Troubled Asset Relief Program
The Troubled Asset Relief Program (TARP) is a program of the United States government to purchase toxic assets and equity from financial institutions to strengthen its financial sector that was passed by Congress and signed into law by President George W. Bush. It was a component of the government's measures in 2009 to address the subprime mortgage crisis.
This article is about the Treasury fund. For the legislative bill and subsequent law, see Public Law 110-343. For the legislative history and the events leading to the law, see Emergency Economic Stabilization Act of 2008.
The TARP originally authorized expenditures of $700 billion. The Emergency Economic Stabilization Act of 2008 created the TARP. The Dodd–Frank Wall Street Reform and Consumer Protection Act, signed into law in 2010, reduced the amount authorized to $475 billion (approximately $648 billion in 2023). By October 11, 2012, the Congressional Budget Office (CBO) stated that total disbursements would be $431 billion, and estimated the total cost, including grants for mortgage programs that have not yet been made, would be $24 billion.[1]
On December 19, 2014, the U.S. Treasury sold its remaining holdings of Ally Financial, essentially ending the program. Through the Treasury, the US Government actually booked $15.3 billion in profit, as it earned $441.7 billion on the $426.4 billion invested.[2][3]
Purpose[edit]
TARP allowed the United States Department of the Treasury to purchase or insure up to $700 billion of "troubled assets", defined as "(A) residential or commercial obligations will be bought, 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".[4]
In short, this allows the Treasury to purchase illiquid, difficult-to-value assets from banks and other financial institutions. The targeted assets can be collateralized debt obligations, which were sold in a booming market until 2007, when they were hit by widespread foreclosures on the underlying loans. TARP was intended to improve the liquidity of these assets by purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses.
TARP does not allow banks to recoup losses already incurred on troubled assets, but officials expect that once trading of these assets resumes, their prices will stabilize and ultimately increase in value, resulting in gains to both participating banks and the Treasury itself. The concept of future gains from troubled assets comes from the hypothesis in the financial industry that these assets are oversold, as only a small percentage of all mortgages are in default, while the relative fall in prices represents losses from a much higher default rate.
The Emergency Economic Stabilization Act of 2008 (EESA) requires financial institutions selling assets to TARP to issue equity warrants (a type of security that entitles its holder to purchase shares in the company issuing the security for a specific price), or equity or senior debt securities (for non-publicly listed companies) to the Treasury. In the case of warrants, the Treasury will only receive warrants for non-voting shares, or will agree not to vote the stock. This measure was designed to protect the government by giving the Treasury the possibility of profiting through its new ownership stakes in these institutions. Ideally, if the financial institutions benefit from government assistance and recover their former strength, the government will also be able to profit from their recovery.[5]
Another important goal of TARP was to encourage banks to resume lending again at levels seen before the crisis, both to each other and to consumers and businesses. If TARP can stabilize bank capital ratios, it should theoretically allow them to increase lending instead of hoarding cash to cushion against future unforeseen losses from troubled assets. Increased lending equates to "loosening" of credit, which the government hopes will restore order to the financial markets and improve investor confidence in financial institutions and the markets. As banks gain increased lending confidence, the interbank lending interest rates (the rates at which the banks lend to each other on a short-term basis) should decrease, further facilitating lending.[5]
TARP will operate as a "revolving purchase facility". The Treasury will have a set spending limit, $250 billion at the start of the program, with which it will purchase the assets and then either sell them or hold the assets and collect the coupons. The money received from sales and coupons will go back into the pool, facilitating the purchase of more assets. The initial $250 billion could be increased to $350 billion upon the president's certification to Congress that such an increase was necessary.[6] The remaining $350 billion may be released to the Treasury upon a written report to Congress from the Treasury with details of its plan for the money. Congress then had 15 days to vote to disapprove the increase before the money will be automatically released.[5] Privately held mortgages would be eligible for other incentives, including a favorable loan modification for five years.[7]
The authority of the United States Department of the Treasury to establish and manage TARP under a newly created Office of Financial Stability became law October 3, 2008, the result of an initial proposal that ultimately was passed by Congress as H.R. 1424, enacting the Emergency Economic Stabilization Act of 2008 and several other acts.[8][9]
On October 8, the British announced their bank rescue package consisting of funding, debt guarantees and infusing capital into banks via preferred stock. This model was closely followed by the rest of Europe, as well as the U.S Government, who on the October 14 announced a $250bn (£143bn) Capital Purchase Program to buy stakes in a wide variety of banks in an effort to restore confidence in the sector. The money came from the $700bn Troubled Asset Relief Program.[10][11]
Timeline of changes to the TARP[edit]
To qualify for this program, the Treasury required participating institutions to meet certain criteria, including: "(1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on the financial institution from making any golden parachute payment to a senior executive based on the Internal Revenue Code provision; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive".[12] The Treasury also bought preferred stock and warrants from hundreds of smaller banks, using the first $250 billion allotted to the program.[13]
The first allocation of the TARP money was primarily used to buy preferred stock, which was similar to debt in that it gets paid before common equity shareholders. This had led some economists to argue that the plan may be ineffective in inducing banks to lend efficiently.[14][15]
In the original plan, the government would buy troubled (also known as 'toxic') assets in insolvent banks and then sell them at auction to private investor and/or companies. This plan was scratched when United Kingdom's Prime Minister Gordon Brown came to the White House for an international summit on the global credit crisis.[16] Prime Minister Brown, in an attempt to mitigate the credit squeeze in England, planned a package of three measures consisting of funding, debt guarantees and infusing capital into banks via preferred stock.[10][11] The objective was to directly support banks' solvency and funding; in some economists' view, effectively nationalizing many banks. This plan seemed attractive to the Treasury Secretary in that it was relatively easier and seemingly boosted lending more quickly. The first half of the asset purchases may not be effective in getting banks to lend again because they were reluctant to risk lending as before with low lending standards. To make matters worse, overnight lending to other banks came to a relative halt because banks did not trust each other to be prudent with their money.[17]
On November 12, 2008, Paulson indicated that reviving the securitization market for consumer credit would be a new priority in the second allotment.[18][19]
On December 19, 2008, President Bush used his executive authority to declare that TARP funds could be spent on any program that Paulson,[20] deemed necessary to alleviate the financial crisis. On December 31, 2008, the Treasury issued a report reviewing Section 102, the Troubled Assets Insurance Financing Fund, also known as the "Asset Guarantee Program". The report indicated that the program would likely not be made "widely available".[21]
On January 15, 2009, the Treasury issued interim final rules for reporting and record keeping requirements under the executive compensation standards of the Capital Purchase Program (CPP).[22] Six days later, the Treasury announced new regulations regarding disclosure and mitigation of conflicts of interest in its TARP contracting.[23]
On February 5, 2009, the Senate approved changes to the TARP that prohibited firms receiving TARP funds from paying bonuses to their 25 highest-paid employees. The measure was proposed by Christopher Dodd of Connecticut as an amendment to the $900 billion economic stimulus act then waiting to be passed.[24] On February 10, the newly confirmed Secretary of the Treasury Timothy Geithner outlined his plan to use the remaining $300 billion or so in TARP funds. He intended to direct $50 billion towards foreclosure mitigation and use the rest to help fund private investors to buy toxic assets from banks. Nevertheless, this highly anticipated speech coincided with a nearly 5 percent drop in the S&P 500 and was criticized for lacking details.[25]
Geithner announced on March 23, 2009, a Public-Private Investment Program (P-PIP) to buy toxic assets from banks' balance sheets. The major stock market indexes in the United States rallied on the day of the announcement rising by over six percent with the shares of bank stocks leading the way.[26] P-PIP has two primary programs. The Legacy Loans Program will attempt to buy residential loans from bank's balance sheets. The Federal Deposit Insurance Corporation (FDIC) will provide non-recourse loan guarantees for up to 85 percent of the purchase price of legacy loans. Private sector asset managers and the U.S. Treasury will provide the remaining assets. The second program was called the legacy securities program, which would buy residential mortgage backed securities (RMBS) that were originally rated AAA and commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) which were rated AAA. The funds would come in many instances in equal parts from the U.S. Treasury's TARP monies, private investors, and from loans from the Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF). The initial size of the Public Private Investment Partnership was projected to be $500 billion.[27] Economist and Nobel Prize winner Paul Krugman had been very critical of this program arguing the non-recourse loans lead to a hidden subsidy that will be split by asset managers, banks' shareholders and creditors.[28] Banking analyst Meredith Whitney argued that banks will not sell bad assets at fair market values because they are reluctant to take asset write downs.[29] Economist Linus Wilson,[30] a frequent commenter on TARP related issues, also pointed to excessive misinformation and erroneous analysis surrounding the U.S. toxic asset auction plan.[31] Removing toxic assets would also reduce the volatility of banks' stock prices. This lost volatility would hurt the stock price of distressed banks. Therefore, such banks would only sell toxic assets at above market prices.[32]
On April 19, 2009, the Obama administration outlined the conversion of the TARP loans to common stock.[33]
Participation criteria[edit]
The Act's criterion for participation stated that "financial institutions" will be included in TARP if they are "established and regulated" under the laws of the United States and if they have "significant operations" in the United States. The Treasury would need to define what institutions will be included under the term "financial institution" and what will constitute "significant operations".[5] Companies that sell their bad assets to the government must have provided warrants so that the government would benefit from future growth of the companies.[6] Certain institutions seemed to be guaranteed participation. These included: U.S. banks, U.S. branches of a foreign bank, U.S. savings banks or credit unions, U.S. broker-dealers, U.S. insurance companies, U.S. mutual funds or other U.S. registered investment companies, tax-qualified U.S. employee retirement plans, and bank holding companies.[5]
The President was to submit a law to cover government losses on the fund, using "a small, broad-based fee on all financial institutions".[6] To participate in the bailout program, "...companies will lose certain tax benefits and, in some cases, must limit executive pay. In addition, the bill limits 'golden parachutes' and requires that unearned bonuses be returned."[6] The fund had an Oversight Board so that the U.S. Treasury cannot act in an arbitrary manner. There was also an inspector general to protect against waste, fraud and abuse.[6]
CAMELS ratings (US supervisory ratings used to classify the nation's 8,500 banks) were being used by the United States government in response to the global financial crisis of 2008 to help it decide which banks to provide special help for and which to not as part of its capitalization program authorized by the Emergency Economic Stabilization Act of 2008. It was being used to classify the nation's 8,500 banks into five categories, where a ranking of 1 means they are most likely to be helped and a 5 most likely to not be helped. Regulators were applying a short list of criteria based on a secret ratings system they use to gauge this.[39]
The New York Times stated: "The criteria being used to choose who gets money appears to be setting the stage for consolidation in the industry by favoring those most likely to survive" because the criteria appears to favor the financially best off banks and banks too big to let fail. Some lawmakers are upset that the capitalization program will end up culling banks in their districts.[39] However, The Wall Street Journal suggested that some lawmakers are actively using TARP to funnel money to weak regional banks in their districts.[40] Academic studies have found that banks and credit unions located in the districts of key Congress members had been more likely to win TARP money.[41]
Known aspects of the capitalization program "suggest that the government may be loosely defining what constitutes healthy institutions. [... Banks] that have been profitable over the last year are the most likely to receive capital. Banks that have lost money over the last year, however, must pass additional tests. [...] They are also asking if a bank has enough capital and reserves to withstand severe losses to its construction loan portfolio, nonperforming loans and other troubled assets."[39] Some banks received capital with the understanding the banks would try to find a merger partner. To receive capital under the program banks are also "required to provide a specific business plan for the next two or three years and explain how they plan to deploy the capital".[39]
Eligible assets and asset valuation[edit]
TARP allowed the Treasury to purchase both "troubled assets" and any other asset the purchase of which the Treasury determined was "necessary" to further economic stability. Troubled assets included real estate and mortgage-related assets and securities based on those assets. This included both the mortgages themselves and the various financial instruments created by pooling groups of mortgages into one security to be bought on the market. This category probably included foreclosed properties as well.[5]
Real estate and mortgage-related assets (and securities based on those kinds of assets) were eligible if they originated (that is, were created) or were issued on or before March 14, 2008, the date of the Bear Stearns bailout.[5]
One of the more difficult issues that the Treasury faced in managing TARP was the pricing of the troubled assets. The Treasury had to find a way to price extremely complex and sometimes unwieldy instruments for which a market did not exist. In addition, the pricing had to strike a balance between efficiently using public funds provided by the government and providing adequate assistance to the financial institutions that need it.[5]
The Act encouraged the Treasury to design a program using market mechanisms to the extent possible. This had led to the expectation that the Treasury would use a reverse auction to price assets. Theoretically, the system would create a market price from bidders that would want to sell at the highest possible price, but also be able to make a sale, therefore the price must set a low enough price to be competitive. The Treasury was required to publish its methods for pricing, purchasing, and valuing troubled assets no later than two days after the purchase of their first asset.[5] The Congressional Budget Office (CBO) used procedures similar to those specified in the Federal Credit Reform Act (FCRA) to value assets purchased under the TARP.[4]
In a report dated February 6, 2009, the Congressional Oversight Panel concluded that the Treasury paid substantially more for the assets it purchased under the TARP than their then-current market value. The COP found the Treasury paid $254 billion, for which it received assets worth approximately $176 billion, for a shortfall of $78 billion. The COP's valuation analysis assumed that "securities similar to those issued under the TARP were trading in the capital markets at fair values" and employed multiple approaches to cross-check and validate the results. The value was estimated for each security as of the time immediately following the announcement by Treasury of its purchase. For example, the COP found that the Treasury bought $25 billion of assets from Citigroup on October 14, 2008, however, the actual value was estimated to be $15.5, creating a 38 percent (or $9.5 billion) subsidy.[22]
As of June 30, 2012, $467 billion had been allotted, and $416 billion spent, according to a literature review on the TARP.[42] Among the money committed, includes:
The Congressional Budget Office released a report in January 2009, reviewing the transactions enacted through the TARP. The CBO found that through December 31, 2008, transactions under the TARP totaled $247 billion. According to the CBO's report, the Treasury had purchased $178 billion in shares of preferred stock and warrants from 214 U.S. financial institutions through its Capital Purchase Program (CPP). This included the purchase of $40 billion of preferred stock in AIG, $25 billion of preferred stock in Citigroup, and $15 billion of preferred stock in Bank of America. The Treasury also agreed to lend $18.4 billion to General Motors and Chrysler. The Treasury, the FDIC and the Federal Reserve have also agreed to guarantee a $306 billion portfolio of assets owned by Citigroup.[4]
The CBO also estimated the subsidy cost for transactions under TARP. The subsidy cost is defined as, broadly speaking, the difference between what the Treasury paid for the investments or lent to the firms and the market value of those transactions, where the assets in question were valued using procedures similar to those specified in the Federal Credit Reform Act (FCRA), but adjusting for market risk as specified in the EESA.[4] The CBO estimated that the subsidy cost of the $247 billion in transactions before December 31, 2008, amounts to $64 billion. As of August 31, 2015, TARP is projected to cost approximately $37.3 billion total—significantly less than the $700 billion originally authorized by Congress.[43]
The May 2015 report of the TARP to Congress stated that $427.1 billion had been disbursed, total proceeds by April 30, 2015, were $441.8 billion, exceeding disbursements by $14.1 billion, though this included $17.7 billion in non-TARP AIG shares. The report predicted a total net cash outflow of $37.7 billion (excluding non-TARP AIG shares), based on the assumption the TARP housing programs' (Hardest Hit Fund, Making Home Affordable and FHA refinancing) funds are fully taken up. Debt is still outstanding, some of which has been converted to common stock, from just under $125 million down to $7,000. Sums loaned to entities that have gone into, and in some cases emerged from bankruptcy or receivership are provided. Additional sums have been written off, for example Treasury's original investment of $854 million in Old GM.[44]
The May 2015 report also detailed other costs of the program, including $1.157 billion "for financial agents and legal firms" $142 million for personnel services, and $303 million for "other services".[44]
TARP fraud[edit]
Some in the financial industry have been accused of not using the loaned dollars for its intended reason. Others further abused investors after the TARP legislation was passed by telling investors their money was invested in the federal TARP financial bailout program and other securities that did not exist. Neil Barofsky, Special Inspector General for the Troubled Asset Relief Program (SIGTARP), told lawmakers, "Inadequate oversight and insufficient information about what companies are doing with the money leaves the program open to fraud, including conflicts of interest facing fund managers, collusion between participants and vulnerabilities to money laundering.[67]
