The Emergency Economic Stabilization Act (EESA)
The Emergency Economic Stabilization Act (EESA) was drafted by the United States Congress and signed into law by President George W. Bush on October 3, 2008. This was a premeditated response to the oncoming financial crisis in the United States, which was reaching near-panic proportions. These financial difficulties began in August 2007, when the value of asset-backed securities, particularly those backed by subprime mortgages, plummeted (King, 2009). The unusual housing boom led to a housing crash. The Federal Reserve (Fed) took concerted steps to restore liquidity in the US market, temporarily soothing it. Yet, mortgage losses lingered and finally spilled over into other markets. Financial firms wrote off the majority of these losses which slowly depleted their capital. Due to this uncertainty in the market, some firms had reduced access to private liquidity. In some cases, this was detrimental. Lehman Brothers’ bankruptcy is a perfect example. The government took over Fannie Mae and Freddie Mac in September 2008 and AIG near collapse that was prevented by $85 billion loans from Fed. Financial firms were unwilling to lend because they were uncertain as to which firms held assets that were now worth much more less that it was previously estimated hence making these firms unreliable.
EESA and Troubled Asset Relief Program (TARP)
EESA enabled the US Department of Treasury to create several programs under Troubled Asset Relief Program (TARP) to help strengthen the US financial system, restart growth of the US economy and counter foreclosures that are avoidable. Treasury announced TARP on 14th October 2008. EESA authorized the Secretary of the US Department of Treasury originally to buy or insure of up to $700 billion of troubled assets owned by financial firms for a maximum term of up to 3rd October 2010 but the Dodd-Frank Wall Street Reform and Consumer Protection Act which was legalized in 2010 reduced the authorized amount to $475 billion (Ash, Michael, et al., 2009). Removing troubled assets from the US financial system would restore confidence between the parties involved in financial transactions hence the system would eventually resume functioning. The Secretary of Treasury was allowed by EESA to decide what assets would be insured or purchased and what qualified as a financial institution. Requirements for reporting and mechanisms for oversight were also stated in EESA. The amendment of EESA that reduced the amount to $475 billion also strengthened the requirements for executive compensation.
TARP Programs
The programs under TARP can be divided into Credit Market Programs, Bank Support Programs, Housing Programs and Other Investment Programs. The Bank Support Programs included Capital Purchase Program (CPP), Community Development Capital Initiative (CDCI), Targeted Investment Program (TIP) and Asset Guarantee Program (AGP).
Capital Purchase Program (CPP)
CPP bought preferred shares in banks. It did not buy mortgage-backed securities that were toxic to the financial system. Adding capital to banks was seen as an excellent strategy to allow banks to counter the effect of toxic assets. As a result, the assets of banks remained on their balance sheets. Under the current program, CPP was closed with no additional disbursements possible. Approximately $205 billion was disbursed with $6.1 billion accounted for as outstanding, and $3.4 billion was written off.
Community Development Capital Initiative (CDCI)
CDCI gave low dividend rates on the purchase of preferred shares from the banks that customize their lending to small businesses, low-income earners, and underserved communities. Many CPP participants converted into CDCI. $0.57 billion was disbursed, with $0.51 billion still outstanding. CDCI is closed. Under the current program, no disbursements under CDCI are possible.
Targeted Investment Program (TIP)
TIP was created for preferred share purchases. It was used for Bank of America and Citigroup only. All $40 billion of the funds disbursed was repaid. TIP is closed.
Asset Guarantee Program (AGP)
AGP was formed as a requirement of EESA, Section 102. It gave guarantees that were part of the exceptional assistance to Bank of America and Citigroup. $5 billion was extended in guarantees, but they were canceled. No funds were disbursed. AGP is closed.
Credit Market Programs
The programs under credit market programs include Public-Private Investment Program (PPIP), Section 7 (a) Securities Purchase Program and Term Asset-Backed Securities Loan Facility (TALF).
Public-Private Investment Program (PPIP)
PPIP provided funding and insurance for banks to purchase mortgage-related securities from their balance sheets (Dooley and Hutchison, 2009). The securities are purchased and managed by private investors who have given capital to invest together with TARP monies. $18.6 billion was disbursed, and it has fully been repaid. PPIP is currently closed.
