, (ii) any amendment to the rights of Senior Preferred, or 
(iii) any merger, exchange or similar transaction.'' CPP Term Sheet, 
supra note 17. In addition, ``[i]f dividends on the Senior Preferred 
are not paid in full for six dividend periods, whether or not 
consecutive, the Senior Preferred will have the right to elect 2 
directors. The right to elect directors will end when full dividends 
have been paid for four consecutive dividend periods.'' CPP Term Sheet, 
supra note 17.
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b. Redemption of Preferred Shares

    In the same way that loans are repaid, preferred shares are 
``redeemed'' by the institution paying back the ``liquidation'' 
amount of the shares, equivalent to the principal amount of a 
loan.\20\ There are both statutory and contractual provisions 
that govern when and how this happens.
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    \20\ In transactions of preferred shares generally, the amount paid 
for preferred shares is not always equal to their liquidation amount.
---------------------------------------------------------------------------
    i. Timing. EESA, as amended, sets requirements for the 
timing of redemption of these investments. Originally, under 
the SPAs, BHCs were not permitted to repay TARP funds within 
the first three years unless they had completed a qualified 
equity offering (QEO) of at least 25 percent of the issue 
price.\21\ A QEO is a sale before 2010 of shares that qualify 
as tier 1 capital that raises an amount of cash equal to the 
value of the preferred shares issued to Treasury.\22\ The 
American Recovery and Reinvestment Act of 2009 (ARRA) amended 
EESA, adding section 111(g), which now provides that, ``subject 
to consultation with the appropriate federal banking agency 
[Treasury] shall permit a TARP recipient to repay [CPP 
preferred] without regard to whether the financial institution 
has replaced such funds from any other source or to any waiting 
period. . . .'' \23\
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    \21\ If the bank did such a qualified equity offering, it could 
redeem up to the amount of the proceeds that it had received in the 
qualified equity offering. CPP Term Sheet, supra note 17.
    \22\ Securities Purchase Agreement, supra note 15, 4.4.
    \23\ American Recovery and Reinvestment Act of 2009 (ARRA), Pub. L. 
111-5, Sec. 7001 (online 
at frwebgate.access.gpo.gov/cgi-bin/
getdoc.cgi?dbname=111_cong_bills&docid=f:h1enr.txt.pdf) (hereinafter 
``ARRA'').
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    Repayment applications must be approved by the bank's 
supervisor before they are sent to Treasury.\24\ The Federal 
Reserve Board has indicated that supervisors will weigh an 
institution's desire to repay its TARP assistance against the 
contribution of that assistance to the institution's overall 
soundness, capital adequacy and ability to lend.\25\ BHCs must 
also have a comprehensive internal capital assessment 
process.\26\ In addition, prior to repayment, the eighteen 
stress-tested BHCs that received TARP funds must have a post-
repayment capital base consistent with the stress test capital 
buffer, and must demonstrate their financial strength by 
issuing senior unsecured debt for terms greater than five 
years, not backed by FDIC guarantees, and in amounts sufficient 
to demonstrate a capacity to meet funding needs 
independently.\27\
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    \24\ Id.
    \25\ Board of Governors of the Federal Reserve System, 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 on the Treasury Capital 
Assistance Program and the Supervisory Capital Assessment Program (May 
6, 2009) (online at www.federalreserve.gov/newsevents/press/bcreg/
20090506a.htm).
    \26\ Id.
    \27\ Id.
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    The Federal Reserve summarizes the criteria that it will 
use in determining whether to allow repayment as requiring that 
stress-tested banks wishing to repay ``have a robust longer-
term capital assessment and management process geared toward 
achieving and maintaining a prudent level and composition of 
capital commensurate with the BHC's business activities and 
firm-wide risk profile.'' \28\ Representative Hensarling, one 
of the five members of the Panel, has introduced legislation 
that would codify the Federal Reserve's criteria as part of 
EESA.\29\ The Panel takes no position on the bill.
---------------------------------------------------------------------------
    \28\ Id.
    \29\ H.R. 2745, TARP Repayment and Termination Act of 2009, 111th 
Cong. (hereinafter ``H.R. 2745'').
---------------------------------------------------------------------------
    In testimony before the Panel on April 21, 2009, Secretary 
of the Treasury Timothy Geithner said the ``ultimate test'' for 
repayment would be whether an individual bank's repayment would 
result in a reduction in the overall credit available to the 
economy.\30\ While any repayment would reduce capital and thus 
funds available for lending, some banks are raising capital 
from the private markets, thereby replenishing that capital.
---------------------------------------------------------------------------
    \30\ Congressional Oversight Panel, Testimony of Treasury Secretary 
Timothy Geithner (Apr. 21, 2009).
---------------------------------------------------------------------------
    The original contractual terms of the SPAs concerning 
approval and timing of redemption of the preferred shares have 
been superseded by the statutory amendments, as described 
above.\31\ Treasury has announced that banks can redeem CPP 
preferred under terms other than those specified in the 
SPA.\32\
---------------------------------------------------------------------------
    \31\ See supra notes 22, 23, and accompanying text.
    \32\ U.S. Department of the Treasury, FAQs addressing Capital 
Purchase Program (CPP) changes under the American Recovery and 
Reinvestment Act of 2009 (Feb. 26, 2009) (online at 
www.financialstability.gov/docs/CPP/CPP-FAQs.pdf).
---------------------------------------------------------------------------
    ii. Pricing. The statute sets no terms for the price 
Treasury must obtain for the preferred shares it holds, other 
than the general statutory injunction that it should administer 
the Act in a manner that will ``minimize any potential long-
term negative impact on the taxpayer.'' \33\ The contractual 
provisions governing the preferred shares provide that they are 
to be redeemed at ``liquidation preference,'' essentially the 
principal amount of the debt. In addition, the institution must 
repay any dividends that are owed but unpaid on the shares.\34\
---------------------------------------------------------------------------
    \33\ EESA, supra note 13, Sec. 113(a)(1) (codified at 12 U.S.C. 
Sec. 5223).
    \34\ Securities Purchase Agreement, supra note 15, Sec. 4.4.
---------------------------------------------------------------------------

                              2. WARRANTS

a. Terms of warrants

    The warrants have a ten year life. Treasury can exercise or 
transfer half of the warrants it holds at any time; the other 
half can be exercised after 2009 if the bank has not engaged in 
a QEO.\35\
---------------------------------------------------------------------------
    \35\ Form of Warrant, supra note 15, Sec. 13(H). As a contractual 
condition to a bank's redemption of its preferred stock, Treasury 
requires that the bank sign a ``cross-receipt.'' This cross-receipt has 
the effect of exchanging the original warrants issued to Treasury for 
``substitute warrants'' that are identical to the original warrants 
except for the removal of the qualified equity offering 50 percent 
warrant decrease provision. The cross-receipt also eliminates the 
warrant transfer restrictions contained in the Securities Purchase 
Agreement. A bank is not, however, required to provide a substitute 
warrant if it informs Treasury of its plans to repurchase the warrants 
immediately.
---------------------------------------------------------------------------
    For BHCs that are public companies,\36\ the warrants must 
be exercisable for an amount of common shares of the bank with 
a value, at the time of the investment, equal to 15 percent of 
the amount of the preferred shares purchased by Treasury from 
the issuer. Because the maximum amount of preferred shares 
eligible for the CPP is generally the lesser of $25 billion and 
three percent of the bank's risk-weighted assets, warrants for 
$3.75 billion in value of the bank's common shares are the 
maximum amount that may be issued by a single institution. The 
bank's shareholders must approve the issuance of the warrant 
shares, the increase in the number of underlying shares to 
cover the warrants, or both.
---------------------------------------------------------------------------
    \36\ Private banks issue warrants to purchase preferred shares 
``having an aggregate liquidation preference equal to 5 percent of the 
Preferred amount on the date of investment.'' The underlying shares of 
a private bank warrant have the same rights as the preferred shares, 
except that they pay dividends of 9 percent per year. U. S. Department 
of the Treasury, TARP Capital Purchase Program (Non-Public QFIs, 
excluding S Corps and Mutual Organizations) Preferred Securities 
Summary of Preferred Terms (Nov. 19, 2008) (online at 
www.financialstability.gov/docs/CPP/Term%20Sheet%20-
%20Private%20C%20Corporations.pdf) (hereinafter ``CPP Term Sheet for 
Private Banks'').
---------------------------------------------------------------------------
    The actual number of shares subject to the warrants is set 
by reference to the market price for the common shares of the 
issuer on the date of the preferred share investment, 
calculated on a 20-trading day trailing average. Thus, if 
warrants for common shares equal to $1 billion in value were to 
be issued and the 20-trading day average stock price was $10, 
then the bank must issue warrants for 100 million shares of the 
common shares.
    The number of underlying shares covered by the warrants is 
subject to two possible adjustments. First, the shares subject 
to warrant could be changed by standard anti-dilution 
adjustments. Thus, if the issuer splits its stock on a two for 
one basis (issuing two shares in place of every existing 
share), the number of shares subject to the CPP warrants in the 
previous example would be increased from 100 to 200 million. On 
the other hand, the number of shares subject to the warrants is 
decreased by 50 percent if the issuer engages, before December 
31, 2009, in a QEO in which it receives gross proceeds of at 
least 100 percent of the liquidation price of the preferred 
shares.\37\
---------------------------------------------------------------------------
    \37\ Form of Warrant, supra note 15, Sec. 13(H). See text 
accompanying supra note 35 for a definition of ``Qualified Equity 
Offering.''
---------------------------------------------------------------------------
    The strike price of the warrants is determined in the same 
way as the number of shares subject to warrant, that is, the 
price is set at the 20-trading day trailing average price of 
the common shares on the date Treasury's investment is made. 
Thus, if the 20-day average stock price is $10, the holder of 
the warrant must pay $10 for each share of stock when it 
exercises the warrant.\38\ Private bank warrants carry an 
exercise price of $0.01 per share. Treasury has announced that 
it will immediately exercise private bank warrants.\39\
---------------------------------------------------------------------------
    \38\ The exercise price, however, is subject to reduction if 
necessary shareholder consents are not obtained; the maximum reduction 
is 45 percent.
    \39\ CPP Term Sheet for Private Banks, supra note 36.
---------------------------------------------------------------------------
    Treasury agrees to waive its voting rights with respect to 
any voting stock it receives when it exercises its 
warrants.\40\ This restriction does not apply to any person to 
whom Treasury transfers the shares or warrants.
---------------------------------------------------------------------------
    \40\ Securities Purchase Agreement, supra note 15, Sec. 4.6. This 
provision reflects the requirements of EESA. See 12 U.S.C. 
Sec. 5223(d)(1)(A).
---------------------------------------------------------------------------

b. Repurchase of warrants

    i. Timing of Repurchase. Timing of repurchase is governed 
by both statutory and contractual provisions. Treasury is of 
the opinion that the contractual provisions are the more 
constraining.
    The statute originally permitted Treasury to convert a 
warrant to cash or exercise it when Treasury decided that doing 
so would allow the public reasonable gain from an increase in 
the price of the stock involved, and that ``the market [was] 
optimal for such assets, in order to maximize the value for 
taxpayers.'' \41\ The amendment that eliminated conditions on 
redemption of preferred shares also required Treasury to 
``liquidate'' the warrants it held when the assistance was 
repaid (i.e., when the preferred shares Treasury held were 
redeemed).\42\ A further amendment to the same provision 
resulted in language that attempts to restore Treasury's 
discretion regarding the timing of warrant repurchases.\43\ 
EESA now provides that Treasury ``may liquidate warrants 
associated with such assistance.'' \44\
---------------------------------------------------------------------------
    \41\ EESA, supra note 13, Sec. 113(a)(2)(A) (codified at 12 U.S.C. 
Sec. 5223(a)(2)(A)).
    \42\ ARRA, supra note 23, Sec. 7001.
    \43\ Helping Families Save Their Homes Act of 2009, Pub.L. 111-22, 
Sec. 403 (May 20, 2009) (online at frwebgate.access.gpo.gov/cgi-bin/
getdoc.cgi?dbname=111_cong_ bills&docid=f:s896enr.txt.pdf) (amending 12 
U.S.C. Sec. 5221). Floor statements made by the provision's sponsor and 
the committee chairman support a plain meaning analysis and explain 
that the sponsors' intentions were to grant Treasury authority to time 
warrant repurchases in order to maximize financial returns on the 
warrants to taxpayers. See Statement of Senator Jack Reed, 
Congressional Record S5114 (May 5, 2009); Statement of Senator 
Christopher Dodd, Congressional Record, S5115 (May 5, 2009).
    \44\ ARRA, supra note 23, Sec. 7001.
---------------------------------------------------------------------------
    The SPAs governing Treasury's purchase of preferred shares 
and warrants were executed before the EESA amendment concerning 
the timing of warrant repurchases became law. The SPAs grant 
the redeeming financial institution the right to repurchase the 
warrants upon notice to Treasury (after it has redeemed its 
preferred shares).\45\ Treasury staff has informed the Panel 
that Treasury is contractually bound by the timing provisions 
of the SPAs. In addition, Treasury staff has stated that it is 
Treasury's policy to dispose of the government's investments as 
soon as practicable.\46\ Therefore, a bank may repurchase its 
warrants as soon as it has redeemed its preferred shares.
---------------------------------------------------------------------------
    \45\ Securities Purchase Agreement, supra note 15, Sec. 4.9(a). 
Though the amended section 111(g) of EESA expressly provides Treasury 
discretion as to when to allow repurchase of the warrants, it does not 
explicitly override the contracts.
    \46\ See U.S. Department of the Treasury, Treasury Announces 
Warrant Repurchase and Disposition Process for the Capital Purchase 
Program (June 26, 2009) (online at www.financialstability.gov/latest/
tg_06262009.html) (hereinafter ``Treasury Warrant Repurchase 
Announcement'') (``The President has clearly stated that his objective 
is to dispose of the government's investments in individual companies 
as quickly as is practicable.'').
---------------------------------------------------------------------------
    Although Treasury is bound by the statute and the 
contracts, it does have flexibility both in the negotiation 
process and in the inputs used in modeling value. As noted 
above, EESA provides that the terms and conditions of the 
warrants be designed ``at a minimum . . . to provide for 
reasonable participation by the Secretary, for the benefit of 
taxpayers, in equity appreciation'' and ``that the Secretary 
may sell, exercise, or surrender a warrant . . . based on 
[these] conditions.'' \47\ The negotiation step of the 
contractual valuation procedure (discussed in detail in the 
next section), requires that Treasury and the bank ``promptly 
meet to resolve the objection and agree on the Fair Market 
Value.'' \48\ In order to provide for ``reasonable 
participation in equity appreciation,'' Treasury could take a 
tougher negotiating position, possibly resulting in a higher 
fair market value. Treasury is not bound as to the basis on 
which it will agree or disagree with the bank's proposed fair 
market value. Of course, there are many considerations that 
Treasury must balance in its decision making, and this is only 
one of them.
---------------------------------------------------------------------------
    \47\ EESA, supra note 13, Sec. 113(d)(2) (codified at 12 U.S.C. 
Sec. 5223(d)(2)).
    \48\ Securities Purchase Agreement, supra note 15, Sec. 4.9(c)(ii).
---------------------------------------------------------------------------
    If the bank informs Treasury that it will repurchase the 
warrants, then it must go through the valuation procedure in 
the SPA, described below.
    ii. Repurchase Price. From a statutory point of view, 
Treasury is required to repurchase warrants ``at market 
price.'' \49\ As discussed below, the SPAs executed for each 
TARP transaction provide for repurchase of the warrants at 
``fair market value,'' reflecting the statutory requirement 
that TARP assets are to be sold ``at a price that the Secretary 
determines, based on available financial analysis, will 
maximize return on investment for the Federal Government.'' 
\50\
---------------------------------------------------------------------------
    \49\ ARRA, supra note 23, Sec. 7001. Initially the statute required 
repurchase at a price set by the Secretary, subject to the overriding 
condition specified above, namely that the price constitutes ``a 
reasonable participation . . . in equity appreciation,'' and 
``additional protection against losses from the sale of [TARP] assets . 
. .'' ARRA overrode that language to require that warrants be 
liquidated at ``current market price,'' and the subsequent amendment 
produced the language in the text, calling for liquidation at ``market 
price.''
    \50\ EESA, supra note 13, Sec. 113(a)(2)(B) (codified at 12 U.S.C. 
Sec. 5223(a)(2)(B)).
---------------------------------------------------------------------------
    The SPAs set out a procedure for valuing the warrants of a 
public bank when the bank invokes its right to repurchase its 
warrants.\51\ After a bank has redeemed 100 percent of its 
preferred shares (or Treasury has transferred the preferred 
shares to an unaffiliated third party), the bank may repurchase 
the warrants issued in conjunction with those preferred 
shares.\52\
---------------------------------------------------------------------------
    \51\ Securities Purchase Agreement, supra note 15, Sec. 4.9.
    \52\ Securities Purchase Agreement, supra note 15, Sec. 4.9(a).
---------------------------------------------------------------------------
    The first step in this procedure is that the bank's board 
of directors must propose the fair market value of the 
warrants, using the opinion of an independent, nationally-
recognized investment banking firm. (The Panel assumes that 
none of the firms used have, or is an affiliate of a BHC or 
bank that has, received TARP assistance and issued TARP 
warrants. Were this assumption to prove incorrect, serious 
conflict of interest questions would arise.)
    The bank's board presents the valuation to Treasury, which 
has ten days to object to the valuation. Though it is not 
specified in the SPA, Treasury will have determined its own 
fair market value, working with outside investment banks and 
consultants. Treasury uses several methods to determine fair 
market value. These include obtaining quotes from a group of 
investment banks and investment companies that have volunteered 
their time,\53\ creating their own model using a binomial 
American-style options model, performing a fundamental analysis 
of the bank, and using outside, paid consultants, who use a 
slightly different binomial American style options model.\54\
---------------------------------------------------------------------------
    \53\ These investment banks' and investment consultants' names are 
not disclosed to the public. They include both domestic and global 
entities. Some of the domestic entities' parent companies received CPP 
funds. Treasury staff has informed Panel staff that when Treasury 
solicits quotes for the warrants, it uses a mix of banks whose parents 
have received CPP and those that have not. Treasury has put into place 
careful conflict of interest rules governing firms that assist Treasury 
with the warrant valuation process.
    \54\ The Panel's methodology for determining the fair market value 
of the CPP and TIP warrants, and its comparison to Treasury's 
methodology, is discussed in detail in Annex A of this report.
---------------------------------------------------------------------------
    If Treasury objects to the bank's proposed fair market 
value, then representatives of Treasury and the bank have ten 
days to meet to resolve the objection and agree on a fair 
market value. If Treasury and the bank cannot agree on a fair 
market value during that period, either party may invoke the 
Appraisal Procedure.
    By invoking the appraisal process a bank can require 
Treasury to allow it to repurchase the warrants, so long as the 
repurchase is made ``as soon as practicable'' after the fair 
market value has been determined. The Appraisal Procedure 
provides that each party chooses an independent appraiser.\55\ 
If within 30 days after their appointment, the independent 
appraisers cannot agree on a fair market value, a third 
appraiser is chosen by mutual consent of the two appraisers. 
This third appraiser will provide its fair market value within 
30 days of its appointment. The average of all three appraisals 
is binding on both Treasury and the bank.\56\ If the bank 
wishes to repurchase the warrants, the bank and Treasury are 
bound by the appraised value. Treasury staff has told Panel 
staff that the bank, however, is not bound to repurchase the 
warrants and may revoke its notice exercising its right to 
repurchase the warrants; the bank may restart the repurchase 
process at any time--unless Treasury has disposed of the shares 
in the interim--by initiating a new round of valuations and 
subject to the same terms.
---------------------------------------------------------------------------
    \55\ The costs of the appraisal process are borne by the bank. 
Securities Purchase Agreement, supra note 15, Sec. 4.9(c)(i).
    \56\ Securities Purchase Agreement, supra note 15, Sec. 4.9(c)(ii). 
If one of the three appraisals is disparate from the middle appraisal 
by more than twice the amount that the other appraisal is disparate 
from the middle appraisal, such appraisal is disregarded in the 
determination of the average.
---------------------------------------------------------------------------
    Like a public bank, a private bank may repurchase its 
warrants once it has redeemed its preferred shares. Private 
bank warrants' values are established in the SPAs at a 
specified dollar amount, so they do not go through the same 
valuation procedure. As mentioned earlier, Treasury exercises 
private bank warrants immediately upon issuance. Private bank 
warrants have a liquidation amount of the full value of the 
preferred shares that Treasury received on exercise. Therefore, 
to repurchase the underlying shares of the warrant, a private 
bank must pay five percent of Treasury's non-warrant equity 
investment.\57\ H.R. 2745 would, for the period through the end 
of September 2009, allow private banks to repurchase the 
underlying shares associated with the warrants issued at the 
time of the CPP investment at the price that Treasury paid for 
the warrants, i.e., one cent per share.\58\
---------------------------------------------------------------------------
    \57\ CPP Term Sheet for Private Banks, supra note 36, at 2; See 
also Schedule A to Warrant to Purchase Preferred Stock, First Southwest 
Bancorporation (Mar. 6, 2009) (online at www.financialstability.gov/
docs/agreements/03202009/First%20Southwest%20Bancorpation.pdf).
    \58\ H.R. 2745, supra note 29.
---------------------------------------------------------------------------
    If the bank chooses not to repurchase its warrants, 
Treasury may sell them to third party investors.\59\ Treasury 
has told the Panel that the Secretary had discretion to 
determine the time period for liquidating the warrants, and 
that in accordance with Treasury policy to dispose of ownership 
interests as soon as possible, it will auction the warrants 
within several months of a bank's delivery of a substitute 
warrant.\60\
---------------------------------------------------------------------------
    \59\ At this point, Treasury may sell all the warrants. This is 
because when the bank determines that it will repurchase the preferred 
shares, it must deliver to Treasury a substitute warrant instrument 
that eliminates the 50 percent qualified equity offering adjustment. 
See U.S. Department of the Treasury, Acknowledgment of Repurchase 
(Public Issuers) (online at www.financialstability.gov/docs/CPP/
UST%20Acknowledgement%20of%20Repurchase%20 (Public%20Issuers).pdf).
    \60\ Letter from Secretary Timothy Geithner, U.S. Department of the 
Treasury, to Chair Elizabeth Warren, Congressional Oversight Panel 
(July 1, 2009) (attached as Appendix II of this report, infra).
---------------------------------------------------------------------------
    Alternately, Treasury may choose to exercise the warrant at 
any time.\61\ If Treasury has exercised the warrants and still 
holds the shares received on exercise, the bank may repurchase 
the shares on the open market, or Treasury may sell the shares 
to a third party.\62\
---------------------------------------------------------------------------
    \61\ If Treasury exercises the warrants before December 31, 2009 
and before the preferred shares are repurchased, it may only exercise 
half of the warrants, as the other half are subject to cancellation if 
the bank makes a qualified equity offering before that date. Securities 
Purchase Agreement, supra note 15, Sec. 4.4.
    \62\ Securities Purchase Agreement, supra note 15, Sec. 4.9(a).
---------------------------------------------------------------------------

            D. Repayments of CPP and TIP Capital Investments

    On June 17, nine of the stress-tested BHCs and one other 
BHC redeemed their CPP preferred shares from Treasury, in 
aggregate returning almost $68.2 billion of taxpayer funds 
provided under the TARP. The annualized return on Treasury's 
investments in these banks is at least five percent, due to the 
required five percent annual dividends paid to CPP preferred 
shares.\63\ It will not be possible to calculate an internal 
rate of return (IRR) with any precision until Treasury has sold 
the warrants it holds for these banks' shares (or sells its 
shares after exercising the warrants). However, even after 
Treasury sells the warrants for these banks, the IRR realized 
on these particular investments--likely the safest of the whole 
program--would not be representative of the potential return on 
the entire TARP portfolio. (IRRs for the few small banks that 
have repurchased their warrants are presented in Section E 
below.)
---------------------------------------------------------------------------
    \63\ Accrued dividends are paid upon the repurchase of the CPP 
preferred shares.
---------------------------------------------------------------------------
    Following the results of the stress tests, and the 
subsequent capital-raising by BHCs which required a 
strengthened capital buffer, the appropriate bank supervisor or 
supervisors authorized repayments based on their determination 
that these banks possessed adequate capital safety buffers to 
absorb losses through 2010 if economic conditions continue to 
deteriorate.\64\ Additionally, the banks were required to 
satisfy a number of conditions set by the Federal Reserve, 
notably the demonstrated ability to access public equity 
markets and raise five-year debt without an FDIC guarantee.\65\ 
The Federal Reserve also evaluated whether repayment would have 
an adverse effect on the future operations of the bank or 
financial markets.\66\
---------------------------------------------------------------------------
    \64\ Only the results of the stress tests under the adverse 
scenario were published, which assumed for 2009: a 3.3 percent decline 
in GDP, 8.9 percent unemployment, and a 22 point decline in the Case-
Shiller 10-city composite index of housing prices.
    \65\ 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/20090601b.htm).
    \66\ Id.
---------------------------------------------------------------------------
    It should be noted, however, that although these banks are 
no longer being supported directly by the TARP, they remain 
eligible to use the FDIC's Temporary Liquidity Guarantee 
Program,\67\ as well as other indirect support through the 
Federal Reserve's various liquidity programs. Except for the 
Term Asset-Backed Securities Loan Facility (TALF), which is 
currently set to expire at the end of 2009, these programs were 
recently extended through February 2010.\68\ All told, the 
Federal Reserve's balance sheet has expanded by almost $1.2 
trillion since August 2007.\69\
---------------------------------------------------------------------------
    \67\ The FDIC's Temporary Liquidity Guarantee Program (TLGP) 
essentially guarantees the senior unsecured debt issued by financial 
institutions, allowing them in effect to obtain financing at reduced 
rates; without the threat of default, the risk premium included in the 
interest charged for the debt is reduced substantially. Currently, the 
TLGP guarantees some $285 billion of debt of 34 BHCs, thrift holding 
companies, and other non-FDIC-insured financial institutions.
    \68\ Board of Governors of the Federal Reserve System, Federal 
Reserve Announces Extensions of and Modifications to a Number of its 
Liquidity Programs (June 25, 2009) (online at www.federalreserve.gov/
newsevents/press/monetary/20090625a.htm).
    \69\ See Board of Governors of the Federal Reserve System, Federal 
Reserve Statistical Release H.4.1: Factors Affecting Reserve Balances 
(July 2, 2009) (online at www.federalreserve.gov/releases/h41/Current/) 
(accessed July 2, 2009) (hereinafter ``Fed Balance Sheet July 2'').

                                   FIGURE 1: CPP REPAYMENTS AS OF JULY 2, 2009
----------------------------------------------------------------------------------------------------------------
                  Date                            Institution          Repurchase amount     Bank or BHC type
----------------------------------------------------------------------------------------------------------------
3/31/2009...............................  Signature Bank............        $120,000,000  Public
3/31/2009...............................  Old National Bancorp......         100,000,000  Public
3/31/2009...............................  Iberiabank................          90,000,000  Public
3/31/2009...............................  Bank of Marin Bancorp.....          28,000,000  Public
3/31/2009...............................   Centra Financial                   15,000,000   Private
                                           Holdings, Inc./Centra
                                           Bank, Inc..
4/8/2009................................   Sun Bancorp, Inc.........          89,310,000   Public
4/15/2009...............................   Shore Bancshares.........          25,000,000   Public
4/22/2009...............................   TCF Financial Corporation         361,172,000   Public
4/22/2009...............................   Firstmerit Bank, National         125,000,000   Public
                                           Association.
4/22/2009...............................   Independent Bank Corp....          78,158,000   Public
4/22/2009...............................   First ULB Corp...........           4,900,000   Private
5/5/2009................................   Sterling Bancshares, Inc.         125,198,000   Public
5/13/2009...............................   Texas Capital Bancshares,          75,000,000   Public
                                           Inc..
5/13/2009...............................   Alliance Financial                 26,918,000   Public
                                           Corporation.
5/20/2009...............................   SCBT Financial                     64,779,000   Public
                                           Corporation.
5/20/2009...............................   Somerset Hills Bancorp...           7,414,000   Public
5/27/2009...............................   Washington Federal Inc...         200,000,000   Public
5/27/2009...............................   First Niagara Financial           184,011,000   Public
                                           Group.
5/27/2009...............................   Berkshire Hills Bancorp,           40,000,000   Public
                                           Inc..
5/27/2009...............................   First Manitowoc Bancorp            12,000,000   Private
                                           Inc..
6/3/2009................................   Valley National Bancorp..          75,000,000   Public
6/3/2009................................   HF Financial Corp........          25,000,000   Public
6/17/2009...............................   JPMorgan Chase & Co......      25,000,000,000   Public
6/17/2009...............................   Morgan Stanley...........      10,000,000,000   Public
6/17/2009...............................   The Goldman Sachs Group..      10,000,000,000   Public
6/17/2009...............................   US Bancorp...............       6,599,000,000   Public
6/17/2009...............................   Capital One Financial           3,555,199,000   Public
                                           Corporation.
6/17/2009...............................   American Express Company.       3,388,890,000   Public
6/17/2009...............................   BB&T Corp................       3,133,640,000   Public
6/17/2009...............................   Bank of New York Mellon..       3,000,000,000   Public
6/17/2009...............................   State Street Corporation.       2,000,000,000   Public
6/17/2009...............................   Northern Trust                  1,576,000,000   Public
                                           Corporation.
                                                                     --------------------
      Total.............................  32 Banks..................      70,124,589,000
----------------------------------------------------------------------------------------------------------------

                        E. Valuing TARP Warrants

    Before presenting the Panel's estimates of the value of 
Treasury's CPP, TIP and Asset Guarantee Program (AGP) warrants, 
it is useful to briefly note the major conceptual approaches to 
making such estimates and to explain the methodology used by 
the Panel. A more detailed discussion of the most widely-used 
warrant valuation methodologies and the choices and assumptions 
made by the Panel in the approach it used is provided in Annex 
A.

                        1. CONCEPTUAL APPROACHES

    An important consideration in valuing a warrant is its 
intrinsic value, given by the difference between the current 
share price and the warrant's strike price. Intrinsic value 
represents the value of the warrant if it were exercised at the 
current moment, and is a useful measure of a warrant's worth if 
it is close to expiration or if it will be exercised early. 
However, intrinsic value reveals only a snapshot value at the 
current moment, not what the value of the warrant may be when 
it expires or at any other time. It does not take into account 
the likelihood that the stock price will increase prior to the 
warrant's expiration, a particularly important consideration 
given the ten-year term of the TARP warrants. Because intrinsic 
value ignores the value of future stock movement, it is not 
used by market participants to value the TARP warrants. More 
likely, potential investors will value warrants using either 
the binomial options pricing model or the Black-Scholes model.
    The binomial options pricing model \70\ values a warrant 
based on how the price of its underlying shares may change over 
the warrant's term.\71\ The binomial model has a number of 
advantages that stem from breaking down a warrant's term into a 
number of discrete time increments. An analyst using a binomial 
model may change his input assumptions at different periods of 
the evaluation--for example, the assumed volatility of the 
underlying shares' price movements can be varied over time. 
Similarly, a binomial model can account for the possibility 
that a warrant will be exercised early if the share price 
exceeds a certain threshold.
---------------------------------------------------------------------------
    \70\ John Cox, Stephen Ross & Mark Rubinstein, Option Pricing: A 
Simplified Approach, Journal of Financial Economics (Mar. 1979) 
(hereinafter ``CRR Binomial Paper'').
    \71\ The binomial model produces a tree of stock prices at 
specified time increments, calculates the intrinsic value of the 
warrant at expiration (based on the estimated stock price 
distribution), and then works backwards through earlier branches to 
calculate the current value of the warrant.
---------------------------------------------------------------------------
    The Black-Scholes model \72\ has been the industry standard 
for option valuation since it was first published in 1973.\73\ 
The popularity of Black-Scholes is largely based on its ease of 
use; it can be calculated on a hand-held calculator with only a 
few inputs.\74\ A Black-Scholes valuation is a specific version 
of the binomial model in which it is assumed that all inputs 
are constant over time. Both derive an expected value for a 
warrant based on the probability of the warrant's underlying 
share price exceeding its strike price.
---------------------------------------------------------------------------
    \72\ Fischer Black & Myron Scholes, The Pricing of Options and 
Corporate Liabilities, Journal of Political Economy (1973) (online at 
www.math.uwaterloo.ca/mboudalh/BS1973.pdf) (hereinafter ``Black-Scholes 
Paper'').
    \73\ Mark Rubinstein, Implied Binomial Trees, Journal of Finance 
(July 1994) (online at www.haas.berkeley.edu/groups/finance/WP/
rpf232.pdf) (hereinafter ``Implied Binomial Trees'') (``This [the 
Black-Scholes] model is widely viewed as one of the most successful in 
the social sciences and has [sic] perhaps (including its binomial 
extension) the most widely used formula, with embedded probabilities, 
in human history.'').
    \74\ The inputs of the Black-Scholes model are the strike price of 
the option, the underlying stock price, the time to expiration of the 
option, the risk-free interest rate, the volatility of the underlying 
stock price, and the dividend yield of the underlying stock.
---------------------------------------------------------------------------
    As is true of all models, the validity of either a Black-
Scholes or a binomial analysis depends on the input assumptions 
used. If one uses equivalent assumptions, these models tend to 
produce very similar results.\75\ The most significant cause of 
divergence between different warrant valuations comes from the 
assumptions made about the future volatility and dividend yield 
of the underlying shares. Future volatility is particularly 
difficult to predict. Nonetheless, nearly all market 
participants, government agencies, specialist firms and 
corporations value warrants through models that use future 
volatility as an input.\76\ Future volatility can be estimated 
in a number of ways, resulting in a range of possible 
volatility assumptions and a range of possible warrant 
values.\77\
---------------------------------------------------------------------------
    \75\ Mathematically, Black-Scholes is essentially the limit of the 
binomial model as the number of steps taken approaches infinity. A 
binomial valuation, given the same assumptions, thus converges on the 
Black-Scholes valuation.
    \76\ See,  e.g.,  Congressional  Oversight  Panel,  Duff  &  Phelps 
 Final  Valuation  Report  to  the  Congressional  Oversight  Panel  
(Feb.  4,  2009)  (online  at  cop.senate.gov / documents / cop-020609-
report-dpvaluation.pdf); Financial  Accounting  Standards  Board,  
Statement  of  Financial  Accounting Standards No. 123 (Oct. 1995) (FSP 
FAS 157-4) (online at www.fasb.org / cs / BlobServer? blobcol = 
urldata&blobtable = MungoBlobs&blobkey = id&blobwhere =  
1175818755677&blobheader=application%2Fpdf); Congressional Budget 
Office, The Troubled Asset Relief Program: Report on Transactions 
Through June 17, 2009 (June 2009) (online at www.cbo.gov/ftpdocs/100xx/
doc10056/06-25-TARP.pdf).
    \77\ Consider the example of a warrant to buy one share of Company 
X at $150 that expires in one year. X's common stock is currently 
trading at $100 and the risk free rate (i.e., the Treasury rate) is one 
percent. Under Black-Scholes, if X's stock price volatility is modeled 
at 30 percent, the warrant would be valued at $1.59; with volatility at 
60 percent, the warrant would be valued at $10.91. If the volatility is 
below 15 percent, the warrant is estimated to be worth less than three 
cents.
---------------------------------------------------------------------------
    There are two commonly used methods for estimating the 
future volatility of a stock. The first is to calculate 
volatility from historical prices changes. Many different 
volatility assumptions for the binomial or Black-Scholes Models 
can be justified from historical figures. An analyst's choice 
of the time period over which he or she will measure historical 
volatility as an estimate of future volatility can have a large 
effect on a valuation. As the past two years have been 
particularly turbulent, the volatility figures derived from 
this period are high and may not be representative of the 
volatility of bank stock prices over the next ten years, and 
will likely overvalue the warrants. On the other hand, using 
volatilities calculated from the past ten years may undervalue 
warrants if one believes that bank shares will be more volatile 
over the next decade than they have been in the previous one.
    The second approach to estimating future stock price 
volatility is to use implied volatility from the market. While 
implied volatility has certain drawbacks, particularly the fact 
that the market's implied volatility may be over a different 
future time period than the term of the warrant being 
valued,\78\ using implied volatility to value a warrant 
provides a better picture of ``fair market value'' because it 
uses actual market information to estimate this important input 
assumption.
---------------------------------------------------------------------------
    \78\ For example, across most banks for which there are data, the 
market is expecting volatility to decrease over time. Thus, using short 
term implied volatility to value long term warrants would overvalue the 
warrants.
---------------------------------------------------------------------------

                2. METHODOLOGY USED IN THIS REPORT \79\
---------------------------------------------------------------------------

    \79\ A full discussion of the Panel's methodology is included in 
Annex A.
---------------------------------------------------------------------------
    The Panel adopted a modified Black-Scholes analysis to 
value the warrants held by Treasury.\80\ As discussed in Annex 
A, the modifications were necessary to account for two aspects 
of the TARP warrants that distinguish them from the type of 
options Black-Scholes was designed to analyze: dilution \81\ 
and dividend yield.\82\ The Panel did not apply a liquidity 
discount in its valuation. If Treasury can hold the warrants to 
expiration, then the value of the warrants to Treasury should 
not include a liquidity discount because Treasury does not need 
to sell them. Further, any liquidity discount for the larger 
institutions, whose warrants constitute the bulk of Treasury's 
portfolio by value, would likely be small since their shares 
are heavily traded.
---------------------------------------------------------------------------
    \80\ In applying the Black-Scholes model rather than a binomial 
model, the Panel assumed that the risk free rate, the dividend yield, 
and the stock price volatility of each bank would be constant through 
time. Market participants and finance professors with whom Panel staff 
consulted thought these were reasonable assumptions given the purposes 
of the analysis.
    \81\ Unlike options, which grant a claim to already-issued stock, 
the exercise of a warrant requires the company to issue new common 
shares, which has the effect of reducing the percentage of the company 
owned by existing shareholders (known as ``dilution'').
    \82\ Dividend yield represents an investor's return on investment 
if the stock is not sold, calculated by the ratio of annual dividends 
per share to share price.
---------------------------------------------------------------------------
    The Panel developed high, low and best estimates for the 
value of the warrants that Treasury held on July 6, 2009, based 
on varying estimates of stock price volatility. In the high 
estimate, the volatility input for each bank was the maximum of 
several historical and implied volatility measures of its stock 
price.\83\ In the low estimate, the volatility input for each 
bank was the minimum of the same set of volatility measures. In 
the best estimate, the volatility input for 18 of the banks was 
derived from the implied volatility of publicly-traded, long 
dated options on those banks' shares. The warrants for these 18 
banks' shares represent 89 percent of the total value of 
Treasury's warrant portfolio. For the remaining banks, the best 
estimate volatility input for each bank was the longest of the 
available one, two, five and ten year historical volatility 
measures of the bank's share price.\84\ For all estimates, each 
bank's dividend yield input was set equal to its five-year 
average dividend yield. The only difference in assumptions for 
the three estimates was the volatility input.\85\
---------------------------------------------------------------------------
    \83\ These Panel's measures were: the (i) two, (ii) five and (iii) 
ten year historical volatilities ending on July 2, 2009; the ten year 
historical volatilities ending on (iv) July 2, 2008, (v) July 2, 2007, 
(vi) July 3, 2006, (vii) July 4, 2005, (viii) July 2, 2004, (ix) July 
2, 2003, (x) July 2, 2002, (xi) July 2, 2001, (xii) July 3, 2000, 
(xiii) July 2, 1999; and (xiv) the midpoint of implied volatilities of 
call and put options on the underlying stock expiring after Dec 31, 
2010 as calculated on July 2, 2009. When any of these measures was 
unavailable, it was removed from the set of possible volatility inputs. 
All historical volatilities were calculated from daily returns, 
adjusted for dividends and capital changes.
    \84\ The implied volatility input for each bank was set equal to 
the midpoint of implied volatilities of call and put options on the 
bank's shares expiring after Dec. 31, 2010 as calculated on July 2, 
2009.
    \85\ All three estimates used each bank's closing price on July 2, 
2009 as the model's share price input. The risk free rate input was 
calculated as the yield on ten year Treasury bonds on July 2, 2009, 
adjusted to be made continuous.
---------------------------------------------------------------------------
    As noted above in Section C, the CPP warrants have a 
reduction provision such that if a recipient bank has a QEO of 
100 percent of the CPP investment by the date of the preferred 
redemption or December 31, 2009, whichever comes sooner, then 
half of Treasury's warrants are eliminated.\86\ To simplify the 
analysis, the Panel assumed that unless a BHC had already 
redeemed its preferred and held a QEO by July 2, 2009, then it 
would not do so by the end of this year. This seems a 
reasonable assumption considering that of the 32 banks which 
had redeemed their preferred shares by July 2, 2009, only three 
had a QEO prior to repayment.\87\ To the extent that there is a 
possibility that CPP-recipient banks will have QEOs prior to 
redeeming their TARP preferred shares or the end of the year, 
the Panel's valuation of the warrants should be discounted 
accordingly.
---------------------------------------------------------------------------
    \86\ See supra notes 34, 35, and accompanying text.
    \87\ These three banks were State Street, First Niagara and 
Iberiabank. U.S. Department of the Treasury, Troubled Asset Relief 
Program: Transactions Report For Period Ending June 30, 2009 (July 2, 
2009) (online at www.financialstability.gov/docs/transaction-reports/
transactions-report_070209.pdf).
---------------------------------------------------------------------------
    Using Black-Scholes, the Panel also estimated the value of 
the warrants that Treasury has already sold.\88\ These 
valuations were performed as of the date of the sale to enable 
a comparison between the fair market value of the repurchased 
warrants, as calculated by Black-Scholes, and the compensation 
Treasury actually received for them.\89\ Other than adjusting 
for the transaction dates, the Panel used the same methodology 
for valuing the past sales as that applied to outstanding TARP 
warrants.
---------------------------------------------------------------------------
    \88\ As of July 2, 2009, 11 banks have repurchased their warrants: 
Treasury sold its warrants in Old National Bank, Iberiabank, 
FirstMerit, Sun Bancorp, Alliance Financial, Independent Bank Co., 
First Niagara Financial Group, Berkshire Hills Bancorp, Somerset Hills 
Bancorp, HF Financial and SCBT Financial. No third party buyers were 
involved in these transactions--Treasury sold the warrants back to the 
banks which originally issued them--and only Iberiabank and First 
Niagara had conducted a QEO by the time the warrants were sold. Id.
    \89\ The valuations of Treasury's remaining portfolio of warrants 
on July 6, 2009 cannot be compared against future transactions that 
involve these warrants as the values of the warrants can change over 
time. Transactions can only be evaluated against fair market value on 
the date of the transaction.
---------------------------------------------------------------------------
    The Panel was aided in its valuation efforts by three 
finance experts, Professor Robert Merton, Professor Daniel 
Bergstresser and Professor Victoria Ivashina, all of the 
Harvard Business School. These three professors independently 
reviewed both the technical valuation model and the assumptions 
that were built into the models; they concluded that the 
approaches reported here were reasonable and that they produced 
reliable estimates.

                               3. RESULTS

    The Panel's high, low and best estimates for the aggregate 
value of Treasury's warrants as of July 6, 2009 are $12.3 
billion, $4.7 billion and $8.1 billion, respectively. The range 
between the Panel's high and low estimates is driven by 
different volatility assumptions in the Black-Scholes model. 
The future volatility and dividend yield of the banks' 
underlying shares are difficult to predict.\90\ The Panel 
accounted for this uncertainty by casting a wide net across 
what it considers reasonable boundaries in developing high and 
low volatility estimates.
---------------------------------------------------------------------------
    \90\ Conversely, strike price, expiration date, underlying share 
price and the risk free rate are all known or easy to estimate.
---------------------------------------------------------------------------
    As shown in figure 2, the Panel's valuation of the warrants 
falls within the same broad ranges as the estimates of Credit 
Suisse, University of Louisiana at Lafayette Assistant 
Professor Linus Wilson, and Bloomberg.\91\ It is important to 
remember that these studies were performed on different dates, 
so some variation would be expected. Among other reasons for 
these studies being incompatible, the value of Treasury's 
warrants is highly correlated to the fluctuating share prices 
of CPP-recipient banks. To the extent that these shares have 
changed in value between the dates of the different valuation 
analyses, the warrants have altered in value accordingly.
---------------------------------------------------------------------------
    \91\ See Linus Wilson, Valuing the First Negotiated Repurchase of 
the TARP Warrants (May 23, 2009) (online at http://papers.ssrn.com/
sol3/papers.cfm?abstract_id=1404069) (Professor Wilson examines Old 
National Bancorp, the first of the CPP recipient banks to repurchase 
its CPP warrants. He concludes that the warrants were sold back to Old 
National Bancorp at a discounted price.); Linus Wilson, A Model for 
Estimating the Cancellation Probabilities of TARP Warrants, University 
of Louisiana at Lafayette (June 16, 2009) (online at http://
papers.ssrn.com/sol3/papers.cfm?abstract_id=1413442) (hereinafter 
``Wilson Cancelation Probabilities'') (Professor Wilson creates a model 
for estimating the value, and likelihood of cancelation, of TARP 
warrants. The established formula can be used in evaluating Treasury's 
negotiation performance.); Edward Tom and Sveinn Palsson, The Valuation 
of TARP Warrant (Part I and II)s, Credit Suisse Research Report (May 
26, 2009, June 2, 2009) (hereinafter ``Credit Suisse Warrant Report'') 
(Credit Suisse used 10 year mean realized volatility to calculate a 
Black-Scholes value for the CPP investments in the 19 stress-tested 
banks, coming up with a median estimate of $5.7 billion, and a range of 
$5.2 to $7.8 billion); Mark Pittman, TARP Warrants Show Banks May Reap 
``Ruthless Bargain'', Bloomberg (May 22, 2009) (online at 
www.bloomberg.com/apps/news?pid=20601206&sid=ae2fQFMrDer4) (hereinafter 
``Bloomberg Warrant Article'').

                         FIGURE 2: COMPARISON OF PANEL'S VALUATION WITH OTHER VALUATIONS
                                     [All values are presented in millions]
----------------------------------------------------------------------------------------------------------------
                                                                                 COP Valuation of Comparable (as
                                                                                            of 7/6/09)
              Valuation by                       Valuation of           Result  --------------------------------
                                                                                    Low        Best       High
----------------------------------------------------------------------------------------------------------------
Credit Suisse 92 (6/2/09)...............  Stress Test Banks ex.          $5,680     $3,470     $5,590     $8,410
                                           Keycorp (CPP Warrants
                                           only).
Linus Wilson 93 (6/10/09)...............  Stress Test Banks (CPP,         9,900      3,930      6,960     10,630
                                           TIP, and AGP).
Bloomberg 94 (5/22/09)..................  JPMorgan, Morgan Stanley,       4,000      2,400      2,830      4,120
                                           and Goldman Sachs.
CBO 95 (6/17/09)........................  CPP Warrants Only.........      6,000      4,310      6,940    10,520
----------------------------------------------------------------------------------------------------------------
\92\ Credit Suisse Warrant Report, supra note 91. Credit Suisse used standard volatilities to calculate a Black-
  Scholes value for the CPP investments in the 18 of the 19 stress tested BHCs (it did not value warrants in
  Keycorp), producing a median estimate of $5.7 billion, and a range of $5.2 to $7.8 billion.
\93\ Wilson Cancelation Probabilities, supra note 91. Wilson estimates the value of the warrants held by the
  government for the 19 stress test banks using the same model as the Panel (Black-Scholes-Merton modified with
  Galai-Schneller). The higher estimates he obtained are likely the result of differing volatility assumptions.
  Wilson calculates implied volatilities derived from short term options, which represent the market's
  prediction of variations in stock price over the next few months. For most securities, such short-term
  predictions tend to be much higher than what the market's prediction of volatility would be for longer periods
  such as those for which the warrants are available to be exercised (10 years). Wilson's methodology also
  adjust for the predicted likelihood of qualified equity offerings by BHCs, a step considered unnecessary by
  the Panel.
\94\ Bloomberg Warrant Article, supra note 91. Information on methodology is unavailable. Bloomberg does not
  break down its valuations by individual BHC.
\95\ The CBO analysis did not consider the effect of Treasury's requirement that banks which repay their
  preferred before Dec. 31, 2009 must sell their warrants immediately or replace Treasury's warrants with
  substantially similar ones that are stripped of the QEO provision.

    Most of the value of Treasury's portfolio of warrants comes 
from only a few banks. By value, the warrants in JP Morgan 
Chase, Bank of America, Morgan Stanley, Goldman Sachs, 
Citigroup and Wells Fargo account for 70 percent of the total 
value. Figure 3 below shows high, low and best estimates for 
Treasury's ten most valuable holdings of warrants.

                                  FIGURE 3: PANEL ESTIMATE OF VALUE OF WARRANTS
                                     [All values are presented in millions]
----------------------------------------------------------------------------------------------------------------
                                                                               Low          High         Best
                Institution                        Investment date           estimate     estimate     estimate
----------------------------------------------------------------------------------------------------------------
Bank Of America...........................  10/28/08, 1/9/09 & 1/16/09...         $430       $1,850       $1,130
JP Morgan Chase...........................  10/28/08.....................          660        1,560        1,020
Wells Fargo & Co..........................  10/28/08.....................          340        1,480        1,020
Goldman Sachs Group.......................  10/28/08.....................          940        1,250          940
Morgan Stanley............................  10/28/08.....................          800        1,310          870
Citigroup.................................  10/28/08, 12/31/08 & 1/16/09.           70        1,030          560
American Express..........................  1/9/09.......................          220          370          300
PNC Financial Services Group..............  12/31/08.....................           70          330          190
Bank Of New York Mellon...................  10/28/08.....................          120          240          160
Capital One Financial.....................  11/14/08.....................          110          210          140
All Other Banks...........................  .............................          950        2,640        1,720
                                           --------------------------------
----------------------------------------------------------------------------------------------------------------

    In its analysis of warrants already repurchased, the Panel 
finds that, in general, Treasury has been selling its warrants 
back to banks at below market value. In the aggregate, Treasury 
sold its warrants in these banks for $18.7 million. Figure 4 
below compares the repurchase price paid by these 11 banks and 
the Panel's valuation of the warrants on the date of 
repurchase. It also shows Treasury's total internal rate of 
return (IRR) on its investments in each of these banks, 
including its return on preferred shares and warrants. A more 
complete discussion of the sources of the difference between 
Treasury's results and the Panel's estimates of the value of 
the warrants sold to date in the context of one particular such 
warrant sale, Old National Bancorp, can be found in Annex B.

