View PDF

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

CONGRESSIONAL OVERSIGHT PANEL

APRIL OVERSIGHT REPORT *

ASSESSING TREASURY’S STRATEGY:
SIX MONTHS OF TARP

APRIL 7, 2009.—Ordered to be printed

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00001

Fmt 6012

Sfmt 6012

E:\HR\OC\A565.XXX

A565

E:\Seals\Congress.#13

mstockstill on PROD1PC66 with HEARING

* Submitted under Section 125(b) of Title 1 of the Emergency Economic
Stabilization Act of 2008, Pub. L. No. 110–343

mstockstill on PROD1PC66 with HEARING

CONGRESSIONAL OVERSIGHT PANEL APRIL OVERSIGHT REPORT

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00002

Fmt 6019

Sfmt 6019

E:\HR\OC\A565.XXX

A565

1

CONGRESSIONAL OVERSIGHT PANEL

APRIL OVERSIGHT REPORT *

ASSESSING TREASURY’S STRATEGY:
SIX MONTHS OF TARP

APRIL 7, 2009.—Ordered to be printed

U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON

48–565

:

2009

For sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800
Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00003

Fmt 5012

Sfmt 5012

E:\HR\OC\A565.XXX

A565

E:\Seals\Congress.#13

mstockstill on PROD1PC66 with HEARING

* Submitted under Section 125(b) of Title 1 of the Emergency Economic
Stabilization Act of 2008, Pub. L. No. 110–343

CONGRESSIONAL OVERSIGHT PANEL
PANEL MEMBERS
ELIZABETH WARREN, Chair
SEN. JOHN SUNUNU
REP. JEB HENSARLING
RICHARD H. NEIMAN

mstockstill on PROD1PC66 with HEARING

DAMON SILVERS

(II)

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00004

Fmt 5904

Sfmt 5904

E:\HR\OC\A565.XXX

A565

CONTENTS
Page

mstockstill on PROD1PC66 with HEARING

Executive Summary .................................................................................................
Section One: Assessing TARP Strategy .................................................................
A. The Federal Government’s Current Strategy ............................................
B. Historical Approaches and Lessons ............................................................
C. Europe: Current Crises and Response .......................................................
D. Taking Stock: Options for Moving Forward ..............................................
Section Two: Additional Views ...............................................................................
A. Richard H. Neiman and John E. Sununu ..................................................
B. John E. Sununu ...........................................................................................
Section Three: Correspondence with Treasury Update ........................................
Section Four: TARP Updates Since Last Report ...................................................
Section Five: Oversight Activities ..........................................................................
Section Six: About the Congressional Oversight Panel ........................................
Appendices:
APPENDIX I: LETTER FROM TREASURY SECRETARY MR. TIMOTHY
GEITHNER TO CONGRESSIONAL OVERSIGHT PANEL CHAIR
ELIZABETH WARREN, DATED APRIL 2, 2009 ......................................
APPENDIX II: LETTER FROM CHAIRMAN OF THE FEDERAL RESERVE BOARD OF GOVERNORS MR. BEN BERNANKE TO CONGRESSIONAL OVERSIGHT PANEL CHAIR ELIZABETH WARREN,
DATED APRIL 1, 2009 .................................................................................
APPENDIX III: LETTER FROM CONGRESSIONAL OVERSIGHT
PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY
MR. TIMOTHY GEITHNER, DATED MARCH 30, 2009 ..........................
APPENDIX IV: LETTER FROM CONGRESSIONAL OVERSIGHT
PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY
MR. TIMOTHY GEITHNER, DATED MARCH 25, 2009 ..........................
APPENDIX V: LETTER FROM CONGRESSIONAL OVERSIGHT
PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY
MR. TIMOTHY GEITHNER, DATED MARCH 24, 2009 ..........................
APPENDIX VI: LETTER FROM CONGRESSIONAL OVERSIGHT
PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY
MR. TIMOTHY GEITHNER, DATED MARCH 20, 2009 ..........................
APPENDIX VII: LETTER FROM CONGRESSIONAL OVERSIGHT
PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY
MR. TIMOTHY GEITHNER, DATED MARCH 5, 2009 ............................
APPENDIX VIII: LETTER FROM CONGRESSIONAL OVERSIGHT
PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY
MR. TIMOTHY GEITHNER, DATED JANUARY 28, 2009 ......................
(III)

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00005

Fmt 5904

Sfmt 0483

E:\HR\OC\A565.XXX

A565

1
5
6
27
49
57
74
74
77
79
81
83
84

85

94

109

116

119

123

129

132

mstockstill on PROD1PC66 with HEARING

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00006

Fmt 5904

Sfmt 0483

E:\HR\OC\A565.XXX

A565

APRIL OVERSIGHT REPORT

APRIL 7, 2009.—Ordered to be printed

EXECUTIVE SUMMARY *

mstockstill on PROD1PC66 with HEARING

With this report, the Congressional Oversight Panel examines
Treasury’s current strategy and evaluates the progress it has
achieved thus far. This report returns the Panel’s inquiry to a central question raised in its first report: What is Treasury’s strategy?
While there is disagreement among Panel members about whether
it is appropriate to present alternatives to Treasury’s strategy at
this time, this report also examines potential policy alternatives
available to Treasury, in the event such alternatives become necessary.
This report comes on the six month anniversary of the passage
of the Emergency Economic Stabilization Act of 2008 (EESA). In a
letter received by the Panel on April 2, 2009, Treasury Secretary
Timothy Geithner described four major challenges that Treasury’s
strategy seeks to address: (1) the collapse of the housing market;
(2) frozen secondary markets that ‘‘have constrained the ability of
even creditworthy small businesses and families’’ to get credit; (3)
uncertainty about the health of financial institutions and the valuation of assets on their balance sheets; and (4) the existence of
‘‘troubled legacy assets’’ on the balance sheets of financial institutions that affect their capitalization and limit their ability to make
loans. The Panel appreciates Treasury’s explanation of its goals,
and it hopes this report inspires a more informed conversation over
the fundamental questions raised by Treasury’s strategy.
In addition to drawing on the $700 billion allocated to Treasury
under the EESA, economic stabilization efforts have depended
heavily on the use of the Federal Reserve Board’s balance sheet.
* The Panel adopted this report with a 3–2 vote. Senator John E. Sununu and Rep. Jeb
Hensarling voted against the report. Additional views are available in Section 2.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00007

Fmt 6659

Sfmt 6602

E:\HR\OC\A565.XXX

A565

mstockstill on PROD1PC66 with HEARING

2
This approach has permitted Treasury to leverage TARP funds well
beyond the funds appropriated by Congress. Thus, while Treasury
has spent or committed $590.4 billion of TARP funds, according to
Panel estimates, the Federal Reserve Board has expanded its balance sheet by more than $1.5 trillion in loans and purchases of government-sponsored enterprise (GSE) securities. The total value of
all direct spending, loans and guarantees provided to date in conjunction with the federal government’s financial stability efforts
(including those of the Federal Deposit Insurance Corporation
(FDIC) as well as Treasury and the Federal Reserve Board) now
exceeds $4 trillion. This report reviews in considerable detail specific criteria for evaluating the impact of these programs on financial markets. Six months into the existence of TARP, evidence of
success or failure is mixed.
Evaluating the wisdom and success of these efforts requires a
broader understanding of the basic choices available to policymakers during this crisis. To deal with a troubled financial system,
three fundamentally different policy alternatives are possible: liquidation, receivership, or subsidization. To place these alternatives
in context, the report evaluates historical and contemporary efforts
to confront financial crises and their relative success. The Panel focused on six historical experiences: (1) the U.S. Depression of the
1930s; (2) the bank run on and subsequent government seizure of
Continental Illinois in 1984; (3) the savings and loan crisis of the
late 1980s and establishment of the Resolution Trust Corporation;
(4) the recapitalization of the FDIC bank insurance fund in 1991;
(5) Sweden’s financial crisis of the early 1990s; and (6) what has
become known as Japan’s ‘‘Lost Decade’’ of the 1990s. The report
also surveys the approaches currently employed by Iceland, Ireland, the United Kingdom, and other European countries.
Experiences from other times and other countries illustrate the
benefits and problems these basic approaches present to dealing
with failing banks. In the 1980s savings and loan crisis, for example, the U.S. government liquidated unhealthy financial institutions by transferring depositors to another bank, selling off assets,
writing down some debt and wiping out investors. There can be
considerable political barriers to this approach, and a surprise or
poorly-explained liquidation can reduce market confidence and
heighten uncertainty about future government interventions in financial markets. But liquidation also avoids the uncertainty and
open-ended commitment that accompany subsidization. It can restore market confidence in the surviving banks, and it can potentially accelerate recovery by offering decisive and clear statements
about the government’s evaluation of financial conditions and institutions.
Another option is government reorganization of troubled financial institutions using conservatorships, as in the case of Continental Illinois in the U.S. and the financial crisis in Sweden in the
1990s. This approach entails an in-place reorganization in which
bad assets are removed, failed managers are replaced, and parts of
the business are spun off. Depositors and some bondholders are
protected, and institutions can emerge from government control
with the same corporate identity but healthier balance sheets. This
option also offers clarity to markets about the balance sheets of the
reorganized financial institutions and encourages capital invest-

