The passage of the Emergency Economic Stabilization Act of 2008 (EESA) last October authorized the U.S. Treasury's Troubled Asset Relief Program (TARP), which was intended to stabilize the U.S. financial system and prevent a systemic collapse. Prior to EESA's passage, a series of escalating events triggered by the failures and near failures of some of the world's largest financial institutions through the summer and early fall of 2008 severely eroded confidence in the U.S. financial system, shut down interbank lending and credit markets, and ultimately affected the real economy. These events helped transform the year-long financial crisis into an economic crisis, which set off global shockwaves and gave rise to the fear of a 1930s-style financial and economic meltdown.
This article will provide an overview of TARP, including legislative changes made to TARP as of this writing, as well as ongoing oversight of TARP. It will also cover details of participation in the TARP Capital Purchase Program (CPP) and CPP redemption criteria and explain TARP within in the context of the Treasury's overarching Financial Stability Plan.
Under EESA, the Treasury was allotted up to $700 billion in three installments to fund TARP-$250 billion initially, with an additional $100 billion to be released contingent upon the approval of the U.S. President, and a third installment of $350 billion contingent upon the approval of both the U.S. President and U.S. Congress. The first two installments, totaling $350 billion, were released to the Treasury in the latter half of 2008. The third installment of $350 billion was released to the Treasury on February 13, 2009, with the passage of the American Recovery and Reinvestment Act (ARRA).
Legislative changes to TARP. TARP and the Treasury's various programs falling under the TARP umbrella have undergone changes since the passage of EESA. Legislatively, the ARRA (2009) retroactively established significant conditions and restrictions around executive compensation, incentive pay, and severance pay for firms receiving TARP funds. The ARRA also authorized the extension of TARP funds to the auto industry and enhanced reporting and recordkeeping requirements for institutions receiving TARP funds.
In addition to legislative changes introduced under the ARRA, the Treasury has continued to refine and develop various programs through its TARP authority and to administer these and other programs that aim to stabilize financial markets and prevent further home foreclosures through the adoption of an overarching Financial Stability Plan framework. The Treasury has described the Financial Stability Plan, which it announced in February 2009, as a broad-based effort that will reach across government agencies to implement a series of financial initiatives alongside the ARRA to help lay the foundation for economic recovery.
Under the plan, the Treasury is administering the following TARP programs:
For information on these initiatives and the Financial Stability Program, go to the
EESA created an oversight board, the Financial Stability Oversight Board (FSOB), for TARP. The FSOB meets monthly to review and discuss TARP-related programs, policies, and financial commitments and other key objectives of EESA. The FSOB is composed of the Secretary of the Treasury, Chairman of the Board of Governors of the Federal Reserve System (chair), Secretary of the Department of Housing and Urban Development, Chairman of the Securities and Exchange Commission, and Director of the Federal Housing Finance Agency. Minutes of the FSOB meetings are made public.
EESA also established a special inspector general (SIGTARP) to conduct, supervise, and coordinate audits and investigations of the purchase, management, and sale of assets under TARP. The goal of the SIGTARP, who has authority to issue subpoenas, is to protect the interest of the American taxpayers by providing effective oversight for TARP and robust criminal and civil enforcement against those who waste, steal, or abuse TARP funds.
The original provisions of TARP under EESA focused on a Treasury asset purchase program to buy the illiquid mortgage-backed assets that many believed were clogging up the balance sheets of financial institutions and hindering their ability to lend and raise private capital. When it became clear that an asset purchase program was too complicated to implement quickly enough to calm the markets and forestall an economic meltdown, the Treasury implemented the CPP.
This move was found by some to be controversial, as the CPP enabled the Treasury to inject capital directly into the financial system by purchasing equity stakes in sound financial institutions. Nine of the largest U.S. financial institutions subsequently accepted between $2 billion and $25 billion each under the CPP, and numerous institutions applied for and voluntarily accepted CPP funds thereafter.
