[JPRT, 111th Congress]
[From the U.S. Government Publishing Office]
CONGRESSIONAL OVERSIGHT PANEL
AUGUST OVERSIGHT REPORT *
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THE CONTINUED RISK OF TROUBLED ASSETS
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
August 11, 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
AUGUST OVERSIGHT REPORT *
__________
THE CONTINUED RISK OF TROUBLED ASSETS
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
August 11, 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
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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: The Continued Risk of Troubled Assets............... 5
A. Background................................................ 5
B. What is a Troubled Asset?................................. 8
C. Estimating the Amount of Troubled Assets.................. 21
D. Current Strategies for Dealing with Troubled Assets....... 29
E. Commercial Real Estate.................................... 43
F. The Future................................................ 46
G. Conclusion................................................ 49
Annex to Section One: Estimating the Amount of Troubled Assets--
Additional Information and Methodology......................... 51
Section Two: Additional Views.................................... 62
A. Senator John E. Sununu.................................... 62
B. Congressman Jeb Hensarling................................ 63
Section Three: Correspondence with Treasury Update............... 73
Section Four: TARP Updates Since Last Report..................... 75
Section Five: Oversight Activities............................... 86
Section Six: About the Congressional Oversight Panel............. 87
Appendices:
APPENDIX I: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY
TIMOTHY GEITHNER AND CHAIRMAN BEN BERNANKE, RE:
CONFIDENTIAL MEMORANDA, DATED JULY 20, 2009................ 88
APPENDIX II: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY
TIMOTHY GEITHNER, RE: TEMPORARY GUARANTEE PROGRAM FOR MONEY
MARKET FUNDS, DATED MAY 26, 2009........................... 91
APPENDIX III: 2009 LETTER FROM SECRETARY TIMOTHY GEITHNER IN
RESPONSE TO CHAIR ELIZABETH WARREN'S LETTER, RE: TEMPORARY
GUARANTEE PROGRAM FOR MONEY MARKET FUNDS, DATED JULY 21,
2009....................................................... 95
APPENDIX IV: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY
TIMOTHY GEITHNER AND CHAIRMAN BEN BERNANKE, RE: BANK OF
AMERICA, DATED MAY 19, 2009................................ 99
APPENDIX V: 2009 LETTER FROM SECRETARY TIMOTHY GEITHNER IN
RESPONSE TO CHAIR ELIZABETH WARREN'S LETTER, RE: BANK OF
AMERICA, DATED JULY 21, 2009............................... 102
APPENDIX VI: LETTER FROM CHAIR ELIZABETH WARREN AND PANEL
MEMBER RICHARD NEIMAN TO SECRETARY TIMOTHY GEITHNER, RE:
FORECLOSURE DATA, DATED JUNE 29, 2009...................... 109
APPENDIX VII: LETTER FROM ASSISTANT SECRETARY HERB
ALLISON IN RESPONSE TO CHAIR ELIZABETH WARREN'S LETTER, RE:
FORECLOSURE DATA, DATED JULY 29, 2009...................... 112
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AUGUST OVERSIGHT REPORT
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August 11, 2009.--Ordered to be printed
_______
EXECUTIVE SUMMARY*
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* The Panel adopted this report with a 4-1 vote on August 10, 2009.
Rep. Jeb Hensarling voted against the report. Additional views are
available in Section Two of this report.
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In the fall of 2008, the American economy was facing a
crisis stemming from steep losses in the financial sector, and
frozen credit markets. Then-Secretary of the Treasury Henry
Paulson and Federal Reserve Board Chairman Ben Bernanke argued
that a program of unprecedented scope was necessary to remove
hundreds of billions of dollars in so-called toxic assets from
banks' balance sheets in order to restore the flow of credit.
By the time the law creating the Troubled Asset Relief
Program (TARP) was signed only a few weeks later, however, the
Secretary had decided, due to a rapid deterioration in
conditions, to use another, more direct, strategy permitted
under TARP to rescue the financial system, by providing
immediate capital infusions to banks to offset the impact of
troubled assets. Now, ten months after its creation, TARP has
not yet been used to purchase troubled assets from banks,
although the capital infusions have provided breathing space
for banks to write-down many of these assets and to build loss
reserves against future write-downs and losses. This report
discusses the implications of the retention of billions of
dollars of troubled assets on bank balance sheets.
In the run-up to the financial crisis, banks and other
lenders made millions of loans to homeowners across America,
expecting that their money would eventually be paid back. It is
now clear that many of these loans will never be repaid.
In some cases, financial institutions packaged these
mortgage loans together and sold pieces of them into the market
place as mortgage-backed securities. In other cases they held
the mortgages as ``whole loans'' on their own books. In either
case, these mortgages, and the securities based on them, are
now said to be ``troubled assets.'' They are no longer expected
to be paid off in full, and they are very difficult to sell.
There is no doubt that the banks holding these assets expect
substantial losses, but the scale of those losses is far from
clear.
As just noted, Treasury's choice to pursue direct capital
purchases resulted in a notable stabilization of the financial
system, and it allowed the write-down of billions of dollars of
troubled assets and reserve building. But, it is likely that an
overwhelming portion of the troubled assets from last October
remain on bank balance sheets today.
If the troubled assets held by banks prove to be worth less
than their balance sheets currently indicate, the banks may be
required to raise more capital. If the losses are severe
enough, some financial institutions may be forced to cease
operations. This means that the future performance of the
economy and the performance of the underlying loans, as well as
the method of valuation of the assets, are critical to the
continued operation of the banks.
For many years, banks were required to mark their assets to
market, meaning they listed the value for many assets based on
what those assets would fetch in the marketplace. In response
to the crisis, banks have been allowed greater flexibility in
the way they value these assets. In most cases we would expect
the new rules to have permitted banks to value assets at a
higher level than before. So long as they do not sell or write-
down those assets, they are not forced to recognize losses on
them.
The uncertainty created by the financial crisis, including
the uncertainty attributable to the troubled assets on bank
balance sheets, caused banks to protect themselves by building
up their capital reserves, including devoting TARP assistance
to that end. One byproduct of devoting capital to absorbing
losses was a reduction in funds for lending and a hesitation to
lend even to borrowers who were formerly regarded as credit-
worthy.
The recently conducted stress tests weighed the ability of
the nation's 19 largest bank holding companies' to weather
further losses from the troubled assets and assessed how much
additional capital would be needed. However, the adequacy of
the stress tests and the resulting adequacy of the capital
buffer required for future financial stability depend heavily
on the economic assumptions used in the tests. As more banks
exit the TARP program, reliance on stress-testing for the
economic stability of the banking system increases. The Panel's
June report evaluated the adequacy of the stress tests.
Treasury's program to remove troubled assets from banks'
balance sheets is the Public Private Investment Program (PPIP).
It has two parts, a troubled securities initiative,
administered by Treasury, and a troubled loans initiative,
administered by the Federal Deposit Insurance Corporation
(FDIC). Treasury is now moving forward with the troubled
securities program. The FDIC has postponed the troubled loans
program, stating that the banks' recently demonstrated ability
to access the capital markets has made a program to deal with
troubled whole loans unnecessary at this time. (The FDIC is
conducting a pilot program for the sale of the loan portfolios
of failed banks.) Whether the PPIP will jump start the market
for troubled securities remains to be seen. It is also unclear
whether the change in accounting rules that permit banks to
carry assets at higher valuations will inhibit banks'
willingness to sell. Similarly, it is unclear whether wariness
of political risks will inhibit the willingness of potential
buyers to purchase these assets.
If the economy worsens, especially if unemployment remains
elevated or if the commercial real estate market collapses,
then defaults will rise and the troubled assets will continue
to deteriorate in value. Banks will incur further losses on
their troubled assets. The financial system will remain
vulnerable to the crisis conditions that TARP was meant to fix.
The problem of troubled assets is especially serious for
the balance sheets of small banks. Small banks' troubled assets
are generally whole loans, but Treasury's main program for
removing troubled assets from banks' balance sheets, the PPIP
will at present address only troubled mortgage securities and
not whole loans. The problem is compounded by the fact that
banks smaller than those subjected to stress tests also hold
greater concentrations of commercial real estate loans, which
pose a potential threat of high defaults. Moreover, small banks
have more difficulty accessing the capital markets than larger
banks. Despite these difficulties, the adequacy of small banks'
capital buffers has not been evaluated under the stress tests.
Given the ongoing uncertainty, vigilance is essential. If
conditions exceed those in the worst case scenario of the
recent stress tests, then stress-testing of the nation's
largest banks should be repeated to evaluate what would happen
if troubled assets suffered additional losses. Supervisors
should continue their increased monitoring of problem banks,
and banks too weak to survive write-downs should be required to
raise more capital. If PPIP participation proves insufficient,
Treasury may want to consider adapting the program to make it
more robust or shifting to a different strategy to remove
troubled assets from the banks' book. Treasury should also pay
special attention to the risks posed by commercial real estate
loans.
Part of the financial crisis was triggered by uncertainty
about the value of banks' loan and securities portfolios.
Changing accounting standards helped the banks temporarily by
allowing them greater leeway in describing their assets, but it
did not change the underlying problem. In order to advance a
full recovery in the economy, there must be greater
transparency, accountability, and clarity, from both the
government and banks, about the scope of the troubled asset
problem. Treasury and relevant government agencies should work
together to move financial institutions toward sufficient
disclosure of the terms and volume of troubled assets on
institutions' books so that markets can function more
effectively. Finally, as noted above, Treasury must keep in
mind the particular challenges facing small banks.
This crisis was years in the making, and it won't be
resolved overnight. But we are now ten months into TARP, and
troubled assets remain a substantial danger to the financial
system. Treasury has taken aggressive action to stabilize the
banks, and the steps it has taken to address the problem of
troubled assets, including capital infusions, stress-testing,
continued monitoring of financial institutions' capital, and
PPIP, have provided substantial protections against a repeat of
2008. These steps have also allowed the banks to take
significant losses while building reserves. Nonetheless,
financial stability remains at risk if the underlying problem
of troubled assets remains unresolved.
SECTION ONE: THE CONTINUED RISK OF TROUBLED ASSETS
The precipitous decline in the value of securities backed
by pools of residential mortgages and whole mortgage loans,
held by banks and other financial institutions,\1\ ignited the
financial crisis. The decline was compounded by the complexity
of many of the securities, the lack of accurate information
about the underlying mortgages, and the chain-reactions
generated by interlocking liabilities among financial
institutions.
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\1\ The Panel's past reports ordinarily refer to bank holding
companies, or BHCs. BHCs are corporations that own one or more banks,
but do not themselves carry out the functions of a bank; they usually
also own other non-bank financial institutions. Most large banks are
owned by BHCs; the 19 stress-tested institutions were all BHCs, for
example. This report, however, deals with both large and small banks;
many of the latter are not BHCs, so the term ``bank'' is used in this
report to include both kinds of institutions. In some cases, where
discussions refer only to BHCs, that term continues to be used.
It should be noted that troubled assets are also owned by non-
depository institutions and their holding companies and affiliates, for
example by insurance companies, pension funds, trading houses, hedge
funds, governments, etc., and the financial crisis has also affected
these institutions, often seriously. The Panel focuses on banks in this
report, however, because the TARP focuses on banks.
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The drop in real estate values that began in 2006
undermined the economic assumptions on which millions of loans
had been made and revealed that many should not have been made
under any circumstances. The same conditions gave a first view
of the size and scope of the potential losses to which the
nation's banks and other financial institutions could become
subject if the asset values did not stabilize, and the degree
to which the capital foundation of even the nation's largest
financial institutions could be impaired if the trend
continued.
A substantial portion of real estate-backed securities and
whole loans remain on bank balance sheets. The success of the
financial stabilization effort continues to depend on how the
potential impact of these assets is managed by Treasury, the
Federal Reserve Board and other financial supervisors, and by
the institutions themselves.
In this report, the Panel examines the risks these
troubled, or ``toxic,'' assets continue to pose for the
financial system and the economy, ten months into the financial
stabilization effort. Further, the report discusses the need
for, and challenges associated with, accurate valuation and
transparent presentation of troubled asset holdings, attempts
to estimate the size and distribution of the holdings of
troubled assets that remain in the U.S. financial system,
discusses Treasury's strategies, including the design and
progress of the PPIP, and suggests factors that may influence
the ability of the financial system to reduce or magnify the
risks troubled assets continue to pose.
A. Background
1. TREASURY'S FLEXIBILITY IN DEALING WITH TROUBLED ASSETS
From the outset, the Emergency Economic Stabilization Act
(EESA)\ 2\ has given Treasury a choice about the way to deal
with troubled assets held by financial institutions. Treasury
could buy real estate-based troubled assets directly from the
institutions that held them, or instead put capital directly
into those institutions by buying their stock, to counteract
the impact of the troubled assets on the institution's
stability.\3\
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\2\ Emergency Economic Stabilization Act of 2008 (EESA), Pub. L.
No. 110-343.
\3\ Id. at 3(9), permitting Treasury to purchase:
(A) residential or commercial mortgages and any securities,
obligations, or other instruments that are based on or related to such
mortgages, that in each case was originated or issued on or before
March 14, 2008, the purchase of which the Secretary determines promotes
financial market stability, and
(B) any other financial instrument that the Secretary, after
consultation with the Chairman of the Board of Governors of the Federal
Reserve System, determines the purchase of which is necessary to
promote financial market stability, but only upon transmittal of such
determination, in writing, to the appropriate committees of Congress.
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Statements from Treasury before EESA's passage initially
emphasized the need to give Treasury the ability to buy
troubled real estate assets from banks and other financial
institutions.\4\ During this time, Treasury was exploring
methods, including reverse auctions, by which to value and
purchase the assets.\5\
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\4\ See U.S. Department of the Treasury, Statement by Secretary
Henry M. Paulson, Jr. on Emergency Economic Stabilization Act (Sept.
28, 2009) (online at www.treas.gov/press/releases/hp1162.htm) (``This
bill provides the necessary tools to deploy up to $700 billion to
address the urgent needs in our financial system, whether that be by
purchasing troubled assets broadly, insuring troubled assets, or
averting the potential systemic risk from the disorderly failure of a
large financial institution.''). See also U.S. Department of the
Treasury, Fact Sheet, Proposed Treasury Authority to Purchase Troubled
Assets (Sept. 20, 2008) (online at www.treas.gov/press/releases/
hp1150.htm) (``This program is intended to fundamentally and
comprehensively address the root cause of our financial system's
stresses by removing distressed assets from the financial system.'');
U.S. Department of the Treasury, Statement by Secretary Henry M.
Paulson, Jr. on Comprehensive Approach to Market Developments (Sept.
19, 2008) (online at www.treas.gov/press/releases/hp1149.htm)
(``[I]lliquid assets are clogging up our financial system, and
undermining the strength of our otherwise sound financial
institutions.'').
\5\ In a reverse auction, banks would bid down from a reserve price
to the lowest price at which they were each willing to sell a
particular asset. Professors Peter Cramton and Lawrence Ausubel of the
University of Maryland worked with Treasury to develop a reverse
auction process that the professors believed would be quick to
implement and would result in a market price for the troubled assets
being purchased. Peter Cramton and Lawrence Ausubel, A Troubled Asset
Reverse Auction (Oct. 5, 2008) (online at www.cramton.umd.edu/
papers2005-2009/ausubel-cramton-troubled-asset-reverse-auction.pdf).
Professors Cramton and Ausubel have informed Panel staff that Treasury
considered two forms of reverse auctions: dynamic and sealed-bid. The
dynamic auction takes place over a series of rounds, whereas the
sealed-bid auction has only a single round of bidding. In either case,
the government is buying toxic assets from the banks, which is why it
is called a reverse auction.
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Throughout the legislative process preceding the passage of
EESA, Treasury and the financial sector appear to have resisted
allowing the government to take equity positions in financial
institutions.\6\
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\6\ See Senate Banking Committee, Testimony of Secretary of the
Treasury Henry M. Paulson, Jr., Turmoil in US Credit Markets: Recent
Actions Regarding Government Sponsored Entities, Investment Banks and
Other Financial Institutions, 110th Congress (Sept. 23, 2008)
(``Putting capital into institutions is about failure. This [the
Paulson Plan] is about success.'').
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Nevertheless, the bill was ultimately amended in the
Senate, with Treasury's apparent support, to widen Treasury's
authority; that expanded authority was explicitly discussed in
the House:
Mr. Moran of Virginia. I do want to clarify that the intent
of this legislation is to authorize the Treasury Department to
strengthen credit markets by infusing capital into weak
institutions in two ways: By buying their stock, debt, or other
capital instruments; and, two, by purchasing bad assets from
the institutions.
Mr. Frank of Massachusetts. I can affirm that. [T]he
Treasury Department is in agreement with this, and we should be
clear, this is one of the things that this House and the Senate
added to the bill, the authority to buy equity. It is not
simply buying up the assets, it is to buy equity, and to buy
equity in a way that the Federal Government will able to
benefit if there is an appreciation.\7\
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\7\ Statements of Representatives Moran and Frank, Congressional
Record, H10763 (Oct. 3, 2008). Representative Frank continued:
In implementing the powers provided for in the Emergency
Stabilization Act of 2008, it is the intent of Congress that Treasury
should use Troubled Asset Relief Program (TARP) resources to fund
capital infusion and asset purchase approaches alone or in conjunction
with each other to enable financial institutions to begin providing
credit again, and to do so in ways that minimize the burden on
taxpayers and have maximum economic recovery impact. Where the
legislation speaks of ``assets'', that term is intended to include
capital instruments of an institution such as common and preferred
stock, subordinated and senior debt, and equity rights. Also, it is the
intent of this legislation that TARP resources should be used in
coordination with regulatory agencies and their responsibilities under
prompt-corrective-action and least-cost resolution statutes.
Statement of Representative Barney Frank, Congressional Record,
H10763 (Oct. 3, 2008).
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2. TREASURY'S CHOICE
Less than two weeks after EESA was signed into law,
Secretary Paulson announced that Treasury would ``purchase
equity stakes in a wide array of banks and thrifts.'' \8\
Treasury later explained that the change in strategy was
motivated both by the severity of the crisis and the need for
prompt action:
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\8\ U.S. Department of the Treasury, Statement by Secretary Henry
M. Paulson, Jr. on Actions to Protect the U.S. Economy (Oct. 14, 2008)
(online at www.treas.gov/press/releases/hp1205.htm).
Given such market conditions, Secretary Paulson and
Chairman Bernanke recognized that Treasury needed to
use the authority and flexibility granted under the
EESA as aggressively as possible to help stabilize the
financial system. They determined the fastest, most
direct way was to increase capital in the system by
buying equity in healthy banks of all sizes. Illiquid
asset purchases, in contrast, require much longer to
execute.\9\
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\9\ U.S. Department of the Treasury, Responses to Questions of the
First Report of the Congressional Oversight Panel for Economic
Stabilization, at 4 (Dec. 30, 2008) (online at cop.senate.gov/
documents/cop-010909-report.pdf). Secretary Paulson later testified:
[In] the last few days before we got the TARP legislation which
passed on October 3rd and in the week after we got the TARP
legislation, the markets continued to freeze up. We had a whole series
of bank failures overseas. Five or six different countries had
intervened to rescue their banks. Market participants were clamoring
for us to do something quickly. We needed to do something quickly. And
the way we were able to do something quickly and make a difference--and
make a dramatic difference and prevent something very dire from
happening was to make the change and inject capital.
After the legislation, it was clear that the problem was continuing
to get worse. The facts were changing. Banks were failing around the
world. And there was quite a problem. We needed to move quickly to
really put out the fire.
House Oversight and Government Reform Committee, Testimony of
Former Treasury Secretary Paulson, Bank of America and Merrill Lynch:
How Did a Private Deal Turn Into a Federal Bailout? Part III, 111th
Cong. (July 16, 2009).
The problems Treasury encountered in October 2008
illustrate the difficulties that are characteristic of attempts
to remove troubled assets directly from bank balance sheets. It
is easy to make direct capital injections, but setting up a
structure to buy particular assets or groups of assets in the
absence of liquid trading markets is more difficult. There was
no assurance that--in fact no basis even for guessing whether--
the $250 billion immediately available under EESA would make an
appreciable dent in the troubled asset problem, but that amount
could stabilize the financial system to buy time for broader
issues to be addressed. No one was certain that fair values, at
which there would be both willing buyers and willing sellers,
could be set, at least not quickly; in fact the complex
structure of the assets involved has made it difficult to this
day to figure out their different values. Similarly, there was
no way of knowing whether an auction or reverse auction
conducted on an emergency basis would produce the very
instability for the selling banks that Treasury was trying to
avoid.
The final consideration may be the most significant. The
distinction between buying troubled assets and making capital
injections into the institutions that hold them is a matter of
strategy in a time of crisis. The difficulty caused by rapidly
declining asset values is the threat of insolvency; even when
markets and credit are frozen, the books of the institution can
be rebalanced by increasing capital through capital injections,
Stabilizing the institution can also give it the time it needs
to write-down its assets in an orderly way.
B. What is a Troubled Asset?
1. GENERAL DEFINITION
Troubled assets include both securities backed by pools of
residential mortgage loans or other assets, and whole mortgage
loans held by banks. (This report focuses on residential loans
because their loss of value is at the heart of the financial
crisis; as discussed below, however, there is a serious
question whether commercial real estate loans may be about to
experience the same drop in value. In addition, assets such as
credit card receivables may be the basis for asset-backed
securities.)
A loan is a transfer of money (principal) from a lender to
a borrower who agrees to repay the principal, plus interest on
the amount that has not been repaid, over the term of the
loan.\ 10\ The amount of the loan and the interest rate
reflect, in addition to prevailing interest rates when the loan
is made, the risk of default and related risks. If the loan is
secured by a piece of property (often called collateral), as
residential or commercial mortgages almost always are, one of
the factors taken into account in setting the amount of the
loan and the degree of risk is the value of the collateral. The
value of the loan payments at any particular time during its
term is called the ``discounted present value'' to reflect the
fact that payments are to be made in the future.\ 11\
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\10\ Usually, the time for repaying a loan, and for paying interest
during the loan term, are predetermined.
\11\ ``Discounted present value'' refers to the value of an asset's
hold-to-maturity payoff--future payment or series of future payments,
discounted to reflect the time value of money, represented by an
accepted rate of interest, and other factors such as investment risk--
at the time the calculation is made. Standard asset pricing models for
mortgage-backed securities, for example, consider an asset's present
value to be the weighted average sum of the future payoffs of the
underlying assets (e.g., residential mortgages) using an appropriate
discount rate based on factors listed below. As such, fair value of
these exposures is based on estimates of future cash flows from the
underlying assets. To determine the performance (hence risk-adjusted
discount rate) of the underlying portfolios (e.g., packaged mortgages),
entities estimate the prepayments, defaults and loss severities based
on a number of macroeconomic factors, including housing price changes,
unemployment rates, interest rates, and borrower and loan attributes.
In addition, mortgage performance data from external sources such as
Treasury's OCC and OTS Mortgage Metrics Report are incorporated into
the pricing models. Default risk on the underlying asset is calculated
using the ratings distributed by rating agencies such as Moody's and
Standard & Poor's. However these agencies have come under heavy
criticism as some of the assets that received a ``AAA'' rating from
these agencies ended up with significant default risk.
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A ``troubled asset'' is a loan or security whose original
credit risk assumptions have come into serious question.
Several factors can cause an asset to become ``troubled,''
including: (1) the fact that the ``credit risk'' on which the
loan was based has increased, so that the loan's value has
dropped; and (2) the fact that the borrower on the underlying
loan has actually failed to make a number of required payments
or has stopped making payments altogether. The degree of non-
performance is important because of the effect of accounting
rules--which may require a write-down of the value of the loan
on the lender's books--although the loan may still be
performing in many cases and could be paid-in-full if held to
maturity.
Reasons for these situations can include: (1) the nature of
the loan itself (i.e., loan terms the borrower proves unable to
meet); (2) the lender's acceptance of greater than normal
credit risk (e.g.., reduced documentation or inadequate
scrutiny of the borrower's credit history); (3) a change in the
economic condition of the borrower (for example, due to
unemployment, disability, or a sudden costly medical
emergency); (4) a decline in the value of the property below
the remaining loan balance owed, that may give a borrower\
12\--especially one to whom one of the other reasons also
applies--fewer options moving forward; and (5) borrower fraud.
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\12\ In early May 2009, Moody's Economy.com estimated that of 78.2
million owner-occupied single-family homes, 14.8 million borrowers, or
19 percent, owed more than their homes were worth at the end of the
first quarter, up from 13.6 million borrowers at the end of 2008. This
is an increase of 8.8 percent between the end of 2008 and the close of
the first quarter of 2009. Deutsche Bank estimated that in the first
quarter of 2011, overall 48 percent of U.S. homeowners will owe more
than their house is worth, including 41 percent of prime conforming
loans, 46 percent of prime jumbo loans, 69 percent of subprime loans
and 89 percent of options adjustable rate loans. Karen Weaver and Ying
Shen, Drowning in Debt--A Look at ``Underwater'' Homeowners, Deutsche
Bank (Aug. 5, 2009).
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Even under normal market conditions, a certain number of
loans will be ``troubled,'' or, to use a more technical term,
``impaired.'' The masses of troubled assets that now weigh down
the financial system are overwhelmingly residential real estate
loans whose loss of value reflects the continued decline in
real estate values and current economic conditions, especially
rising unemployment (as discussed below).\13\ The volume stems
from the boom in mortgage lending produced by the real estate
bubble.\14\
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\13\ Loans other than residential mortgage loans, for example,
commercial mortgage loans, credit card receivables, automobile loans
and student loans, can also face problems relating to performance. Many
of these loans are themselves pooled and repackaged as complex
securities; a deeper recession, including rising unemployment and
falling real estate values, can change the repayment expectations
attached to those loans as well. As the Panel noted in its May report,
credit card and student loan delinquencies or defaults are increasing.
Congressional Oversight Panel, May Oversight Report: Reviving Lending
to Small Businesses and Families and the Impact of the TALF, at 26-30
(May 7, 2009) (online at cop.senate.gov/documents/cop-050709-
report.pdf) (hereinafter ``Panel May Report''). Therefore, a
substantial challenge for financial institutions is to determine how
much of a capital buffer they should have in place to make up for these
other types of loans that enter into default.
\14\ After decades of relative stability, the rate of U.S.
homeownership began to surge in the early part of this decade, rising
from 64 percent in 1994 to a peak of 69 percent in 2004. Federal
Reserve Bank of San Francisco, FRBSF Economic Letter: The Rise in
Homeownership (Nov. 3, 2006) (online at www.frbsf.org/publications/
economics/letter/2006/el2006-30.html).
---------------------------------------------------------------------------
The troubled assets at the heart of the crisis generally
fall into two categories: (1) complex securities, part or all
of which were sold to third parties;\15\ and (2) whole loans.
Within the banking system, a relatively small number of banks
(out of the more than 8,000 U.S. chartered banks) typically own
pieces (or all) of the complex securities. The troubled assets
held by smaller and community banks are likely to be whole
loans. Although larger banks also hold whole loans,\16\ these
smaller and community bank holdings serve as a powerful
reminder that the troubled assets problem extends far beyond
the 19 largest banks subject to the government stress tests.
---------------------------------------------------------------------------
\15\ As discussed below, vast quantities of these loans were
combined into pools that were in turn fragmented and resold as
investments in ways that make valuing either the investments or the
underlying loans difficult or impossible. Moreover, the sale to third
parties was in many cases not complete, as also discussed below, a fact
multiplied the ultimate risk of liability involved.
\16\ Office of the Comptroller of the Currency, Comptroller Dugan
Expresses Concern About Commercial Real Estate Concentrations (Jan. 31,
2008) (online at www.occ.gov/ftp/release/2008-9.htm) (According to data
from the Office of the Comptroller of the Currency, between 2002 and
2008, the ratio of commercial real estate loans to capital at community
banks nearly doubled to a record 285 percent. By early 2008, nearly
one-third of all community banks had commercial real estate
concentrations that exceeded 300 percent of their capital.); Maurice
Tamman and David Enrich, Local Banks Face Big Losses, Wall Street
Journal (May 19, 2009) (online.wsj.com/article/
SB124269114847832587.html). According to an analysis conducted by the
Wall Street Journal, commercial real estate loans could generate losses
of $100 billion by the close of 2010 at more than 900 small and midsize
U.S. banks if the recession deepens. Total aggregate losses could
surpass $200 billion during that period, according to the Journal's
analysis, which utilized the same worst-case scenario that the federal
government used in its recent stress tests of the 19 largest banks. In
such circumstances, ``more than 600 small and midsize banks could see
their capital shrink to levels that usually are considered worrisome by
federal regulators.''
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2. COMPLEX SECURITIES
Troubled complex securities began as pools of thousands of
individual loans (primarily residential) that were securitized
for sale to investors.\17\ The pools became the basis for a
bewildering array of multi-level investment arrangements that
tried to divide the cash flow from the pools into various
degrees of risk and return. These were based, in turn, on
assumptions about the rate at which mortgages would pay off and
the level of default the mortgages in the pool were likely to
experience.
---------------------------------------------------------------------------
\17\ See Panel May Report, supra note 13, at 34-40.
---------------------------------------------------------------------------
The simplest type of structure is illustrated by the
following figure.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The levels (or ``tranches'') that characterize complex
securities reflect different degrees of risk and return and
have different priorities in receiving interest and principal
flows from the underlying mortgages. The senior level receives
its pass-through of interest and principal payments first, but
it receives a relatively lower interest payment to reflect its
lower risk. The mezzanine level falls in the middle--possessing
a second call on payments and a higher interest rate to reflect
its higher risk. The junior tranche receives its portion of the
pass-through of interest and principal payments only after the
first two levels receive their portions and would be the first
to suffer upon non-payment or default of the underlying
mortgages. Correspondingly, holders of the junior tranche would
receive the highest interest rate--assuming no default--to
reflect their higher risk.
---------------------------------------------------------------------------
\18\ This diagram is based on the chart that appears in Janet M.
Tavakoli, Structured Finance and Collateralized Debt Obligations: New
Developments in Cash and Synthetic Securitization (John Wiley and Sons
Ltd.), at 71 (2008).
---------------------------------------------------------------------------
Super-senior tranches sit above the senior tranche and
hence receive their payments before anyone else. But their
value was theoretically a sliver of the total value of the pool
and they were presumed--incorrectly as it turned out--to be
substantially risk-free. Banks generally kept these securities
(or placed them in special purpose vehicles--SPVs--that they
had created); this increased the relative return on the senior
securities by removing the calculation of that return the slice
of the total that had the lowest return because it had the
least risk.
In the years preceding the financial crisis, the
securitization market experienced widespread growth and
attracted substantial investor interest. Strong global growth
and low interest rates\ 19\ encouraged investors to seek high-
yield returns in a deeply liquid market (which they found in
mortgage-related securities), inflating asset prices and
further suppressing interest rates in the process.\20\ Some
banks and other financial institutions, themselves enticed by
the prospect of higher returns and the supposed low-risk of
these types of mortgage-related investments, purchased complex
securities for investment purposes.\21\
---------------------------------------------------------------------------
\19\ The Federal Funds effective rate remained under three percent
from October 2001 until April 2005. See Board of Governors of the
Federal Reserve System, Federal Reserve Statistical Release H.15:
Selected Interest Rates Historical Data (daily) (online at
www.federalreserve.gov/releases/h15/data/Daily/H15--FF--O.txt)
(accessed Aug. 2, 2009).
\20\ Letter from Secretary of the Treasury Timothy F. Geithner to
Congressional Oversight Panel Chair Elizabeth Warren (Apr. 2, 2009).
\21\ Id.
---------------------------------------------------------------------------
In response, the securitization markets became increasingly
complex. Different types of structured vehicles were created
based upon underlying assets. At the more senior levels of
debt, investors were able to obtain better yields than those
available on more traditional securities (e.g., corporate
bonds) with a similar credit rating.\22\ Investors, including
banks, insurance companies, investment funds, hedge funds, and
wealthy individuals, also perceived added benefits resulting
from the diversification of the complex securities portfolios
and the credit support built into the transactions. This
increased investor interest prompted the creation of different
types of securities as issuers started looking for new assets
to collateralize or new ways to collateralize them.\23\ Some of
these structured finance developments included:
---------------------------------------------------------------------------
\22\ It turned out that the credit ratings assigned to the complex
securities vehicles proved inaccurate.
