The Emergency Economic Stabilization Act of 2008
On Friday, October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (EESA). The 451-page EESA authorizes up to $700 billion in new spending authority for the US Secretary of the Treasury to purchase, manage and ultimately dispose of troubled assets. The initial three-page proposal sent to Congress by Treasury Secretary Henry Paulson contained few restrictions on how this funding could be spent. The House of Representatives rejected the initial legislation by a vote of 205-228. The Senate subsequently passed expanded legislation on October 1, 2008, by a vote of 74-25, followed by an affirmative vote in the House of 263-171. The EESA now includes numerous oversight mechanisms, addresses issues related to individual homeowners facing mortgage difficulties, and gives Congress the ability to reject half of the proposed $700 billion in funding.
Troubled Asset Relief Program
Congress has authorized up to $700 billion in funding for a newly created Troubled Asset Relief Program (TARP). This program gives the Treasury Department the authority to purchase, manage and sell assets on terms acceptable to the Treasury Secretary. The authority to purchase troubled assets expires on December 31, 2009, unless extended by the Secretary for an additional year. There is no sunset on Treasury’s authority to continue to own, manage or sell troubled assets. Use of the funding will be limited to financial institutions that have significant operations in the United States.1
The program will be supervised by a newly appointed Assistant Treasury Secretary, who will serve as the head of a new Office of Financial Stability, under the existing Office of Domestic Finance at the US Treasury. Mr. Neel Kashkari, a former Goldman Sachs executive, has been named the Interim Assistant Treasury Secretary for Financial Stability. Mr. Kashkari had served as the Assistant Secretary for International Economics and Development, having joined the Treasury Department in July 2006 as Senior Advisor to Secretary Paulson.
The $700 billion TARP funding will be sequenced in three phases:
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The first $250 billion will be available immediately.
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The next $100 billion will be available only after the President submits a declaration of need to Congress. (A vote by Congress is not required to agree or disagree with this declaration.)
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The final $350 billion will be made available only after both houses of Congress have had 15 days to reject by a majority vote the use of this $350 billion.
The Treasury Secretary is empowered to engage outside contractors and to designate financial institutions as financial agents of the United States government. Importantly, there are few requirements to follow existing federal guidelines in making these selections. The Treasury Secretary is required to establish new guidelines to: (i) identify mechanisms for purchasing troubled assets; (ii) address conflicts of interest; (iii) price these assets; and (iv) select the assets and the criteria for identifying assets to be purchased.2 These guidelines must be made available publicly within the earlier of 45 days after the enactment of the legislation or two business days after the first purchase of troubled assets.
Not less than every 60 days, the General Accounting Office must provide reports to Congress on the performance of TARP. Detailed reporting to Congress is required every time $50 billion or more in funding is used by the Secretary of the Treasury. A separate Office of Special Inspector to oversee the TARP is also created. Participants in TARP will be permitted to challenge the decisions of the Treasury Secretary in federal court only if they can prove the decisions were arbitrary and capricious or represented an abuse of discretion.
Troubled Assets Insurance Financing Fund
The Treasury Secretary must also establish an insurance program for assets that originated or were issued prior to March 14, 2008, including mortgage-backed assets. Upon a request from a financial institution, the Secretary may guarantee timely payment for up to 100 percent of principal and interest, based on terms and conditions set by the Secretary. Although the Treasury Secretary may vary premiums depending on risk, the criteria for determining the premium amount must be made publicly available.
Private Homeowners
To preserve homeowners, the Hope for Homeowners Program is being expanded. The Secretary may use loan guarantees and credit enhancements so loans can be modified to prevent foreclosures. Also, the Secretary can consent to term extensions, rate-reductions and principal write-downs. Federal agencies that own mortgage loans are directed to seek modifications prior to foreclosures. Tenants of rental property are also given greater protections from eviction if there is a foreclosure on the property. These provisions may make it difficult for a property purchaser to obtain title to an unoccupied structure. Under the legislation, homeowners whose debt is discharged before January 1, 2013, will not have this discharge considered as taxable income by the IRS.
Equity Sharing and Direct Investment
The law requires any financial transaction undertaken by Treasury to include some measure of equity sharing to minimize the risk to the government. Essentially, this will allow the federal government to own equity in banks under certain circumstances. For example, when Treasury purchases a troubled asset from a financial institution, it may also receive preferred or non-voting stock in the institution if it is publicly traded or some other senior debt instrument. Treasury may also consider a voluntary program of making direct investments into banks – including healthy ones-in exchange for equity interests.