In its October 2011 quarterly report to Congress, SIGTARP reported "more than 150 ongoing criminal and civil investigations". SIGTARP had already achieved criminal convictions of 28 defendants (19 had already been sentenced to prison), and civil cases naming 37 individuals and 18 corporate/legal entities as defendants. It had recovered $151 million, and prevented $553 million going to Colonial Bank, which failed.[68]
The first TARP fraud case was brought by the SEC on January 19, 2009, against Nashville-based Gordon Grigg and his firm ProTrust Management.[69] The latest occurred in March 2010, with the FBI claiming Charles Antonucci, the former president and chief executive of the Park Avenue Bank, made false statements to regulators in an effort to obtain about $11 million from the fund.[70]
Similar historical federal banking programs[edit]
The nearest parallel action the federal government has taken was in investments made by the Reconstruction Finance Corporation (RFC) in the 1930s. The RFC, an agency chartered during the Herbert Hoover administration in 1932, made loans to distressed banks and bought stock in 6,000 banks, totalling $1.3 billion. The New York Times, citing finance experts on October 13, 2008, noted that, "A similar effort these days, in proportion to today's economy, would be about $200 billion." When the economy had stabilized, the government sold its bank stock to private investors or the banks, and is estimated to have received approximately the same amount previously invested.[71]
In 1984, the government took an 80 percent stake in the nation's then seventh-largest bank Continental Illinois Bank and Trust. Continental Illinois made loans to oil drillers and service companies in Oklahoma and Texas. The government was estimated to have lost $1 billion because of Continental Illinois, which ultimately became part of Bank of America.[71]
The $24 billion for the estimated subsidy cost of TARP was less than the government's cost for the savings and loan crisis of the late 1980s, although the subsidy cost does not include the cost of other "bailout" programs (such as the Federal Reserve's Maiden Lane Transactions and the Federal takeover of Fannie Mae and Freddie Mac). The cost of the S&L crisis amounted to 3.2 percent of GDP during the Reagan/Bush era, while the GDP percentage of the TARP cost was estimated at less than 1 percent.[72]
American Bankers Association's attempts to expunge the TARP warrants[edit]
By March 31, 2009, four banks out of over five hundred had returned their preferred stock obligations. None of the publicly traded banks had yet bought back their warrants owned by the U.S. Treasury by March 31, 2009.[87] According to the terms of the U.S. Treasury's investment, the banks returning funds can either negotiate to buy back the warrants at fair market value, or the U.S. Treasury can sell the warrants to third party investors as soon as feasible. Warrants are call options that add to the number of shares of stock outstanding if they are exercised for a profit. The American Bankers Association (ABA) has lobbied Congress to cancel the warrants owned by the government, calling them an "onerous exit fee".[88] Yet, if the Capital Purchase Program warrants of Goldman Sachs are representative, then the Capital Purchase Program warrants were worth between $5 billion and $24 billion as of May 1, 2009. Canceling the CPP warrants thus amounts to a $5 billion to $24 billion subsidy to the banking industry at government expense.[89] While the ABA wants the CPP warrants to be written off by the government, Goldman Sachs does not hold that view. A representative of Goldman Sachs was quoted as saying "We think that taxpayers should expect a decent return on their investment and look forward to being able to provide just that when we are permitted to return the TARP money."[90]
Impact[edit]
In total, U.S. government economic bailouts related to the global financial crisis had federal outflows (expenditures, loans, and investments) of $633.6 billion and inflows (funds returned to the Treasury as interest, dividends, fees, or stock warrant repurchases) of $754.8 billion, for a net profit of $121 billion.[91] Of financial system bailout outflows, 38.7% went to banks and other financial institutions, 30.2% to Fannie Mae and Freddie Mac, 12.6% to auto companies, and 10.7% to AIG, with the remaining 7.8% in other programs.[91]
A 2019 study by economist Deborah Lucas published in the Annual Review of Financial Economics estimated "that the total direct cost of the 2008 crisis-related bailouts in the United States" (including TARP and other programs) was about $500 billion, or 3.5% of the United States's GDP in 2009, and that "the largest direct beneficiaries of the bailouts were the unsecured creditors of financial institutions."[92] Lucas noted that this cost estimate "stands in sharp contrast to popular accounts that claim there was no cost because the money was repaid, and with claims of costs in the trillions of dollars."[92]
In a 2012 survey of leading economists conducted by the University of Chicago Booth School of Business' Initiative on Global Markets, economists generally agreed that unemployment at the end of 2010 would have been higher without the program.[93]