Confusion and Criticism over Treasury's Changing Plans, as Saturday's G20 Meeting Begins

Financial Reform Watch November 9–16, 2008

Financial Reform Watch is a Blank Rome Government Relations LLC series of alerts developed for our colleagues needing to keep current on Washington's response to the turmoil in the financial markets.

Friday, November 14—AM Report

With each passing day it becomes more apparent that neither the Congress nor the Bush Administration has an appetite for significant new actions to aid the financial system or the economy at large before the end of the year. Congressional leaders on Thursday made it clear that passage of an economic stimulus package or a package to aid the auto industry were looking increasingly difficult. At the Treasury Department, consideration is being given to making Capital Purchase Program assistance available to non-bank financial institutions, but no guidelines for how that might happen or what form the assistance may take have emerged. Meanwhile, congressional Republicans have begun clamoring for more information on the actions Treasury and the Federal Reserve have already taken to assist ailing financial institutions and other companies.

Sen. Chuck Grassley (R-IA), Ranking Member of the Senate Finance Committee, sent a harshly worded letter to the Treasury Secretary and Federal Reserve Chairman "to express concerns and receive answers to questions" he has regarding implementation of the Emergency Economic Stabilization Act of 2008 (EESA). In a statement released along with his letter, Grassley said of the implementation thus far, "When you see so many changes, you wonder if they really know what they’re doing."

Senate Banking Committee Chairman Christopher Dodd (D-CT) told reporters yesterday that they do not have the votes in the Senate to pass new legislation to bail out auto manufacturers. Despite that, Dodd said that Treasury currently has the authority under the EESA to help the industry, but he wants to move cautiously toward a plan that Congress and the incoming administration can support. The Senate Banking Committee plans to hold a hearing early next week to examine ways to expand the $700 billion rescue package to non-bank institutions, including the auto industry.

The subject of mitigating mortgage foreclosures also continues to dominate Capitol Hill hearings and press conferences. The Federal Deposit Insurance Corporation (FDIC) today unveiled its "Loss Sharing Proposal to Promote Affordable Loan Modifications." According to the FDIC, only four percent of seriously delinquent loans are being modified each month. To encourage wider adoption of a systemic loan modification program, the FDIC proposes paying servicers $1000 to cover the expenses of modifying each loan and also having the federal government absorb up to 50 percent of the loss if a modified loan subsequently defaults. The FDIC estimates this program can help half of the current 4.4 million troubled loans, avoid roughly 1.5 million foreclosures, and cost approximately $24.4 billion. It is unclear yet whether Congress will push the Treasury Department to embrace this proposal.

Against this chaotic backdrop, leaders of the G20 nations will converge tomorrow on Washington for a one-day meeting on international financial regulation. While key foreign leaders may arrive with some concrete suggestions on potential steps to be taken, it is unlikely the Bush Administration would agree to anything substantive at this juncture. So expectations for this meeting are best calibrated in the direction of principles for further talks. That at least might be achievable.

Wednesday, November 12—PM Report

Treasury Secretary Hank Paulson today announced the Treasury Department will assist nonbank financial institutions with Troubled Asset Relief Program (TARP) funds and that the department will not use any funds for the original stated purpose of the program—the purchase of troubled assets from banks. The announcement of his intention to provide assistance to nonbank institutions represents a new step for Paulson. In making the announcement, the Secretary acknowledged that Treasury has not worked through the issue of funding organizations that are not federally regulated, however they are “designing further strategies for building capital in financial institutions,” and he said, “We will also consider capital needs of non-bank financial institutions not eligible for the current Capital Purchase Program.” He focused his remarks on the importance of shoring up the asset-backed securitization market by working with the Federal Reserve to develop a liquidity facility for AAA securities. Paulson acknowledged the need to “get lending going again,” and said, “While this securitization effort is targeted at consumer financing, the program we are evaluating may also be used to support new commercial and residential mortgage-backed securities lending.”

The accompanying announcement that Treasury does not intend to use TARP funds to purchase troubled assets as originally planned was a surprise to most observers. Paulson said he would seek to address the liquidity issues in the mortgage finance market by making additional capital available to banks if those funds were matched with private capital.

Congress originally authorized $700 billion for the TARP, and Treasury continues to modify the spending strategy around it. Thus far, the department has set aside $250 billion for the Capital Purchase Program (CPP), which will infuse banks with money in exchange for federal ownership shares. Treasury has committed another $40 billion to purchase shares of troubled insurance giant AIG. For the remaining $410 billion under the TARP, Paulson said the money would be used to accomplish three critical priorities:

reinforce the stability of the financial system, which may include giving capital to nonbanks
support consumer access to credit outside of the banking system, targeting credit cards, auto loans, and student loans
reduce the risk of foreclosure.

(See the below chart to see how the TARP money has been allocated thus far.)