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00008

Fmt 6659

Sfmt 6602

E:\HR\OC\A565.XXX

A565

mstockstill on PROD1PC66 with HEARING

3
ment in the newly-reorganized entity. But reorganization can also
tax government capacity and resources. If they are not quickly returned to private hands, government-run financial institutions also
pose a risk that political pressure will press the institutions to lend
to favored interests and support public policy at the expense of the
bank’s health, although there is no evidence that this has occurred
in recent banking crises.
The third option is government subsidization of troubled institutions. Japan’s approach was characterized by a series of direct and
indirect subsidizations. Subsidies may be direct, by providing
banks with capital infusions, or indirect, by purchasing troubled assets at inflated prices or reducing prudential standards. Cash assistance can provide banks with bridge capital necessary to survive
in tough economic times until growth begins again. But subsidies
carry a risk of obscuring true valuations. They involve the added
danger of distorting both specific markets and the larger economy.
Subsidization also carries a risk that it will be open-ended, propping up insolvent banks for an extended period and delaying economic recovery.
A review of these historical precedents reveals that each successful resolution of a financial crisis involved four critical elements:
• Transparency. Swift action to ensure the integrity of bank
accounting, particularly with respect to the ability of regulators
and investors to ascertain the value of bank assets and hence assess bank solvency.
• Assertiveness. Willingness to take aggressive action to address failing financial institutions by (1) taking early aggressive action to improve capital ratios of banks that can be rescued, and (2)
shutting down those banks that are irreparably insolvent.
• Accountability. Willingness to hold management accountable
by replacing—and, in cases of criminal conduct, prosecuting—failed
managers.
• Clarity. Transparency in the government response with forthright measurement and reporting of all forms of assistance being
provided and clearly explained criteria for the use of public sector
funds.
Historical precedents always involve some differences from the current crises. Nonetheless, experience can provide an important comparison against which current approaches can be tested.
One key assumption that underlies Treasury’s approach is its belief that the system-wide deleveraging resulting from the decline in
asset values, leading to an accompanying drop in net wealth across
the country, is in large part the product of temporary liquidity constraints resulting from nonfunctioning markets for troubled assets.
The debate turns on whether current prices, particularly for mortgage-related assets, reflect fundamental values or whether prices
are artificially depressed by a liquidity discount due to frozen markets—or some combination of the two.
If its assumptions are correct, Treasury’s current approach may
prove a reasonable response to the current crisis. Current prices
may, in fact, prove not to be explainable without the liquidity factor. Even in areas of the country where home prices have declined
precipitously, the collateral behind mortgage-related assets still retains substantial value. In a liquid market, even under-collateral-

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00009

Fmt 6659

Sfmt 6602

E:\HR\OC\A565.XXX

A565

4

mstockstill on PROD1PC66 with HEARING

ized assets should not be trading at pennies on the dollar. Prices
are being partially subjected to a downward self-reinforcing cycle.
It is this notion of a liquidity discount that supports the potential
of future gain for taxpayers and makes transactions under the CAP
and the PPIP viable mechanisms for recovery of asset values while
recouping a gain for taxpayers.
On the other hand, it is possible that Treasury’s approach fails
to acknowledge the depth of the current downturn and the degree
to which the low valuation of troubled assets accurately reflects
their worth. The actions undertaken by Treasury, the Federal Reserve Board and the FDIC are unprecedented. But if the economic
crisis is deeper than anticipated, it is possible that Treasury will
need to take very different actions in order to restore financial stability.
By offering this assessment of Treasury’s current approach and
identifying alternative strategies taken in the past, the Panel
hopes to assist Congress and Treasury officials in weighing the
available options as the nation grapples with the worst financial
crisis it has faced since the Great Depression.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00010

Fmt 6659

Sfmt 6602

E:\HR\OC\A565.XXX

A565

5
SECTION ONE: ASSESSING TARP STRATEGY

mstockstill on PROD1PC66 with HEARING

This is the fifth TARP oversight report of the Congressional
Oversight Panel. In our first and second reports, we asked the
question, ‘‘What is Treasury’s strategy?’’ In the absence of a clear
answer to that question, in our third report, we looked at whether
Treasury’s programs produced a clear value for the taxpayer by
valuing the preferred stock that Treasury had purchased using
TARP funds. In our fourth report, we looked in detail at the mortgage crisis, a key component of the financial crisis that gave rise
to the TARP. Now we return to the issue of strategy as a new Administration begins to announce its intentions in detail for the
TARP.
This report takes up four related topics: (1) an analysis of Treasury’s strategy, (2) a preliminary assessment of the direction of key
financial and economic indicators since the inception of the TARP,
(3) a detailed analysis, comprising the majority of this report, of approaches to bank crises historically, and (4) an analysis of the alternatives facing Treasury. The Panel strongly believes that Treasury should continue to explain its strategy to Congress and the
public. Financial institutions, businesses, and consumers are more
likely to return to healthy investment in the economy if they believe that the federal government is following an intelligible road
map. Articulating a clear strategy for financial stabilization would
have the following benefits:
• Public Confidence. If Treasury is frank in its explanation
of its strategy and transparent in its execution, Congress and
the public will have greater confidence that taxpayer dollars
are being used appropriately or, conversely, will be able to engage with the Administration in an informed manner to advocate change.
• Expectations. A clear strategy that sets forth the guiding
principles for future actions by the Administration, including
the FDIC and the Federal Reserve Board, would provide the
public with a basis for planning future investment and consumption.
• Metrics and Accountability. A clear strategy will also provide Congress and the public with standards and metrics by
which to measure its progress and judge its success.
The six month anniversary of the enactment of the TARP 1 presents a useful opportunity for the Panel to assess TARP strategy
to date and review alternative courses of action for moving forward
with this massive financial rescue program. This report will discuss
ways to stabilize and rebuild our nation’s banking system, based
both on current expert and government analyses and on the experiences—good and bad—of similar efforts in the past and elsewhere
in the world. These alternative approaches will provide Congress
and Treasury with a framework for considering course changes
should they become necessary.
1 The Emergency Economic Stabilization Act of 2008 (EESA), Pub. L. No. 110–343, passed on
October 3, 2008.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00011