                                                    FIGURE 4: WARRANT REPURCHASES AS OF JULY 2, 2009
                                                           [All values presented in thousands]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                      Panel
             Institution                      Inv. date                  QEO 96           Repurchase   Repurchase   valuation    Price/est.     IRR 97
                                                                                             date        amount    (best est.)   (percent)    (percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Old National.........................  12/12/08...............  No.....................       5/8/09       $1,200       $2,150           56          9.3
Iberiabank...........................  12/5/08................  Yes....................      5/20/09        1,200        2,010           60          9.4
FirstMerit...........................  1/9/09.................  No.....................      5/27/09        5,052        4,260          118         20.3
Sun Bancorp..........................  1/9/09.................  No.....................      5/27/09        2,100        5,580           38         15.3
Independent Bank.....................  1/9/09.................  No.....................      5/27/09        2,200        3,870           57         15.6
Alliance Financial...................  12/19/08...............  No.....................      6/17/09          900        1,580           57         13.8
First Niagara Financial..............  11/21/08...............  Yes....................      6/24/09        2,700        3,050           89          8.0
Berkshire Hills......................  12/19/08...............  No.....................      6/24/09        1,040        1,620           64         11.3
Somerset Hills.......................  1/16/09................  No.....................      6/24/09          275          580           48         16.6
SCBT Financial.......................  1/16/09................  No.....................      6/24/09        1,400        2,290           61         11.7
HF Financial.........................  1/21/09................  No.....................      6/30/09          650        1,240           52         10.1
                                                                                                     --------------------------
--------------------------------------------------------------------------------------------------------------------------------------------------------
\96\The issue is discussed infra Part C Section one of this report. Upon a qualified equity offering, the number of shares underlying Treasury's
  warrants is halved.
\97\This is the total return Treasury has received on its investment in each bank. The calculation includes returns from dividends, preferred shares
  repayments and warrant repurchases. The IRRs in this figure very slightly underestimate the actual rate of return because the Panel assumed that all
  dividends were paid on the date of repurchase of the preferred, when in fact they were paid quarterly.

    The results show that in its sales of warrants Treasury has 
received about 66 percent of the Panel's best estimate of fair 
market value. These results may suggest that Treasury has not 
been successful in receiving fair market value for its warrants 
and in maximizing taxpayer returns. On the other hand, factors 
not included in the Panel's model, such as the illiquidity of 
the warrants--especially for smaller institutions--may explain 
the difference between the amount that Treasury has received 
for its sold warrants and the Panel's valuation of those 
warrants.
    In interpreting these results, it is important to bear in 
mind the scale of the warrant repurchases as compared to the 
total warrant portfolio. The sold warrants represent less than 
one quarter of one percent of the Panel's best estimate of the 
value of Treasury's warrant portfolio on July 6, 2009. Thus, 
these sold warrants represent a very small slice of the 
outstanding warrants, and Treasury's relative performance in 
selling them may not accurately predict its success in selling 
the balance of the warrants it holds.
    The results also show that Treasury received a 12 percent 
rate of return on the 11 CPP investments in public banks that 
have fully exited the TARP. However, this rate of return is not 
predictive of the rate of return Treasury will receive across 
its entire TARP portfolio because it only reflects the return 
on these 11 early repaying banks. These banks are among the 
healthiest of the TARP-recipient banks and thus Treasury's 
return on these banks is likely to be higher than its return on 
its aggregate TARP investment.\98\ Further, this rate of return 
does not factor in the likelihood that some banks, including 
systemically significant institutions, may be unable to repay 
their TARP investments.
---------------------------------------------------------------------------
    \98\ Each bank's TARP repayment is conditioned on that bank's 
supervisors finding that the bank is sufficiently capitalized to no 
longer need a government investment. Thus, only healthy banks have been 
able to repay. Supra note 23.
---------------------------------------------------------------------------

             F. Alternatives for Disposing of TARP Warrants

    Although, thus far, Treasury has sold warrants back only to 
the banks which issued them, as discussed in Section C it may 
sell the warrants to any party subject to the following two 
restrictions: first, before December 31, 2009, or, if earlier, 
the date when a bank redeems its preferred, Treasury may sell 
only half of its warrants in that bank; second, after a bank 
redeems its preferred it may negotiate to repurchase its 
warrants, and, if this fails, the bank may invoke an appraisal 
procedure which leads to a binding price at which Treasury must 
sell.\99\
---------------------------------------------------------------------------
    \99\ The issue is discussed supra in Part C of Section One of this 
report.
---------------------------------------------------------------------------
    Thus, Treasury's options are dictated by whether a bank has 
redeemed its preferred shares. Before a bank redeems its 
preferred, Treasury can sell half of its warrants in that bank 
to any party. After a bank redeems its preferred, Treasury must 
allow that bank a chance to negotiate the repurchase of its 
warrants if the bank wishes to do so. If the negotiations reach 
an impasse and the appraisal procedure is not invoked, or if 
the procedure is invoked but the bank is not willing to 
purchase at the resulting binding price, then Treasury can sell 
all of its warrants in that bank on the open market. In other 
words, if the parties cannot agree on a price and if the bank 
is unwilling to purchase at the price determined by the 
appraisers, then Treasury may sell its warrants through a 
public auction or other public sale.

                      1979 CHRYSLER LOAN GUARANTEE

    The federal government has received warrants before in 
exchange for providing credit support to ensure a company's 
viability. The federally-guaranteed loan made to a teetering 
Chrysler Corporation in 1980 is one example. In that case, the 
federal government seemed to make a profit on its loan to 
Chrysler when the warrants were sold.
    The Chrysler Corporation Loan Guarantee Act of 1979 was 
officially signed into law on January 7, 1980. It created the 
Chrysler Corporation Loan Guarantee Board, which was 
responsible for determining the conditions for making a 
commitment to guarantee third party loans to Chrysler. Any 
loans made under the Act had to be repaid by December 30, 1990, 
and the amount outstanding at any time was not to exceed $1.5 
billion.\100\
---------------------------------------------------------------------------
    \100\ Chrysler Corporation Loan Guarantee Act of 1979, Pub. L. No. 
96-185.
---------------------------------------------------------------------------
    Chrysler used $1.2 billion of the $1.5 billion in loan 
guarantees. In return for the loan guarantees, the federal 
government received warrants to purchase 14.4 million shares of 
Chrysler stock at $13 per share until 1990.\101\ At the time 
they were granted in 1980, Chrysler stock was selling for about 
$5 a share.
---------------------------------------------------------------------------
    \101\ Id.
---------------------------------------------------------------------------
    After receiving the loans, Chrysler's fortunes changed for 
the better. Between 1980 and 1982, the corporation downsized a 
significant amount of its operations, cutting roughly half of 
its work force,\102\ and quickly returned to 
profitability.\103\ By the first half of 1982, the company made 
a profit of $482.2 million. It repaid its government guaranteed 
notes in June and August of 1982.\104\
---------------------------------------------------------------------------
    \102\ Thomas J. Lueck, Chrysler Tops Bids to Buy Back Stock Rights, 
New York Times (Sep. 13, 1983).
    \103\ Id.
    \104\ Id.
---------------------------------------------------------------------------
    The U.S. government auctioned the Chrysler warrants on 
September 12, 1983. At the auction, Chrysler purchased the 
warrants for $311 million.\105\ Chrysler officials said that 
they sought to avoid having the warrants converted into common 
shares because conversion would dilute the value of the current 
shares. The stocks that the warrants purchased represented 12 
percent of Chrysler's shares outstanding. Chrysler also had the 
option of retiring the warrants at no cost. It chose not do so, 
though, because it did not want to forgo $187 million in income 
it could earn from the exercise of the warrants.\106\
---------------------------------------------------------------------------
    \105\ Id.
    \106\ Id.
---------------------------------------------------------------------------
    Whether or not Treasury actually made a profit on the sale 
of its Chrysler warrants is subject to debate. Prior to 1992, 
federal loan guarantees were treated as a contingent liability 
of the U.S. government for budgetary purposes. As a result, a 
loan guarantee resulted in no cost to the budget unless and 
until the guarantee was called and resulted in an actual loss. 
Under this budgeting convention, the federal government could 
show a $311 million profit on its loan guarantees and warrant 
for Chrysler Corporation in the early 1980s. Today, however, 
the cost of a similar loan guarantee would require an upfront 
appropriation to cover the possibility of default. No such 
estimate was made at the time, however, so it cannot be 
determined whether such an estimate would have been greater or 
less than the $311 million the government received upon sale of 
the warrants.

      1. SELLING TARP WARRANTS THROUGH NEGOTIATION WITH THE BANKS

    Treasury sold its warrants in Old National Bank, 
Iberiabank, FirstMerit, Sun Bancorp, Alliance Financial, 
Independent Bank Co., First Niagara Financial Group, Berkshire 
Hills Bancorp, Somerset Hills Bancorp, HF Financial and SCBT 
Financial through exclusive negotiations with the issuing 
banks. These banks initiated the negotiations by first 
redeeming Treasury's preferred shares and then invoking their 
right to repurchase the warrants they had issued to Treasury. 
None of these banks invoked the appraisal procedure; they all 
reached a negotiated agreement with Treasury on the price to be 
paid for the warrants.
    When negotiating with a bank on the repurchase price of 
that bank's warrants, Treasury makes an assessment of the 
warrant's fair market value. Treasury's valuation process has 
four inputs: comparable market data, warrant pricing models, 
fundamental company analysis and an outside consultant's 
appraisal.\107\ First, Treasury finds comparable securities 
that are publicly traded and solicits quotes from market 
participants on the warrants being valued to develop a market 
perspective of their fair value. Second, Treasury utilizes an 
American-style binomial option pricing model and a Black-
Scholes option pricing model to develop a theoretical value for 
the warrants. Treasury calculates the volatility input for this 
model from both implied and historical volatility measures--
Treasury uses the average 60-day trailing volatility for the 
last ten years to determine a stock's historical volatility. 
For each bank, Treasury develops a dynamic volatility curve, 
which generally shows volatility decreasing over time from 
current levels to historic norms.\108\ Third, Treasury performs 
a fundamental analysis of the repurchasing bank's performance, 
looking at growth projections, price-to-book ratios, and other 
indicators of financial health. Fourth, Treasury obtains an 
outside consultant's appraisal of the warrants. In addition to 
the four inputs, Treasury may also include a liquidity discount 
in its valuation of the warrants. This discount ranges from 
zero to 50 percent and is determined by analyzing factors such 
as (1) a potential buyer's ability to hedge its warrant 
position by shorting the company's stock, and (2) the volume of 
shares traded. An additional discount may be applied for 
insolvency risk over the ten-year period. Using these inputs, 
Treasury develops a range of acceptable values at which it will 
sell the warrants. It should also be noted that Treasury has 
devoted a team to valuing the warrants and that each warrant 
sale must meet the approval of a four-person committee and the 
Assistant Secretary for Financial Stability.\109\
---------------------------------------------------------------------------
    \107\ On June 26, 2009 Treasury released information on its 
valuation procedure. In conversations with Panel staff, Treasury 
provided further insight into its method. Treasury Warrant Repurchase 
Announcement, supra note 46.
    \108\ Generally, the blended volatility of this curve is slightly 
above the historical ten-year volatility of repurchasing bank's shares.
    \109\ U.S. Department of the Treasury, Treasury Announces 
Repurchase and Disposition Process for the Capital Purchase Program 
(June 26, 2009) (online at www.financialstability.gov/docs/CPP/Warrant-
Statement.pdf).
---------------------------------------------------------------------------
    This is a sophisticated valuation procedure and likely 
results in a reasonable valuation for the warrants. 
Nonetheless, it may not produce a maximization of taxpayers' 
return on the warrants. As discussed above, for the warrants it 
had sold by July 2, 2009, Treasury only received 66 percent of 
the Panel's best estimate valuation. There are several reasons 
why this may be the case.
    Treasury may be generous to banks in its valuation of the 
warrants. Treasury is restricted by the terms of its warrant 
contracts, which require it to give banks the right to 
repurchase their warrants at ``fair market value.'' This is a 
nebulous term in the absence of market exchanges, so Treasury 
has considerable leeway in determining the fair market value 
for which it will sell the warrants. Treasury's model may lead 
to a lower valuation than is necessary in at least two ways. 
First, Treasury's use of average 60-day trailing volatility 
over ten years as its measure of historical volatility leads to 
a lower volatility model input and a lower warrant valuation 
than would the use of other historical volatility 
measures.\110\ Other measures, such as historical daily 
volatility, as used by the Panel, result in higher volatility 
inputs and higher valuations. These other, higher volatility 
measures are in common use and are legitimate inputs for option 
pricing models. Second, Treasury includes significant liquidity 
discounts in valuing the warrants. If Treasury can hold the 
warrants to expiration, it is not clear that their valuation 
should include a liquidity discount at all.\111\ Even if a 
liquidity discount is merited, the discount Treasury applies is 
significantly larger than that used by other accredited 
valuation firms.\112\
---------------------------------------------------------------------------
    \110\ Treasury's measure of historic volatility, average 60-day 
trailing volatility for ten years, is distinct from ten year historic 
volatility. When calculated for the same time period, the two measures 
will vary significantly because they are different mathematical 
computations. Inputting Treasury's measure of historic volatility, the 
average 60-day trailing volatility for ten years, into the Panel's 
model results in a valuation of $5.5b for Treasury's outstanding 
warrants. By comparison, the Panel derived its volatility assumptions 
from implied volatilities for some banks and ten year historical 
volatilities for the rest of the banks, valuing the warrants at $8.1b. 
Using only the ten year historic volatilities for all of the banks 
results in a valuation of $7.5b.
    \111\ The issue is discussed infra in Part C of Section One and 
Annex B of this report.
    \112\ In its February report to the Panel on the value of 
Treasury's TARP assets, the valuation firm Duff and Phelps' used a zero 
to 20 percent liquidity discount range. Duff and Phelps, Valuation 
Report to the Congressional Oversight Panel (Feb. 4, 2009) (online at 
cop.senate.gov/documents/cop-020609-report-dpvaluation.pdf).
---------------------------------------------------------------------------
    Further, banks may not be willing to pay as much as other 
market participants for warrants in their own equity. The only 
way Treasury can maximize taxpayers' return on their investment 
is to sell its warrants to the buyers who are willing to pay 
the best price. To the extent that a bank is unwilling to pay 
as much as other market participants, a two-party exclusive 
negotiation process necessarily fails to maximize returns 
because it excludes other buyers who may be willing to pay 
higher prices. On the other hand, it is possible that a bank 
will actually pay a premium over other market participants to 
keep its warrants from trading into unknown hands in the 
market.
    Finally, in conversations with Panel staff, Treasury staff 
has explained that its valuation model is designed to arrive at 
a ``correct and reasonable'' valuation, not a valuation that 
maximizes taxpayer returns. Treasury then uses this valuation 
as its first bid in negotiations with each repurchasing bank. 
To the extent that Treasury's initial valuation is then lowered 
as part of the negotiation process, Treasury's good faith 
effort to reach agreement is resulting in valuations that are 
below its own model's valuation of fair market value. On the 
other hand, Treasury is contractually obligated to negotiate. 
The warrant contracts stipulate that if Treasury rejects a 
bank's valuation of its warrants, then it must work to 
``resolve the objection[s] and to agree upon a Fair Market 
Value.'' \113\
---------------------------------------------------------------------------
    \113\ Securities Purchase Agreement, supra note 15, at Sec. 4.9.
---------------------------------------------------------------------------

                   2. SELLING WARRANTS TO THE MARKET

    Treasury would be more likely to maximize taxpayer returns 
if it sold the warrants through auctions. The reason is 
straightforward: an auction would cause the warrants to be 
allocated to the buyers willing to pay the highest price, and 
competitive pressures in the bidding process may push bids up. 
By setting proper reserve values, Treasury can protect itself 
against a failed auction and ensure that it will at least 
receive fair market value. Equally important, auctions can put 
upward pressure on negotiated transactions by setting new, 
higher transaction precedents and by showing that a secondary 
market for these warrants exists, leading to a smaller 
liquidity discount in the negotiated transactions.
    Selling the warrants through auctions would have auxiliary 
policy benefits to Treasury. Auctions would enable Treasury to 
sell at least half of its warrants immediately. By returning 
these warrants to the private market, auctions would further 
Treasury's aim of exiting its equity positions in TARP-
recipient banks as soon as possible. Auctions would also 
require significantly less time commitment from Office of 
Financial Stability (OFS) staff and could easily be outsourced 
if Treasury preferred. Finally, auctions would have the 
additional benefit of promoting transparency in Treasury's 
disposition of the warrants.
    To be sure, there are obstacles to using an auction 
process. Banks have the contractual right to an exclusive 
negotiation for their warrants following the redemption of 
their preferred shares. Thus, there is a period following a 
bank's redemption of its preferred shares when Treasury cannot 
auction its warrants in that bank. However, Treasury may 
auction half a bank's warrants even before the bank redeems its 
preferred. Treasury could initiate this process immediately. 
More importantly, Treasury could use the threat of an auction 
as a bargaining chip in discussions with banks to ensure that 
negotiated transactions are consummated at fair market value. 
Selling some warrants through auctions would make it clear to 
all banks that Treasury has well-developed and viable options 
if the bank does not offer an adequate price for the warrants.
    Other obstacles are related to whether there are sufficient 
bidders for auctions to be successful. It is possible that the 
illiquidity of these securities--especially for smaller 
institutions--will cause investors to stay away, and many 
potential bidders are banks that may be restricted from bidding 
because of regulations on inter-bank ownership. Interest may be 
further depressed by investor concerns regarding the risk of 
bank insolvency over the warrants' ten year horizon, the 
limited ability of investors to hedge the warrants, and 
pessimism about the bank sector in general. Further, rather 
than buy Treasury's warrants in any given bank, an investor may 
find it much simpler to invest in the bank directly or to buy 
call options. On the other hand, it is hard to believe that an 
auction with a proper reserve value would ever achieve a lower 
valuation than a negotiation.
    Ultimately, open market transactions are the only way to 
determine true ``fair market value.'' In his testimony before 
the Panel on June 24, 2009, Assistant Secretary Allison 
explained this in relation to the toxic assets on bank balance 
sheets: ``We can have our theories, [but] in the last analysis 
that's why you have financial markets. You have to have liquid 
interchanges and then the truth will come out as to what the 
assets are actually worth.''\114\ The same should be said about 
pricing Treasury's warrants.
---------------------------------------------------------------------------
    \114\ Congressional Oversight Panel, Testimony of Assistant 
Treasury Secretary for Financial Stability Herbert Allison, Jr., 
Hearing with Assistant Treasury Secretary Herbert Allison (June 24, 
2009) (online at cop.senate.gov/hearings/library/hearing-062409-
allison.cfm).
---------------------------------------------------------------------------

                               G. Issues

    In reaching a judgment with the bank supervisors to allow a 
particular bank to repay its TARP assistance and in determining 
the price, time and manner at which it will sell the warrants 
it holds in that bank, Treasury must take into account two 
overriding statutory considerations:

          (1) protecting the interests of taxpayers by 
        maximizing overall returns and minimizing the impact on 
        the national debt; [and] (2) providing stability and 
        preventing disruption to financial markets in order to 
        limit the impact on the economy and protect American 
        jobs, savings, and retirement security.\115\
---------------------------------------------------------------------------
    \115\ EESA, supra note 13, Sec. 103 (1) and (2) (codified at 12 
U.S.C. Sec. 5213(1) and (2)). Sec. 5213 lists seven additional facts 
that Treasury must take into consideration in administering EESA.

    EESA also recognizes that the two objectives complement one 
---------------------------------------------------------------------------
another:

          The Secretary shall use the authority under this Act 
        in a manner that will minimize any potential long-term 
        negative impact on the taxpayer, taking into account 
        the direct outlays, potential long-term returns on 
        assets purchased, and the overall economic benefits of 
        the program, including economic benefits due to 
        improvements in economic activity and the availability 
        of credit, the impact on the savings and pensions of 
        individuals and reductions in losses to the Federal 
        Government.\116\
---------------------------------------------------------------------------
    \116\ 12 U.S.C. 5223 Sec. 113(a)(1).
---------------------------------------------------------------------------
    The public has a strong interest in recovering the money 
spent to provide assistance to the financial system. But it 
also has an important stake in restoration of stability to the 
financial markets as part of a general economic recovery. 
Treasury must balance the public interests in financial 
stabilization and economic growth.
    In this section, the Panel examines issues Treasury faces 
in trying to reach such a balance. It looks in turn at the 
problem from the perspective of the financial stabilization 
program and of the BHCs and banks subject to the program.

                   1. FINANCIAL STABILIZATION PROGRAM

    Treasury has consistently stated that the decision by the 
government to take ownership positions in financial 
institutions was a result of emergency conditions, and, 
consequently, it intends to limit its involvement in management 
of those institutions and to divest itself of its preferred 
shares ownership positions in financial institutions \117\ as 
soon as financial conditions normalize.\118\ As referenced 
above, the Federal Reserve Board has indicated that its 
approval for repayment (and hence to a substantial degree its 
determination that emergency conditions no longer affect the 
BHC or bank whose repayment is permitted) is based on (i) 
capital to lend, (ii) ability to maintain the capital levels 
that supervisors expect, and (iii) ability to satisfy 
counterparty risk while reducing reliance on government 
capital. Three important additional considerations not 
mentioned prominently in Treasury statements are (i) various 
regulatory and related considerations involving Treasury's 
maintenance of bank ownership interests (ii) the status of 
funds repaid to Treasury, and (iii) the remaining period of 
Treasury's TARP authority.
---------------------------------------------------------------------------
    \117\ Treasury owns common stock in Chrysler LLC and is in the 
process of converting preferred stock into common stock for Citicorp. 
Treasury contains convertible preferred shares in AIG and GMAC and is 
in the process of receiving common stock in GM (NewCo). The origin and 
terms of disposition for those equity interests are outside the scope 
of this report.
    \118\ See, e.g., Treasury Warrant Repurchase Announcement, supra 
note 46 (``The President has clearly stated that his objective is to 
dispose of the government's investments in individual companies as 
quickly as is practicable.''); U.S. Department of the Treasury. 
Secretary Geithner Introduces Financial Stability Plan (Feb. 10, 2009) 
(online at www.treasury.gov/press/releases/tg18.htm) (``We believe our 
policies must be designed to mobilize and leverage private capital, not 
to supplant or discourage private capital. When government investment 
is necessary, it should be replaced with private capital as soon as 
possible.''); U.S. Department of Treasury, Treasury White Paper: The 
Capital Assistance Program and Its Role in the Financial Stability Plan 
(February 9, 2009) (online at http://www.ustreas.gov/press/releases/
reports/tg40_ capwhitepaper.pdf) (``[T]o the extent that significant 
government stake in a financial institution is an outcome of the 
program [Capital Assistance Program], our goal will be to keep the 
period of government ownership as temporary as possible and encourage 
the return of private capital to replace government investment.'').
---------------------------------------------------------------------------

a. Financial Stability and the Stress Tests

    The ``restor[ation] of liquidity and stability to the 
financial system of the United States'' is a primary purpose 
for Congressional authorization of the TARP.\119\ The critical 
judgment in approving repayment, as the Federal Reserve Board 
criteria for approval for stress-tested BHCs recognize, is the 
ability of those BHCs to ``maintain core capital levels 
consistent with supervisory expectations.'' \120\ The Board has 
also linked adequate capital to ability to lend.\121\
---------------------------------------------------------------------------
    \119\ EESA, supra note 13, 2 (1).
    \120\ 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, supra note 65.
    \121\ Board of Governors of the Federal Reserve System, The 
Supervisory Capital Assessment Program: Overview of Results (May 7, 
2009) (online at www.federalreserve.gov/newsevents/press/bcreg/
bcreg20090424a1.pdf)() (``Given the heightened uncertainty about the 
economy and potential losses in the banking system, and the potential 
in the current environment for adverse economic outcomes to be 
magnified through the banking system, supervisors believe it prudent 
for large BHCs to hold substantial capital to absorb losses should the 
economic downturn be longer and deeper than now anticipated.'').
---------------------------------------------------------------------------
    In its evaluation of the stress tests,\122\ the Panel cited 
the finding of its academic experts that the economic modeling 
used to conduct the tests was generally soundly conceived and 
conservative (based on the information available). It stated 
that ``the addition of capital to ten of the tested BHCs is 
certainly a good step forward,'' although it also concluded 
that the tests ``should not be taken for more than they are'' 
because ``they do not project the capital necessary to prevent 
banks from being stressed to near the breaking point.'' \123\
---------------------------------------------------------------------------
    \122\ Panel June Report, supra note 2, at 30-35.
    \123\ The Panel gave the supervisors themselves credit for not 
over-emphasizing the scope of the tests, which they made clear were 
conducted within ``the present supervisory framework.'' Panel June 
Report, supra note 2, at 49-50 (``[I]t 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.'').
---------------------------------------------------------------------------
    When one turns to repayment of TARP assistance, two of the 
Panel's observations about the stress tests are particularly 
relevant. The first is that ``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.'' \124\ 
Second, it emphasized that ``[t]he 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.'' \125\
---------------------------------------------------------------------------
    \124\  Panel June Report, supra note 2, at 50.
    \125\  Panel June Report, supra note 2, at 50.
---------------------------------------------------------------------------
    Because the Federal Reserve Board's repayment standards 
require the institution involved to be able to maintain the 
capital ratios set by the stress tests, it is important that no 
repayments compromise that ability. Some commentators believe 
that U.S. banks are unlikely to experience a ``lost decade'' 
that beset banks in Japan in the 1990s because, unlike Japan, 
U.S. banks will have well performing loans and will be able to 
``earn'' their way out of future solvency problems.\126\ In 
this respect, the various loan facilities and guarantees on 
bank debt that have been instituted by the FDIC can be viewed 
not simply as an effort to restore confidence and liquidity in 
the banking system, but also as a mechanism to aid banks' 
efforts to earn their way to solvency. Other commentators are 
less sanguine and have argued that the possibility of further 
or renewed economic decline, insufficient private investment, 
and immense commercial real estate and other debts to be 
refinanced will limit the ability of the banking system to earn 
its way to health.\127\
---------------------------------------------------------------------------
    \126\ Mark Trumbull, Ten US Banks To Repay TARP Money, The 
Christian Science Monitor (June 9, 2009) (online at 
features.csmonitor.com/economyrebuild/2009/06/09/ten-us-banks-to-repay-
tarp-money/) (citing Goldman Sachs economist Jan Hatzius that U.S. 
banks should have sufficient profit streams on good loans ``to offset 
even a rising tide of losses through 2010.'').
    \127\ See, e.g., The Economist, Less Wobbly Now: The Process of 
Returning Banks to Private Ownership Begins (June 9, 2009) (online at 
www.economist.com/businessfinance/displayStory.cfm?story--id=13811147); 
Martin Neil Baily and Douglas J. Elliott, Brookings Institution, The US 
Financial and Economic Crisis: Where Does It Stand and Where Do We Go 
from Here?, at 11-13 (June 2009) (online at www.brookings.edu//media/
Files/rc/papers/2009/0615_economic_crisis_baily_elliott/
0615_economic_crisis_baily_elliott.pdf) (concluding that there is 
``wide band of uncertainty'' regarding future bank capital requirements 
given future credit losses in categories such as commercial real 
estate, commercial and industrial loans, and credit cards).
---------------------------------------------------------------------------

b. Macroeconomic conditions

    The goal of the stress tests was the ability of the tested 
institutions to maintain current levels of activity based on an 
``adverse scenario'' for deterioration of economic conditions 
through the end of 2010.\128\ Thus, the state of the economy is 
a crucial element for any decision to approve repayment of TARP 
assistance.
---------------------------------------------------------------------------
    \128\ 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). ; Panel June report, supra note 2.
---------------------------------------------------------------------------
    As shown in the table below, two key economic measures used 
in the stress test continue to show troublesome trends and 
pessimistic IMF forecasts.

