Financial Reform Watch : Financial Services News & Information : Blank Rome Government Relations Lobbying Firm : Government Relations, Corporate Governance : Financial Reform Watch Law Blog

Since President Obama signed Dodd-Frank into law on July 21, 2010, the financial industry has been anxiously awaiting the appointments of the key individuals to lead the newly-created offices of Financial Research (OFR) and Federal Insurance (FIO), along with the Consumer Financial Protection Bureau (CFPB). But now the wait is over—at least for the one director position that doesn’t require Senate confirmation.

Treasury Secretary Tim Geithner announced on Thursday that Michael McRaith, the director of the Illinois Department of Insurance, will assume the helm of the new FIO. Under Dodd-Frank, the Treasury-housed office will be charged with collecting, analyzing, and disseminating data and information gathered from the insurance industry in order to help coordinate federal insurance policy. (Health insurance and long term care insurance are excluded from the FIO’s purview).

In an effort to preserve the longstanding state-based regulatory structure for the insurance industry, Congress crafted language that explicitly prohibits the FIO from exercising regulatory or enforcement authority. However, voices on Capitol Hill and within the financial industry have expressed concerns with the FIO’s sweeping authority to collect data and how that may impact business compliance costs and data security.

One of McRaith’s primary functions as FIO director will be to serve as a non-voting member on the Financial Stability Oversight Council (FSOC)—a council of regulators charged with monitoring the broader financial system—requiring consultation with the Treasury Secretary as to whether certain insurers or insurance practices may pose systemic risk.

As the FSOC continues to issue proposed rules that will ultimately determine how regulators designate non-bank financial companies for heightened supervision, a bipartisan group of lawmakers—including Reps. Barney Frank (D-MA) and Ed Royce (R-CA)—have been urging the Obama administration to quickly fill the FIO director position in order for the insurance industry to have a voice at the table during the FSOC’s rulemaking process.

Under Dodd-Frank, the FIO Director is also empowered to negotiate—along with the U.S. Trade Representative—all international insurance agreements on behalf of the U.S.

Mr. McRaith has served as secretary/treasurer of the National Association of Insurance Commissioners (NAIC) and has represented state regulators in negotiations with the International Association of Insurance Supervisors and the international Organization for Economic Cooperation and Development.

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Since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act on July 21, 2010, the agencies charged with implementing the Act have begun laying the groundwork for managing their new responsibilities.

The Department of Treasury’s Assistant Secretary for Financial Institutions Michael Barr provided a window into the action during his remarks to the Chicago Club yesterday. The first meeting of the Financial Stability Oversight Council (FSOC) – the council of financial regulators charged with managing systemic risk – will be in September. The Treasury is currently working to stand up the new Office of Financial Research that will support the FSOC by collecting and analyzing data pertaining to systemic risk. Internationally, Treasury is working to raise capital requirements – the ratios and the quality of the underlying capital – and also institute explicit, quantitative liquidity requirements. According to Barr, the Dodd-Frank reforms also require that, “Regulators must supplement existing approaches to supervision with mandatory ‘stress tests,’ credit exposure reporting, and ‘living wills,’ so that they can adequately assess the potential impact of the activities and risk exposures of these firms on each other, on critical markets, and on the broader financial system.”

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Treasury Secretary Timothy Geithner notified Congress today that the $700 billion Troubled Asset Relief Program (TARP) would be extended until October 3, 2010 – a move that, although expected, adds fuel to an ongoing debate on Capitol Hill whether to wind down the politically unpopular program or utilize its excess funds for broader economic recovery efforts.

In a letter sent to House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid, Geithner sought to quell political concerns by outlining a TARP “exit strategy” and narrowing the program’s focus to three specific areas in 2010: home foreclosure mitigation; small-business lending; and the Term Asset-Backed Securities Loan Facility (TALF) in order to facilitate lending through securitization markets.  According to Geithner, no TARP funds will be spent beyond these specific areas “unless necessary to respond to an immediate and substantial threat to the economy.”  In addition, the Capital Purchase Program – aimed at boosting bank lending through nearly $250 billion in direct capital injections – will cease.

Key to the administration’s TARP extension is the assumption that only $550 billion of the $700 billion program will be necessary for deployment, a figure buoyed by Treasury estimates that TARP-recipient banks could repay as much as $175 billion by the end of 2010.  Sanguine figures such as these have opened the floodgates to recent congressional proposals that would use TARP proceeds to create or expand economic recovery initiatives -- including a job-creation proposal outlined yesterday by President Obama – and, at the same time, remain budget-neutral.

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Even Cabinet Members (maybe ESPECIALLY Cabinet Members) need an August break. Various media outlets have reported that Treasury Secretary Geithner delivered an expletive-laced tirade to the principal U.S. financial regulators during a meeting last Friday, in what sources say was a clear show of frustration over the internal opposition to some key elements of the Obama administration's financial regulatory proposal.

Fortunately, for inquisitive lawmakers, several of the meeting attendees were on Capitol Hill today to testify before the Senate Banking Committee on “Strengthening and Streamlining Prudential Bank Supervision,” including Federal Deposit Insurance Corporation (FDIC) Chairman Sheila Bair, Federal Reserve Governor Daniel Tarullo, Acting Director of the Office of Thrift Supervision (OTS) John Bowman and Comptroller of the Currency John Dugan.

Confirming the veracity of the reports, the regulators were also unwilling to soften their criticism, as Bair and her fellow regulators expressed sharp resistance to the administration's proposal to consolidate the bank supervisory functions of the OTS and the OCC into a new National Banking Supervisor -- citing concerns that unified regulation would undercut the interests of community banks and would do little to close the most glaring regulatory gaps that occurred in the non-bank, or "shadow," banking system.

After hearing from the witnesses, Senate Banking Committee Chairman Chris Dodd (D-CT) openly speculated about the administration's plan, commenting that it is “…a thoughtful proposal but I wonder if it is the right prescription.”  Then again, Dodd’s comments may offer more insight on where his mind has focused these past several weeks than about the financial reform outlook.

The House adjourned last Friday and the Senate will adjourn this Friday for the August recess. Dodd is going home to face some challenging poll numbers as he gears up his 2010 re-election campaign. The opinion landscape is shifting rapidly, and legislators may come back in September with some different notions than they left with in August. One thing is for certain, it is going to be a very busy fall.

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Expanding shareholder voting rights to include corporate executive compensation has been a topic of considerable debate in Washington over the past few years, but not until the fall of 2008—when the federal government began undertaking unprecedented steps to stabilize the financial system—did “say on pay” gain real momentum. By late fall, there was strong public outcry for action as recipients of government bailout money reported high executive salaries and bonuses that appeared disconnected from their companies' financial health.

Congress took the first steps towards strengthening investor influence by imposing say on pay requirements for all Troubled Asset Relief Program (TARP) recipients in the American Recovery and Reinvestment Act, passed in February. However, in response to public uproar over American International Group’s (AIG) distribution of $165 million in corporate bonuses to their much-maligned financial products unit, the Obama Administration went one step further in early June by proposing an extension of say on pay to all publicly-traded companies.

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The Treasury Department today released draft legislative language that would require all public companies to hold annual, non-binding shareholder votes on executive compensation packages as well as impose stricter standards to ensure the independence of corporate compensation committees. The "Say on Pay" proposal is modeled after a rule the United Kingdom adopted in 2002. Starting December 15, 2009, proxy materials will have to include tables summarizing the salary, bonus, stock option awards, and total compensation package for senior executives and also narrative explanations of any golden parachute and pension compensation packages. In the event of a merger or acquisition, companies will need to hold separate votes on golden parachutes and must lay out simply and clearly what the departing executives will receive.