\23\ Kenneth E. Scott and John B. Taylor, Why Toxic Assets Are So
Hard to Clean Up, Wall Street Journal (July 20, 2009) (online at
online.wsj.com/article/SB124804469056163533.html) (hereinafter ``Why
Toxic Assets Are So Hard to Clean Up'').
---------------------------------------------------------------------------
Mortgage pools that were combined with separate
mortgage pools.
Mortgage pools that were combined with pools of
loans from entirely different types of asset pools (i.e., other
types of mortgages, automobile loans, student loans, credit
card receivables, small business loans and some corporate
loans).
Complex securities that were created by using
existing tranches of other complex securities as collateral.
In these cases, the underlying pool consisted of
interests in tranches of many different asset-backed
securities.
The perception was that having multiple pools of
mortgages reflected in the complex security would
provide increased diversification benefits along with
loss mitigation if a small number of mortgages were to
become nonperforming.
This list is only illustrative. There are even more
complicated variations.
However, the structures unwound quickly--or at least
appeared to do so--for what are, at bottom, simple reasons.
Once rates of default on subprime and other mortgages began to
increase and real estate prices began to drop steeply, it
increasingly appeared that the rate of return, and thus the
value of these structured investments, reflected faulty
assumptions about risk. The complexity of the structured
vehicles surrounding securitization and the lack of
distribution and disclosure of information about the terms of
the underlying loans, coupled with uncertainty about future
performance, made the challenges associated with asset
valuation and liquidity quickly apparent.
As the economic assumptions about property values and
default rates reflected in these securities proved increasingly
inaccurate, the securities' values dropped precipitously, and
no one could agree on what they were worth. Any price-discovery
mechanism for these assets was frozen because most investors or
traders would not take the risk of purchasing them under any
circumstances. The more defaults increased and home prices
dropped, the more the assets became--in the popular term--
``toxic,'' and the more difficult it was to turn the assets
into cash. In other words, the more illiquid the market for
them became, the more attention began to turn to the risks they
posed for their holders, especially banks.
As the security structures became more removed from the
original pools that ostensibly supported them, the valuation,
and even the awareness of the degree of risk carried by the
securities for either their originators or their investors,
became more and more difficult, and ultimately almost
impossible, to estimate.
Banks could have exposure in several ways to these
fluctuations in value:
1. A bank could have originated the sale of the securities
and retained a portion of one or more of the tranches in
connection with their origination by the bank, to facilitate
the sale of the securities in general, or to meet related
capital requirements. This proved to be most serious in the
case of the super-senior tranches banks retained. As credit
rating agencies recognized that they had been ``far too
generous with their ratings of securities based on subprime
mortgages, including their triple-A ratings of super-senior
tranches of [certain asset-backed complex securities],'' they
issued ``sudden, multi-notch downgrades in massive and
historically unprecedented proportions.'' \24\ These
substantial downgrades caused ``huge mark-to-market losses'' on
super-senior tranches held by nearly all large financial
institutions,\25\ with resulting reductions in bank capital in
at least some cases.
---------------------------------------------------------------------------
\24\ Office of the Comptroller of the Currency, Remarks of John C.
Dugan, Comptroller of the Currency, Before the Global Association of
Risk Professionals, New York, NY, at 7 (Feb. 27, 2008) (online at
www.occ.treas.gov/ftp/release/2008-22a.pdf).
\25\ Id. at 8.
---------------------------------------------------------------------------
2. A bank could have retained a direct or indirect monetary
commitment to the investors in the securities it originated.
Because most securitized investments must be bankruptcy remote,
securitization transactions are routed through SPVs. The loans
are sold to the SPVs and then investors purchase securities
issued by the SPVs. As discussed below, new accounting rules
will require the value of these assets to be restored directly
to bank balance sheets beginning in 2010 under many
circumstances--a change that will further increase bank
exposure.\26\
---------------------------------------------------------------------------
\26\ Based on information submitted by the BHCs, bank supervisors
predict that this change alone could result in approximately $900
billion in assets being brought back onto the balance sheets of these
institutions. Board of Governors of the Federal Reserve System, The
Supervisory Capital Assessment Program: Design and Implementation, at
16 (Apr. 24, 2009) (online at www.federalreserve.gov/newsevents/press/
bcreg/bcreg20090424a1.pdf) (hereinafter ``SCAP Design Report'').
---------------------------------------------------------------------------
In addition, a feature of the present troubled securities
was a so-called ``bank buy-back'' feature that entitled holders
to give the securities back to the bank upon a triggering event
such as economic decline, at a premium to the current market
price. This is much like a money-back guarantee to the buyer of
the loan if the debtor defaults. As defaults increased,
institutions with such obligations faced a double-edged sword
because these assets moved back onto their balance sheets,
while these institutions wound up paying a premium price for
them even though they were worth significantly less due to
market conditions.
3. A bank could have bought securities originated by other
banks, for trading or investment. Banks that had purchased
complex securities, either to trade or hold, were faced with a
direct problem--how to value those securities in their various
asset accounts. These issues are discussed below.
4. A bank could have issued or held a credit default swap
\27\ relating to a particular complex security or held a share
in a pool of credit default swaps based on the underlying value
of other complex securities. In either case, a decline in the
value of the complex securities underlying the swap, or pool of
swaps, would likely flow through to the bank's balance sheet
because the bank either was called upon to make good or post
additional collateral on swaps it had written, or saw the value
of its own swap or interest in a swap pool decline.
---------------------------------------------------------------------------
\27\ Credit default swaps are a way of managing debt. The issuer of
the swap agrees to pay the holder (the issuer's counter party) the
amount of a debt that the counterparty is owed by a third party, if the
third party fails to do so. For example, the holder of a corporate bond
may hedge its exposure by entering into a CDS contract as the buyer of
protection. If the bond goes into default, the proceeds from the CDS
contract will cancel out the losses on the underlying bond.
---------------------------------------------------------------------------
3. WHOLE LOANS
A whole loan is a single loan recorded on the books of the
bank that made it. A loan becomes troubled if the likelihood
that it will be repaid has declined below the amount of the
bank's loan loss reserve for that loan. The reasons for the
decline are no different than those that affect the worth of
mortgages underlying complex securities, but the decline in the
value of whole loans does not set off the sort of chain
reaction created by troubled securities.
The impairment of whole loans may be structurally less
complicated than the impairment of complex securities, but its
potential impact is no less difficult or important. The growing
number of unpaid whole loans is also worrisome. For example,
recent reports and statistics published by the FDIC indicate
that overall loan quality at American banks is the worst in at
least a quarter century, and the quality of loans is
deteriorating at the fastest pace ever. Of the total book of
loans and leases at all banks, totaling $7.7 trillion at the
end of March 2009, 7.75 percent were showing signs of
distress--a total of $596.75 billion.\28\ The percentage of
loans at least ninety days overdue, or on which the bank has
ceased accruing interest or has written-off, is also at its
highest level since 1984, when the FDIC first began collecting
such statistics.\29\
---------------------------------------------------------------------------
\28\ Federal Deposit Insurance Corporation, Quarterly Banking
Profile (First Quarter 2009), at 5-13 (online at www2.fdic.gov/qbp/
2009mar/qbp.pdf).
\29\ Id. One banker has said that ``[t]he financial system is
weighed down by trillions of loans that cannot possibly be repaid.''
Daniel Alpert, No Good Deed Goes Unpunished: How Bank Bailouts Have
Threatened the Resolution of the Debt Crisis, Westwood Capital LLC
Research (July 8, 2009) (online at www.westwoodcapital.com/opinion/
images/stories/articles_jan09/nogooddeedgoesunpunished.pdf).
---------------------------------------------------------------------------
The predominance of whole loans, not only in residential
real estate but in areas such as commercial real estate,
further underscores the importance of those loans to bank
balance sheets. The consequences of defaults of course spread
into the real economy, and by reducing, for example, employment
in construction and related fields, have a redoubled effect on
the default rate in whole loans. But the range of potential
harm goes even beyond that; defaults on commercial loans that
support multi-family housing can lead to deterioration in
building maintenance and ultimately to displacement of tenants.
The threat of growing waves of whole loan defaults can
cause more significant problems for small and midsize
institutions than for large ones.\30\ Smaller institutions are
less able to tap capital markets than their larger rivals,
increasing their need for government assistance to help
counteract the impact of the defaulted loans on their balance
sheets. As of August 7, 72 banks, most of them community
institutions, had failed since the beginning of 2009.\31\ This
is in addition to the 26 banks that failed during the course of
2008.\32\ The recent release of quarterly results from regional
banks provides a sobering portrayal of the potential pitfalls
in the future.\33\ These problems highlight the substantial gap
between large banks, some of which have recently announced
profits in investment banking and trading, and small and
midsize banks that rely on more traditional transactional
services such as accepting deposits and issuing loans.\34\ Such
problems are expected to worsen as commercial real estate loans
continue to decline.
---------------------------------------------------------------------------
\30\ Richard Parkus and Jing An, The Future Refinancing Crisis in
Commercial Real Estate, Part II: Extensions and Refinements, at 23
(July 15, 2009) (hereinafter ``Parkus July Report'') (``[E]xposure [to
commercial real estate loans] increases markedly for smaller banks. For
the four largest banks (on the basis of total assets), this exposure is
12.3%, for the 5-30 largest banks, the exposure is 24.5%, while for the
31-100 largest banks, the exposure grows to 38.9%.'').
\31\ Federal Deposit Insurance Corporation, Failed Bank List
(online at www.fdic.gov/bank/individual/failed/banklist.html) (accessed
Aug. 9, 2009).
\32\ Id.
\33\ Andrew Martin, Regional Banks' Profits Are Hurt by Loan
Losses, New York Times (July 23, 2009) (online at www.nytimes.com/2009/
07/23/business/
23bank.html?_r=1&scp=1&sq=regional%20banks'%20profits&st=cse) (noting
how KeyCorp of Cleveland is preparing for losses on commercial real
estate loans and SunTrust Banks and Wells Fargo remain very concerned
about residential real estate loans).
\34\ Id.
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4. TROUBLED LOANS, BANK BALANCE SHEETS, AND BANK CAPITAL
Troubled loans have a significant negative effect on the
capital of the banks that hold them; the two operate jointly.
Although bank capital computations are often very technical and
complicated, the core of the rules can be stated simply. A
bank's capital strength is generally measured as the ratio of
specified capital elements on the firm's consolidated balance
sheet (for example, the amount of paid-in capital and retained
earnings) to its total assets.\35\ Decreases in the value of
assets on a bank's balance sheet change the ratio by requiring
that amounts be withdrawn from capital to make up for the
losses. Losses in asset value that are carried directly to an
institution's capital accounts without being treated as items
of income or loss have the same effect.\36\
---------------------------------------------------------------------------
\35\ The value of the assets is generally ``risk-weighted,'' that
is, determined based on the risk accorded the asset.
\36\ Although these losses are carried directly to the capital
account they have no effect on regulatory capital calculations when
recorded in the other-comprehensive-income account.
---------------------------------------------------------------------------
During the financial crisis, all of these steps accelerated
dramatically. A plunge in the value of a bank's loan portfolio
that has a significant impact on the value of the bank's
assets--as it usually will--triggers a response by the bank's
supervisor, one that usually requires the institution to raise
additional capital or even pushes a bank into receivership.
Otherwise, the bank's assets simply cannot support its
liabilities and it is insolvent. The TARP attempted to restore
a balance by shoring up bank capital directly \37\--this was
one of the reasons for Treasury's decision in the late fall of
2008 that only capital infusions made sense.
---------------------------------------------------------------------------
\37\ Congressional Oversight Panel, Testimony of Assistant U.S.
Treasury Secretary for Financial Stability Herbert Allison, (June 24,
2009) (hereinafter ``Allison Testimony'') (Treasury seeks to enable
banks ``to sell marketable securities back into [the] market and free
up balance sheets, and at the same time [to make] available, in case
it's needed, additional capital to these banks which are so important
to [the] economy''); See also Id. (``Treasury . . . is providing a
source of capital for the banks and capital is essential for them in
order that they be able to lend and support the assets on their balance
sheet and there has been--there was an erosion of capital in a number
of those banks.'').
---------------------------------------------------------------------------
The problem of unresolved bank balance sheets is
intertwined with the problem of lending, as the Panel has
observed before.\38\ Uncertainty about risks to bank balance
sheets, including the uncertainty attributable to bank holdings
of the toxic assets, caused banks to protect themselves by
building up their capital reserves, including devoting TARP
assistance to that end. One consequence was a reduction in
funds for lending and a hesitation to lend even to borrowers
who were formerly regarded as credit-worthy.
---------------------------------------------------------------------------
\38\ See, e.g., Congressional Oversight Panel, June Oversight
Report: Stress-Testing and Shoring Up Bank Capital, at 6, 11-12 (June
9, 2009) (online at cop.senate.gov/documents/cop-060909-report.pdf)
(hereinafter ``Panel June Report'').
---------------------------------------------------------------------------
5. LOAN LOSS RESERVES
The effect of the loan losses that unbalanced the
relationship between bank assets and liabilities passed through
banks' loan loss reserves to their income statements and on to
their balance sheets. Loan loss reserves are accounts set aside
by entities to cover probable loan losses.\39\ Each quarter a
bank charges off losses incurred during the past quarter,
thereby reducing the allowance for loan losses (i.e., the
account). It also makes a provision (``provides,'' adding to
the allowance) for future loan losses based on the losses that
are reasonable and estimable at that point in time. Such
provisions are derived from macroeconomic conditions, loan and
portfolio specific conditions (results of internal loan
reviews),\40\ and recent charge-off history. Because no one can
foretell the future, the adequacy of loss reserves are
reevaluated continuously, hence new provisions are made each
quarter. Banks have both specific reserves (linked to
individual assets) and general reserves (linked to portfolios,
i.e., consumer loans, or generally available).
---------------------------------------------------------------------------
\39\ This reserve is an estimate of uncollectible amounts and is
used to reduce the book value of loans and leases to the amount that is
expected to be collected. To establish an adequate allowance, a bank
must be able to estimate probable credit losses related to specifically
identified loans as well as probable credit losses inherent in the
remainder of the loan portfolio that have been incurred as of the
balance sheet date. Thus, the amount of a bank's loan loss reserves
should be based on past events and current economic conditions.
\40\ An effective loan review system and controls that identify,
monitor, and manage asset quality problems in an accurate and timely
manner are essential. These systems and controls must be responsive to
changes in internal and external factors affecting the level of credit
risk and ensure the timely charge-off of loans, or portions of loans,
when a loss has been confirmed.
---------------------------------------------------------------------------
Loan loss reserve adjustments reflect the carrying value of
bank loan portfolios and the allowance must be maintained at a
level that is adequate to absorb all estimated probable
inherent losses in the loan and lease portfolio as of its
evaluation date.\41\ The provision for loan losses is a
necessary feature of accrual accounting under generally
accepted accounting principles (GAAP) to present the financial
outlook of the bank.\42\ However, if the institution then
suffers additional credit losses and must increase its
reserves, the increase will reduce current earnings and may
ultimately produce a reduction in equity capital. Thus,
building accurate reserves against losses is a critical part of
avoiding the negative impact of excessive losses on bank
solvency.
---------------------------------------------------------------------------
\41\ Financial Accounting Standards Board, Statement of Financial
Accounting Standards No. 5: Accounting for Contingencies (FAS No. 5),
at 3 (Mar. 1975) (hereinafter ``FAS No. 5'').
\42\ From an accounting perspective, loan loss reserves guidance is
provided by the Financial Accounting Standards Board. See FAS No. 5,
supra note 41; Financial Accounting Standards Board, Statement of
Financial Accounting Standards No. 114: Accounting by Creditors for
Impairment of a Loan, an Amendment of FASB Statements No. 5 and 15 (FAS
No. 114) (May 1993). Paragraph 8 of FAS No. 5 stipulates the following
two conditions for a firm to record a provision for loan loss:
1. Information available prior to issuance of the financial
statements indicates that it is probable that an asset had been
impaired or a liability had been incurred at the date of the financial
statements. It is implicit in this condition that it must be probable
that one or more future events will occur confirming the fact of the
loss.
2. The amount of loss can be reasonably estimated.
Paragraph 20A of FAS No. 114 stipulates:
For each period for which results of operations are presented, a
creditor also shall disclose the activity in the total allowance for
credit losses related to loans, including the balance in the allowance
at the beginning and end of each period, additions charged to
operations, direct write-downs charged against the allowance, and
recoveries of amounts previously charged off.
---------------------------------------------------------------------------
Loan loss reserves were upset by the uncertainties, lack of
information, and fear verging on panic that characterized 2008.
To make matters worse, the linkage between various assets and
institutions produced calls on various forms of back-up
guarantees such as credit default swaps, or forced banks to
take back obligations onto their balance sheets, further
straining their capital.
Therefore, many financial institutions did not allocate
sufficient reserves during countercyclical periods (periods of
earnings growth) before the financial meltdown of 2008 for
future loan losses. As an example, Figure 2 is an excerpt from
the 2008 Bank of America 10-K--Notes on Financial Statements--
Allowance for Credit Losses. This note highlights the
significant increase in charge-offs in 2008, relative to 2007
and 2006, and the resulting need for a significant increase in
the bank's provision for loan losses. Figure 2 highlights that
Bank of America added $26.9 billion of provision for loan loss
during 2008 and $13.4 billion in the first quarter of 2009--a
total of $40 billion to bring its loan loss reserves (net of
loan loss charges) to $30.4 billion at the end of first quarter
2009. During the same period, Bank of America incurred $16.2
and $6.9 billion of net loan losses respectively--a total of
$23 billion. Increasing provisions for loan losses reduces
earnings and adds significant strain to institutions during
cyclical periods.
The following table summarizes the changes in the allowance
for credit losses for 2008, 2007, and 2006.
FIGURE 2: BANK OF AMERICA ALLOWANCE FOR CREDIT LOSSES, 2006-2008 \43\
(Dollars in millions)
------------------------------------------------------------------------
2008 2007 2006
------------------------------------------------------------------------
Allowance for loan and lease $11,588 $9,016 $8,045
losses, January 1............
Adjustment due to the adoption ............ (32) ............
of SFAS 159..................
Loans and leases charged off.. (17,666) (7,730) (5,881)
Recoveries of loans and leases 1,435 1,250 1,342
previously charged off.......
Net charge-offs............... (16,231) (6,480) (4,539)
Provision for loan and lease 26,922 8,357 5,001
losses.......................
Other (*)..................... 792 727 509
Allowance for loan and lease 23,071 11,588 9,016
losses, December 31..........
Reserve for unfunded lending 518 397 395
commitments, Jan. 1..........
Adjustment due to the adoption ............ (28) ............
of SFAS 159..................
Provision for unfunded lending (97) 28 9
commitments..................
Other......................... ............ 121 (7)
Reserve for unfunded lending 421 518 397
commitments, Dec. 31.........
Allowance for credit losses, $23,492 $12,106 $9,413
December 31..................
------------------------------------------------------------------------
* The 2008 amount includes the $1.2 billion addition of the Countrywide
allowance for loan losses as of July 1, 2008. The 2007 amount includes
the $725 million and $25 million additions of the LaSalle and U.S.
Trust Corporation allowance for loan losses as of October 1, 2007 and
July 1, 2007. The 2006 amount includes the $577 million addition of
the MBNA allowance for loan losses as of January 1, 2006.
\43\ The data used in creating this exhibit were derived from the
quarterly and yearly SEC filings of Bank of America from the period 12/
31/08 to 3/31/09 (online at www.secinfo.com/$/SEC/FilingTypes.asp).
FIGURE 3: BANK OF AMERICA ALLOWANCE FOR CREDIT LOSSES, Q12008--Q12009
(Dollars in millions)
------------------------------------------------------------------------
2009 2008
------------------------------------------------------------------------
Allowance for loan and lease losses, January $23,071 $11,588
1..........................................
Loans and leases charged off................ ($7,356) ($3,086)
Recoveries of loans and leases previously $414 $371
charged off................................
Net charge-offs............................. ($6,942) ($2,715)
Provision for loan and lease losses......... $13,352 $6,021
($433) ($3)
Allowance for loan and lease losses, March $29,048 $14,891
31.........................................
Reserve for unfunded lending commitments, $421 $518
January 1..................................
Allowance for credit losses, March 31....... $30,405 $15,398
------------------------------------------------------------------------
6. ACCOUNTING FOR TROUBLED ASSETS
a. Fair Value Accounting for Debt and Equity Securities
The method for valuation of loans is set by the Financial
Accounting Standards Board (FASB) as part of its promulgation
of generally accepted accounting principles (GAAP). Particular
principles are embodied in particular Financial Accounting
Standards (FASs).
Prior to 1993, assets such as mortgages and mortgage-backed
securities were generally carried on bank books according to
the original loan amount. A new value would not be implemented
until after the asset was sold. Under the basic standard issued
and implemented in 1993 (FAS 115), the manner in which debt and
equity securities are valued depends on whether those loans are
held on the books of a financial institution in its (1) trading
account (an account that holds debt and equity securities that
the institution intends to sell within a year), (2) available-
for-sale account (an account that holds debt and equity
securities that the institution does not necessarily intend to
sell, certainly in the near term), or (3) held-to-maturity
account (an account, as the name states, for debt securities
that the institution intends to hold until they are paid off).
Assets in a trading account are bought and sold regularly
in a liquid market, such as the New York Stock Exchange or the
various exchanges on which derivatives and options are bought
and sold, that sets fair market values for these assets. The
bank designates assets that are readily tradable in the near
future by classifying these assets in a trading account. By
definition, there is no debate about market value; the worth of
the assets in that classification must be adjusted to reflect
changes in prices recorded in the liquid buyers and sellers
market, whether or not those losses have been realized by an
actual sale. The adjustments affect earnings directly.
Assets in an available-for-sale account are carried at
their ``fair value.'' In this case, any changes in value that
are not realized through a sale do not affect earnings, but
directly affect equity on the balance sheet (reported as
unrealized gains or losses through an equity account called
``Other Comprehensive Income''). However, unrealized gains and
losses on available-for-sale assets are not included as part of
regulatory capital. Assets that are regarded as held-until-
maturity are valued at cost minus repaid amounts (an
``amortized basis'').
These rules change if assets in either an available-for-
sale or a held-to-maturity account become permanently
impaired.\44\ In the former case, the write-down had to be
reflected through earnings; in the latter, the write-down had
to be carried to the balance sheet (as opposed to not having
any effect).
---------------------------------------------------------------------------
\44\ Credit impairment is assessed using a cash flow model that
estimates cash flows on the underlying mortgages, using the security-
specific collateral and transaction structure. The model estimates cash
flows from the underlying mortgage loans and distributes those cash
flows to various tranches of securities, considering the transaction
structure and any subordination and credit enhancements that exist in
the structure. It incorporates actual cash flows on the mortgage-backed
securities through the current period and then projects the remaining
cash flows using a number of assumptions, including default rates,
prepayment rates, and recovery rates (on foreclosed properties). If
cash flow projections indicate that the entity does not expect to
recover its amortized cost basis, the entity recognizes the estimated
credit loss in earnings.
---------------------------------------------------------------------------
b. Impact of New Mark-to-Market Accounting Rules
FAS 115 was implemented before financial innovation spawned
complex securitization products that were more difficult to
price. To deal with the complexity problem, the accounting
rules were changed in 2006.\45\ FAS 157, implemented in 2006,
was meant to provide a clear definition of fair value based on
the types of metrics utilized to measure fair value (market
prices and internal valuation models based on either observable
inputs from markets, such as current economic conditions, or
unobservable inputs, such as internal default rate
calculations). In effect, the new rules governed when a
permanent impairment had to be recognized by a bank holding the
asset. When mortgage defaults rose in 2007 and 2008, the value
of underlying assets, such as mortgage loans, dropped
significantly, causing banks to write-down both whole loans and
mortgage-related securities on their balance sheets through
unrealized losses on their income statements. Many banks
expressed displeasure, arguing that the available market prices
were misleading because they reflected the values that would
have been obtained through forced sales within a distressed
market when no such sales were taking place. Banks claimed that
the rule distorted their financial positions because they were
not in fact selling the assets in question and in fact might
well recover more than the fire sale write-down price.\46\ The
banks also claimed that the distortions had an immediate effect
on available required capital and the stock prices of the
institutions involved, both as a result of shareholder sales
and market speculation.\47\
---------------------------------------------------------------------------
\45\ Financial Accounting Standards Board, Statement of Financial
Accounting Standards No. 157: Fair Value Measurements (FAS 157)
(September 2006) (hereinafter ``FAS 157''). FAS 157 specifies a
hierarchy of valuation techniques based on whether the inputs to those
valuation techniques are observable or unobservable. Observable inputs
reflect market data obtained from independent sources, while
unobservable inputs reflect the entity's market assumptions. FAS 157
requires entities to maximize the use of observable inputs and minimize
the use of unobservable inputs when measuring fair value of assets.
These two types of inputs have created a three fair value hierarchy:
Level 1 Assets (mark-to-market), Level 2 Assets (mark-to-matrix), and
Level 3 Assets (mark-to-model).
Level 1--Liquid assets with publicly traded quotes. The financial
institution has no discretion in valuing these assets. An example is
common stock traded on the NYSE.
Level 2--Quoted prices for similar instruments in active markets;
quoted prices for identical or similar instruments in markets that are
not active; and model-derived valuations in which all significant
inputs and significant value drivers are observable in active markets.
The frequency of transactions, the size of the bid-ask spread and the
amount of adjustment necessary when comparing similar transactions are
all factors in determining the liquidity of markets and the relevance
of observed prices in those markets.
Level 3--Valuations derived from valuation techniques in which one
or more significant inputs or significant value drivers are
unobservable. If quoted market prices are not available, fair value
should be based upon internally developed valuation techniques that
use, where possible, current market-based or independently sourced
market parameters, such as interest rates and currency rates.
\46\ John Heaton, Deborah Lucas, and Robert McDonald, Is Mark-to-
Market Accounting Destabilizing? Analysis and Implications for Policy,
University of Chicago and Northwestern University, at 3 (May 11, 2009)
(hereinafter ``Mark-to-Market Analysis'').
\47\ Id.
---------------------------------------------------------------------------
In April 2009, FASB again adjusted the accounting rules to
loosen the use of immediate fair value accounting. It adjusted
marking-to-market guidance in circumstances when fair value
indicates a necessary adjustment to reflect a permanent
impairment. One of the new rules suspends the need to apply
fair value principles for securities classified under
available-for-sale or held-to-maturity if market prices are
either not available or are based on a distressed market.\48\
The rationale for this amendment is that security investments
held by an entity without the intent to sell can distort
earnings in an adverse market climate.
---------------------------------------------------------------------------
\48\ Financial Accounting Standards Board, FASB Staff Position:
Determining Fair Value When the Volume and Level of Activity for the
Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly (FSP FAS 157-4) (Apr. 9, 2009)
(hereinafter ``FSP 157-4''). FSP 157-4 relates to determining fair
values when there is no active market or where the price inputs being
used represent distressed sales. For this the FSP establishes the
following eight factors for determining whether a market is not active
enough to require mark-to-mark accounting:
1. There are few recent transactions.
2. Price quotations are not based on current information.
3. Price quotations vary substantially either over time or among
market makers.
4. Indexes that previously were highly correlated with the fair
values of the asset or liability are demonstrably uncorrelated with
recent indications of fair value for that asset or liability.
5. There is a significant increase in implied liquidity risk
premiums, yields, or performance indicators (such as delinquency rates
or loss severities) for observed transactions or quoted prices when
compared with the reporting entity's estimate of expected cash flows,
considering all available market data about credit and other
nonperformance risk for the asset or liability.
6. There is a wide bid-ask spread or significant increase in the
bid-ask spread.
7. There is a significant decline or absence of a market for new
issuances for the asset or liability or similar assets or liabilities.
8. Little information is released publicly.
---------------------------------------------------------------------------
The second new rule (FAS 115-2) applies to permanently
impaired assets classified as available-for-sale or held-to-
maturity, that the holder does not intend to sell, or believes
it will not be forced to sell, before they mature.\49\ Under
the new rule, the part of the permanent impairment that is
attributable to market forces does not reduce earnings and does
not reduce regulatory capital; under the old rule, the part of
the permanent impairment attributable to market forces does
reduce earnings and regulatory capital. Banks argued that the
market prices for many asset-backed debt securities had fallen
sharply due to adverse market conditions despite the underlying
loans backing the securities continuing to pay as expected.
Hence the rule change protects bank capital from changes in the
market value of impaired assets that the bank decides to hold
in the hope of eventual recovery.
---------------------------------------------------------------------------
\49\ Financial Accounting Standards Board, FASB Staff Position:
Recognition and Presentation of Other-Than-Temporary Impairments (FSP
No. FAS 115-2 and FAS 124-2) (hereinafter ``FSP FAS 115-2''). This FASB
Staff Position (FSP) amends the recognition guidance for the other-
than-temporary impairment (OTTI) model for debt securities and expands
the financial statement disclosures for OTTI on debt securities. Under
the FSP, an entity must distinguish debt securities the entity intends
to sell or is more likely than not required to sell the debt security
before the expected recovery of its amortized cost basis. The credit
loss component recognized through earnings is identified as the amount
of principal cash flows not expected to be received over the remainder
term of the security as projected based on the investor's projected
cash flow projections using its base assumptions. Part of the entity's
required expansion in disclosure includes detailed explanation on the
methodology utilized to distinguish securities to be sold or not sold
and to separate the impairment between credit and market losses. FSP
FAS 115-2 does not change the recognition of other-than-temporary
impairment for equity securities.
---------------------------------------------------------------------------
The changes in these accounting rules are the subject of a
continuing debate on which the Panel takes no position. First,
although the new interpretation was issued at the beginning of
April, it was made retroactive to the beginning of 2009 for
firms that elected early adoption and wished to restate their
financial reports. For example, Bank of New York Mellon
experienced a one-time increase in their first quarter 2009
earnings of $676 million (after-tax) \50\ on net income of $322
million as a result of retroactively implementing the new mark-
to-market FASB rules.
---------------------------------------------------------------------------
\50\ The Bank of New York Mellon Corporation, First Quarter 2009
Form 10 Q (Apr. 8, 2009), at 46 (online at www.sec.gov/Archives/edgar/
data/1390777/000119312509105511/d10q.htm#tx88461_27).
---------------------------------------------------------------------------
Second, institutions moved securities from their trading
account to available-for-sale and held-to-maturity accounts to
take them out of an automatic mark-to-market classification and
into classifications that fall under the new rule.
Third, the new rule reduces investor transparency as
institutions are not required to use observable market inputs
if the bank managers consider the market to be ``distressed.''
\51\ As such, investors have difficulty valuing assets that
fall under the new rule.\52\
---------------------------------------------------------------------------
\51\ FSP 157-4, supra note 48, at 16.
\52\ Mark-to-Market Analysis, supra note 46, at 12.
---------------------------------------------------------------------------
The details of these accounting issues are less important
than their impact. As a result of the crisis, asset values are
uncertain. By increasing bank managements' use of discretion in
valuing assets, the new rules reinforce the underlying
uncertainty in valuation, especially because banks may not
apply the rules in a uniform way. Thus, there is no way of
knowing whether a bank's assets are of a sufficient realizable
value to support the bank's liabilities, let alone to preserve
the capital necessary to support lending. To lower the risk of
this uncertainty, banks, especially large banks, have reduced
participation in the credit markets. Whatever the merits of the
new accounting rules, their application adds to the sort of
uncertainty on which financial crises feeds.
C. ESTIMATING THE AMOUNT OF TROUBLED ASSETS
The risks troubled assets continue to pose for the banking
system depend on how many troubled assets there are. But no one
appears to know for certain. To frame the discussion in the
report, this section provides readers with a perspective on the
size and current state of the troubled assets pool.