Executive Compensation
One of the most politically charged provisions in the legislation is the financial compensation provided to top executives of public companies. Under the law, companies that participate in the TARP program may not deduct the amount of salaries and benefits of top executives that exceed $500,000 per year. Golden parachutes for these executives are also subject to increased taxes.3 Although these provisions may not have much of a financial impact on the use of the $700 billion in taxpayer funds, it has resonated politically with Members of Congress.
Mark-to-Market Changes
The Securities and Exchange Commission is expressly granted the authority to suspend mark-to-market requirements if the SEC determines it is appropriate to do so. The SEC is required to undertake a study on the impact of mark-to-market activity within 90 days. The number of news accounts blaming mark-to-market activity for the lack of credit has grown in recent days. Most analysts believe the SEC already has the authority to waive or modify such rules and, on September 29, 2008, the SEC issued a new interpretation of the mark-to-market rule.4
Higher FDIC and NCUA Insurance Limits
In response to extensive lobbying by banks and credit unions, the legislation increases the maximum amount that deposit accounts can be insured by the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Association (NCUA) to $250,000 per account from the prior coverage of $100,000.
Implementing the Law
On October 6, the Treasury Secretary issued three requests for proposals (RFPs) for interested parties to submit bids to become: (i) whole loan asset managers (ii) securities asset managers; (iii) and providers of custodian services. Confidential submissions for each RFP were due by 5:00 pm EST on October 8. These submissions contained information about fees and the backgrounds of key managers. It is expected many applicants will have potential conflicts that will need to be addressed in the final contract.
Among other requirements, whole asset managers must either currently manage a portfolio of at least $25 billion or prove it can handle such a portfolio. Securities asset managers must have at least $100 billion in dollar-denominated fixed-income assets under management and have received an unqualified auditor’s opinion for the last five years. Providers of custodian services must have at least $500 billion in domestic assets under custody.
The Treasury Department will select a number of applicants to continue to a second phase of the RFP in which additional qualification information will be sought from each applicant, possibly under a confidentiality agreement. Applicants who are not selected will not be provided the reasons for not being chosen. In the third and final phase, face-to-face interviews may be required of the finalists. Those ultimately selected will be designated as financial agents of the United States, thereby imposing a fiduciary responsibility on each successful applicant to act in the best interests of the United States.
Financial Stability Oversight Board and Other Oversight
Several new oversight programs will also be established under the legislation. The Financial Stability Oversight Board is being created to oversee the appointment of financial agents, the effect of the plan upon homeowners, and to identify fraud. The Board will consist of the Chairman of the Board of the Federal Reserve, the Treasury Secretary, the Director of the Federal Home Finance Agency, the Chairman of the SEC, and the Secretary of Housing and Urban Development. The Financial Stability Oversight Board is required to meet within two weeks of any asset acquisition by the Treasury Secretary. The Board will automatically be dissolved after the last use of the new insurance program or the sale of the last asset originally purchased by the United States. GAO is also required to undertake a study on the impact of leverage on the current financial problems and recommend changes by June 1, 2009. In addition, a new congressional oversight panel is created to oversee all of the new authorities created by the legislation.
Other Points of Interest
Notably, a bankruptcy “cramdown” provision favored by some Members of Congress is not included. This provision would have permitted bankruptcy court judges to modify the terms of mortgage contracts by reducing the amount of principal.
The revised bill also includes tax extender provisions related to the alternative minimum tax (AMT), individual tax provisions and deductions, business tax provisions, tax administration provisions, additional tax relief and other tax provisions, and disaster relief.
Arent Fox will continue to monitor the progress of this important legislation and advise clients accordingly. Questions concerning the legislation should be addressed to:
Mark Katz
202.857.6260
katz.mark@arentfox.com
David Dubrow
212.484.3957
dubrow.david@arentfox.com
Craig Engle
202.775.5791
engle.craig@arentfox.com
Jon Bouker
202.857.6183
bouker.jon@arentfox.com
1The financial institutions covered by the bill include banks, savings associations, credit unions, securities brokers and dealers, insurance companies, any institution established and regulated under the laws of the United States, and any state, territory, or possession of the United States and having significant operations in the United States, including US branches of foreign-owned banks. The bill excludes any central bank or institution owned by a foreign government unless they are holding troubled assets as a result of extending financing to financial institutions that have failed or defaulted.
2 Among the market mechanisms the Treasury Department may use are auctions or reverse auctions to set the discount at which the assets are priced. Assets will include mortgage-backed securities. Debt tied to auto loans, credit cards, student loans, and other non-mortgage related assets may also be included.
3 Also included is a claw-back provision that allows recovery by the financial institution of any bonus or other incentive compensation paid to a senior executive officer based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate.