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Financial Services Update – Issue 8

Senate Financial Regulatory Reform Bill
On Friday, Senate Banking Committee Chairman Christopher Dodd (D-CT) said his Committee has not reached an agreement on the pending financial services regulatory reform bill, but he hopes one will be reached within days. Dodd also indicated that the independence of the proposed “Consumer Financial Products Agency” continues to be the major point of contention between Republicans and Democrats. Senate Banking Committee Republicans oppose making the watchdog an independent agency, but have said they could support it as a unit within an existing banking regulatory agency. Dodd has suggested putting the consumer protection division in the Federal Reserve as a possible compromise. However, Dodd has drawn the line at Republican demands that a banking regulator have veto power over the consumer entity’s rule-making authority. Meanwhile, the third ranking Senate Banking Committee Democrat, Jack Reed of Rhode Island, said he would still introduce an amendment at the Committee’s markup that will insert language into the bill that would establish the consumer protection watchdog as an independent agency.
February Jobs Numbers Announced
On Friday, the Bureau of Labor Statistics announced that the nonfarm payroll employment declined by 36,000 jobs, fewer than the 50,000 that analysts predicted. February’s statistics place the total number of people out of work at 14.9 million or roughly 9.7%. While the Bureau of Labor Statistics, White House Economic Advisors Larry Summers and Christina Romer all cited the impact of February’s bad weather as a possible contributing factor to the continued job losses, Republicans cited the Administration’s yearlong battle to pass a health care bill as a distraction from job creation.
House Ways and Mean Committee Shakeup

On Thursday, after now-former Ways and Means Chairman Charles Rangel (D-NY) indicated he would step aside temporarily, Rep. Pete Stark (D-CA), who was next in line behind Rangel, indicated that he would not pursue the Chairmanship. House Democrats installed Rep. Sander Levin (D-MI) as acting chairman of the powerful tax writing panel for the remainder of the year, or until Rangel is sufficiently cleared by the Ethics Committee. If Democrats retain their majority in the House, however, the Chairmanship of the Committee would reopen and sources indicate Massachusetts Rep. Richard Neal, Washington Rep. Jim McDermott, and Georgia Rep. John Lewis may challenge Levin for the top spot.

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Estimating the TARP Capital Purchase Program Value

The Wall Street Journal Economics Blog has an excellent post by Jon Faust, the director of the Center for Financial Economics at Johns Hopkins University, criticizing Elizabeth Warren’s claim that the Treasury is only getting 66 cents in value for every TARP dollar spent.

Overall, the 66 cent myth is based on the assumption that markets were functioning normally, that the Treasury would pursue a panic sale, and that banks required no compensation due to risk of Congressional meddling.

These arguments are not revelations. Before Warren’s panel commissioned the market-value report, the Panel asked Treasury to perform this valuation. According to testimony, Treasury replied that the market valuation was not relevant. Indeed, Treasury agreed that the assets would be below par if valued at prevailing market prices but argued that the investments would be “at or near par” on a more reasonable basis.

Finally, Treasury reminded the panel that part of the value to the taxpayer was to come in “ensuring the stability of the financial system,” a factor that plays no role in market valuations.

Rather than evaluating these arguments, Warren complained that Treasury didn’t explain itself sufficiently well. Perhaps Treasury could have been clearer, but the basic ideas sketched above are not subtle. If Warren’s panel had insufficient expertise to understand these arguments, the investment bank it hired could easily have explained them.

In addition to these criticisms, as we’ve previously noted, Warren’s analysis uses a one-size-fits-all investment analysis, despite criticizing the Treasury for doing the same thing.  The 66 cent figure is based on the value received by the Treasury under the TARP Capital Purchase Program exclusively for its investment in the first eight recipients of TARP Capital Purchase Program funds.  While these entities have received the bulk of the TARP Capital Purchase Program funds, there have been over 500 additional recipients of these funds, many of which look virtually nothing like the original eight recipients, and about half of which have received TARP Capital Purchase funds under the private term sheet, resulting in a different investment vehicle.

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Does the Treasury need to Mark-to-Market?

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.

