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




                     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





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



 
                        AUGUST OVERSIGHT REPORT

                                _______
                                

                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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.''
---------------------------------------------------------------------------

                         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.
---------------------------------------------------------------------------

        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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \95\ Id. at 209.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.'').
---------------------------------------------------------------------------

                  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.
---------------------------------------------------------------------------
    \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'').
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.''
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
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    \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.
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    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'').
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \221\ See Appendix II of this report, infra.
    \222\ See Appendix III of this report, infra.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \223\ See Appendix IV of this report, infra.
    \224\ See Appendix V of this report, infra.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


 APPENDIX II: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY 
GEITHNER, RE: TEMPORARY GUARANTEE PROGRAM FOR MONEY MARKET FUNDS, DATED 
                              MAY 26, 2009

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


 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

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


 APPENDIX IV: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY 
GEITHNER AND CHAIRMAN BEN BERNANKE, RE: BANK OF AMERICA, DATED MAY 19, 
                                  2009

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


APPENDIX V: 2009 LETTER FROM SECRETARY TIMOTHY GEITHNER IN RESPONSE TO 
 CHAIR ELIZABETH WARREN'S LETTER, RE: BANK OF AMERICA, DATED JULY 21, 
                                  2009

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


   APPENDIX VI: LETTER FROM CHAIR ELIZABETH WARREN AND PANEL MEMBER 
  RICHARD NEIMAN TO SECRETARY TIMOTHY GEITHNER, RE: FORECLOSURE DATA, 
                          DATED JUNE 29, 2009

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


   APPENDIX VII: LETTER FROM ASSISTANT SECRETARY HERBERT ALLISON IN 
  RESPONSE TO CHAIR ELIZABETH WARREN'S LETTER, RE: FORECLOSURE DATA, 
                          DATED JULY 29, 2009

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


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