----------------------------------------------------------------------------------------------------------------
                                          Baseline            More adverse         IMF projections      Current
                                   ------------------------------------------------------------------ data \129\
              Metric                                                                                 -----------
                                       2009       2010       2009       2010       2009       2010       (Most
                                                                                                        recent)
----------------------------------------------------------------------------------------------------------------
GDP Growth........................       -2.0        2.1       -3.3        0.5  -2.6 \130        0.0  -5.5 \131\
                                                                                        \
Unemployment Rate.................        8.4        8.8        8.9       10.3  8.9 \132\       10.1  9.5 \133\
----------------------------------------------------------------------------------------------------------------
\129\ Because the baseline and adverse scenarios are projected as annual averages, they are not directly
  comparable to monthly or quarterly data.
\130\ International Monetary Fund, World Economic Outlook: Update, at 2 (July 8, 2009) (online at www.imf.org/
  external/pubs/ft/weo/2009/ update/02/pdf/0709.pdf).
\131\ First quarter 2009, percent change from preceding quarter in chained 2000 dollars (final figure, revised
  from the preliminary estimate of -5.7 percent). U.S. Department of Commerce, Bureau of Economic Analysis,
  Gross Domestic Product, 1st quarter 2009 (final) (June 25, 2009) (online at www.bea.gov/newsreleases/national/
  gdp/gdpnewsrelease.htm) (accessed July 9, 2009). This figure is up from the 6.3 percent decline in the fourth
  quarter of 2008. Id.
\132\ 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).
\133\ U.S. Department of Labor, Bureau of Labor Statistics, The Employment Situation: June 2009 (July 2, 2009)
  (USDL 09-0742) (online at www.bls.gov/news.release/pdf/empsit.pdf) (accessed July 6, 2009) (hereinafter
  ``Employment Situation''). This figure is the unemployment rate through June 2009. The year-to-date average
  unemployment rate stands at 8.67 percent. See Id. at 11.

    Thus, the supervisors must consider the possibility of 
unrealized losses in commercial real estate, credit card, and 
other sectors that have not yet shown up on bank balance 
sheets. This issue is particularly important in the case of 
small commercial and regional banks, some of which have 
extensive commercial real estate loans on their portfolios that 
are not now mature, but may face defaults upon maturity.\134\
---------------------------------------------------------------------------
    \134\ Panel June Report, supra note 2 at 41-42; 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); Maurice Tamman and David Enrich, Local Banks Face Big 
Losses, Wall Street Journal (May 19, 2009) (online at online.wsj.com/
article/SB124269114847832587.html).
---------------------------------------------------------------------------

c. Government's dual role

    A benefit from repayment of TARP assistance is the end of 
the government's conflicting roles as regulator of the very 
institutions in which it owns shares and on whose profitability 
repayment of public funds depends. Specific regulatory 
policies, for example those affecting capital levels, the 
application of accounting conventions to financial reporting by 
BHCs or banks, and conflicts among regulators of various parts 
of BHCs, are complicated by the government's dual interests.

d. Future of the TARP

    The most difficult problem raised by repayment of TARP 
assistance may prove to be its impact on Treasury's ability to 
respond to a second wave of financial distress. Treasury 
believes that it can maintain TARP assistance up to a ceiling 
of $700 billion until expiration of its authority to make new 
TARP purchases.\135\ But its authority to expend funds to 
reinfuse capital into the nation's financial institutions 
through the purchase of bank securities or of assets on an 
institution's books terminates at the end of 2009, unless the 
Secretary of the Treasury extends that authority until October 
3, 2010.\136\ But at that point any additional expenditure 
depends on Congressional action further extending EESA.\137\
---------------------------------------------------------------------------
    \135\ Treasury's position, as most recently been expressed in a 
letter from Secretary Geithner to Senator David Vitter, is that the 
interaction of various sections of EESA produces the following result: 
(i) Treasury's authority to purchase ``troubled assets'' is ``limited 
to $700 billion outstanding at any one time,'' (ii) amounts repaid to 
Treasury must be returned to the government's general accounts, and 
(iii) repaid funds free up an additional amount of space under the 
ceiling, and Treasury can use the proceeds of the sale of government 
securities to restore that amount to the fund from which TARP 
expenditures can be made, so long as the fund does not somehow exceed 
$700 billion. See EESA, supra note 13, Sec. 106 (d), 115(a), 118 
(codified at 12 U.S.C. Sec. Sec. 5216(d), 5225(a), 5228). Treasury's 
reading is disputed. An attempt to amend EESA to make it clear that all 
repayments simply reduce remaining expenditure authority failed in the 
Senate 48-47. S. Amend. 1030, (May 5, 2009) (online at http://
thomas.loc.gov/cgi-bin/bdquery/z?d111:SP1030:). H.R. 2745 would amend 
EESA to reach the same result. H.R. 2745, supra note 29, adding 
Sec. 137(d)(2) to EESA.
    \136\ H.R. 2745, supra note 29, would amend EESA to eliminate the 
ability of the Secretary to extend Treasury's TARP authority.
    \137\ EESA, supra note 13, Sec. 120. Expiration of the authority to 
make new expenditures does not affect Treasury's ability to hold or 
repurchase preferred stock. EESA, supra note 13, 106(e) (codified at 12 
U.S.C. Sec. 5216(e)). 12 USC 5216(e).
---------------------------------------------------------------------------
    Treasury has evidently made the decision that repayment of 
TARP assistance will not affect the government's ability to 
respond to future crises, and Secretary Geithner has stated 
that the decision whether or not to extend the TARP or seek 
Congressional approval for a further extension of the TARP has 
not been made.\138\ However, the lack of a publicly-expressed 
position about the future is worrisome. The Panel noted in its 
June report that both its own independent experts and other 
commentators have expressed a concern that the results of the 
tests understate the risks that existing loans will result in 
substantial losses in 2011, following the two-year period for 
which the stress testing occurred.
---------------------------------------------------------------------------
    \138\ U.S. Treasury Secretary Timothy Geithner, Testimony to the 
Senate Committee on Banking, Housing, and Urban Affairs (June 18, 
2009).
---------------------------------------------------------------------------

                         2. WARRANT REPURCHASE

    The issues surrounding warrant repurchase are relatively 
simple. Although they may constitute only a limited portion of 
the value of Treasury's total investment in the institutions 
involved, the warrants are the only vehicle through which the 
public can realize a return on its investment in addition to 
the dividends paid on the preferred shares for the relatively 
short period for which the stock will prove to have been held. 
The warrants cover a ten-year period, however, and as noted in 
the valuation discussion above, their value likely more 
accurately reflects the market's long-term assessment of the 
prospects of institutions whose operations Treasury stabilized.
    As indicated above, Treasury's choices in continuing to 
hold the warrants it now holds are limited by the SPAs. But 
even if it continues to hold warrants in institutions that 
repay their assistance but do not opt to repurchase their 
warrants, Treasury should consider carefully its alternative 
courses of action. There is, of course, a chance for equity 
appreciation greater than that predicted by present valuation; 
but there is likewise a chance that by continuing to hold 
warrants their potential value will drop, wiping out any upside 
that can be captured by taxpayers. However, the scenario in 
which bank stock prices fall is also likely to be a scenario in 
which banks' capital positions are weaker than they are today.
    The disposition of the warrants is of direct financial 
interest to the public. For that reason, it is especially 
important that Treasury be absolutely transparent about the 
nature and substance of the decisions it is making and the 
reasons for those decisions. The Panel has emphasized the need 
for transparency in administration of the TARP since its first 
report, and it is disheartening to have received the following 
response from Secretary Geithner about warrant valuation data:

          It is not Treasury's policy to publish estimates of 
        the fair market value of its investments made under the 
        Troubled Asset Relief Program (``TARP''). In the 
        present case, Treasury believes it would not be in the 
        taxpayer's interest for Treasury to disclose any 
        valuations it has performed in connection with warrants 
        whose repurchase is currently pending or that may be 
        repurchased in the near term.\139\
---------------------------------------------------------------------------
    \139\ Letter from Secretary Timothy Geithner to Congressional 
Oversight Panel Chair Elizabeth Warren (July 1, 2009) (attached as 
Appendix II to this report).

    However, warrants are still only 15 percent of the original 
CPP investment. Since it is the healthy banks that are 
currently repaying, the value of their respective warrants has 
no doubt gone up. In this respect, early sales of these 
warrants may leave Treasury holding the warrants of weaker 
institutions with lower stock prices and less likelihood of 
appreciation in the value of their warrants, at least in the 
immediate future.
    The Panel recognizes that Treasury must protect proprietary 
information and use care to avoid giving other institutions 
information that would prejudice the interests of the taxpayer, 
but it must make any decision to restrict disclosure for these 
reasons only in the most thoughtful and judicious manner. 
Transparency throughout the negotiation process is essential 
for accountability and acceptance of the valuations.

               3. THE FINANCIAL INSTITUTIONS' PERSPECTIVE

    Financial institutions, especially large ones, appear to 
want to repay their TARP assistance as soon as they can obtain 
approval to do so. In some cases, of course, they may feel that 
they simply do not need the money any longer. However, there 
are likely several additional reasons for pursuing prompt 
repayment of the TARP investments.
    Despite the Administration's consistent statements that its 
policy is not to be involved in bank management and to cease to 
hold ownership positions in banks as soon as practicable,\140\ 
Treasury retains influence over the business decisions and 
internal governance of institutions in which it holds 
substantial preferred shares and warrant interests. Although 
ownership of preferred shares or warrants convertible into 
nonvoting common shares does not provide the sort of leverage 
that common shares ownership does, holding a substantial block 
of preferred shares with the terms of the Treasury preferred 
(discussed below) significantly constrains aspects of the 
issuing institution. Such constraints, for example, hinder the 
ability to pay dividends or engage in certain capital 
transactions, in exchange for bolstering the institution's 
capital. Replacing the Treasury investment with independently 
raised equity frees the institution from those constraints. At 
the same time, however, repayment of TARP assistance will not 
free an institution from the scope of the enhanced supervisory 
regime that has evolved during the worst months of the crisis 
as that regime would apply to the institution in any event.
---------------------------------------------------------------------------
    \140\ See supra note 46 Congrerssional Oversight Panel Hearing, 
Testimony of Herbert Allison, Assistant Secretary of the Treasury for 
Financial Stability (June 24, 2009) (``We are very reluctant 
shareholders in corporations. We don't want to be in that position.'').
---------------------------------------------------------------------------
    The second motivation for prompt repayment of TARP 
investments has to do with the specific rules or conditions to 
which TARP recipients are subject. The prime examples involve 
executive compensation and corporate governance restrictions 
applicable to TARP recipients. While banks were aware that they 
were subject to restrictions upon entrance into the CPP,\141\ 
they point to new provisions established in ARRA and by 
subsequent Treasury regulatory action\142\ that are 
retroactively applicable to past recipients of TARP financial 
assistance who have not yet repaid Treasury. As the American 
Bankers Association explained in a letter sent to the House of 
Representatives opposing additional restrictions on executive 
compensation for CPP recipients because of the impact of 
uncertainty on business operations, ``the risk of unilateral 
changing of the rules at any time . . . is extremely disruptive 
to sound business planning.'' \143\
---------------------------------------------------------------------------
    \141\ CPP contracts contained a covenant obligating recipients to 
implement the executive compensation provisions required under section 
111(b) of the EESA and any Treasury regulations implementing the 
section promulgated by the closing date of the investments. Section 
111(b) provisions included: (1) a prohibition on TARP recipients from 
receiving tax deductions for bonuses above $500,000 for top five senior 
executives; (2) a clawback provision for any top five executives who 
knowingly engage in providing inaccurate information that is used to 
calculate their bonuses; and (3) a golden parachute restriction that 
prevents top five top executives from receiving severance bonuses in 
excess of three years' compensation.
    By contract, Treasury imposed more stringent requirements on SSFI 
program and TIP investments beyond those required by the section 111(b) 
regulations. Most notably, the size of the 2008 and 2009 bonus pools 
for AIG, Citigroup, and BofA were capped. In February 2009, Treasury 
imposed new compensation requirements for future CAP recipients that 
were slightly more restrictive than those applicable to their CPP 
counterparts and retroactively applicable requirements for recipients 
of ``exceptional assistance,'' including restricting non-restricted 
stock compensation to $500,000 for senior executives, imposition of 
non-binding say-on-pay shareholder votes, expanding the number of 
executives subject to clawback and golden parachute payments, and 
mandating exposure on company policy on luxury expenditures. U.S. 
Department of the Treasury, Press Release: Treasury Announces New 
Restrictions on Executive Compensation (Feb. 4, 2009) (available at 
www.treasury.gov/press/releases/tg15.htm).
    \142\ Robin Sidel, U.S. Gets TARP Payback from 10 Banks, Wall 
Street Journal (June 18, 2009) (http://online.wsj.com/article/
SB124524619467123215.html) (``some bankers complained it had outlived 
its purpose and imposed needless complications on compensation and 
other decisions.'').
    \143\ See Memorandum from Floyd Stoner, American Bankers 
Associations to Members of the House of Representatives (March 30, 
2009) (online at www.aba.com/NR/rdonlyres76DCD307-2D7E-48A6-A10F-
623175F0AEAD/59034/ExecComp_ABAHouseLetter_033009.pdf).
---------------------------------------------------------------------------
    With respect to employee compensation, ARRA's amendment of 
EESA's executive compensation and corporate governance 
restrictions and Treasury's subsequent regulatory action has 
subjected CPP recipients to restrictions that are, in many 
respects, stronger and more far reaching than those that they 
faced under the CPP contracts and pre-ARRA regulations.\144\ In 
one respect, however, ARRA's amendment to section 111 of EESA 
has benefitted banks seeking to be free from executive 
compensation regulations: if a bank redeems all of its CPP 
preferred shares, it is immediately free from these conditions 
regardless of whether Treasury still holds warrants for the 
purchase of its common shares.\145\
---------------------------------------------------------------------------
    \144\ As compared to EESA's original provisions, the new 
requirements cover more employees (in some cases expanding their scope 
from five senior executives to twenty and, in cases of exceptional 
assistance recipients, an additional 100 most highly compensated 
employees). They also contain stricter restrictions on bonus and 
severance payments, encompass additional corporate governance 
standards, and are in part enforced by the new Treasury office of 
Special Master for TARP Executive Compensation. In addition, by 
regulation, Treasury has created a Special Master for TARP Executive 
Compensation who has authority to review any compensation (payments) 
for senior executive officers and next 20 most highly compensated 
employees at firms receiving exceptional assistance; to approve the 
compensation structure for the next 100 highly compensated employees of 
such firms; and to issue advisory opinions on the compensation and 
compensation structure at non-exceptional assistance TARP recipients. 
See ARRA, supra note 23, Sec. 7001; U.S. Department of the Treasury, 
Interim Final Rule on TARP Standards for Compensation and Corporate 
Governance (accessed June 12, 2009) (online at www.treas.gov/press/
releases/reports/ec%20ifr%20fr%20web%206.9.09tg164.pdf); U.S. 
Department of the Treasury, Press Release: U.S. Department of the 
Treasury, Interim Final Rule on TARP Standards for Compensation and 
Corporate Governance (June 10, 2009) (online at www.treas.gov/press/ 
releases/tg165.htm).
    \145\ ARRA, supra note 23, Sec. 7001.
---------------------------------------------------------------------------
    Banks have argued that TARP-related executive compensation 
restrictions are making it difficult for them to attract or 
retain talented executives and employees because these 
employees can be better compensated by financial services firms 
free of the restrictions. These include private equity and 
hedge funds,\146\ large international financial institutions 
such as HSBC or Barclays that are ineligible to receive TARP 
funds, and firms that have freed themselves of the restraints 
by redeeming their CPP preferred shares.
---------------------------------------------------------------------------
    \146\ Edmund Andrews and Eric Dash, Stimulus Plan Places New Limits 
on Wall St. Bonuses, New York Times (Feb. 13, 2009) (online at 
www.nytimes.com/2009/02/14/business/economy/14pay.html) (``Top economic 
advisers to President Obama adamantly opposed the pay restrictions, 
according to Congressional officials, warning lawmakers behind closed 
doors that they went too far and would cause a brain drain in the 
financial industry during an acute crisis. . . . Others warned that 
because of the rules, firms might lose their best traders and managers 
to hedge funds and foreign banks.'').
---------------------------------------------------------------------------
    In addition to executive compensation and corporate 
governance restrictions, TARP-recipient banks are subject to 
restrictions on hiring foreign workers. The Employ American 
Workers Act (EAWA), section 1611 of ARRA, prohibits any 
recipient of funding under Title I of EESA or section 13 of the 
Federal Reserve Act from hiring new H-1B workers unless they 
had offered positions to equally- or better-qualified U.S. 
workers, and it prevents recipients from hiring H-1B workers in 
occupations in which they have laid off U.S. workers.\147\ 
Hence, while EAWA applies to CPP recipients, repayments will 
not necessarily free banks from its restrictions such as 
restraints on hiring foreign workers.
---------------------------------------------------------------------------
    \147\ ARRA, supra note 23, Sec. 1611(b).
---------------------------------------------------------------------------
    Banks also explain that they are motivated to repay TARP 
funds as soon as possible so they can be free of conditions 
currently imposed by contract, statute, or regulation on 
recipients and the uncertainty related to the possibility of 
new conditions in the future.\148\
---------------------------------------------------------------------------
    \148\ Eric Dash, 10 Large Banks Allowed to Exit U.S. Aid Program, 
New York Times (June 10, 2009) (online at www.nytimes.com/2009/06/10/
business/economy/10tarp.html) (``The banks are eager to escape TARP and 
the restrictions that come with it, particularly the limits on how much 
they can pay their 25 most highly compensated workers.''); Deborah 
Solomon, Nine Banks to Repay TARP Money, Wall Street Journal (June 9, 
2009) (online at online.wsj.com/article/SB124450458046896047.html) 
(``many [TARP recipients] are uncomfortable with the restrictions that 
come with the government's investment, including on pay, dividends and 
stock buybacks''); Robin Sidel, U.S. Gets TARP Payback from 10 Banks, 
Wall Street Journal (June 18, 2009) (online at online.wsj.com/article/
SB124524619467123215.html ) (``some bankers complained it had outlived 
its purpose and imposed needless complications on compensation and 
other decisions''); Stephen Labaton, Some Banks, Feeling Chained, Want 
to Return Bailout Money, New York Times (Mar. 10, 2009) (online at 
www.nytimes.com/2009/03/11/business/economy/11bailout.html) (``One of 
the biggest concerns of the banks is that the program lets Congress and 
the administration pile on new conditions at any time.'').
---------------------------------------------------------------------------
    The SPA places restrictions on a bank's dividend and 
repurchase abilities. These restrictions apply until the 
earlier of the date the bank redeems its shares, when the 
shares are transferred to a third party, or three years after 
the CPP preferred shares' issuance.\149\ There are two dividend 
restrictions. The first is a common restriction for preferred 
shares that gives dividend payments to preferred shareholders 
priority over dividend payments to common or junior preferred 
shares. The second dividend restriction is much less common, 
and quite favorable to Treasury. It caps for a period of time 
the amount of dividends that the bank can pay on its common 
shares The cap is set at the amount of the last regular 
quarterly cash dividend prior to October 14, 2008.\150\ The 
stock repurchase restrictions are parallel to the dividend 
restrictions.\151\ The bank may not redeem common or junior 
preferred shares if dividends on the preferred have not yet 
been paid. Redemption of common and junior preferred shares is 
prohibited during the times in which dividends are capped.
---------------------------------------------------------------------------
    \149\ Securities Purchase Agreement, supra note 15, Sec. 4.8(a).
    \150\ Securities Purchase Agreement, supra note 15, Sec. 4.8(a)(i). 
The dividend amount is subject to certain adjustments, for stock 
splits, etc.
    \151\ The repurchase of common stock is economically equivalent to 
a dividend.
---------------------------------------------------------------------------
    These restrictions improve the value of the warrants by 
preventing banks from paying excessive dividends, which, in 
turn, could impair the bank's capital structure and ultimately 
negatively impact the value of its shares. Moreover, these 
restrictions protect the value of the preferred shares by 
prioritizing dividend payments to preferred shareholders over 
those of junior preferred and common shareholders.
    Finally, a number of institutions argue that they were 
forced directly or indirectly by Treasury and their supervisors 
to participate in the CPP in the interests of stability of the 
financial system as a whole. They may be worried that, 
especially after the stress tests, their failure to repay the 
assistance they receive will have unfair consequences in the 
way the markets assess their strength. Some, especially small, 
banks may worry about general public anger at ``bailout 
banks.'' \152\
---------------------------------------------------------------------------
    \152\ Eric Dash, Four Small Banks Are the First to Pay Back TARP 
Funds, New York Times (Mar. 10, 2009) (online at www.nytimes.com/2009/
04/01/business/01bank.html) (``About 500 small banks have received 
$73.7 billion. But the purpose of the TARP money and the public 
perception of the fund have changed since then. What was billed as a 
program intended to help healthy banks increase lending and swallow up 
troubled rivals widened to include a number of struggling banks. . . 
`We don't want to be touched by the stigma attached to firms that had 
taken money,' said Scott A. Shay, the chairman of Signature Bank.''); 
David Segal, We're Dull, Small Banks Say, but Have Profits, New York 
Times (May 11, 2009) (online at http://www.nytimes.com/2009/05/12/
business/12small.html) (``[C]ommunity bankers have felt compelled in 
recent months to mount public relations campaigns to emphasize their 
fiscal health and in some cases to announce they rejected Troubled 
Asset Relief Program, or TARP, funds. Some have held cookouts, others 
have held `reassurance' meetings in their lobbies, hoping to educate 
customers and prevent panics. All are dealing with banker jokes and the 
occasional wisecrack.''); Bob Davis and Jon Hilsenrath, Federal 
Intervention Pits `Gets' vs. `Get-Nots,' Wall Street Journal (June 15, 
2009) (online at http://online.wsj.com/article/
SB124501974568613573.html) (``Some businesses are trying to tap this 
antibailout sentiment. Worthington National Bank has erected billboards 
around Fort Worth, Texas, boasting that it hasn't been bailed out--a 
shot at a crosstown rival that took federal cash.'').
---------------------------------------------------------------------------
    The reasons why many banks may be seeking to repay their 
CPP investments promptly may also help to explain why some 
institutions have declined to participate in the TARP. Since 
the introduction of the CPP, a total of 372 banks have 
withdrawn their applications after receiving preliminary 
approval by Treasury. On occasion, this situation has arisen 
when Treasury or the regulator had reason to believe that a 
bank would not receive final approval, and therefore encouraged 
it to withdraw voluntarily (so as not to create a disclosable 
event). In the vast majority of cases, however, it was entirely 
the bank's decision not to take the funds.\153\
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    \153\ Weekly data reported to the Panel by Treasury do not 
distinguish between banks that withdrew after receiving approval and 
those that withdrew at any time, but it would appear that voluntary 
withdrawals, rare occurrences in the last months of 2008, increased in 
frequency starting around the second week of January.
---------------------------------------------------------------------------