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Obama's TARP Commitments

Obama's TARP Commitments

January 16, 2009

Authored by: Robert Klingler

In connection with the Senate’s rejection of the withholding of the second $350 billion under the Emergency Economic Stabilization Act of 2008, Director-designate of the National Economic Council, Larry Summers, submitted a letter to Senator Reid containing additional commitments of the Obama administration.  The letter is generally focused on the use of the second $350  billion, but also contains several provisions that may affect existing TARP Capital programs.

The Obama administration has committed that the TARP funds will be used to protect the financial and housing markets, and will not be used to implement a broader industrial policy, and that at least $50 to $100 billion of the remaining funds will be allocated to an effort to address foreclosures.  In addition, the letter highlights four areas of reform that it intends to implement:

  1. Provide a  Clean and Transparent Explanation for Investments
  2. Measure, Monitor and Track the Impact on Lending
  3. Impose Clear Conditions on Firms Receiving Government Support
  4. Focus Support on Increasing the Flow of Credit

The letter provides that the Treasury will make a condition of federal assistance for healthy banks that they “will increase lending above baseline levels.”  It appears that Treasury will require quarterly reports, perhaps in conjunction with Call Reports of SEC filings.

Among the conditions that Summers lists (which may or may not apply to TARP Capital investments), community bankers may find both positive and negative implications.  On the positive side, the only additional limitation on executive compensation is that compensation “above a specified threshold” must be paid in restricted stock or similar form that cannot be liquidated until the government has been repaid.  Substantive dividend restrictions appear limited to those banks that receive “exceptional assistance.”  For all others, dividends must be “approved” by their primary federal banking regulator; presumably, federal banking regulators will continue to use the same standards to determine whether dividends are acceptable.  “Summers also provides that the investments will be designed to “promote early repayment and to encourage private capital to replace public investments as soon as economic conditions permit.”  The Obama administration will not permit government funds to be used to purchase “healthy” institutions.

Positively, the Summers letter specifically provides that funds should be provided to “ensure the soundness of community banks throughout the country.”

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Treasury Publishes Second Report to Congress

On January 6, 2008, the Treasury released its Second Report to Congress as required under Section 105(a) of the Emergency Economic Stabilization Act.  While the Second Report does not contain any new information, it does contain two nuggets of information that may be of interest to community bankers: (a) how Treasury believes the effectiveness of the TARP Capital program should be measured; and (b) confirmation that terms applicable to S corporations and mutuals are still in the works.

The Second Report begins with a note that Treasury has continued to make significant investments in financial institutions through the Capital Purchase program.  “These investments have improved the capitalization of these institutions, which is essential to improving the flow of credit to businesses and consumers and boosting the confidence of depositors, investors, and counterparties alike. With higher capital levels and restored confidence, banks can continue to play their vital role as lenders in our communities, a necessary requisite for economic recovery and a return to prosperity.”

In discussing the details of the Capital Purchase program, the Second Report notes that “terms applicable to S corporations and mutual organizations are still under consideration.”

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NPR Interview with Congressional Oversight Chair

On December 10, 2008, the Congressional Oversight Panel for Economic Stabilization issued its first report on the Treasury’s implementation of the Troubled Assets Relief Program. On December 11, 2008, the Chair of the Oversight Panel, Harvard Law Professor Elizabeth Warren, sat down with Terry Gross on NPR’s Fresh Air to discuss how taxpayer money is being spent in the financial bailout program.  The report and interview give insight into how the political process surrounding the TARP program may affect the program going forward.

The Congressional Oversight Panel has presented ten questions for analyzing the TARP program.

  1. What is Treasury’s Strategy?
  2. Is the Strategy Working to Stabilize Markets?
  3. Is the Strategy Helping to Reduce Foreclosures?
  4. What Have Financial Institutions Done with the Taxpayers’ Money Received So Far?
  5. Is the Public Receiving a Fair Deal?
  6. What is Treasury Doing to Help the American Family?
  7. Is Treasury Imposing Reforms on Financial Institutions that are taking Taxpayer Money?
  8. How is Treasury Deciding Which Institutions Receive the Money?
  9. What is the Scope of Treasury’s Statutory Authority?
  10. Is Treasury Looking Ahead?
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