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

6
A. The Federal Government’s Current Strategy

mstockstill on PROD1PC66 with HEARING

In a letter sent on April 2, 2009, Secretary Geithner provided the
Panel with a description of Treasury’s strategy for combating the
financial crisis. Secretary Geithner described four major challenges
that Treasury’s strategy seeks to address: (1) the collapse of the
housing market; (2) frozen secondary markets that ‘‘have constrained the ability of even creditworthy small businesses and families’’ to get credit; (3) uncertainty about the health of financial institutions and the valuation of assets on their balance sheets; and
(4) the existence of ‘‘troubled legacy assets’’ on the balance sheets
of financial institutions that affect their capitalization and limit
their ability to make loans. The letter describes the manner in
which each of Treasury’s programs addresses these challenges. The
Panel commends Treasury for this response, but believes that a
clearer understanding of Treasury’s strategy is discernable from
statements made by senior officials and Treasury’s latest TARP initiatives. The Panel believes that Treasury’s strategy can be described as follows:
• Address Bank Solvency and Capitalization. This was accomplished first through the Capital Purchase Program (CPP) and
the Systemically Significant Failing Institutions (SSFI) Program,
then through the Targeted Investment Program (TIP), and, in the
future, will be accomplished through the Capital Assistance Program (CAP). The PPIP will leverage public and private capital to
create markets for troubled assets in order to remove them from
the balance sheets of financial institutions.
• Increase Availability of Credit in Key Markets. Treasury
is coordinating with the Federal Reserve Board and FDIC to restart key credit markets through the establishment of Federal Reserve Board lending facilities targeting money and capital markets.
Another facility, the Term Asset-Backed Securities Lending Facility
(TALF), is designed to restart secondary markets to increase lending for auto sales, college loans, credit cards and small businesses.
One of the two components of the PPIP is designed to revive markets for mortgage-backed securities (MBS). This effort is also an
element of continuity between the current and previous administrations.
• Assess the Health of Financial Institutions. The first step
of the CAP is a coordinated supervisory assessment, the so-called
‘‘stress test,’’ that will provide regulators with an analysis of the
ability of the 19 largest banks to withstand worse-than-anticipated
economic conditions. In conformity with Treasury’s assumptions,
regulators will be relying extensively on the work of the incumbent
financial management of the 19 firms in making these assessments.
• Directly Address the Foreclosure Crisis. The Administration’s housing plan, examined in the Panel’s March oversight report,2 seeks to help families and stabilize real estate values in communities with high levels of foreclosures, thus contributing to a revival of real estate values.
2 Congressional Oversight Panel, Foreclosure Crisis: Working Toward a Solution (Mar. 6,
2009) (hereinafter ‘‘Panel March Oversight Report’’).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00012

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

7
• Increase Long-Term Confidence Through Regulatory
Reform. While regulatory reform will not be discussed at great
length in this report, it is clear that Treasury believes that a comprehensive plan for reforming financial regulation will boost market confidence.3
Treasury’s expectation is that these measures, in concert, will
keep the large banks afloat until the economy revives, propelled by
the liquidity provided by TALF and the resolution of housing market and household finance weakness that will come from addressing the foreclosure crisis. The revival of the economy will lead to
recovery of the asset side of bank balance sheets and a return of
the major banks to health.
Treasury’s strategy is profoundly linked to Treasury’s assumptions about the nature of major financial institution weakness,
about the proper role for government when it has invested in private financial institutions, and whether the value of troubled assets
can be restored through programs like PPIP and TALF. The discussion below examines this strategy in greater detail and offers some
initial evaluation of Treasury’s efforts to stabilize the financial system. This section also examines several key metrics of economic
performance.
1. COP EFFORTS TO ASCERTAIN TREASURY’S STRATEGY

mstockstill on PROD1PC66 with HEARING

The Panel’s conclusions about Treasury’s strategy laid out above
are in part based on Secretary Geithner’s April 2 letter explaining
Treasury’s understanding of the origins of the crisis and describing
the Department’s strategy, in part derived from public statements
by senior officials, and in part inferred from Treasury’s actions.
The Panel has pressed Treasury for a clear statement of its strategy for stabilizing the financial system since it first posed the question in its initial oversight report in December 2008.4 In recognition of the value of a clear strategy to well-functioning markets, the
Panel sought an answer to this question from Treasury in its January report and in a pair of letters sent to Secretary Geithner.5 The
findings of the Panel’s February Valuation report, which revealed
that Treasury provided the top ten TARP recipients with a subsidy
of $78 billion over the market value of the preferred shares purchased,6 despite Treasury’s representations of these purchases as
3 House Committee on Financial Services, Testimony of Timothy F. Geithner, Addressing the
Need for Comprehensive Regulatory Reform, 111th Cong. (Mar. 26, 2009) (‘‘These failures have
caused a great loss of confidence in the basic fabric of our financial system, a system that over
time has been a tremendous asset for the American economy. To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game.’’).
4 See Congressional Oversight Panel, Questions About the $700 Billion Emergency Economic
Stabilization Funds, at 4–8 (Dec. 10, 2008) (hereinafter ‘‘Panel December Oversight Report’’).
5 See Congressional Oversight Panel, Accountability for the Troubled Asset Relief Program, at
5 (Jan. 9, 2009) (hereinafter ‘‘Panel January Oversight Report’’); Appendix VIII infra, Letter
from Elizabeth Warren, Chairperson, Congressional Oversight Panel to Timothy Geithner, Secretary of the Treasury (Jan. 28, 2009) (requesting that Secretary Geithner respond to unanswered questions remaining from the previous two reports); Appendix VI infra, Letter from Elizabeth Warren, Chairperson, Congressional Oversight Panel to Timothy Geithner, Secretary of
the Treasury (Mar. 5, 2009) (requesting that Treasury provide a detailed explanation of its
strategy and respond to three specific questions about strategy).
6 See Congressional Oversight Panel, February Oversight Report: Valuing Treasury’s Acquisitions (Feb. 6, 2009) (hereinafter ‘‘Panel February Oversight Report’’).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00013

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

8
being made ‘‘at par,’’ 7 reinforced the importance of a comprehensive explanation by Treasury of its strategy and approach. While
the Panel understands the difficulties faced by both the Bush Administration and the Obama Administration in managing the policy response to the financial crisis while going through a change in
administrations, the need for a clearly articulated strategy remains
paramount. We are pleased that Secretary Geithner will appear before the Panel on April 21, we appreciate his April 2 letter to the
Panel, and we look forward to learning more in the coming weeks
about Treasury’s strategy.
2. AN EXAMINATION OF TREASURY’S STRATEGY

mstockstill on PROD1PC66 with HEARING

Explanations by the Secretary of the Treasury and by senior officials suggest that the Administration views the current crisis as a
vicious and self-reinforcing cycle that arose as a consequence of the
financial excesses of the past decade. Rapid drops in asset prices
and the collapse of millions of unsustainable subprime mortgages
led to losses both in the loans themselves and in a myriad of financial products built on those loans. Falling asset values and massive
losses prompted system-wide deleveraging by financial institutions.
This led to additional drops in prices, which prompted investors to
flee capital markets and secondary markets to freeze up. The end
result of these processes is a banking system reeling from losses
and undercapitalization. Secretary Geithner described these cycles
of losses and withdrawal from markets as a ‘‘dangerous dynamic’’
in which the ‘‘financial system is working against recovery.’’ 8 Lawrence Summers, Director of the National Economic Council, described this effect as ‘‘the paradox at the heart of the financial crisis,’’ adding, ‘‘In the past few years, we’ve seen too much greed and
too little fear; too much spending and not enough saving; too much
borrowing and not enough worrying. Today, however, our problem
is exactly the opposite.’’ 9 This diagnosis of the financial crisis is
driving the Administration’s aggressive interagency effort to revive
credit markets and strengthen the balance sheets of financial institutions through capital injections and the removal of toxic assets.
Yet this approach assumes that the decline in asset values and the
accompanying drop in net wealth across the country are in large
part the products of temporary liquidity discounts due to nonfunctioning markets for these assets and, thus, are reversible once market confidence is restored. While critics of this approach warn
against a more fundamental solvency problem plaguing the financial institutions holding onto these toxic assets,10 Treasury and key
7 U.S. Department of the Treasury, Responses to Questions of the First Report of the Congressional Oversight Panel for Economic Stabilization, at 8 (Dec. 30, 2008) (hereinafter ‘‘Treasury
December Response to Panel’’) (‘‘When measured on an accrual basis, the value of the preferred
stock is at or near par.’’).
8 U.S. Department of the Treasury, Remarks by Treasury Secretary Timothy Geithner Introducing the Financial Stability Plan (Feb. 10, 2009) (online at treas.gov/press/releases/tg18.htm)
(hereinafter ‘‘Geithner Financial Stability Statement’’).
9 Brookings Institution, Lawrence Summers on the Economic Crisis and Recovery (Mar. 13,
2009)
(online
at
www.brookings.edu/∼/media/Files/events/2009/0313lsummers/
0313lsummerslremarks.pdf) (hereinafter ‘‘Summers, Economic Crisis and Recovery’’).
10 See, e.g., Desmond Lachman, Obama Policies Have the U.S. on the Road to Deflation, American Banker (Apr. 1, 2009) (‘‘Particularly striking is the fact that instead of addressing the bank
insolvency issue head on, the Administration is choosing to continue the charade that the banks’
problems are largely those of liquidity rather than those of solvency.’’); Ian Bremmer and
Nouriel Roubini, Expect the World Economy to Suffer Through 2009, Wall Street Journal (Jan.
23, 2009) (‘‘The U.S. economy is, at best, halfway through a recession that began in December