To ensure the independence of corporate compensation committee members, the legislation calls for "exacting new standards" modeled on how Sarbanes Oxley established the independence of audit committees. The provisions would require compensation committees to be granted the funding and authority necessary to hire compensation consultants, legal counsel, and other advisers—all of whom should be independent of the company's management—to help the committee negotiate pay packages that are "in the best interests of shareholders."

Financial Reform Watch will be tracking this legislation as it moves through Congress.

Treasury: Proposed Legislation re Executive Compensation or "Say on Pay" (PDF)

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Late yesterday afternoon, the Treasury Department released draft legislation that would require advisers to hedge funds, private equity funds, venture capital funds, and other private pools of capital to register with the Securities and Exchange Commission (SEC) if they have more than $30 million of assets under management. In addition to registering, the advisers will be subjected to new reporting, recordkeeping, compliance, and disclosure requirements as well as conflict of interest and anti-fraud prohibitions. In its release, Treasury said,

"The Administration's legislation would help protect investors from fraud and abuse, provide increased transparency, and provide the information necessary to assess whether risks in the aggregate or risks in any particular fund pose a threat to our overall financial stability."

Financial Reform Watch will be tracking this legislation as it moves through Congress.

Treasury:  Proposed Legislatve Language for the Registration of Hedge Funds (PDF) 

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After nearly four months of delay, the Treasury on Wednesday launched the Legacy Securities program—a key component of the administration’s Public-Private Investment Program (PPIP) aimed at relieving financial institutions of illiquid assets that continue to hamper the flow of credit markets.

Scaling back the scope of the Legacy Securities program as originally envisioned in March, the Treasury, together with the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve, offered a framework that will provide government investments of up to $30 billion so that private sector fund managers and private investors might purchase legacy commercial mortgage-backed securities (MBS) and non-agency MBS off the balance sheets of banks and other financial institutions.

Selected from a pool of over 100 applicants, below is a list of the nine private fund managers pre-qualified by Treasury to participate in the initial round of the Legacy Securities program:

• AllianceBernstein, LP and its sub-advisors Greenfield Partners, LLC and Rialto Capital Management, LLC
• Angelo, Gordon & Co., L.P. and GE Capital Real Estate
• BlackRock, Inc.
• Invesco Ltd.
• Marathon Asset Management, L.P.
• Oaktree Capital Management, L.P.
• RLJ Western Asset Management, LP.
• The TCW Group, Inc.
• Wellington Management Company, LLP

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The Treasury Department today released draft legislation outlining a central pillar of the Obama administration’s financial regulatory overhaul: the creation of the Consumer Financial Protection Agency (CFPA), an independent regulator with broad authority over “any financial product or service” used by consumers. Seeking to clarify the administration’s June 17th white paper on financial regulatory reform, the legislation provides lawmakers and industry leaders with the statutory details regarding the proposed CFPA.

According to the draft language, in order to continuously monitor consumer risks, the agency—composed of a five-member board led by a presidentially-appointed director subject to Senate confirmation—would collect information related to loans, products, and services from both banks and non-banks. Additionally, consumer financial regulations that are currently divided among several agencies—the Federal Reserve, FDIC, Office of Comptroller of the Currency, Office of Thrift Supervision, Federal Trade Commission, and National Credit Union Administration—will be consolidated within the CFPA. The legislation would have these regulators transfer functions, rules, and employees to the new CFPA within six to eighteen months following enactment. The agency must research, analyze, and report on consumer awareness and understanding of financial products, related disclosure statements, related risks and benefits, and consumer behavior related to such products. The agency would also collect and track consumer complaints and create a new, integrated disclosure form for mortgage transactions, unless the Department of Housing and Urban Development and the Fed can achieve the same goal prior to the transfer of such responsibilities to the CFPA. There are also provisions related to civil penalties and enforcement authority.

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Now that everyone has had a day or more to digest the Obama administration’s plan for Financial Regulatory Reform, suggestions, questions, and critiques are coming from all corners. Here is a sampling of the top issues under discussion.

Systemic Risk Regulator –

Sen. Mark Warner (D-VA), who sits on the Banking Committee, objects to the plan’s expansion of the Federal Reserve’s role in managing systemic risk, believing it would concentrate too much power in one entity. Warner instead proposes the establishment of a Systemic Risk Council comprised of the Treasury, the Fed, and the other financial regulators that would, together with a permanent council staff, be able to assess and minimize risks comprehensively across the financial landscape. The House Republicans also prefer the council approach, proposing their own version – the “Market Stability and Capital Adequacy Board”-- last week.

Tier I Financial Holding Companies --

What companies will be considered Tier I Financial Holding Companies and subject to new regulation by the Fed? The Fed and Treasury are to establish the criteria, but some companies that are not currently subject to federal regulation might include General Electric, Berkshire Hathaway, State Farm Insurance, or even WalMart. Those not used to federal regulation will be given five years to ease into the new regime – the non-financial activity restrictions in the Bank Holding Company Act.
 

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Last month we were entertained by a Financial Service Primer set in Winnie the Pooh’s Hundred Acre Wood. Since then, Christopher Robin has unveiled his big plan to reform the financial services markets.  Please click below to read about financial reform through a different lens.

Another Romp Through the Hundred Acre Wood

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President Obama is today releasing his plan for a new regulatory structure to mitigate risk in the financial marketplace. Please click here to see the proposal from the Administration. Financial Reform Watch will be posting analysis shortly.
 

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Tired of being labeled as obstructionists, Republicans on the House Financial Services Committee on Thursday issued their plan for financial regulatory reform. Led by the committee’s Ranking Minority Member Spencer Bachus (R-AL) and TARP Congressional Oversight Committee member Jeb Hensarling (R-TX), the Republican solutions stem from three principles – prevent any future Wall Street bailouts; stop the government from picking winners and losers in the financial system; and restore market discipline.

While the Republican plan does not address every issue -- most notably missing is insurance regulation – those included represent a consensus view within their caucus. Bachus described their plan as a “line in the sand” from which Republicans can negotiate with the Democrats. Hensarling, who before coming to Congress served on the executive compensation committee of a company publicly traded on the New York Stock Exchange, was particularly critical of the latest push to regulate compensation. A better approach, Hensarling believes, is the creation of a new “Market Stability and Capital Adequacy Board,” which would be charged with flagging risky practices across the board. The Republicans offered as an example the practice of rewarding loan originators for loan volume with no regard to loan quality, saying that such a board would have been able to halt that.

The White House plans to release its comprehensive reform plan on June 17th. Will the Obama administration give a nod to bipartisanship by including a few elements of the Republican plan? Financial Reform Watch will compare and contrast the plans later this week.

Central Elements of the Republican Plan

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The Obama Administration took additional steps to rein-in executive compensation today by announcing the appointment of a "pay czar" at the White House and announcing proposed principles for regulating executive compensation where authority exists to do so. They also asked for legislation to advance the concept of giving shareholders a "say on pay." The suggested principles are not as prescriptive as some may have feared, but taken together, today's proposals and actions are generating some concerns about how the rules of the game are being changed.

