On Friday, February 9, 2009, the TARP Congressional Oversight Panel released its February Oversight Report, with significant press coverage that the Treasury paid too much under TARP.

The Panel’s analysis revealed that in the ten largest transactions made with TARP funds, for every $100 spent by Treasury, it received assets worth, on average, only $66. This disparity translates into a $78 billion shortfall for the first $254 billion in TARP funds that were spent.

Extrapolation to Community Banks?

The Panel’s analysis explicitly extrapolates the value of the Treasury’s investments in 311 banks, including many private community banks will less than $1 billion in total assets, based solely on the individual risk characteristics of Bank of America, Citi, JPMorgan, Morgan Stanley, Goldman Sachs, PNC Financial, US Bancorp, and Wells Fargo.  While criticizing the Treasury for using a “one-size-fits-all investment policy,” the Oversight Panel’s analysis uses a one-size-fits-all investment analysis.  Other than a footnote acknowledging this extrapolation, the Congressional Oversight Panel’s report does not explain why it believes this extrapolation is appropriate.

The Summary Valuation Report prepared by the Duffs & Phelps Corporation includes a footnote that acknowledges some of the differences, and declines to evaluate whether such extrapolation is appropriate.

Treasury’s subsequent investments under the CPP were to institutions that differed from those analyzed by Duff & Phelps in several important respects such as size and scope of activities, and the transactions took place under different market conditions.  In extrapolating the costs, we did not attempt to evaluate the effect of these differences.  (emphasis added)

In addition to the differences noted by Duffs & Phelps above, the majority of TARP Capital Purchase program investments to date in 2009 have been under the private term sheet rather than the public term sheet.

Appropriate to Use Capital Markets to Value Bank Investments?

In light of the market turbulence that contributed to the need for the Troubled Asset Relief Program, it is somewhat surprising that one would use a market analysis to determine the value of the Treasury’s investment.  The Summary Valuation Report again acknowledges this assumption, without comparing to other notions of fundamental economic value.

All of these approaches rely on some basic assumptions, the most important of which is that the prices for securities similar to those issued under the TARP were trading in the capital markets at fair values, which as defined by D&P is “the price at which they would change hands between a willing buyer and a willing seller when neither is acting under compulsion and when both have a reasonable knowledge of the relevant facts.” Despite the turmoil in the capital markets, the Advisory Committee believes, and D&P confirmed through analysis, that there was sufficient liquidity and market volume in the trading of securities at that time to rely on market pricing for analysis. D&P was not asked to consider whether these market prices were consistent with other notions of fundamental economic value.