Some caveats are in order at the outset. It is impossible
to ever arrive at an exact dollar amount of troubled assets,
but even the challenges of making a reliable estimate are
formidable. There are several reasons. No agreed-upon
definition of ``troubled asset'' (or of asset subcategories)
exists.\53\ It is difficult to assemble relevant (and reliable)
numbers from publicly-available information. Values and asset
quality fall along a constantly changing continuum. The
relevant markets are huge, complex, and global. It is often
difficult to distinguish troubled assets from assets that have
already been written-down to reflect current conditions.
Finally, the effect of future conditions on the asset pool can
only be projected, and loss estimates are no better than the
projections themselves, a fact reflected in the steep drop in
the value of troubled complex securities once the wave of
subprime loan defaults began. However, meaningful estimates can
still be derived to help inform this discussion.
---------------------------------------------------------------------------
\53\ There are, however, accepted definitions of degrees of loan
impairment.
---------------------------------------------------------------------------
This section reflects several approaches. First, it
assembles information from the financial statements for the 19
stress-tested bank holding companies. Second, it examines the
data on loans from these same BHCs that are more than 90 days
past due. Next it discusses the credit default exposure of
these same BHCs. Finally it models prospective losses on whole
loans for all BHCs with over $600 million in assets, thus
including smaller national and regional BHCs and the largest
community banks that are BHCs. (A more in-depth discussion of
the techniques used can be found in the Annex to Section One of
this report.)
In publicly-available data reviewed by the Panel, the 19
stress-tested BHCs have reported:
$657.5 billion in Level 3 assets;\54\
---------------------------------------------------------------------------
\54\ As of March 31, 2009. Level 3 assets are described supra note
45.
---------------------------------------------------------------------------
$132.9 billion in annualized loan losses;
\55\
---------------------------------------------------------------------------
\55\ As of June 30, 2009.
---------------------------------------------------------------------------
$264.6 billion in past due loans; and \56\
---------------------------------------------------------------------------
\56\ As of March 31, 2009.
---------------------------------------------------------------------------
$8.9 trillion in credit default sub-
investment grade exposure.\57\
---------------------------------------------------------------------------
\57\ As of March 31, 2009.
---------------------------------------------------------------------------
1. INFORMATION FROM COMPANY FINANCIAL STATEMENTS AND FEDERAL RESERVE
BHC REPORTS \58\
---------------------------------------------------------------------------
\58\ See Annex to Section One for details on sourced data.
---------------------------------------------------------------------------
The Panel has aggregated information from public financial
records by summing the values of the appropriate line items
from each bank's financial statements as reported to the SEC
and the Federal Reserve Board. The usefulness of public
financial records is limited, though, by a lack of uniformity
in reporting and formatting and a lack of granularity.\59\ The
Panel is not trying to determine the correct valuation of any
of these assets, simply to reach an estimate of their size
based on the values banks assigned to them.
---------------------------------------------------------------------------
\59\ See Annex to Section One for further discussion.
---------------------------------------------------------------------------
a. Level 3 Assets
The Panel first examined Level 3 assets which are required
to be reported and disclosed by the Financial Accounting
Standards Board (under FAS No. 157) and the Federal Reserve
Board.\60\ Level 3 assets include assets for which it is
difficult to find reliable external indicators of value.\61\
Because many toxic assets are inherently difficult or
impossible to model, they are most likely to be found on a
bank's balance sheet as Level 3 assets, thus this number is
instructive. Given the complexity of the packaging of certain
real estate-related securities and the illiquidity in the
markets, certain assets that fall under the Level 3 category
are not non-performing assets, and certain assets that fall
within the Level 2 assets (and occasionally even Level 1) may
also ultimately prove troubled.
---------------------------------------------------------------------------
\60\ See Federal Financial Institutions Examination Council,
Instructions for Preparation of Consolidated Reports of Condition and
Income, at 424-25 (June 2009) (online at www.ffiec.gov/PDF/FFIEC_forms/
FFIEC031_FFIEC041_200906_i.pdf).
\61\ See supra note 45.
---------------------------------------------------------------------------
According to first quarter 2009 financial statements, the
19 stress-tested financial institutions held approximately
$657.5 billion of Level 3 assets.\62\ This was a 14.3 percent
increase in Level 3 assets compared to three months prior
(December 31, 2008). In addition, certain financial
institutions such as Bank of America, PNC Financial, and Bank
of New York Mellon had twice as many assets (in terms of
dollars) classified as Level 3 in the first quarter of 2009
compared to year-end 2008. BHCs such as Morgan Stanley had more
than ten percent of their total assets categorized as Level 3.
---------------------------------------------------------------------------
\62\ Does not include American Express which did not report Level 3
Asset data in its SEC filings.
FIGURE 4: LEVEL 3 ASSET EXPOSURES \63\
Quarter ended March 31, 2009--(USD in billions)
--------------------------------------------------------------------------------------------------------------------------------------------------------
% of
MBS ABS Loans Mortg. Other Deriv. AFS Corp. Other Total % Total
serv. assets sec. debt sec. change assets
--------------------------------------------------------------------------------------------------------------------------------------------------------
Bank of America............................. $10.4 $9.6 $14.3 $14.1 $6.1 $41.8 $11.9 $18.7 $126.9 127% 5%
Bank of New York-Mellon..................... $3.1 $0.2 $0.1 $0.3 $3.7 441% 2%
BB&T........................................ $0.4 $0.2 $1.0 $1.6 3% 1%
Capital One Financial....................... $0.3 $2.2 $0.7 $2.3 $5.4 30% 3%
Citigroup................................... $18.5 $26.1 $0.2 $5.5 $2.5 $49.9 $20.9 $123.6 -15% 7%
Fifth Third Bank............................ $0.0 $0.0 $0.2 $0.2 24% 0%
GMAC........................................ $1.0 $1.7 $2.6 $0.5 $0.3 $0.4 $6.6 -9% 4%
Goldman Sachs............................... $11.6 $9.9 $12.0 $7.6 $13.6 $54.7 -8% 6%
JPMorgan Chase.............................. $38.7 $3.0 $10.6 $10.6 $69.4 $12.5 $144.8 33% 7%
KeyCorp..................................... $1.1 $0.0 $0.8 $1.9 -8% 2%
MetLife..................................... $0.8 $2.0 $0.2 $0.4 $3.4 $10.9 $1.5 $19.2 -13% 4%
Morgan Stanley.............................. $8.8 $26.0 $31.5 $1.0 $67.3 -22% 11%
PNC Financial............................... $1.2 $1.1 $1.6 $0.2 $14.4 $18.5 163% 6%
Regions Financial........................... $0.1 $0.2 $0.3 -50% 0%
State Street................................ $9.8 $0.6 $0.1 $10.5 14% 7%
SunTrust Banks.............................. $1.4 $0.7 $0.4 $1.4 $3.9 6% 2%
U.S. Bancorp................................ $3.6 $0.6 $1.2 $1.6 $7.0 47% 3%
Wells Fargo................................. $10.2 $4.5 $12.4 7.8 $26.7 $61.7 47% 5%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total................................... $657.5
--------------------------------------------------------------------------------------------------------------------------------------------------------
\63\ The data used in creating this chart is derived from the quarterly and yearly SEC filings of the following companies from the period 12/31/08 to 3/
31/09: Bank of America; Bank of New York Mellon; BB&T; Capital One Financial; Citigroup; Fifth Third Bank; GMAC; Goldman Sachs; J.P. Morgan Chase;
KeyCorp; MetLife; Morgan Stanley; PNC Financial; Regions Financial; State Street; SunTrust Bank; U.S. Bancorp.
Analysis does not include American Express which did not report Level 3 Asset data in its SEC filings.
b. Loan Losses and Non-Performing Loans \64\
---------------------------------------------------------------------------
\64\ Analysis on loan losses does not include GMAC which did not
report loan losses in its SEC filings. Analysis on non-performing loans
does not include American Express, GMAC, and MetLife which did not
report loan losses in their SEC filings.
---------------------------------------------------------------------------
The Panel conducted an analysis of loan losses and non-
performing loans based on data from the financial statements
from year-end 2007 through the second quarter of 2009 for the
19 stress-tested BHCs. As of the second quarter of 2009, the 19
stress-tested BHCs had $132.9 billion in annualized loan
losses. With a combined loan loss cumulative annual growth rate
during this period of 56.6 percent, the stress-tested BHCs
continue to experience substantial whole loan write-downs on
their balance sheets. Further, non-performing loans increased
significantly for all the stress-tested BHCs between the second
quarters of 2008 and 2009.
c. 90+ Day Past Due Loans \65\
---------------------------------------------------------------------------
\65\ Analysis does not include GMAC and MetLife, which did not
report 90+ Day Past Due Loans data in its FED Y-9Cs.
---------------------------------------------------------------------------
Exposure to past due securitization assets for the 19
largest BHCs increased from $23.2 billion year-end 2007 to
$264.6 billion as of the end of the first quarter 2009. Past
due securitization assets increased eleven times in 15 months.
For example, Bank of America had $5.0 billion of past due
securitization assets \66\ on its balance sheet at the end of
2007, but that number ballooned to $141.7 billion at the end of
March 2009 (some of this resulted from its acquisitions of
Countrywide and Merrill Lynch).
---------------------------------------------------------------------------
\66\ Includes direct positions only.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
d. Credit Default Sub-Investment Grade Exposure \68\
---------------------------------------------------------------------------
\67\ The data used in creating this chart came from the quarterly
Federal Reserve Bank Holding Company Performance Reports of the
following companies from the period 12/31/07 to 3/31/09: Bank of
America; Bank of New York Mellon; BB&T; Capital One Financial;
Citigroup; Fifth Third Bank; Goldman Sachs; J.P. Morgan Chase; KeyCorp;
Morgan Stanley (online at www.ffiec.gov/nicpubweb/nicweb/
Top50Form.aspx).
This graph present two very different sets of values given the
amount of Past Due 90+ Loans held by the various banks differs
substantially. Presenting the data in this way reflects each bank's
holdings on a percentage basis as each.
\68\ This analysis does not include American Express, GMAC, and
MetLife which did not include Credit Derivative Sub-Investment Grade
data per their FED Y-9Cs.
---------------------------------------------------------------------------
Credit derivatives on sub-investment grade assets create
large amounts of unregulated exposure to potential defaults on
lower quality loans, amplifying the effect of defaults. Similar
to past due securitization assets, credit derivative exposure
for sub-investment grade assets experienced a significant
uptick in the same period. Sub-investment grade credit
derivative exposure for the 19 largest BHCs grew from $1.6
trillion in year end 2007 to $8.9 trillion in the first quarter
of 2009 as a result of downgrades.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
---------------------------------------------------------------------------
\69\ The data used in creating these graphs were derived from the
quarterly Federal Reserve Bank Holding Company Performance Reports of
the following companies from the period 12/31/07 to 3/31/09: Bank of
America; Bank of New York Mellon; BB&T; Capital One Financial;
Citigroup; Fifth Third Bank; Goldman Sachs; J.P. Morgan Chase; KeyCorp;
Morgan Stanley; PNC Financial; Regions Financial; Sun Trust Banks; U.S.
Bancorp; Wells Fargo (online at www.ffiec.gov/nicpubweb/nicweb/
Top50Form.aspx).
These graphs presents two very different sets of values given the
amount of Sub-investment Grade Credit Derivative held by the various
banks differs substantially. Presenting the data in this way reflects
each bank's holdings on a percentage basis as each.
As the data collected for this graph is driven by filings that are
required of BHCs, no data is available prior to the first quarter of
2009 for Goldman Sachs and Morgan Stanley (which only recently became
BHCs).
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
2. MODELING LOAN LOSSES \70\
---------------------------------------------------------------------------
\70\ See Annex to Section One for a more thorough discussion of the
Panel's model.
---------------------------------------------------------------------------
Whole loans have been the primary source of income for
traditional banks for more than 100 years, and remain such for
many of the smaller banks in the United States. A loan is
simply modeled by discounting its expected cash flows to the
present, while along the way applying some default and recovery
assumptions. Given knowledge about the individual or entity
that the loan was made to, and the value of its collateral, it
is fairly simple to calculate default and recovery rates.\71\
For these reasons, the Panel focused its quantitative efforts
on modeling losses in whole loans, assets which represent over
$5.9 trillion in the 719 banks modeled by the Panel.\72\ The
Panel also chose to model only whole loans because they are the
only troubled asset for which sufficient information is
available to create a reasonable model with few assumptions
that can be tested under a number of different scenarios. As a
result, the Panel's modeling is of greatest relevance to banks
that have invested a larger portion of their assets in whole
loans, which tend to be smaller banks. It should be remembered
that this does not portray the whole problem for larger banks
because it does not include their exposure to losses on account
of complex securities.
---------------------------------------------------------------------------
\71\ Even with this information, however, default rates cannot be
predicted with perfect accuracy. Importantly, such predictions are
based on the assumption that the information passed on by the
originator of the loan is absolutely correct, an assumption which,
especially in 2006 and 2007, was not always true. Moreover, default
rates are typically based on historical experience, which is an
unreliable guide after the bursting of an unprecedented bubble.
\72\ Data was obtained from Bank Holding Company Consolidated
Financial Statements, also known as Federal Reserve Form Y-9C (online
at www.ffiec.gov/nicpubweb/nicweb/NicHome.aspx).
---------------------------------------------------------------------------
a. Modeling
The Panel used a model developed by SNL Financial \73\ to
assess whole loan losses and potential capital shortfalls for
all BHCs with over $600 million in assets.\74\ This group
includes the stress-tested BHCs, national BHCs that were not
stress tested, but more significantly includes medium to large
regional BHCs.
---------------------------------------------------------------------------
\73\ Based in Charlottesville, Virginia, SNL Financial provides
news, data, and analysis on various business sectors, including banking
and other financial institutions.
\74\ Excluding 66 banks which did not supply enough information to
calculate Tier 1 common capital for the period ending March 31, 2009.
---------------------------------------------------------------------------
The model tested the banks against two scenarios: it began
with the ``starting point'' assumptions used similar to the
Federal Reserve Board in its analysis, and then used
assumptions that were 20 percent more negative.\75\ These
assumptions were used to project loan losses \76\ and BHCs' net
revenue, before subtraction for loan loss reserves, for the
next two years.\77\ Using this information and data on the
BHCs' loan loss reserves, the model was then able to calculate
the amount of capital necessary for each BHC to recapitalize
after the losses it sustained in the scenario.
---------------------------------------------------------------------------
\75\ See SCAP Design Report, supra note 26.
\76\ Loan losses are calculated as the product of the loan loss
rate as dictated by the scenario, with the total loans of that type
held by each bank. The Panel used two methods to calculate loan losses:
a standard and a customized. The standard method used the loan loss
rates stated in the stress test and uniformly applied them across all
of the BHCs considered. The customized approach attempted to tailor
these aggregate loan loss rates to individual banks, on the basis of
their past performance. Thus for banks whose loans consistently
outperformed the market, their loan loss rate was lowered, while banks
that consistently hold lower quality loans had their loan loss rates
raised.
\77\ Calculated based on data from the past two years.
---------------------------------------------------------------------------
b. Results of the Panel's Analysis of Loan Losses \78\
---------------------------------------------------------------------------
\78\ To test the accuracy of its estimates, the Panel calibrated
its model to the results of the stress tests. In doing so, it simply
used the results as a baseline and did not mean to accept or reject the
assumptions made there. The median result reached by the Panel in
calibrating its results was 2.5 percent higher than the stress tests;
the difference was most likely the result of the portions of the stress
tests that cannot be independently replicated.
---------------------------------------------------------------------------
The Panel's analysis shows that given the necessary capital
additions raised since May 2009, the 18 largest BHCs \79\ would
be able to deal with projected losses in their whole loan
portfolios. This strength is, in large part, due to the rebound
in earnings of banks in the first quarter of 2009; those
earnings increased even if one excludes one-time accounting
adjustments. This is very encouraging, especially considering
the recent trends in the Case-Shiller index, which showed that
housing prices may be rebounding.\80\ But again, this analysis
deals only with whole loans; it does not include the risks
these large banks face from their holdings of complex
securities. The Panel has not analyzed how the interaction of
whole loans and complex security holdings could affect large
banks.
---------------------------------------------------------------------------
\79\ Excludes GMAC due to no reported data in the FED Y9-C reports.
\80\ See, e.g., Standard & Poor's, Home Price Declines Continue to
Abate According to the S&P/Case-Shiller Home Price Indices (July 28,
2009) (online at www2.standardandpoors.com/spf/pdf/index/
CSHomePrice_Release_072820.pdf) (``[T]he 10-City and 20-City [Case-
Shiller] Composites reported positive returns for the first time since
the summer of 2006.''). This figure is not seasonally adjusted.
---------------------------------------------------------------------------
The Panel's analysis of troubled whole loans suggests they
pose a threat to the financial health of smaller banks (``$600
million to $100 billion group'').\81\ Using the same
assumptions, it looks as if banks in the $600 million to $100
billion group will need to raise significantly more capital, as
the estimated losses will outstrip the projected revenue and
reserves. Under the ``starting point'' scenario, this second
group of banks will need to raise $12-14 billion in capital to
offset their losses, while in the ``starting point + 20%''
scenario, non-stress-tested banks are expected to have to raise
$21 billion in capital to offset their losses. The capital
shortfall for those relatively smaller banks, as shown below in
Figure 8, is primarily due to the lack of reserves, which on
average account for only 25 percent of the expected loan
losses.
---------------------------------------------------------------------------
\81\ $600 million was chosen as the floor asset level because it is
the lowest at which the requisite information for modeling the loan
losses and revenues was present in public filings.
FIGURE 7: LOAN LOSSES PROJECTED FROM Q1 2009 INFORMATION
[Dollars in millions]
----------------------------------------------------------------------------------------------------------------
Starting Point Starting Point + 20%
----------------------------------------------------------------
Standard Customized \82\ Standard Customized
----------------------------------------------------------------------------------------------------------------
Top 18 BHCs \83\............................... 486,458 504,083 583,749 604,804
All Banks with Assets $100B to $600M \84\...... 152,134 123,069 182,560 146,560
----------------------------------------------------------------
Total (All banks $600M+)................... 638,591 627,152 766,309 751,364
----------------------------------------------------------------------------------------------------------------
\82\ See supra, note 74. See also Annex to Section One of this report.
\83\ Stress-tested BHCs excluding GMAC.
\84\ Excluding Keycorp, which is one of the 18 BHCs, but whose assets have fallen below $100 billion.
FIGURE 8: CAPITAL SHORTFALLS PROJECTED FROM Q1 2009 INFORMATION
[dollars in billions]
----------------------------------------------------------------------------------------------------------------
Starting Point Starting Point + 20%
---------------------------------------------------------------
Standard Customized Standard Customized
----------------------------------------------------------------------------------------------------------------
Top 18 BHCs \85\................................ 0.0 0.0 8.71 2.33
All Banks with Assets $100B to $600M \86\....... 11.70 13.99 21.45 21.25
---------------------------------------------------------------
Total (All banks $600M+).................... 11.70 13.99 30.16 23.57
----------------------------------------------------------------------------------------------------------------
\85\ Stress-tested BHCs, excluding GMAC.
\86\ Excluding Keycorp, which is one of the 18 BHCs, but whose assets have fallen below $100 billion.
The calculations performed by the Panel imply that while
the 18 largest BHCs are sufficiently capitalized to deal with
whole loan losses, the relatively smaller BHCs, i.e., those in
the $600 million to $100 billion group, are not, and are going
to require additional capital given more severe economic
conditions. The Panel sees the undercapitalization of the BHCs
in the latter group as a serious issue; those banks may have
access to a comparatively smaller pool of investors, and could
face significant challenges in raising the necessary capital.
3. ESTIMATES FROM OTHER SOURCES
The Federal Reserve, IMF, Goldman Sachs and RGE Monitor
have each performed independent analyses of expected loan
losses and complex securities write-downs across U.S. banks.
These analyses looked at the entirety of bank portfolios, not
just whole loans. Although none of these organizations made
public the models they used, it is useful to compare their
results to gain a sense of the scale of the troubled asset
problem. It is important to remember that while the IMF,
Goldman Sachs and RGE Monitor estimates were based on neutral
projections of the future, the Federal Reserve estimate was
based on a downside, or stressed, projection. It should be
noted that the Panel's analysis of whole loans is a subset of
the universe of assets these estimates looked at, and so the
Panel's estimates of troubled whole loan exposure should not be
directly compared to these estimates.
FIGURE 9: COMPARISON OF 2009-10 WRITE-DOWN ESTIMATES FOR U.S. BANKS
----------------------------------------------------------------------------------------------------------------
Assumed Peak to
Trough House Total Write- Remaining
Test Banks Measured Price Decline Date downs (2007- Write-downs
\87\ 10) ($b) (2009-10) ($b)
----------------------------------------------------------------------------------------------------------------
Federal Reserve Stress Test 19 largest U.S. 47% May 2009....... N/A $ 599.2
(Adverse Case). BHCs \88\.
IMF.......................... All U.S. Banks. 40% April 2009..... $ 1,060 $ 550
Goldman Sachs................ All U.S. Banks. 40% January 2009... $ 960 $ 450
RGE Monitor \89\............. All U.S. Banks. 41% January 2009... $ 1,730 $ 1,220
----------------------------------------------------------------------------------------------------------------
\87\ The Case-Shiller 20-City Composite Index shows that housing prices have declined 32 percent from peak to
trough as of May 2009. 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_072820.xls)
(accessed Aug. 4, 2009). However, non-seasonally adjusted home prices increased in May 2009, the first month
to see an increase since July 2006, perhaps indicating that the home price slide is beginning to bottom out.
\88\ These BHCs hold two thirds of U.S. bank assets.
\89\ RGE Monitor's remaining write-downs estimate for U.S. banks is significantly higher than the other
estimates both because it estimates a greater amount of credit losses and because it predicts a greater
percentage of those losses will be borne by U.S. banks. For example, as compared to the IMF estimate, RGE
Monitor assumes 29 percent greater aggregate credit losses, and assigns 49 percent, as compared to the IMF's
39 percent, to U.S. banks.
All of these estimates, including the Panel's own, suggest
that substantial troubled assets remain on banks' balance
sheets.
D. CURRENT STRATEGIES FOR DEALING WITH TROUBLED ASSETS
Approaches taken in two prior banking crises are useful in
placing current strategies in perspective. Those approaches
also suggest some possible steps to address the current
situation.
1. PAST APPROACHES
a. Less Developed Country (LDC) Crisis
Beginning in the early 1970s, Latin American countries'
borrowing increased significantly. At the end of 1970,
outstanding debt from all sources totaled $159 billion.\90\ By
1978, it had risen to $506 billion, and in 1982 it totaled $722
billion.\91\ The eight largest money-center banks held $121
billion of this debt.\92\ By the early 1980s, money-center
banks carried high exposure to the risks of these loans--the
average money-center bank carried an LDC loan to total capital
and reserves concentration of 217 percent.\93\ In August of
1982, Mexico was the first country to announce that it could no
longer make interest payments on the debt. By the end of that
year, approximately 40 other countries had joined it in failure
to meet debt service obligations.\94\
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\90\ All dollar values in this section are adjusted for inflation,
as measured by the consumer price index (CPI), to reflect their
approximate current-dollar value. See U.S. Department of Labor, Bureau
of Labor Statistics, CPI Detailed Report, Data for June 2009, at 72, 74
(July 15, 2009) (online at www.bls.gov/cpi/cpid0906.pdf).
\91\ Federal Deposit Insurance Corporation, History of the
Eighties--Lessons for the Future, Ch. 5: The LDC Debt Crisis, at 199
(online at www.fdic.gov/bank/historical/history/191_210.pdf) (accessed
Aug. 3, 2009) (hereinafter ``History of the Eighties'').
\92\ Id.
\93\ Id. at 199.
\94\ Id. at 206.
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From 1983 through 1989, the banks and countries negotiated
to reschedule and restructure the debt. At the same time, banks
increased loan loss reserves; by the end of 1989, banks' loan
loss reserves totaled nearly 50 percent of their outstanding
LDC loans. In 1989, Treasury Secretary Nicholas Brady developed
a plan to convert the non-performing LDC debt into tradable,
dollar denominated bonds. Because these bonds, called Brady
Bonds, were tradable, they allowed banks to get the debt off
their balance sheets, thus reducing the concentration risk. It
also amounted to a forgiveness of approximately one third of
the $328 billion in outstanding debt.\95\
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\95\ Id. at 209.
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The success of the work-outs in this situation raises the
question whether a series of work-outs shaped to the current
crisis would help alleviate the situation. Indeed, Treasury,
the Federal Reserve Board, and the Federal Reserve Bank of New
York have taken something of this approach in dealing with
AIG.\96\ Treasury has indicated its view that such work-outs
cannot play more than a limited role now, \97\ but repayment of
TARP assistance by many institutions and the hoped for
restarting of the markets for troubled securities make
supervised work-outs a matter worth exploring.
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\96\ One example of a work-out in the current crisis is the use of
two entities (Maiden Lane LLC II and III) organized by the Federal
Reserve Bank of New York (the Bank) to buy toxic assets held by AIG or
its counterparties. Maiden Lane II bought $20.8 billion of toxic
residential mortgage-backed securities from AIG using in part a $19.5
billion loan from the Federal Reserve Bank; Maiden Lane III bought from
counterparties of AIG approximately $29.6 billion of complex securities
backed by a number of asset types, using in part a $24.3 billion loan
from the Federal Reserve Bank.
\97\ See U.S. Department of the Treasury, Financial Regulatory
Reform, A New Foundation: Rebuilding Financial Supervision and
Regulation at 76 (June 2009) (online at www.financialstability.gov/
docs/regs/FinalReport_web.pdf) (``Thus, if a large, interconnected bank
holding company or other nonbank financial firm nears failure during a
financial crisis, there are only two untenable options: obtain
emergency funding from the US government as in the case of AIG, or file
for bankruptcy as in the case of Lehman Brothers. Neither of these
options is acceptable for managing the resolution of the firm
efficiently and effectively in a manner that limits the systemic risk
with the least cost to the taxpayer.'').
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b. The Resolution Trust Corporation
A few years later, the banking industry faced a domestic
asset quality crisis. In the late 1980s, over one thousand
savings and loan institutions (or ``thrifts'') failed.\98\ In
1989, Congress created the Resolution Trust Corporation (RTC)
to aid the FDIC in the process of resolving failed savings and
loan institutions.\99\ The RTC's role was to take control of
the assets, both sound and troubled, of any thrift the FDIC
placed in receivership, and eventually sell them on the market.
The RTC sold the assets of 747 failed institutions with total
assets of approximately $400 billion.\100\ It disposed of 95
percent of the thrifts' overall assets, with a recovery rate of
approximately 85 percent of the value of the assets it
acquired.
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\98\ See Congressional Oversight Panel, April Oversight Report:
Assessing Treasury's Strategy: Six Months of TARP, at 44-50 (April 7,
2009) (online at cop.senate.gov/documents/cop-040709-report.pdf).
\99\ See Financial Institutions Reform, Recovery and Enforcement
Act of 1989 (FIRREA), Pub. L. No. 101-73, at Sec. 501.
\100\ Government Accountability Office, Financial Audit: Resolution
Trust Corporation's 1995 and 1004 Financial Statements, at 8 (July
1996) (online at www.gao.gov/cgi-bin/getrpt?AIMD-96-123) (hereinafter
``GAO Audit'').
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The RTC experience presents an example of one course the
government can take to resolve failed banks and their troubled
loan portfolios. In contrast to assisting banks that remain
open for business, with or without some amount of government
ownership, the RTC dealt with only closed institutions and
their assets. In its operations, the RTC attempted to sell as
many whole thrifts as possible, which had the effect of passing
along both the assets and liabilities of a failed institution.
Investors contemplating bidding for any particular institution
would have to exercise substantial due diligence in reviewing a
failed thrift's assets to estimate reasonably their salvageable
value, including the ability to readily foreclose on defaulted
loans and acquire the underlying collateral. In practice, this
meant that the bids the RTC received, especially early on,
reflected a substantial risk premium.
Not all of the failed savings and loans assigned to the RTC
could be resolved using the whole thrift transaction process.
The FDIC often shut the thrift down and paid off the
depositors. The RTC would then sell the assets.\101\ The RTC
used three methods for disposing of assets. It sold the
majority of the assets through auctions, but assets were also
disposed of through equity partnerships and securitization. At
least $232 billion of assets were sold using these three
methods.\102\
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\101\ In addition, on some occasions, the FDIC stripped out certain
assets before placing the institution up for auction.
\102\ GAO Audit, supra note 100, at 9.
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Auctions were the most common method that the RTC used to
dispose of assets. Initially it sold assets one by one, but by
mid-1990 it began to use bulk sales of packaged assets. The
auctions were either sealed-bid auctions or ``open outcry''
auctions, using an auctioneer and often held near the location
of the assets.
The RTC used equity partnerships in situations where the
market price for a bulk sale was significantly less than what
the RTC hoped to obtain for the assets. These partnerships
involved a private sector partner \103\ that would obtain a
partial interest in the group of assets, while the RTC retained
an equity interest. The private sector partner would manage the
assets and the sale of the assets, providing the RTC with
distributions from the proceeds of the sales. In addition the
RTC used securitization as a method to dispose of commercial
and multi-family loans. It is seen as a pioneer in this field.
---------------------------------------------------------------------------
\103\ Section 21A(b)(II)(A)(ii) of the Federal Home Loan Bank Act
of 1932 required the RTC to use private sector resources to the extent
that it was ``practicable and efficient.''
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The RTC is widely regarded as having been a success. But
that success was in large measure a function of the nature of
the institutions it resolved and the composition and relative
transparency of their loan portfolios. The resolution of a
failed institution is a very different task than attempting to
coax a solvent firm to take significant write-downs by selling
its loans at a discount. The RTC had two other important
differences from the current situation. First, the RTC sold
assets held by bankrupt thrifts that had been seized by
regulators. Second, it was selling assets, not buying them
(albeit a subsidy was provided in both cases). In contrast to
certain types of troubled assets held by troubled financial
institutions in the current financial crisis, the underlying
properties on which thrifts had made loans were easily
identifiable and were often large projects that could be
appraised and for which completion costs could be readily
estimated. Whether investors acquired these tangible assets
directly from the RTC or as collateral for the troubled loans
of the institutions on which they were successful bidders, the
ability of the market to value these assets to the satisfaction
of buyers and sellers was a key factor in the RTC's successful
sales.
2. TREASURY'S PRESENT STRATEGY
Treasury's policies to date have indicated its awareness of
the problems posed by the continued presence of troubled assets
in the banking system. It has recognized that valuation
directly affects bank solvency and ability to lend. Treasury's
implementation of the TARP--especially its capital injection
policy and the related implementation of the stress tests by
the Federal Reserve Board--combines a variety of approaches
toward protecting the financial system against the threat posed
by troubled assets and weak balance sheets. Those approaches
are promising, but they also face obstacles.
a. The Capital Purchase and Capital Assistance Programs
Treasury can inject further capital assistance into banks
under the original Capital Purchase Program or the Capital
Assistance Program (CAP).\104\ Thus, Treasury retains the
option to follow the strategy it used at the beginning of the
crisis: shoring up bank capital directly to offset losses
derived from troubled assets. It may prove that this capacity
is important, to assist smaller banks, as well as to continue
to support larger institutions that prove to still be at risk.
Approximately 445 banks have received capital assistance since
January 1, 2009.\105\ However, this type of assistance has in
the past raised issues as to whether the transactions maximized
taxpayer value (see February report).
---------------------------------------------------------------------------
\104\ U.S. Department of the Treasury, TARP Transactions Report For
Period Ending July 31, 2009 (Aug. 4, 2009) (online at
www.financialstability.gov/docs/transaction-reports/transactions-
report_08042009.pdf) (hereinafter ``July 31 TARP Transactions
Report''). This excludes Bank of America.
\105\ Id.
---------------------------------------------------------------------------
b. The PPIP
Treasury's Public-Private Investment Program (PPIP) is
aimed directly at troubled assets. Treasury has worked to build
a structure that it believes can restart the market, and
encourage price discovery, for those assets, and thus go a long
way to resolving uncertainty about the way banks should value
the assets.
The PPIP was originally created with two sub-programs: a
legacy securities program, aimed at complex securities, and a
legacy loans program, aimed at troubled whole loans.
