• The Emergency Economic Stabilization Act of 2008
  • October 21, 2008 | Author: Kenneth G. Lore
  • Law Firm: Bingham McCutchen LLP - Washington Office
  • On October 3, 2008, President George W. Bush signed the Emergency Economic Stabilization Act of 2008 (the “Act”) into law.


    The purpose of the Act is to provide “immediate authority and facilities that the Secretary of the Treasury (the “Secretary”) can use to restore liquidity and stability to the financial system of the United States” and to ensure that such authority and resources are used in a manner that protect and preserve personal savings, home values, jobs and economic growth.

    Establishment of Troubled Asset Relief Program

    Under the Act, the Secretary is authorized to create the Troubled Asset Relief Program (“TARP”) to purchase troubled assets and to create an Office of Financial Stability that will be tasked with implementing TARP. On October 6, Secretary Henry Paulson showed that the Department of Treasury is moving quickly to create TARP by announcing that Neel Kashkari, a former Goldman Sachs executive, will lead TARP and the newly created Office of Financial Stability.

    The Act requires the Secretary to publish program guidelines which address:

    1. mechanisms for purchasing troubled assets;
    2. methods for pricing and valuing troubled assets;
    3. procedures for selecting asset managers; and
    4. criteria for identifying troubled assets for purchase.

    The pricing and valuing of the troubled assets are critical elements to this new legislation, and the effectiveness of the Act will in part ultimately hinge on how the Secretary elects to determine the price and value of these assets. It is also unclear how the Secretary will proceed with purchasing the troubled assets. The Act seems to contemplate the Secretary using one or more methods to acquire the troubled assets including direct purchases with financial institutions, auctions and/or reverse auctions, where appropriate. These mechanisms will need to be clarified and will impact the pricing of the troubled assets.

    Insurance Program for Troubled Assets

    The Act also provides for an insurance program whereby the Secretary may, upon the request of a financial institution, guarantee the timely payment of principal and interest on troubled assets, and, in return, the financial institution will pay a premium in an amount to be determined by the Secretary. The Secretary is required to publish the methodology it uses for setting the premiums and may take credit risks into consideration when determining the premiums for particular troubled assets. The premium rates and underwriting criteria established by the Department of the Treasury will play an important role in determining whether the Act is effective in helping to stabilize the financial markets.

    All fees collected by the Secretary under this insurance program are to be deposited into a new fund called the Troubled Assets Insurance Financing Fund, and the amounts held in this fund are to be used by the Secretary to fulfill payment obligations under the guarantees provided to the financial institutions for troubled assets.


    Troubled assets are defined broadly under the Act to include any residential or commercial mortgages, and any security, obligations, or other instrument based on or related to mortgages, that were issued on or before March 14, 2008, that the Secretary determines the purchase of which will promote financial market stability, and any other financial instrument that the Secretary after consultation with the chairman of the Board of Governors of the Federal Reserve System and upon delivering notice to congressional committees, determines the purchase of which is necessary to promote financial market stability.

    Financial institutions are also defined very broadly to include “any institution including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the United States or any state, territory, or possession of the United States, the District of Columbia, Commonwealth of Puerto Rico, Commonwealth of Northern Mariana Islands, Guam, American Samoa or the United States Virgin Islands, and having significant operations in the United States, but specifically excluding any central bank of, or institution owned by, a foreign government.” Given that this definition could be interpreted to include nearly any domestic entity, further guidance from the Secretary may prove necessary to flush this out.

    Spending Power

    Upon its enactment, the Act provided the Secretary with $250 billion in troubled asset purchasing authority. The President of the United States may increase this amount by an additional $100 billion at any time by submitting a written certification to Congress that states the Secretary needs such additional purchasing authority. After the purchasing authority has been increased to $350 billion, if there is a need for additional purchasing authority, the President must submit a written report to Congress outlining the plan for the additional funds and, unless Congress enacts a joint resolution within 15 calendar days of receiving the report, the purchasing authority shall be increased to $700 billion. To the extent that the Secretary elects to guarantee troubled assets under the insurance program described above, the amount of the Secretary’s purchasing authority shall be reduced by the amount of the outstanding obligations covered by the guarantees. In addition, these limits relate to the amount of troubled assets that the Secretary may hold and/or guarantee at any one time. Therefore, if the Secretary reaches the purchasing authority limits, it would not prevent the Secretary from selling troubled assets and then purchasing new troubled assets for the same or a lesser amount.

