Troubled assets relief program

Financial turmoil began in August 2007 when asset-backed securities, particularly those backed by subprime mortgages, suddenly became illiquid and fell sharply in value as an unprecedented housing boom turned to a housing bust. The Federal Reserve (Fed) stepped in with emergency measures to restore liquidity, temporarily calming markets. Losses in mortgage markets, however, continued and spilled into other markets.

Financial firms eventually wrote down many of these losses, depleting their capital. Uncertainty about future losses on illiquid and complex assets led to some firms having reduced access to private liquidity, with the loss in liquidity being catastrophic in some cases.

On September 19, 2008, the Secretary of the Treasury proposed a broad program of financial intervention to stabilize markets. The Treasury plan called for government purchases of up to $700 billion in mortgage-related securities, in the hope that, by partially purging the system of these troubled assets, normal functioning of the financial markets could be restored.

The idea of broad asset purchases, as in the original Treasury plan, is only one of a number of methods that could be used to address the uncertainties regarding mortgage-related assets. Among the other concepts put forward have been

• A federal guarantee program to insure mortgage-related assets, thus eliminating much of the uncertainty surrounding these securities;
• Direct capital injections by the Treasury into financial institutions, thus shoring up their capitalization; and
• Direct support for homeowners, thus decreasing mortgage default rates and increasing the value of mortgage-related securities.

In October 2008, the Emergency Economic Stabilization Act of 2008 (Division A of Public Law 110-343) established the Troubled Asset Relief Program (TARP) to enable the Department of the Treasury to promote stability in financial markets through the purchase and guarantee of “troubled assets.”

The law defines troubled assets as “(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and (B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.”

Provisions of TARP as Enacted

Asset Purchase Program

Section 101 of EESA provides authority to the Secretary of the Treasury to purchase “troubled assets” from any financial institution established and regulated under federal or state law, but excluding any foreign governmental entity. These assets are defined by the statute as “residential or commercial mortgages,” including securities “based on, or related to such mortgages.” In addition to the mortgage-related assets that were the focus of the program, the Secretary is authorized to purchase “any other financial instrument” that is “necessary to promote financial market stability.” Congress must be notified of the Secretary’s determination to purchase nonmortgage related assets, but the Secretary does not need Congress’ approval to do so. The Secretary is to take steps to prevent “unjust enrichment” of financial institutions selling assets to the government, in particular preventing the sale of troubled assets at a price higher than what the seller initially paid for the asset. Section 113 directs the Secretary to use market mechanisms, such as auctions, to purchase assets when possible.

Asset Insurance Program

Section 102 of EESA provides that, if the asset purchase program is created, the Secretary must also create an insurance program providing federal guarantees for troubled assets. This insurance program is to be funded by premiums paid by financial institutions for the federal guarantee, with no specific provision for the TARP insurance fund to borrow from the U.S. Treasury. Under the statute, the guarantees may be up to 100% of the value of the asset and the premiums may be riskbased, but the Secretary is not required to implement either of these provisions.

Size of the Programs

Under Sections 115 and 102, the total size of the insurance and asset purchase program combined is not to exceed $700 billion at any given time, which does allow the program to buy and sell assets, then use the sales proceeds to purchase other assets. Authority to purchase or insure $250 billion is effective on the date of enactment, with an additional $100 billion in authority effective upon submission of a Presidential certification. The final $350 billion in authority may be exercised upon transmission of a written report by the President detailing the plan for the exercise of this authority. Congress has 15 calendar days to pass a joint resolution under “fast track” rules, to deny the authority to use the final $350 billion.

History

The Troubled Asset Relief Program (TARP) was created by the Emergency Economic Stabilization Act (EESA; P.L. 110-343) in October 2008. EESA was enacted to address an ongoing financial crisis that reached near-panic proportions in September 2008. The act granted the Secretary of the Treasury authority to either purchase or insure up to $700 billion in troubled assets owned by financial institutions. This authority was granted for up to two years from the date of enactment and was very broad. In particular, the definitions of both “troubled asset” and “financial institution” allowed the Secretary wide leeway in deciding what assets might be purchased or guaranteed and what might qualify as a financial firm.

The financial crisis grew out of an unprecedented housing boom that turned into a housing bust. Much of the lending for housing during the boom was based on asset-backed securities that used the repayment of housing loans as the basis of these securities. As housing prices fell and mortgage defaults increased, these securities became illiquid and fell sharply in value, causing capital losses for firms holding them. Uncertainty about future losses reduced many firms’ access to private liquidity, with the loss in liquidity being catastrophic in some cases. September 2008 saw the government takeover of Fannie Mae and Freddie Mac, the bankruptcy of Lehman Brothers, and the near collapse of AIG, which was saved only by an $85 billion loan from the Federal Reserve. There was widespread lack of trust in the financial markets as participants were unsure which firms might be holding so-called toxic assets that might now be worth much less than previously estimated, and thus might be unreliable counterparties in financial transactions. This prevented firms from accessing credit markets to meet their liquidity needs.