The legacy loans program was designed to create Public-
Private Investment Funds (PPIFs) using a mix of private and
public equity and FDIC-guaranteed debt that would be created to
buy and manage pools of mortgages and similar assets. A bank,
in consultation with its primary regulators, Treasury, and the
FDIC, would identify assets, typically a pool of loans that the
bank would like to sell. Then the FDIC would analyze the asset
pool to determine the appropriate guaranteed debt-to-equity
ratio that could be supported by the pool for the PPIF that
would buy the loans, guided by a third party valuation firm.
The highest ratio permitted would be a six-to-one debt-to-
equity ratio. The debt would be guaranteed by the FDIC on a
non-recourse basis, so that the borrower had no additional
liability; Treasury, using TARP funds, and the private
investors would split the remaining equity investment.\106\
Investors would be sought via auction for a transaction
structured in this fashion.
---------------------------------------------------------------------------
\106\ Treasury provided the following example in its press release
announcing the program:
If a bank has a pool of residential mortgages with $100 face value
that it is seeking to divest, the bank would approach the FDIC. The
FDIC would determine, according to the above process, that they would
be willing to leverage the pool at a 6-to-1 debt-to-equity ratio. The
pool would then be auctioned by the FDIC, with several private sector
bidders submitting bids. The highest bid from the private sector--in
this example, $84--would be the winner and would form a Public-Private
Investment Fund to purchase the pool of mortgages. Of this $84 purchase
price, the FDIC would provide guarantees for $72 of financing, leaving
$12 of equity. The Treasury would then provide 50 percent of the equity
funding required on a side-by-side basis with the investor. In this
example, Treasury would invest approximately $6, with the private
investor contributing $6. The private investor would then manage the
servicing of the asset pool and the timing of its disposition on an
ongoing basis--using asset managers approved and subject to oversight
by the FDIC.
U.S. Department of the Treasury, Treasury Department Releases
Details on Public Private Partnership Investment Program (Mar. 23,
2009) (online at www.financialstability.gov/latest/tg65.html)
(hereinafter ``PPIP March Release'').
---------------------------------------------------------------------------
The legacy securities program was designed to buy mortgage-
backed securities by creating funds managed by private fund
managers selected by the government to act on behalf of
Treasury and private investors. The fund managers were to raise
$500 million in private equity, which would then be matched by
an equal amount of Treasury equity. The fund thus created would
then be able to obtain up to an additional $1 billion in
Treasury financing, bringing the total amount available to as
much as $2 billion.\107\
---------------------------------------------------------------------------
\107\ PPIP March Release, supra note 106.
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In announcing the PPIP in February, the Administration
cited the need to provide greater means for financial
institutions to cleanse their balance sheets of both types of
what it calls ``legacy assets.'' \108\ In a follow-up March
press release, Treasury emphasized one of the major points of
this report, namely, that troubled assets, ``create uncertainty
around the balance sheets of . . . financial institutions,
compromising their ability to raise capital and their
willingness to increase lending.'' \109\ Treasury reaffirmed
and expanded on these themes in the white paper accompanying
the March 23, 2009 press release announcing the details of the
program:
---------------------------------------------------------------------------
\108\ U.S. Department of the Treasury, Public-Private Investment
Program (online at www.treas.gov/press/releases/reports/
ppip_whitepaper_032309.pdf) (accessed Aug. 3, 2009) (hereinafter ``PPIP
White Paper'').
\109\ PPIP March Release, supra note 106.
A variety of troubled legacy assets are currently
congesting the U.S. financial system. An initial
fundamental shock associated with the bursting of the
housing bubble and deteriorating economic conditions
generated losses for leveraged investors including
banks. This shock was compounded by the fact that loan
underwriting standards used by some originators had
become far too lax and by the proliferation of
structured credit products, some of which were ill
---------------------------------------------------------------------------
understood by some market participants.
The resulting need to reduce risk triggered a wide-
scale deleveraging in these markets and led to fire
sales. As prices declined further, many traditional
sources of capital exited these markets, causing
declines in secondary market liquidity. As a result, we
have been in a vicious cycle in which declining asset
prices have triggered further deleveraging and
reductions in market liquidity, which in turn have led
to further price declines. While fundamentals have
surely deteriorated over the past 18-24 months, there
is evidence that current prices for some legacy assets
embed substantial liquidity discounts.\110\
---------------------------------------------------------------------------
\110\ PPIP White Paper, supra note 108.
The crucial elements of the program, according to Treasury,
are: (1) ``maximizing the impact of each taxpayer dollar'' by
using private capital to leverage public financing;\111\ (2)
shifting some of the risk onto the private sector by using
private capital; and (3) using market competition to assist in
setting prices.\112\
---------------------------------------------------------------------------
\111\ As the securities portion of the PPIP is structured, the
amount of risk the public sector may bear depends on how the individual
fund manager chooses to provide funding to the fund. The fund manager
may choose to create a $1 billion fund with $500 million of private
equity and $500 million of public (Treasury) equity, in which case the
private investors and the public have half the risk and half the
reward. The fund manager may alternatively seek to create a fund of up
to $2 billion by accepting $1 billion in public financing in the form
of secured non-recourse loans from Treasury. Under this scenario, the
public is at risk for 75 percent of the downside and 50 percent of the
upside.
The fund managers may also use the TALF to shift even more of the
downside risk to the public. Treasury has explicitly stated that it
anticipates that fund managers will seek TALF financing to purchase
eligible CMBS.
In this case, a fund manager would request a TALF loan to pay the
$500 million private equity portion of the PPIP fund (or PPIF).
Assuming a haircut of 15 percent, the Fund would receive a TALF loan of
$425 million and would therefore need to raise only $75 million in the
capital markets. The private sector would have only 3.75 percent of the
downside while still retaining the right to 50 percent of the upside.
Under the loan program, the private investor may buy at up to a
six-to-one-debt-to-equity ratio. And the equity is contributed in equal
parts by the private investor and Treasury. Since the financing is
provided in the form of non-recourse loans, the public could be
responsible for up to 90 percent of the downside risk for each
investment while sharing in only 50 percent of the potential profit.
Although the current allocation places the heavier risk on the
public, Treasury has noted that the risk allocation under the PPIP is
more favorable to taxpayers than an alternative that would require the
U.S. government to purchase assets directly and therefore bear all of
the risk.
\112\ PPIP March Release, supra note 106.
---------------------------------------------------------------------------
The proper balance of risk and reward between the public
and private investors is key to the PPIP's success. Treasury
has said that ``[t]his approach is superior'' to the
alternatives because ``[s]imply hoping for banks to work legacy
assets off over time risks prolonging a financial crisis,''
while government action alone would require taxpayers to ``take
on all the risk of such purchases--along with the additional
risk that taxpayers will overpay if government employees are
setting the price for those assets.''\113\ Alternative options
for tackling this problem relied solely on public funds and did
not sufficiently address the pricing issues plaguing these
markets.\114\
---------------------------------------------------------------------------
\113\ PPIP March Release, supra note 106. Treasury has the right to
terminate a fund in several situations to protect the taxpayers'
investments from changes in circumstance. Several rules assure that
Treasury will share equally in all distributions. All of the investment
funds must report to Treasury each month.
\114\ PPIP March Release, supra note 106.
---------------------------------------------------------------------------
A key aspect of the PPIP is its purported ability to use
the markets to provide some form of reliable valuation for
these assets. Treasury believes the PPIP can create a ``market
pricing mechanism.''\115\ The PPIP is designed to give
investors an incentive, in the form of risk sharing with and
financing guaranteed by the government, to compete to buy
legacy securities; the more money that flows into the markets
because of this competition and the more auction results
indicate asset prices, the more the markets will open and banks
have objective indicators to firm up accurate values for the
assets they retain on their balance sheets. Although the
current funding structure of the legacy securities program
involves a degree of subsidization, Treasury has noted that the
ability to share equally in asset price increases (as well as
losses) is a critical program feature and is far preferable to
a situation in which the government is forced to purchase all
of the risk of direct asset purchases.\116\ In addition to this
risk sharing, Treasury has built the legacy securities program
to help create market demand--and hence liquidity--by
encouraging competition among the funds created under the
program. It hopes that the presence of nine (or potentially
more) funds created for the sole purpose of buying legacy
securities will create incentives to raise price levels as the
funds compete until prices reach a level at which banks are
willing to sell.\117\
---------------------------------------------------------------------------
\115\ PPIP White Paper, supra note 108.
\116\ PPIP March Release, supra note 106. Obviously, such a
situation would also provide the public with the opportunity to reap
100 percent of any upside as well.
\117\ Competition among applicants for selection as fund managers
is also important. The application process includes a review of the
applicant's experience managing assets such as the ``legacy''
securities, the value of the applicant's current assets under
management, and other related qualifications. Treasury has reported
receiving more than 100 applications for the limited number of
positions. To the extent this process awards fund manager status to
only the most highly qualified, Treasury believes it has the advantage
of retaining top talent for the task of valuing and purchasing assets
through a mechanism that may be more effective than hiring such
qualified investors as government employees as would be necessary to
enable the government to buy the assets on its own.
---------------------------------------------------------------------------
In building the PPIP, Treasury's strategy resembles its
strategy for the TARP generally. It does not seek to ``clear''
all troubled assets from bank balance sheets, or to have a
stake in buying all troubled assets, any more than it wants to
own permanent stakes in banks. Instead it hopes to reinvigorate
the markets so that normal market processes can again operate;
if investors become confident that troubled assets carried on
bank balance sheets can be reliably priced, the system again
becomes self-supporting, subject to normal supervisory
oversight. Treasury remains ready to inject more money into the
program if further ``pump-priming'' is necessary to accomplish
that objective.
Assistant Secretary of the Treasury for Financial Stability
Herbert Allison explained Treasury's view of PPIP in his
testimony before the Panel on June 24, 2009:
It's our belief that when markets are illiquid and a
bank tries to sell assets, they're selling at fire sale
prices because it's a highly-inefficient market. The
idea is that if we increase liquidity, if we can act as
a catalyst to get these markets going, we will see the
spreads between bid and ask declining and there will be
more activity, more sales by banks, more investment by
individuals in a self-reinforcing process, but we have
to, we think, play a role in jumpstarting sectors of
the securitization market so that can happen.\118\
---------------------------------------------------------------------------
\118\ Allison Testimony, supra note 37.
The success of the PPIP as described by Treasury depends on
whether the circumstances in which it operates enable it to
restart the markets in a way that leads to accurate price
discovery and creates an upward spiral (more accurate pricing,
more investors, and so forth) to replace the downward spiral of
2008. Several obstacles lie in the way. It is not necessary
that they be eliminated all at once; in fact it is in the
nature of an effort such as this that progress will at first
perhaps be incremental.
There is a question as to whether the PPIP produces true
price discovery because of the degree of government
subsidization involved. The value of an asset is discounted by
the magnitude of the risk, but the intention of the program is
to reduce the risk and therefore reduce the discount required
by the buyer. The risk does not evaporate but is instead being
absorbed by the government. This is likely the reason that
Treasury is emphasizing the return of liquidity to the markets
once initial purchases are made on a subsidized basis; market
participants can determine a nonsubsidized price to keep the
market going--the key is to bring the first investors back into
the markets so that the process can start.
The next problem is more serious. Once a bank sells a
legacy security or legacy loan, it must book the sale value,
but if the bank holds the asset, it may continue to mark the
asset at the higher value permitted by the new rule. Thus any
sale at less than amortized cost value would forgo the benefit
of being able to avoid distress pricing and force perhaps
substantial write-downs. In addition, the acceptance of
accurate pricing in the market may require banks to write-down
even the holdings they retain. At the same time, of course,
banks can book a profit, especially if they have already
written-down the asset in question, and then sell it for more
than its carrying value.
But the central issue underlying the PPIP is the same as
the question underlying virtually all discussions of troubled
assets: valuation. As discussed above, the program may start an
upward cycle to start the markets flowing (although that
objective is in itself not without some risk to banks if it
forces downward valuation of assets that remain on balance
sheets). But the converse is also possible, namely that the
market will not function because prospective buyers will value
such assets only at prices at which institutions holding them
will not sell, either because to do so will require them to
record write-downs on their books--reducing operating income
and ultimately capital--or because they believe that the
economic value at which they are carrying the loans is accurate
and reflects economic conditions they expect to improve, or
both.\119\
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\119\ It is unlikely that the distinction between liquidity and
price is absolute. Thus, the market for legacy securities may be
characterized in part by an absence of liquidity (for example, because
investors are unwilling to commit themselves for more than a short
period given anticipated changes in interest rates, others may remain
wary of pricing uncertainty). As indicated in the text, this
distinction can put something of a ceiling on the degree to which the
PPIP can attack the problem. Lucian Bebchuck, Buying Troubled Assets
(Apr. 2009) (online at www.law.harvard.edu/programs/olin_center/papers/
pdf/Bebchuk_636.pdf).
---------------------------------------------------------------------------
As with all TARP programs, there is a risk that banks and
investors may be wary of the program because of fears that
participation will subject them to statutory restrictions,
including those that they cannot anticipate. Government
involvement has been viewed by many institutions as subject to
unpredictable change.\120\ The public outrage that followed the
disclosure of bonus plans of various firms that have previously
received TARP assistance has highlighted the public's
expectations and may have exacerbated the problem.\121\
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\120\ In a recent newsletter, banking and finance lawyer Harold
Reichwald of the law firm Manatt, Phelps & Phillips noted that a
provision of the newly enacted Helping Families Save Their Homes Act of
2009 would require certain participants in the PPIP loans program to
provide government access to financials and other information. The
newsletter notes that, without further clarity from the FDIC and
Treasury on the execution of this provision, ``there is a considerable
risk that potential purchasers may decide it is better to simply sit on
the sidelines without have an audit spotlight on them.'' Harold
Reichwald, PPIP and TARP Transparency (May 21, 2009) (online at
www.manatt.com/news.aspx?id=9498).
President of the Federal Reserve Bank of New York, William Dudley,
has also recently attributed a relatively low participation rate in the
TALF program to such concerns:
One reason why the TALF has gotten off to a relatively slow start
is the reluctance of investors to participate . . . Some investors are
apparently reluctant not because the economics of the program are
unattractive, but because of worries about what participation might
lead to. The TARP loans to banks led to intense scrutiny of bank
compensation practices given that TALF loans are ultimately secured by
TARP funds, investor anxiety about using the program has risen.
Federal Reserve Bank of New York, Remarks as Prepared for Delivery
by President and Chief Executive Officer of the New York Federal
Reserve Bank William C. Dudley at Vanderbilt University: The Federal
Reserve's Liquidity Facilities (Apr. 18, 2009) (online at
www.newyorkfed.org/newsevents/speeches/2009/dud090418.html)
(characterizing fears expressed by some investors that participation in
TALF may lead to increased regulation of investor practices as
``misplaced'' but ``understand[able] . . . given the political
discourse'' and the ``intense scrutiny of bank compensation practices''
that arose from TARP investments in financial institutions).
\121\ 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.'' Memorandum from Floyd Stoner, American Bankers
Association to Members of the House of Representatives (March 30, 2009)
(online at www.aba.com/NR/rdonlyres/76DCD307-2D7E-48A6-A10F-
623175F0AEAD/59034/ExecComp_ABAHouseLetter_033009.pdf).
In a Gallup poll of just over 1,000 Americans taken on March 17,
2009, 76 percent said that the government should take action to block
or recover the bonuses American International Group (AIG) paid to its
executives and 59 percent said that they were personally ``outraged''
by AIG actions in awarding the bonuses. Lymarie Morales, Outraged
Americans Want AIG Bonus Money Recovered (Mar. 18, 2009) (online at
www.gallup.com/poll/116941/outraged-americans-aig-bonus-money-
recovered.aspx).
---------------------------------------------------------------------------
Although Treasury has attempted to build into the program a
number of protections for the public, including conflict of
interest rules for the selection and operation of fund
managers, the Special Inspector General for TARP (the SIGTARP)
described continuing concerns regarding those protections in
its July 21, 2009 quarterly report to Congress.\122\ In its
April 2009 report, the SIGTARP noted a number of concerns,
including concerns regarding conflicts of interest, collusion
among fund managers, money laundering, and increased government
exposure through the use of the Term Asset-Backed Loan Facility
(TALF) and PPIP in conjunction with one another.\123\ These
issues, the July report found, have been largely ameliorated.
The SIGTARP found, however, that several concerns remain
unaddressed. First, the SIGTARP is concerned that Treasury has
not mandated strong ``walls'' between PPIFs and the other funds
managed by fund managers. Treasury has resisted stronger
``walls,'' citing funds' inability to use a firm's best talent
if those employees would be walled off from any other firm
work, statements by various pre-qualified fund managers that
they would withdraw if required to implement such walls, and
lack of necessity since PPIF managers would, according to
Treasury, not have material non-public information from
Treasury. These and other factors are, in Treasury's view,
sufficient to mitigate the potential harm.\124\ The SIGTARP
believes such walls are nonetheless necessary to protect
against improper transfer of information within firms.
---------------------------------------------------------------------------
\122\ SIGTARP, Quarterly Report to Congress (July 21, 2009) (online
at www.sigtarp.gov/reports/congress/2009/
July2009_Quarterly_Report_to_Congress.pdf).
\123\ Id.
\124\ Id. at 175-179.
---------------------------------------------------------------------------
Other issues that still concern the SIGTARP include the
SIGTARP's requests that Treasury: (1) provide regular
disclosures to the SIGTARP (which may be then disclosed to the
public) of PPIF trading activity;\125\ (2) implement a system
of metrics by which to measure PPIF performance and that would
provide a benchmark for determining whether the manager of an
under-performing PPIF may be removed for cause;\126\ (3)
require fund managers to disclose to Treasury information about
holdings in eligible assets and in related assets or exposures
to related liabilities;\127\ and (4) require the disclosure by
the fund managers of beneficial ownership of the PPIFs.\128\
---------------------------------------------------------------------------
\125\ Id. at 179.
\126\ Id. at 182.
\127\ Id. at 182-183.
\128\ Id. at 183.
---------------------------------------------------------------------------
Although on its way to becoming operational, the current
PPIP represents a significantly scaled-down version of the $75-
100 billion program originally outlined for the securities and
loan programs combined. Instead, Treasury has announced that it
will commit $30 billion to this program. Treasury has stated
that the larger program is no longer needed because of
improvements in the financial sector and in banks' ability to
raise capital, but that the program could be expanded later if
necessary.\129\
---------------------------------------------------------------------------
\129\ 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) (hereinafter ``Legacy Asset Program Statement'').
---------------------------------------------------------------------------
At present, only one of the two sub-programs--the legacy
securities program--is on the path to becoming fully
operational. On July 8, 2009, Treasury announced that it had
pre-qualified nine fund managers.\130\ When the Program was
announced in late March, Treasury stated that it expected to
pre-qualify at least five fund managers, but that it would
select more if the pool of applicants proved to be sufficiently
strong.\131\ The fact that almost twice the planned number of
fund managers was selected is encouraging as it reflects both
the level of interest among serious contenders and the quality
of the applicants. Furthermore, a larger number of fund
managers means a larger number of buyers competing in the
marketplace for the same legacy assets, which, as discussed
above, should have a positive impact on the market's ability to
assign value to the assets. As of the date of this report, the
selected firms have until early October to raise $500 million
in capital. Treasury expects that some of the firms will have
done so, and that the first legacy securities transactions will
close in August.
---------------------------------------------------------------------------
\130\ The nine firms selected are: BlackRock Inc., Invesco Ltd.,
AllianceBernstein LP, Marathon Asset Management, Oaktree Capital
Management, RLJ Western Asset Management, the TCW Group Inc.,
Wellington Management Co., and a partnership between Angelo, Gordon &
Co. LP, and GE Capital Real Estate. Id.
\131\ PPIP March Release, supra note 106.
---------------------------------------------------------------------------
The legacy loan program, however, has been postponed. On
June 3, 2009, the FDIC announced that it would postpone the
loan program until further notice. A press release from the
FDIC stated that ``development of the Legacy Loans Program
(LLP) will continue, but that a previously planned pilot sale
of assets by open banks will be postponed.'' \132\ The press
release continued, quoting FDIC chairman Sheila Bair as saying
that ``[b]anks have been able to raise capital without having
to sell bad assets through the LLP, which reflects renewed
investor confidence in our banking system.'' \133\ Instead, the
FDIC plans to ``test the funding mechanism contemplated by the
LLP in a sale of receivership assets this summer.'' On July 31,
the FDIC indicated that it ``would continue to develop this
program by testing the LLP's funding mechanism through the sale
of receivership assets,'' and that this step will allow the
FDIC to be ready to offer the LLP to open banks ``as needed.''
\134\
---------------------------------------------------------------------------
\132\ 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).
\133\ Id.
\134\ Legacy Asset Program Statement, supra note 129.
---------------------------------------------------------------------------
While the current strategy for the legacy securities
program may be appropriate, the delay in the legacy loan
program may be problematic. As indicated above, many smaller
and community banks continue to hold whole loans. As the
effects of the economic downturn have rippled through every
layer of the nation's financial system, unemployment continues
to climb and smaller businesses to falter, these local banks
have faced ever increasing default levels. Unlike large banks
that can sustain a certain number of defaults, even of large
commercial loans, smaller banks may have far more difficulty in
absorbing more than a few large loan losses. The FDIC's
statement that ``[b]anks have been able to raise capital
without having to sell bad assets through the LLP'' may not
reflect the reality for these banks.
Moreover, the FDIC pilot program may not provide a complete
picture of the issues that will be encountered in extending the
legacy loans program to solvent banks. Under that program, as
indicated above, a bank may not want to sell. But the FDIC does
have an incentive to sell because it wishes to dispose of
assets it obtained in its receivership capacity. It may be
willing to sell assets at a lower price than an operating bank,
for the reasons discussed above. And an auction that sets a low
price under these circumstances may trigger the sort of
downward cycle that is the opposite of the PPIP's objective.
In the end, it may be best to evaluate the PPIP not in
terms of the number of assets its partnerships purchase, but in
terms of whether the program actually creates price discovery
for assets where currently no transactions are occurring and
that transactions then occur without federal support. Treasury
believes that the programs can push the markets in that
direction and that this push would make the PPIP a
success.\135\ At the end of the day, banks may or may not be
pleased by a return to market pricing for assets for which
there were previously no transactions, but the problem of
troubled assets cannot be resolved until such pricing returns.
A key question is whether the PPIP is properly designed and/or
robust enough to produce that result.
---------------------------------------------------------------------------
\135\ Panel May Report, supra note 13.
---------------------------------------------------------------------------
Either way, one barrier to the success of the PPIP is a
simple lack of information. There remains only fragmentary
knowledge about the size of the supply pool for legacy
securities because there is little or no transparency in the
troubled asset markets.\136\ The published stress test results
gave no information about the total holdings of potentially
troubled assets on the books of the banks tested. But markets
need information to retain liquidity and function efficiently.
---------------------------------------------------------------------------
\136\ Why Toxic Assets Are So Hard to Clean Up, supra note 23.
---------------------------------------------------------------------------
The question is whether steps could be taken to increase
the level of information about troubled assets on bank balance
sheets, to facilitate the success of the legacy loan and
securities programs, without creating a risk of market
instability. Treasury and relevant government agencies should
work together to move financial institutions toward sufficient
disclosure of the terms and volume of troubled assets on banks'
books so that markets can function more effectively. For
example, the agencies could explore a uniform definition of
troubled securities and uniform rules for balance sheet
presentation, as a means to creating a database of the
available information.\137\ This approach would not encompass
the universe of legacy securities, many of which are held by
non-banks, but it could assist the legacy loans program more
successfully because that program only applies to the purchase
of loans from banks.
---------------------------------------------------------------------------
\137\ The supervisors would not have to require the banks to adopt
uniform valuation methods within the FASB's expanded rules.
---------------------------------------------------------------------------
b. The Stress Tests
One of Treasury's strategies for addressing the impact of
troubled assets on BHCs' balance sheet was stress tests.\138\
The stress tests estimated the losses that the 19 largest BHCs
would suffer through the end of 2010, based on specified
economic assumptions, resulting from debtors defaulting on the
loans made by those BHCs, decreases in value of the securities
the BHCs held as investments (for the BHCs with the largest
trading portfolios), and losses on the trading of securities.
---------------------------------------------------------------------------
\138\ Panel June Report, supra note 38.
---------------------------------------------------------------------------
The loss totals for the relevant classes of assets were:
Mortgages (first & second lien, junior)--
$185.5 billion;
Commercial & Industrial Loans (including real
estate)--$113.1 billion;
Securities (AFS and HTM), Trading &
Counterparty--$134.5 billion; and
Credit Card Loans & Other--$166.1 billion.
The tests then projected how much capital the BHCs would
need in order to absorb those losses.
The stress tests were designed to extend the stabilization
of the banking system through 2010 based on certain assumptions
about the current value and likely losses of troubled
assets.\139\ In their conception and execution, they indicate
an evolution of Treasury's original capital infusion strategy.
Once again, Treasury and the supervisors stated that their
purpose was to ensure that the tested banks have enough capital
to balance the potential impact of any losses,\140\ including
those derived from existing troubled assets and attempts to
work out the problem by the banks involved; for that reason 10
of the tested banks had to increase their capital base to have
enough capital on hand. The process required that banks attempt
to increase their capital with privately-raised equity or debt,
rather than with additional funds supplied by the taxpayers.
Taxpayer funds could only be obtained if private funding was
unavailable, at the cost of issuance of additional stock
(potentially common stock) to Treasury.
---------------------------------------------------------------------------
\139\ In its June report, the Panel discussed in detail criticisms
and differing viewpoints on the stress tests. See Panel June Report,
supra note 38.
\140\ Allison Testimony, supra note 37 (June 24, 2009) (``[T]he
stress tests were aimed at assuring that the major banks, the largest
banks, will have adequate capital if they undergo additional stress out
in the marketplace because of continued difficulties in the
economy.'').
---------------------------------------------------------------------------
It is also significant that the stress tests are ``forward-
looking,'' as the banking supervisors have emphasized. Rather
than waiting to respond to events, the supervisors have used
the tests to require capital buffers to be built in advance of
any problem, based on projections about the economy and its
impact on bank operating results. Finally, the forward-looking
nature of the stress tests can have a corollary impact on the
troubled assets problem. It may provide a breathing period that
allows the tested banks to dispose of their troubled assets in
an orderly way, without imposing extreme effects on their
operating results in any one period.\141\
---------------------------------------------------------------------------
\141\ At the same time, the stress tests applied only to the
nation's 19 largest BHCs.
---------------------------------------------------------------------------
At the same time, the protection the stress tests provide
for banks may not extend past 2010; the Federal Reserve Board
has said that reduction of capital to normal levels after 2010
is permitted. ``[i]f the economy recovers more quickly than
specified in the more adverse scenario, firms could find their
capital buffers at the end of 2010 more than sufficient to
support their critical intermediation role and could take
actions to reverse their capital build-up.'' \142\ The
supervisors should be careful to assure that the timing of any
such reduction does not leave bank balance sheets exposed to a
sudden economic turnabout.
---------------------------------------------------------------------------
\142\ SCAP Design Report, supra note 26, at 5. In its paper
discussing the results of the stress tests, the Board stated that:
``Specifically, the stress test capital buffer for each BHC is sized to
achieve a Tier 1 risk based ratio of at least 6 percent and a Tier 1
Common capital ratio of at least 4 percent at the end of 2010 under the
more adverse macroeconomic scenario. By focusing on Tier 1 Common
capital as well as Tier 1 capital, the stress tests emphasized both the
amount of a BHC's capital and the composition of its capital structure.
Once the stress test upfront buffer is established, the normal
supervisory process will continue to be used to determine whether a
firm's current capital ratios are consistent with regulatory
guidance.'' Board of Governors of the Federal Reserve System, The
Supervisory Capital Assessment Program: Overview of Results, at 14 (May
7, 2009) (online at www.federalreserve.gov/newsevents/press/bcreg/
bcreg20090507a1.pdf) (hereinafter ``SCAP Results'').
---------------------------------------------------------------------------
An additional caution is that the stress tests only apply
to the nation's 19 largest institutions. Smaller banks are not
subject to the same degree of protection. Attempting to
ameliorate that difference is discussed below.
Finally, it should be noted that the stress test process
was built on existing regulatory and accounting requirements
and did not introduce new measures of risk or change the way
banks' risk was measured. The tests were affected only to a
limited extent by new accounting rules. Recent accounting
guidance that allows more flexibility in calculating the value
of securities portfolios was not taken into account in
estimating losses. On the other hand, accounting rules not yet
in effect that will require off-balance sheet assets (such as
special-purpose vehicles formed to securitize banks' assets) to
be brought onto banks' balance sheets were treated as already
in effect, resulting in a more conservative calculation.
c. Conditions for Exit from the TARP
When Treasury and the bank regulators allow an institution
to repay its TARP assistance, they have made a judgment that it
no longer requires the boost to its balance sheet that the
initial assistance provided at the deepest part of the
financial crisis. An implicit conclusion is that the risk of
troubled assets on a particular institution's balance sheet is
not more than its own capital base can support.
The terms for approval of repayment require this
conclusion:
[Bank] 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.\143\
BHCs must also have a comprehensive internal capital
assessment process.\144\ 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.\145\
---------------------------------------------------------------------------
\143\ 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).
\144\ Id.
\145\ Id.
This statement indicates that the supervisors see the
stress tests and the repayment of assistance as working
together to protect bank balance sheets. But supervisory
flexibility underlies the stress test's assumptions. The
supervisors' administration of these conditions should take
account of the possibility of greater losses on those assets
than are anticipated by the stress tests and the current value
at which those assets are carried on the balance sheets of the
banks they supervise.
d. Economic Improvement
In the end, as Treasury has recognized, nothing will help
control the risks of troubled assets as much as economic
improvement, and nothing will increase those risks as much as
deterioration in economic conditions. A consequence of a more
robust economy should be an increase in property values,
stabilization and then steady decrease in unemployment, and a
slowing of mortgage defaults. But whether deteriorating
conditions will worsen the problem of troubled assets depends
on the extent to which those assets have been already written-
down on balance sheets. As the report indicates, it is likely
that some write-downs in the value of complex securities have
occurred, although the write-down rate for whole loans may be
less. Thus management of the economy goes hand-in-hand with
specific supervisory measures to limit the damage troubled
assets can cause.
e. Treasury Strategy: A Summary
Treasury has built a set of interlocking measures to deal
with troubled assets. It hopes to build capital protections
going out 18 months through the stress tests, require
supervisory approval before banks can pay back their TARP
assistance, and use the PPIP to get the market for troubled
assets going again.
All of these steps reflect a desire to resolve the troubled
assets problem and return to a strengthened financial sector,
subject to careful supervision and retention of the capacity to
intervene again if conditions worsen. The steps indicate that
Treasury, the supervisors, and, hopefully, the banks
themselves, have learned from the crisis, but the success of
those steps also depends on the degree to which that education
has taken place. The question remains whether Treasury's
assumptions are correct, and whether the protections they have
built into the system are sufficient.
E. Commercial Real Estate
The future of commercial real estate values may prove to be
an important factor for the maintenance of stability in the
banking sector. Like residential property, commercial property
is held both in the form of complex securities and whole loans,
and a similar crisis in that sector could trigger losses of its
own.\146\ Before turning to a discussion of the future of the
toxic assets problem, the report briefly reviews the state of
the market for commercial real estate.
---------------------------------------------------------------------------
\146\ The stress tests indicate potential losses for commercial
real estate loans for the 19 stress-tested institutions of $53.0
billion through 2010. SCAP Results, supra note 142.
---------------------------------------------------------------------------
1. COMMERCIAL MORTGAGE-BACKED SECURITIES
Bank troubles with CMBS are two-pronged: defaults are
rising, suggesting eventual write-downs of ownership stakes,
and the new issuance market remains nearly completely silent.