Early in the day, Treasury Secretary Geithner unveiled the administration’s approach to regulating executive compensation practices at financial institutions and publicly-traded companies. In order to “encourage sound risk management” and to align pay practices with long-term corporate health, the administration laid out the following broad principles:

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Ever since the AIG bonus brouhaha, TARP recipients knew the day would come when federal officials would step in to manage their compensation structure. Several have been scrambling to raise the private capital necessary to repay their TARP loans just to avoid the anticipated executive compensation restrictions. There are reports today that Treasury Secretary Geithner may announce new guidelines as early as this week. However, he is not currently scheduled to appear on Capitol Hill on this topic until the House Financial Services Committee hearing on June 18th. Whenever he makes his announcement, we expect he will explain that the new executive compensation rules will apply to some TARP recipients permanently – those that accepted more than one round of bailout money -- regardless of whether or not they have paid back the federal funds. In addition, it is also reported that Treasury will be suggesting "guidelines" to be used for executive compensation in financial services firms that have not receive TARP assistance.

It appears the restrictions will be imposed on a company’s 25 highest earners. Reportedly, federal bank regulators will also be granted new authority to impose compensation restrictions on banks not in the TARP program whose pay systems encourage too much risk. How much risk is too much and who determines that remain important questions.

The expected move to extend the pay restrictions beyond the life of the TARP involvement in the firms raises some important questions. Are restrictions that outlive TARP money in the firms consistent with the agreements the institutions made originally with the government? Will there be any sunset whatsoever on the proposed restrictions? Where GM is concerned, will the company emerging from bankruptcy be considered a "new" company?

To the extent the new guidelines would reach into companies who have not received TARP funds, it is legitimate to ask the question as to whether these are a legitimate shareholder's rights issues or an overreach by federal regulators into areas best left to the executive suite and the boardroon.

Since there are very few facts available and only rumors, Financial Reform Watch will reserve judgment until the Treasury releases the new rules, however, there is much to ponder in the meantime.

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The European Commission yesterday put forward its framework proposal on Financial Supervision in Europe. The proposal covers a set of far-reaching reforms to the current architecture of supervisory committees, with the creation of a new European Systemic Risk Council (ESRC) and European System of Financial Supervisors (ESFS), composed of new European Supervisory Authorities. Legislation to embody these proposals will follow in the autumn and will thus be finalized under the leadership of new Commissioners who will be appointed during the summer.

With this initiative, the Commission is responding to the weaknesses identified during the financial crisis as well as to the G20 call to take action to build a stronger, more globally consistent, regulatory and supervisory system for financial services. The proposed financial supervision package involves two key elements.

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The news last week that six insurance companies had been preliminarily approved for TARP money was viewed as the culmination of a process that began under the Bush Administration through which insurers sought assistance from the Federal government. In the six months since they initially applied for TARP funds, the companies' ardor for this sort of federal investment seems to have cooled somewhat.

The insurance companies approved for TARP money are being consistently cautious about accepting it. One, Ameriprise Financial, announced it would decline the funds. The others -- Prudential, Hartford, Lincoln National, Principal, and Allstate -- released statements to the effect that they are still evaluating their options.

The companies’ reactions could be viewed as a positive sign that, unlike in November when they submitted their applications, there are now alternatives to the TARP for raising capital. It may also be that companies are wary of getting too entangled with the government in light of issues surrounding executive compensation and business structure that have been faced by banks and auto companies who have taken federal assistance. In any case, it may be that they will view it as sign of strength to turn down assistance from Washington. While Treasury Department officials might see that as a "bait and switch" strategy, the companies have a legitimate case to make that things have changed between November and now.

We will be following the insurance industry's relationship with Treasury and the TARP and will keep our readers posted on developments.
 

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In a letter to House and Senate leaders yesterday, Treasury Secretary Timothy Geithner proposed amending the “Commodity Exchange Act , the securities laws, and other relevant laws” to enable the government “to regulate the OTC [over-the-counter] derivatives markets effectively for the first time.” A related Treasury press release explains, “As the AIG situation has made clear, massive risks in derivatives markets have gone undetected by both regulators and market participants. But even if those risks had been better known, regulators lacked the proper authorities to mount an effective policy response.”

The Obama Administration therefore proposes changing laws, rules, and practices in order to put in place the following requirements aimed at minimizing risk to the financial system; promoting efficiency and transparency; preventing fraud and market abuses; and protecting against the inappropriate marketing of OTC derivatives to “unsophisticated parties”

• Clear all standardized OTC derivatives through regulated central counterparties (CCP), which are to impose robust margin requirements and necessary risk controls.
• Subject OTC derivatives dealers and firms that create large exposures to counterparties to a “robust regime of prudential regulation” to include—conservative capital requirements; business conduct standards; reporting requirements; and initial margin requirements with respect to bilateral credit exposures
• Authorize the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) to impose—recordkeeping and reporting requirements; requirements for trades not cleared by CCPs to be reported to a regulated trade repository; obligations on the CCPs and trade repositories to make aggregate data on open positions and trading volumes publicly available and individual counterparty’s trades and positions available to federal regulators; moving standardized trades onto regulated exchanges and regulated transparent electronic trade execution systems; the development of a system for timely reporting of trades, prices, and other trade information.
• Give the CFTC and the SEC the authority—to police fraud, market manipulation, and other market abuses; to set position limits on OTC derivatives that perform or affect a significant price discovery function with respect to futures markets; and to gather the complete picture of market information from CCPs, trade repositories, and market participants for market regulators.
• Strengthen the laws and participation limits to ensure that OTC derivatives are not marketed inappropriately to “unsophisticated parties.” The CFTC and SEC are reviewing current participation limits to recommend tighter limits or increased disclosure requirements related to marketing derivatives to counterparties “such as small municipalities.”

House Financial Services Committee Chairman Barney Frank (D-MA) and Agriculture Committee Chairman Colin Peterson (D-MN), whose committee has jurisdiction over the CFTC, released a joint statement welcoming the Treasury proposals and committing to working together to achieve “strong, comprehensive, and consistent regulation of OTC derivatives.”

Treasury: Letter to Harry Reid Re: Regulatory Framework for OTC Derivatives (PDF) 

Treasury: Press Release Re: Regulatory Reform for OTC Derivatives

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Treasury Secretary Timothy Geithner announced this morning that, in anticipation of some large institutions paying back their TARP money, the department plans to re-open the Capital Purchase Program (CPP) for small banks with total assets under $500 million. Since the launch of the program in November, 579 institutions have received money through the CPP, 300 of which are small banks. Treasury will soon open a six month window during which new banks can apply, current CPP participants can reapply, and small banks can “form a holding company for the purposes of CPP.” Participants already in the CPP will have an “expedited approval process.” Treasury is raising the amount for which qualifying institutions can apply from 3 percent to 5 percent of risk-weighted assets. Presumably more details about the re-opened program will be forthcoming.

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At 5 p.m. Eastern Daylight Time today, the Federal Reserve and Treasury unveiled the official results of the Supervisory Capital Assessment Program (SCAP), revealing that ten of the 19 participating banks need to increase their capital buffers for a combined total of $74.6 billion. The SCAP conducted stress tests on the nation’s largest bank holding companies to predict “potential losses, the resources available to absorb losses, and the resulting capital buffer needed” based on various economic scenarios.

The banks needing to increase their capital buffers will have to work with their primary regulators, in consultation with the FDIC, to develop a capital plan sometime in the next 30 days (by June 8, 2009), and they will have six months to implement the plans (by November 9, 2009).

Each capital plan must contain the following three elements:

• A detailed description of specific actions the bank will take to increase capital in order to satisfy the capital buffer requirement. Treasury and the Fed encourage banks to raise new capital from private sources.
• A list of steps to address weaknesses in the bank’s internal processes for assessing capital needs and engaging in capital planning.
• An outline of steps the bank will take over time to repay government-provided capital.