As EESA moved through Congress, most attention was focused on the idea of the government purchasing mortgage-related toxic assets, thus alleviating the widespread uncertainty and suspicion by cleaning up bank balance sheets. The initial TARP Capital Purchase Program, however, directly added capital onto banks’ balance sheets through preferred share purchases, rather than removing assets that had become liabilities through purchasing mortgage-related assets. Several other TARP programs followed, including an asset guarantee program; programs designed to spur consumer and business lending; financial support for companies such as AIG, GM, and Chrysler; and programs to aid homeowners at risk of foreclosure. Eventually, the Public-Private Investment Program resulted in the purchase of some mortgage-related assets, but this has remained a relatively small part of TARP. Most of the TARP programs are now closed.

With the immediate crisis subsiding through 2009, congressional attention to financial services turned largely to consider broad regulatory changes. The resulting Dodd-Frank Act (P.L. 111-203) amended the TARP authority, including

• reduction of the overall amount to $475 billion;
• removal of the ability to reuse TARP funds that had been repaid; and
• removal of the authority to create new TARP programs or initiatives. The original TARP authority to purchase new assets or enter into new contracts expired on October 3, 2010.

Outlays under the existing contracts, however, may continue through the life of these contracts. Overall budget-cost estimates for TARP have decreased significantly since the passage of EESA, with the latest Congressional Budget Office estimates foreseeing $32 billion in costs and the latest Treasury estimates foreseeing $60 billion in costs.

Most of these costs are from aid for homeowners, for the insurer AIG, and for U.S. automakers. The assistance to banks is generally showing a gain for the government. In the 112th Congress, several bills have been introduced to repeal all or part of TARP, including H.R. 189, H.R. 430, H.R. 830, H.R. 839, H.R. 1315, S. 162 and S. 527.

TARP Programs

Treasury reacted quickly after the enactment of EESA, announcing the TARP Capital Purchase Program, on October 14, 2008, and several other programs followed. These programs can be broadly broken down into Bank Support Programs, Credit Market Programs, Other Programs, and Housing Programs with several programs under each of these headings:

• Bank Support Programs

Capital Purchase Program (CPP)

The CPP did not purchase the mortgage backed securities that were seen as toxic to the system, but instead purchased preferred shares in banks. The resulting addition of capital, it was hoped, would allow banks to overcome the effect of the toxic assets while the assets remained on bank balance sheets. The CPP is now closed, with $11.6 billion outstanding, but no additional disbursements are possible under the current program.

Targeted Investment Program (TIP)

This program provided for exceptional preferred share purchases and was used only for Citigroup and Bank of America. This program is closed, with all funds repaid.

Asset Guarantee Program (AGP)

The AGP, required by Section 102 of EESA, provided guarantees that were also part of the exceptional assistance to Citigroup and Bank of America. This program is closed, with all guarantees cancelled and no funds having been actually disbursed.

Community Development Capital Initiative (CDCI)

The CDCI provided for lower dividend rates on preferred share purchases from banks that target their lending to small businesses. Many of the participants in the CDCI converted into the program from the CPP, This program is closed with $0.57 billion still outstanding, but no new disbursements are possible under the current program.

• Credit Market Programs

Public-Private Investment Program (PPIP)

This program provides funds and guarantees for purchases of mortgage-related securities from bank balance sheets. Purchases and management of the securities is done by private investors who have provided capital to invest along with the TARP funds. The PPIP is still open under previous contracts with $18.0 billion of a possible $21.9 billion disbursed.

Term Asset-Backed Securities Loan Facility (TALF)

The program was operated by the Federal Reserve to support the asset-backed security market.

Initial losses, should there be any, however, are to accrue to TARP. To this point, no losses have occurred, although $0.1 billion was disbursed, largely to cover expenses. Up to $4.2 billion in additional disbursements are possible under TALF, but substantial disbursements are not expected.

Section 7(a) Securities Purchase Program

This program supported the Small Business Administration’s (SBA’s) Section 7(a) loan program through purchases of pooled SBA guaranteed securities to increase credit availability for small businesses. It is now closed with no funds outstanding.

• Other Programs

AIG Assistance (Systemically Significant Failing Institution Program)

TARP preferred share purchases supplemented and ultimately supplanted assistance to AIG previously provided by the Federal Reserve.

Automobile Industry Support.

This program initially provided loans to support General Motors (GM) and Chrysler and ultimately included preferred share purchases from the auto financing company GMAC (now renamed Ally Financial).

• Housing Programs

These programs are unlike the other TARP programs in that they do not result in valuable assets or income in return for the TARP funding. All of these programs remain open under the contracts previously agreed to and substantial funds remain to be disbursed:

Home Affordable Modification Program (HAMP)

HAMP pays mortgage servicers if they modify mortgages to reduce the financial burden on homeowners. A total of $29.9 billion in disbursements is possible under the program, with $2.85 billion disbursed.

Hardest Hit Fund (HHF)

HHF provides aid to state housing finance agency programs in states that have high unemployment rates or experienced the steepest declines in home prices. Eighteen states and the District of Columbia are participating in HHF. Of a possible $7.6 billion, $0.9 billion has been disbursed.

FHA Short Refinance

This program promotes refinancing of mortgages on “underwater” properties, those on which the mortgage balance is greater than the equity in the house, if lenders agree to forgive some of the principal balance owed on the mortgages. Of a possible $8.1 billion, $0.06 billion has been disbursed.