• The Emergency Economic Stabilization Act of 2008
  • October 26, 2008 | Authors: James D. Friedman; Michael L. O'Shaughnessy; John P. Vail
  • Law Firms: Quarles & Brady LLP - Milwaukee Office; Quarles & Brady LLP - Chicago Office
  • Introduction. On October 3, 2008, the President signed into law sweeping legislation previously passed by the Senate and the House, including the Emergency Economic Stabilization Act of 2008 (the “Act”). The Act’s stated purpose is “to restore liquidity and stability to the financial system of the United States.” In addition to the Act, the legislation contained other sections intended to address the current financial crisis, including numerous tax and spending provisions, most if not all of which served to elicit the necessary support for the legislation in the Congress.

    This Client Alert is the first in a series of email communications to clients and friends of the firm regarding the legislation and its implications for the credit markets, financial institutions, taxes, financial planning, and other areas of the economy that will be affected by the current turmoil and the Act’s provisions. Any summary of legislation of this scope is necessarily selective, and this Client Alert is just that, an overview of provisions of the Act specifically targeted at the credit markets and financial institutions. Additional Client Alerts will be available on specific provisions of the Act (and the implementing regulations), including a Client Alert on tax changes contained in the legislation.

    Troubled Asset Relief Program. Under the Act, the Secretary of the Treasury (the Secretary) is authorized to establish a Troubled Asset Relief Program (TARP) to purchase “troubled assets” from “financial institutions.” Under the Act, “troubled assets” are residential and commercial mortgages and any securities, obligations, or other instruments based on or related to such mortgages, that were originated or issued on or before March 14, 20081. “Financial institutions” which can participate in the program are any institutions, including but not limited to banks, S&Ls, credit unions, brokerages or insurance companies established and regulated under U.S. law or the law of any State, territory or possession and having significant U.S. operations (including certain foreign banks with such operations). The Act gives the Secretary discretion to more clearly identify those organizations that will be considered “financial institutions” under the Act. In determining the price at which to purchase the troubled assets, the Secretary is directed to take such steps as are necessary to prevent unjust enrichment by participants in the program. The Secretary must publish guidelines and policies to carry out the purposes of the Act within two business days after the first purchase of troubled assets, but not later than November 17, 2008. (Sec. 101)

    Insurance Alternative. If the Secretary establishes the TARP program, the Secretary must establish an alternate program to guarantee troubled assets of financial institutions originated on or before March 14, 2008. The program may guarantee up to 100% of the principal and interest payments on troubled assets. The Secretary must also establish risk-based premiums for such guarantees sufficient to cover anticipated claims, and must report to Congress on the establishment of the guarantee program. (Sec. 102)

    Authority to Manage and Sell; Considerations; Reports; Profits. The Secretary has the authority to manage and, on terms and conditions determined by the Secretary, sell or enter into other financial transactions with regard to troubled assets. In the Secretary’s use of that authority, the Secretary must take a number of considerations into account, including the interests of taxpayers, minimizing the impact on the national debt, providing stability to the financial markets, preserving homeownership, the long-term viability of an institution, the needs of all financial institutions regardless of size or other characteristics, financial assistance to previously well-capitalized institutions with assets less than $1,000,000,000 and which have suffered a drop in capital level2, and the needs of local communities. Profits from the sale of troubled assets must be used to pay down the national debt. The Secretary must report its activities under TARP to Congress on a monthly basis and provide detailed financial statements illustrating how the program has been implemented. In addition, for every $50 billion in assets to which the Secretary commits to purchase under the program, the Secretary is required to provide a report to Congress containing a detailed description of all transactions, a description of the pricing mechanisms used, and justifications for the financial terms of such transactions. The Secretary is also required to compile a summary report on the entire state of the financial markets for Congress by April 30, 2009. (Secs. 103, 105, 106)

    Foreclosure Mitigation Efforts; Assistance to Homeowners. For mortgages and mortgage-backed securities acquired through TARP, the Secretary must implement a plan to mitigate foreclosures and to encourage servicers of mortgages to modify loans through HOPE for Homeowners3 and other programs. The Secretary is permitted to use loan guarantees and credit enhancement to avoid foreclosures. The Secretary must coordinate with other federal entities that hold troubled assets in order to identify opportunities to modify loans, considering net present value to the taxpayer. Similar efforts are required of institutions that hold mortgages and mortgage-backed securities, such as the Federal Housing Finance Agency, the FDIC and the Federal Reserve, and mortgage loan modifications can include reductions in interest rates, principal and other modifications. (Secs. 109, 110)

    Executive Compensation and Corporate Governance. The Secretary will promulgate executive compensation rules governing financial institutions that sell the Secretary troubled assets. The standards will apply to both public and privately-held companies. Where the Secretary purchases troubled assets directly, the financial institution must observe standards that include excluding incentives for senior executive officers to take unnecessary and excessive risks that threaten the value of the financial institution, allowing clawbacks of bonuses or incentive compensation paid to senior executives based on earnings or other criteria that are later proven to be materially inaccurate, and prohibiting golden parachute payments to senior executive officers while the government holds a debt or equity position in the financial institution. When the Secretary purchases troubled assets at auction, an institution that has sold more than $300 million in troubled assets at auction (or a combination of auction and direct purchases) is subject to a prohibition on any new employment contracts with senior executives that have a “golden parachute” in the event of an involuntary termination, bankruptcy filing, insolvency or receivership. In addition, selling institutions may be subject to additional excise taxes and limits on tax deductions for certain compensation payments. (Secs. 111, 302)