As part of their 30 day review process, banks are also directed to evaluate their existing management and board of directors to make certain their leadership has the capability to “manage the risks presented by the current economic environment and maintain balance sheet capacity sufficient to continue prudent lending to meet the credit needs of the economy.”

The banks needing to increase their capital buffer (amounts in billions) are Bank of America ($33.9); Citi ($5.5); FifthThird ($1.1); GMAC ($11.5); KeyCorp ($1.8); Morgan Stanley ($1.8); PNC ($0.6); Regions ($2.5); SunTrust ($2.2); and Wells Fargo ($13.7). See the Fed report for more details.

Federal Reserve: Supervisory Capital Assessment Program - Overview of Results (PDF)

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The Treasury Department yesterday released its new improved “Making Home Affordable” (MHA) program that will now offer assistance for second mortgages, such as home equity loans, in addition to assistance with first mortgages. The administration announced the MHA in February and released the details in early March. Tuesday’s announcement addressed the expansion of MHA as well as more support for the Hope for Homeowners program. Treasury estimates that 50 percent of “at risk” mortgages also have second liens. Under the new program, both first and second mortgages would be modified “in tandem.” Interest rates on second loans would be reduced to one percent, unless they are interest-only loans, in which cases the rate would be two percent. The term of the modified second loan would be extended to match the term of the modified first mortgage. After five years, the interest rate on the second would be adjusted to the same rate as the modified first mortgage, and the second mortgage would be re-amortized over the remaining term at the higher rate. The MHA also includes “pay for success” incentives for servicers and borrowers similar to those announced for first mortgage relief.

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The Treasury Department is working to complete stress tests on 19 top U.S. banks. Reports are circulating that all the banks will receive a passing grade, but there is going to be some differentiation in the results between those that are particularly strong and those that are not. Several media outlets today are citing "senior Administration officials" as saying Treasury plans to release—or to encourage the banks to release—the results of the stress tests. The purpose for this, according to these officials, is to prevent rumors about "weak" institutions from causing investors, creditors, borrowers, and depositors to lose confidence in certain institutions. The release of the results will not occur before the end of the "earnings season"— April 24.

It does appear to us that the stress test results will be a contributing factor to a sorting of the banking industry into the healthy and the less healthy—to look at it in the most charitable light. Some banks are contributing to that sorting process by touting early their first quarter results and by openly discussing paying back the TARP funding they have received.

So faced with this developing story, we here at Financial Reform Watch have some questions we are pondering:

• Will Treasury actually sort the banks into categories of strength?
• What information will Treasury release and what information will the banks release?
• Will the markets react as Treasury hopes to the release of information, or will they focus only on the less good results as a reason to drive down the values of certain institutions' stocks?

If this sorting process develops through the spring and the summer, talk of consolidation in the industry is likely to increase. So that supposition leads to questions as to whether or not Secretary Geithner will become an advocate for consolidation as Secretary Paulson before him did in suggesting through the capital injection process that certain banks—usually smaller ones—should be taken over by others.

In any case, the release of stress test results and information compiled in conducting the test could just as easily roil the markets as calm them in our view.

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Participation by insurance companies in the TARP program appears to be back on the front burner at Treasury. However, eligibility standards for receiving assistance and the requirements that come along with it are very much under discussion.

Back in the fall , several big-name insurance companies rushed to make the November 14 deadline to apply for assistance from the TARP program. A few were in the news for buying small banks or thrifts in order to qualify for TARP funds, since only federally regulated deposit institutions are eligible for the TARP’s Capital Purchase Program. (AIG has its own special category for TARP assistance—Systemically Significant Failing Institutions.) But as November turned to December it became clear the Bush Administration was not going to move on assistance to insurers.

Now, almost five months later, some life insurance stocks are seeing significant gains on rumors that Treasury is about to provide billions of bailout dollars to their companies.

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The House of Representatives approved yesterday, by a vote of 247 to 171, the “Pay for Performance” bill (H.R. 1664), which would prohibit TARP recipients from paying “unreasonable or excessive compensation” to its employees. The legislation tasks the Treasury Department with defining exactly what is “unreasonable or excessive.” The bill also repeals the controversial amendment in the American Recovery and Reinvestment Act that exempted bonuses based on employment contracts dated prior to February 11, 2009. While this is a far cry from the AIG-targeted bill the House passed earlier— imposing a 90 percent excise tax on AIG bonuses—H.R. 1664 is one more example of government treading into traditionally private sector turf.

The legislation applies to companies that have outstanding capital investments from the TARP or through the Housing and Economic Recovery Act, which covers Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. In addition to prohibiting unreasonable or excessive compensation, affected companies could not pay bonuses or other supplemental payments not directly based on performance standards set by Treasury. The Treasury Secretary has the authority to exempt community investment institutions and institutions receiving less than $250 million from the TARP. The legislation also directs Treasury to establish a payback process for those institutions that would prefer to return the government’s money rather than be subject to the new compensation rules. For those institutions subject to the rules, the bill requires them to submit an annual report to Treasury with the number of employees whose compensation falls into each of these categories: over $500,000; over $1 million; over $2 million; over $3 million; and over $5 million.

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At last Treasury has come forward with its Public Private Investment Program for dealing with toxic assets, only now that there is a plan, the proper term is “troubled legacy assets.” Stocks have rallied since Treasury announced the plan this morning, and legislators on Capitol Hill have halted their rush to claw back the AIG bonus money, some say partly in order to study the new plan. The Treasury Secretary is scheduled to testify before the House Financial Services Committee on Thursday. Will the positive momentum continue up to and following his hearing performance? Secretary Geithner has a lot riding on this week.

The plan, which will use $100 billion of TARP funds, has two parts intended to revive the anemic financial system—the Public Private Investment Fund (PPIF) for Legacy Loans and the PPIF for Legacy Securities. Both are aimed at residential and commercial real estate-related assets. Banks tend to hold the assets as loans and entities such as insurers, pension funds, mutual funds and individual retirement accounts tend to hold the assets as securities backed by loans. The Federal Deposit Insurance Corporation with Treasury will work to create PPIFs that will purchase “loans and other asset pools” from participating banks, and the FDIC will determine eligibility criteria. The FDIC will also be using contractors to help it analyze loan pools and determine the level of debt to be issued by the PPIFs (with leverage not exceeding a 6 to 1 debt-to-equity ratio). The FDIC will then auction off each loan pool to the highest bidder. Treasury will provide 50 percent of equity financing and the private sector auction winner will provide the other 50 percent. The private sector winner can obtain financing by issuing new debt, which the FDIC will guarantee, that is collateralized by the purchase.

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The Obama Administration has stepped up its preparation for the G20 summit next week by moving on two fronts—a plan to purchase toxic assets from banks and a new regulatory regime for financial products and companies. Taken together, these emerging plans appear designed to allow President Obama to come to London saying the U.S. has addressed the three major pillars of a recovery program—stimulus, bank rescue and regulatory reform .

Today's announcement by Treasury Secretary Geithner of the plan for toxic assets follows the broad outline he announced to poor reviews last month. The stock market's swoon after the previous Geithner announcement was blamed on the lack of detail he offered. Today, Geithner described how a program of up to $1 trillion to relieve banks of bad assets will be managed. Based on a public/private partnership concept, the Geithner plan allows for the participation of hedge funds and private equity funds as managers of portfolios of assets. Those managers will have the opportunity to make significant profits if they are successful in selling those assets back into a healthier market in the future. The government will also share in those profits. The reaction of the media and Congress to this plan bears watching. They will focus immediately on the issue of executive compensation for managers participating in the program and on the issue of allowing the very kind of firms that helped create the mess to make a profit on cleaning it up. Careful selection of managers will be crucial.