    Term of Programs

    Pursuant to the Act, the Secretary’s powers under TARP and the program of insuring troubled assets expire on December 31, 2009, unless the Secretary extends the term of the programs by submitting a written certification to Congress. Such an extension by the Secretary can be for no more than two years from the date of the enactment of the Act.

    Warrants and Debt Instruments

    Any financial institution that sells troubled assets to the Secretary must, depending on the situation, give the Secretary either a warrant to receive common or preferred stock or a debt instrument. The Act provides the Secretary with broad discretion to determine the percentage of equity the warrants will represent and the Secretary has the right to sell, exercise, or surrender warrants, at any time that it is in the interest of taxpayers to do so.

    Policy Considerations

    When implementing the Act, the Secretary is required to take several items into consideration including the interests of taxpayers and the stability of the financial markets. In addition, the Secretary is required to consider the long-term viability of a financial institution before determining whether or not to purchase troubled assets from such financial institution in order to ensure the most effective use of funds under the Act. Presumably, this provision is designed to prevent the Secretary from investing funds in financial institutions where the assistance is not sufficient to prevent a failure.

    Management of Troubled Assets and Selection of Asset Managers

    Under the Act, the Secretary is authorized to immediately begin managing and exercising any rights received in connection with troubled assets that are purchased under the Act. The Secretary may also sell or enter into other financial transactions related to the purchased troubled assets. The Department of the Treasury will have to determine its approach in dealing with property owners: where whole loans are involved the question is whether assets will be sold or worked out on an individual basis. The challenges will of course differ depending on the type of asset (single family, multi-family or commercial) and the borrower.

    This approach becomes much more complicated when dealing with asset-backed securities where investors hold only a fractional share of the interests in the mortgages. Considerable thought and structuring (and perhaps additional legislative action) may be necessary to effectively deal with these underlying assets and enhance values. This process will be complex and fraught with issues relating to ownership rights of the holders of securities not purchased or held by Treasury.

    Any proceeds or revenues received from the purchased troubled assets are to be paid into the general fund of the Treasury to reduce the public debt. When it comes to hiring contractors or advisors as necessary to implement the Act (e.g., to serve as asset managers or otherwise), the Secretary is authorized to waive specific provisions of the Federal Acquisition Regulations if there is an urgent and compelling reason to do so. The Act also provides that the Federal Deposit Insurance Corporation (“FDIC”) is eligible and shall be considered in the selection of asset managers for residential mortgages and residential mortgage-backed securities.

    The Secretary is also required to issue regulations or guidelines regarding conflicts of interest that may arise during the implementation of the Act including conflicts of interests arising out of the hiring of asset managers and the management of troubled assets. As a sign that the Secretary is moving swiftly to implement the Act, the Department of the Treasury released a set of procedures on October 6, 2008 that outlines how it will select asset mangers for the portfolios of troubled assets expected to be purchased. These procedures provide that separate asset managers will be selected for mortgaged-backed securities and for whole loan assets. For example, asset managers tasked with mortgaged-backed securities will handle prime, Alt-A and subprime residential mortgaged-backed securities, while asset managers tasked with whole loans will handle residential first mortgages, home equity loans and commercial mortgage loans.

    Financial institutions can be designated as asset managers, and such asset managers will be considered financial agents of the United States who have a fiduciary agent-principal relationship the Department of the Treasury and thus a responsibility to protect the interests of the United States. Financial institutions interested in being appointed as an asset manager should monitor the Department of the Treasury’s website (www.ustreas.gov), which is where notices will be posted to solicit prospective financial agents. Separate notices will be issued for mortgage-backed securities asset managers and for whole loan asset managers. The Department of the Treasury advises that the timeline for the selection process will be very short and that there will be extremely short deadlines set for responding to the requests.