Section 7 (a) Securities Purchase Program
Section 7 (a) Securities Purchase Program gave support to the Small Business Administration’s (SBA’s) Section 7(a) loan program. This was through buying of pooled SBA guaranteed securities to increase the availability of credit to small businesses. $0.37 billion was distributed, and it has fully been serviced. Section 7 (a) Securities Purchase Program is closed (Veronesi, Pietro and Zingales, 2010).
Term Asset-Backed Securities Loan Facility (TALF)
TALF was founded to give support to asset-backed security markets and cushion it from the initial losses. It was operated by Fed. $0.1 billion was disbursed for expenses. This was fully repaid. No funds were released for losses because income from the TALF program was deemed sufficient to cushion against any possible losses. The TALF loans were extended to 2015. The commitment of TARP to TALF was later canceled.
Housing Programs
Unlike the other TARP programs, housing programs were not meant to bring in income or valuable assets to TARP. They remain open under the contracts agreed to and funded to be disbursed(Calomiris and Khan, 2015). These programs include Home Affordable Modification Program (HAMP), FHA Short Refinance and Hardest Hit Fund (HHF).
Home Affordable Modification Program (HAMP)
HAMP was created to pay mortgage servicers if they modified mortgages to reduce the financial burden to homeowners. A maximum of $29.9 billion is possible. $5.6 billion has been disbursed.
FHA Short Refinance
FHA Short Refinance encourages mortgage refinancing on properties, whose mortgage balance is more that the current market price of the house if lenders forego some of the owed principal balance on mortgages. $0.06 billion out of the possible $1 billion has been disbursed.
Hardest Hit Fund (HHF)
HHF aim is to provide help to state housing finance agency programs in US states which have the steepest reduction in prices of homes and those states with high levels of unemployment. There are 18 states taking part in HHF. HHF has disbursed $2.6 billion out of the possibly $7.6 billion.
Other Investment Programs
Other Investment Programs include Automobile Industry Support and AIG Assistance (Systemically Significant Failing Institution Program).
Automobile Industry Support
Automobile Industry Support gave loans to support Chrysler and General Motors (GM). It later included buying of shares from GMAC (now renamed Ally Financial), an auto financing company and a loaning Chrysler Financial. This program gave the government 60.8% ownership of GM, 74% of GMAC and 9.9% of Chrysler (Baily, Neil and Elliott 2009). In December 2010, a public share offer reduced the government’s ownership of GM to 33.3% (Nguyen, Phuong and Enomoto, 2009). Equity sales have reduced this over the years to 13.8%. Additional dilution has been made possible due to the exercise of private options. May 2011 saw the sale of government’s ownership in Chrysler to Fiat. A public share offer on GMAC was made in mid-2011 but postponed. No date has since been set for sale of government’s stake at GMAC. $79.7 billion has been disbursed with $23.6 billion still outstanding. The loss made is $11.9 billion. Under the current program, there are no new disbursements possible.
AIG Assistance (Systemically Significant Failing Institution Program)
TARP provided share purchases to supplement the assistance given to AIG by the Fed. In January 2011, government-owned 92% of common equity at AIG and Treasury had disbursed $67.84 billion. With time, Treasury sold its equity until it was depleted in December 2012. From the TARP equity sales, Treasury made a loss of $13.5 billion.
TARP Revisions and Other Regulations
14th October 2008, President Bush and Secretary of Treasury (Henry Paulson), announced revisions to TARP program. Treasury intended to purchase senior preferred shares from nine of the largest American banks. Certain criteria had to be met by the institutions. The bank had to ensure that incentive package for senior executives did not encourage excessive and unnecessary risks which would threaten the values of the institution. Clawback of incentive compensation or bonuses paid to senior executives based on gains or statement of earnings which are later proven to be inaccurate materially. Prohibit any financial institution from making golden parachute payments to a senior executive (Levinson 2009). This was based on a provision in the Internal Revenue Code. They must agree not to make tax deductions on the compensation of more than $500,000 for each senior executive. Treasury used the first $250 billion allotted for TARP to buy preferred warrants and stocks from smaller banks. Preferred stock is similar to debt because it is paid before common equity shareholders. This has resulted in some economists arguing that TARP may have been ineffective in encouraging banks to lend effectively.