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The U.S. Treasury announced today a new program that will provide $5 billion to finance auto suppliers and hopefully unfreeze credit in the auto sector. Treasury will provide the money to participating domestic auto companies, which will in turn decide “which suppliers and which receivables” to support.

In the course of reviewing GM’s and Chrysler’s viability plans and the state of the industry, the President’s Auto Task Force determined the need for immediate action “to help stabilize the auto supply base,” which employs more than 500,000 workers across the country. Declining auto sales have left many suppliers unable to access credit. The task force concluded,

“This vicious cycle of frozen credit markets, growing supplier uncertainty, and growing auto company uncertainty has the potential to unravel the industry and short-circuit restructuring efforts at companies like GM and Chrysler.”

Eligible suppliers must be U.S. based and ship to a participating auto manufacturer. GM and Chrysler have already signed up for the program. An eligible receivable is one “created with respect to goods shipped after March 19, 2009 that is made on qualifying commercial terms between a supplier and a participating auto company.” Suppliers will have to get consent from their lenders to participate in the program and will have to pay a “modest” participation fee. Suppliers will also have the option of selling their receivables into the program for “a modest discount” in order to gain liquidity. Further details are available in the attached fact sheet.

Treasury:  Auto Supplier Support Program (PDF)

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There was plenty of activity in Washington this week but none of it enough to settle the roiling stock market, which keeps sinking like a rock. Is there too much activity or not enough of the right kind of activity?

From the White House and the Treasury—The Obama Administration released the details of its “Making Home Affordable” program, which was introduced in February. With incentives for mortgage holders and servicers, audit and documentation requirements, and qualification limits, major industry players such as the Mortgage Bankers Association and the American Bankers Association reacted positively to the new details.

From the Treasury—Secretary Tim Geithner was on Capitol Hill most of the week defending and explaining the president’s budget proposal, especially the $250 billion “contingent reserve” amount in the Treasury budget to support up to $750 billion worth of asset purchases. Geithner assured the Senate Finance Committee that the $750 billion is not an estimate of future rescue efforts, but rather “just a recognition of reality that it’s possible we’re going to need to do this with more resources.” The Secretary promised to provide more details in the coming weeks on future bailout efforts, including plans for the remaining $300 billion of TARP funds, and the eagerly anticipated public private partnership to take on troubled assets.

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Some surprises were included in today's announcement by the Federal Reserve and the Treasury on new developments with the soon-to-be $1 trillion Term Asset-Backed Securities Loan Facility (TALF). Of particular note is the statement that the two agencies will push for legislation to re-tool the program.

According to the joint release, the TALF is “designed to catalyze the securitization markets by providing financing to investors to support the purchase of certain AAA-rated asset-backed securities” and will at first be limited to newly and recently originated auto, credit card, student, and SBA-guaranteed small business loans. The TALF funds will go out monthly starting in March, and they are already anticipating a program expansion for April that will include “asset backed securities (ABS) backed by rental, commercial, and government vehicle fleet leases and ABS backed by small ticket equipment, heavy equipment, and agricultural equipment.” The Treasury and the Fed are also analyzing how to expand the program in future months to include commercial mortgage backed securities and other AAA-rated, newly issued ABS.

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The Treasury Department yesterday afternoon began to release some much anticipated details of the Obama Administration’s Financial Stability Plan first announced on February 10th—TARP re-branded. Yesterday was all about the Capital Assistance Program (CAP) and the related "stress test" that regulators will perform on the 19 largest banks, those with consolidated assets in excess of $100 billion. Treasury announced,

"The purpose of the CAP is to restore confidence throughout the financial system that the nation’s largest banking institutions have a sufficient capital cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers."

If the stress test shows that a bank needs a larger capital buffer, then the bank has six months to raise the necessary amount of private capital or access the CAP, which Treasury describes as "a bridge to private capital in the future." The CAP funds would be available to the bank immediately.

The administration stressed it wants to keep government ownership temporary and will encourage replacing the government’s stake with private capital. Additionally, the Treasury announced it would set up a separate trust "to manage the government’s investments in US financial institutions."  There were no further details about the trust, but Financial Reform Watch will continue to monitor this.

Treasury:  The Capital Assistance Program and its role in the Financial Stability Plan (PDF)

Treasury: Capital Assistance Program FAQs (PDF)

Treasury: Capital Assistance Program Term Sheet (PDF)

Federal Reserve/FDIC: Supervisory Capital Assistance Program FAQs (PDF)

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While the results of the G7 meeting in Rome may have been disappointing to some, due to a communiqué light on substance, it can be argued it made a step in the right direction in combating protectionism. The communiqué included this statement:

"An open system of global trade and investment is indispensable for global prosperity. The G7 remains committed to avoiding protectionist measures, which would only exacerbate the downturn, to refraining from raising new barriers and to working towards a quick and ambitious conclusion of the Doha Round.”

 Another development at the meeting was the apparent softening of the German government's attitude about "bailouts" of euro-bloc nations needing to refinance debt. Whereas German Finance Minister Peter Steinbreuck said before the G7 meeting that Austria would have to solve its own problems, Steinbreuck's post-G7 statements appear to open the door for assistance to Austria as well as Ireland and Greece, who may also soon need help.

The EU states are now working hard to find a solution that would essentially be a preemptive de facto bailout, bearing in mind the legal limitations of the EU Treaty which has a "no bailout" clause. A common EU policy on state and bank bailouts would constitute a huge leap forward for EU integration.

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U.S. Treasury Secretary Tim Geithner today announced the administration’s new “Financial Stability Plan” but revealed few details beyond the plan’s overarching principles. The new plan aims to provide more capital for banks while holding them to higher lending and accountability standards, establish a public-private investment fund to deal with “troubled” assets, provide more assistance to homeowners and small businesses, and increase the transparency of the program in order to protect taxpayers.

After an unusual introduction by Senate Banking Committee Chairman Chris Dodd—presumably intended to underscore the administration’s dual commitment to the economic stimulus legislation intended to jump start the economy and fixing the financial system—Geithner described the current situation. He said credit markets are not working, which has led to serious business cut backs and resulted in a financial system “working against recovery.” Geithner criticized the government’s efforts thus far as “absolutely essential, but they were inadequate.”

Following the Treasury announcement, the stock market nose-dived all afternoon, with the Dow Jones industrial average dropping 4.6 percent and the Standard and Poor’s 500-stock index slipping 4.9 percent. Several financial analysts directly linked the market’s poor performance to the plan’s lack of detail, especially regarding the Public Private Investment Fund intended to leverage private capital with government financing. Some analysts contend that today’s announcement exacerbated the uncertainty plaguing the markets. When reporters questioned Geithner about filling in the blanks around the public private partnership, he responded that the administration does not want to release details until they are fully confident they have the right structure. He said they are very committed to bringing in private capital.

Here is a brief overview of the Financial Stability Plan:

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Next week President Obama and Treasury Secretary Geithner will unveil the administration’s broad financial reform agenda—a strategy to get credit moving again—but yesterday offered a preview as they unveiled new restrictions on executive compensation. The announcement was in direct response to public outrage over the use of taxpayer funds to subsidize “excessive compensation packages on Wall Street.” The president railed against “lavish bonuses” and a “culture of narrow self-interest and short-term gain at the expense of everything else.” It will be interesting to see if this policy, which could affect compensation policies at industry-leading institutions, will result in a reduction and/or restructuring of executive compensation throughout the financial services industry. Even though the new policy appears intended to have just such a leavening effect on compensation, President Obama tried to reassure free-marketers by saying: “This is America. We don’t disparage wealth…and we believe success should be rewarded.”  But he went on to say that executives being rewarded for failure, especially with taxpayer money, is wrong.

