Last week, the federal government provided several updates on the status of the Troubled Asset Relief Program: the Third Tranche Report to Congress (December 2nd); a speech by SEC Chairman Cox (December 4th); the first Section 105(a) Report to Congress (December 5th); and a speech by Treasury Interim Assistant Secretary Kashkari (December 5th). We have highlighted the more important components of each update below.
Third Tranche Report to Congress
The Third Tranche Report to Congress provides the basic factors that the Treasury will use in analyzing whether an institution should be supported under the Systemically Significant Failing Institutions (SSFI) Program. It was under the SSFI Program that Treasury closed a $40 billion transaction with AIG on November 26, 2008. Participation in the SSFI Program will continue to be on a case-by-case basis, based on these and other factors:
- The extent to which the failure of an institution could threaten the viability of its creditors and counterparties because of their direct exposure to the institution.
- The number and size of financial institutions that are seen by investors or counterparties as similarly situated to the failing institution, or that could otherwise be likely to experience indirect contagion effects from the failure of the institution.
- Whether the institution is sufficiently important to the nation’s financial and economic system that a disorderly failure would, with a high probability, cause major disruptions to credit markets or payments and settlement systems, seriously destabilize key asset prices, significantly increase uncertainty or losses of confidence thereby materially weakening overall economic performance.
- The extent and probability of the institution’s ability to access alternative sources of capital and liquidity, whether from the private sector or other sources of government funds.
It seems unlikely that the Treasury will include any financial institutions other than the largest ones in the SSFI Program, unless an institution can make a strong case that its stability is critical to the overall stability of the nation’s financial and economic system.
Speech by SEC Chairman Cox
On December 4, 2008, SEC Chairman Cox addressed the need to develop an exit strategy for TARP investments. As the Emergency Economic Stabilization Act provides that the Chairman of the SEC is on the oversight board for TARP, Chairman Cox’s comments should be read with great significance.
Chairman Cox noted the size of the TARP program in a staggering comparison.
The $700 billion TARP program alone is worth more, in inflation-adjusted dollars, then the combined cost of the Hoover Dam, the Panama Canal, the first Gulf War, the Marshall Plan, the Louisiana Purchase, and all of the moon missions. Multiply that ninefold, and you have the current running total of the federal government’s economic rescue programs.
Chairman Cox’s comparison ignores (i) that less than half of the TARP program dollars have been approved by Congress for expenditure, and (ii) the distinction between an investment in our financial institutions and a capital expenditure. Nonetheless, it is an eye-opening comparison that highlights the size of the TARP program.
Chairman Cox then turned to the importance for policy makers to carefully and deliberately construct an exit strategy for each and every aspect of these extraordinary federal interventions in the market.
[I]t is incumbent upon federal policy makers to ensure that the extraordinary actions of the past month are understood to be temporary, and constructed so that they are self-liquidating. Since government programs do not on their own go away, there has to be a deliberate design to eliminate them, and a relentless adherence to execution of that plan. Anything short of this will almost certainly guarantee eternal life for these vast new federal roles.
Our objective in each case should be to monetize the federal government’s positions as quickly as possible. But our ability to do so will be highly contingent on the type of instrument, the type of individual issuer, and the then-prevailing market conditions. As a result, we will need to constantly monitor these positions, the firms, and the markets. We will also need to be very mindful that the size of our positions is material, and we should seek strategies for liquidating them that are the least disruptive to the capital markets. Liquidations must be regular and predictable, in order to reduce market surprises and to avoid depressing the market into which we are selling.
As many of the restrictions associated with TARP Capital, including dividend restrictions and executive compensation limits, are tied to the Treasury’s continued holdings of equity in an institution, a policy of monetizing the government’s investment should be attractive to TARP Capital participants.
Section 105(a) Report to Congress
On December 5, 2008, the Treasury made its initial Section 105(a) Report to Congress under the Economic Emergency Stabilization Act. The report updates Congress on the general implementation of the TARP Program, including a financial statement update. While there is little new information to be gleaned from the report, there are some interesting nuggets of information:
- With regard to the TARP Capital program, “only viable institutions are accepted into the program” and “terms applicable to S corporations and mutual organizations are still under consideration.”
- Through November 30, 2008, Treasury had spent over $5.3 million to pay for financial agents and legal firms.
Speech by Treasury Interim Assistant Secretary Kashkari
On December 5, 2008, Treasury Interim Assistant Secretary Kashkari gave an update on TARP. Kashkari first commented on the timing of TARP Capital approvals and transactions.
The Treasury Investment Committee meets daily and reviews dozens of applications per meeting and Treasury makes the final decision on all investments. It is typically less than a week between when a regulator submits a recommendation to Treasury and when Treasury makes an investment decision. It sometimes takes as little as two days.
We often close transactions in a couple weeks – which is a record for either the private or public sector.
We have more applications under-review in the pipeline and many others have already been pre-approved from depositories across the country. Often banks need more time to complete their legal requirements than Treasury needs to execute the investments.
This progress is remarkable not only in its speed and quality, but also in its scope. We have touched almost every banking market in the nation with applications representing small and large banks alike. The largest investment has been $25 billion. The smallest investment has been $9 million.
Assistant Secretary Kashkari then touched on whether banks will use the TARP Capital to increase lending.
People also ask: when we will see banks making new loans? First, we must remember that just over half the money is out the door. Although we are executing at record speed, it will take a few months to process all the remaining applications. The money needs to get into the system before it can have the desired effect. Second, we are still at a point of low confidence – both due to the credit crisis and due to the economic downturn. While confidence is low, banks will remain cautious about extending credit, and consumers and businesses will remain cautious about taking on new loans. As confidence returns, we expect to see more credit extended.
This lending won’t materialize as fast as any of us would like, but it will happen much faster as a result of having used the TARP to stabilize the system and to increase the capital in our banks.
We firmly believe that healthy banks of all sizes should use this program to continue making credit available in their communities. As Secretary Paulson has said, we expect banks to increase their lending as a result of these efforts and it is important that they do so. As such, Treasury supports the statement issued by bank regulators on November 12 to that effect. The statement emphasized that the extraordinary government actions taken to stabilize and strengthen the banking system are not merely one-sided; all banks – not just those participating in the Capital Purchase Program – have benefited from the government’s actions to restore confidence in the financial system. Banks, in turn have obligations to their communities, particularly in this time of economic disruption. They have an obligation to continue making credit available to creditworthy borrowers and an obligation to work with borrowers who are struggling to avoid preventable foreclosures. At the same time, institutions must not repeat the poor lending practices that were a root cause of today’s problems.
Tracking where individual dollars flow through an organization is also difficult. However, we are working with the regulators to try to develop ways to determine the effectiveness of the program.