Originally, Paulson proposed that the government buys troubled assets from insolvent banks then auction them to private companies or investors. Prime Minister of the United Kingdom (UK), Gordon Brown, met Paulson at the White House. He changed Paulson’s line of thought on the original plan. Gordon was in the US for an international summit addressing the credit crisis globally. Gordon planned to deal with debt guarantees, funding and capital infusion into banks through preferred stocks to mitigate the looming credit squeeze in the UK. The main goal was to support the solvency of banks and funding. Some economists agree with this plan as a way to effectively nationalize many banks. Paulson saw this plan to be easy and boost lending faster. Initial funds of asset purchases would not get banks to lend because of the reluctance to lend due to the low lending standards as before. Inter-bank lending stopped because banks lacked trust in their counterparts regarding their prudence in lending.
12th November 2008, Paulson implied that the second allotment of TARP would prioritize revamping of the securities market for consumer credit. 19 December 2008, President Bush declared that funding of TARP could be used on programs that Paulson saw necessary to mitigate the looming financial crisis in the US. On the last day of December 2008, Treasury issued a report on the Troubled Assets Insurance Financing Fund (also Asset Guarantee Program) which reviewed Section 102. It indicated that this program would not be widely available. Mid-January 2009, Treasury gave rules for the requirements of record keeping and reporting under executive compensation standards for CPP.
21st January 2009, new regulations on TARP disclosure and mitigating conflicts of interest were issued. 5th February 2009, changes to TARP on the prohibition of firms which received TARP funds by paying incentive compensation to their 25 highest executive employees, was passed by the Senate. This motion was forwarded to the Senate by Christopher Dodd of Connecticut. It was an amendment to $900 billion economic stimulus act, which had not been passed. 10th February 2009, Timothy Geithner, the new Secretary of Treasury, explained on how he will utilize the remaining $300 billion TARP funds. $50 billion was to be used in foreclosure mitigation and the remainder to support private investors to purchase troubled assets from the banks.
23rd March 2009, Timothy announced a Public-PIP (P-PIP) to purchase troubled assets from banks. On the same day, many US stock market indexes rose by over 6% with shares in bank stocks in the lead. P-PIP had two components. First, the Legacy Loans Program (LLP) purchased residential loans from banks. The Federal Deposit Insurance Corporation (FDIC) provided non-recourse loan securities for up to 85% of the buying price of the LLP. Treasury and private sector provided the remaining assets. Second is the legacy securities program that purchased residential mortgage-backed securities (RMBS) which were rated AAA; commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) that were AAA rated. Nobel Prize winner and economist, Paul Krugman, was very instrumental in this journey. 19th April 2009, President Barrack Obama announced the converting of banks bail-outs to equity shares.
The Secretary of Treasury had until 25th June 2010 to decide the insuring or buying of any asset under TARP. However, legal contracts that were entered into in prior regimes are still valid. This means that in future TARP funds can still be disbursed from Treasury. The programs that have the largest gap between the inherent legal commitments and the amount disbursed hence the greatest potential to grow in future; are the housing programs.
References
Ash, Michael, et al. "A Progressive Program for Economic Recovery & Financial Reconstruction."New York and Amherst, MA: Schwartz Center for Economic Policy Analysis (SCEPA) and Political Economy Research Institute (PERI) (2009).
Baily, Martin Neil, and Douglas J. Elliott (2009). "The US financial and economic crisis: Where does it stand and where do we go from here." Brookings Institution.
Calomiris, C. W., & Khan, U. (2015). An assessment of TARP assistance to financial institutions. The Journal of Economic Perspectives, 29(2), 53-80.
Dooley, Michael, and Michael Hutchison (2009). "Transmission of the US subprime crisis to emerging markets: Evidence on the decoupling–recoupling hypothesis." Journal of International Money and Finance 28.8: 1331-1349.
King, Michael R. (2009) "Time to buy or just buying time? The market reaction to bank rescue packages."
Levinson, Mark (2009). "The economic collapse."Dissent 56.1: 61-66.
Nguyen, Anh Phuong, and Carl E. Enomoto (2009)."The Troubled Asset Relief Program (TARP) and the financial crisis of 2007-2008."Journal of Business & Economics Research 7.12 (2009): 91.
Veronesi, Pietro, and Luigi Zingales.(2010) "Paulson's gift."Journal of Financial Economics 97.3: 339-368.