The Treasury executive compensation reform guidelines fall into three categories covering:

• all TARP recipients;
• participants in a “generally available capital access program,” such as the Capital Purchase Program; and
• institutions that receive “exceptional assistance,” such as Citigroup, Bank of America, and AIG. 

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There is a new team in town, and in one of his first public acts as Treasury Secretary, Tim Geithner established a policy aimed at increasing the transparency and accountability of the Troubled Asset Relief Program (TARP). Treasury will now post all TARP contracts on the Internet. New contracts will go on Treasury’s website within five to ten business days, and the department will post existing agreements on a rolling basis. At the time of the Secretary’s announcement, Treasury had already posted the agreements of the major nine institutions that first partook in the Capital Purchase Program; the Citigroup contract under the Targeted Investment Program; the AIG deal under the Systemically Significant Failing Institutions Program; and the GM, GMAC, and Chrysler contracts under the Automotive Industry Financing Program. At the request of individual institutions, the department will redact confidential and proprietary information.

The Secretary also met today with the individuals tasked with TARP oversight – the head of the General Accounting Office, the TARP Special Inspector General at Treasury, and the TARP Congressional Oversight Panel. Geithner promised to unveil more reforms in the coming weeks.

U.S. Department of Treasury, EESA Contracts

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On the first full day of the Obama Administration, key federal officials outlined a potential strategy for managing the government rescue of the financial sector. At his confirmation hearing today, Treasury Secretary-designate Tim Geithner told the Senate Finance Committee that the Obama Administration is considering the establishment of a “bad bank” or an “aggregator bank” that would take over the toxic asset-backed securities currently corroding the U.S. banking system. Several lawmakers have suggested the concept of a federally-operated entity modeled after the Resolution Trust Corporation, which, from 1989 to 1995, took over and liquidated 747 failed thrifts with assets of $394 billion. An aggregator bank would cost several trillion dollars according to various experts, including former Federal Reserve Chairman and current Obama economic advisor Paul Volcker.

Today Geithner assured the Senate panel that President Obama “will come before the Congress in the next few weeks and lay out to the American people a comprehensive plan to help stabilize the core of the financial system so that banks, which are so critical to our economy, are able to provide the credit necessary to get recovery going again.” He also promised to reform the TARP program with increased taxpayer protections, transparency, foreclosure mitigation for homeowners, and access to credit for small business owners.

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What will it take to jolt the U.S. economy back into shape? Congressional leaders have floated ideas for an economic stimulus package ranging from $500 to $700 billion. President-elect Obama is not espousing numbers yet but has assembled his economic team and charged it with developing recommendations for restoring economic growth and creating 2.5 million jobs. While serious rumors about his economic advisors started circulating last week, Obama officially presented the group at a noon press conference today:

• Treasury Secretary—Timothy F. Geithner, President and CEO of the Federal Reserve Bank of New York and former long-time Treasury official
• Director of the National Economic Council—Lawrence H. Summers, former Clinton Administration Treasury Secretary and Harvard economist
• Director of the Council of Economic Advisors—Christina D. Romer, University of California at Berkeley economics professor
• Director of the Domestic Policy Council—Melody C. Barnes, former counsel to Sen. Edward Kennedy (D-MA) and policy director of the Center for American Progress
• Deputy Director of the Domestic Policy Council—Heather A. Higginbottom, former legislative director and presidential campaign advisor to Sen. John Kerry (D-MA)

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In a further demonstration that the markets prefer certainty over uncertainty, the likely appointment of Federal Reserve Bank of New York President Timothy F. Geithner as the next Treasury Secretary appears to have calmed the market’s fears to some degree, since the Dow Jones Industrial Average was up 6.5 percent at today’s close. Geithner has worked closely with Treasury Secretary Hank Paulson to address the financial crisis, and insiders predict a very smooth transition from Paulson to Geithner.

The issue of Geithner’s role with Paulson on the more controversial decisions, such as saving Bear Stearns while leaving Lehman Brothers to fail, has been the only point of criticism among otherwise glowing reviews. Geithner has led the New York Fed for five years, and prior to that directed policy at the International Monetary Fund and was a senior fellow at the Council on Foreign Relations. During the Clinton Administration, Geithner served as Under Secretary of the Treasury for International Affairs. He served in various capacities at the Treasury Department from 1988 to 2001. While he represents change, Geithner brings a depth of Treasury experience that may be reassuring to many.

In other news, Congress left for the Thanksgiving holiday but first gave the Big Three automakers the homework assignment of "writing a plan for viability" by December 2nd. If the plans demonstrate that the domestic automakers would be a sensible, long-term investment for $25 billion worth of taxpayer loans, Congress will return to Washington on December 8th to pass auto bailout legislation. House Speaker Nancy Pelosi said Congress will also begin work on an economic stimulus proposal that will be ready to go at the start of the 111th Congress.

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With each passing day it becomes more apparent that neither the Congress nor the Bush Administration has an appetite for significant new actions to aid the financial system or the economy at large before the end of the year. Congressional leaders on Thursday made it clear that passage of an economic stimulus package or a package to aid the auto industry were looking increasingly difficult. At the Treasury Department, consideration is being given to making Capital Purchase Program assistance available to non-bank financial institutions, but no guidelines for how that might happen or what form the assistance may take have emerged. Meanwhile, congressional Republicans have begun clamoring for more information on the actions Treasury and the Federal Reserve have already taken to assist ailing financial institutions and other companies.

Sen. Chuck Grassley (R-IA), Ranking Member of the Senate Finance Committee, sent a harshly worded letter to the Treasury Secretary and Federal Reserve Chairman "to express concerns and receive answers to questions" he has regarding implementation of the Emergency Economic Stabilization Act of 2008 (EESA). In a statement released along with his letter, Grassley said of the implementation thus far, "When you see so many changes, you wonder if they really know what they’re doing."

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Treasury Secretary Hank Paulson today announced the Treasury Department will assist nonbank financial institutions with Troubled Asset Relief Program (TARP) funds and that the department will not use any funds for the original stated purpose of the program—the purchase of troubled assets from banks. The announcement of his intention to provide assistance to nonbank institutions represents a new step for Paulson. In making the announcement, the Secretary acknowledged that Treasury has not worked through the issue of funding organizations that are not federally regulated, however they are “designing further strategies for building capital in financial institutions,” and he said, “We will also consider capital needs of non-bank financial institutions not eligible for the current Capital Purchase Program.” He focused his remarks on the importance of shoring up the asset-backed securitization market by working with the Federal Reserve to develop a liquidity facility for AAA securities. Paulson acknowledged the need to “get lending going again,” and said, “While this securitization effort is targeted at consumer financing, the program we are evaluating may also be used to support new commercial and residential mortgage-backed securities lending.”

The accompanying announcement that Treasury does not intend to use TARP funds to purchase troubled assets as originally planned was a surprise to most observers. Paulson said he would seek to address the liquidity issues in the mortgage finance market by making additional capital available to banks if those funds were matched with private capital.

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On Wednesday, just one day after Senator Barack Obama won the presidency, the Treasury Department detailed how it planned to borrow a record $550 billion before the end of this year to back the bailout. Treasury said it would sell $55 billion in bonds next week, including a reintroduction of the three-year note—all part of a massive borrowing effort required because of the cost of the bailout and a budget deficit that some believe could hit nearly $1 trillion next year.
The government's surging financing needs are a stark reminder of the challenges awaiting the Obama Administration even as the current administration moves to implement its rescue program and the Fed fine-tunes its approach to the crisis. Treasury Secretary Paulson has pledged to work with incoming administration to ensure a smooth transition.