By one estimate, CMBS trusts hold 45 percent of outstanding
U.S. commercial mortgages.\147\ The CMBS market has been
virtually frozen since the spring of 2008.\148\ (No CMBS were
issued from January 2009 through May 2009.) During its last
active period, the spring of 2008, banks were estimated to hold
an estimated 23 percent portion of total CMBS investments.\149\
These CMBS investors are now holding asset pools with a
delinquent unpaid balance of $28.85 billion, an alarming 585
percent increase over the June 2008 delinquent unpaid balance
of $4.18 billion.\150\ In line with this sharp jump, CMBS pools
held as collateral 54 percent of all commercial loans that
moved from delinquency to outright default.\151\ The number of
CMBS pool loans either 90 days delinquent or already foreclosed
(thus in default or on the cusp of default) rose 32 percent
from May to June and is up 411 percent versus June 2008.\152\
---------------------------------------------------------------------------
\147\ Commercial Mortgage Securities Association, Compendium of
Statistics: Exhibit 20: Holders of Commercial & Multifamily Mortgage
Loans, Percentage Distribution (June 16, 2009) (online at
www.cmsaglobal.org/uploadedFiles/CMSA_Site_Home/Industry_Resources/
Research/Industry_Statistics/CMSA_Compendium.pdf) (hereinafter ``CMSA
Statistics Compendium'').
\148\ Id. at Exhibit 1, CMBS Issuance by Month: 2006-2009.
\149\ Commercial Mortgage Securities Association, Investors of CMBS
in 2008 (accessed July 29, 2009) (online at www.cmsaglobal.org/
uploadedFiles/CMSA_Site_Home/Industry_Resources/Research/
Industry_Statistics/Investors.pdf).
\150\ Realpoint Research, Monthly Delinquency Report_Commentary
(July 2009) (online at www.federalreserve.gov/FOMC/Beigebook/2009/
20090729/FullReport.htm) (hereinafter ``Realpoint Report'').
\151\ As recently as year-end 2008, CMBS collateral represented
only 30 percent of all distressed CRE loans. Real Capital Analytics,
Capital Trends Monthly: Office, at 5 (July 2009) (hereinafter ``Real
Capital Report'').
\152\ Realpoint Report, supra note 150, at 1.
---------------------------------------------------------------------------
Bank CMBS holdings represent nearly a quarter of an
increasingly troubled overall CMBS market whose now diminished
value is still nevertheless a substantial $750 billion.\153\
Banks do generally report their CMBS holdings on quarterly
filings.\154\ But, as with other possibly troubled assets, it
is an open question as to when or if a bank chooses to write
off a troubled asset, whether commercial or otherwise.
Regardless of whether this write-off occurs, though, testimony
at the Panel's hearing in New York on commercial real estate
suggests continued losses in commercial real estate (CRE) asset
value over the next several years as the pools containing the
most troubled loan vintages face high rates of term
default.\155\
---------------------------------------------------------------------------
\153\ CMSA Statistics Compendium, supra note 147, at 14, Exhibit
11: CMBS Breakdowns by Deal and Property Type.
\154\ See ,e.g., J.P. Morgan Chase & Co., Form 10-Q for the
Quarterly Period Ended March 31, 2009 (May 7, 2009) (online at
www.sec.gov/Archives/edgar/data/19617/000095012309008271/
y76962e10vq.htm).
\155\ A recent report notes that ``[l]enders have been slow to
foreclose on assets and the phrase ``pretend & extend'' has recently
entered the vernacular.'' Real Capital Report, supra note 151, at 15.
The Panel heard testimony in May indicating that not all future CRE
losses of this sort were taken into account by the bank supervisors'
stress tests, to the extent such losses might occur in 2011 or later.
See Congressional Oversight Panel, Transcript of COP Field Hearing in
New York City on Corporate and Commercial Real Estate Lending, at 57-58
(May 28, 2009).
---------------------------------------------------------------------------
2. WHOLE LOANS \156\
---------------------------------------------------------------------------
\156\ See Part B(3) of Section One of this report for a discussion
of whole loans as they relate to troubled assets generally.
---------------------------------------------------------------------------
While CMBS problems are undoubtedly a concern, the Panel
finds even more noteworthy the rising problems with whole
commercial real estate loans held on bank balance sheets. These
bank loans tend to offer a riskier profile as compared to
CMBS,\157\ suggesting high term default rates while the economy
remains weak. Another worrying and salient feature of these
loans is that they are held in a higher proportion by super-
regional, regional and smaller banks as opposed to larger money
center banks.\158\ In a recent speech, Janet L. Yellen, the
President of the San Francisco Federal Reserve Bank stated that
``[t]o date, the community banks under greatest financial
stress are those with high real estate concentrations in
construction and land development lending.''\159\ Under its
worst case scenario, the Panel's model of whole loan losses
estimates potential core CRE and construction loan losses
through 2010 of $81.1 billion at 701 banks with assets between
$600 million and $80 billion.\160\
---------------------------------------------------------------------------
\157\ Bank loans, especially those originated during the period
from 2004-2007 when underwriting standards were most lacking, tended to
be more heavily tilted toward much riskier construction and development
loans as opposed to core commercial real estate loans. Parkus July
Report, supra note 30.
\158\ Parkus July Report, supra note 30.
\159\ Federal Reserve Bank of San Francisco, Presentation to the
Oregon Bankers Association Annual Convention with the Idaho Bankers
Association, at 12 (July 28, 2009) (online at www.frbsf.org/news/
speeches/2009/0728.pdf).
\160\ When potential multifamily residence loan losses are added to
core CRE and construction loan losses, the estimate rises to $87.7
billion through 2010. See supra, section C(2) for a complete discussion
of the Panel's model methodology and results. See also Maurice Tamman
and David Enrich, Local Banks Face Big Losses, Wall Street Journal (May
19, 2009) (online at online.wsj.com/article/SB124269114847832587.html)
(presenting an analysis suggesting the possibility of $99.7 billion in
CRE loan losses through 2010 at 900 small and midsize banks).
---------------------------------------------------------------------------
Term defaults of these bank loans present a near term
problem. But another obstacle looms if a loan is able to escape
term default and reach maturity. The Panel, informed by the
testimony of a prominent CRE market analyst, took note of this
issue in its June Report:
[P]oorly underwritten CRE loans made in the easy
credit years (e.g., 2005-2007) will reach maturity and
will in many instances fail to qualify for refinancing.
As the [Deutsche Bank] report explains, the high
percentage of loans not qualifying for refinancing, and
hence in danger of default without significant
injections of new equity, is attributable to the
combined effects of stricter underwriting standards,
steep declines in property values, and reduced income
streams to finance the loans because of lower rents and
increased vacancies. The findings are based on
quantitative data for commercial mortgage-backed
securities (CMBS), which constitute 25 percent of the
core CRE market. While the authors of the report state
that there was insufficient data to perform a detailed
study in the larger non-CMBS sector, the authors say
they expect a similar if not higher level of maturity
defaults on non-securitized CRE bank portfolio loans
because portfolio loans typically have shorter
maturities (which would not allow sufficient time for
property values to recover from their present depressed
levels) and higher risk profiles than CMBS.\161\
---------------------------------------------------------------------------
\161\ Panel June Report, supra note 38; Parkus July Report, supra
note 30.
If the heaviest losses were still solely on the horizon, it
is possible that intervening actions might function to prevent
the worst loss predictions. Banks might be able to restructure
problem CRE loans with more success than they have found in the
residential mortgage sector. Property values could stabilize,
moderating the issue of negative equity. But what seems to have
occurred between May and July 2009 is a growing recognition
that loan losses are both occurring now in greater numbers even
while maturity losses still loom in the future. Second quarter
2009 earnings releases already reflect mounting commercial
property write-downs.\162\ This reflects the significant rise
in term defaults occurring now; maturity defaults will enter
the picture beginning in 2010 when the first wave of troubled
bank loan vintages mature. Because the CMBS market remains
substantially impaired,\163\ banks are also generally unable to
distribute the risk of their current portfolios through
packaged securities.\164\
---------------------------------------------------------------------------
\162\ Wells Fargo reported non-performing CRE loans jumped 69
percent in second quarter 2009. Wells Fargo & Company, Wells Fargo
Reports Record Net Income (July 22, 2009) (online at
www.wellsfargo.com/pdf/press/2q09pr.pdf). Morgan Stanley wrote down
$700 million out of its $18 billion CRE and CMBS portfolio. See Morgan
Stanley, Financial Supplement--2Q 2009, at 16 (July 22, 2009) (online
at www.morganstanley.com/about/ir/earnings--releases.html).
\163\ Wharton School of the University of Pennsylvania, On Shaky
Ground: Commercial Real Estate Faces Financial Tremors (July 22, 2009)
(online at knowledge.wharton.upenn.edu/article.cfm?articleid=2296).
\164\ The Federal Reserve's Term Asset Lending Facility (TALF) is
meant to address this issue and was recently opened up to both new CRE
loans as well as existing CMBS. It is unclear as to whether TALF will
be successful at unfreezing the CMBS market.
---------------------------------------------------------------------------
The data above raise several concerns as to how the
commercial property market will affect the larger issue of
troubled assets. Troubled commercial real estate loans can
themselves be considered a type of troubled asset. Significant
write-downs of these loans may make it more difficult for banks
to remain healthy without removing other troubled assets from
their balance sheets. Most concerning is the speed with which
the commercial market has deteriorated in 2009. If consumer
lending and residential mortgages also remain weak, banks may
face additional losses in asset value. Both banks and
regulators will be forced to face this issue in the larger
context of addressing a solution for bank troubled assets.
F. The Future
The nation's banks continue to hold on their books billions
of dollars in assets about whose proper valuation there is a
dispute and that are very difficult to sell without banks
experiencing substantial write-downs that can trigger a return
to financial instability. Whatever values are assigned to these
troubled assets for accounting purposes, their actual value and
their potential impact on the solvency of the banks that hold
them are uncertain and will likely remain so for some time; the
degree of uncertainty is difficult for anyone to estimate
confidently. Treasury's strategy works to control the impact of
the uncertainty, and it has stabilized the financial situation
effectively, but the impact of the strategy may be less strong
if present conditions change.
There are a number of reasons that present conditions may
worsen:
1. Unemployment continues to rise,\165\ and both government
and private economists have noted that an improvement in
employment may lag several years behind the return of economic
growth generally, as is true in most recoveries and has been
noted as a potential problem for this recovery.
---------------------------------------------------------------------------
\165\ See, e.g., House Committee on Financial Services, Testimony
of Chairman of the Board of Governors of the Federal Reserve System Ben
Bernanke, Hearing on the Semi-Annual Report of the Federal Reserve on
Monetary Policy, 111th Cong. (July 21, 2009) (``Even though--if the
economy begins to turn up in terms of production, unemployment is going
to stay high for quite a while. And so, it's not going to feel like a
really strong economy.''); Phil Izzo, Few Economists Favor More
Stimulus (July 10, 2009) (online at online.wsj.com/article/
SB124708099206913393.html) (`` `The mother of all jobless recoveries is
coming down the pike,' said Allen Sinai of Decision Economics.''). See
Allison Testimony, supra note 37, at 15:20-23 (``[O]ur financial system
and our economy remain vulnerable, with unemployment still rising,
house prices falling, and pressure on commercial real estate continuing
to build.'').
---------------------------------------------------------------------------
2. Bank lending has not recovered.\166\
---------------------------------------------------------------------------
\166\ See, e.g., U.S. Department of the Treasury, Treasury
Department Monthly Lending and Intermediation Snapshot: Summary
Analysis for May 2009 (Aug. 4, 2009) (online at
www.financialstability.gov/docs/surveys/Snapshot_Data_May2009.pdf)
(Showing the 21 largest CPP recipients made $200 billion in loans
during May 2009, compared to $218 billion in new loans during October
2008); Board of Governors of the Federal Reserve System, Federal
Reserve Statistical Release H.8: Assets and Liabilities of All
Commercial Banks in the United States: Historical Data (online at
www.federalreserve.gov/datadownload/Choose.aspx?rel=H.8) (accessed Aug.
4, 2009) (for all domestically chartered commercial banks, $6.957
trillion in outstanding loans and leases as of July 22, 2009 compared
to $7.281 trillion in outstanding loans and leases on October 1, 2008);
Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release H.3: Aggregate Reserves of Depository Institutions
and the Monetary Base (Instrument: Reserves of Depository Institutions,
Excess, NSA) (July 30, 2009) (online at www.federalreserve.gov/
releases/h3/current/) (accessed Aug. 4, 2009) (Demonstrating that, for
a variety of reasons, banks hold $740 billion in reserves in excess of
required levels, compared to under $2 billion in August 2008. The fact
that these funds are not being used to make new loans indicates
substantial unused capacity in the banking system).
---------------------------------------------------------------------------
3. Both large BHCs, somewhat smaller regional BHCs, and
small banks are increasingly at risk from troubled whole loans,
as discussed above.
4. The plunge in values that affected the residential real
estate market may be moving to the commercial real estate
market as properties come up for refinancing and that financing
is unavailable because of the drop in commercial and retail
activity arising from the economic downturn.\167\ Like
residential property, commercial property is held both in the
form of complex securities and whole loans, and a similar sell-
off in that sector could trigger losses of its own and a more
general renewed pressure on bank balance sheets that would
again call into question the true value of residential mortgage
loans.\168\
---------------------------------------------------------------------------
\167\ See Allison Testimony, supra note 37, at 59:20-23 (``[M]uch
of the commercial real estate financing in recent years has been
through the securitization markets which for some time were pretty much
shut down.'').
\168\ See Part E of Section One of this report.
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5. To the extent banks have not written-down troubled
assets, they are in effect continuing to invest in those assets
by holding them for a future return.\169\ That is not an
unreasonable strategy in itself. But it only postpones the day
of reckoning if it turns out that, rather than appreciating,
the assets depreciate.
---------------------------------------------------------------------------
\169\ There is evidence of widespread write-downs of the most toxic
assets, but it is unclear how many written-down assets may have been
shifted back to held-for-sale from trading accounts and revalued.
---------------------------------------------------------------------------
As the report has discussed, Treasury's strategy has
stabilized the system. There are several additional measures
that Treasury should consider to supplement that strategy in
certain circumstances.
Continued Stress-Testing. First, as the Panel recommended
in June and Assistant Treasury Secretary Allison agreed,\170\
the Federal Reserve Board should repeat the stress tests,
looking forward two years, if economic conditions worsen to the
point that they exceed the adverse economic scenario used in
the tests. In addition, stress-testing should be a regular
feature of the 19 BHCs' examination cycles so long as an
appreciable amount of troubled assets remain on their books,
economic conditions do not substantially improve, or both.
---------------------------------------------------------------------------
\170\ Allison Testimony, supra note 37 at 22:17-20 (June 24, 2009)
(``Treasury agrees that over time, especially for the larger banks,
there should be periodic stress-testing by the regulators, and I'd be
fairly confident that that's going to be taking place over time.'');
See also Id. (``I would agree with [Chairwoman Warren], that there's a
need for ongoing stress-testing, especially of the larger banks.'').
---------------------------------------------------------------------------
It is important to recognize that only the nation's 19
largest institutions have been stress-tested. There are
approximately 7,900 other banks, some large national
institutions, some smaller regional institutions, and many
small and community banks, and more than 350 of those banks
also received capital infusions under the TARP. More important,
many of the smaller institutions may be especially at risk if
the economy does not improve.
Resource considerations would likely bar stress-testing for
these institutions in the same manner as the prior tests. But
it may be that sample testing, rules for self-testing, or
general templates could provide a reasonable approximation of
the direction given to the large banks by the stress tests, and
perhaps lead to a general formula for determining whether
additional capital buffers were required.
Continued Monitoring. Supervisors are already monitoring
potential problem banks at an increasing rate. For example, the
Federal Reserve Board, Office of the Comptroller of the
Currency, and FDIC are issuing supervisory memoranda (requiring
capital or similar actions by particular banks), at a rate that
would exceed the rate for 2008 by about 50 percent.\171\ The
review of conditions for repayment of TARP assistance also
represent a careful type of monitoring, in line with the
objectives of the stress tests.
---------------------------------------------------------------------------
\171\ Damien Paletta and Dan Fitzpatrick, Regulators Are Getting
Tougher on Banks, Wall Street Journal, (July 31, 2009) (online at
online.wsj.com/article/SB124900956863596085.html).
---------------------------------------------------------------------------
An important part of the necessary monitoring, as the
supervisors have recognized, will involve a review of the way
banks themselves model the risk from the assets they hold, as
part of their balance sheet and reporting determinations.
Especially after hundreds of billions of dollars of TARP
assistance, the banks themselves must assume a heavy
responsibility for better risk management and capital
protection.
A Balance Between Credit and Protection. One of the most
serious consequences of the crisis was the bank pull-back from
lending as capital was devoted to strengthening balance sheets.
It is important that capital is raised to levels at which the
two objectives do not compete; otherwise, the economic
recovery--and with it the slow resolution of the problem of
troubled assets will be stopped, if not reversed.
Careful Calibration of the Legacy Loans and Legacy
Securities Programs. PPIP should be monitored closely to
determine whether it is fulfilling its purpose. Even given its
use to restart the markets rather than to take large numbers of
troubled assets off bank balance sheets, Treasury should
consider whether the PPIP legacy securities program should be
expanded if the markets would appear to benefit from additional
``pump-priming.'' If the program is not working, Treasury
should consider adopting a different strategy to remove the
troubled assets from banks' books.
The future of the legacy loans program is more important.
Given the growing problem of whole loan defaults and the way in
which those defaults affect smaller banks that were not stress
tested, it is difficult to understand why the same approach
should not be applied to whole loans as is to be applied to
legacy securities. As the only initiative designed specifically
to reopen the market for troubled whole loans, failure to start
the legacy loan program raises concerns about whether Treasury
has a workable strategy to deal with banks' troubled loans.
Increased Disclosure. In order to advance a full recovery
in the economy, there must be greater transparency,
accountability, and clarity, from both the government and
banks, about the scope of the troubled asset problem. Treasury
and relevant government agencies should work together to move
financial institutions toward sufficient disclosure of the
terms and volume of troubled assets on banks' books so that
markets can function more effectively.
The events of September 2008 and the course of previous
financial crises are a reminder that, despite all of these
steps, the risks exist that current strategies will not
suffice.\172\ If that were so, recourse to additional capital
infusions could again arguably be the best way to stabilize the
system (assuming of course that any infusions were backed by
adequate protections for the taxpayers). But unless Congress
extends the authority of Treasury to enter into new TARP
commitments, more capital infusions may not be possible because
Treasury's ability to make such commitments expires no later
than October 2010.\173\
---------------------------------------------------------------------------
\172\ It is worth remembering that the years 1930-1933 were marked
not by one, but by several banking crises. The first occurred in 1930,
and was noted by the failures of Caldwell and Company and the Bank of
the United States. Caldwell and Company was a prominent Tennessee bank,
whose failure sparked a series of bank failures in the Southeast. The
Bank of the United States was the fourth largest bank in New York City,
whose failure induced a panic in the Northeast. The second crisis
occurred in 1931, and hit mainly the Chicago and Cleveland areas. The
third crisis also occurred in 1931 after Britain abandoned the gold
standard. In the U.S., the crisis was notable in three cities,
Pittsburgh, Philadelphia and again Chicago. The final crisis hit in
1933 and involved multiple bank failures.
\173\ EESA 120(b).
---------------------------------------------------------------------------
In that circumstance, a great share of the burden may fall
on the FDIC. During the early days of the crisis, the FDIC sold
either the assets it assumed in resolving a bank failure or the
failed institution itself in transactions that cost the
insurance fund billions of dollars. The FDIC lost $10.7 billion
in resolving the failure of IndyMac,\174\ and $4.9 billion in
resolving the failure of Bank United.\175\ It could do so
again, but such losses could be on an even greater scale, and
they would mean that the FDIC and ultimately the taxpayer
absorb the asset pricing uncertainties that have infected the
system all along.
---------------------------------------------------------------------------
\174\ FDIC, FDIC Closes Sale of Indymac Federal Bank, Pasadena,
California (Mar. 19, 2009) (online at www.fdic.gov/news/news/press/
2009/pr09042.html).
\175\ FDIC, BankUnited Acquires the Banking Operations of
BankUnited, FSB, Coral Gables, Florida (May 21, 2009) (online at
www.fdic.gov/news/news/press/2009/pr09072.html). The FDIC estimates
this to the cost to the Deposit Insurance Fund.
---------------------------------------------------------------------------
If no additional TARP funding were available, the
government might consider the costs and benefits of using an
RTC-like strategy to purchase for eventual resale potentially
troubled assets from open banks meeting certain capital
standards, in order to maintain the health of those banks. Such
an approach would require careful structuring, and it would,
again, shift, but not eliminate the problems of value and
pricing of the purchased assets. It would also entail
substantial funding both to purchase the assets and to pay for
operating costs, including the hiring of experienced personnel
to manage the loan purchase and resale program. The funding
might be provided by the issuance of bonds by the entity (as
was the case with the RTC). The Panel is not recommending this
alternative, merely suggesting its consideration by policy-
makers.
G. CONCLUSION
Troubled assets were at the heart of the crisis that
gathered steam during the last several years and erupted in
2008. The stabilization of the financial system is a
significant achievement, but it does not mark an end to the
crisis. One continuing uncertainty is whether the troubled
assets that remain on bank balance sheets can again become the
trigger for instability.
It is impossible to resolve the argument about whether
banks are or are not solvent because of the uncertain value of
their loans. The importance of that question will be reduced
substantially if the economy improves and unemployment drops.
However, the acid test will come if unemployment remains high
and residential and commercial mortgage defaults increase.
Moreover, such instability may not emerge until the full extent
of any coming crisis in commercial mortgages is fully felt or
banks can evaluate the experience of loans that come due after
the 2009-10 stress test period.
Treasury has adopted a strategy that it hopes will
strengthen at least the nation's largest banks to withstand a
return instability. Several supplemental steps may help reduce
the risks that this could occur:
1. As recommended by the Panel in June, supervisors should
repeat the stress tests if economic conditions worsen beyond
the adverse economic scenario originally used.
2. Treasury must assure robust legacy securities and legacy
loan programs or consider a different strategy to do whatever
can be done to restart the market for those assets.
3. Treasury and relevant government agencies should work
together to move financial institutions toward sufficient
disclosure of the terms and volume of troubled assets on banks'
books so that markets can function more effectively.
4. Treasury must be prepared to turn its attention to small
banks in crafting solutions to the growing problem of troubled
whole loans. Those banks face special risks with respect to
problems in the commercial real estate loan sector. As one
example, the methodology and capital buffering involved in the
stress tests could be extended to the nation's smaller banks on
a forward-looking basis.
Ultimately, everything depends on the care and
responsibility exercised by both banks and supervisors in
carefully controlling risk and watching for signs of trouble.
There is no substitute for acting in advance of a crisis,
especially now that some of the signals of potential concern
should be clear.
The problem of troubled assets was long in the making, and
it would be foolish to think that it could be resolved
overnight, or that doing so would not involve balancing equally
legitimate considerations affecting the banking industry and
the public interest. But it would be equally foolish to think
that the risk of troubled assets has been mitigated or that it
does not remain the most serious risk to the American financial
system.
ANNEX TO SECTION ONE: ESTIMATING THE AMOUNT OF TROUBLED ASSETS--
ADDITIONAL INFORMATION AND METHODOLOGY
A. Caveats in Assessing the Amount of Troubled Assets
1. FINDING TROUBLED SECURITIES IN FINANCIAL STATEMENTS
In its search for the value of U.S. bank held troubled
assets, the Panel found that the information required in
regulatory filings is insufficient for fully assessing the
value of troubled assets. The two main issues the Panel had to
navigate were the lack of uniformity and the lack of
granularity in the public statements of these institutions.
The lack of uniformity in financial reporting precludes
almost any attempt to aggregate data across institutions. While
some institutions provide very detailed statements, which break
down asset items to reasonable levels of classification, other
institutions provide almost no detailed data at all, leaving
the reader to guess at line items that incorporate a number of
sometimes very dissimilar items. As a result of these
classification differences, when aggregating, the Panel was
forced to use only the least detailed company's categories,
thus rendering an enormous amount of information unusable.
Even the formatting of the financial statements is entirely
different across banks. As a result of these classification
differences, even finding the line item in each statement is a
difficult task, requiring a long search through reports which
can be over 300 pages.
Because of the change in accounting rules brought about by
FAS 157-4, assets which were formerly held in the trading
account, and thus marked-to-market, can be transferred out,
labeled as held-to-maturity, and marked-to-model.\176\ As a
result of differing policies regarding early adoption of FAS
157-4, the statements for individual companies use a different
methodology from the fourth quarter of 2008 to the first
quarter of 2009, making comparisons problematic from one
quarter to the next.
---------------------------------------------------------------------------
\176\ Financial Accounting Standards Board, Determining Fair Value
When the Volume and Level of Activity for the Assets or Liability Have
Significantly Decreased and Identifying Transactions That Are Not
Orderly (Apr. 9, 2009) (FSP FAS 157-4).
---------------------------------------------------------------------------
The lack of granularity means that even at the most
detailed level presented, the information provided is not rich
enough to determine the amount of troubled assets. For example,
Citigroup, in which the government has a very large equity
stake (34 percent), prepares extraordinarily comprehensive
financial statements, showing a great deal of information at
very detailed levels.\177\ However, even Citigroup, in the 10-Q
from the first quarter of 2009, presents only a blanket number
of $49.9 billion in Level 3 derivatives.\178\ Obviously
derivatives come in many shapes and sizes, but Citigroup
provides no information on the nature of this nearly $50
billion line item.\179\ Furthermore, it is unclear how much of
this Level 3 exposure is netted out.\180\ As Citigroup
aggregates amounts, almost $1 trillion was netted out of
derivatives Levels 1 through 3.\181\ This means that Citigroup
could have anywhere from $0 to $50 billion dollars in Level 3
derivatives exposure.\182\
---------------------------------------------------------------------------
\177\ Citigroup Inc., Citi Announces Final Results of Public Share
Exchange and Completes Further Matching Exchange with U.S. Government
(July 30, 2009) (online at www.citigroup.com/citi/press/2009/
090730b.htm).
\178\ Citigroup Inc., First Quarter of 2009--Form 10-Q, at 124 (May
11, 2009) (online at www.citigroup.com/citi/fin/data/
q0901c.pdf?ieNocache=52) (hereinafter ``Citigroup First Quarter 2009
10-Q'').
\179\ Id.
\180\ Netting is the accounting process that lets institutions
remove opposing positions from their balance sheet. The concept behind
this is that if a bank simultaneously holds two opposite positions, for
all intents and purposes, the two cancel each other out.
\181\ Citigroup First Quarter 2009 10-Q, supra note 178, at 125.
\182\ Citigroup First Quarter 2009 10-Q, supra note 178.
---------------------------------------------------------------------------
In addition, it is common knowledge among market
participants that loans that originated in 2006 and 2007 were
created under relatively lenient lending practices, meaning
that many of the loans from this period, and the securities
based on them, are more likely to default.\183\ It would
therefore be useful for the BHCs to break out their loan and
MBS numbers by vintage, allowing investors to judge for
themselves how much they trust the securities' ratings. In the
search for troubled assets, failure to identify these items
causes troubled and non-troubled assets to be placed on the
same line, making it impossible to differentiate the two types
of assets.
---------------------------------------------------------------------------
\183\ See, e.g., Chris Mayer, Karen Pence, and Shane M. Sherlund,
Board of Governors of the Federal Reserve System, The Rise in Mortgage
Defaults, Finance and Economics Discussion Series (Nov. 20, 2008)
(online at www.federalreserve.gov/pubs/feds/2008/200859/200859pap.pdf);
Office of the Comptroller of the Currency, Comptroller Dugan Tells
Lenders that Unprecedented Home Equity Loan Losses Show Need for Higher
Reserves and Return to Stronger Underwriting Practices (May 22, 2008)
(online at www.occ.treas.gov/ftp/release/2008-58.htm).
---------------------------------------------------------------------------
Finally, and most importantly, each bank uses a different,
undisclosed method to calculate the value of the items in their
financial statements; all of these models however must conform
to GAAP and their results must be reviewed by the banks
independent public accounting firm. Still, because troubled
assets are, by their nature, Level 3, and therefore marked-to-
model, it is impossible with reasonable confidence to compare
the values of troubled assets across banks. For example, Bank
of America might hold a set of derivatives that it values at
$100 billion under its valuation model, but that Citigroup, if
it held those same derivatives, may value them at $50 billion
under its valuation model. The differences in modeling
techniques of different banks, combined with the fundamentally
difficult issues in modeling these securities, even assuming
access to the relevant data, makes it impossible to fully
assess the value of troubled assets based on the public
disclosures of the banks.
2. DIFFICULTIES IN MODELING TROUBLED SECURITIES AND CREDIT DEFAULT
SWAPS\184\
---------------------------------------------------------------------------
\184\ Inherent in this discussion is the assumption that all of the
information required to model a security is available; however, for the
outside observer, this simply is not true. As shown in Part 1 above,
the financial statements provide almost no useful information to be
used as a basis for a model. This information does exist, in
proprietary products which are offered by research firms.
---------------------------------------------------------------------------
There are a number of different types of troubled assets,
each with its own degree of modeling difficulty. The simplest
is a loan. The relative ease in modeling whole loans reflects
the fact that their payouts, and hence their value, are only
based on one security, the loan itself. Mortgage backed
securities (MBS), on the other hand, group together larger
numbers of loans whose future values were deemed to depend on
one another only to a small degree. Banks pooled many whole
loans into an SPV, and then defined a set of rules governing
tranches which they issued. The set of rules was structured so
that the vast majority of the purchased tranches would be
investment grade, and all of the risk would be associated with
the subordinate tranches. Thus, for a large group of randomly
collected loans, it seemed exceedingly unlikely that a large
percentage of them would default. The pricing, and rating, of
these securities required assumptions about the default
correlations between each of the mortgages in the pool. With
pools containing thousands of whole loans, such an assessment
is nearly impossible.
Estimates of correlation have an enormous effect on the
rating, and thus the estimated likelihood of default of a
complex security. A correlation of 1.0 would imply that all of
the securities would fail at once, meaning that the entire pool
retained the default probabilities of the loans of which it was
composed. If, on the other hand, the correlation was 0, then
the failure of one loan would be independent of the failure of
another loan, making the probability that the entire pool would
default the product of the default probabilities from each
individual loan. These two results are clearly divergent, and a
slight variation in the estimated correlation can have a large
effect on the credit rating, and therefore the value of a loan.
One of the main reasons that these securities are now troubled
is that the banks and rating agencies under-estimated the
correlative effect of a systemic shock. In other words, in a
recession, mortgage default rates rise, causing many loans to
default at the same time that would otherwise not do so. As a
result, the diversification which the banks had relied on to
strengthen the credit of their MBSs disappeared, vastly
lowering the credit rating, and thus the value of these
securities.
The issue of measuring correlations within a mortgage pool
grows more complicated when we consider CDOs, which packed many
MBS together from different mortgage pools. In this case, the
payouts can be tied to so many whole loans at their base that
it is impossible to model the correlations between all of these
loans, or even to figure out which loans are backing the
payments. The more complicated the structures became the more
difficult it became to model the correlations. At this point it
becomes nearly impossible to sort through all of the securities
that a tranche is dependent upon, or the correlation between
all of the securities.
Credit Default Swaps (CDS) can be purchased on many
different debt securities, from residential real estate loans
to bonds.\185\ Essentially, the value of a credit default swap
is based on two main features of a debt product, its default
and recovery rates. Thus, the value of a credit default swap is
the difference between the payments made by the buyer and the
expected payout of the seller. The default rate determines how
likely it is that the seller will be forced to pay, and the
recovery rate determines how much. CDSs are more difficult to
value than loans, because inherently their values are based off
the prediction of low-probability large payouts, much like
other forms of insurance. This is further complicated by the
fact that a CDS is based solely on the two most difficult
pieces of a debt product to predict, its default and recovery
rates.
---------------------------------------------------------------------------
\185\ CDS can be sold on any debt based product, such as CDOs or
CLOs. Whereas the inherent structure of the CDO or CLO complicates the
modeling of these instruments, it is the inherent properties of the
underlying that present issues when valuing CDS securities. The
structure of the CDS is in most cases very simple.