              H. Conclusion--Policy Choices and Trade-Offs

    The repayment of more than one-third of the financial 
assistance provided under the CPP portion of the TARP, by 
financial institutions comprising approximately one-third of 
bank and bank holding company assets, marks a turning point in 
the TARP and requires careful examination of Treasury's exit 
strategy for the program. If the program has contributed to the 
restoration of stability in the nation's financial system, 
forming an important piece of the broader economic recovery 
effort, then the timing and manner in which the TARP is wound 
down is as important as the way it was begun.
    The judgments involved in the timing of the decision to 
permit repayment of financial assistance are not simple. 
Government ownership of substantial interests in the financial 
institutions that it is supposed to regulate presents 
substantial challenges, in part because it runs the risk of 
appearing to prefer some institutions in which it has made 
investments over others. However, that difficulty has been 
inherent in the TARP from the beginning. The question now is 
whether there have been sufficient changes in the last eight 
months in the condition of the nation's largest financial 
institutions and the state of the nation's economic recovery to 
justify repayment of TARP assistance.
    The banks that have been permitted to repay have for the 
most part been able to raise funds in the equity markets. But 
there is little firm evidence that their lending figures have 
improved or that their capital condition will remain firm. The 
stress tests, as the Panel's June report made clear, are a step 
forward, but do not resolve the issue. Moreover, there are 
questions about whether the economy has improved to a 
sufficient degree to eliminate the capital buffer the 
assistance created, or whether weak loans and similar assets 
have been sufficiently eliminated from the institutions' 
balance sheets. In addition, the desire of banks to free 
themselves of various regulatory restrictions imposed on TARP 
recipients cannot in any way influence the policy of Treasury 
and the Federal Reserve Board in determining whether and when 
to allow TARP assistance to be repaid.
    The Panel's valuations offer reasonable estimates of the 
fair market value of the warrants. They may help Treasury as it 
balances the return to the taxpayer indicated by its own 
estimates of value and the host of other relevant market, 
regulatory and economic factors applicable to the disposition 
of sophisticated financial instruments. In addition, Treasury 
should promptly provide written reports to the American 
taxpayers analyzing in sufficient detail the fair market value 
determinations for any warrants either repurchased by a TARP 
recipient from Treasury or sold by Treasury through an auction, 
and it should disclose the rationale for its choice of an 
auction or private sale. Most important, Treasury should 
undertake to negotiate the disposition of the warrants in a 
manner that is as transparent and fully accountable as 
possible.
    As the Panel has made clear since its beginning, 
transparency is essential--perhaps now more than ever. Treasury 
and the Federal Reserve Board must explain fully and clearly to 
the public the reasons for approval for repayment of financial 
assistance. Treasury must be equally transparent about the way 
warrants are valued, the exit strategy for, or future use of 
the TARP. Without such transparency, the credibility of the 
decisions of Treasury and the Federal Reserve Board and of 
Treasury's stewardship of the TARP can only fall into serious 
question.

      ANNEX A: Technical Explanation of Warrant Valuation Methods

    This annex provides background on the most commonly used 
methods of valuing warrants and an explanation of the 
assumptions the Panel made in applying one such method to 
calculate the value of the TARP warrants.
    The most prominent warrant valuation model is Black-
Scholes, which has been the method of choice since it was first 
published in 1973.\154\ Since that time, it has seen many 
extensions and modifications, but the main theoretical and 
mathematical basis for the method has remained the same. 
Another method, the binomial options pricing model, introduced 
by Cox, Ross and Rubinstein in 1979,\155\ relies on many of the 
ideas set forth in Black-Scholes while approaching the 
mathematical calculations in a very different manner. Finally, 
the simplest valuation of an option is its intrinsic value, 
which values the option solely on its moneyness.\156\ These 
three methods are representative of the majority of valuation 
techniques used today, and most traders use models based on one 
of these three models.
---------------------------------------------------------------------------
    \154\ Fischer Black & Myron Scholes, The Pricing of Options and 
Corporate Liabilities, Journal of Political Economy, Vol. 81 No. 3 
(May/June 1973) 637-654.
    \155\ John Cox, Stephen Ross & Mark Rubinstein, Option Pricing: A 
Simplified Approach, Journal of Financial Economics (July 1979) Vol. 7 
229-263.
    \156\ Moneyness is the property of an option that describes the 
relationship between its strike price and the current share price of 
the underlying stock. An option is ``In The Money'' when its strike 
price is less than the underlying's current share price, ``At The 
Money'' when its strike is equal to it the underlying's share price, 
and ``Out of The Money'' when its strike is above the current share 
price.
---------------------------------------------------------------------------
    The intrinsic value of a warrant is calculated by the 
simple equation:

       Warrant Price = Current Share Price - Strike Price     (1)

    The resultant value is the net gain a trader would realize 
upon exercising the warrant and selling the underlying stock at 
any given moment. This value is very useful in determining the 
prices of warrants very near the end of their terms, and for 
modeling hypothetical early executions of non-European 
options.\157\ However, in valuing warrants that are not near 
their expiration date, and especially in valuing Long-Term 
Equity Anticipation Securities (LEAPs) \158\ such as the 
warrants issued under the TARP, using intrinsic value to model 
fair market value presents significant problems. These problems 
stem from its one major flaw--the assumption that no matter the 
term, a warrant's value is the difference between the 
underlying share price and the warrant's strike price. While 
intrinsic value can provide useful information about the value 
of a warrant if exercised immediately, it says very little 
about the future value of that warrant or its value on the open 
market, as there is always a positive probability that the 
underlying stock price will increase. Since intrinsic value 
ignores the value of future stock movement and the time option 
captured in a warrant, the TARP warrants must be worth more 
than their intrinsic value.
---------------------------------------------------------------------------
    \157\ European options are options which can only be exercised on 
the day they expire. The most prevalent type of non-European option is 
the American option, which can be exercised on any day until it 
expires.
    \158\ Long-Term Equity AnticiPation securities are options that 
have an expiry date more than one year away.
---------------------------------------------------------------------------
    The binomial options pricing model and the Black-Scholes 
model rely on many of the same assumptions: efficient markets, 
no transaction costs, Brownian motion,\159\ and lognormal 
growth.\160\ For the binomial model, these assumptions allow a 
binomial tree to be constructed that follows a random walk of 
the underlying share prices, where the term of the option is 
split into different periods. The first period consists of one 
point that represents the current share price. From this, using 
the model inputs,\161\ a possible increase in the share price 
and a possible decrease are calculated. These newly calculated 
points represent the two possible prices which could be 
attained by the stock in the next period. This process is 
continued through all of the periods in the model until the 
warrant's term is complete. This process creates a lattice of 
interconnecting possible future paths of the underlying share 
price. From this result, option prices are calculated backward 
from the final period to determine the appropriate price, given 
the statistical probabilities of the outcomes, of the option in 
the original period.
---------------------------------------------------------------------------
    \159\ A theory developed by Robert Brown to describe the random 
movements of particles in suspensions, which was later quantified by 
Einstein and Smoluchowski and used to prove the existence of atoms. The 
mathematical model describes random movement and is often used in many 
fields to mathematically describe random events. In this context, it is 
used to describe the random motion of stock prices.
    \160\ At this limit, or after a large number of periods, the result 
of the Binomial Options Pricing Model becomes equivalent to the pricing 
of the Black-Scholes model with respect to the valuation of European 
Options. Lognormal growth, an underlying tenant of Black-Scholes, is 
found to be a property at the limit as well.
    \161\ The assumption of no arbitrage allows the model to assume 
that all of the stocks information is appropriately incorporated into 
the share price.
---------------------------------------------------------------------------
    While a Black-Scholes valuation relies on a continuous 
model of share prices, the binomial model operates in discrete 
periods of time. Because of this, the binomial model has a 
number of beneficial features, all of which stem from its 
ability to incorporate different assumptions at different 
periods in a warrants term. Further, it allows for the modeling 
of American options which can be exercised early.\162\ However, 
the ability to add these features results in a more 
sophisticated set of inputs, creating a more complicated and 
less reproducible model as a result.
---------------------------------------------------------------------------
    \162\ An American option can be exercised at any time until the 
expiration date. By contrast, a European option can only be exercised 
on the expiration date.
---------------------------------------------------------------------------
    The lack of reproducibility caused by the use of 
sophisticated and complex inputs is one of the major problems 
of the binomial model. Since the Panel attempted a transparent 
valuation of the TARP warrants, it used a Black-Scholes model, 
which uses only a few simple inputs.
    The most popular option pricing model is Black-Scholes, 
which has been an industry standard since it was first 
introduced and is routinely used by options traders. To value 
an option, the Black-Scholes model sets up a fully hedged 
portfolio, which is long the underlying stock and short the 
option. Since in an efficient market a portfolio cannot exist 
with a guaranteed return greater than the risk free rate, this 
perfectly hedged portfolio must earn the risk free rate. This 
parity can be expanded out through stochastic calculus to a 
partial differential equation which has the closed-form 
solution:\163\
---------------------------------------------------------------------------
    \163\ This expansion is made possible by a number of assumptions 
including: the assumption that stock prices ``follow a random walk, in 
continuous time with a variance rate proportional to the square of the 
stock price. Thus the distribution of possible stock prices at the end 
of any finite interval is lognormal.'' Black-Scholes Paper, supra 72, 
at 640. In equations (2) (3) and (4), N(d) refers to cumulative normal 
density function, w(x,t) refers to the price of the warrant with 
respect to the share price of the underlying(x) and time(t). (r) refers 
to the risk free interest rate, and (c) refers to the strike price. (v) 
refers to the volatility of the underlying.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



    The popularity of the Black-Scholes model is driven by its 
ease of use, which is the product of its closed form solution. 
Anyone can plug in the standard inputs required for valuing any 
option and then solve the equation for the value of the option. 
The model is also preferred by options traders because it has a 
high degree of accuracy. Although some believe that the 
binomial model is more accurate, the Black-Scholes model's ease 
of use has made it the industry standard for valuing warrants, 
as acknowledged by many respected options experts, including 
Mark Rubinstein, the co-creator of the binomial method.\164\
---------------------------------------------------------------------------
    \164\ Rubinstein Implied Binomial Trees Paper, supra note 73 (``The 
[Black-Scholes] formula can be implemented in a fraction of a second on 
widely available low-cost computers and calculators. In many situations 
of practical relevance, the inputs can be easily measured and the 
related securities are traded in highly efficient markets. This model 
is widely viewed as one of the most successful in the social sciences 
and has perhaps (including its binomial extension) the most widely used 
formula, with embedded probabilities, in human history.'').
---------------------------------------------------------------------------
    It is important to note that the Black-Scholes model, as 
well as every other popular options pricing model, was created 
to reflect the prices of options with short terms, ranging from 
days to months. As no options are traded on the Chicago Board 
Options Exchange (CBOE) with terms longer than three 
years,\165\ it is very difficult to come up with a ``fair 
market value'' of the TARP warrants which have terms of ten 
years. The lack of publicly traded comparable derivatives makes 
any valuation of ten-year warrants difficult.
---------------------------------------------------------------------------
    \165\ Chicago Board Options Exchange, Product Specification: Equity 
LEAPS (online at www.cboe.com/Products/EquityLEAPS.aspx) (accessed July 
8, 2009) (``Expirations Months: May be up to 39 months from the date of 
initial listing, January expiration only.'' However, there may be some 
FLEX options with terms as long as 15 years, however these are custom 
instruments, and not traded, listed, or priced like regular options, 
and therefore unusable for the purposes of this analysis.).
---------------------------------------------------------------------------
    More generally, there is the problem of lack of knowledge 
about most of the inputs to the model. For example, while ten-
year Treasury bills factor in what the market expects the 
interest rate risk for the next ten years to be, it is 
impossible to know the validity of the market's expectations. 
Thus, once again, it is important to note that the value that 
we are searching for here is not based on our expectations of 
the future, but rather our estimate of the market's 
expectations. Because the goal of the Panel's valuations was to 
estimate the value the financial markets would place on these 
warrants, we tried to use the inputs most likely to be used by 
prospective buyers.
    The input that is the least defined in the Black-Scholes 
model and has the largest effect on the price of the warrant is 
the volatility of the underlying stock price. Volatility is 
defined as the standard deviation of the continuously 
compounding returns of a stock. It is clear from this 
definition that there are an almost infinite number of 
variations of the calculation of this number. The volatility is 
important in the Black-Scholes model because it features 
prominently in both of the probability calculations in the 
closed-form solution, meaning that differing values of 
volatility can create substantial differences in the final 
valuations of the warrants. The following example illustrates 
this point with respect to the Black-Scholes model. Assume that 
a warrant to buy one share of company XYZ at $150 expires in 
one year, that XYZ is currently trading at $100 and that the 
risk free rate is one percent. If XYZ's volatility is 30 
percent, the warrant is worth $1.59, but if the volatility is 
60 percent, the warrant is worth $10.91. In fact, if the 
volatility is below 15 percent, the warrant is virtually 
worthless.
    There are two main ways to estimate the future volatility 
of a stock. The first is to calculate it from historical 
prices. Any time period can be used to measure volatility, 
although standard practice dictates that the time period chosen 
be at least three months and at most ten years backward from 
the valuation day. An analyst's choice of the time period over 
which he or she will measure historical volatility as an 
estimate of future volatility can have a large effect on a 
valuation. For example, since the past two years have been 
particularly turbulent, the volatility figures derived from 
this period are high and may not be representative of the 
volatility of stocks over the next ten years. Using these 
volatility figures to value the TARP warrants would likely lead 
to an overvaluation. On the other hand, using volatilities 
calculated from the past ten years may undervalue the warrants 
if one believes that shares will be more volatile over the next 
decade than they have been in the previous one. Modulating the 
time period over which historical volatility is calculated can 
affect the valuation of the warrants in some banks by more than 
an order of magnitude. Apart from the time period over which 
volatility is measured, historical volatility measures also 
differ based on the time increments from which they calculate 
variance in returns: days, weeks, months, or other lengths of 
time.
    The second method of determining volatility of a stock is 
to derive its ``implied volatility.'' Implied volatility of a 
stock is calculated by solving the Black-Scholes equation for 
volatility after plugging in the market price of a publicly 
traded option on that stock. This process yields the market's 
estimate of the stock's volatility, following from the Black-
Scholes assumption that all of a security's information is 
incorporated into its price. While this number has its 
drawbacks, particularly because publicly traded options do not 
have terms nearly as long as the TARP warrants, it is the best 
estimate of the market's current perception of volatility.
    While these two methods of calculating volatility are the 
most widely used, and thus the most useful in estimating the 
fair market value of the TARP warrants, there are a number of 
other methods that can be used to calculate volatility. One 
example is the calculation of volatility from credit default 
swaps (CDS). Using Merton's model, which defines an option on a 
stock as an option on the underlying firm's assets, it is 
possible to translate CDS spreads into implied volatilities, 
which is useful, since the market for ten-year CDSs is more 
liquid than the market for ten-year options. However, 
calculations based on CDSs rely on the Merton model's 
characterization of equity, which may be incorrect due to the 
different tiers debt and equity represent in a firm's capital 
structure. This method for calculating volatility is most 
appropriately used ``when the long-term prospects of a company 
are driven by downside credit concerns rather than upside 
growth potential.'' \166\ In today's market of relatively low 
stock prices and extensive government support for the financial 
sector, it appears that share prices for banks are more likely 
to be determined by the potential for rebound, as opposed to 
potential failures due to credit problems. This means that CDS 
spreads are not likely to be as useful in calculating the value 
of TARP warrants.
---------------------------------------------------------------------------
    \166\ Credit Suisse Valuation Report, supra note 91.
---------------------------------------------------------------------------
    While the lack of a specific method for calculating 
volatility creates uncertainty in the determination of Black-
Scholes values, the model may also fail to account for a number 
of other factors which affect the value of options. One 
overlooked factor is the dividend yield. Dividend yield is 
calculated as the ratio of annual dividends per share to share 
price. The dividend yield represents an investor's return on 
investment if the stock is not sold. While the Black-Scholes 
model assumes that companies do not issue dividends, most do, 
and dividends create a premium for holding the underlying stock 
compared to the warrant. As a result, all other things being 
equal, the higher the dividend yield of the underlying stock, 
the lower the value of the warrant. Since many of the companies 
for which Treasury holds warrants issue dividends, it is 
necessary to adjust for this factor in any valuation of its 
holdings.
    While the Black-Scholes model provides insight into the 
pricing of short term European call options on stocks that do 
not pay dividends, it does not provide a proper valuation for 
American LEAPs on companies that pay dividends, like the TARP 
warrants. In order to price these securities, it is necessary 
to use some of the many extensions that have been developed for 
Black-Scholes since its inception. The first extension was 
created by Robert C. Merton in 1973 before the Black-Scholes 
paper was published. This extension allows for the integration 
of dividends into the Black-Scholes model by making the 
assumption that ``since the warrant owner is not entitled to 
any part of the dividend return, he only considers that part of 
the expected dollar return to the common stock due to price 
appreciation.'' \167\ This extension is used as the standard 
for pricing options that have a dividend-issuing underlying 
stock, and has been adopted in the methodology used by the 
Panel in this report.
---------------------------------------------------------------------------
    \167\ Robert C. Merton, Theory of Rational Option Pricing, The Bell 
Journal of Economics and Management Science, at 170 (Spring 1973).
---------------------------------------------------------------------------
    The other extension that the Panel used is that of Galai 
and Schneller.\168\ This extension accounts for the fact that 
warrants are fundamentally different from call options, since 
exercising a warrant causes an increase in the number of 
outstanding shares, diluting common equity holders. This means 
that--all other things being equal--a stock is worth less after 
the exercise of a warrant than it was before exercise. In order 
to account for this, the Black-Scholes value of the option is 
calculated, multiplied by the ratio of the number of warrants 
to the number of fully diluted shares, and then this value is 
added to the share price to create a new share price input. The 
Black-Scholes value is calculated again, using this new share 
price input. This process is carried out repeatedly until the 
Black-Scholes values converge, at which point dilution has been 
sufficiently factored out of the warrant's price. This final 
value is then multiplied by the ratio of the number of shares 
outstanding to the number of shares outstanding plus the number 
of warrants to arrive at a warrant valuation that considers the 
effect of dilution.
---------------------------------------------------------------------------
    \168\ Dan Galai and Meir I. Schneller, Pricing of Warrants and the 
Value of the Firm, The Journal of Finance, at 1333-1342 (Dec. 1978).
---------------------------------------------------------------------------

   A FINAL NOTE ON THE CONVERGENCE OF THE BINOMIAL AND BLACK-SCHOLES 
                                METHODS

    The binomial method and the Black-Scholes model are both 
used extensively to model the values of warrants. In fact, FAS 
123(R) states that, ``A lattice model (for example, a binomial 
model) and a closed-form model (for example, the Black-Scholes-
Merton formula) are among the valuation techniques that meet 
the criteria required by this Statement for estimating the fair 
values of employee share options and similar instruments,'' 
acknowledging both Black-Scholes-Merton and the binomial method 
as valid in pricing stock options issued as compensation.\169\ 
The Panel has chosen to use the Black-Scholes method for the 
reasons described above. In fact, however, the choice does not 
matter, because, given the same inputs, the binomial method 
converges on Black-Scholes as the number of nodes in the 
binomial tree grows (see Figure 5). In fact, the Black-Scholes 
equations are merely the closed form solution of the binomial 
model in the special case that inputs are constant and that the 
number of nodes is taken to the limit. From this, it is clear 
that any difference in the valuations of warrants is due not to 
the choice of the binomial or Black-Scholes model, but rather 
the input assumptions that are made. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    \169\ While executive compensation options are not the same as TARP 
warrants, they share certain characteristics, such as their long terms. 
Thus, methods acceptable for valuing executive compensation options are 
also probably appropriate for valuing TARP warrants. Financial 
Accounting Standards Board, Statement of Financial Accounting Standards 
No. 123(R): Share-Based Payment (October 1995).