Paulson’s third priority was largely addressed yesterday in a joint announcement with the Federal Housing Finance Agency, the Federal Housing Authority, Fannie Mae, Freddie Mac, and the private sector alliance HOPE NOW, wherein they unveiled a new “streamlined loan modification program” (SMP). The program targets homeowners who have missed three or more mortgage payments on their primary residence; have not filed for bankruptcy; can show that financial hardship or changed circumstances have caused them to fall behind in payments; and have a current loan-to-value ratio of 90 percent or higher. The SMP allows loan servicers to reduce monthly mortgage payments by reducing the interest rate; extending the life of the loan (to 40 years); and/or deferring payment on the principal. The new, reduced monthly payment must not exceed 38 percent of a borrower’s gross monthly income. Fannie Mae and Freddie Mac will soon issue SMP guidance to mortgage servicers, who must agree to participate by December 15 and will receive $800 for every loan modified through this program.

When questioned specifically about the auto industry’s eligibility, the Secretary acknowledged the industry’s importance, but decisively maintained that TARP assistance is limited to the financial industry.

Use of TARP Funds as of 11/12/08:

Citigroup	$25 billion
JPMorgan	$25 billion
Wells Fargo	$25 billion
Bank of America	$15 billion
Merrill Lynch	$10 billion
Goldman Sachs	$10 billion
Morgan Stanley	$10 billion
PNC Financial Services	$7.7 billion
Capital One Financial	$3.55 billion
Regions Financial	$3.5 billion
SunTrust Banks	$3.5 billion
Fifth Third Bancorp	$3.45 billion
BB&T Corp	$3.1 billion
Bank of New York Mellon	$3 billion
KeyCorp	$2.5 billion
Comerica	$2.25 billion
State Street Corp	$2 billion
Marshall and Ilsley	$1.7 billion
Northern Trust Corp	$1.5 billion
Huntington Bancshares	$1.4 billion
Zions Bancorp	$1.4 billion
First Horizon National	$866 million
City National Corp	$395 million
Valley National Bancorp	$330 million
UCBH Holdings Inc	$298 million
Umpqua Holdings Corp	$214 million
Washington Federal	$200 million
First Niagara Financial	$186 million
HF Financial Corp	$25 million
Bank of Commerce	$17 million
*Total:*	*$160.1 billion*

Monday, November 10—PM Report

The U.S. Department of Treasury is proving it is nothing if not flexible. Before dawn this morning, Treasury issued a statement that it will use the authority granted under the Emergency Economic Stabilization Act to restructure insurance giant AIG. Valued at roughly $150 billion, Treasury is retooling its earlier bailout of the insurance company with a program that includes the purchase of $40 billion worth of AIG senior preferred stock, $30 billion to purchase securities underlying credit default swaps, $22.5 billion for purchasing residential mortgage securities, and other reductions in outstanding debt and interest rates. There are strings attached—executive pay and bonuses will be restricted as well as corporate expenses and lobbying. Treasury is clearly reacting to market conditions and flexing the Troubled Asset Relief Program (TARP) accordingly. However, today’s and other recent Treasury actions raise an important question: Is Treasury’s reactive approach helping or just prolonging the uncertainty plaguing the financial markets?

Treasury’s inconsistency means an automotive industry rescue package is still possible. The Interim Secretary for Financial Stability, Neel Kashkari, told an audience of financial executives this morning, “The TARP’s foremost purpose is to stabilize the financial system,” and their goal is “to use the TARP to attack the root cause of the financial market turmoil.” Is Treasury prepared to adopt a comprehensive, consistent strategy to address the crisis? Or will the agency continue to dig for new solutions?

On the tactical side, Treasury is looking for a few good asset managers to implement the Capital Purchase Program (CPP). In a November 7^th notice, Treasury said it seeks “multiple Financial Institutions to provide asset management services for the portfolio of senior preferred shares, senior debt, warrants and other equity securities and debt obligations that the Treasury will receive from public and private Financial Institutions participating in the CPP.” The notice adds that Treasury may also use these services for other programs in addition to the CPP.

Treasury anticipates assigning each asset manager a certain portfolio of Financial Institutions, and the asset manager will perform the following services:

Value assets issued by public and private financial institutions and analyze the financial condition, capital structure, and risks of the financial institutions;
Conduct equity and debt financial analysis on behalf of Treasury; advise on the optimal disposition of Treasury’s assets; and execute transactions (according to Treasury’s instructions and “Investment Policy and Guidelines”); and
Provide Treasury with detailed analysis and recommendations on corporate actions, proxy voting, disclosures, consents, waivers, and anything else affecting Treasury’s ownership stake and compliance responsibilities.

According to Treasury, “The size of the overall portfolio will reach hundreds of billions of dollars, and will likely involve securities and obligations issued by thousands of public and private Financial Institutions.” Treasury will pick large and small asset managers that have at least $100 million in dollar-denominated assets under management. The attached document contains the details of the application process, and applications are due no later than November 13, 2008 at 5 p.m. ET.

To view the Financial Reform Watch alerts from previous weeks:

Notice: The purpose of this newsletter is to review the latest developments which are of interest to clients of Blank Rome. The information contained herein is abridged from legislation, court decisions, and administrative rulings and should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.