---------------------------------------------------------------------------
To summarize, modeling the performance of complex
securities, based on the performance of thousands of loans, is
like trying to model large chunks of the mortgage market, and
then trace all of the payments from individual loans through
layers of rules governing payouts, until you reach the top.
Further, this task is made less possible by the amplification
of the issues with modeling the securities at the lower levels.
For example, the difficulties in modeling the default rate for
a loan are multiplied over the enormous number of loans that
feed into the more complex securities. Thus it seems that the
only products on which an outside observer can attempt to make
a good faith valuation are whole loans, a fact confirmed to the
Panel by more than a dozen academics.
B. Troubled Assets from Financial Statements
Although somewhat limited, meaningful estimates can still
be derived from public documents to help inform the scope of
troubled assets. Figure 10 below highlights Level 3 assets for
the stress-tested BHCs as of December 31, 2009 which includes
assets that are difficult to find reliable external indicators
of value. This illustrates the dollar amount of Level 3 assets
as a percentage of total assets.
FIGURE 10: LEVEL 3 ASSET EXPOSURES \186\
Quarter ended December 31, 2009--(USD in billions)
--------------------------------------------------------------------------------------------------------------------------------------------------------
% of
MBS ABS Loans Mortg. Other Deriv. AFS Corp. Other Total Total
Serv. Assets Sec. Debt Sec. Assets
--------------------------------------------------------------------------------------------------------------------------------------------------------
Bank of America...................................... $7.3 ....... $5.4 $12.7 $3.6 $8.3 $18.7 ....... ....... $56.0 3%
Bank of New York-Mellon.............................. ....... ....... ....... ....... $0.2 $0.08 $0.4 ....... ....... $0.7 0%
BB&T................................................. $0.004 ....... $0.0 $0.4 ....... $0.04 $1.1 ....... ....... $1.5 1%
Capital One Financial................................ ....... ....... ....... $0.2 $1.5 $0.06 $2.4 ....... ....... $4.2 3%
Citigroup............................................ $50.8 ....... $0.2 $5.7 $0.4 $60.7 $28.3 ....... ....... $146.0 8%
Fifth Third Bank..................................... ....... ....... $0.007 ....... $0.03 ....... $0.1 ....... $0.0 $0.2 0%
GMAC................................................. $1.5 ....... $1.9 $2.8 $0.04 $0.1 $0.8 ....... ....... $7.2 4%
Goldman Sachs........................................ $15.5 ....... $12.0 ....... ....... $8.5 ....... $7.6 $16 $59.6 7%
JPMorgan Chase....................................... $12.9 ....... $19.8 $9.4 $11.4 $31.8 $12.4 $6.5 $4.9 $109.0 5%
KeyCorp.............................................. ....... ....... ....... ....... $1.1 $0.0 ....... ....... $0.9 $2.0 2%
MetLife.............................................. $0.9 $2.5 ....... $0.2 ....... $3.0 ....... $13.4 $2.0 $22.0 4%
Morgan Stanley....................................... ....... ....... ....... ....... $9.5 $40.9 ....... $34.5 $1.1 $85.9 13%
PNC Financial........................................ ....... ....... $1.4 ....... $0.7 $0.1 $4.8 ....... ....... $7.0 2%
Regions Financial.................................... ....... ....... ....... ....... ....... $0.1 $0.1 ....... $0.4 $0.5 0%
State Street......................................... ....... $8.7 ....... ....... $0.4 ....... ....... ....... $0.2 $9.2 5%
SunTrust Banks....................................... $1.4 ....... $0.8 ....... ....... ....... $1.5 ....... ....... $3.6 2%
U.S. Bancorp......................................... $1.8 ....... ....... $1.2 $1.7 ....... ....... ....... ....... $4.8 2%
Wells Fargo.......................................... ....... ....... $4.7 $14.7 $2.0 $7.9 $22.7 ....... $3.5 $55.5 4%
--------------------------------------------------------------------------------------------------
Total............................................ ....... ....... ....... ....... ....... ....... ....... ....... ....... $575.1
--------------------------------------------------------------------------------------------------------------------------------------------------------
\186\ The data used in creating this chart is derived from the quarterly and yearly SEC filings of the following companies from the period 12/31/08 to 3/
31/09: Bank of America; Bank of New York Mellon; BB&T; Capital One Financial; Citigroup; Fifth Third Bank; GMAC; Goldman Sachs; J.P. Morgan Chase;
KeyCorp; MetLife; Morgan Stanley; PNC Financial; Regions Financial; State Street; SunTrust Bank; U.S. Bancorp.
Analysis does not include American Express (AXP) which did not include Level 3 Asset data in its SEC filings.
Figure 11 below illustrates the change in dollar amount of
the loan losses (net charge-offs) and loan loss reserves for
the stress-tested BHCs over an eighteen month period (January 1
2007--June 30 2009). This highlights the significant increase
in loan losses recognized over this period for all the stress-
tested banks.
FIGURE 11: LOAN LOSSES AND LOAN LOSS RESERVES \187\
[Dollars in billions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Quarter Ended 6/ Quarter Ended 3/ Year Ended 12/ Year Ended 12/
30/2009 31/2009 31/2008 31/2007 ----------------------
------------------------------------------------------------------------
Net Loan Net Loan Net Loan Net Loan Net Loan Loss
Charge- Loss Charge- Loss Charge- Loss Charge- Loss Charge- Resrv.CAGR
Offs Resrv. Offs Resrv. Offs Resrv. Offs Resrv. Offs CAGR
--------------------------------------------------------------------------------------------------------------------------------------------------------
American Express......................................... * * 5.14 3.86 * * * * * *
Bank of America.......................................... 34.80 33.75 27.77 29.05 16.23 23.07 6.48 11.59 75.1% 42.80%
Bank of New York Mellon.................................. 0.22 0.43 0.20 0.47 0.07 0.42 0.06 0.33 55.9% 9.9%
BB&T..................................................... 1.68 2.15 1.55 1.87 0.85 1.57 0.34 1.00 70.8% 28.8%
Capital One Financial.................................... 4.48 4.48 4.55 4.65 3.47 4.52 1.96 2.96 31.7% 14.8%
Citigroup................................................ 33.42 35.94 29.13 31.70 19.02 29.62 10.45 16.12 47.3% 30.6%
Fifth Third Bank......................................... 2.50 3.49 1.96 3.07 2.71 2.79 0.46 0.94 75.5% 54.9%
GMAC LLC................................................. * * * * * * * * * *
Goldman Sachs............................................ * * 0.00 0.00 * * * * * *
JPMorgan Chase........................................... 24.08 29.03 17.58 27.38 9.84 23.16 4.54 9.23 74.4% 46.5%
KeyCorp.................................................. 2.16 2.50 1.96 2.19 1.26 1.80 0.28 1.20 98.7% 27.7%
MetLife Inc.............................................. * * 0.32 0.49 0.16 0.32 0.05 0.21 * *
Morgan Stanley........................................... * * 0.02 0.15 * * * * * *
PNC Financial Services................................... 3.18 4.57 1.72 4.30 0.54 3.92 0.20 0.83 151.0% 76.6%
Regions Financial........................................ 1.96 2.28 1.56 1.86 1.55 1.83 0.29 1.32 89.2% 18.7%
State Street............................................. * * 0.03 0.09 0.00 0.02 0.00 0.02 * *
SunTrust Banks........................................... 3.20 2.90 2.44 2.74 1.56 2.35 0.42 1.28 96.4% 31.2%
U.S. Bancorp............................................. 3.72 4.38 3.15 3.95 1.82 3.51 0.79 2.06 67.4% 28.6%
Wells Fargo & Co......................................... 17.54 23.53 13.03 22.80 7.84 21.01 3.54 5.31 70.5% 64.3%
--------------------------------------------------------------------------------------------------------------------------------------------------------
* Data not available
\187\ The data used in creating this chart were derived from models prepared by the Panel staff in conjunction with information from the quarterly and
yearly SEC filings, and company earnings reports of the following companies from the period 12/31/07 to 6/30/09: American Express; Bank of America;
Bank of New York Mellon; BB&T; Capital One Financial; Citigroup; Fifth Third Bank; GMAC; Goldman Sachs; J.P. Morgan Chase; KeyCorp; MetLife; Morgan
Stanley; PNC Financial; Regions Financial; State Street; SunTrust Bank; U.S. Bancorp; Wells Fargo.
Analysis does not include GMAC which did not include loan losses and non-performing loans data in its SEC filings.
Figure 12 below illustrates the significant increase in
non-performing loans as a percentage of total loans for the
stress-tested BHCs over a one year period (June 30 2008--June
30 2009). This highlights the significant increase in non-
performing loans on the banks' balance sheets over this period.
FIGURE 12: NON-PERFORMING LOANS \188\
[Dollars in millions]
----------------------------------------------------------------------------------------------------------------
% of % of
Total Total Total Total
Q2 2009 Q2 2008 Loans Q2 Loans Q2 Loans Loans % Change
2009 2008 2Q09 2Q08
----------------------------------------------------------------------------------------------------------------
Bank of America.................... $29,181 $9,156 $942,248 $870,464 3.10 1.05 294.43
Bank of NY Mellon.................. $372 $273 $32,895 $39,831 1.13 0.69 165.00
BB&T............................... $2,091 $1,016 $100,334 $95,715 2.08 1.06 196.33
Capital One........................ * * $146,555
Citigroup.......................... $28,246 $11,626 $641,700 $746,800 4.40 1.56 282.75
Fifth Third........................ $2,587 $1,726 $81,573 $83,537 3.17 2.07 153.49
Goldman Sachs...................... * *
JPMorgan Chase..................... $14,785 $5,273 $680,601 $538,029 2.17 0.98 221.43
KeyCorp............................ $2,188 $814 $70,803 $75,855 3.09 1.07 287.98
Morgan Stanley..................... * *
PNC Financial Services............. $4,032 $695 $168,888 $72,828 2.39 0.95 250.17
Regions............................ $2,618 $1,410 $96,149 $98,267 2.72 1.43 189.76
State Street....................... * * $9,365 $10,643
SunTrust........................... $5,504 $2,625 $124,100 $125,200 4.44 2.10 211.53
U.S. Bancorp....................... $3,014 $971 $173,177 $163,070 1.74 0.60 292.29
Wells Fargo........................ $15,798 $4,073 $821,614 $399,237 1.92 1.02 188.47
----------------------------------------------------------------------------------------------------------------
* Data not available
\188\ The data used in creating this chart were derived from models prepared by the Panel staff in conjunction
with information from the quarterly and yearly SEC filings, and company earnings reports of the following
companies from the period 12/31/07 to 6/30/09: Bank of America; Bank of New York Mellon; BB&T; Capital One
Financial; Citigroup; Fifth Third Bank; Goldman Sachs; J.P. Morgan Chase; KeyCorp; Morgan Stanley; PNC
Financial; Regions Financial; State Street; SunTrust Bank; U.S. Bancorp; Wells Fargo.
Does not include American Express, GMAC and Metlife which did not include loan losses and non-performing loans
data in their SEC filings.
Thus, by several different estimates from publicly
available information, significant amounts of troubled assets
appear to remain on banks' balance sheets.
C. The Panel's Model of Loan Losses and Capital Shortfalls
1. INTRODUCTION
The Panel's quantitative efforts focused on modeling losses
in whole loans, assets which represent over $5.9 trillion in
the 719 banks modeled by the Panel.\189\ Such loans are the
only troubled asset for which sufficient information is
available to create a reasonable model with few assumptions
that can be tested under a number of different scenarios.
---------------------------------------------------------------------------
\189\ Data from BHC Y-9Cs.
---------------------------------------------------------------------------
2. METHODS
SNL Financial developed a model for assessing loan losses
and capital requirements for banks that was modified by the
Panel for scenario testing.\190\ The model tests all BHCs \191\
which have assets greater than $600 million, a group that
includes the stress-tested and other large BHCs and medium to
large regional BHCs, against more severe economic scenarios,
similar to the Federal Reserve Board in its analysis. Loan
losses are calculated as the product of the loan loss rate as
dictated by the scenario, with the total loans of that type
held by each BHC. This number is combined with an estimate of
the company's Pre-Provision Net Revenue (PPNR) for the next two
years, a number which is calculated from the past two years,
and the company's loan loss reserves to yield the amount of
capital necessary for the bank to be recapitalized after the
losses sustained in the scenario.
---------------------------------------------------------------------------
\190\ See Part E of this Annex to Section One for a detailed
discussion of SNL's methods.
\191\ Excluding 66 banks which did not supply enough information to
calculate Tier 1 common capital for the period ending March 31, 2009.
---------------------------------------------------------------------------
The Panel used two methods to calculate loan losses: a
standard and a customized. The standard method used the loan
loss rates similar to the Federal Reserve Board in its analysis
and uniformly applied them across all of the BHCs considered.
The customized approach attempted to tailor these aggregate
loan loss rates to individual banks, on the basis of their past
performance. Thus for banks whose loans consistently
outperformed the market, their loan loss rate was lowered,
while BHCs that consistently hold lower quality loans had their
loan loss rates raised.\192\
---------------------------------------------------------------------------
\192\ This calculation would not have resulted in any net change in
the aggregate loan loss numbers; however, the panel imposed a floor of
25% and a cap of 200% on these modifications.
---------------------------------------------------------------------------
Two scenarios were analyzed by the Panel. In each scenario,
the only modifications were in the loan loss expectations. The
loan loss assumptions in the two scenarios were:
FIGURE 13: ASSUMED LOAN LOSS RATES
------------------------------------------------------------------------
Starting Point Starting
\193\ Point + 20
(Percent) percent \194\
------------------------------------------------------------------------
First lien mortgages.................... 8.5 10.2
Closed-end junior lien mortgages........ 25.0 30.0
Home equity lines of credit (HELOC)..... 11.0 13.2
Commercial & industrial loans........... 8.0 9.6
Construction & land development loans... 18.0 21.6
Multifamily loans....................... 11.0 13.2
Commercial real estate loans (nonfarm, 9.0 10.8
nonresidential)........................
Credit card loans....................... 20.0 24.0
Other consumer loans.................... 12.0 14.4
Other loans............................. 10.0 12.0
------------------------------------------------------------------------
\193\ Loan loss rates were taken from the stress test's ``more adverse''
scenario. Federal Reserve Board, The Supervisory Capital Assessment
Program Overview of Result, at 5 (May 7, 2007) (online at
www.federalreserve.gov/newsevents/press/bcreg/bcreg20090507a1.pdf).
\194\ Loan loss rates were calculated as 1.2 times the rates from the
``starting point'' scenario.
D. Results\195\
---------------------------------------------------------------------------
\195\ To test the accuracy of its estimates, the Panel calibrated
its model to the results of the stress tests. In doing so, it simply
used the results as a base line and did not mean to accept or reject
the assumptions made there. The median result reached by the Panel in
calibrating its results was 2.5% higher than the stress tests, and was
most likely the result of the portions of the stress tests that cannot
be independently replicated.
---------------------------------------------------------------------------
The Panel's analysis shows that although the stress-tested
BHCs may be sufficiently capitalized to deal with losses in
their whole loan portfolios, BHCs in the $600 million to $100
billion range will likely need to raise significantly more
capital if they experience increased loan losses due to an
economic downturn. As shown by the following graph, smaller
banks have fewer reserves to absorb losses.
FIGURE 14: LOAN LOSSES PROJECTED FROM Q1 2009 INFORMATION
[Dollars in millions]
----------------------------------------------------------------------------------------------------------------
Starting Point Starting Point + 20%
---------------------------------------------------------------------------
Standard Customized Standard Customized
----------------------------------------------------------------------------------------------------------------
Top 18 BHCs \196\................... 486,458 504,083 583,749 604,804
All Banks with Assets $100B to $600M 152,134 123,069 182,560 146,560
\197\..............................
Total (All banks $600M+)........ 638,591 627,152 766,309 751,364
----------------------------------------------------------------------------------------------------------------
\196\ Stress tested BHCs excluding GMAC.
\197\ Excluding Keycorp, which is one of the 18 BHCs, but whose assets have fallen below $100B.
FIGURE 15: CAPITAL SHORTFALLS PROJECTED FROM Q1 2009 INFORMATION
[Dollars in billions]
----------------------------------------------------------------------------------------------------------------
Starting Point Starting Point + 20%
---------------------------------------------------------------------------
Standard Customized Standard Customized
----------------------------------------------------------------------------------------------------------------
Top 18 BHC \198\.................... 0.0 0.0 8.71 2.33
All Banks with Assets $100B to $600M 11.70 13.99 21.45 21.25
\199\..............................
Total (All banks $600M+)........ 11.70 13.99 30.16 23.57
----------------------------------------------------------------------------------------------------------------
\198\ Stress tested BHCs excluding GMAC.
\199\ Excluding Keycorp, which is one of the 18 BHCs, but whose assets have fallen below $100B.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
As evidenced by the graph below, the projected capital
shortfall is concentrated in banks with total assets ranging
from $1 billion to $100 billion. Under both scenarios, the
capital shortfall for banks with less than $100 billion in
assets is an order of magnitude greater than the shortfalls for
the 18 stress-tested BHCs. The Panel sees this as a serious
issue; smaller banks may have access to a comparatively smaller
pool of investors, and could face significant challenges in
raising the necessary capital.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
E. SNL Financial Model Methodology
1. OVERVIEW
SNL conducted two stress tests on the Tier 1 common capital
of bank holding companies with assets greater than $600
million, using two different hypothetical loan loss rate
methodologies. One methodology assumed loan losses over the
next two years for each bank by evaluating their current
delinquency rates for each loan type, while the other uniformly
applied the more adverse loan loss rates that were specified in
the Supervisory Capital Assessment Program (SCAP) report,
regardless of individual bank delinquency rates. SNL used
regulatory financials as of March 31, 2009, but Tier 1 common
capital was adjusted for common capital offerings completed
between April 1st and July 24th, following the methodology of
the SCAP report. All data used in the model is from the March
31, 2009 bank holding company Y9-C filings with the Federal
Reserve.
---------------------------------------------------------------------------
\200\ The starting point + 20% portion of the column represents the
marginal increase from the capital required under the starting point
scenario.
---------------------------------------------------------------------------
2. LOAN LOSSES--CUSTOMIZED SCENARIO
SNL determined hypothetical loan loss rates by adjusting
the SCAP's adverse loan loss rates for each bank. SNL compared
each bank's delinquent loans by loan type--defined as loans 30
to 89 days past due and 90-plus days past due, and loans in
nonaccrual status, excluding any government-guaranteed loans--
to the aggregate delinquency rate, by loan type, for all of the
banks in the analysis and calculated a ratio for each bank (the
bank's individual delinquencies divided by the industry
delinquency rate for each loan type). SNL then applied this
ratio to the SCAP's adverse loan loss rates to create
individualized loss rates for each bank. For instance, if a
company had a delinquency rate lower than the industry average,
SNL lowered the hypothetical loan loss rate by the same
proportion.
SNL limited the maximum loss rates to the greater of the
bank's delinquency rates or 4 the SCAP's more adverse
rate (the pro-rated loss rates were also capped at 100
percent). It also set a minimum loss rate of 25 percent of the
SCAP's more adverse rate. As such, the aggregate loan loss
rates for the banks in this analysis will not equal the most
adverse loan loss rates specified in the SCAP report due to the
caps and floors imposed on the customized loss rates for each
loan type.
3. LOAN LOSSES--STANDARDIZED SCENARIO
Using the ``more adverse'' loan loss rates from the SCAP
report, SNL uniformly applied these rates to each loan type for
each bank holding company to determine the total losses for
each loan portfolio. For example, the SCAP report specified
that First Lien Mortgages were stressed under the most adverse
scenario at an 8.5 percent loss rate. This rate was then
applied to each bank within the analysis.
Under each scenario, consolidated loans in both foreign and
domestic offices for each loan type are used where possible.
However, real estate loan types in the model, such as first
lien and closed-end junior lien mortgages, home equity lines,
multifamily loans, construction and land development, and
commercial real estate loans, represent the bank's domestic
loans in each category due to lack of disclosure of
consolidated loans. Therefore, the total loans stress-tested
may not equal the total amount of consolidated loans at each
bank holding company.
For both loan loss scenarios, a 35 percent tax rate was
applied to the loss for each bank. The calculated loan losses
for each bank were then applied against the bank's excess loan
loss reserve. SNL assumed that each bank would have to maintain
a one percent loan loss reserve to total loans ratio. SNL then
decreased Tier 1 common capital for the losses not absorbed by
the excess reserves.
The loan portfolio detail for each bank holding company
used to calculate loan losses is located in the HC-C schedule
(Loans & Leases) within the bank's Y-9C filing with the Federal
Reserve.
4. FUTURE EARNINGS
Like the Federal Reserve in its stress test, SNL used pre-
provision net revenue to predict 2009 and 2010 earnings for the
banks. SNL predicted pre-provision net revenue for each bank by
taking the average pre-provision net revenue, from each bank's
Y-9C filing, as a percent of average assets for the last twelve
months ending March 31, 2009, and the prior twelve months
ending March 31, 2008, and projecting that rate forward over
two years, based on the company's most recent asset size. Pre-
provision net revenue was defined by the Federal Reserve as net
interest income plus non-interest income minus non-interest
expense, but SNL ``normalized'' its predictions by excluding
gains on sale of securities (losses were included), goodwill
impairment and amortization of intangibles from 2007 and 2008
data. For banks that did not have any data available for the
last two years or for any bank with pre-provision net revenue
less than 0.75 percent of assets over the period, SNL assumed a
pre-provision net revenue rate of 0.75 percent of most recent
assets. SNL found that some banks had large losses related to
sale of securities that occurred primarily due to write-downs
associated with Fannie Mae's collapse in 2008. Since these
losses were one-time and were are not recurring, SNL assumed a
0.75 percent rate as a minimum for pre-provision net revenue as
that represented roughly half the mean rate for the banks
stress-tested. A 35 percent tax rate was then applied to each
bank's pre-provision net revenue.
The income statement detail for each bank holding company
used to calculate pre-provision net revenue is located in the
HI schedule (Income Statement) within the bank's Y-9C filing
with the Federal Reserve.
5. NET CAPITAL REQUIREMENTS
SNL calculated Tier 1 common capital for each bank holding
company from their HC-R schedule (Regulatory Capital) of the Y-
9C filing with the Federal Reserve. A total of 66 banks were
excluded from the analysis since they did not supply enough
information to calculate Tier 1 common capital for the period
ending March 31, 2009.
SNL calculated the hypothetical decrease in Tier 1 common
capital by netting out the amount of loan losses under each
scenario, assuming that loan loss reserves could be depleted to
just one percent of loans, and adding in the expected two-year
PPNR, all after taxes. SNL then added any common capital raised
between March 31, 2009, and July 24, 2009.
Those bank holding companies with a pro forma Tier 1 common
capital to risk-adjusted assets ratio less than four percent,
the SCAP capital requirement, were designated as needing
additional capital under an adverse economic environment; the
additional capital needed was specified as the amount needed to
increase their Tier 1 common capital levels to equal four
percent of their risk-adjusted assets.
SECTION TWO: ADDITIONAL VIEWS
A. Senator John E. Sununu
I believe that the purchase of troubled assets as proposed
under the PPIP is an important area of oversight for the Panel.
The August Report, however, was affected by many of the same
challenges that have prevented the Panel from achieving a
greater level of consensus in its work to date. These include
an approach in early drafts that is often too broad in its
treatment of institutions and regulators, delays in preparing
drafts driven by the significant changes that must be made, and
the inclusion of policy recommendations that are controversial
and/or fall outside the Panel's statutory mission.
Through extended and extraordinary work, the Panel staff
has been able to incorporate a very large number of requests
for changes to the Report. While the improvements made to the
text of the August Report have been sufficient to allow me to
support its passage, I feel that it is important to highlight
and clarify the areas where problems remain, where consensus
has not been reached, and where the Panel should refocus its
oversight efforts.
First, the August Report discusses and pursues specific
changes in or alternatives to existing federal policy. Some
proposals are framed as ``alternatives,'' others as
``conclusions.'' These include alternative Strategies for
Dealing with Troubled Assets (pp. 36-39), a discussion of
proposals for The Future (pp. 58-60), and a series of
Conclusions (pp. 60-61). Engaging in an extended presentation
of policy alternatives and recommendations is inappropriate for
several reasons:
Scope. Policy-making falls well outside the
primary statutory mission of the Congressional Oversight Panel.
This is the job of Congress, Treasury, and the responsible
regulatory agencies. The Panel should work to inform policy
makers by collecting and presenting information, and providing
sound analysis of existing TARP programs. Good oversight may
not always attract the same headlines as controversial policy
proposals, but it is valuable; more important, this is the task
assigned to the Panel.
Expertise. Several of the assessments and
conclusions within the August Report are based upon the Panel
staff performing loan loss modeling and stress tests on
financial institutions (see pp. 33-35). The economic
environment chosen--``20 percent more negative''--appears to be
quite arbitrary, and a broad conclusion is drawn that ``. . .
while the largest BHCs are sufficiently capitalized to deal
with whole loan losses, the smaller BHC's are not (p. 35).''
These results are then used to suggest a modification or re-
evaluation of the capital ratios for financial institutions (p.
61, item 4). Conducting stress tests, making conclusions about
regulatory capital, and recommending changes to the capital
requirements of financial institutions are well outside the
Panel's area of responsibility and expertise.
Timing. Even in a situation where some Panel
members feel that alternatives to existing programs should be
discussed, we should at least provide the opportunity for
programs to be established before offering criticism. It is
quite premature to consider modifications to PPIP, a program
that has yet to be fully implemented.
Costs to Taxpayers. At no point in the
presentation of alternatives or conclusions are the potential
costs to taxpayers discussed in detail. This includes, for
example, a suggestion that ``Treasury must* * *do whatever can
be done to restart the market for those securities'' (p. 61,
item 2) as well as recommendations for conducting stress tests
on smaller banks (p. 61, item 4). It is unwise to include
sweeping, and potentially costly, suggestions in a report that
should be focused on basic oversight and program operations.
A second broad concern is that the time and effort devoted
to extended discussion of policy alternatives in the August
Report (as well as previous Reports) has limited or even
prevented the Panel's assessment of several key programs
established under the TARP. Congressman Jeb Hensarling provides
a thorough summary of the need for more oversight in these
areas within his own Alternative Views. Most notably, however,
the Panel has yet to formally evaluate the following programs:
Funding for Systemically Significant Failing
Institutions (AIG)
Funding and Programs affecting Fannie Mae and
Freddie Mac
Funding Provided to Auto Manufacturers, Automotive
Parts Manufacturers, and Automotive Finance Firms
Portfolio Guarantees provided to Citigroup and
Bank of America
These are large programs that consume over twenty percent
of the total funds Congress has authorized under TARP. Congress
and the public would benefit from the Panel's assessment of
their structure, cost, and implementation to date. Nine months
after establishing the Congressional Oversight Panel, this has
yet to be done.
The work of the Congressional Oversight Panel is important
to Congress, the Treasury, and to taxpayers. Our statutory
mission and primary focus should be to provide an independent
assessment of the operation and performance of programs created
under the Troubled Asset Relief Program. Where material
weaknesses in programs exist, the Panel should be clear about
the need for improvements. The Panel is not, however, a policy-
making body. By refocusing effort on the essential oversight of
TARP programs, the Panel can better meet congressional intent
and serve the public interest as well.
B. Rep. Jeb Hensarling
Although I commend the Panel and its staff for their
efforts in producing the August Report, I do not concur with
all of the analysis and conclusions presented in the report and
cannot support its approval.
The Panel proposes a number of approaches regarding the
problems presented by toxic assets. Although there is no
assurance that any of these alternatives will offer definitive
solutions, it is clear that most of the proposals will require
taxpayers to fund significant amounts either to purchase
distressed loans and securities or prop-up problematic
financial institutions. It is possible that the toxic asset
market is already beginning to heal itself and that the
intervention proposed by the Panel could be inappropriate--if
not counterproductive. For this reason, I think it premature to
endorse one or more of the approaches proposed by the Panel,
but, instead, suggest that Treasury and the Fed continue to
monitor the toxic asset market. If the ``green shoots'' of
economic recovery continue to develop it's likely that the bid-
asked spreads for toxic assets will narrow as the sellers and
buyers of those assets regain confidence and as the inventory
of houses and commercial property is absorbed into the broader
economy.\201\ The process will not proceed as quickly as we
would like. In my view, a less than optimal pace of recovery
should not be used by the Obama Administration or Congress to
justify additional governmental investment of involuntary
taxpayer capital.\202\
---------------------------------------------------------------------------
\201\ See, e.g., Sara Murray, Job Losses Slow as Rate Drops, Wall
Street Journal (Aug. 8, 2009) (online at online.wsj.com/article/
SB124964812540714249.html); Peter A. McKay and Donna Kardos Yesalavich,
Job Report Keeps Wind Behind Stocks, Wall Street Journal (Aug. 10,
2009) (online at online.wsj.com/article/SB124964397459514109.html)
(noting that the Dow Jones Industrial Average and S&P 500 rose to their
highest levels of 2009); Liam Pleven, AIG Returns to a Tenuous Profit
(Aug. 10, 2009) (online at online.wsj.com/article/
SB124964014232314037.html).
\202\ In fact, even the suggestion that the government will somehow
come to the rescue regarding losses and capital inadequacies generated
by toxic assets may create moral hazard issues, impede true price
discovery and thwart the healing process that appears to have already
commenced. That said, it is important to remain vigilant and the Panel
should continue to monitor issues created by distressed whole loans and
securitized loans.
---------------------------------------------------------------------------
As the report alludes, there is no doubt a need for an
``accurate valuation'' of the projected losses and capital
shortfalls arising from the troubled assets that continue to
plague the balance sheets and income statements of both large
and small financial institutions. Were such a valuation
accomplished, it would be helpful in assessing systemic
financial contagion and establishing a path to economic
recovery. Although an interesting and insightful project, this
is a task that I view as almost impossible and one not nearly
as important as providing taxpayers with insight into whether
TARP is actually working and what financial institutions (and
even auto makers) have done with TARP investments.
The Panel originally undertook to model whole loans and
securitized loans, but finally chose to model only projected
losses and capital shortfalls arising from whole loans held by
certain ``banks.'' The Panel started with the ``more adverse''
assumptions used by the Federal Reserve Board in conducting the
recently completed stress-test analysis and then ran the
numbers again based upon assumptions that were 20 percent more
negative. The Panel concluded that ``while the 18 largest BHCs
are sufficiently capitalized to deal with whole loan losses,
the . . . smaller BHCs . . . are not, and are going to require
additional capital given more adverse economic conditions.''
While I am encouraged by the Panel's conclusion regarding the
18 largest BHCs, I am not necessarily discouraged by the
results for the smaller banks since it is entirely possible
that the input assumptions used by the Panel were excessively
pessimistic. As with any econometric model, input assumptions
drive the output results and it is far from clear that future
economic conditions will be 20 percent more negative than the
``more adverse'' standard adopted by the Fed for the stress-
tests. Observers should resist the temptation to report the
Panel's finding in this regard in a simplistic and alarmist
manner.
When an oversight body attempts to place a price tag on any
group of toxic assets, the implication is that the government
must intervene to either purchase or arrange a purchase of such
assets, which would likely require a generous taxpayer subsidy
as an incentive to remove them from the holders' balance
sheets. If assets like mortgage-backed securities are thinly-
traded because spreads are too wide for a legitimate price
discovery process, then a valuation below the reservation price
of the financial institutions holding the assets could infer
that the government should inject even more capital into the
institutions. A valuation equal to or above the reservation
price of the financial institutions could infer that the
government should subsidize private investors. As I discussed
in an addendum to the Panel's July Report on TARP warrant
repurchases, I am worried that the current report may again
attempt to jumpstart the price discovery process using
mechanisms the Panel or outside experts have developed without
understanding the costly consequences.
In the section of the report dedicated to ``The Future'' of
the Continued Risk of Toxic Assets, the Panel concludes: ``Even
given its use to restart the markets rather than to take large
numbers of troubled assets off bank balance sheets, Treasury
should consider whether the PPIP legacy securities program
should be expanded if the markets would appear to benefit from
additional `pump-priming.' If the program is not working,
Treasury should consider adopting a different strategy to
remove the troubled assets from banks' books.'' Additionally,
in the ``Conclusion'' section of the current report the Panel
states: ``Treasury must assure robust legacy securities and
legacy loan programs or consider a different strategy to do
whatever can be done to restart the market for those assets.''
Although limited governmental intervention may be merited
under certain circumstances, both of these recommendations seem
to me as advocacy for yet another bailout of failed federal
program with involuntary taxpayer capital while voluntary
investor capital remains on the sidelines--largely due to the
uncertainty injected into the program by the Administration and
by Congress. It is worthwhile to note that private capital has
given a lackluster reception to Treasury's Public-Private
Investment Program (PPIP), citing concerns about ``doing
business with the government.'' Many investors factor ``Country
Risk'' into investment decisions when dealing in economies
affected by unstable governments. My fear is now they must now
do so when investing in the United States economy.
If PPIP's investment vehicles experience high returns, and
participants are paid contractually-agreed upon returns, will
they be subject to confiscatory measures if the amounts are
considered in retrospect ``excessive''? What sort of corporate
governance measures will be required? Could statutory
provisions governing TARP be enacted that would apply
additional restrictions? The Panel's report does not adequately
address these issues. With such questions lingering, firms will
calculate the risks associated with a program like PPIP and
quite possibly view alternative investments as more favorable
undertakings. As I discussed in an addendum to the Farm Credit
Report,\203\ it is critical that the Obama Administration and
Congress properly vet all issues of ``political risk'' \204\
that may arise with respect to any retroactive mandates that
are incorporated into the PPIP program after its launch.\205\
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\203\ My comments on political risk are noted on pages 99-100 of
the Farm Credit Report at cop.senate.gov/documents/cop-072109-
views.pdf.
In addition, 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 Capital Purchase
Program advances but have warrants outstanding to Treasury) may be
subjected to future adverse rules and regulations. In my opinion the
TARP program should be terminated due to, among other reasons, (1) the
clear desire of the American taxpayers for the TARP recipients to repay
all TARP related investments sooner rather than later, (2) the
troublesome corporate governance and regulatory conflict of interest
issues raised by Treasury's ownership of equity interests in the TARP
recipients, (3) the stigma associated with continued participation in
the TARP program by the recipients, and (4) the demonstrated ability of
the current Administration to use the program to promote its economic,
social and political agenda. I introduced legislation (H.R. 2745) to
end the TARP program on December 31, 2009. In addition, the legislation
(1) requires Treasury to accept TARP repayment requests from well
capitalized banks, (2) 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, (3) provides incentives for
private banks to repurchase their warrant preferred shares from
Treasury, and (4) reduces spending authority under the TARP program for
each dollar repaid.
\204\ The report includes the following single reference to
``political risk'': ``Similarly, it is unclear whether wariness of
political risks will inhibit the willingness of potential buyers to
purchase these assets.'' This is far too significant of an issue to be
brushed aside with such a muted acknowledgement.
\205\ In addition, I have other concerns with the PPIP program.
Will the newly revised mark-to-market rules discourage holders of
distressed securities from selling those securities to a PPIP
partnership or another purchaser? Holders may understandably elect not
to dispose of their distressed securities if the sales would generate
accounting losses and increase the holders' capital requirements. Will
the PPIP program create a sufficient market for distressed securities
so as to require holders of such securities to apply mark-to-mark
accounting even though they may have no present intent to sell the
securities? If so, many financial institutions may have to book
additional losses and raise new capital. Is the PPIP program simply a
subsidy by the government that finances the purchase of distressed
securities at inflated prices? If so, the program may do more harm than
good when non-subsidized purchasers refuse to purchase distressed
securities at the subsidized prices.
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I am also troubled by the nature of the Panel's oversight
as presented in this report. Once again, the policy
recommendations presented in the report is outside the scope of
the Panel's authority and could diminish the Panel's ability to
discharge its statutory responsibility of investigating current
programs in dire need of oversight. TARP has morphed into a
complex web of eight official programs, \206\ and the Panel
should continue to press Treasury for a legal justification for
its authority to recycle TARP funds for other uses and new
programs. In my view, proper oversight should include (1)
analyzing programs proposed by Treasury to determine if they
are reasonable, transparent, accountable and properly designed
for their intended purpose, (2) determining if the programs are
being properly implemented in a reasonable, transparent and
accountable manner, (3) determining if taxpayers are being
protected, (4) determining the success or failure of the
programs based upon reasonable, transparent, accountable and
objective metrics, (5) analyzing Treasury's exit strategy with
respect to each investment of TARP funds, (6) analyzing the
corporate governance policies and procedures implemented by
Treasury with respect to each investment of TARP funds, (7)
holding regular public hearings with the Secretary and other
senior Treasury officials as well as with the senior management
of the institutions that received TARP funds, (8) determining
how TARP recipients invested and deployed their TARP funds,
and, most importantly, (9) reporting the results to the
taxpayers in a clear and concise manner. The Panel should
conduct its oversight activity in the most reasonable,
transparent, accountable and objective manner possible with
measurable standards that hold Treasury accountable for the
statutory mandate of EESA that taxpayer protection is made an
upmost priority.\207\
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\206\ The eight official programs are as follows: (1) Capital
Purchase Program (initial equity injections to institutions), (2)
Automotive Industry Financing Program, (3) Automotive Supplier Support
Program, (4) Targeted Investment Program (Citigroup, Bank of America),
(5) Asset Guarantee Program, (6) Consumer and Business Lending
Initiative Investment Program (TALF cushion), (7) Systemically
Significant Failing Institutions (AIG) and (8) Home Affordable
Modification Program.
\207\ EESA Sec. 113, ``Minimization of Long-Term Costs and
Maximization of Benefits for Taxpayers.''
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In addition to providing ongoing oversight across TARP
programs, it troubles me that the Panel does not investigate
and report upon the following uses of taxpayer funds, which
carry significant exposure to risk, on a more regular basis.
The Panel should rigorously apply the above strategy to ensure
complete transparency for the taxpayers.
Systemically Significant Failing Institutions Program: This
is the formal name given to the rescue of AIG using $69.84
billion \208\ in TARP funds.
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\208\ U.S. Department of the Treasury, Section 105(a) Troubled
Assets Relief Program Report to Congress for the Period June 1, 2009 to
June 30, 2009 (July 10, 2009) (online at www.financialstability.gov/
docs/105CongressionalReports/105aReport_07102009.pdf) (hereinafter July
10 TARP Congressional Report'').
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In April of 2009, Treasury made the decision to add almost
$30 billion to the existing $40 billion already provided to AIG
in exchange for preferred stock with warrants. The government
has a 77.9 percent stake in the insurer. Were it to convert
preferred shares into common equity, as occurred for Citigroup,
the nature of ownership would change and taxpayer risk would be
enhanced. (On top of this, the Federal Reserve has created a
$60 billion revolving loan facility for AIG, of which $25
billion will be forgiven in exchange for preferred interest in
two of its life insurance subsidies.\209\ It also holds $36
billion in AIG mortgage-backed securities through ``Maiden Lane
II LLC'' and ``Maiden Lane III LLC.'') \210\ Even though AIG
just announced that it turned a quarterly profit for the first
time in two years, it is still a struggling company that
continues to draw on government loans.\211\ CEO Edward Liddy
has stated that he expects to repay the government in three to
five years,\212\ although he has provided no detailed plan on
how this will be accomplished.
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\209\ U.S. Department of the Treasury, U.S. Treasury and Federal
Reserve Board Announce Participation in AIG Restructuring Plan (Mar. 2,
2009) (online at www.financialstability.gov/latest/tg44.html).
\210\ Board of Governors of the Federal Reserve System, Federal
Reserve Statistical Release H.4.1: Factors Affecting Reserve Balances
(Aug. 6, 2009) (online at www.federalreserve.gov/releases/h41/Current/)
(accessed Aug. 10, 2009).
\211\ David Goldman, AIG logs first quarterly profit since 2007,
CNNMoney (Aug. 7, 2009) (online at money.cnn.com/2009/08/07/news/
companies/aig_earnings/index .htm?postversion=2009080707&eref=edition).
\212\ Id.
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While it has conducted some meaningful oversight since
November, the Panel has provided limited oversight of TARP
funds invested in AIG and its affiliates.
Citigroup and Bank of America: Citigroup has received $45
billion \213\ in committed aid through TARP's Capital Purchase
Program and Targeted Investment Program. On top of that,
Treasury and the FDIC have agreed to guarantee about $306
billion \214\ in assets of Citigroup.
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\213\ July 10 TARP Congressional Report, supra note 208.
\214\ U.S. Department of the Treasury, Joint Statement by Treasury,
Federal Reserve and the FDIC on Citigroup (Nov. 23, 2008) (online at
www.financialstability.gov/latest/hp1287.html).
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Bank of America has received $45 billion \215\ in committed
aid through TARP's Capital Purchase Program and Targeted
Investment Program. On top of that, Treasury and the FDIC have
agreed to guarantee about $118 billion \216\ in assets, the
majority of which Bank of America acquired through Merrill
Lynch.
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\215\ July 10 TARP Congressional Report, supra note 208.
\216\ U.S. Department of the Treasury, Treasury, Federal Reserve
and the FDIC Provide Assistance to Bank of America (Jan. 16, 2009)
(online at www.financialstability.gov/latest/hp1356.html).
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It is the Panel's responsibility to shed light into TARP,
including the Citigroup and Bank of America investments. The
stress tests performed by the Federal Reserve assessed the
capital needed for both institutions to survive an additional
round of losses or further deterioration of earnings. It did
not, however, fully gauge the banks' ability to repay TARP
funds or track the ways they channeled the money. The Panel
should be conducting ongoing interviews with these and other
major recipients of TARP funds to probe for such information,
as well as to hold Treasury accountable for articulating its
exit strategy with respect to each investment.
In addition, I repeat my concerns that no major traditional
financial institution has testified before the Panel. In fact,
only three TARP recipients have appeared as hearing witnesses;
the largest was M&T Bank Corporation, which received $600
million in aid.
While it has conducted some meaningful oversight since
November, the Panel has provided limited oversight of how
taxpayer funds were spent by financial institutions.
Chrysler and GM: The panel held a field hearing on July 27,
2009 featuring Ron Bloom from the President's Auto Task Force,
Chrysler and GM officials, bankruptcy experts and a
representative from the Indiana State pension funds, a creditor
of Chrysler. No witness from the UAW, which currently holds a
67.7 percent stake in Chrysler and a 17.5 percent stake in GM
through its retiree benefits trust, was available to testify,
despite the Panel's selection of a hearing location that was
about a 15-minute drive from UAW headquarters.
Because this is a significant and ongoing issue involving
over $80 billion \217\ in TARP funds and government ownership--
and several questions remain unanswered about Treasury's
involvement in the bankruptcy negotiations--it is incumbent
upon the Panel to make oversight of the two automakers a key
area of continuing focus beyond the Panel's report that is
scheduled for release in early September.
---------------------------------------------------------------------------
\217\ July 10 TARP Congressional Report, supra note 208 $80 billion
includes TARP investments in Chrysler Financial Services Americas LLC
and GMAC LLC.
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Here is an overview of the post-bankruptcy allocations of
Chrysler and GM.
Chrysler. Pursuant to the Chrysler bankruptcy, the equity
of New Chrysler was allocated as follows:
1. United States government (9.846 percent initially,
but may decrease to 8 percent),
2. Canadian government (2.462 percent initially, but
may decrease to 2 percent),
3. Fiat (20 percent initially, but may increase to 35
percent), and
4. UAW (comprising current employee contracts and a
VEBA for retired employees) (67.692 percent, but may
decrease to 55 percent).
The adjustments noted above permit Fiat to increase its
ownership interest from 20 percent to 35 percent by achieving
specific performance goals relating to technology, ecology and
distribution designed to promote improved fuel efficiency,
revenue growth from foreign sales and U.S. based production.
Some, but not all, of the claims of the senior secured
creditors were of a higher bankruptcy priority than the claims
of the UAW/VEBA. The Chrysler senior secured creditors received
29 cents on the dollar ($2 billion cash for $6.9 billion of
indebtedness).
The UAW/VEBA, an unsecured creditor, received (1) 43 cents
on the dollar ($4.5 billion note from New Chrysler for $10.5
billion of claims) and (2) a 67.692 percent (which may decrease
to 55 percent) equity ownership interest in New Chrysler.
GM. Pursuant to the GM bankruptcy, the equity of New GM was
allocated as follows:
1. United States government (60.8 percent),
2. Canadian government (11.7 percent),
3. UAW (comprising current employee contracts and a
VEBA for retired employees) (17.5 percent), and
4. GM bondholders (ten percent).
The bankruptcy claims of the UAW/VEBA and the GM
bondholders were of the same bankruptcy priority.
The equity interest of the UAW/VEBA and the GM bondholders
in New GM may increase (with an offsetting reduction in each
government's equity share) to up to 20 percent and 25 percent,
respectively, upon the satisfaction of specific conditions. It
is important to note, however, the warrants received by the
UAW/VEBA and the GM bondholders are substantially out of the
money and it's unlikely they will be exercised. As such, it
seems most likely that the UAW/VEBA and the GM bondholders will
hold 17.5 percent and ten percent, respectively, of the equity
of New GM.
The GM bondholders exchanged $27 billion in unsecured
indebtedness for a ten percent (which may increase to 25
percent) common equity interest in New GM, while the UAW/VEBA
exchanged $20 billion in claims for a 17.5 percent (which may
increase to 20 percent) common equity interest in New GM and $9
billion in preferred stock and notes in New GM.
Among others, I have asked that the Administration answer
the following questions for the record:
Will the Administration provide the Panel with the
written criteria the Administration uses to determine which
entities or types of entities are allowed to receive assistance
through TARP?
How much additional funding and credit support
does the Administration expect to ask the American taxpayers to
provide each of Chrysler and GM (1) by the end of this year and
(2) during each following year until all investments have been
repaid in full in cash and all credit support has been
terminated? What will be the source of these funds?
Will the Administration provide the Panel with a
formal written legal opinion justifying (1) the use of TARP
funds to support Chrysler and GM prior to their bankruptcies,
(2) the use of TARP funds in the Chrysler and GM bankruptcies,
(3) the transfer of equity interests in New Chrysler and New GM
to the UAW/VEBAs, and (4) the delivery of notes and other
credit support by New Chrysler and New GM for the benefit of
the UAW/VEBAs?
Will the Administration agree to provide the
American taxpayers with timely reports describing in sufficient
detail the full extent of their investments in Chrysler and GM?
What is the Administration's exit strategy
regarding Chrysler and GM?
When does the Administration anticipate that
Chrysler and GM will repay in full in cash all TARP funds
advanced by the American taxpayers?
By making such an unprecedented investment in
Chrysler and GM the United States government by definition
chose not to assist other Americans that are in need. Given the
economic suffering that the American taxpayers have endured
during the last several months please tell us why Chrysler and
GM merited such generosity to the exclusion of other American
taxpayers? In other words, why would the United States
government choose to reward two companies that have been
mismanaged for many years, as evidenced by a protracted
deterioration in the financials of both companies, at the
expense of hard working American taxpayers? What information
does the Administration possess that proves Chrysler and GM are
both sound investments for the taxpayer?
TARP funds were used by New Chrysler and New GM to
purchase assets of the old auto makers, yet a substantial
portion of the equity in the new entities was transferred to
the UAW/VEBAs. As such, TARP funds were transferred to the UAW/
VEBAs. In addition, New Chrysler and New GM entered into
promissory notes and other contractual arrangements for the
benefit of the UAW/VEBAs. Why did the United States government
spend billions of dollars of taxpayer money to give preference
to employees and retirees of the UAW to the detriment of other
non-UAW employees and retirees whose pension funds invested in
Chrysler and GM indebtedness? Why didn't New Chrysler and New
GM transfer some of their equity interests to, or enter into
promissory notes and other contractual arrangements for the
benefit of, the non-UAW/VEBA creditors of Old Chrysler and Old
GM?
Given the judicial holdings in the Chrysler and GM
bankruptcies, one might expect future firms to face a higher
cost of capital, thus impeding economic development at a time
when the country can least afford impediments to growth. Did
the Administration consider these consequences when it
orchestrated a plan that deprived certain creditors of the
benefit of their bargains? How does the Administration defend
the concern that, based on the Chrysler and GM precedents, the
contractual rights of investors may be ignored when dealing
with the United States government?
Will Chrysler and GM promptly disclose all
contractual arrangements with (1) the United States government
and (2) recipients of TARP funds, together with a detailed
description of the contract, its purpose, the transparent and
open competitive bidding process undertaken and the arm's
length and market directed nature of the contract?
Will Chrysler or GM be able to obtain private or
public credit or enter into other contractual arrangements at
favorable rates because of the implicit governmental guarantee
of such indebtedness and contracts?
How will the United States government resolve any
conflict of interest issues arising from its role as a creditor
or equity holder in Chrysler and GM and as a supervising
governmental authority for Chrysler and GM?
Did the Administration in any manner pressure or
encourage Chrysler to accept a deal with Fiat?
Did the Administration in any manner thwart or
discourage any merger or business combination or arrangement
between Chrysler and GM?
Regarding the reorganization of the auto parts
manufacturer, Delphi, on July 17 The New York Times reported:
Delphi's new proposal [reached with its lender group] is
similar to its agreement with Platinum [Equity, a private
equity firm], which was announced June 1, the day GM filed for
bankruptcy. But hundreds of objectors, including the company's
debtor-in-possession lenders, derided that proposal as a
``sweetheart deal'' that gave the private equity firm control
of Delphi for $250 million and a $250 million credit line.
On June 24 The New York Times reported that ``Delphi worked
with G.M. and the Obama administration to negotiate with
Platinum. . .''
Why would the Administration participate in the negotiation
of a ``sweetheart deal'' for the benefit of Platinum Equity?
Thomas E. Lauria, the Global Practice Head of the
Financial Restructuring and Insolvency Group at White & Case
LLP, represented a group of senior secured creditors, including
the Perella Weinberg Xerion Fund (``Perella Weinberg''), during
the Chrysler bankruptcy proceedings.
On May 3, The New York Times reported:
In an interview with a Detroit radio host, Frank
Beckmann, Mr. Lauria said that Perella Weinberg ``was
directly threatened by the White House and in essence
compelled to withdraw its opposition to the deal under
threat that the full force of the White House press
corps would destroy its reputation if it continued to
fight.''
In a follow-up interview with ABC News's Jake Tapper, he
identified Mr. [Steven] Rattner, the head of the auto task
force, as having told a Perella Weinberg official that the
White House ``would embarrass the firm.''
At the hearing Mr. Bloom stated that Mr. Rattner denied Mr.
Lauria's allegations.
Has any member of the Administration spoken with Mr. Lauria
or representatives of Perella Weinberg regarding this matter?
If so, what did they say? If not, why not?
Does the Administration plan to ask SIGTARP to subpoena Mr.
Rattner, Mr. Lauria and representatives of Perella Weinberg and
ask them to respond under oath? If not, why not?
Expansion of Fannie Mae and Freddie Mac through TARP:
Housing government-sponsored enterprises (GSEs) Fannie Mae and
Freddie Mac,\218\ which currently have books of business
totaling $5.27 trillion, or 72 percent of the housing market,
are a centerpiece of Treasury's ``Making Home Affordable''
plan. Fifty billion dollars from TARP has been committed to
this loan modification effort, which is being run by the two
GSEs. This TARP money will not be recouped, according to the
Congressional Budget Office, which has assigned a 100 percent
subsidy rate to the program. The largest segment of the plan,
the Home Affordable Modification Plan (HAMP) has so far failed
to produce the results the Administration initially advertised.
When it was launched, Treasury said HAMP would serve three to
four million homeowners, but a recent GAO report indicated it
has only helped 180,000 borrowers as of July 20, 2009.\219\
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\218\ On September 6, 2008, Treasury put the Federal National
Mortgage Association [Fannie Mae] and the Federal Home Loan Mortgage
Corporation [Freddie Mac] into conservatorship under the Federal
Housing Finance Agency [FHFA].
\219\ Government Accountability Office, Troubled Assets Relief
Program: Treasury Actions Needed to Make the Home Affordable
Modification Program More Transparent and Accountable (July 23, 2009)
(GAO09/837) (online at www.gao.gov/new.items/d09837.pdf).
SECTION THREE: CORRESPONDENCE WITH TREASURY UPDATE
On behalf of the Panel, Chair Elizabeth Warren sent a
letter on July 20, 2009,\220\ to Secretary of the Treasury
Timothy Geithner and Chairman Bernanke requesting copies of
confidential memoranda of understanding involving informal
supervisory actions entered into by the Federal Reserve Board
and the Office of the Comptroller of the Currency with Bank of
America and Citigroup. The letter further requests copies of
any similar future memoranda of understanding executed with
Bank of America, Citigroup, or any of the other bank holding
companies that were subject to the Supervisory Capital
Assessment Program (SCAP). Finally, the letter asks that the
Panel be apprised of any other confidential agreements relating
to risk and liquidity management that Treasury, or any of the
bank supervisors, has or will enter into with any of the SCAP
bank holding companies. The Panel is waiting for Secretary
Geithner's and Chairman Bernanke's responses.
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\220\ See Appendix I of this report, infra.
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On behalf of the Panel, Chair Elizabeth Warren sent a
letter on May 26, 2009,\221\ to Secretary Geithner requesting
information about Treasury's Temporary Guarantee Program for
Money Market Funds, which is funded by TARP. The Temporary
Guarantee Program uses assets of the Exchange Stabilization
Fund to guarantee the net asset value of shares of
participating money market mutual funds. The letter requests a
description of the program mechanics and an accounting of its
obligations and funding mechanisms. On July 21, 2009, Secretary
Geithner responded by letter to this request.\222\
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\221\ See Appendix II of this report, infra.
\222\ See Appendix III of this report, infra.
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On behalf of the Panel, Chair Elizabeth Warren sent a
letter on May 19, 2009,\223\ to Secretary Geithner and Chairman
Bernanke referencing public concern that Treasury and the Board
had applied strong pressure on Bank of America to complete its
acquisition of Merrill Lynch, despite Bank of America's
concerns about Merrill Lynch's deteriorating financial state.
The letter cites this episode as an example of the conflicts of
interest that can arise when the government acts simultaneously
as regulator, lender of last resort, and shareholder. The
letter concludes by soliciting Secretary Geithner's and
Chairman Bernanke's thoughts on how to manage these inherent
conflicts to ensure that similar episodes do not undermine
government efforts to stabilize the financial system in the
future. On July 21, 2009, Secretary Geithner responded by
letter.\224\ The Panel has not yet received a response from
Chairman Bernanke.
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\223\ See Appendix IV of this report, infra.
\224\ See Appendix V of this report, infra.
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Chair Elizabeth Warren and Panel member Richard H. Neiman
sent a letter to Secretary Geithner on June 29, 2009,\225\
requesting assistance with the Panel's oversight of federal
foreclosure mitigation efforts. In order to evaluate the
effectiveness of foreclosure mitigation efforts, the letter
requests copies of the data collected under the Making Home
Affordable program, as well as relevant reports, beginning on
July 31, 2009, and monthly thereafter. Assistant Secretary for
Financial Stability Herbert Allison responded on July 29,
2009.\226\ The Panel continues to work with Treasury to obtain
the necessary data and reports.
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\225\ See Appendix VI of this report, infra.
\226\ See Appendix VII of this report, infra.
SECTION FOUR: TARP UPDATES SINCE LAST REPORT
A. General Motors Emerges From Bankruptcy
General Motors emerged from bankruptcy on July 10, 2009, as
a new, smaller company with a pared down product line and plans
to cut up to 35 percent of its management-level positions. The
bankruptcy proceedings were completed in less than six weeks.
The federal government holds approximately 60 percent of the
outstanding shares of the new GM.
B. TARP Repayment
Financial institutions Goldman Sachs, State Street, BB&T,
US Bancorp, American Express, Bank of New York Mellon and
Morgan Stanley have repurchased all of the outstanding warrants
that were issued by each firm to the U.S. Treasury under the
Capital Purchase Program (CPP) in late 2008. Goldman Sachs paid
back $10 billion in TARP funds, and paid $1.1 billion to
repurchase its outstanding warrants. State Street paid back $2
billion in TARP funds, and paid $60 million to repurchase its
outstanding warrants. BB&T paid back $3.13 billion in TARP
funds, and paid $67 million to repurchase its outstanding
warrants. US Bancorp paid back $6.599 billion in TARP funds,
and paid $139 million to repurchase its outstanding warrants.
American Express paid back $3.389 billion in TARP funds, and
paid $340 million to repurchase its outstanding warrants. Bank
of New York Mellon repaid $3 billion in TARP funds, and
repurchased its outstanding warrants for $163 million. Morgan
Stanley paid back $10 billion in TARP funds, and paid $950
million to repurchase its outstanding warrants. JPMorgan has
repaid $25 billion but has declined to repurchase its warrants,
instead asking Treasury to sell them at auction. A total of 33
banks have fully repaid their TARP investment provided under
the CPP to date.
C. 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 May 2009 and shows that CPP
recipients had $5.13 billion in loans outstanding as of May 31,
2009. This represents a 0.39 percent decline in loans between
the end of April and the end of May.
D. Regulatory Reform Proposals
The Obama Administration has sent a series of legislative
proposals to Congress over the past several weeks. Among the
proposals are legislation to increase the SEC's authority to
regulate investment advisers and broker-dealers, require hedge
funds to register with the SEC, provide shareholders with a
non-binding ``say on pay'' or vote on executive compensation,
increase compensation committee independence, increase the
SEC's authority over rating agencies, consolidate the Office of
Thrift Supervision and the Office of the Comptroller of the
Currency into a new National Bank Supervisor, provide the
federal government with emergency authority to resolve any
large, interconnected financial firm in an orderly manner, and
provide Treasury the authority to appoint the FDIC or the SEC
as conservator or receiver for a failing financial firm that
poses a threat to financial stability.
E. Legacy Loan Program (Public Private Investment Program)
The Legacy Loan Program, which is part of the Public-
Private Investment Program, was designed to remove troubled
loans from the balance sheets of banks. In June, the Federal
Deposit Insurance Corporation announced that it would conduct a
test pilot of the program with the sale of bank assets in
receivership. On July 31, 2009, the FDIC announced that it will
conduct its first testing of the Legacy Loan Program funding
mechanism.
Under the pilot program, the receivership will transfer a
portfolio of residential mortgage loans to a limited liability
company (LLC) on servicing basis in exchange for an ownership
interest in the LLC. The LLC will also sell an equity share to
investors, who will be responsible for managing the portfolio.
Investors will be offered two different options. The first
option is on an all cash basis with the FDIC owning an equity
share of 80 percent and the investor owning 20 percent. The
second option is a sale with leverage based on a 50-50 equity
split between the FDIC and the investor.
According to the FDIC, the funding mechanism is financing
offered by the receivership to the LLC using an amortizing note
that is guaranteed by the FDIC. Financing will be offered with
leverage of either 4-to-1 or 6-to-1, depending upon certain
elections made in the bid submitted by the private investor.''
F. Term Asset-Backed Securities Loan Facility (TALF)
The Federal Reserve Bank of New York held its second
special subscription on July 16, 2009, for TALF loans secured
by commercial mortgage-backed securities (CMBS). The second
subscription made loans available for both newly issued (issued
on or after January 1, 2009) and legacy CMBS (issued before
January 1, 2009). The first subscription had made loans
available only for newly issued CMBS. During the July 16th
subscription, $669 million in TALF loans were requested. All of
the loans were requested for legacy CMBS; no loans were
requested for newly issued CMBS. The next subscription for CMBS
will occur August 20, 2009.
During the regular TALF subscription on August 6, 2009,
$6.9 billion in loans was requested. As a point of comparison,
there were $5.4 billion in loans requested at the July
facility, $11.5 billion 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
August 6th subscription included requests for loans secured by
asset-backed securities in the auto, credit card, floor plan,
servicing advances, small business, and student loan sectors.
There were no requests for loans in the equipment, or premium
finance sectors.
G. Home Price Decline Protection Incentives
On July 31, 2009, Treasury announced the Home Price Decline
Protection (HPDP) Program. HDPD is an expansion to the Home
Affordable Modification Program (HAMP). Under the HPDP,
Treasury will provide investors additional incentives for loan
modifications made under HAMP on homes located in areas where
home prices housing declined. According to Treasury,
``incentive payments will be linked to the rate of recent home
price decline in a local housing market, as well as the unpaid
principal balance and mark-to-market loan-to-value ratio of the
mortgage loan.'' Only HAMP loan modifications begun after
September 1, 2009 are eligible for HPDP payments. Mortgage
loans that are owned or guaranteed by Fannie Mae or Freddie Mac
are not eligible. Treasury has allocated up to $10 billion for
the new program.
H. Metrics
The Panel continues to monitor a number of financial market
indicators 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 since
the release of the Panel's July report.
Interest Rate Spreads. Key interest rate spreads
have leveled off following precipitous drops between the
Panel's May and June oversight reports. 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.\227\
---------------------------------------------------------------------------
\227\ See Allison Testimony, supra note 37 (``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 18: INTEREST RATE SPREADS
----------------------------------------------------------------------------------------------------------------
Current Spread\228\ Percent Change Since
Indicator (as of 8/05/09) Last Report (7/9/09)
----------------------------------------------------------------------------------------------------------------
3 Month LIBOR-OIS Spread \229\................................ 0.27 -12.9%
1 Month LIBOR-OIS Spread \230\................................ 0.09 -18.18%
TED Spread \231\ (in basis points)............................ 29.26 11.17%
Conventional Mortgage Rate Spread \232\....................... 1.58 -0.63%
Corporate AAA Bond Spread \233\............................... 1.73 -7.49%
Corporate BAA Bond Spread \234\............................... 3.24 -11.23%
Overnight AA Asset-backed Commercial Paper Interest Rate 0.21 16.67%
Spread \235\.................................................
Overnight A2/P2 Nonfinancial Commercial Paper Interest Rate .18 -33.33%
Spread \236\.................................................
----------------------------------------------------------------------------------------------------------------
\228\ Percentage points, unless otherwise indicated.
\229\ 3 Mo LIBOR-OIS Spread, Bloomberg (online at www.bloomberg.com/apps/quote?ticker=.LOIS3:IND) (accessed Aug.
5, 2009).
\230\ 1 Mo LIBOR-OIS Spread, Bloomberg (online at www.bloomberg.com/apps/quote?ticker=.LOIS1:IND) (accessed Aug.
5, 2009).
\231\ TED Spread, Bloomberg (online at www.bloomberg.com/apps/quote?ticker=.TEDSP:IND) (accessed Aug. 5, 2009).
\232\ 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 Aug. 5, 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 Aug. 5, 2009) (hereinafter ``Fed H.15 10-Year Treasuries'').
\233\ 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 Aug. 5, 2009); Fed H.15
10-Year Treasuries, supra note 232.
\234\ 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 Aug. 5, 2009); Fed H.15
10-Year Treasuries, supra note 232.
\235\ 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 Aug. 5, 2009) (hereinafter ``Fed CP AA
Nonfinancial Rate'').
\236\ 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 Aug. 5, 2009); Fed CP AA
Nonfinancial Rate, supra note 235.
Commercial Paper Outstanding. Commercial paper
outstanding, a rough measure of short-term business debt, is an
indicator of the availability of credit for enterprises. All
three measured commercial paper values decreased since the
Panel's July report. Asset-backed, financial and nonfinancial
commercial paper have all decreased since October 2008 with
nonfinancial commercial paper outstanding declining by over 44
percent.
FIGURE 19: COMMERCIAL PAPER OUTSTANDING
----------------------------------------------------------------------------------------------------------------
Current Level (as of 7/
Indicator 31/09) (dollars Percent Change Since
billions) Last Report (7/9/09)
----------------------------------------------------------------------------------------------------------------
Asset-Backed Commercial Paper Outstanding (seasonally $437.8 -4.15%
adjusted) \237\..............................................
Financial Commercial Paper Outstanding (seasonally adjusted) $517.5 -6.62%
\238\........................................................
Nonfinancial Commercial Paper Outstanding (seasonally $110.4 -11.99%
adjusted) \239\..............................................