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00014

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

9

mstockstill on PROD1PC66 with HEARING

policymakers in the Administration argue that the recently-passed
fiscal stimulus passage, Treasury’s foreclosure mitigation plan, and
the public-private program to revive markets for toxic assets will
strengthen the fundamental value of these assets.11
The Panel has held two field hearings examining the impact of
the financial crisis on America’s communities, one in Clark County,
Nevada, the other in Prince Georges County, Maryland.12 The
hearings portray home mortgage-related losses on a large scale. Assessing the extent and persistence of these losses is key to understanding the plausibility of Treasury’s assumptions. This is a matter of underlying housing values, the durability of the new housing
stock, and the ability of borrowers to make mortgage payments in
the future.
Since Treasury has not provided the baseline economic projections behind its stabilization efforts, this report assumes that consensus growth estimates and the Economic Report of the President
are the foundation for Treasury’s efforts. The Administration is in
line with most forecasts by predicting economic contraction continuing into mid-2009 with recovery commencing in the second half
of the year.13 This projection is consistent with forecasts issued by
the Congressional Budget Office (CBO) and Blue Chip Economic
Indicators, though the latter has been steadily downgrading its
forecasts each month. As of late February, the Obama Administration projected an annual decline in real Gross Domestic Product
(GDP) of 1.2 percent, a slightly more optimistic forecast than the
1.5 percent contraction recently projected by the CBO.14 The Blue
Chip Economic Indicators survey, which offered a projection of a
1.9 percent contraction in its January report, recently downgraded
this projection to a 2.6 percent contraction in March.15 Another economic projection that may be guiding Treasury policy is predicted
losses from U.S. toxic assets. Goldman Sachs issued a projection of
2007 and will prove the longest and most severe of the postwar period. Credit losses of close
to $3 trillion are leaving the U.S. banking and financial system insolvent. And the credit crunch
will persist as households, financial firms and corporations with high debt ratios and solvency
problems undergo a sharp deleveraging process.’’).
11 Council on Foreign Relations, A Conversation with Timothy F. Geithner (Mar. 25, 2009) (online at www.cfr.org/publication/18925/conversationlwithltimothylflgeithner.html) (‘‘So we’re
not treating, have never treated, this as a liquidity crisis. It has those two core dimensions. And
as you can see, in the president’s broad agenda * * * you’re not going to be able to fix the financial system without very strong, sustained support from monetary and fiscal policy. And that
broad package together has the best chance of getting us * * * more quickly to the path of recovery.’’); Timothy Geithner, My Plan for Bad Bank Assets, Wall Street Journal (Mar. 23, 2009)
(‘‘By providing a market for these assets that does not now exist, this program will help improve
asset values, increase lending capacity by banks, and reduce uncertainty about the scale of
losses on bank balance sheets. The ability to sell assets to this fund will make it easier for
banks to raise private capital, which will accelerate their ability to replace the capital investments provided by the Treasury.’’).
12 These hearings can be viewed in their entirety at the Panel website: www.COP.Senate.gov.
13 White House Council of Economic Advisors, Economic Report of the President, at 53 (Jan.
2009) (‘‘The contraction is projected to continue into the first half of 2009, followed by a recovery
in the second half of 2009 that is expected to be led by the interest-sensitive sectors of the economy. The overall decline, from the second-quarter level of GDP to the quarter with the lowest
real GDP, is projected to slightly exceed the depth of the average post-World War II recession.
This pattern translates into a small decline during the four quarters of 2008, followed by a small
increase during 2009.’’).
14 Congressional Budget Office, A Preliminary Analysis of the President’s Budget and an Update of CBO’s Budget and Economic Outlook, at 19 (Mar. 2009) (‘‘In CBO’s forecast, on a fourthquarter-to-fourth-quarter basis, real (inflation-adjusted) gross domestic product falls by 1.5 percent in 2009 before growing by 4.1 percent in both 2010 and 2011.’’); Office of Management and
Budget, A New Era of Responsibility: Renewing America’s Promise, at 132 (Feb. 26, 2009).
15 Sickly U.S. Economy Set for 2nd Half Rebound: Survey, Reuters (Mar. 10, 2009) (citing
Randell E. Moore, Blue Chip Economic Indicators: Top Analysts’ Forecasts of the U.S. Economic
Outlook for the Year Ahead (Mar. 10, 2009)).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00015

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

10

mstockstill on PROD1PC66 with HEARING

losses from U.S.-originated credit assets of $2.1 trillion.16 Another
projection comes from the International Monetary Fund, which expects U.S. credit losses of $2.2 trillion.17 For both of these projections, half or less of these losses will take place in the U.S. because
a portion of the risks was transferred to foreign investors. While
these losses will likely require additional capital infusions from
public and private sources, the road to recovery for the banking
system will be shorter based on these projections than it would be
if the projections of some of the leading pessimists (see below) are
borne out.18 Even if U.S. financial institution losses are ‘‘only’’ $1
trillion, however, they will nonetheless be approximately twice the
entire amount of money allocated by Treasury under the TARP, including money allocated to programs like PPIP that has not been
expended yet.
While these estimates represent a consensus view of expected
economic contraction and credit losses for 2009, critics of Treasury’s
actions can point to prominent, and significantly more pessimistic,
economic projections by economist Nouriel Roubini. Roubini, whose
warnings of the collapse of the housing bubble proved prescient,
forecasts an economic contraction of 3.4 percent 19 and total credit
losses of $3.6 trillion, half of which would be borne by U.S. banks,
in 2009.20
Furthermore, declines in housing prices as shown by the latest
data from the Case-Shiller index could indicate that the housing
market has yet to hit bottom. The numbers from January 2009 revealed a continued decline in home prices, with the 20-city index
showing a 2.8 percent decline from the previous month 21 and a 19
percent annual decline from January 2008.22 Overall, the 20-city
index shows a 29.1 percent decrease from the housing market’s
peak in the second quarter of 2006.23
The debate over the use of Treasury’s Public-Private Investment
Partnerships to purchase troubled assets and achieve price discovery turns significantly on questions surrounding the health and
trajectory of the economy as a whole, as well as the relationship
16 Jan Hatzius and Michael A. Marschoum, Home Prices and Credit Losses: Projections and
Policy Options, Goldman Sachs Global ECS Research, at 14 (Jan. 13, 2009) (Global Economics
Paper No. 177) (online at garygreene.mediaroom.com/file.php/216/Global+Paper+No++177.pdf).
17 International Monetary Fund, Global Financial Stability Report Market Update, at 2 (Jan.
28, 2009) (‘‘The worsening credit conditions affecting a broader range of markets have raised
our estimate of the potential deterioration in U.S.-originated credit assets held by banks and
others from $1.4 trillion in the October 2008 GFSR to $2.2 trillion.’’).
18 See Douglas J. Elliott, Bank Nationalization: What is it? Should we do it?, at 10 (Feb. 25,
2009) (‘‘In sum, the banking system can be restored to the capital levels that held prior to this
recession, which were considered more than adequate at the time, if the economy and credit
losses perform as the IMF or Goldman Sachs expects. These forecasts are roughly in line with
the consensus economic view.’’).
19 Roubini Global Economics, RGE Monitor 2009 Global Economic Outlook, at 1–2 (Jan. 2009)
(online at www.rgemonitor.com/redir.php?cid=316328&sid=1&tgid=10000).
20 Nouriel Roubini and Elisa Parisi-Capone, Total $3.6T Projected Loans and Securities Losses,
$1.8T of Which at U.S. Banks/Brokers: The Specter of Technical Insolvency, RGE Analysts’
EconoMonitor (Jan. 21, 2009) (online at www.rgemonitor.com/blog/economonitor/255236/totall
36tlprojectedlloanslandlsecuritiesllossesl18tloflwhichlatlusl
banksbrokerslthelspecterlofltechnicallinsolvency).
21 Standard
&
Poor’s,
S&P/Case-Shiller
Home
Price
Indices
(online
at
www2.standardandpoors.com/spf/pdf/index/CSHomePricelHistoryl033114.xls) (accessed Apr.
3, 2009) (hereinafter ‘‘Case-Shiller Indices’’).
22 Standard & Poor’s, The New Year Didn’t Change the Downward Spiral of Residential Real
Estate Prices According to the S&P/Case-Shiller Home Prices Indices (Mar. 31, 2009) (online at
www2.standardandpoors.com/spf/pdf/index/CSHomePricelReleasel033114.pdf)
(hereinafter
‘‘Case-Shiller Press Release’’).
23 Id.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00016

