• Emergency Economic Stabilization Act Establishes Office of Financial Stability and Program to Purchase Troubled Assets
  • October 27, 2008 | Authors: Robert L. Harris; Jason J. Shields; Daniel W. Flournoy
  • Law Firm: Waller Lansden Dortch & Davis, LLP - Nashville Office
  • The Emergency Economic Stabilization Act of 2008 (the Act) passed by Congress on Oct. 3, 2008 authorizes the establishment of a new federal program in response to the nation’s current economic issues. The Secretary of the Treasury (the Secretary), through a newly created Office of Financial Stability, is authorized to establish the Troubled Asset Relief Program (TARP) to purchase in a graduated structure up to $700 billion in “troubled assets” (residential or commercial mortgages, and any securities or obligations based on such mortgages) from financial institutions as well as a program to insure the payment of principal and interest on such troubled assets to financial institutions.

    The Act also contains a wide range of tax provisions aimed at providing relief for financial institutions and homeowners. Additionally, the Act includes a wide range of tax provisions and tax extenders that are not focused on financial institutions or the financial system.

    The Emergency Economic Stabilization Act of 2008, a revision to the bill defeated in the House of Representatives on Sept. 29, 2008, is targeted at stabilizing the economy and increasing liquidity in the national credit markets. Under the Act, the Secretary has immediate authority to use $250 billion to carry out the TARP, plus, upon a Presidential certification of need, another $100 billion. The Secretary may access an additional $350 billion upon the submission of a plan to Congress regarding the use of additional funds unless Congress passes a joint resolution within 15 days disapproving the plan. The details of the TARP will not be available until publication of program guidelines by the Secretary, which is required no later than 45 days after the Act becomes law.

    The authority to purchase and guarantee assets terminates on Dec. 31, 2009. When the troubled assets are eventually sold, the profits from the sales will be used to pay down the debt incurred to purchase the troubled assets. If a shortfall remains after five years, the President must submit to Congress a proposal that recoups from the financial industry any projected losses to taxpayers.

    In addition to the authority granted to the Secretary, the Securities and Exchange Commission is authorized to suspend the application of mark-to-market accounting, a provision that requires banks to hold mortgages securities on their books at current market values.

    Method of Purchasing Assets
    The Secretary is required to make purchases of assets at the lowest prices consistent with the purposes of the Act through the use of market mechanisms such as auctions and reverse auctions. If the Secretary determines that the use of a market mechanism is not feasible or appropriate and the purposes of the Act are best met through direct purchases from individual financial institutions, the Secretary shall pursue additional measures to ensure that prices paid for assets reasonably reflect the underlying values of assets.

    Ownership and Corporate Governance Implications
    Financial institutions that are publicly traded may sell troubled assets only if they provide the Treasury with a warrant to purchase nonvoting common stock or preferred stock. All other selling financial institutions must provide the Treasury with a senior debt instrument. The terms of any warrants or debt issued through the TARP must be commercially reasonable, must contain standard anti-dilution provisions, and may be sold or exercised by the Secretary.

    Financial institutions which participate in the TARP will be treated differently depending on whether troubled assets are sold directly without a bidding process or at an auction. If the Treasury buys troubled assets directly from and obtains an equity or debt position in a financial institution, the institution must have appropriate standards to:

    1. Limit executive pay to officers that take unnecessary and excessive risks as determined by the Secretary
    2. Allow the recovery of bonuses or other incentive compensation paid to executive officers based on financial statements or other criteria that are subsequently proven to be materially inaccurate
    3. Prohibit golden parachute payments to senior executive officers.

    When troubled assets are purchased by the Treasury through an auction process, a financial institution that sells more than $300 million in assets (or whose combined assistance from direct purchases and auctions reaches $300 million) is prohibited from negotiating any new employment contract that contains a golden parachute payment.

    Increase in Deposit Amounts Insured by the FDIC and NCUA
    The Act raises the limit for each account insured by the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration (NCUA) from $100,000 to $250,000, until Dec. 31, 2009. The FDIC and NCUA are authorized to borrow any amount necessary to cover the account limit increases from the Secretary.

    Reporting and Analysis
    The Secretary is periodically required to report the details of transactions effected pursuant to the Treasury’s authority under the Act. The Act also requires analysis on the state of the financial markets, the effectiveness of the financial regulatory system, the contribution of financial institution leveraging on the current financial crisis and the impact of mark-to-market accounting on recent bank failures to be conducted.

    Office of the Special Inspector General
    The Act establishes the Office of the Special Inspector General for the TARP, led by the Special Inspector General appointed by the President, to conduct, supervise and coordinate audits and investigations of the actions undertaken by the Secretary under the Act. The Special Inspector General is required to submit a quarterly report to Congress summarizing its activities and the activities of the Secretary under the Act.

    Tax Provisions
    The Act also contains a number of tax provisions aimed at providing relief for financial institutions and homeowners and at preventing government subsidization of executive compensation. Additionally, the Act contains numerous tax provisions for energy and disaster relief and tax extenders that were not present in the bill that failed to pass on Sept. 29, 2008.