         ANNEX B: Analysis of the Old National Bancorp Warrants

    This annex compares Treasury's valuation and sale of its 
Old National Bancorp warrants with the Panel's valuation of 
those warrants and illustrates the general valuation processes 
carried out by Panel staff and Treasury. As noted in the text, 
11 BHCs have already repurchased their warrants for $18.69 
million. Old National Bancorp was the first BHC to do so.
    Headquartered in Evansville, Indiana, Old National Bancorp 
is a BHC with $8.3 billion in assets.\170\ Its stock is traded 
on the New York Stock Exchange under the ticker ONB. ONB 
received a $100 million CPP investment on December 12, 2008. 
The bank then repaid its CPP investment on March 31, 2009 at 
par value. In the interim, it paid over $1.5 million in 
dividends to Treasury. Upon repayment of its CPP investment, 
ONB entered into negotiations with Treasury to buy back 
warrants for 813,008 shares of its stock, which it had issued 
to Treasury in conjunction with the initial CPP investment in 
December. On May 8, ONB completed the repurchase of these 
warrants for $1.2 million. Using a Black-Scholes-Merton model 
extended by Galai-Schneller, as described in Annex A of this 
report, the Panel staff valued these warrants at $2.15 million.
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    \170\ Board of Governors of the Federal Reserve System, Bank 
Holding Company Peer Group Reports: Peer Group 2, at 28 (Mar. 31, 2009) 
(online at www.ffiec.gov/nicpubweb/content/BHCPRRPT/REPORTS/BHCPR_PEER/
March2009/PeerGroup_2_March2009.pdf).
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    The standard inputs to any warrant valuation model are the 
strike price of the warrant, the expiration date, the 
underlying share price, the future dividend yield, the future 
volatility of the underlying shares, and the risk free rate 
over the term of the warrant. The Panel staff and Treasury used 
the same strike price and expiration date, $18.45 and December 
12, 2018 respectively, as inputs to their models for the ONB 
warrants. The Panel staff used the closing share price on May 
7, 2009, the day before the ONB transaction closed, for the 
underlying share price input. The share price on this day was 
$13.78. Treasury used the 20-day trailing average share price 
on April 22, $13.15. It is unclear to the Panel staff why 
Treasury used this unconventional input, particularly when it 
yields a lower valuation than the most recent closing share 
price would.
    Dividend yield, which is the ratio of dividends paid to 
share price, must be forecast for the term of the warrant being 
valued. Obviously, in the case of the TARP warrants, predicting 
the dividend issuances of TARP recipients for the next ten 
years is difficult. Market participants informed Panel staff 
that they would typically seek the input of securities analysts 
who follow the company in question in order to obtain 
predictions for dividend yield. To preserve the clarity and 
reproducibility of the Panel's methodology, Panel staff elected 
to forgo this process.
    Instead, the Panel staff used an alternative standard 
practice, predicting future dividends from average historical 
dividend yields. This number is calculated by averaging the 
dividends paid over a particular period of time and then 
dividing them by the average market price per share during that 
period.\171\ The Panel used ONB's five-year average dividend 
yield, 4.19 percent. Treasury used ONB's ten-year average 
dividend yield, 3.69 percent. Treasury's assumption may seem 
more logical as the historical period it analyzes mirrors the 
duration of the TARP warrants. However, the Panel staff 
believes that the more recent past is more indicative of future 
bank dividend policy.\172\ Thus, the Panel staff, in 
consultation with academics and market participants, used a 
five-year average dividend yield to predict the future dividend 
performance of ONB and the other TARP recipients. In the case 
of ONB, the difference between the five and ten-year average 
dividend yields was only 50 basis points.
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    \171\ Average Dividend Yield = Average Dividends Over Period  
Average Share Price Over Period  100
    \172\ It is also important to note that TARP recipients' dividend 
payments are capped at the amount of the last regular quarterly cash 
dividend prior to October 14, 2008 while the government continues to 
hold preferred shares in them. Therefore, dividend yields for banks 
which have not repaid their TARP investments are likely to be lower 
than they have been in the past.
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    The choice of volatility input has a large effect on any 
warrant valuation. There are two main ways to predict future 
volatility, implied volatility and historical volatility. 
Implied volatility is derived from publicly traded comparable 
options, through solving an extended Black-Scholes model for 
volatility. Implied volatility is what the market predicts 
volatility will be over the term of the comparable option.
    Historical volatility is calculated from the historical 
returns of a stock. It assumes a log normal distribution of 
returns. The historical volatility of a stock over a period of 
time is calculated as the standard deviation of the natural log 
of the interim returns in that period. Different interim 
returns can be used: daily, weekly, or monthly returns, for 
example, would all be acceptable.\173\
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    \173\ Theoretically the choice of interim period should not have an 
effect on the volatility measurement.
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    Both methods of calculating volatility are valid. However, 
as many TARP recipients have only thinly traded options with 
short durations, Panel staff believes that the implied 
volatilities calculated from these options are unreflective of 
the market's long term volatility expectations. For example, 
the implied volatility calculated from ONBLW call options on 
ONB, which had a strike price of $17.50 and a maturity date of 
December 12, 2009, was estimated by the Panel to be 57.2%.\174\ 
The Panel staff believes that this figure is more indicative of 
the market's expectations for ONB short term volatility than 
its volatility over the next ten years.
---------------------------------------------------------------------------
    \174\ Option price was calculated from the average of the closing 
bid and ask prices.
---------------------------------------------------------------------------
    The drawbacks in using implied volatility to value the ONB 
warrants led Panel staff to use historical volatility instead. 
The most important assumption in calculating historical 
volatility is the period over which it will be measured. In 
this case, the most standard choice is to calculate the 
historical volatility from the date of the valuation backward 
for the term of the option. For example, the TARP warrants all 
have terms of ten years, so the ten-year historical volatility 
would be the most appropriate estimate of volatility over the 
next ten years. Following standard practice, the Panel staff 
calculated ONB's ten-year historical volatility from daily 
returns for the period ending May 7, 2009 at 34.12%. This value 
was used in the Panel's model to arrive at a best estimate of 
the value of the ONB warrants.
    Treasury also calculated volatility over a ten-year period 
for the TARP recipients, but used a very different and 
unorthodox method. Treasury used ``the average 60-day trailing 
volatility for the last ten years'' to determine each BHC's 
historical volatility.'' \175\ Specifically, Treasury's ten-
year volatility measure is calculated by taking the arithmetic 
average of the 60-day trailing historical volatilities for each 
day over the past ten years.\176\ According to calculations 
performed by Panel staff, Treasury's procedure results in a 
ten-year volatility measure for ONB of 27.5%, more than 650 
basis points lower than the Panel's ten-year volatility 
measure. In consultation with academics and market 
participants, Panel staff has determined that over any time 
period Treasury's estimation of historical volatility will, in 
almost all cases, yield volatilities that are lower than those 
calculated by more standard methods. As a result of this 
difference, ceteris paribus, Treasury's valuation of the TARP 
warrants will be significantly lower than valuations using more 
standard volatility inputs.
---------------------------------------------------------------------------
    \175\ U.S. Department of Treasury, Treasury Announces Warrant 
Repurchase and Disposition Process for the Capital Purchase Program, 
supra note 46.
    \176\ Treasury further adjusts this number downward to compensate 
for unusual volatility during the financial crisis beginning in late 
2007. Treasury also considers implied volatility numbers, but has not 
given the Panel any guidance on how.
---------------------------------------------------------------------------
    Some portion of the difference between the Panel's estimate 
of the value of the ONB warrants, $2.15 million, and the price 
actually received by Treasury, $1.2 million, can be explained 
by the differing share price, dividend yield and volatility 
assumptions as discussed above. However, in its final 
determination of the ONB warrants' fair market value, Treasury 
also applied a liquidity discount. For thinly traded stocks, 
such as ONB, Treasury believes that its warrant positions are 
too large to be sold for their model value on the open market. 
Therefore, Treasury applies a liquidity discount to better 
approximate what they believe the warrants' fair market value 
would be. Treasury staff has told Panel staff that these 
liquidity discounts range from zero to 50 percent depending on 
the recipient institution. Treasury staff has also indicated 
that they have applied discounts from 15 to 35 percent in 
transactions to date. As discussed above,\177\ it is unclear 
whether liquidity discounts of this magnitude should be applied 
in valuing TARP warrants or even if they should be applied at 
all.
---------------------------------------------------------------------------
    \177\ See Section One Part F of this report.
---------------------------------------------------------------------------
    One final observation, based upon market data, calls into 
question the adequacy of the price Treasury received for its 
ONB warrants. On May 7, 2009, the day before ONB repurchased 
its warrants, the last bid on the ONBLW option--an option on 
ONB stock with a strike price of $17.50 and a duration of 7 
months--was $0.75, while the last asking price was $1.35. 
Backing out Treasury's sale price for the ONB warrants yields a 
value of $1.48 per warrant. This means that Treasury sold the 
ten-year warrants it held in ONB for 13 cents per share more 
than the asking price of a comparable option with a term of 
only seven months.
                     SECTION TWO: ADDITIONAL VIEWS


                          A. Richard H. Neiman

    I agree with the main thrust of this month's report that 
the warrants need to be valued carefully and at fair market 
value by Treasury and that the process should be conducted with 
as much transparency as possible. While I voted for the report, 
I am providing these Additional Views to clarify my positions 
and to add some perspective, particularly on issues where the 
Panel did not reach consensus.

                    1. BENEFITS TO THE U.S. TAXPAYER

    The total benefit to the American taxpayer has to take into 
account the non-financial as well as the financial returns. The 
financial returns include repayment of the principal of the 
preferred stock loans, the dividends received, and the value of 
the warrants. The non-financial benefits include the important 
policy objectives that have been achieved on behalf of the 
American people of stabilizing and reviving the financial 
system during a very difficult period of time. The CPP program 
has achieved and continues to achieve objectives and we should 
not lose sight of this. I think that this report focuses at 
times too narrowly on the warrants to the exclusion of other 
important components of return.

                            2. EXIT STRATEGY

    I support the Administration's and Treasury's stated policy 
objective to exit the warrant holdings as soon as practicable 
after the banks have repaid their preferred stock under the 
CPP. Government capital support for the banks was the product 
of crisis conditions and the government should exit these 
investments as soon as conditions stabilize. I would not 
support selling the warrants while the preferred stock is 
outstanding; nor do I think it would be wise to hold the 
warrants for any protracted period after the preferred stock is 
repaid in an effort to maximize value by trying to time the 
markets.
    I think it is sound policy that the banks have the 
opportunity to elect to repurchase their warrants at market 
prices, as they do under the Security Purchase Agreements, 
before a market auction is held. The Chrysler sidebar in the 
report demonstrates that the warrant issuer (in that case 
Chrysler; in this case the banks) will often have the greatest 
motivation to purchase its warrants in order to prevent share 
dilution. Then, if the banks elect not to repurchase or if a 
fair market value cannot be agreed upon, a fully transparent 
auction should be held.
    I also believe that the Federal Reserve and other banking 
regulators have described a very reasonable and robust process 
to screen banks for eligibility to repay the taxpayer's 
investment, as outlined at pages 9-10 of the report. Therefore 
I think that this process should be allowed to work and that 
the return of the banks to private capital markets should be 
encouraged wherever it is deemed appropriate.

                  3. IMPACT OF SMALL BANK REPURCHASES

    The report draws certain conclusions based on an analysis 
of the warrants of eleven small banks that have already been 
repurchased. I believe that reasonable minds can disagree about 
the appropriateness of liquidity discounts and complex 
volatility measures. As the report points out these warrants 
were a fraction of one percent of the value of all warrants 
outstanding. We should be cautious before extrapolating too 
many conclusions about the entire repurchase program based on 
these early and small redemptions. Hopefully lessons can be 
learned from these early efforts.

                    4. NEED FOR GREATER TRANSPARENCY

    I believe it is vital from this point forward, especially 
with the very large repaying banks' warrants coming up for 
repurchase or auction in the near future, that there be greater 
disclosure and transparency than there has been until now. In 
this regard I am encouraged by Treasury's June 26 commitment to 
greater transparency by:

          [P]ublishing additional information on each warrant 
        that is repurchased, including a bank's initial and 
        subsequent determinations of fair market value, if 
        applicable. Following the completion of each 
        repurchase, Treasury will also publish the independent 
        valuation inputs used to assess the bank's 
        determination of fair market value.\178\
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    \178\ See, Treasury Warrant Repurchase Announcement, supra note 46.

    Disclosure as described above should substantially improve 
the transparency of the warrant repurchase process going 
forward.

                         B. Rep. Jeb Hensarling

    I concur with the issuance of the July report subject to 
the following observations.\179\ Treasury should accept the 
panel's estimates of fair market value as good faith guidance 
worthy of careful consideration along with its own estimates of 
value and the host of other relevant market, regulatory and 
economic factors applicable to the disposition of sophisticated 
financial instruments. I object, however, to any inference that 
(i) the panel's estimates reflect ``the'' fair market value of 
the warrants, instead of an estimate of such value, (ii) the 
panel's estimates should necessarily serve as the ``floor'' in 
a negotiated private party transaction or the ``reserve price'' 
in an auction, (iii) an auction of the warrants will 
necessarily yield a more favorable return to Treasury than a 
privately negotiated sale, and (iv) holding the warrants for 
the intermediate to long-term will necessarily yield a more 
favorable return to Treasury.
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    \179\ I commend the panel and its staff for their efforts in 
producing the report.
---------------------------------------------------------------------------
    The determination of ``fair market value'' for financial 
instruments as complex as the warrants issued by the TARP 
recipients to Treasury requires a thoughtful and judicious 
mixture of science--financial models such as Black-Scholes--and 
art--an appreciation of the dynamics that influence the actions 
of market participants. Treasury should resist the temptation 
to rely upon science to the exclusion of art. It is worthwhile 
to recall the lessons of the past year or so and the hubris of 
financial modelers who asserted with profound conviction that, 
for example, credit default swaps issued over mortgage backed 
securities were virtually free of risk and that AAA-rated 
tranches of collateralized debt obligations were investment 
grade securities. Financial analysts may counter by claiming 
that their models incorporate an appropriate mixture of inputs 
and risk analysis and as such may be trusted to yield market 
ready results. In many instances that is no doubt true but in 
other cases it is critical for the decision makers to leave the 
models and sit down at the table and engage in the art of 
negotiation. I encourage Treasury to reflect upon the lessons 
of this financial crisis in negotiating the disposition of its 
warrants.

     1. PANEL'S ATTEMPT TO ESTIMATE THE VALUE OF THE TARP WARRANTS

    The warrant valuation process involves more than merely 
plugging numbers into a financial model, Black-Scholes or 
otherwise. Such determination requires the careful exercise of 
judgment which comes from a seasoned understanding of the 
business operations and prospects for each TARP recipient. 
Experienced investment professionals may disagree on 
fundamental concepts such as volatility and other subjective 
inputs as well as whether Treasury should pursue a negotiated 
private sale or an auction of the warrants. Given the various 
permutations of potential inputs it is generally 
counterproductive to argue that one professionally rendered 
well-vetted assumption or approach is more reasonable than or 
inherently preferable to another. What is clear, however, is 
that Treasury should adopt a surgical approach that focuses on 
each particular transaction and not on a one-size-fits-all 
approach that misses the subtle distinctions that certainly 
exist among the various TARP recipients.
    At this time it appears that Treasury and the TARP 
recipients are reasonably well positioned to appreciate the 
multitude of factors that influence a negotiated determination 
of fair market value pursuant to the terms of the Securities 
Purchase Agreements (SPAs). Specifically, the SPAs, under 
certain circumstances, provide each TARP recipient with the 
right to repurchase its warrants granted to Treasury at a fair 
market value price. If the parties fail to agree on the 
valuation price an appraisal process is triggered. If the fair 
market value price established by the appraisers is not 
acceptable to a TARP recipient such recipient may reject the 
price and not purchase its warrants from Treasury. In addition 
and under certain circumstances, Treasury has the right to sell 
the TARP warrants to third-parties through an auction process. 
Under both procedures the fair market value of the warrants 
will be determined pursuant to market oriented terms by well-
advised adverse parties who are negotiating at arm's length 
without a compelling need to purchase or sell. I am concerned 
that the TARP recipients and market participants may view the 
panel's report as an attempt to prospectively second-guess 
future determinations of fair market value undertaken in 
accordance with the SPAs and the policies adopted by 
Treasury.\180\ Any such perception may disrupt an otherwise 
orderly valuation process.\181\
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    \180\ Although I do not object to the undertaking, I nevertheless 
question the necessity of the Panel's attempt to determine the fair 
market value of the warrants since the procedures provided in the SPAs 
for the disposition of the warrants as well as the internal procedures 
adopted by Treasury for the valuation of the warrants appear market 
oriented and reasonable in form and substance. Since the report does 
not provide any indication that the process outlined in the SPAs is 
inherently flawed (i.e., substantially off-market or subject to 
manipulation or abuse) or that Treasury or any TARP recipient is not 
acting in good faith, it is arguably premature for the Panel to attempt 
to value the warrants.
    In the February report I concurred with the Panel's attempt to 
value the preferred stock and warrants acquired by Treasury from the 
TARP recipients. As with the February report, I concur with the 
issuance of this report. However, I believe the circumstances have 
changed considerably since then. At the time the February report was 
written, no TARP recipient was prepared or permitted to redeem its 
warrants issued to Treasury and the valuation served an appropriate 
purpose. Since February 6, 2009, when the Panel's report on ``Valuing 
Treasury's Assets'' was released, events have materially changed. The 
American Recovery and Reinvestment Act of 2009 was signed into law on 
February 17, 2009, which requires Treasury to permit TARP recipients to 
repay Capital Purchase Plan assistance without replacement of capital 
from other sources. Since then, several TARP recipients have either 
redeemed or are preparing to redeem their warrants. As such, I believe 
that any attempt to value the warrants on a prospective basis is far 
more nuanced than the approach taken in February and much more likely 
to influence in an inappropriate and unintentional manner the actions 
of Treasury, the TARP recipients and market participants as they 
negotiate the redemption and sale of the warrants pursuant to the SPAs.
    \181\ It is worth noting that although the TARP warrants have also 
been valued by Credit Suisse, Bloomberg, Professor Linus Wilson and the 
CBO, the Panel's report will most likely receive greater media 
attention and become the de facto third-party appraisal.
---------------------------------------------------------------------------
    If the panel's determination of fair market value is too 
low, the American taxpayers may not receive the benefit of 
their bargain, and if the panel's determination is too high, 
Treasury may fail in its efforts to sell the warrants back to 
the TARP recipients or to third-parties pursuant to the market 
oriented procedures provided in the SPAs. The latter result may 
cause Treasury to hold the warrants for the intermediate to 
long-term even though the President has clearly stated that his 
objective is to dispose of the warrants ``as quickly as is 
practicable.'' \182\ Although I disagree with the President on 
many issues, I concur with this determination given (i) the 
profound difficulty in valuing the warrants and advantageously 
timing the market, (ii) the inherent risk associated with 
holding investments of this nature, (iii) the clear desire of 
the American taxpayers for the TARP recipients to repay all 
TARP related investments sooner rather than later, (iv) the 
troublesome corporate governance and regulatory conflict of 
interest issues raised by Treasury's continued ownership of the 
TARP warrants, and (v) the stigma associated with continued 
participation in the TARP program by the recipients.\183\ If 
the panel disagrees with the President on this issue the report 
should clearly indicate such dissent, but the valuation process 
itself should not directly or indirectly work to influence 
Treasury's holding period of the TARP warrants. Such result 
will occur if the panel accepts input metrics and assumptions 
that overvalue the warrants and chill the resale market.\184\
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    \182\ On June 26, 2009 Treasury released information on its 
valuation procedure. The release contains the following statement: 
``The President has clearly stated that his objective is to dispose of 
the government's investments in individual companies as quickly as is 
practicable. In reaching the judgment to dispose of the warrants in the 
manner described, Treasury considered a range of options including 
holding the warrants for a longer term or until their expiration. Under 
those alternate scenarios, there was no certainty that we would realize 
higher values, and it was not appropriate for the government to be 
exercising discretionary judgment on timing market sales.'' U.S. 
Department of Treasury, Treasury Announces Warrant Repurchase and 
Disposition Process for the Capital Purchase Program, supra note 46.
    \183\ More precisely, I believe that Treasury should promptly/
immediately dispose of its TARP warrants. If the somewhat vague notion 
of ``as quickly as is practicable'' is interpreted by Treasury to 
encompass an intermediate to long-term holding period for the TARP 
warrants, then I disagree with such approach.
    \184\ I do not intend to imply that the Panel has intentionally 
attempted to overvalue the TARP warrants. Instead, I believe the Panel 
may have taken the perspective of the ``seller'' of the warrants and as 
such the Panel should appreciate that the ``buyer'' may have a 
materially different perspective regarding fair market value.
---------------------------------------------------------------------------
    Evidence of my concern may be found in the panel's report. 
In a passage destined to grab its share of media attention the 
panel concludes that ``Treasury has received about 66% of the 
Panel's best estimate of fair market value'' from the sale of 
its warrants back to eleven TARP recipients (the ``Redeeming 
Issuers'').\185\ The implication is clear--Treasury is 
virtually giving the warrants back to the issuers. What should 
the American taxpayers make of this claim? Should they conclude 
that Treasury and its advisors are incompetent or that they 
negotiated the repurchase of the warrants in bad faith and in 
contravention of the letter and spirit of the SPAs? If the 
panel believes that Treasury acted in an untoward manner or is 
simply not up to the task then it should clearly state such 
position and promptly investigate.
---------------------------------------------------------------------------
    \185\ See Section E.3. of the report.
---------------------------------------------------------------------------
    If we assume that Treasury discharged is duties and 
responsibilities in good faith (and the report does not suggest 
to the contrary) then we are left with a fairly pedestrian 
disagreement between Treasury and the panel regarding the 
valuation of the warrants; that is, a good faith difference of 
opinion exists between Treasury's experts and the panel's 
experts regarding the fair market value of the warrants issued 
to Treasury by the Redeeming Issuers. As stated above, 
reasonable minds may differ regarding these matters and 
modestly different assumptions may materially affect the 
valuation of warrants with a ten-year term. It is possible that 
the panel selected inputs destined to yield the highest 
possible ``reasonable'' set of valuations for the warrants of 
the Redeeming Issuers. Such approach, however, is of little 
benefit if it yields fair market value prices for the warrants 
that neither the TARP recipient nor the market is willing to 
pay. The panel should appreciate that the use of financial 
models to value ten-year term warrants will at best only offer 
a ``sticker price'' and, like careful consumers, sophisticated 
market participants seldom pay ``sticker.'' \186\
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    \186\ It is not at all surprising that the negotiated sales prices 
fell short of the estimates generated by the financial models, 
particularly those that do not incorporate liquidity discounts and 
other appropriate adjustments. It appears reasonable to conclude that 
in the context of the TARP warrants (and other sophisticated financial 
instruments) any estimate of fair market value derived from financial 
models will merely serve as the starting point for the negotiation of a 
mutually agreeable valuation and under limited circumstances will such 
price be accepted by an adverse party without challenge. It also 
appears that Treasury terminated negotiations with two or so TARP 
recipients and that the recipients did not invoke the appraisal 
process. As such, Treasury will most likely seek to dispose of those 
warrants in an auction in accordance with its current policy. Such 
action indicates that Treasury will not accept a significantly off-
market price and will employ an auction where appropriate.
    It is worth noting that the Panel states in Section E.3. of the 
report that ``These results may suggest that Treasury has not been 
successful in receiving fair market value for its warrants and in 
maximizing taxpayer returns. On the other hand, factors not included in 
the Panel's model, such as the illiquidity of the warrants especially 
for smaller institutions may explain the difference between the amount 
that Treasury has received for its sold warrants and the Panel's 
valuation of those warrants.''
    Since it appears that liquidity discounts and other adjustments may 
be applicable to some or all of the Redeeming Issuers, it is 
interesting that the Panel did not attempt to incorporate such 
discounts into their fair market estimates. It seems that any statement 
by the Panel regarding the price received by Treasury for the warrants 
of the Redeeming Issues should note such qualification.
    In the same section the Panel also states that the warrants 
redeemed by the Redeeming Issuers represent ``less that one quarter of 
one percent of the Panel's best estimate of the value of Treasury's 
warrant portfolio as of July 6, 2009'' and that ``Treasury's relative 
performance in selling them may not accurately predict its success in 
selling the balance of the warrants it holds.''
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    The report also suggests that Treasury may receive a 
greater return on its investment if it disposes of its warrants 
pursuant to an auction process rather than privately negotiated 
transactions with the TARP recipients.\187\ While I generally 
subscribe to the panel's reasoning it is important to note that 
such approach should not be applied on a de facto basis. For 
example, with respect to the disposition of the warrants issued 
by the Redeeming Issuers it is entirely possible that a viable 
auction market did not exist for the warrants of such 
institutions and may not exist for the warrants of any other 
TARP recipient the common stock of which is thinly traded. It 
is also possible that similar liquidity, marketability, 
minority interest and other appropriate discounts and 
adjustments were demanded by the Redeeming Issuers as well as 
the group of potential auction participants and that Treasury 
after analyzing these inputs simply elected to proceed with the 
least burdensome and costly approach.\188\
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    \187\ See Section F.2. of the report.
    \188\ In Section E.2. of the report the Panel states ``[i]f 
Treasury can hold the warrants to expiration, then the value of the 
warrants to Treasury does not include a liquidity discount because 
Treasury does not need to sell them.'' It does not follow that 
Treasury's ability (which it clearly has) to hold the warrants for 
their full ten-year term should dictate such a holding period. As 
noted, several compelling public policy issues favor an early 
disposition of the warrants.
---------------------------------------------------------------------------
    Treasury will not be served by any ``failed auctions'' and 
it should only go to market when its investment advisors are 
all but assured of a successful disposition at an appropriate 
price. Simply rolling out an auction with a Black-Scholes 
generated ``reserve price'' without conducting a thoughtful 
market-check is fraught with peril. I cannot help but wonder 
how the markets would have responded if Treasury had set a 
reserve price at or near the panel's ``Best Estimate'' price 
for the warrants of the Redeeming Issuers. It is not 
unreasonable to suspect that Treasury may have suffered one or 
more failed auctions. This is a serious concern because 
Treasury cannot afford to lose credibility with market 
participants or TARP recipients. It will be interesting to note 
how the fair market value determinations provided by the panel 
will appear in a year or so and how many market dispositions 
will occur at or near the panel's ``Best Estimate'' price.
    It is also not unreasonable to expect that a TARP recipient 
may be the highest bidder for its warrants. A repurchasing 
institution may possess material inside information regarding 
its business operations and prospects that permits it to pay a 
premium over a pure market price. In addition, a TARP recipient 
may pay a premium over market so as to cancel its warrants, 
increase its earning per share and, perhaps, its market 
capitalization.\189\ These complex matters must be considered 
on a case-by-case basis. It is certainly no secret that the 
public shares of many TARP recipients have traded at steep 
discounts over the past year or so and, as such, it is not 
unreasonable to think that the market will apply a similar 
discount to the warrants of such institutions. Treasury and its 
advisors should consider these factors in analyzing its exit 
strategy and should select the approach that best fits the 
particular facts and circumstances. I disagree with any 
inference in the report to the effect that an auction of the 
TARP warrants will necessarily yield a more favorable return to 
Treasury than a privately negotiated sale.
---------------------------------------------------------------------------
    \189\ Warrants sold in an auction remain outstanding while warrants 
repurchased by the issuer may be cancelled. Warrants sold in an 
auction, however, do not deplete the resources of the issuer since the 
acquisition price is funded by the third-party purchaser and not by the 
issuer. In addition, financial accounting, regulatory and tax 
considerations may favor one approach over the other.
---------------------------------------------------------------------------
    Although I am willing to grant Treasury and the TARP 
recipients reasonable latitude in discharging their duties and 
responsibilities under the SPAs, Treasury should promptly 
provide written reports to the American taxpayers analyzing in 
sufficient detail the fair market value determinations for any 
warrants either repurchased by a TARP recipient from Treasury 
or sold by Treasury through an auction. Since an auction may 
yield the most favorable result for Treasury in some instances 
and a privately negotiated sale in others, Treasury should 
disclose its rationale for pursuing one method instead of the 
other. Treasury should also undertake to negotiate the 
disposition of the warrants in a transparent and fully 
accountable manner with the stipulation that Treasury should 
not be required to place itself (and the American taxpayers) in 
an adverse negotiating position by disclosing proprietary 
information that TARP recipients could use to their advantage 
in subsequent negotiations. If Treasury finds it necessary to 
omit from disclosure certain information that could be harmful 
to negotiations were it made public, it must do so in only in 
the most thoughtful and judicious manner.