    Please note that three such solicitation notices were posted by the Department of the Treasury late yesterday and the response deadline is 5:00 pm on October 8, 2008. These solicitation notices indicate that the Department of the Treasury is currently looking for major financial institutions to undertake (a) whole loan asset management responsibilities; (b) securities asset management responsibilities; and (c) custodian, accounting, auction management and other infrastructure services. In order to be considered for these positions, the financial institutions must meet the following criteria:

    1. financial institutions interested in providing whole loan asset management services:
      •   must have been continuously engaged as a principal business in managing whole loan assets for the last 5 years; and
      • must either (i) currently manage a portfolio of at least $25 billion in mortgage loans or (ii) provide "clear and credible evidence" that it can scale its capacity to manage a portfolio of this size.
    2. financial institutions interested in providing securities asset management services:
      • must be registered investment advisors under the Investment Advisers Act of 1940;
      • must have at least $100 billion in dollar-denominated fixed income assets under management;
      • must have been continuously engaged as a principal business in managing portfolios of dollar-denominated MBS for the last 5 years;
      • must have received an unqualified auditor's opinion for the last 5 years; and
      • must have a primary portfolio manager to assign to Treasury's account with at least 10 years of experience in managing fixed income assets.
    3. financial institutions interested in providing custodian, accounting, auction management and other infrastructure services:
      • must have at least $500 billion in domestic assets under custody.

    In addition, all financial institutions selected through these solicitations must covenant to disclose any potential conflicts of interest and to avoid or mitigate any such conflicts identified by the Treasury, and must be able and willing to work and coordinate with the Treasury and other governmental and non-governmental entities when the Treasury determines it to be in the government's best interest. Furthermore, all financial institutions selected to be asset managers will be expected to enter into a Financial Agency Agreement with the Department of the Treasury. The notice posted by the Department of the Treasury clearly states that a financial institution’s willingness to enter to the standard Financial Agency Agreement will be a factor considered when selecting asset managers.


    The Act establishes the Financial Stability Oversight Board (the “Oversight Board”) which is tasked with reviewing TARP, other programs developed under the Act, and the policies adopted by the Secretary and the Office of Financial Stability, and determining the effect of such actions on American families and taxpayers. The Oversight Board will also make recommendations to the Secretary regarding the use of authority under the Act and will monitor fraud, misrepresentations, or malfeasance for TARP. The Oversight Board will begin to meet monthly once the troubled assets purchasing authority under the Act is first exercised by the Secretary and it will report directly to Congress on no less than a quarterly basis.

    The Comptroller General shall also have ongoing oversight responsibilities related to the activities of TARP and TARP agents, and other entities or programs created by the Secretary under the Act. Specifically, the Comptroller General will monitor foreclosure mitigation, cost reduction, whether taxpayers are being protected and whether the programs have increased stability or prevented disruption in the financial markets and banking system.

    In addition, the Act establishes the Office of the Special Inspector General for TARP. This office is tasked with conducting, supervising, and coordinating audits and investigations of the purchase, management and sale of assets under TARP and the troubled assets insurance program.

    The Act also establishes a Congressional Oversight Panel which will monitor the financial markets, the regulatory system and the use and impact of the Secretary’s authority under this Act.

    Assistance for Homeowners

    The Act also contains measures specifically designed to help American homeowners by requiring that the Secretary, the Federal Housing Finance Agency as conservator of Fannie Mae and Freddie Mac, and the FDIC implement plans to maximize assistance to homeowners to use their authority to encourage servicers of mortgages to minimize foreclosures. Such measures for residential mortgages may include interest rate reductions and reduction of loan principal amounts.

    Executive Compensation and Corporate Governance

    Any financial institution that directly sells any of its troubled assets to the Secretary under the terms of the Act must satisfy certain new executive officer compensation requirements. These include limits on executive officer compensation, the recovery of any bonus or incentive-based compensation paid to a senior executive officer based on a statement of earnings, gains or other criteria that later proved to be materially inaccurate, and the prohibition of golden parachute payments to senior executive officers. These requirements will bind the financial institution for as long as the Secretary holds an equity or debt position in the financial institution.

    In situations where the Secretary purchases troubled assets from a financial institution through an auction purchase, the financial institution shall be prohibited from entering into any new employment contract that provides a golden parachute in the event of an involuntary termination, bankruptcy filing, insolvency or receivership.

    Additional Changes and the Future Political Landscape

    In addition to the matters described in this alert, the Act includes several other statutory changes such as the temporary increase of the FDIC coverage from $100,000 to $250,000 until the end of next year, the addition of several new tax provisions, and it permits the Securities and Exchange Commission to suspend mark-to-market accounting if it determines it is necessary or appropriate.