Treasury gave Congress its first report on the operation of the bailout fund, detailing the $125 billion the government spent last week to buy stakes in nine of the country's largest banks. The bailout legislation requires Treasury to issue reports each time its spending passes a $50 billion marker.

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Based on conversations with sources on Capitol Hill and administration officials, it now seems somewhat less likely the Treasury Department will expand its Capital Purchase Program (CPP) to include the insurance industry. Some life insurers may have publicly overstated their discussions with Treasury, leading to press accounts and misperceptions that the issue had been resolved.
Likewise, sources say Treasury is unlikely to assist the auto industry with funds from the $700 billion financial rescue package unless Congress makes legislative changes.

However, there is one scenario under which two leading auto makers might be able to get some Treasury assistance. GMAC LLC, which is the lending arm of General Motors, is owned 51 percent by Cerberus Capital Management and 49 percent by GM. Cerberus could become a bank holding company in order to qualify for EESA assistance. According to the Wall Street Journal, the federal rules for this would require GM to transfer much of its GMAC holdings to Cerberus so that GM would own less than 24.9 percent of the voting shares and would have no controlling interest in GMAC. Transforming into a bank holding company would enable GMAC to participate in Treasury’s Capital Purchase Program. Additionally, since Cerberus owns 80.1 percent of Chrysler, which is in merger talks with GM, the companies may be able to structure a deal in which Cerberus would exchange Chrysler shares for GMAC shares.

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Developments surrounding the Treasury's Capital Purchase Program (CPP) in recent days are causing the Department to take a hard look at the justifications for federal investment in industries beyond those federally regulated. Appeals from the insurance and the auto industry are both being reviewed.

It appears the insurance industry proposals are getting the strongest consideration at present, but there are clearly some cross-currents at work that are complicating the decision about whether or not to include them in the CPP. Reflecting that duality, Treasury’s assistant secretary for financial institutions, David Nason, appeared on CNBC’s "Squawk Box" this morning and indicated that there is some difficulty for Treasury to assess the capital needs of an industry that does not fall under federal regulation. He noted that while for the banking industry Treasury is relying on federal regulatory agencies, there is no such federal role in the insurance industry. On the other hand, he noted that it may be important for the stability of the financial sector to expand the CPP to cover insurance. Treasury is evaluating that question as well.

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Events of yesterday continued to demonstrate how major elements of the current financial crisis are interrelated. First, with the world waiting to see how a new administration in Washington will approach the financial crisis, President Bush's announcement of a November 15 summit of international leaders puts the discussion of a new regulatory regime for the financial sector squarely in the middle of the U.S. presidential transition. While both Sens. John McCain and Barack Obama praised the summit, it will present the winner of the November 4 election with an interesting quandary—how to participate in and/or react to the event. It may also force the hand of the President-Elect to name his economic team before the summit takes place. Doing so will allow the administration-in-waiting to have a more organized response to the events of the summit.

Second, the impacts of the financial crisis on the U.S. auto industry may be putting additional pressure on the $700 billion rescue package enacted on October 3. As potential car buyers continue to face a credit crunch, bipartisan leaders of the Michigan congressional delegation yesterday urged the Treasury to make a portion of the funds available to back auto loans. The request came from House Energy and Commerce Committee Chair John Dingell (D-MI) and Rep. Fred Upton (R-MI). If Treasury takes up that suggestion, funds available to supply capital to community banks or purchased troubled mortgages would be reduced.

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Testimony from academics and industry during today’s House Financial Services Committee hearing produced broad bipartisan consensus that the current regulatory structure is outdated. Testifying on behalf of industry were leaders from the Independent Community Bankers Association (ICBA), the Financial Services Roundtable, the American Bankers Association (ABA), and the Securities Industry and Financial Markets Association. As the committee’s first major hearing following the federal financial rescue efforts, it covered a wide swath of issues outlined below. 

• Creation of a Select Committee on Financial Reform—Chairman Barney Frank and several members supported this idea. In addition to Financial Services Committee members, a select committee would include members from the House Committees on Oversight and Government Reform, Agriculture, and Ways and Means. One of the academic witnesses, University of Rochester President Joel Seligman, suggested a commission modeled after the 9-11 Commission. 
• Derivatives—What role did credit default swaps play in the financial crisis? Should there be increased capitalization requirements for derivatives’ issuers? The questions remain, but most agreed on the need for increased oversight of complex financial derivatives. 

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Reports in the media today indicate that the Treasury Department is considering using part of the $250 billion from the initial tranche of financial rescue money to support acquisitions by stronger banks of weaker ones. In retrospect, there was a foretelling of this strategy in the announcement of the initial round of recapitalization transactions with the "big 9" institutions. At that time, Treasury announced that of the $25 billion given both to Bank of America and Wells Fargo, a $5 billion portion in each case was to support their recent acquisitions.

This new emphasis on restructuring the banking system raises some important questions about how deep the Treasury Department plans to go in assisting banks farther down the food chain. On Monday, Secretary Paulson indicated that all "qualifying" regional and community banks would receive capital under the recapitalization program—implying that assistance would not be limited due to a lack of available funds. At the same time, however, Treasury has made it clear that not all applications for capital infusion will be accepted.

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A short time ago, Treasury Secretary Hank Paulson announced some much-awaited details about the Department’s Capital Purchase Program (CPP). The Treasury will invest $250 billion of capital to U.S. financial institutions in the form of preferred stock. Nine of the largest banks have already agreed to participate in the CPP, which leaves $125 billion remaining. Paulson stressed that the program will not be implemented on a first-come-first-served basis, stating, "Sufficient capital has been allocated so that all qualifying banks can participate."

The Department has developed a single application form for qualified, interested banks to submit to their primary federal regulator—the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of Comptroller of the Currency, or the Office of Thrift Supervision. Once a bank’s primary regulator reviews the application, the regulator will forward the bank’s application to Treasury’s Office of Financial Stability for approval. Paulson said Treasury will "give considerable weight" to the recommendations of the federal regulators. The terms will be the same for all applicants, and regulators will use a standardized review process. Treasury will announce all transactions within 48 hours of execution; however, the Treasury will not publicly reveal any applications that are withdrawn or denied. The application deadline remains November 14, 2008.

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Many unresolved issues continue to surround the financial relief program as evidenced by a flurry of diverse actions today. The nation’s banking regulators—the Federal Reserve, the Federal Deposit Insurance Agency, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision—issued a joint release about tax relief for banking organizations that have suffered losses on their Fannie Mae and Freddie Mac holdings. The regulators will allow banking organizations “to recognize the effect of the tax change enacted in Section 301 of the Emergency Economic Stabilization Act of 2008 (EESA) in their third quarter 2008 regulatory capital calculations.” Without today’s decision, banking institutions would not have seen any tax benefit until the fourth quarter of 2008.

Also today, leaders of the Independent Community Bankers Association (ICBA) met with President Bush and Secretary Paulson to discuss the Treasury’s capital purchase program. The FDIC will be the main overseer of that program; however, institutions’ primary regulators (e.g., OCC or OTS) will assist the FDIC. The Treasury has released some details of the program, but according to an ICBA press release, more details are needed. Association leaders urged Treasury to provide “details on how mutual, Subchapter S corporation, privately held and non-publicly traded community banks can participate.”

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As the stock market continues its seesaw sessions this week, the Treasury Department is focusing on implementation of the programs that flow from the financial rescue package assembled in recent weeks.

