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Proposed Treasury Bill to Purchase Troubled Assets - What it Says and What it Means to You
Credit Crisis Update
September 2008
Authors: Stephen B. Selbst

Read this quickly. By the time you finish it, the sands may have shifted again.

It's mid-morning on Tuesday, and you are no doubt aware that Congress stands on the brink of an unprecedented and historic intervention in the capital markets. The Treasury Department's proposed $700 billion program to purchase troubled assets from financial institutions is intended to address the underlying cause of the financial system's weakness by removing distressed assets from the balance sheets of participating financial institutions.

The Treasury Department's original proposal was only two pages long and raised more questions than it answered. Significant changes to it since Saturday still leave plenty of issues to be resolved. We explain below what it says as of today, and what it means to you. We will continue to monitor the progress of discussions regarding this important bill and will update you as necessary.

Covered Assets. The Treasury Department says it will use the funds to purchase residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. Although mortgages and mortgage-backed securities are the cause of the current crisis, the current bill does not limit Treasury's authority to acquiring this asset class Under the broad language of the bill, Treasury could acquire other types of consumer loans, such as auto or bank loans or credit card receivables. The bill says that Treasury will have the discretion necessary to stabilize financial markets, including the timing and scale of any purchases. The bill does not describe how Treasury will set the prices to be paid for troubled assets

Asset and Institutional Eligibility for the Program. To qualify for the program, assets must have been originated or issued on or before September 17. Participating financial institutions must have significant operations in the U.S., unless the Secretary of the Treasury determines that broader eligibility is necessary to effectively stabilize financial markets. One question is how "financial institution" will be defined. Clearly banks are intended to be covered, but the draft bill does not yet define which other financial institutions it will cover.

Management and Disposition of the Assets. Private asset managers will manage the assets at Treasury's direction. Treasury will have full authority over the management of the assets as well as the exercise of any rights received in connection with the purchase of the assets. Treasury may sell assets or hold them to maturity. Cash received from liquidating the assets, including any appreciation on the assets, will be returned to Treasury's general fund for the benefit of American taxpayers. The bill does not yet provide any meaningful guidance on how Treasury will dispose of these assets.

Funding. Treasury will fund the program directly from its general fund Borrowing in support of this program will be subject to the national debt limit, which will be increased by $700 billion accordingly. One issue is the ultimate cost. Is the program a one-time authorization of $700 billion, or is it a revolving fund of up to $700 billion outstanding at any time? In other words, as Treasury receives payment for assets it sells, can it use the proceeds to buy more assets?

Reporting. Within three months of the first asset purchase under the program, and semi-annually thereafter, Treasury will provide Congress with periodic updates on the program.

The Political Layer. The Democrats have voiced general support for the Administration's proposal but are pushing for some key changes. They want:

  • the government to receive equity stakes in institutions that sell assets, to ensure that taxpayers benefit from any profitability;
  • limits on executive compensation at participating institutions; and
  • increased transparency, mostly in the form of possible judicial review of the program, which is excluded in the current iteration of the bill.

Conclusion. The Administration is making its case for immediate passage of aggressive legislation that allows for Treasury's absolute discretion, and some in Congress are urging a brief pause for reflection and resolution of outstanding issues. Meanwhile, we note with interest, the Federal Reserve just announced that in a reversal of longstanding policy, it will allow buyout firms and private investors to take major stakes in banks. This move, which attempts to increase available capital and liquidity without tapping further into taxpayer-generated dollars, is at least a nod toward the finite tolerance of taxpayers to finance the bailout.

While the legislation and related government action take final shape:

  • institutional lenders should assess their portfolios and consider what might qualify for sale to the government, and
  • investors should begin to position themselves to seize opportunity and buy at deep discounts when the time and prices are right.

Please contact Stephen Selbst at (212) 592-1405 or if you have any questions regarding this update.

Copyright © 2008 Herrick, Feinstein LLP. The Credit Crisis Update  is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.