           2. TREASURY'S HOLDING PERIOD FOR THE TARP WARRANTS

    The report may be interpreted to reflect the theme that 
Treasury will somehow ``leave money on the table'' at the 
expense of the American taxpayers unless it holds the TARP 
warrants for the intermediate to long-term. Such impression is 
misguided since (among other reasons) it is exceedingly 
difficult to predict the value of financial securities and time 
the markets over the short term much less the ten-year term of 
the TARP warrants.\190\
---------------------------------------------------------------------------
    \190\ If we look back ten years to the summer of 1999 our economy 
was in the middle of the dot com expansion and many (if not most) 
investors viewed the financial markets as exceedingly robust. Just a 
few months later the economy commenced a significant contraction--the 
dot com collapse. September 11 followed with yet another material 
disruption in the markets. The economy recovered and the value of 
investment securities (such as the TARP warrants) steadily rose in 
value only to fall dramatically beginning around the summer of 2007. To 
say that the past ten years have yielded unpredictable results in the 
financial markets is an understatement.
    As such, any attempt by Treasury to time the disposition of its 
ten-year term warrants with any degree of meaningful precision may be 
met with disappointment. It is also possible that Treasury may sell the 
warrants in a few years at a greater price than is available in the 
near term but actually earn a lower return on a risk adjusted present 
value basis.
---------------------------------------------------------------------------
    I appreciate that modern corporate finance has developed 
many fascinating econometric models whereby certain securities 
may be valued with some degree of relative precision. The 
report does a fine job of describing many of these techniques, 
such as the binomial options pricing and Black-Scholes models. 
While these models are remarkably sophisticated, they suffer 
from the same problem endemic to all mathematical equations--
they are entirely dependent upon the input variables selected. 
A thoughtful (and, perhaps, lucky) selection of variables may 
yield meaningful results; otherwise the old adage of ``garbage 
in, garbage out'' will prevail.\191\ Predicting inputs, such as 
``volatility,'' and market adjustments, such as ``liquidity 
discounts,'' over the next ten years for incorporation into the 
TARP warrant valuation models is problematic at best.\192\ In 
addition, valuations have a short shelf life. What may appear 
reasonable today may look hopelessly out of date within a 
relatively short period of time.\193\ As such, any attempt to 
reflect or represent the panel's valuations as ``the'' fair 
market value of the warrants is misguided.\194\ Decision makers 
at Treasury should not subjugate their exercise of judgment 
regarding the disposition or retention of any of the TARP 
warrants solely to the results generated by financial models.
---------------------------------------------------------------------------
    \191\ Many trading strategies adopted by hedge funds and other 
alternative investment vehicles employ sophisticated econometric 
models. They often perform as advertised and yield superior risk 
adjusted returns, but occasionally they fail in a spectacular and 
public manner as occurred with Long Term Capital Management in 1998 and 
other investment funds over the past two years.
    \192\ See Annex A to the report which includes: ``It is important 
to note that the Black-Scholes model, as well as every other popular 
options model, was created to reflect the prices of options with short 
terms, ranging from days to months. As no options are traded on the 
CBOE with terms longer than three years, it is very difficult to come 
up with a ``fair market value'' of the TARP warrants which have terms 
of ten years. The lack of publicly traded comparable derivatives makes 
any valuation of ten year warrants difficult.
    ``More generally, there is the problem of lack of knowledge about 
most of the inputs to the model. For example, while ten year Treasury 
bills factor in what the market expects the interest rate risk for the 
next ten years to be, it is impossible to know the validity of the 
market's expectations. Thus, once again, it is important to note that 
the value that we are searching for here is not based on our 
expectations of the future, but rather our estimate of the market's 
expectations. The goal of the Panel's valuations is to estimate the 
value the financial markets would place on these warrants, and thus for 
the inputs to our model, we try to use the inputs most likely to be 
used by prospective buyers.
    ``The input that is the least defined in the Black-Scholes model 
and has the largest effect on the price of the warrant is the 
volatility of the underlying stock price. Volatility is defined as the 
standard deviation of the continuously compounding returns of a stock. 
It is clear from this definition that there are an almost infinite 
number of variations of the calculation of this number. The volatility 
is important in the Black-Scholes model because it features prominently 
in both of the probability calculations in the closed-form solution, 
meaning that differing values of volatility can create substantial 
differences in the final valuations of the warrants. The following 
example illustrates this point with respect to the Black-Scholes model. 
Assume that a warrant to buy one share of company XYZ at $150 expires 
in one year, that XYZ is currently trading at $100 and that the risk 
free rate is one percent. If XYZ's volatility is 30 percent, the 
warrant is worth $1.59, but if the volatility is 60 percent, the 
warrant is worth $10.91. In fact, if the volatility is below 15 
percent, the warrant is virtually worthless.''
    The preceding example emphasizes the sensitivity of financial 
models to changes in the various input variables. Since it is my 
understanding that financial models may be ``manipulated'' or ``gamed'' 
but still yield ``perfectly defensible results,'' Treasury should 
remain circumspect regarding fair market value determinations generated 
by financial models without a real world market-check.
    \193\ As an example, according to The New York Times, Citigroup 
closed at $52.52 on July 9, 2007 and at $2.62 on July 8, 2009. Who 
would have predicted such results?
    \194\ The report reflects this concept in Section H as follows: 
``The Panel's valuations offer reasonable estimates of the fair market 
value of the warrants. They may help Treasury as it balances the return 
to the taxpayer indicated by its own estimates of value and the host of 
other relevant market, regulatory and economic factors applicable to 
the disposition of sophisticated financial instruments.''
    Although quite helpful, I remain concerned that others may construe 
the Panel's estimates as somehow reflective of a single set of 
``correct'' values.
---------------------------------------------------------------------------
    The report also correctly notes that many recipients have 
been stigmatized by their association with TARP and wish to 
leave the program as soon as their regulators permit. Some of 
the adverse consequences that have arisen for TARP recipients 
include, without limitation, executive compensation 
restrictions, corporate governance and conflict of interest 
issues, employee retention difficulties and the distinct 
possibility that TARP recipients (including those who have 
repaid all CPP advances but have warrants outstanding to 
Treasury) may be subjected to future adverse rules and 
regulations.\195\
---------------------------------------------------------------------------
    \195\ See Sections G(1)(c) and G(3) of the report.
---------------------------------------------------------------------------
    For these and other reasons, I recommend that Treasury not 
operate under any inherent bias in favor of holding the TARP 
warrants for the intermediate to long-term as opposed to 
disposing of the warrants over the near term.\196\ Fortunately, 
Treasury concurs with this perspective.\197\ In electing to 
dispose of its warrants it appears that Treasury appreciates 
that the warrants represent high risk, difficult to value 
investment securities that are subject to the vagaries of the 
markets and may materially diminish in value. The panel should 
not discourage Treasury from promptly selling its warrants back 
to the TARP recipients or from offering the warrants for sale 
in the market pursuant to the SPAs. As noted, the exit strategy 
undertaken by Treasury with respect to the warrants of each 
TARP recipient must be carefully crafted to the facts and 
circumstances of that recipient as well as the prevailing 
market conditions in effect at the time of the proposed 
disposition.\198\
---------------------------------------------------------------------------
    \196\ As noted above, I believe that Treasury should promptly 
dispose of its warrants for the following reasons: (i) the profound 
difficulty in valuing the warrants and advantageously timing the 
market, (ii) the inherent risk associated with holding investments of 
this nature, (iii) the clear desire of the American taxpayers for the 
TARP recipients to repay all TARP related investments sooner rather 
than later, (iv) the troublesome corporate governance and regulatory 
conflict of interest issues raised by Treasury's continued ownership of 
the TARP warrants, and (v) the stigma associated with continued 
participation in the TARP program by the recipients.
    \197\ See footnote 184.
    \198\ I recently introduced legislation (H.R. 2745, supra note 29 
that would require Treasury to divest its warrants in each TARP 
recipient following the redemption of all outstanding TARP-related 
preferred shares issued by such recipient and the payment of all 
accrued dividends on such preferred shares.
---------------------------------------------------------------------------

                            3. OTHER ISSUES

    In Section G.1.c. of the report the Panel states:

          A benefit from repayment of TARP assistance is the 
        end of the government's conflicting roles as regulator 
        of the very institutions in which it owns shares and on 
        whose profitability repayment of public funds depends. 
        Specific regulatory policies, for example those 
        affecting capital levels, the application of accounting 
        conventions to financial reporting by BHCs or banks, 
        and conflicts among regulators of various parts of 
        BHCs, are complicated by the government's dual 
        interests.

    In Section G.3. of the report the Panel states:

          Despite the Administration's consistent statements 
        that its policy is not to be involved in bank 
        management and to cease to hold ownership positions in 
        banks as soon as practicable, Treasury retains 
        influence over the business decisions and internal 
        governance of institutions in which it holds 
        substantial preferred stock and warrant interests. 
        Although ownership of preferred shares or warrants 
        convertible into nonvoting common shares does not 
        provide the sort of leverage that common stock 
        ownership does, holding a substantial block of 
        preferred stock with the terms of the Treasury 
        preferred (discussed below) significantly constrains 
        aspects of the issuing institution. Such constraints, 
        for example, hinder the inability to pay dividends or 
        engage in certain capital transactions, in exchange for 
        bolstering the institution's capital). Replacing the 
        Treasury investment with independently raised equity 
        frees the institution from those constraints.

    The second motivation for prompt repayment of TARP 
investments has to do with the specific rules or conditions to 
which TARP recipients are subject. The prime examples involve 
executive compensation and corporate governance restrictions 
applicable to TARP recipients. While banks were aware that they 
were subject to restrictions upon entrance into the CPP, banks 
point to new provisions established in ARRA and by subsequent 
Treasury regulatory action that are retroactively applicable to 
past recipients of TARP financial assistance who have not yet 
repaid Treasury.''
    I concur with these remarks and recommend that Treasury 
promptly proceed to dispose of its TARP warrants.

                         4. TERMINATION OF TARP

    I reject any implication contained in the report to the 
effect that the TARP program should be extended, or that well 
capitalized TARP recipients should be prevented from redeeming 
their preferred stock and warrants issued to Treasury.

                    5. TARP AS A REVOLVING FACILITY

    From my review of the EESA statute I am not convinced that 
Treasury may re-advance funds that have been repaid by the TARP 
recipients. The panel should ask Treasury to provide a formal 
written legal opinion regarding the matter.

                        6. PRIVATE BANK WARRANTS

    The report briefly notes several of the unique issues that 
have arisen with respect to the repurchase of private bank 
warrants. I introduced legislation (H.R. 2745) to end the TARP 
program on December 31, 2009. In addition, the legislation (i) 
requires Treasury to accept TARP repayment requests from well 
capitalized banks, (ii) requires Treasury to divest its 
warrants in each TARP recipient following the redemption of all 
outstanding TARP-related preferred shares issued by such 
recipient and the payment of all accrued dividends on such 
preferred shares, (iii) provides incentives for private banks 
to repurchase their warrant preferred shares from Treasury, and 
(iv) reduces spending authority under the TARP program for each 
dollar repaid. The legislation enables private banks to 
repurchase the exercised warrant preferred shares on or before 
September 30, 2009 at their pre-exercise price. As such, 
private banks that typically issued warrant preferred shares to 
Treasury for $0.01 per share may repurchase the shares for 
$0.01 per share. This legislation provides that each bank must 
be current on all dividends to be eligible for repayment. The 
policy objective for economically encouraging private banks to 
repurchase their warrant preferred shares relates to the 
structural differences between private and public bank 
warrants. Pursuant to the SPAs, private banks are economically 
encouraged to delay the repurchase of their warrant preferred 
shares so as to decrease the overall cost to the private banks 
of their participation in the TARP program.

                             C. John Sununu

    This Report represents a good faith attempt to describe the 
factors that must be weighed by Treasury, Regulators, Congress, 
and Financial Institutions as the capital issued under the TARP 
is returned to the Treasury. By offering a detailed examination 
of these issues at the beginning of this process, the 
Congressional Oversight Panel will help ensure that Treasury 
and Congress place the maximum value on transparency and 
consistency in the management of the CPP. These two qualities 
are essential to sustaining public confidence in both 
government and the financial marketplace.
    In his Additional Views, Panel member Richard Neiman 
highlights several key questions for policy makers: considering 
the non-financial returns of the TARP, maintaining a clear 
policy for exiting Treasury's warrant holdings in a timely 
fashion, and exercising caution in drawing conclusions based 
upon repayments by just a few small banks. These are very 
important issues, and in each area I share the concerns he 
describes in detail. I also wish to add several points of 
emphasis and clarification:
     Treasury and Congress should be particularly 
mindful that retroactive changes in policy, process, or 
contracts undermine confidence in TARP programs and discourages 
participation. Both effects make any given program less likely 
to fulfill its objectives. As Treasury works to protect 
taxpayer interests during the CPP repayment process, it should 
work to increase transparency while operating within the spirit 
and letter of agreements that govern the CPP transactions.
     Both the current and previous administrations have 
made clear policy determinations to exit their warrant holdings 
as soon as is practicable as banks redeem preferred shares 
under the CPP. This policy is consistent with the original 
intent of the legislation, reduces downside risk to taxpayers, 
and conforms to the original share purchase agreements. Equally 
important, this policy sends an important signal to the public 
and to investors that the Federal Government does not wish to 
exert undue control or influence over firms that are on solid 
financial footing.
     In most cases, the value of warrants held by 
Treasury will prove difficult to calculate with precision due 
to the broad assumptions that must be made with regard to both 
the volatility and liquidity of the underlying securities. In 
such an event, Treasury has taken important steps in defining a 
clear process for repayments under CPP, utilizing independent 
firms for valuation, and establishing an approach for resolving 
differences in valuations that may arise.
     As a final point, it should be noted that the 
Executive Summary states that ``The Panel has not reached a 
consensus on whether it is wise policy to release banks from 
the TARP program at this time . . .'' This phrase suggests that 
the Treasury has (or should have) the power to force healthy 
banks that meet all regulatory requirements to hold CPP issued 
securities. I do not believe that such powers were ever 
contemplated by Congress in authorizing TARP. Nor do I believe 
that it is the responsibility of the Congressional Oversight 
Panel to determine which banks should be eligible (or required) 
to participate in TARP.
    As can be seen in the Panel Report, taxpayers will see a 
positive rate of return for all repayments that have been 
approved to date by Treasury under the CPP--even if the value 
of warrants were excluded. While it is important that taxpayers 
receive fair value for these securities, it is equally 
important that the principal objectives of TARP, namely a 
stable financial system, be realized and sustained. The best 
way to ensure balance between these goals is to allow the 
principles of transparency and consistency to guide the hand of 
policy makers in the months ahead.
           SECTION THREE: CORRESPONDENCE WITH TREASURY UPDATE

    On behalf of the Panel, Chair Elizabeth Warren sent a 
letter to Secretary Geithner on June 12, 2009, requesting 
information about Treasury's announcement on June 9, 2009, to 
allow ten of the largest U.S. financial institutions 
participating in the CPP to repay their TARP funds.\199\ The 
letter seeks answers to several key questions raised by the 
TARP repayments and additional information relating to 
Treasury's valuations of warrants outstanding, repurchased, and 
of those ten institutions with which it is in warrant 
repurchase negotiations. The letter specifically requests a 
meeting between Panel staff and Treasury staff about the TARP 
repayments and the treatment of warrants as part of those 
repayments. On July 1, 2009, Secretary Geithner responded by 
letter \200\ to this request. The letter, noting that Treasury 
staff has recently held two meetings with Panel members Richard 
H. Neiman and Damon Silvers and Panel staff concerning these 
issues, represented Treasury's response to the Panel's 
questions and information requests. Treasury provided copies of 
the recently issued warrants policy press release and FAQ and a 
written responses to each of the Panel's questions and 
information requests, which Panel staff is currently reviewing.
---------------------------------------------------------------------------
    \199\ See Appendix I of this report, infra. 
    \200\ See Appendix II of this report, infra. 
---------------------------------------------------------------------------
    Chair Elizabeth Warren and Panel member Richard H. Neiman 
sent a letter to Secretary Geithner on June 29, 2009, 
requesting assistance with the Panel's oversight of federal 
foreclosure mitigation efforts.\201\ In particular, the letter 
references how the lack of adequate mortgage data has hampered 
policymaking and notes Secretary Geithner's decision to include 
data collection requirements for mortgage loans participating 
in President Obama's Making Home Affordable (MHA) program, 
announced on February 18, 2009. In order to evaluate the 
effectiveness of foreclosure mitigation efforts, the letter 
requests copies of the data collected under the MHA program, as 
well as relevant reports, to be delivered on a monthly basis.
---------------------------------------------------------------------------
    \201\ See Appendix III of this report, infra. 
              SECTION FOUR: TARP UPDATES SINCE LAST REPORT


A. INTERIM FINAL RULE ON TARP STANDARDS FOR COMPENSATION AND CORPORATE 
                               GOVERNANCE

    On June 10, 2009, Treasury released interim regulations 
implementing the executive compensation and corporate 
governance provisions governing TARP recipients set forth in 
the American Recovery and Reinvestment Act of 2009 (ARRA), 
announced a set of principles for future executive compensation 
reform for all public corporations, and proposed two 
legislative initiatives designed to advance these principles. 
In announcing the interim rule, Secretary Geithner outlined 
five principles for reform of executive compensation: (1) 
compensation plans should properly measure and reward 
performance; (2) compensation should be structured to account 
for the time horizon of risks; (3) compensation practices 
should be aligned with sound risk management; (4) retirement 
packages should align with executive and shareholder interests; 
(5) and compensation process should be transparent and 
accountable. The Administration also indicated that it would 
propose new legislation to provide compensation committees with 
independence similar to the independence of audit committees 
under Sarbanes-Oxley, and to provide the SEC authority to 
require non-binding annual say-on-pay votes on compensation for 
the top five executives and golden parachutes for executives at 
all public companies.

                     B. REGULATION REFORM PROPOSAL

    On June 17, 2009, Treasury released the Administration's 
proposal entitled ``Financial Regulatory Reform: A New 
Foundation,'' detailing its agenda and recommendations for 
rebuilding financial supervision and regulation. The 
Administration's plan touches almost every corner of financial 
markets, from tougher consumer protection policies to stricter 
rules over exotic financial products, such as credit 
derivatives. The plan would bring many of the financial 
products and companies that previously operated outside of the 
banking system under federal scrutiny. In its proposal, 
Treasury announced five principles for financial regulatory 
reform: (1) promote robust supervision and regulation of 
financial firms; (2) establish comprehensive regulation of 
financial markets; (3) protect consumers and investors from 
financial abuse; (4) provide the government with the tools it 
needs to manage financial crises; and (5) raise international 
regulatory standards and improve international cooperation.
    On June 30, 2009, the Obama Administration sent a 150-page 
proposal to Congress for a new agency to oversee consumer 
lending and other financial activity, the Consumer Financial 
Protection Agency. The proposed agency would consolidate 
regulatory authority now spread over multiple agencies and 
would have the authority to monitor and introduce regulation 
aimed at ensuring transparency in consumer financial products.

C. CONFIRMATION OF HERBERT ALLISON AS ASSISTANT SECRETARY FOR FINANCIAL 
                               STABILITY

    On June 19, 2009, the Senate confirmed Herbert Allison as 
Assistant Secretary for Financial Stability. In this role, Mr. 
Allison will develop and coordinate Treasury programs related 
to financial stability, including the TARP. Mr. Allison's prior 
positions include President and Chief Executive Officer of 
Fannie Mae, Chairman, President, and Chief Executive Officer of 
TIAA-CREF, and President and Chief Operating Officer of Merrill 
Lynch.

           D. TREASURY ANNOUNCES PROCESS FOR REPAYMENT OF CPP

    On June 9, 2009, Treasury announced that ten of the largest 
Capital Purchase Program (CPP) participants had been approved 
to repay the TARP funds they had received. The repayment is 
expected to be approximately $68 billion.
    On June 26, 2009, Treasury announced the process by which 
TARP recipients would be able to repurchase the warrants issued 
as part of the Capital Purchase Program in 2008. Under these 
terms, once a bank has repaid the TARP money, it has 15 days to 
submit a determination of fair market value to Treasury. 
Treasury, within 10 days, may either accept the determination 
or, if it is unable to reach agreement on the value with the 
bank, may use the appraisal process outlined in the relevant 
transaction documents. According to the appraisal process, 
Treasury and the bank each select an independent appraiser. 
Once the appraisers have conducted their own valuations, they 
will attempt to agree on a fair market price. If they fail to 
agree, a third appraiser is hired and a composite value from 
the three appraisers is used as the fair market price.

          E. TERM ASSET-BACKED SECURITIES LOAN FACILITY (TALF)

    The Federal Reserve Bank of New York held a special 
subscription on June 16, 2009, for TALF loans secured by new 
commercial mortgage-backed securities (CMBS). There were no 
requests made for loans on that date. The Bank intends to hold 
a special subscription for legacy CMBS (those issued before 
January 1, 2009) in late July.
    During the regular TALF subscription on July 7, 2009, $5.4 
billion in loans was requested. As a point of comparison, there 
were $11.5 billion in loans requested at the June facility, 
$10.6 billion requested at the May facility, $1.7 billion at 
the April facility, and $4.7 billion at the March facility. The 
July 7 subscription included requests for loans secured by 
asset-backed securities in the auto, credit card, servicing 
advances, small business, and student loan sectors. There were 
no requests for loans in the equipment, floor plan, or premium 
finance sectors. The July 7 subscription was not available for 
loans secured by CMBS; a special CMBS subscription is planned 
for later this month.

               F. GENERAL MOTORS BANKRUPTCY PLAN APPROVED

    On July 5, 2009, Judge Robert Gerber of the Bankruptcy 
Court for the Southern District of New York approved a 
bankruptcy plan for General Motors that would permit the auto 
maker to emerge from bankruptcy as soon as mid-July. Under the 
plan, NGMCO, Inc., an entity funded by the U.S. Treasury, would 
purchase substantially all of GM's assets. NGMCO would then 
change its name to General Motors Company and continue most of 
former GM's business with a more streamlined product portfolio. 
The new GM will remain headquartered in Detroit, Michigan, and 
will be led by Fritz Henderson as president and CEO, and Edward 
Whitacre as chairman of the board of directors. Of the common 
stock for the new GM, 60.8 percent will be owned by the US 
Treasury, 17.5 percent by the UAW Retiree Medical Benefits 
Trust; 11.7 percent by the governments of Canada and Ontario, 
and ten percent by old GM.

                     G. CPP MONTHLY LENDING REPORT

    Treasury releases a monthly lending report showing loans 
outstanding for CPP recipients. The most recent report includes 
data up through the end of April 2009 and shows that CPP 
recipients had $5.15 billion in loans outstanding as of April 
30, 2009. This represents a 0.67 percent decline in loans 
between the end of March and the end of April.

       H. FUND MANAGERS FOR PPIP LEGACY SECURITIES FUNDS SELECTED

    On July 8, 2009, Treasury, the Federal Reserve, and the 
FDIC issued a joint release announcing the selection of nine 
applicants for pre-qualification as PPIP fund managers. Ten 
small, veteran-, minority-, and/or women-owned firms were also 
selected to partner with the fund managers to provide asset 
management, capital raising, broker-dealer, research, advisory, 
investment sourcing, and fund administration services. The pre-
qualified firms will have twelve weeks to raise $500 million in 
equity, $20 million of which must be provided by the firms 
themselves. Once this money has been raised, the PPIP funds 
will receive matching $500 million in Treasury equity, and will 
be eligible for additional government-sponsored financing.

                               I. METRICS

    In recent months, the Panel's oversight reports have 
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. This section discusses 
changes that have occurred in several indicators since the 
release of the Panel's June report.
     Interest Rate Spreads. Key interest rate spreads 
have leveled off to some extent following precipitous drops 
between the Panel's May and June oversight reports. While there 
was no general pattern in interest rate spread movement in 
recent weeks (some decreased modestly while others increased 
modestly), spreads remain well below the crisis levels seen 
late last year, and Treasury and Federal Reserve officials 
continue to cite the moderation of these spreads as a key 
indicator of a stabilizing economy.\202\
---------------------------------------------------------------------------
    \202\ See Congressional Oversight Panel, Testimony of Assistant 
Treasury Secretary for Financial Security Herbert Allison, Jr., Hearing 
with Assistant Treasury Secretary Herbert Allison (June 24, 
2009)(online at cop.senate.gov/hearings/library-062409-
allison.cfm)(``There are tentative signs that the financial system is 
beginning to stabilize and that our efforts have made an important 
contribution. Key indicators of credit market risk, while still 
elevated, have dropped substantially.'')

                     FIGURE 6: INTEREST RATE SPREADS
------------------------------------------------------------------------
                                                         Percent Change
             Indicator                Current Spread   Since Last Report
                                      (as of 7/9/09)        (6/8/09)
------------------------------------------------------------------------
3 Month LIBOR-OIS Spread \203\....               0.31             -24.39
1 Month LIBOR-OIS Spread \204\....               0.11              10.00
TED Spread \205\ (in basis points)              32.94             -31.03
Conventional Mortgage Rate Spread                1.79              14.01
 \206\............................
Corporate AAA Bond Spread \207\...               1.87              -6.50
Corporate BAA Bond Spread \208\...               3.65              -9.88
Overnight AA Asset-backed                        0.18               0.00
 Commercial Paper Interest Rate
 Spread \209\.....................
Overnight A2/P2 Nonfinancial                     0.27            -15.63
 Commercial Paper Interest Rate
 Spread \210\.....................
------------------------------------------------------------------------
\203\ 3 Mo LIBOR-OIS Spread, Bloomberg (online at www.bloomberg.com/apps/
  quote?ticker=.LOIS3:IND1) (accessed July 9, 2009).
\204\ 1 Mo LIBOR-OIS Spread, Bloomberg (online at www.bloomberg.com/
  apps;/quote?ticker=.LOIS1:IND1) (accessed July 9, 2009).
\205\ TED Spread, Bloomberg (online at www.bloomberg.com/apps/
  quote?ticker=.TEDSP:IND) (accessed July 9, 2009).
\206\ 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 July 9, 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 July 9, 2009)
  (hereinafter ``Fed H.15 10-Year Treasuries'').
\207\ 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 July 9, 2009); Fed H.15 10-Year Treasuries,
  supra note 206.
\208\ 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 July 9, 2009); Fed H.15 10-Year Treasuries,
  supra note 206.
\209\ 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 July 9, 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
  July 9, 2009) (hereinafter ``Fed CP AA Nonfinancial Rate'').
\210\ 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 July 9, 2009).