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

11
the economy as a whole will have to portfolios of bad assets held
by banks and other financial institutions. Economic forecasters
have predicted that a recovery in GDP will commence in the fall.
However, the trend line in adjustments to those predictions has
been consistently downward, with the projected beginning of the recovery receding into the future and its scale diminishing. Secondly,
it is unclear what the relationship between economic recovery,
when it comes, and bank assets will be. Unemployment, a key driver of consumer defaults in areas like mortgages and credit cards,
is a lagging indicator, with joblessness typically increasing significantly after GDP turns around. More profoundly, recovery in real
estate markets following an asset bubble can be very slow in coming. In many parts of the United States, real estate prices did not
recover from the real estate bust of the late 1980s until ten years
later.
Finally and most importantly, there is the question of the role
the health of the banks themselves will play. Treasury’s strategy
envisions a larger economic recovery pulling the banks back to
health. Given the current degree of concentration in the banking
industry, many have expressed concern that weak banks will drag
the economy down by failing to lend. Japan’s ‘‘lost decade,’’ discussed in Part B of this section, was in part the story of an economy that suffered anemic yet largely positive economic growth in
tandem with a prolonged crisis in the financial sector. To the extent that this is an accurate description of our financial situation,
time is not on our side.
Thus, disagreements over the true nature and severity of the economic downturn and expectations of credit losses are at the heart
of debates over Treasury’s strategy and programs for addressing
the financial crisis. While the Panel does not have a view on the
accuracy of these economic projections, it does note that Treasury
can better anchor its strategy by sharing the baseline economic
projections for its current approach. Disclosure of these assumptions for growth and expected bank losses will make debate over
contingency strategies, in the event that a course change becomes
necessary down the road, more constructive.

mstockstill on PROD1PC66 with HEARING

a. Address Bank Solvency and Capitalization—Capital Infusions and Leveraged Asset Purchases
Treasury’s primary mechanisms for improving bank balance
sheets are through its equity investment programs such as CPP
and CAP and its forthcoming efforts to provide government financing for leveraged special purpose entities to purchase distressed assets through the PPIP. The basic elements of these programs are
described below:
• CAP. On February 10, 2009, Secretary Geithner announced
plans for the remainder of TARP funds.24 The central component
of Treasury’s plan is the Capital Assistance Program (CAP), which
consists of a two-step program. The first step is a supervisory exercise, the ‘‘stress test,’’ in which the 19 U.S. banking organizations
with over $100 billion in assets are evaluated for their ability to
absorb losses in worse-than-expected economic conditions. While
24 Geithner

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

Financial Stability Statement, supra note 8.

PO 00000

Frm 00017

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

12
the 19 largest banks will be required to undergo stress tests, all
banks are free to apply to the CAP. Banks deemed to require an
additional capital cushion will receive a six month window to raise
that capital privately or access it through the CAP. The second
component of the CAP will consist of government investments in
banks in the form of non-voting preferred securities that can be
converted into common equity by the bank—an effective call on the
preferred exercisable to the government’s detriment when a bank
is trouble.
PPIP. On March 3, 2009, Treasury announced the details of the
PPIP. The PPIP involves the creation of leveraged special purpose
entities, capitalized with small amounts of equity capital from private sources and designed to purchase bad assets from banks. Private investors would capture 50 percent of the profits of these entities. Their purpose is to buy distressed bank assets at prices and
volumes that private parties are unwilling to do. Treasury hopes
that these transactions will promote bank lending,25 and improve
market liquidity. It is unclear whether the introduction of these
funds will lead private sector investors who do not benefit from
government subsidies to have any greater interest in transacting in
distressed assets than they do today. Treasury hopes this program
will unfreeze the asset-backed securities market and reverse the
negative economic cycle of declining asset prices, deleveraging, and
declining asset values.26 PPIP has two components: the Legacy
Loan Program targeting distressed loans held on bank balance
sheets and the Legacy Securities Program that is intended to facilitate the purchase of certain, primarily asset-backed securities
through TALF.
At the time of the announcement of these programs, Mr. Summers expressed his expectation that ‘‘further support for capital
markets, transparency with respect to the condition of banks, and
infusion of capital into the banking cycle, will create virtuous cycles
in which stronger markets beget stronger financial institutions,
which beget stronger markets.’’ 27 Statements like these provide additional evidence of the assumptions underlying Treasury’s actions,
to wit, that senior officials believe that current prices for impaired
assets are at or near their lowest levels and will rebound if Treasury can revive markets for these assets.
In Part D of this report, we provide further preliminary analysis
of CAP and PPIP. In further reports, as these plans proceed, the
Panel will seek to analyze the financial impact of these programs
on the banks, the private sector investors in these leveraged investment vehicles, and on the public.

mstockstill on PROD1PC66 with HEARING

b. Increase Availability of Credit in Key Markets
Another major component of Treasury’s financial stabilization
program is its use of TARP funds in coordination with the Federal
25 Although the program takes these assets off bank balance sheets, there does not appear to
be any corresponding requirement about a selling bank’s use of the proceeds it receives for those
assets.
26 The illiquidity of the asset-backed securities market is obviously closely tied to this economic cycle. As prices have declined, those who hold the assets have been increasingly unwilling
to sell.
27 Summers, Economic Crisis and Recovery, supra note 9.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00018

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

13

mstockstill on PROD1PC66 with HEARING

Reserve Board’s use of its balance sheet to inject over two trillion
dollars of financing into credit markets and public-private investment facilities. A common thread among the various facilities that
constitute this component of the plan is the assumption of risk by
Treasury and the Federal Reserve Board in order to induce renewed private participation in securitization. Senior officials believe that restarting markets will increase credit availability and
reduce the liquidity discounts impairing the sale of many toxic assets. Official efforts take the form of Treasury’s investments in
TALF and PPIP and the lending facilities established by the Federal Reserve Board. Federal Reserve Board Chairman Ben
Bernanke stated that the purpose of these programs is ‘‘both to
cushion the direct effects of the financial turbulence on the economy and to reduce the virulence of the so-called adverse feedback
loop, in which economic weakness and financial stress become mutually reinforcing.’’ 28 Mr. Summers reinforced this view in his address to the Brookings Institution on March 13, 2009: ‘‘Reactivating
the capital markets is essential to realistic asset valuation, to restarting nonbank lending, and to enabling banks to divest toxic assets when they judge it appropriate.’’ 29
TALF and PPIP have some fundamental differences. TALF seeks
to revive asset securitization markets by having the Federal Reserve Board encourage issuance of new high-quality securitized
debt instruments through collateralized non-recourse loans; loan
principal will be discounted by haircuts on the securities’ face value
that depend on the type of loans backing the security. PPIP envisions buying existing distressed assets and low quality assets off
bank balance sheets using Special Purpose Entities where private
sector actors, presumably hedge funds and private equity firms, invest a small amount of capital and stand to gain 50 percent of any
profits.
Treasury and the Federal Reserve Board clearly believe that we
cannot revive the U.S. economy without healthy asset
securitization markets. The phenomenal growth of the size of those
markets in recent years and their current centrality to mortgage,
auto, student loan and credit card financing would tend to support
that belief. Nonetheless, some question the fundamental premise
behind the expenditure of TARP funds and assumption of risk by
taxpayers, arguing that securitization itself, absent reform, weakens effective risk management by financial institutions.30 Of
28 Board of Governors of the Federal Reserve System, Address by Ben S. Bernanke, Chairman,
at the Stamp Lecture, London School of Economics, London, England: The Crisis and Policy
Response
(Jan.
13,
2009)
(online
at
www.federalreserve.gov/newsevents/speech/
bernanke20090113a.htm).
29 Summers, Economic Crisis and Recovery, supra note 9.
30 See, e.g., Paul Krugman, The Market Mystique, New York Times (Mar. 26, 2009) (‘‘Above
all, the key promise of securitization—that it would make the financial system more robust by
spreading risk more widely—turned out to be a lie. Banks used securitization to increase their
risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.’’); Robert Kuttner, Slouching Towards Solvency, American Prospect (Mar. 23,
2009) (online at www.prospect.org/cs/articles?article=slouchingltowardslsolvency) (‘‘At the
heart of this entire mess is the system of securitization, which dates only to the 1970s. In principle, it usefully allowed banks to sell off loans and thereby replenish cash to make other loans.
But in practice, the system turned into an unsupervised doomsday machine. Not only did the
system invite lenders to relax underwriting standards because some sucker down the line was
absorbing the risk; more seriously it led to an aftermath that has proven impossible to unwind
Continued