    Minimization of Long-Term Costs and Maximization of Benefits for Taxpayers; Warrants. The Secretary is required to hold troubled assets to maturity or for resale until such time and for such price as the Secretary determines is optimal and will maximize return on investment. Purchases of troubled assets are to be made at the lowest price as is determined to be consistent with the purposes of the Act. Private sector purchases of troubled assets and investments in financial institutions are encouraged. In order to cover losses and administrative costs, as well as to allow taxpayers to share in value appreciation, the Act requires that the Secretary receive warrants for non-voting common or preferred stock, or in some cases senior debt instruments, from participating financial institutions. (Sec. 113)

    Market Transparency: 48-hour Reporting Requirement. The Secretary is required, within 2 business days of exercising authority under the Act, to publicly disclose the details of any transaction. (Sec. 114)

    Graduated Authorization to Purchase. The Act makes available up to $700 billion as requested by the Secretary for implementation of TARP, and it allows the Secretary to immediately use up to $250 billion in authority under the Act. Upon a Presidential certification of need, the Secretary may access an additional $100 billion. The final $350 billion may be accessed if the President transmits a written report to Congress requesting such authority. The Secretary may use this additional authority unless within 15 days Congress passes a joint resolution of disapproval which may be considered on an expedited basis. (Sec. 115)

    Oversight and Audits; Study and Report on Margin Authority. The Comptroller General is required to conduct ongoing oversight of the activities and performance of TARP, and to report every 60 days to Congress. The Comptroller General is required to conduct an annual audit of TARP. In addition, TARP is required to establish and maintain an effective system of internal controls. The Act directs the Comptroller General to conduct a study and report back to Congress by June 1, 2009, on the role of leverage and the sudden deleveraging of financial institutions in the current financial crisis. In addition to the oversight of the Comptroller General, a Financial Stability Oversight Board is also created under the Act to monitor TARP and to gauge its overall effectiveness. A Special Inspector General for TARP is also to be appointed by the President. (Secs. 104, 116, 117, 121)

    Limited Judicial Review and Remedies; Preservation of Homeowners’ Rights. The acts of the Secretary are subject to limited judicial review, and injunctive relief is generally unavailable with respect to those acts, but all claims and defenses of homeowners under their residential mortgages remain available to them. (Sec. 119)

    Termination of Authority. The Act provides that the authority to purchase and to guarantee assets terminates on December 31, 2009. The Secretary may extend the authority for a period of time not longer than two years from the date of enactment of the Act upon certification of need to Congress. The termination does not apply to the powers of the Secretary to hold troubled assets beyond that date or to purchase or fund the purchase of troubled assets pursuant to a commitment entered into prior to that date. (Secs. 120, 106)

    Increase in the Statutory Limit on the Public Debt. The Act raises the debt ceiling from $10 trillion to $11.3 trillion. (Sec. 122)

    HOPE for Homeowners Amendments. The Act strengthens the HOPE for Homeowners program to increase eligibility and improve the tools available to prevent foreclosures. (Sec. 124)

    Congressional Oversight Panel. The Act establishes a Congressional Oversight Panel to review the state of the financial markets, the regulatory system, and the use of authority under TARP. The panel is required to report to Congress every 30 days and to submit a special report on regulatory reform prior to January 20, 2009. The panel will consist of five members appointed by the House and Senate Minority and Majority leadership. (Sec. 125)

    Disclosures on Exercise of Loan Authority. The Act requires the Federal Reserve to provide a detailed report to Congress, in an expedited manner, upon the use of its emergency lending authority under Section 13(3) of the Federal Reserve Act. (Sec. 129)

    Authority to Suspend Mark-to-Market Accounting. The Act restates the Securities and Exchange Commission’s authority to suspend the application of Statement Number 157 of the Financial Accounting Standards Board if the SEC determines that it is in the public interest and protects investors. (Sec. 132)

    Study on Mark-to-Market Accounting. The Act requires the SEC, in consultation with the Federal Reserve and the Treasury, to conduct a study on mark-to-market accounting standards as provided in FAS 157, including its effects on balance sheets, impact on the quality of financial information, and other matters, and to report to Congress within 90 days on its findings. (Sec. 133)

    Recoupment. The Act requires that in five years, the President submit to the Congress a proposal that recoups from the financial industry any projected losses to the taxpayer. (Sec. 134)

    Temporary Increase in Deposit and Share Insurance Coverage. The Act raises the FDIC and the National Credit Union Share Insurance Fund deposit insurance limits from $100,000 per account to $250,000 until December 31, 2009, and it temporarily raises the borrowing limits at the Treasury for the FDIC and the National Credit Union Share Insurance Fund. (Sec. 136)

    Footnotes:

    1 The term “troubled assets” also includes any other financial instrument that the Secretary, after consultation with the Chairman of the Federal Reserve, determines the purchase of which is necessary to promote financial market stability, but only after transmittal of that determination to the appropriate financial oversight committees of Congress.

    2 A discussion of the possible implications and benefits of this factor will be included in a separate Client Alert to be issued shortly. That will be coupled with a discussion of the possible implications and benefits of Section 301 of the Act, which provides for ordinary income/loss treatment for certain sales of Fannie Mae and Freddie Mac preferred stock.

    3 The HOPE for Homeowners Act was enacted on July 30, 2008 as a temporary, voluntary program to assist borrowers with refinancing into affordable, fixed-rate, government-insured mortgages.