The Treasury created the CPP to address the severe strains affecting the financial markets and obstructing the free flow of credit essential to a well-functioning economy. Under the CPP, which is voluntary, the Treasury is providing capital to viable financial institutions through the purchase of up to $25 billion of a financial institution's preferred shares. These investments enable participating financial institutions to build their capital base, thereby increasing their capacity to lend to households and businesses and support the economy. As of March 31, 2009, the Treasury has invested approximately $198.8 billion in 532 financial institutions under the CPP.1
Provisions built into the Treasury's CPP agreements are meant to protect the interests of the taxpayers and generate a return on the Treasury's investment. Publicly-held participating financial institutions, for example, pay the Treasury a five percent dividend on senior preferred shares for the first five years following the Treasury's investment and nine percent per year thereafter. To protect the taxpayers, participating financial institutions must adhere to executive compensation and dividend and stock repurchase agreements. They must also provide the Treasury with warrants as specified under EESA, the CPP program rules, and the terms of their purchase agreements.
Institutions that qualified for the CPP include U.S.-controlled banks, savings associations, security brokers or dealers, and insurance companies. Additionally, financial institutions that filed a bank or thrift holding company application on or before December 8, 2008, and were approved on or before January 15, 2009, were also permitted to apply for CPP funds. Any bank or thrift holding company that has CPP funds must maintain its status as a bank or thrift holding company until those funds are repaid.
While the original application deadlines for the CPP have closed, the Treasury recently announced that the CPP application window for all term sheets-public and private corporations, Subchapter S corporations, and mutual institutions-will be reopened for institutions with total assets under $500 million. The terms of the program will also be revised to raise the amount for which qualifying institutions can apply from three percent of risk-weighted assets to five percent. Current CPP participants will be allowed to reapply with an expedited approval process.
The Treasury also indicated that it will extend the deadline for small banks to form a holding company for the purposes of the CPP. The window to form a holding company and the window to apply or reapply for the CPP will be open for six months.
The Treasury's capital injections under the CPP are intended to restore the credit markets and encourage financial institutions to resume lending at more normal pre-crisis levels to businesses and consumers, a prerequisite to stabilizing the financial sector and improving investor confidence in financial institutions and the markets. Financial recovery has been a slow process, however, and although short-term credit markets are functioning better and bank and nonbank lending has picked up considerably since last fall, the amount of financing extended to consumers and businesses remains somewhat restricted.
The changes implemented by the ARRA, especially those surrounding executive compensation and incentive pay, have prompted many institutions to evaluate the costs and benefits associated with CPP funds. For some institutions, the perceived stigma associated with TARP has been a determining factor in their decision to pull their applications for Treasury investments under CPP or, for those that have already accepted funds, to pay back those funds early.
The original CPP placed a number of conditions on repaying funds. The ARRA, however, revised the terms of CPP to permit financial institutions to redeem CPP funds prior to any contractual waiting period specified in their purchase agreements with the Treasury and permits them to redeem CPP funds with funds obtained from any source.
Institutions that are interested in redeeming their CPP funds are advised to notify their primary regulator and to notify the Treasury. After receiving an institution's notice, the Treasury will consult with the institution's primary regulator.
Following are FAQ links for institutions interested in paying back TARP funds:
Some observers have compared the government's intervention under TARP to the 1930s, with the chartering of the Reconstruction Finance Corporation Act, which made loans to various state and local governments, as well as distressed financial institutions. Supporters of EESA today argue that government intervention has prevented a catastrophic collapse of the financial system and has had some effect in restoring short-term lending markets and improving the flow of credit to businesses and consumers. These supporters also believe that there is the possibility that the government may recoup a portion-potentially all-of its investment, although critics have objected to the enormous cost of the intervention and the uncertainty of the outcome.
It is still too early to have a good understanding of the impact of the CPP on the U.S. economy. Demand for credit typically falls during economic downturns, as lenders and borrowers react to the uncertain economic environment. It is also difficult to isolate the effect of the CPP from the host of other governmental economic recovery efforts implemented during the same timeframe. The Treasury has recently developed tools to better measure the lending and disintermediation activities of institutions receiving CPP funds. These tools should eventually provide more insight into the impact of the CPP and the role it is playing, as the industry continues to progress toward financial and economic recovery.
For more information on the CPP, please visit the website .