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00019

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

14
course, reforming securitization markets, as the Panel recommended in its regulatory reform report of January 29, 2009, is not
necessarily incompatible with Treasury’s strategy of keeping those
markets from freezing. Another criticism of this approach is that
markets requiring heavy government subsidization will not lead to
true price discovery of assets or create sustainable markets for
these assets.31 Such subsidization can distort markets and, once
ceased, is unlikely to affect later, non-subsidized market transactions. A third concern centers on the terms of the PPIP deal for
the American taxpayer insofar as the government is bearing most
of the risk while splitting the gains with program participants.
On the other hand, many forms of securitization involve instruments that are straightforward. A revival of securitization markets,
if subject to strong regulatory oversight, can help restore financial
stability because it re-circulates capital for banks to lend again,
and without a functioning secondary market access to credit would
be sharply decreased, delaying or even preventing our economic recovery. The Panel urges Treasury, as it works to restart these markets to improve lending, to discuss its vision for reforming
securitization within its broader program for modernizing financial
regulation.

mstockstill on PROD1PC66 with HEARING

c. Assess the Health of Financial Institutions
The stress tests build on the efforts under the Capital Purchase
Program by the Paulson Treasury Department to assess the health
of banks applying for funding under the CPP. The stress tests will
analyze whether the targeted banks have the necessary capital to
continue lending while absorbing potential losses in the case of a
more severe economic decline than anticipated by consensus estimates.32 These examinations involve collaboration between Treasury, federal banking supervisors, and other agencies, and they commenced on February 25, 2009. For some banks, a comparatively
clean bill of health from Treasury may provide an opportunity for
eased terms and early repayment. This assessment exercise may
provide stronger signals to the industry and the market about
which banks may face a greater government ownership stake. The
actions taken by Treasury following the completion of these stress
tests may also offer investors a good indication of future government intervention in financial markets, which could encourage a
return to a healthy level of investment. On the other hand, the
tests may prove to be insufficiently rigorous to give regulators a
true picture of the health of financial institutions. Even if the tests
are adequate, regulators may lack the will to act on what they
without having government temporarily take the big banks into receivership to sort out what’s
really on their books.’’).
31 See, e.g., Jeffrey Sachs, Obama’s Bank Plan Could Rob the Taxpayer, Financial Times (Mar.
25, 2009) (‘‘It is dressed up as a market transaction but that is a fig-leaf, since the government
will put in 90 per cent or more of the funds and the ‘price discovery’ process is not genuine.
It is no surprise that stock market capitalisation of the banks has risen about 50 per cent from
the lows of two weeks ago. Taxpayers are the losers, even as they stand on the sidelines cheering the rise of the stock market. It is their money fuelling the rally, yet the banks are the beneficiaries.’’).
32 Treasury states that the consensus baseline assumptions for real GDP growth are those
found in the February projections published by Consensus Forecasts, the Blue Chip survey, and
the Survey of Professional Forecasters. U.S. Department of the Treasury, FAQs: Supervisory
Capital Assessment Program (online at files.ots.treas.gov/482033.pdf) (accessed Apr. 2, 2009).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00020

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

15
learn. In either case, the stress tests would not produce the desired
results.
The Panel is interested in: (1) the extent to which the stress tests
will rely on risk management models like Value At Risk (VAR),
which some have identified as having contributed to risk management failures that fed the financial bubble; and (2) the extent to
which the stress tests will be conducted, in the first instance, by
the financial management teams of the financial firms themselves.
The Panel needs additional information on the stress tests before
it can offer further analysis.
3. FEDERAL GOVERNMENT EFFORTS

mstockstill on PROD1PC66 with HEARING

Treasury’s efforts to date to combat the financial crisis have focused upon improving bank balance sheets and providing liquidity
to financial institutions and key credit markets. A critical player in
government stabilization efforts is the Federal Reserve Board,
which has added over $1.5 trillion dollars to its balance sheet beyond its normal monetary policy open-market operations.33 Likewise, the FDIC has also had a major role. FDIC, the Federal Reserve Board, and Treasury are extending over $1.7 trillion in guarantees as well. See Figure 1 for a complete presentation of Federal
resources—outlays, loans and guarantees—that have been provided
to date in conjunction with the financial market rescue efforts.
The Panel has broadly classified the resources that the federal
government has devoted to stabilizing the economy in a myriad of
new programs and initiatives as outlays, loans, and guarantees. Although the Panel calculates the total value of these resources at
over $4 trillion, this would translate into the ultimate ‘‘cost’’ of the
stabilization effort only if: (1) assets do not appreciate; (2) no dividends are received, no warrants are exercised, and no TARP funds
are repaid; (3) all loans default and are written off; and (4) all
guarantees are exercised and subsequently written off.
Outlays constitute $522.4 billion or about 13 percent of total federal resources and primarily reflect Treasury expenditures under
the TARP. The majority of outlays are structured as Treasury’s equity investments in financial institutions ($328 billion) and Treasury co-investments with private investors in mortgage-based loans
and securities under the PPIP ($100 billion). It is possible that the
federal government could recoup much of the value of its investments in financial institutions through receipt of dividend payments, financial institutions’ repayments of TARP funds, appreciation of the value of the TARP equity investments, and resolution
of financial institutions in bankruptcy or receivership. Similarly,
the PPIP co-investments could be profitable if the mortgage loans
and mortgage-backed securities in these funds appreciate in value.
On the other hand, insolvency of financial institutions that are
funded by the TARP, or poor performance or pricing of PPIP equity
investments, would result in a substantial amount of long-term
losses to the federal government.
The $2.0391 trillion in loans almost exclusively represent an expansion of assets on the Federal Reserve Board’s balance sheet as
33 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release
H.4.1: Factors Affecting Reserve Balances (Apr. 2, 2009) (online at www.federalreserve.gov/
releases/h41/20090502/) (hereinafter ‘‘Fed Balance Sheet April 2’’).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00021

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

16
a result of the creation of a variety of new programs. According to
Federal Reserve Board Chairman Ben Bernanke, ‘‘the great majority of [the Federal Reserve Board’s] lending is extremely well secured.’’ 34 Nevertheless, even if Chairman Bernanke is correct in
his analysis, any losses incurred on loans not in the extremely well
secured category potentially could create significant long-term
losses to the federal government.
Finally, the risks of long-term losses to the federal government
posed by the over $1.7 trillion in guarantees, mostly made by the
Federal Reserve Board and FDIC, are difficult to estimate. Potential losses are largely dependent on the specific risks of each guarantee program, some of which (including PPIP) are still being designed, and on underlying economic performance.
FIGURE 1: RESOURCES DESIGNATED FOR FINANCIAL STABILIZATION EFFORTS
Program
(dollars in billions)

Treasury
(TARP)

mstockstill on PROD1PC66 with HEARING

American International Group (AIG) ............................................................
Outlays 35 ..............................................................................................
Loans .....................................................................................................
Guarantees 36 ........................................................................................
Bank of America ...........................................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Citigroup ........................................................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Capital Purchase Program (Other) ..............................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Capital Assistance Program .........................................................................
TALF ................................................................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
PPIF (Loans) 51 ..............................................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
PPIF (Securities) ...........................................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Commercial Paper Funding Facility ............................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity
Facility ......................................................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Homeowner Affordability and Stability Plan ...............................................
Outlays ..................................................................................................