After Monday's announcement of the capital infusion to the nine largest US banks, attention is turning to the thousands of community and regional banks nationwide that may be eligible for assistance from the capital purchase program. The Treasury Department has announced that November 14 is the deadline for institutions to get their applications in for assistance under the program. Our report on Tuesday, October 14 included the details of the capital purchase program.

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World stock markets responded well this morning to the emerging consensus among European and U.S. officials to focus on capitalizing banks with government funds in exchange for an ownership stake in them. Wednesday's announcement from U.K. Prime Minister Gordon Brown that he plans to inject capital directly into banks and to guarantee interbank lending accelerated momentum for similar moves by the United States and European central bankers. Meetings on Friday and over the weekend among the G7 finance ministers and at the International Monetary Fund in Washington helped to bring these key players into alignment.

Meanwhile, the Treasury Department took further steps to implement the Troubled Asset Relief Program (TARP). In a speech this morning before the Institute of International Bankers, acting assistant secretary of the Office of Financial Stability (OFS) Neel Kashkari outlined progress and the seven internal policy teams established to execute the TARP: 

1. Mortgage-backed Securities Purchase Program—will examine which assets to purchase, from whom, and how
2. Whole Loan Purchase Program—will work with bank regulators to determine which loans to purchase first, how to value them, and how to purchase them
3. Insurance Program—on Friday, Treasury solicited public comments on how to insure troubled assets; comments are due within 14 days, at which point OFS will develop the program
4. Equity Purchase Program—will establish a standardized program to buy equity in a broad array of financial institutions; program will be voluntary with attractive terms so healthy institutions will participate and also raise private capital to complement public capital
5. Homeownership Preservation—will work with the Department of Housing and Urban Development to help homeowners when the Treasury purchases mortgages and mortgage-backed securities
6. Executive Compensation Program—will define firms’ participation requirements for three scenarios: auction purchase of troubled assets, broad equity or direct purchase program, and an intervention to prevent the failure of a systemically significant firm
7. Compliance Program—will set up the Oversight Board, the on-site participation of the General Accounting Office, the selection of a special inspector general, and all the reporting mechanisms

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Leading negotiators from the House and Senate began a negotiating session at noon today with a goal to work as long as it takes to resolve the 15 issues remaining on the table. They are taking a break as we write this, with plans to return to their discussions this evening. Secretary Paulson is in the Capitol to assist the negotiators and ensure the Administration's views are being taken into account. Momentum continues to build towards the announcement of a deal by Sunday afternoon. Leaders of the House and Senate hope to have votes on Monday, but the complexities of drafting the legislation may require that votes be pushed off until after Rosh Hashanah which ends on Tuesday at sundown.

As this afternoon's negotiating session began Sens. Judd Gregg (R-NH) and Mitch McConnell (R-KY) both said the Senators and Representatives meeting today would stay in the room until a deal was reached. While that may be over-optimistic, it is indicative of the fact that these leaders are feeling pressure to get something accomplished.

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Momentum continues to build for enactment of the $700 billion Administration plan to buy troubled assets from financial institutions. As an indicator of the increasingly upbeat mood around the package, the Dow Jones Industrial Average increased by over 200 points for the day.

As we write this, President Bush is meeting with Sens. McCain and Obama and Congressional leaders to discuss how to advance the plan. While this meeting is viewed by many as a sideshow, a forceful statement by the sitting president and the two men seeking to replace him will add to the overall sense that action on Capitol Hill is soon possible.

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Spending their every waking hour on Capitol Hill trying to convince lawmakers to accept the financial bailout plan may finally be paying off for Treasury Secretary Paulson and Fed Chairman Bernanke. Reports coming out of meetings held this morning and early afternoon have been decidedly more upbeat than anything we have heard thus far.

In addition to testifying at hearings and briefing large groups, Paulson held a private meeting earlier with House Speaker Nancy Pelosi (D-CA) and Minority Leader John Boehner (R-OH). While aides would not confirm whether the leaders and Paulson struck an agreement, there are signs the administration has made changes to the Paulson plan. In his House Banking Committee testimony this afternoon, close watchers noted that Paulson modified his remarks to allow for a compromise on limiting executive compensation as long as it does not "undermine the effectiveness of the program."

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This morning’s Senate Banking Committee hearing was still continuing as the Bush Administration, House Banking Committee Chairman Barney Frank (D-MA), and House leadership were making plans for an urgent briefing today at 4 p.m. to convince House members to agree to the Treasury’s Troubled Asset Relief Program (TARP). Press reports about this morning’s House Democratic and Republican conference meetings characterized members’ reactions as “resistant.” Our sources on the Hill and off are saying the meetings were worse than reported, and the mood at both was antagonistic. As of now, the House does not have anywhere near the 218 votes needed to pass the Treasury plan, even with Chairman Frank’s endorsement.

Members of the Senate Banking Committee, including Sen. Chuck Schumer (D-NY), questioned whether the TARP could be funded in installments, precluding the need for Congress to authorize $700 billion in one lump sum. However, both Federal Reserve Chairman Bernanke and Paulson rejected the suggestion, saying that bolstering consumer confidence requires Treasury to have the full $700 billion authority, even if they do not utilize the entire amount. Both Paulson and Bernanke repeated on several occasions that lawmakers must not view the $700 billion as an expenditure, but as an investment that would be recovered – though perhaps not in full – over time.

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While congressional leaders and the Administration continue to make progress in developing a compromise $700 billion package to shore up the financial markets, this morning’s news is that skeptics in both parties are making their voices heard very strongly. This skepticism is not likely to derail the plan altogether, but it may slow its path to enactment.

Events in public and in private this morning have brought out the opponents of Secretary Paulson’s plan. A public hearing at the Senate Banking Committee began at 10 a.m. this morning and continues as this is written. At the hearing, Fed Chairman Ben Bernanke emphasized the importance of quick action on the plan. He said financial institutions continue to be at risk and the pending plan will be important to staving off further failures. Secretary Paulson pressed again for a “clean” piece of legislation (meaning with minimal add-ons) but also telegraphed some flexibility on issues like oversight and mortgage assistance for homeowners. Members of the committee from both sides of the aisle hit the Administration hard for pushing a plan that appears to be a “blank check” for the Treasury Secretary.

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Congress and the Administration have made significant progress today in refining the proposal released Saturday by Treasury Secretary Hank Paulson for a $700 billion purchase by the government of troubled financial assets. Prospects remain strong for Congress and the Administration to adopt a plan by the end of the week.

Between the release of the plan on Saturday and the opening of the markets today, Paulson made two important changes to his original plan. The first change was to broaden the class of assets eligible for purchase to include non-mortgage assets as deemed necessary. The second change was to allow foreign institutions with a significant US presence to participate in the asset purchase program.

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The Treasury Department this past weekend submitted legislation to the Congress requesting authority to purchase troubled assets from financial institutions in order to promote market stability, and help protect American families and the US economy. This program is intended to fundamentally and comprehensively address the root cause of our financial system's stresses by removing distressed assets from the financial system.

The following description reflects Treasury's proposal as of Saturday afternoon.

Scale and Timing of Asset Purchases. Treasury will have authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets. The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. The Secretary will have the discretion, in consultation with the Chairman of the Federal Reserve, to purchase other assets, as deemed necessary to effectively stabilize financial markets. The timing and scale of any purchases will be at the discretion of Treasury and its agents, subject to this total cap. The price of assets purchases will be established through market mechanisms where possible, such as reverse auctions. The dollar cap will be measured by the purchase price of the assets. The authority to purchase expires two years from date of enactment.

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