----------------------------------------------------------------------------------------------------------------
\237\ 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 Aug. 5, 2009).
\238\ 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 Aug. 5, 2009).
\239\ 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 Aug. 5, 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. Mortgage originations--excluding
refinancing--increased by over 8 percent from April to May;
further, mortgage originations have increased by more than 75
percent since October of 2008. The dramatic drop in commercial
real estate has continued from the previously reported period.
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
misleading.
FIGURE 20: LENDING BY THE LARGEST TARP-RECIPIENT BANKS \240\
----------------------------------------------------------------------------------------------------------------
Most Recent Data (May
Indicator 2009) (dollars in Percent Change Since Percent Change Since
millions) April 2009 October 2008
----------------------------------------------------------------------------------------------------------------
Total Loan Originations.............. $200,298 .51% -8.19%
Total Mortgage Origination........... 77,792 8.06% 75.64%
C&I New Commitments.................. $33,482 3.06% -43.20%
CRE New Commitments.................. $2,971 -14.38% -71.77%
Mortgage Refinancing................. $52,682 -7.50% 180.71%
Total Average Loan Balances.......... $3,337,318 -0.62% -2.50%
----------------------------------------------------------------------------------------------------------------
\240\ On July 10, 2009 the Federal Reserve announced that it had made changes to the data in its H.8 release,
which has changed previously reported figures. In order to represent measured trends accurately, the Panel has
updated its figures to reflect the latest reported Federal Reserve data. See Board of Governors of the Federal
Reserve System, H8: Changes to Data and Items Reported on the Release for July 1, 2009 (July 10, 2009) (online
at www.tradingurus.com/index2.php?option=com_content&do_pdf=1&id=17314).
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. Loans and leases outstanding for large and
small domestic banks both fell last month.\241\ Total loans and
leases outstanding at large banks have dropped by over 5.8
percent since last October.\242\
---------------------------------------------------------------------------
\241\ 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 Aug.5, 2009).
\242\ 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 Aug. 5, 2009).
FIGURE 21: LOANS AND LEASES OUTSTANDING \243\
[Dollars in billions]
----------------------------------------------------------------------------------------------------------------
Percent Change Since
Indicator Current Level (as of 8/ Percent Change Since ESSA Signed into Law
05/09) Last Report (7/9/09) (10/3/08)
----------------------------------------------------------------------------------------------------------------
Large Domestic Banks--Total Loans and $3,817.8 -1.41% -5.81%
Leases..............................
Small Domestic Banks--Total Loans and $2,517.4 -0.63% -0.01%
Leases..............................
----------------------------------------------------------------------------------------------------------------
\243\ These figures differ from the amount of total loans and leases in bank credit cited in section B of this
report because FDIC data include all FDIC-insured institutions whereas the data above measure only the loans
and leases in bank credit for domestically chartered commercial institutions.
Housing Indicators. Foreclosure filings increased
by over four percent from May to June, in turn raising the rate
to twenty percent above the level of last October. Housing
prices, as illustrated by the S&P/Case-Shiller Composite 20
Index, continued to decline in April. The index remains down
over ten percent since October 2008.
FIGURE 22: HOUSING INDICATORS
----------------------------------------------------------------------------------------------------------------
Percent Change From
Most Recent Data Available at Time Percent Change Since
Indicator Monthly of Last Report (8/05/ October 2008
Data 09)
----------------------------------------------------------------------------------------------------------------
Monthly Foreclosure Filings \244\................ 336,173 4.57% 20.25%
Housing Prices--S&P/Case-Shiller Composite 20 140.1 -0.16% -10.82%
Index \245\.....................................
----------------------------------------------------------------------------------------------------------------
\244\ RealtyTrac, Foreclosure Activity Press Releases (online at www.realtytrac.com//ContentManagement/
PressRelease.aspx) (accessed Aug. 5, 2009). The most recent data available is for June 2009.
\245\ 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 Aug. 5,
2009). The most recent data available is for May 2009 (seasonally adjusted).
FIGURE 23: ASSET-BACKED SECURITY ISSUANCE \246\
[Dollars in millions]
----------------------------------------------------------------------------------------------------------------
Data Available at Time Percent Change From
Indicator (dollars in billions) Most Recent Quarterly of Last Report (1Q Data Available at Time
Data (2Q 2009) 2009) of Last Report (7/9/09)
----------------------------------------------------------------------------------------------------------------
Auto ABS Issuance.................... $12,026.8 $7,574.4 58.8%
Credit Cards ABS Issuance............ $19,158.5 $3,000 538.6%
Equipment ABS Issuance............... $2,629.1 $514.7 410.8%
Home Equity ABS Issuance............. $707.4 $782.1 9.55%
Other ABS Issuance................... $6,444 $2,386.5 170%
Student Loans ABS Issuance........... $7,643.8 $1,955.8 290.8%
Total ABS Issuance................... \247\ $48,609.6 $16,213.5 199.8%
----------------------------------------------------------------------------------------------------------------
\246\ Securities Industry and Financial Markets Association, US ABS Issuance (accessed Aug. 5, 2009) (online at
www.sifma.org/uploadedFiles/Research/Statistics/SIFMA_USABSIssuance.pdf).
\247\ Of this amount, $23 billion was supported under the TALF. See Federal Reserve Bank of New York, Term Asset-
Backed Securities Loan Facility: Announcements (accessed Aug. 5, 2008) (online at www.newyorkfed.org/markets/
talf_announcements.html).
I. Financial Update
Each month since its April oversight report, the Panel has
summarized the resources that the federal government has
committed to economic stabilization. The following financial
update provides: (1) an updated accounting of the TARP,
including a tally of dividend income and repayments the program
has received as of July 31, 2009; and (2) an update of the full
federal resource commitment as of July 30, 2009.
1. TARP
a. Costs: Expenditures and Commitments \248\
Treasury is currently committed to spend $532.8 billion of
TARP funds 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.\249\ Of this total, $370.2 billion is
currently outstanding under the $698.7 billion limit for TARP
expenditures set by EESA, leaving $328.5 billion available for
fulfillment of anticipated funding levels of existing programs
and for funding new programs and initiatives. The $370.2
billion 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 (SPV)
used to guarantee Federal Reserve TALF loans; and the $5
billion Citigroup asset guarantee, which has subsequently been
exchanged for a guarantee fee composed of additional preferred
shares and warrants.\250\ Additionally, Treasury has allocated
$20 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.
---------------------------------------------------------------------------
\248\ Treasury will release its next tranche report when
transactions under the TARP reach $450 billion.
\249\ EESA, as amended by the Helping Families Save Their Homes Act
of 2009, limits Treasury to $698.7 billion in purchasing authority
outstanding at any one time as calculated by the sum of the purchase
prices of all troubled assets held by Treasury. EESA 115(a)-(b);
Helping Families Save Their Homes Act of 2009, Pub. L. 111-22,
Sec. 402(f) (reducing by $1.26 billion the authority for the TARP
originally set under EESA at $700 billion).
\250\ July 31 TARP Transactions Report, supra note 104.
---------------------------------------------------------------------------
b. Income: Dividends and Repayments
The repayments of CPP preferred shares by nine of the
large, stress-tested BHCs has led to a surge this month in
amount of total TARP repayments--from the just under $2 billion
reported in our July report to over $70 billion largely as a
result of repayments.\251\ Several of those BHCs have also
repurchased the warrants Treasury received in conjunction with
its preferred stock investments. In addition, Treasury is
entitled to dividend payments on preferred shares it has
purchased, usually five percent per annum for the first five
years and nine percent per annum thereafter.\252\ Treasury has
begun to report dividend payments made by CPP participant banks
pursuant to a recommendation in GAO's March TARP oversight
report.\253\
---------------------------------------------------------------------------
\251\ July 31 TARP Transactions Report, supra note 104.
\252\ 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'').
\253\ See Government Accountability Office, Troubled Asset Relief
Program: March 2009 Status of Efforts to Address Transparency and
Accountability Issues, at 1 (Mar. 2009) (online at www.gao.gov/
new.items/d09504.pdf).
---------------------------------------------------------------------------
c. TARP Accounting as of July 31, 2009
FIGURE 24: TARP ACCOUNTING (AS OF JULY 31, 2009)
[Dollars in billions]
----------------------------------------------------------------------------------------------------------------
Anticipated Net Current
TARP Initiative Funding Purchase Price Repayments Investments Net Available
----------------------------------------------------------------------------------------------------------------
Total........................... 532.8 442.5 72.3 370.2 328.5
CPP............................. 218 204.3 70.2 134.2 \254\ 13.6
TIP............................. 40 40 0 40 0
SSFI Program.................... 69.8 69.8 0 69.8 0
AIFP............................ 80 80 2.1 77.8 \255\ 0
AGP............................. 5 5 0 5 0
CAP............................. TBD 0 N/A 0 N/A
TALF............................ 20 20 0 20 0
PPIP............................ 30 0 N/A 0 30
Supplier Support Program........ \256\ 3.5 3.5 0 3.5 \257\ 0
Unlocking SBA Lending........... 15 0 N/A 0 15
HAMP............................ 50 \258\ 19.9 0 19.9 30.1
(Uncommitted)................... 167.4 N/A N/A N/A 239.8
----------------------------------------------------------------------------------------------------------------
\254\ This figure reflects the repayment of $70.173 billion in CPP funds. Secretary Geithner has suggested that
funds from CPP repurchases will be treated as uncommitted funds upon return to the Treasury. See This Week
with George Stephanopoulos, Interview with Secretary Geithner (Aug. 2, 2009) (online at www.abcnews.go.com/
print?id=8233298) (``[W]hen I was here four months ago, we had roughly $40 billion of authority left in the
TARP. Today we have roughly $130 billion, in partly [sic] because we have been very successful in having
private capital come back into this financial system. And we've had more than $70 billion . . . come back into
the government''). The Panel has therefore presented the repaid CPP funds as uncommitted (i.e., generally
available for the entire spectrum of TARP initiatives). The difference between the $130 billion of funds
available for future TARP initiatives cited by Secretary Geithner and the $239.8 billion calculated as
available here is the Panel's decision to classify certain funds originally provisionally allocated to TALF
and PPIP as uncommitted and available for TARP generally. See infra notes xiv and xvi.
\255\ Treasury has indicated that it will not provide additional assistance to GM and Chrysler through the AIFP.
See Nick Bunkley, U.S. Likely to Sell G.M. Stake Before Chrysler, New York Times (Aug. 5, 2009) (online at
www.nytimes.com/2009/08/06/business/06auto.html?_r=1&scp=2&sq=ron%20bloom&st=cse) (hereinafter ``U.S. Likely
to Sell''). The Panel therefore considers the repaid AIFP funds to be uncommitted.
\256\ On July 8, 2009, Treasury lowered the total commitment amount for the program from $5 billion to $3.5
billion, this reduced GM's portion from $3.5 billion to $2.5 billion and Chrysler's portion from $1.5 billion
to $1 billion. July 31 TARP Transactions Report, supra note 104.
\257\ Treasury has indicated that it will not provide additional funding to auto parts suppliers through the
Supplier Support Program. See U.S. Likely to Sell, supra note 255.
\258\ This figure reflects the cap set on payments to each mortgage servicer. See July 31 TARP Transactions
Report, supra note 104.
FIGURE 25: TARP INCOME (AS OF JULY 31, 2009) \259\
[Dollars in billions]
----------------------------------------------------------------------------------------------------------------
Warrants
TARP Initiative Repayments Dividends \260\ Repurchased \261\ Total
----------------------------------------------------------------------------------------------------------------
Total....................................... 72.3 7.3 \262\ 1.7 81.3
CPP......................................... 70.2 5.5 1.7 77.4
TIP......................................... 0 1.5 0 1.5
AIFP........................................ 2.1 .2 N/A 2.3
AGP......................................... 0 .2 0 .2
----------------------------------------------------------------------------------------------------------------
\259\ This table only reflects programs that have provided Treasury with reimbursements in the form of
investment repayments, warrant repurchases or dividend payments. The table does not include interest payments
made by participants in the programs.
\260\ As of July 31, 2009. This information was provided to the Panel by Treasury staff.
\261\ This number includes $1.6 million in proceeds from the repurchase of preferred shares by privately-held
financial institutions. For privately-held financial institutions that elect to participate in the CPP,
Treasury receives and immediately exercises warrants to purchase additional shares of preferred stock.
\262\ Two warrant repurchases that were agreed to after July 31, 2009 are not reflected in the $1.7 billion
figure. The Bank of New York Mellon Corporation announced on Aug. 5, 2009 that it had repurchased its warrants
for $136 million. The Bank of New York Mellon, The Bank of New York Mellon Repurchases Warrant Related to TARP
Capital Investment (Aug. 5, 2009) (online at bnymellon.mediaroom.com/file.php/715/pr080509.pdf). In addition,
Morgan Stanley announced on August 6, 2009 that it had agreed to repurchase its warrants for $950 million.
Morgan Stanley, Morgan Stanley Agrees to Repurchase Warrant from the U.S. Government (Aug. 6, 2009) (online at
www.morganstanley.com/about/press/articles/42d008d5-8209-11de-b5d1-6d6288639586.html). Thus, the total
anticipated warrant repurchases through August 6, 2009 are at least $2.28 billion.
2. OTHER FINANCIAL STABILITY EFFORTS
Federal Reserve, FDIC, and Other Programs
In addition to the direct expenditures Treasury has
undertaken through TARP, the federal government has engaged in
a much broader program directed at stabilizing the U.S.
financial system. Many of these initiatives explicitly augment
funds allocated by Treasury under specific TARP initiatives,
such as FDIC and Federal Reserve 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 section 13(3)
facilities and SPVs or the FDIC's Temporary Liquidity Guarantee
Program, operate independent of TARP.
3. TOTAL FINANCIAL STABILITY RESOURCES (AS OF JULY 31, 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 calculates the total value of these resources at over
$3.1 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.
With respect to the FDIC and Federal Reserve programs, the
risk of loss varies significantly across the programs
considered here, as do the mechanisms providing protection for
the taxpayer against such risk. The FDIC, for example, assesses
a premium of up to 100 basis points on Temporary Liquidity
Guarantee Program (TLGP) debt guarantees. The premiums are
pooled and reserved to offset losses incurred by the exercise
of the guarantees, and are calibrated to be sufficient to cover
anticipated losses and thus remove any downside risk to the
taxpayer. In contrast, the Federal Reserve's liquidity programs
are generally available only to borrowers with good credit, and
the loans are over-collateralized and with recourse to other
assets of the borrower. If the assets securing a Federal
Reserve loan realize a decline in value greater than the
``haircut,'' the Federal Reserve is able to demand more
collateral from the borrower. Similarly, should a borrower
default on a recourse loan, the Federal Reserve can turn to the
borrower's other assets to make the Federal Reserve whole. In
this way, the risk to the taxpayer on recourse loans only
materializes if the borrower enters bankruptcy. The only loans
currently ``underwater''--where the outstanding principal
amount exceeds the current market value of the collateral--are
the non-recourse loans to the Maiden Lane SPVs (used to
purchase Bear Stearns and AIG assets).
FIGURE 26: FEDERAL GOVERNMENT FINANCIAL STABILITY EFFORT (AS OF JULY 30, 2009)
[Dollars in billions]
----------------------------------------------------------------------------------------------------------------
Treasury Federal
Program (TARP) Reserve FDIC Total
----------------------------------------------------------------------------------------------------------------
Total....................................................... 698.7 1,608.2 836.7 \iii\ 3,143
.6
Outlays \i\............................................. 390.3 0 37.7 425.5
Loans................................................... 43.6 1378.4 0 1422
Guarantees \ii\......................................... 25 229.8 799 1053.8
Uncommitted TARP Funds.................................. 239.8 0 0 239.8
AIG......................................................... 69.8 98 0 167.8
Outlays................................................. \iv\ 69.8 0 0 69.8
Loans................................................... 0 \v\ 98 0 98
Guarantees.............................................. 0 0 0 0
Bank of America............................................. 45 0 0 45
Outlays................................................. \vii\ 45 0 0 45
Loans................................................... 0 0 0 0
Guarantees \vi\......................................... 0 0 0 0
Citigroup................................................... 50 229.8 10 289.8
Outlays................................................. \viii\ 45 0 0 45
Loans................................................... 0 0 0 0
Guarantees.............................................. \ix\ 5 \x\ 229.8 \xi\ 10 244.8
Capital Purchase Program (Other)............................ 97.8 0 0 97.8
Outlays................................................. \xii\ 97.8 0 0 97.8
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 0 0
Capital Assistance Program.................................. TBD 0 0 \xiii\ TBD
TALF........................................................ 20 180 0 200
Outlays................................................. 0 0 0 0
Loans................................................... 0 \xv\ 180 0 180
Guarantees.............................................. \xiv\ 20 0 0 20
PPIP (Loans) \xvi\.......................................... 0 0 0 0
Outlays................................................. 0 0 0 0
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 0 0
PPIP (Securities)........................................... \xvii\ 30 0 0 30
Outlays................................................. 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 \xix\ 50
Outlays................................................. \xviii\ 50 0 0 50
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 0 0
Automotive Industry Financing Program....................... 77.8 0 0 77.8
Outlays................................................. \xx\ 55.2 0 0 55.2
Loans................................................... 22.6 0 0 22.6
Guarantees.............................................. 0 0 0 0
Auto Supplier Support Program............................... 3.5 0 0 3.5
Outlays................................................. 0 0 0 0
Loans................................................... \xxi\ 3.5 0 0 3.5
Guarantees.............................................. 0 0 0 0
Unlocking SBA Lending....................................... 15 0 0 15
Outlays................................................. \xxii\ 15 0 0 15
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 0 0
Temporary Liquidity Guarantee Program....................... 0 0 789 789
Outlays................................................. 0 0 0 0
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 \xxiii\ 789 789
Deposit Insurance Fund...................................... 0 0 37.7 37.7
Outlays................................................. 0 0 \xxiv\ 37.7 37.7
Loans................................................... 0 0 0 0
Guarantees.............................................. 0 0 0 0
Other Federal Reserve Credit Expansion...................... 0 1,100.4 0 1,100.4
Outlays................................................. 0 0 0 0
Loans................................................... 0 \xxv\ 1,100 0 1,100.4
.4
Guarantees.............................................. 0 0 0 0
Uncommitted TARP Funds...................................... \xxvi\ 239. 0 0 239.8
8
----------------------------------------------------------------------------------------------------------------
\i\ 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. Outlays as used here represent investments and assets
purchases and commitments to make investments and asset purchases and are not the same as budget outlays,
which under section 123 of EESA are recorded on a ``credit reform'' basis.
\ii\ 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.
\iii\ This figure is roughly comparable to the $3.0 trillion current balance of financial system support
reported by SIGTARP in its July report. See Office of the Special Inspector General for the Troubled Asset
Relief Program, Quarterly Report to Congress, at 138 (July 21, 2009) (online at www.sigtarp.gov/reports/
congress/2009/July2009_Quarterly_Report_to_Congress.pdf). However, the Panel has sought to capture anticipated
exposure beyond the current balance, and thus employs a different methodology than SIGTARP.
\iv\ 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 31 TARP Transactions Report, supra note 104.
\v\ This number represents the full $60 billion that is available to AIG through its revolving credit facility
with the Federal Reserve ($43 billion had been drawn down as of July 30, 2009) and the outstanding principle
of the loans extended to the Maiden Lane II and III SPVs to buy AIG assets (as of July 30, 2009, $17.2 billion
and $20.8 billion respectively). See Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release H.4.1: Factors Affecting Reserve Balances (July 30, 2009) (online at
www.federalreserve.gov/releases/h41/Current/) (accessed Aug. 4, 2009) (hereinafter ``Fed Balance Sheet July
30''). Income from the purchased assets is used to pay down the loans to the SPVs, 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 ).
\vi\ As noted in its previous report, the Panel no longer accounts for the $118 billion Bank of America asset
guarantee which, despite preliminary agreement, was never signed. See Congressional Oversight Panel, July
Oversight Report: TARP Repayments, Including the Repurchase of Stock Warrants, at 85 (July 7, 2009) (online at
cop.senate.gov/documents/cop-071009-report.pdf) (hereinafter ``Panel July Report'').
\vii\ July 31 TARP Transactions Report, supra note 104. 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.
\viii\ July 31 TARP Transactions Report, supra note 104. 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.
\ix\ U.S. Department of the Treasury, Summary of Terms: Eligible Asset Guarantee (Nov. 23, 2008) (online at
www.treasury.gov/press/releases/reports/cititermsheet_112308.pdf) (hereinafter ``Citigroup Asset Guarantee'')
(granting a 90 percent federal guarantee on all losses over $29 billion of a $306 billion pool of Citigroup
assets, with the first $5 billion of the cost of the guarantee borne by Treasury, the next $10 billion by
FDIC, and the remainder by the Federal Reserve). 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).
\x\ Citigroup Asset Guarantee, supra note ix.
\xi\ Citigroup Asset Guarantee, supra note ix.
\xii\ 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, and the
$70.2 billion in repayments that will be reflected as uncommitted TARP funds. This figure does not account for
future repayments of CPP investments, nor does it account for dividend payments from CPP investments.
\xiii\ Funding levels for the CAP have not yet been announced but will likely constitute a significant portion
of the remaining $239.8 billion of TARP funds.
\xiv\ This figure represents a $20 billion allocation to the TALF SPV on March 3, 2009. July 31 TARP
Transactions Report, supra note 104. In previous reports, the Panel had projected TALF funding at a total
level of $800 billion, comprising $80 billion in Treasury (TARP) guarantees and $720 billion in Federal
Reserve loans. See, e.g., Panel July Report, supra note vi, at 86. However, it now appears unlikely that the
program will exceed the initial $200 billion funding level, described infra. As of August 7, 2009, $41.4
billion had been lent out through the TALF to finance the purchase of ABS. Federal Reserve Bank of New York,
Term Asset-Backed Securities Loan Facility: non-CMBS (accessed August 7, 2009) (online at http://
www.newyorkfed.org/markets/TALF_recent_operations.html); Federal Reserve Bank of New York, Term Asset-Backed
Securities Loan Facility: CMBS (accessed August 7, 2009) (online at http://www.newyorkfed.org/markets/
CMBS_recent_operations.html). While TALF subscriptions are expected to increase due to various factors,
including the seasonal nature of student loans, the time required to structure deals related to CMBS (recently
made eligible as collateral under the program), and the financing of PPIP legacy securities purchases, it
would require an extremely large increase in the rate of TALF subscriptions to surpass the $200 billion
currently available by year's end.
\xv\ 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 $20 billion of losses on its $200 billion in loans,
the Federal Reserve Board's maximum potential exposure under the TALF is $180 billion.
\xvi\ It now appears unlikely that resources will be expended under the PPIP Legacy Loans Program in its
original design as a joint Treasury-FDIC program to purchase troubled assets from solvent banks. In June, the
FDIC cancelled a pilot sale of assets that would have been conducted under the program's original design. 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). In July, the FDIC announced that it would rebrand
its established procedure for selling the assets of failed banks as the Legacy Loans Programs. Federal Deposit
Insurance Corporation, Legacy Loans Program--Test of Funding Mechanism (July 31, 2009) (online at www.fdic.gov/
news/news/press/2009/pr09131.html). These sales do not involve any Treasury participation, and FDIC activity
is accounted for here as a component of the FDIC's Deposit Insurance Fund outlays.
\xvii\ 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) (``Treasury will invest up to $30 billion of equity and
debt in PPIFs established with private sector fund managers and private investors for the purpose of
purchasing legacy securities''); U.S. Department of the Treasury, Fact Sheet: Public-Private Investment
Program, at 4-5 (Mar. 23, 2009) (online at www.treas.gov/press/releases/reports/ppip_fact_sheet.pdf)
(hereinafter ``Treasury PPIP Fact Sheet'') (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.
\xviii\ 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, $19.9 billion has been allocated
as of July 31, 2009, and no funds have yet been disbursed. See July 31 TARP Transactions Report, supra note
104.
\xix\ 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).
\xx\ July 31 TARP Transactions Report, supra note 104. A substantial portion of the total $80 billion in loans
extended under the AIFP has since been converted to common equity and preferred shares in restructured
companies. $26.1 billion has been retained as first lien debt (with $7.7 billion committed to GM and $14.9
billion to Chrysler), which is classified below as loans. See also Government Accountability Office, Troubled
Asset Relief Program: June 2009 Status of Efforts to Address Transparency and Accountability Issues, at 43
(June 31, 2009) (GAO09/658) (online at www.gao.gov/new.items/d09658.pdf).
\xxi\ July 31 TARP Transactions Report, supra note 104.
\xxii\ Treasury PPIP Fact Sheet, supra note xvii.
\xxiii\ 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. $339.0 billion of debt subject to the guarantee has been issued to date, which represents about
43 percent of the current cap. Federal Deposit Insurance Corporation, Monthly Reports on Debt Issuance Under
the Temporary Liquidity Guarantee Program: Debt Issuance Under Guarantee Program (June 30, 2009) (online at
www.fdic.gov/regulations/resources/TLGP/total_issuance6-09.html) (updated July 16, 2009).
\xxiv\ 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).
\xxv\ This figure is derived from adding the total credit the Federal Reserve Board has extended as of July 30,
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 30, supra note ix. The level of Federal
Reserve lending under these facilities will fluctuate in response to market conditions.
\xxvi\ 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 (Sep. 29,
2008) (online at www.treas.gov/press/releases/hp1161.htm). This program uses assets of the Emergency
Stabilization Fund (ESF) to guarantee the net asset value of participating money market mutual funds. Id. In
response to an inquiry from the Panel, see Letter from Congressional Oversight Panel Chair Elizabeth Warren to
Treasury Secretary Timothy F. Geithner (May 26, 2009) (attached as Appendix I), Treasury has indicated that
funds with ``an aggregate designated asset base on nearly $2.5 trillion calculated as of September 19, 2008''
were participating in the Program as of May 1, 2009. See Letter from Treasury Secretary Timothy F. Geithner to
Congressional Oversight Panel Chair Elizabeth Warren (July 21, 2009) (attached as Appendix II, hereinafter
``Treasury MMMF Letter''). In previous reports, the Panel has suggested that Treasury may fund any losses
suffered by the ESF under the program--incurred if payouts on the program guarantees exceed income earned
through premiums paid by participants--through the use of otherwise uncommitted TARP funds. Treasury has
determined, however, that section 131 of EESA's mandate that Treasury reimburse the ESF ``from funds under
this Act'' does not permit Treasury to use TARP funds, which are reserved for the purchase or insurance of
troubled assets, but instead, by default, directs Treasury to use non-TARP funds made available pursuant to
section 118 of EESA, which provides for the payment of ``actions authorized by this Act, including the payment
of administrative expenses.'' Id. Treasury has indicated that it believes that it lacks authority to extend
the program beyond September 18, 2009, the expiration date of the program under the guarantee agreements with
participants because section 131(b) of EESA prohibits the use of the ESF ``for the establishment of any future
guaranty programs for the United States money market mutual fund industry.'' Id. In our past reports, we have
noted the operation of the program but have not included it in our accounting, in part because of the
uncertainty of the extent of Treasury's exposure. While we now know that Treasury's exposure theoretically is
$2.5 trillion (the amount of the money market mutual funds guaranteed), Treasury is intent on letting the
program expire on September 18, 2009 irrespective of whether it has authority to extend it. Given the
program's imminent expiration, the desire to preserve comparisons with our earlier accountings, and the
unlikelihood of any losses under the program, the Panel will continue to exclude it from its accounting.
SECTION FIVE: OVERSIGHT ACTIVITIES
The Congressional Oversight Panel was established as part
of Emergency Economic Stabilization Act (EESA) and formed on
November 26, 2008. Since then, the Panel has produced eight
oversight reports, as well as a special report on regulatory
reform, issued on January 29, 2009, and a special report on
farm credit, issued on July 21, 2009. Since the release of the
Panel's July oversight report on warrant valuation, the
following developments pertaining to the Panel's oversight of
the Troubled Asset Relief Program (TARP) took place:
The Panel held a field hearing on July 27, 2009 in
Detroit to hear testimony on Treasury's administration of the
Automotive Industry Financing Program. The Panel heard
testimony from Ron Bloom, Senior Advisor at the Department of
Treasury, Jan Bertsch, Senior Vice President, Treasurer, and
Chief Information Officer at Chrysler, Walter Brock, Treasurer
at General Motors, Sean McAlinden, Executive Vice President and
Chief Economist at the Center for Automotive Research, and
Barry Adler, Charles Seligson Professor of Law at the New York
University School of Law. Written testimony and audio from the
hearing can be found on the Panel's website at http://
cop.senate.gov/hearings/library/hearing-072709-
detroithearing.cfm.
The Helping Families Save Their Homes Act of 2009
(P.L. 111-22), signed into law on May 20, 2009, required the
Panel to produce a special report on farm loan restructuring.
Specifically, the Panel was asked to analyze the state of the
commercial farm credit markets and the use of loan
restructuring as an alternative to foreclosure by financial
institutions receiving government assistance through TARP.
Pursuant to the statute, the Panel released the report on July
21, 2009. A copy of the report can be found on the Panel's
website at http://cop.senate.gov/documents/cop-072109-
report.pdf.
In June, the Panel sent a letters to each of the
largest mortgage servicing companies that had not signed a
contract to formally participate in the Making Home Affordable
foreclosure mitigation program. The letter inquired, 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. The Panel has
received a number of responses and is currently reviewing them.
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
September. The report will provide an updated review of TARP
activities and continue to assess the program's overall
effectiveness. The report will also examine Treasury's
administration of its Automobile Industry Financing Program,
which is funded under TARP.
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. Congress subsequently expanded the Panel's
mandate by directing it to produce a special report on the
availability of credit in the agricultural sector. The report
was issued on July 21, 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.
ACKNOWLEDGEMENTS
The Panel would like to acknowledge SNL Financial for their
contribution to the modeling section of this report. The Panel
would specially like to acknowledge John-Patrick O'Sullivan,
Senior Product Manager, for his time and effort in formulating
SNL's model. Special thanks also to Professor Clayton Rose
(Harvard University), Professor Ken Scott (Stanford
University), Professor Simon Johnson (Massachusetts Institute
of Technology), Professor Tyler Cowen (George Mason
University), William M. Issac, Professor Mark Thoma (University
of Oregon), Professor John Geanakoplos (Yale University),
Professor Luigi Zingales (University of Chicago), Professor
Joshua Coval (Harvard University), Nicolas Veron, Professor
Peter Cramton (University of Maryland), Professor Lawrence
Ausubel (University of Maryland), and Professor Deborah Lucas
(Northwestern University) for their thoughts and suggestions.
APPENDIX I: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY
GEITHNER AND CHAIRMAN BEN BERNANKE, RE: CONFIDENTIAL MEMORANDA, DATED
JULY 20, 2009
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APPENDIX II: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY
GEITHNER, RE: TEMPORARY GUARANTEE PROGRAM FOR MONEY MARKET FUNDS, DATED
MAY 26, 2009
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APPENDIX III: 2009 LETTER FROM SECRETARY TIMOTHY GEITHNER IN RESPONSE
TO CHAIR ELIZABETH WARREN'S LETTER, RE: TEMPORARY GUARANTEE PROGRAM FOR
MONEY MARKET FUNDS, DATED JULY 21, 2009
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APPENDIX IV: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY
GEITHNER AND CHAIRMAN BEN BERNANKE, RE: BANK OF AMERICA, DATED MAY 19,
2009
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APPENDIX V: 2009 LETTER FROM SECRETARY TIMOTHY GEITHNER IN RESPONSE TO
CHAIR ELIZABETH WARREN'S LETTER, RE: BANK OF AMERICA, DATED JULY 21,
2009
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APPENDIX VI: LETTER FROM CHAIR ELIZABETH WARREN AND PANEL MEMBER
RICHARD NEIMAN TO SECRETARY TIMOTHY GEITHNER, RE: FORECLOSURE DATA,
DATED JUNE 29, 2009
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APPENDIX VII: LETTER FROM ASSISTANT SECRETARY HERBERT ALLISON IN
RESPONSE TO CHAIR ELIZABETH WARREN'S LETTER, RE: FORECLOSURE DATA,
DATED JULY 29, 2009
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