70
37 70

0
0
52.5
39 45
0
40 7.5
50
43 45
0
44 5
168
47 168
0
0
TBD
55
0
0
49 55
50
50
0
0
50
53 20
30
0
0
0
0
0
0
0
0
0
50
56 50

Federal
Reserve
Board

FDIC

Total

89.3
0
838 9.3
0
87.2
0
0
41 87.2
229.8
0
0
45 229.8
0
0
0
0
TBD
495
0
50 495
0
0
0
0
0
0
0
0
0
249.7
0
54 249.7
0

0
0
0
0
2.5
0
0
42 2.5
10
0
0
46 10
0
0
0
0
TBD
0
0
0
0
600
0
0
52 600
0
0
0
0
0
0
0
0

159.3
70
89.3
0
142.2
45
0
97.2
289.8
45
0
244.8
168
168
0
0
48 TBD
550
0
495
55
650
50
0
600
50
20
30
0
249.7
0
249.7
0

6.1
0

0
0
0
0
0
0

6.1
0
6.1
0
57 50
50

55 6.1

0
0
0

34 Board of Governors of the Federal Reserve System, Address by Ben S. Bernanke, Chairman,
at the Federal Reserve Bank of Richmond 2009 Credit Market Symposium, Charlotte, North
Carolina: The Federal Reserve’s Balance Sheet (Apr. 3, 2009) (online at www.federalreserve.gov/
newsevents/speech/bernanke20090403a.htm).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00022

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

17
FIGURE 1: RESOURCES DESIGNATED FOR FINANCIAL STABILIZATION EFFORTS—Continued
Program
(dollars in billions)

Treasury
(TARP)

mstockstill on PROD1PC66 with HEARING

Loans .....................................................................................................
Guarantees ............................................................................................
Automotive Industry Financing Plan ...........................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Auto Supplier Support Program ...................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Unlocking Credit for Small Business ..........................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Temporary Liquidity Guarantee Program ....................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Deposit Insurance Fund ...............................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Other Federal Reserve Board Credit Expansion Since September 1,
2008 ...........................................................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Uncommitted TARP Funds ............................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Total ...............................................................................................................
Outlays ..................................................................................................
Loans .....................................................................................................
Guarantees ............................................................................................
Uncommitted TARP Funds ....................................................................

Federal
Reserve
Board

FDIC

Total

0
0
24.9
58 24.9
0
0
5
59 5
0
0
15
60 15
0
0
0
0
0
0
0
0
0
0

0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0

0
0
0
0
0
0
0
0
0
0
0
0
0
0
768.9
0
0
61 768.9
29.5
62 29.5
0
0

0
0
24.9
24.9
0
0
5
5
0
0
15
15
0
0
768.9
0
0
768.9
29.5
29.5
0
0

0
0
0
0
64 109.6
TBA
TBA
TBA
700
492.9
30
67.5
109.6

1,169
0
63 1,169
0
0
0
0
0
2,326.1
0
2,009.1
317
0

0
0
0
0
0
0
0
0
1,410.9
29.5
0
1,381.4
0

1,169
0
1,169
0
109.6
TBA
TBA
TBA
65 4,437
522.4
2,039.1
1,765.9
109.6

35 Treasury outlays are face values, based on: (1) Treasury’s actual reported expenditures and (2) Treasury’s anticipated funding levels as
estimated by a variety of sources, including Treasury pronouncements, GAO estimates, and news reports. Anticipated funding levels are set at
Treasury’s discretion, have changed from initial announcements, and are subject to change further. The outlay concept used here is not the
same as budget outlays, which under § 123 of EESA are recorded on a ‘‘credit reform’’ basis.
36 While many of the guarantees may never be exercised or exercised only partially, the guarantee figures included here represent the federal government’s maximum financial exposure.
37 Government Accountability Office, Troubled Asset Relief Program: March 2009 Status of Efforts to Address Transparency and Accountability Issues, at 9 (Mar. 31, 2009) (GAO09/504) (online at www.gao.gov/new.items/d09504.pdf) (hereinafter ‘‘March GAO Report’’). This number includes a $40 billion investment made on November 25, 2008 under the Systemically Significant Failing Institutions (SSFI) Program and
a $30 billion equity capital facility announced on March 2, 2009 that AIG may draw down when in need of additional capital in exchange for
additional preferred stock and warrants to be held by Treasury. U.S. Department of the Treasury, Office of Financial Stability, Troubled Asset
Relief Program Transactions Report For Period Ending March 31, 2009 (Apr. 2, 2009) (online at www.financialstability.gov/docs/transactionreports/transactionlreportl04-02-2009.pdf) (hereinafter ‘‘April 2 Transaction Report’’); U.S. Department of the Treasury, Term Sheet (Mar. 2,
2009) (online at www.treas.gov/press/releases/reports/030209laigltermlsheet.pdf).
38 Fed Balance Sheet April 2, supra note 33. This figure includes the AIG credit line as well as the Maiden Lane II LLC and Maiden Lane
III LLC special purpose vehicles.
39 April 2 Transaction Report, supra note 37. This figure includes: (1) a $15 billion investment made by Treasury on October 28, 2008
under the Capital Purchase Program (CPP), (2) a $10 billion investment made by Treasury on January 9, 2009 also under the CPP, and (3) a
$20 billion investment made by Treasury under the Targeted Investment Program (TIP) on January 16, 2009.
40 U.S. Department of the Treasury, Summary of Terms: Eligible Asset Guarantee (Jan. 15, 2009) (online at www.treas.gov/press/releases/
reports/011508bofatermsheet.pdf) (granting a $118 billion pool of Bank of America assets a 90 percent federal guarantee of all losses over
$10 billion, the first $10 billion in federal liability to be split 75/25 between Treasury and the FDIC and the remaining federal liability to be
borne by the Federal Reserve).
41 Id.
42 Id.
43 April 2 Transaction Report, supra note 37. This figure includes: (1) a $25 billion investment made by Treasury under the CPP on October
28, 2008 and (2) a $20 billion investment made by Treasury under the TIP on December 31, 2008.
44 U.S. Department of the Treasury, Summary of Terms: Eligible Asset Guarantee (Nov. 23, 2008) (online at www.treasury.gov/press/releases/
reports/cititermsheetl112308.pdf) (hereinafter ‘‘Citigroup Asset Guarantee’’) (granting a 90 percent federal guarantee on all losses over $29
billion of a $306 billion pool of Citigroup assets, with the first $5 billion of the cost of the guarantee borne by Treasury, the next $10 billion
by FDIC, and the remainder by the Federal Reserve). See also U.S. Department of the Treasury, U.S. Government Finalizes Terms of Citi Guarantee Announced in November (Jan. 16, 2009) (online at www.treas.gov/press/releases/hp1358.htm) (reducing the size of the asset pool from
$306 billion to $301 billion).
45 Citigroup Asset Guarantee, supra note 44.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00023

