On December 30, 2008, the Treasury responded to the ten questions raised by the Congressional Oversight Panel.  The Treasury has provided a measured and reasoned response to the questions raised, but has not provided any significant new information, but rather has done a good job assembling existing information for the Congressional Oversight Panel.

We have highlighted the Treasury’s response to three questions:  Why Capital Investments?  Has it Worked?  and What is the Application Process?  You can review all of the Treasury’s answers in its formal response.

Why Capital Investments?

In response to the question of what specific facts led to a change in strategy by Treasury from purchasing troubled assets to making investments in financial institutions, the Treasury points to the increases in the LIBOR-OIS spread.  Typically this spread, a gauge of funding pressures and perceived counterparty credit risk, is between 5-10 basis points.  On September 18th, when the Treasury first approached Congress, the rate was 135 basis points.  By the time the bill passed on October 3rd, the LIBOR-OIS spread had risen to 263 basis points, and by October 10th, the spread stood at 338 basis points.  Given those market conditions, the Treasury determined that the fastest, most direct way to help stabilize the financial system was to increase capital in the system by buying equity in health banks of all sizes.  The Treasury also notes as evidence that the Treasury’s actions are working that the LIBOR-OIS spread is now approximately 28 basis points.

Has it Worked?

The Treasury notes that the recipients of TARP Capital investments “include regional, small and community banks, as well as Community Development Finance Institutions, all of which play a vital role in their communities.”  The Treasury’s response does not, however, provide any information about the Treasury’s efforts to include Subchapter S institutions in the program.

Responding to the Congressional Oversight Panel’s question of what the financial institutions have done with the taxpayers’ money, the Treasury emphasizes that “it will be challenging to view the impact of the Capital Purchase Program in isolation and at the institutional level.  Moreover, each individual financial institution’s circumstances are different, making comparisons challenging at best, and it is difficult to track where individual dollars flow through an organization.  Nonetheless, Treasury is working with the banking regulators to develop appropriate measurements….”  The Treasury also notes that the money still must work its way into the system, that we are still at a point of low confidence (meaning banks will remain cautious), and that credit quality is still deteriorating.  “This lending won’t materialize as fast as anyone 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.”

The Treasury also notes that the TARP Capital infusions may prevent further declines in lending activity.  “By injecting new capital into health banks, the CPP has helped banks maintain strong balance sheets and eased the pressure on them to scale back their lending and investment activities.”

What is the Application Process?

The Treasury provides little new information in its analysis of the application process, but does a great job of consolidating the publicly known information in one place.  Rather than attempt to paraphrase this information, we have simply copied this portion of the Treasury’s response.

All information about the terms and conditions of the CPP, including the formal application process and forms, is publically available on the Treasury website, as well as on the websites of all the primary federal regulators.

  • Institutions: The Capital Purchase Program is available to a broad array of private and publically held- financial institutions of all sizes- including qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies. The program is designed for healthy banks – banks that are considered viable without government investment. It is designed to have attractive terms to encourage healthy banks to participate; they are best positioned to increase the flow of credit in their communities.
  • Terms: The terms for this program are the same for all institutions. Treasury issued a term sheet for publically held banks and followed with term sheet for private depositories. The minimum subscription amount available to a participating institution is 1 percent of risk-weighted assets. The maximum subscription amount in this program is the lesser of $25 billion or 3 percent of risk-weighted assets. Treasury also created a standard investment agreement for all banks, regardless of size.
  • Application Process: There is one common application form that all qualified and interested financial institutions used to submit to their primary regulator – the Federal Reserve, the FDIC, the OCC or the OTS. This common application form is available on the websites of all the regulatory agencies.
  • Evaluation Process: Treasury worked closely with the banking regulators to establish a standardized evaluation process; this means that all regulators use the same standards to review all applications to ensure consistency. Once a Federal regulator has reviewed an application, it will take one of the following three actions:
  1. For applications the regulator does not recommend, it may encourage the institution to withdraw the application.
  2. For applications the regulator strongly believes should be included in the program, it directly sends the application and its recommendation to the TARP Investment Committee at the Treasury Department.
  3. For cases that are less clear, the regulator will forward the application to a Regulatory Council, made up of senior representatives of the four banking regulators for a joint review and recommendation. Treasury is an observer on the Council. The Regulatory Council will make a joint recommendation of either withdrawal or approval.

The Treasury TARP Investment Committee reviews all recommendations from the regulators and recommendations for CPP investment are made based on all of the information received from the above process. The Investment Committee gives considerable weight to the recommendations of the banking regulators. In some cases, the Committee will send the application back to the primary regulator for additional information, or even remand it to the Regulatory Council for further review. At the end of the evaluation process, Treasury notifies all approved institutions.

Institutions then have 30 days to complete the required documents before Treasury funds the transaction. All completed transactions will be publicly announced within 2 business days of execution, as required by the law. Treasury will not, however, announce any applications that are withdrawn or denied.

Treasury’s investment committee includes senior officials on financial markets, economic policy, financial institutions, and financial stability, as well as the Chief Investment Officer for the TARP. For SSFI and other programs, Treasury makes the decision on a case-by-case basis.

The goal of TARP is to stabilize the financial system and restore confidence in and of financial institutions, enabling credit to flow to consumers and businesses. In March of 2008, Treasury published an extensive Blueprint for a Modernized Regulatory Structure that proposes a framework and many specific recommendations for reforming our financial regulatory system. Our current system is a patchwork quilt that developed over many decades and is not optimal for our complex financial system today. Treasury is using TARP to stabilize the financial system today, while regulatory modernization will likely take several years to complete.