     Commercial Paper Outstanding. Commercial paper 
outstanding, a rough measure of short-term business debt, is an 
indicator of the availability of credit for enterprises. While 
financial commercial paper outstanding saw an increase last 
month, asset-backed and nonfinancial commercial paper levels 
have continued to drop, with both falling by nearly 20 percent 
since early June.

                 FIGURE 7: COMMERCIAL PAPER OUTSTANDING
------------------------------------------------------------------------
                                    Current Level (as
                                        of 7/9/09)       Percent Change
             Indicator                   (dollars      Since Last Report
                                        billions)           (6/8/09)
------------------------------------------------------------------------
Asset-Backed Commercial Paper                 $456.75             -18.06
 Outstanding (seasonally adjusted)
 \211\............................
Financial Commercial Paper                     554.15               4.46
 Outstanding (seasonally adjusted)
 \212\............................
Nonfinancial Commercial Paper                  125.49            -19.89
 Outstanding (seasonally adjusted)
 \213\............................
------------------------------------------------------------------------
\211\ 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 July 9, 2009).
\212\ 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 July 9, 2009).
\213\ 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 July 9, 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 decreased across nearly all 
categories of bank lending in April when compared to 
March.\214\ Lenders surveyed by Treasury attribute this decline 
in originations to seasonality and a decrease in demand.\215\ 
The dramatic drop in commercial and industrial and commercial 
real estate originations is particularly noteworthy, with 
originations in both categories decreasing by over 30 percent. 
Banks reported that demand for these commercial loans was well 
below normal levels; further, banks predicted that this lower 
demand would continue through the remainder of the second 
quarter of 2009.\216\ Average loan balances fell across all 
categories from March to April, with banks reporting that 
borrowers are paying down existing debt.\217\ 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.
---------------------------------------------------------------------------
    \214\ U.S. Department of the Treasury, Treasury Department Monthly 
Lending and Intermediation Snapshot Data for October 2008-April 2009 
(June 15, 2009) (online at www.financialstability.gov/docs/surveys/
Snapshot_Data_April%202009.xls)(hereinafter ``Treasury Snapshot April 
Summary Data'').
    \215\ U.S. Department of the Treasury, Treasury Department Monthly 
Lending and Intermediation Snapshot: Summary Analysis for April 2009 
(June 15, 2009) (online at www.financialstability.gov/docs/surveys/
SnapshotAnalysisApril2009.pdf)(hereinafter ``Treasury April Lending 
Snapshot'').
    \216\ Id.
    \217\ Id.

          FIGURE 8: LENDING BY THE LARGEST TARP-RECIPIENT BANKS
------------------------------------------------------------------------
                                   Most recent
                                       data       Percent      Percent
                                      (April       change       change
            Indicator                 2009)     since March     since
                                   (dollars in      2009       October
                                    millions)                    2008
------------------------------------------------------------------------
Total Loan Originations..........     $199,284        -9.48        -8.66
C&I New Commitments..............       32,488       -37.15       -44.89
CRE New Commitments..............        3,470       -30.78       -67.03
Mortgage Refinancing.............       49,009        -7.74       161.13
                                  ---------------------------
------------------------------------------------------------------------

     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 both fell last month.\218\ However, total loans 
and leases outstanding at small domestic banks remain slightly 
above last October's level, while total loans and leases 
outstanding at large banks have dropped by over 4.4 percent 
since that time.\219\
---------------------------------------------------------------------------
    \218\ 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 July 9, 2009).
    \219\ 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 July 9, 2009).

                 FIGURE 9: LOANS AND LEASES OUTSTANDING
------------------------------------------------------------------------
                                                               Percent
                                     Current      Percent       change
                                    level  (as     change     since ESSA
            Indicator               of 7/9/09)   since last     signed
                                   (dollars in  report (6/8/   into law
                                    billions)       09)       (10/3/08)
------------------------------------------------------------------------
Large Domestic Banks--Total Loans      3,939.9        -1.13        -4.41
 and Leases......................
Small Domestic Banks--Total Loans      2,449.0        -1.26         0.09
 and Leases......................
------------------------------------------------------------------------

     Housing Indicators. Foreclosure filings fell by 
roughly six percent from April to May, while remaining nearly 
15 percent above the level of last October. Housing prices, as 
illustrated by the S&P/Case-Shiller Composite 20 Index, 
continued to dip in April. The index remains down over ten 
percent since October 2008.

                      FIGURE 10: HOUSING INDICATORS
------------------------------------------------------------------------
                                                  Percent
                                                change from    Percent
                                   Most recent      data        change
            Indicator                monthly     available      since
                                       data      at time of    October
                                                last report      2008
                                                  (6/8/09)
------------------------------------------------------------------------
Monthly Foreclosure Filings \220\      321,480        -6.01        14.99
Housing Prices-S&P/Case-Shiller          140.1        -0.88       -10.82
 Composite 20 Index \221\........
------------------------------------------------------------------------
\220\ RealtyTrac, Foreclosure Activity Press Releases (online at
  www.realtytrac.com//ContentManagement/PressRelease.aspx) (accessed
  July 9, 2009).
\221\ 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_063055.xls (accessed July 9, 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 July 2, 
2009, and (2) an update of the full federal resource commitment 
as of July 2, 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 
loans for facilities designed to restart secondary 
securitization markets, Treasury has committed to spend $645.5 
billion, leaving $60.8 billion available for new programs or 
other needs.\222\ Of the $645.5 billion that Treasury has 
committed to spend, $441 billion has already been allocated and 
counted against the statutory $698.7 billion limit.\223\ This 
includes purchases of preferred shares, warrants and/or debt 
obligations under the CPP, TIP, SSFI Program, and AIFP, a $20 
billion loan to TALF LLC, the special purpose vehicle used to 
guarantee Federal Reserve TALF loans, and the $5 billion 
Citigroup asset guarantee already exchanged for a guarantee fee 
composed of additional preferred shares and warrants.\224\ 
Additionally, Treasury has allocated $18 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 the TARP reach $450 billion.
---------------------------------------------------------------------------
    \222\ 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 13, 
Sec. 115(a)-(b) (codified at 12 U.S.C. 5225(a)-(b)); Helping Families 
Save Their Homes Act of 2009, Pub. L. No. 111-22, sec. 402(f) (online 
at frwebgate.access.gpo.gov/cgi-bin/
getdoc.cgi?dbname=111_cong_bills&docid=f:s896enr.txt.pdf) (reducing by 
$1.26 billion the authority for the TARP originally set under EESA at 
$700 billion).
    \223\ This figure does not include the repurchases of CPP preferred 
shares.
    \224\ U.S. Department of the Treasury, Troubled Asset Relief 
Program: Transactions Report For Period Ending June 30, 2009. (July 2, 
2009) (online at www.financialstability.gov/docs/transaction-reports/
transactions-report_070209.pdf) (hereinafter ``July 2 TARP Transaction 
Report'').
---------------------------------------------------------------------------

b. Income: Dividends and Repayments

    Following the repayments of CPP infusions by nine of the 
stress-tested BHCs, the total amount of TARP repayments surged 
from just under $2 billion to over $70 billion.\225\ In 
addition, Treasury's investment in preferred shares 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.\226\ Treasury has not yet 
begun to officially report dividend payments on its transaction 
reports.
---------------------------------------------------------------------------
    \225\ Id. See also Section One, Part F of this report (providing a 
table with detailed information on repurchases to date).
    \226\ See, e.g., Securities Purchase Agreement, supra note 15.
---------------------------------------------------------------------------

c. TARP Accounting as of July 2, 2009

                                 FIGURE 11: TARP ACCOUNTING (AS OF July 2, 2009)
                                              [Dollars in billions]
----------------------------------------------------------------------------------------------------------------
                                                     Announced      Purchase
                  TARP Initiative                     Funding        Price         Repayments    Dividend Income
----------------------------------------------------------------------------------------------------------------
Total.............................................          638    \227\ 441       \228\ 70.124      \229\ 6.651
    CPP...........................................          218          203.2           70.124            5.255
    TIP...........................................           40           40              0                1.128
    SSFI Program..................................           70           69.8            0                0
    AIFP..........................................           80           80              0                0.160
    AGP...........................................            5            5              0                0.108
    CAP...........................................          TBD            0              0                0
    TALF..........................................           80           20              0                0
    PPIP..........................................           75            0              0                0
    Supplier Support Program......................            5            5              0                0
    Unlocking SBA Lending.........................           15            0              0                0
    HAMP..........................................           50     \230\ 18.0            0               0
----------------------------------------------------------------------------------------------------------------
\227\ See July 2 TARP Transaction Report, supra note 224.
\228\ See July 2 TARP Transaction Report, supra note 224.
\229\ As of June 30, 2009. This information was provided to the Panel by Treasury staff.
\230\ Reflects the cap set on payments to each mortgage servicer. See July 2 TARP Transactions Report, supra
  note 224.

                  2. OTHER FINANCIAL STABILITY EFFORTS

Federal Reserve, FDIC, and Other Programs

    In addition to the more direct expenditures Treasury has 
undertaken through the 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 PPIP Legacy Loans or asset guarantees for Citigroup, or 
operate in tandem with Treasury programs, such as the 
interaction between PPIP and TALF. Other programs, like the 
Federal Reserve'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 the TARP and 
seek to accomplish different goals.

       3. TOTAL FINANCIAL STABILITY RESOURCES AS OF JULY 2, 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 12: FEDERAL GOVERNMENT FINANCIAL STABILITY EFFORT (AS OF JULY 2, 2009)
                                              [Dollars in billions]
----------------------------------------------------------------------------------------------------------------
                                                         Treasury       Federal
                       Program                            (TARP)        Reserve          FDIC          Total
----------------------------------------------------------------------------------------------------------------
Total...............................................          698.7        2,197.2        1,372.7  \233\ 4,268.6
    Outlays \231\...................................          516.6            0             37.7          554.3
    Loans...........................................           36.3         1967.4            0          2,003.7
    Guarantees \232\................................           85            230          1,335          1,649.8
    Uncommitted TARP Funds..........................           60.8            0              0             60.8
AIG.................................................           70            100              0            170
    Outlays.........................................     \234\ 70              0              0             70
    Loans...........................................            0      \235\ 100              0            100
    Guarantees......................................            0              0              0              0
Bank of America.....................................           45              0              0             45
    Outlays.........................................     \237\ 45              0              0              0
    Loans...........................................            0              0              0              0
    Guarantees \236\................................            0              0              0              0
Citigroup...........................................           50            229.8           10            289.8
    Outlays.........................................     \238\ 45              0              0             45
    Loans...........................................            0              0              0              0
    Guarantees......................................      \239\ 5      \240\ 229.8     \241\ 10            244.8
Capital Purchase Program (Other)....................          168              0              0            168
    Outlays.........................................    \242\ 168              0              0            168
    Loans...........................................            0              0              0              0
    Guarantees......................................            0              0              0              0
Capital Assistance Program..........................          TBD            TBD            TBD      \243\ TBD
TALF................................................           80            720              0            800
    Outlays.........................................            0              0              0              0
    Loans...........................................            0      \245\ 720              0            720
    Guarantees......................................     \244\ 80              0              0              0
PPIF (Loans) \246\..................................           45              0            540            585
    Outlays.........................................           45              0              0             45
    Loans...........................................            0              0              0              0
    Guarantees......................................            0              0      \247\ 540            540
PPIF (Securities)...................................           30              0              0             30
    Outlays.........................................     \248\ 12.5            0              0             12.5
    Loans...........................................           17.5            0              0             17.5
    Guarantees......................................            0              0              0              0
Home Affordable Modification Program................           50              0              0       \250\ 50
    Outlays.........................................     \249\ 50              0              0             50
    Loans...........................................            0              0              0              0
    Guarantees......................................            0              0              0              0
Automotive Industry Financing Program...............     \251\ 80              0              0             80
    Outlays.........................................     \252\ 66.1            0              0             66.1
    Loans...........................................           13.8            0              0             13.8
    Guarantees......................................            0              0              0              0
Auto Supplier Support Program.......................            5              0              0              5
    Outlays.........................................            0              0              0              0
    Loans...........................................      \253\ 5              0              0              5
    Guarantees......................................            0              0              0              0
Unlocking SBA Lending...............................           15              0              0             15
    Outlays.........................................      \254\15              0              0             15
    Loans...........................................            0              0              0              0
    Guarantees......................................            0              0              0              0
Temporary Liquidity Guarantee Program...............            0              0            785            785
    Outlays.........................................            0              0              0              0
    Loans...........................................            0              0              0              0
    Guarantees......................................            0              0      \255\ 785            785
Deposit Insurance Fund..............................            0              0             37.7           37.7
    Outlays.........................................            0              0       \256\ 37.7          037.7
    Loans...........................................            0              0              0              0
    Guarantees......................................            0              0              0              0
Other Federal Reserve Credit Expansion..............            0          1,147.4            0          1,147.4
    Outlays.........................................            0              0              0              0
    Loans...........................................            0    \257\ 1,147.4            0          1,147.4
    Guarantees......................................            0              0              0              0
Uncommitted TARP Funds..............................     \258\ 60.8            0              0             60.8 
----------------------------------------------------------------------------------------------------------------
\231\ 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 Sec.  123 of
  EESA are recorded on a ``credit reform'' basis.
\232\ 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.
\233\ 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). 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 credit extensions outside of the TALF or FDIC
  guarantees under the Temporary Liquidity Guarantee Program and sets the maximum Federal Reserve guarantees
  under the TALF at $1 trillion.
\234\ This number includes investments under the SSFI program: a $40 billion investment made on November 25,
  2008, and a $30 billion investment committed on April 17, 2009 (less a reduction of $165 million representing
  bonuses paid to AIG Financial Products employees). July 2 TARP Transaction Report, supra note 224.
\235\ This number represents the full $60 billion that is available to AIG through its revolving credit facility
  with the Federal Reserve ($43.5 billion had been drawn down as of July 1) and the outstanding principle of the
  loans extended to the Maiden Lane II and III special purpose vehicles (AIG SPVs) to buy AIG assets (as of July
  1, $17.5 billion and $22.4 billion respectively). See Fed Balance Sheet July 2, supra note 69. The Panel
  continues to calculate the exposure attributable to the revolving credit facility at $60 billion. However,
  whereas previously the Panel had calculated the exposure attributable to the AIG SPVs at the initially
  announced amount of Federal Reserve loans to the SPVs, we have changed our methodology. Based on its review of
  new Federal Reserve documents, the Panel now believes that its previous methodology overstated the Federal
  Reserve's exposure to AIG. The initially announced amount of loans was based on the Federal Reserve's
  estimated cost to purchase a particular pool of AIG assets. However, the value of these assets declined by the
  time the AIG SPVs purchased them, necessitating a smaller loan than was initially announced. Furthermore,
  income from the purchased assets is used to pay down the loan, reducing the taxpayers' exposure to losses over
  time. See Board of Governors of the Federal Reserve System, Federal Reserve System Monthly Report on Credit
  and Liquidity Programs and the Balance Sheet, at 14-16 (June 2009) (online at www.federalreserve.gov/
  newsevents/monthlyclbsreport200906.pdf ); Letter from Federal Reserve Chairman Benjamin Bernanke to
  Congressional Oversight Panel Chair Elizabeth Warren (June 26, 2009).
\236\ Based on its review of newly available information from the Federal Reserve, the Panel has revised its
  calculation of support provided to Bank of America by excluding from the total the $118 billion asset
  guarantee agreement between Bank of America, the Federal Reserve, Treasury, and the FDIC. 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). The reason for the change is that it is now clear that, despite
  preliminary agreement, the asset guarantee was never signed; it is not currently in effect, and will likely
  not be consummated. House Committee on Oversight and Government Reform, Testimony of Federal Reserve Chairman
  Ben Bernanke, Bank of America and Merrill Lynch: How Did a Private Deal Turn Into a Federal Bailout? Part II,
  111th Cong. (June 25, 2009).
\237\ July 2 TARP Transaction Report, supra note 224. 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.
\238\ July 2 TARP Transaction Report, supra note 224. 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.
\239\ 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). 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) (reducing the size of the asset pool from $306 billion to $301
  billion).
\240\ Id.
\241\ Id.
\242\ This figure represents the $218 billion Treasury has anticipated spending under the CPP, minus the $50
  billion investment 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.
\243\ Funding levels for the CAP have not yet been announced but will likely constitute a significant portion of
  the remaining $60.8 billion of TARP funds.
\244\ Senate Committee on Banking, Housing, and Urban Affairs, Testimony of Secretary Geithner, Oversight of the
  Troubled Asset Relief Program, 111th Cong., at 1 (May 20, 2009) (online at banking.senate.gov/public/
  index.cfm?FuseAction=Files.View&FileStore_id=b64da0f5-9f9b-448a-a352-ad0590543ef9) (hereinafter ``May 20
  Geithner Testimony''); July 2 TARP Transactions Report, supra note 224. 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.
\245\ This number derives from the unofficial 1:10 ratio of the value of Treasury loan guarantees to the value
  of Federal Reserve loans under the TALF. See U.S. Department of the Treasury, Fact Sheet: Financial Stability
  Plan (Feb. 10, 2009) (online at www.financialstability.gov/docs/fact-sheet.pdf) (describing the initial $20
  billion Treasury contribution tied to $200 billion in Federal Reserve loans and announcing potential expansion
  to a $100 billion Treasury contribution tied to $1 trillion in Federal Reserve 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.
\246\ 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. Treasury has indicated that, of
  the $100 billion maximum allocation to the PPIP, it plans to disburse $25 billion to the TALF for the
  financing of the PPIP Legacy Securities program, and $30 billion to the Legacy Securities Program as initial
  equity and debt funding (leaving at most $45 billion to be allocated to the Legacy Loans Program). 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, And Chairman Of The Federal Deposit
  Insurance Corporation Sheila Bair: Legacy Asset Program (July 8, 2009) (online at www.financialstability.gov/
  latest/tg_07082009.html). However, the FDIC has postponed the implementation of the Legacy Loans program, see
  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). It is not yet clear how this postponement will
  affect the allocation of TARP funds for the PPIP.
\247\ Id at 2-3 (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 $45 billion), the amount of FDIC loan
  guarantees will be reduced proportionally.
\248\ Id 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.
\249\ Government Accountability Office, Troubled Asset Relief Program: June 2009 Status of Efforts to Address
  Transparency and Accountability Issues, at 2 (June 17, 2009) (GAO09/658) (online at www.gao.gov/new.items/
  d09658.pdf). Of the $50 billion in announced TARP funding for this program, only $18.0 billion has been
  allocated as of June 30, and no funds have yet been disbursed. See July 2 TARP Transactions Report, supra note
  224.
\250\ Fannie Mae and Freddie Mac, government-sponsored entities (GSEs) that were placed in conservatorship of
  the Federal Housing Finance Housing 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).
\251\ Figures do not total due to rounding.
\252\ July 2 TARP Transactions Report, supra note 224. A substantial portion of the total $80.0 billion in loans
  extended under the AIFP has since been converted to common equity and preferred shares in restructured
  companies. Only $13.8 billion has been retained as first lien debt (with $6.7 billion committed to GM and $7.1
  billion to Chrysler), which is classified below as loans.
\253\ July 2 TARP Transactions Report, supra note 224.
\254\ May 20 Geithner Testimony, supra note 244, at 15.
\255\ 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.
  $345.8 billion of debt subject to the guarantee has been issued to date, which represents about 44 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 31, 2009) (online at www.fdic.gov/
  regulations/resources/TLGP/total_issuance5-09.html) (updated June 17, 2009).
\256\ 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 and the first quarter of 2009. 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); Federal Deposit Insurance
  Corporation, Chief Financial Officer's (CFO) Report to the Board: DIF Income Statement (First Quarter 2009)
  (online at www.fdic.gov/about/strategic/corporate/cfo_report_1stqtr_09/income.html).
\257\ 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), 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 July 2, supra note 69. The level of Federal
  Reserve lending under these facilities will fluctuate in response to market conditions and independent of any
  federal policy decisions.
\258\ One potential use of uncommitted funds is Treasury's obligation to reimburse the Exchange Stabilization
  Fund (ESF), currently valued at $52.1 billion. See U.S. Department of Treasury, Exchange Stabilization Fund,
  Statement of Financial Position, as of May 31, 2009 (online at www.ustreas.gov/offices/international-affairs/
  esf/esf-monthly-statement.pdf) (accessed July 2, 2009). Treasury must reimburse any use of the fund to
  guarantee money market mutual funds from TARP money. See EESA, supra note 13, 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. Sec.  131 of EESA 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 seven 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 June oversight report, 
the following developments pertaining to the Panel's oversight 
of the TARP took place:
     Chair Elizabeth Warren, on behalf of the Panel, 
and Special Inspector General for the Troubled Asset Relief 
Program Neil M. Barofsky sent a joint letter on June 10, 2009 
to Chairman Christopher J. Dodd and Ranking Member Richard C. 
Shelby of the Senate Committee on Banking, Housing, and Urban 
Affairs, and Chairman Barney Frank and Ranking Member Spencer 
Bachus of the House Financial Services Committee, to notify 
them of a special coordinated effort between SIGTARP and the 
Panel to examine the pricing of warrants in the context of the 
repayment of TARP funds by TARP-recipient institutions.\259\ 
The letter discusses the Panel's plans to release its valuation 
estimates and analysis relating to the pricing of warrants 
which Treasury holds in relation to its Capital Purchase 
Program (``CPP'') investments with its July monthly report, and 
SIGTARP's plans to conduct an audit of Treasury's warrant 
repurchase/sale process.
---------------------------------------------------------------------------
    \259\ See Appendix IV of this report, infra.
---------------------------------------------------------------------------
     The Panel held a hearing on June 24, 2009 with 
newly confirmed Assistant Secretary of the Treasury for 
Financial Stability Herbert Allison regarding the Troubled 
Asset Relief Program. Written testimony and video from the 
hearing can be found on the Panel's website at http://
cop.senate.gov/hearings/library/hearing-062409-allison.cfm.
     The Helping Families Save Their Homes Act of 2009 
(P.L. 111-22), signed into law on May 20, 2009, requires the 
Congressional Oversight Panel to issue a special report on farm 
loan restructuring. To assist in this mandate, the Panel held a 
hearing on July 7, 2009 in Greeley, Colorado, on the subject of 
commercial farm credit markets and the use of farm loan 
restructuring as an alternative to foreclosure. It heard 
testimony from representatives of the USDA, farm credit 
lenders, and farmers themselves. It also had the opportunity to 
hear from the Greeley community on issues related to farm 
credit. Written testimony and audio from the hearing can be 
found on the Panel's website at http://cop.senate.gov/hearings/
library/hearing-070709-farmcredit.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 banks' repayment of preferred shares and warrants, 
TALF and PPIP, the stress tests, and Treasury's plan to 
purchase directly securities backed by Small Business 
Administration (SBA) 7(a) loans.
     Panel staff has reviewed documents pertaining to 
the stress tests, provided by both Treasury and the Federal 
Reserve Board of Governors. Several other document requests 
sent to Treasury are still pending.
     The Panel has sent letters to the largest mortgage 
servicing companies that have not yet signed a contract to 
formally participate in the Making Home Affordable foreclosure 
mitigation program. This letter inquires, among other things, 
if the servicer intends to participate, how it is handling loan 
modifications, and what barriers and obstacles might limit 
participation in the program. This is part of the Panel's 
continuing oversight of foreclosure mitigation efforts.

                     Upcoming Reports and Hearings

     The Panel will release its next oversight report 
in August. 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 issue of 
troubled assets, their role in the economic crisis, and how the 
TARP addresses them.
     On July 21, 2009, the Panel will release a report 
in which it 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. This report is 
pursuant to section 501 of the Helping Families Save Their 
Homes Act of 2009 (P.L. 111-22).
     The Panel is planning a field hearing in Detroit 
on July 27, 2009 to hear testimony on Treasury's administration 
of the Automotive Industry Financing Program.
          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 SECRETARY TIMOTHY 
 GEITHNER REQUESTING INFORMATION ON THE REPAYMENT OF TARP ASSISTANCE, 
                          DATED JUNE 12, 2009


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  APPENDIX II: LETTER FROM SECRETARY TIMOTHY GEITHNER IN RESPONSE TO 
 CHAIR WARREN'S LETTER REQUESTING INFORMATION ON THE REPAYMENT OF TARP 
                     ASSISTANCE, DATED JULY 1, 2009


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   APPENDIX III: LETTER FROM CHAIR ELIZABETH WARREN AND PANEL MEMBER 
RICHARD NEIMAN TO SECRETARY TIMOTHY GEITHNER REQUESTING ASSISTANCE WITH 
THE PANEL'S OVERSIGHT OF FEDERAL FORECLOSURE MITIGATION EFFORTS, DATED 
                             JUNE 29, 2009


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