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

18

mstockstill on PROD1PC66 with HEARING

46 Citigroup Asset Guarantee, supra note 44.
47 March GAO Report, supra note 37. This figure represents the $218 billion Treasury reported anticipating spending under the CPP to GAO,
minus the $50 billion CPP investments in Citigroup ($25 billion) and Bank of America ($25 billion) identified above. This figure does not account for anticipated repayments or redemptions of CPP investments, nor does it account for dividend payments from CPP investments. Treasury originally set CPP funding at $250 billion and has not officially revised that estimate.
48 Funding levels for the Capital Assistance Program (CAP) have not yet been announced but will likely include a significant portion of the
remaining $109.6 billion of TARP funds.
49 March GAO Report, supra note 37. Treasury has committed $20 billion of TARP money to TALF already; Treasury later indicated it would
expand to a $100 billion TARP commitment to TALF, but has recently pulled back to a $55 billion commitment. Michael R. Crittenden,
Treasury Seeks to Free Up Funds by Shuffling Spending in TARP, Wall Street Journal (Apr. 2, 2009) (online at online.wsj.com/article/
SB123870719693083971.html). The increase in funding has coincided with an increase in asset classes eligible for the facility, including allowing legacy securities access to the facility instead of limiting access only to new securitizations.
50 This number derives from the unofficial 1:10 ratio of the value of Treasury loan guarantees to the value of Federal Reserve loans under
TALF. See U.S. Department of the Treasury, Fact Sheet: Financial Stability Plan, at 2–3 (Feb. 10, 2009) (online at www.financialstability.gov/
docs/fact-sheet.pdf) (describing the initial $20 billion Treasury contribution tied to $200 billion in Federal Reserve loans and announcing potential expansion to a $100 billion Treasury contribution tied to $1 trillion in Federal Reserve loans). Because Treasury is responsible for reimbursing the Federal Reserve for $55 billion of losses on its $550 billion in loans, the Federal Reserve’s maximum potential exposure under
TALF is $495 billion.
51 Because the PPIP funding arrangements for loans and securities differ substantially, the Panel accounts for them separately. Treasury
has not formally announced either total program funding level or the allocation of funding between PPIP Legacy Loans Program and Legacy
Securities Program. Treasury initially provided a $75–100 billion range for PPIP outlays. U.S. Department of the Treasury,
Fact Sheet: Public- Private Investment Program, at 2 (Mar. 23, 2009) (online at www.treas.gov/press/releases/reports/ppiplfactlsheet.pdf)
(hereinafter ‘‘Treasury PPIP Fact Sheet’’). While SIGTARP has estimated a $75 billion Treasury commitment, we adopt GAO’s higher estimate of
$100 billion. See Senate Committee on Finance, Testimony of SIGTARP Neil Barofsky, TARP Oversight: A Six Month Update, 111th Cong. (Mar.
31, 2009) (hereinafter ‘‘Barofsky Testimony’’); See March GAO Report, supra note 37, at 9. We further assume that Treasury will fund the programs equally at $50 billion each.
52 Treasury PPIP Fact Sheet, supra note 51, at 2–3 (explaining that, for every $1 Treasury contributes in equity matching $1 of private contributions to public-private asset pools created under the Legacy Loans Program, FDIC will guarantee up to $12 of financing for the transaction to create a 6:1 debt to equity ratio). If Treasury ultimately allocates a lower proportion of funds to the Legacy Loans Program (i.e. less
than $50 billion), the amount of FDIC loan guarantees will be reduced proportionally.
53 Treasury PPIP Fact Sheet, supra note 51, at 4–5 (outlining that, for each $1 of private investment into a fund created under the Legacy
Securities Program, Treasury will provide a matching $1 in equity to the investment fund; a $1 loan to the fund; and, at Treasury’s discretion, an additional loan up to $1). In the absence of further Treasury guidance, this analysis assumes that Treasury will allocate funds for
equity co-investments and loans at a 1:1.5 ratio, a formula that estimates that Treasury will frequently exercise its discretion to provide additional financing.
54 Fed Balance Sheet April 2, supra note 33. The level of Federal Reserve lending under this facility will fluctuate in response to market
conditions and independent of any federal policy decision.
55 Fed Balance Sheet April 2, supra note 33. The level of Federal Reserve lending under this facility will fluctuate in response to market
conditions and independent of any federal policy decision.
56 March GAO Report, supra note 37, at 9.
57 Fannie Mae and Freddie Mac, government-sponsored entities (GSEs) that were placed in conservatorship of the Federal Housing Finance
Housing Agency on September 7, 2009, will also contribute up to $25 billion to the Homeowner Affordability and Stability Plan. See U.S. Department of the Treasury, Making Home Affordable: Updated Detailed Program Description (Mar. 4, 2009) (online at www.treas.gov/press/
releases/reports/housinglfactlsheet.pdf).
58 April 2 Transaction Report, supra note 37.
59 March GAO Report, supra note 37, at 9.
60 March GAO Report, supra note 37, at 9.
61 Federal Deposit Insurance Corporation, Monthly Reports on Debt Issuance Under the Temporary Liquidity Guarantee Program: Debt
Issuance under Guarantee Program (online at www.fdic.gov/regulations/resources/TLGP/totallissuance1–09.html) (accessed Apr. 1, 2009). This
figure represents the current maximum aggregate debt guarantees that could be made under the program, which, in turn, is a function of
the number and size of individual financial institutions participating. $252.6 billion of debt subject to the guarantee has been issued to date,
which represents about 33 percent of the current cap. Id.
62 Federal Deposit Insurance Corporation, Chief Financial Officer’s (CFO) Report to the Board: DIF Income Statement (Fourth Quarter 2008)
(online at www.fdic.gov/about/strategic/corporate/cfolreportl4qtrl08/income.html) (provision for insurance losses of $17.6 billion); Federal
Deposit Insurance Corporation, Chief Financial Officer’s (CFO) Report to the Board: DIF Income Statement (Third Quarter 2008) (online at
www.fdic.gov/about/strategic/corporate/cfolreportl3rdqtrl08/income.html) (provision for insurance losses of $11.9 billion). Outlays reflect
disbursements or potential disbursements in conjunction with failed bank resolutions.
63 This figure is derived from adding the total credit the Federal Reserve has extended as of April 1, 2009 through the Term Auction Facility (Term Auction Credit), Discount Window (Primary Credit), Primary Dealer Credit Facility (Primary Dealer and Other Credit), Central Bank Liquidity Swaps, Bear Stearns Assets (Maiden Lane I), GSE Debt (Federal Agency Debt Securities), and Mortgage Backed Securities Issued by
GSEs. See Fed Balance Sheet April 2, supra note 33.
64 Committed TARP funds listed above total $590.4 billion; $109.6 billion remains uncommitted for the $700 billion authorization under
EESA and is included in this accounting because it will almost certainly be allocated in the future. One potential use of uncommitted funds
is Treasury’s obligation to reimburse the Exchange Stabilization Fund (ESF), currently valued at $49.4 billion. See U.S. Department of Treasury,
Exchange Stabilization Fund, Statement of Financial Position, as of February 28, 2009 (online at www.ustreas.gov/offices/international-affairs/
esf/esf-monthly-statement.pdf) (accessed April 6, 2009). Treasury must reimburse any use of the fund to guarantee money market mutual
funds from TARP money. See EESA, supra note 1, at 131. In September 2008, in response to the Reserve Primary Fund ‘‘breaking the buck,’’
see Diya Gullapalli, Shefali Anand, and Daisy Maxey, Money Fund, Hurt by Debt Tied to Lehman, Breaks the Buck, Wall Street Journal (Sept.
17, 2008) (online at online.wsj.com/article/SB122160102128644897.html), Treasury opened its Temporary Guarantee Program for Money Mutual
Funds, U.S. Department of Treasury, Treasury Announces Temporary Guarantee Program for Money Market Mutual Funds (Sept. 29, 2008) (online at www.treas.gov/press/releases/hp1161.htm). This program uses assets of the ESF, which was created under the Gold Reserve Act of
1934, to guarantee the net asset value of participating money market mutual funds. Id. Section 131 of EESA protected the ESF from incurring
any losses from the program by requiring that Treasury reimburse the ESF for any funds used in the exercise of the guarantees under the
program. The program has recently been extended through September 18, 2009. U.S. Department of Treasury, Treasury Announces Extension of
Temporary Guarantee Program for Money Market Funds (Mar. 31, 2009) (online at www.treas.gov/press/releases/tg76.htm).
65 This figure differs substantially from the $2,476–2,976 billion range of ‘‘Total Funds Subject to SIGTARP Oversight’’ reported during testimony before the Senate Finance Committee on March 31, 2009. Barofsky Testimony, supra note 51, at 12. SIGTARP’s accounting, designed to
capture only those funds potentially under its oversight authority, is both less and more inclusive than, and thus not directly comparable to,
the Panel’s. Among the many differences, SIGTARP does not account for Federal Reserve credit extensions outside of TALF or FDIC guarantees
under the Temporary Liquidity Guarantee Program and sets the maximum Federal Reserve loan extensions under TALF at $1 trillion.

a. Treasury Programs
Through an array of programs used to purchase preferred shares
in financial institutions, offer loans to small businesses and auto
companies, and leverage Federal Reserve Board loans for facilities
designed to restart secondary securitization markets, Treasury has

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00024

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

19
spent or committed $590.4 billion.66 This figure is down from the
$667.4 billion sum of the upper bounds of all Treasury commitments announced to date.67 The discrepancy results from Treasury
revising its estimates of anticipated commitments down from the
maximum announced program funding levels; for example, Treasury initially announced that it would commit $250 billion to CPP
purchases but now only anticipates spending $218 billion.68 Treasury will also leverage billions more in public and private capital to
facilitate large-scale asset purchases of legacy assets through the
PPIP, expanding the total impact on the economy without extending more in outlays.
Treasury estimates only $565.5 billion in commitments.69 The
discrepancy between this figure and the numbers independently determined by the General Accountability Office (GAO), SIGTARP,
and the Panel results from $25 billion in CPP investments that
Treasury expects recipients to repay or liquidate.70 Although describing this estimate as ‘‘conservative,’’ 71 neither Secretary
Geithner nor Treasury has identified the institutions who will supply these anticipated repayments or when they will supply these
repayments. As a result, the Panel agrees with the GAO and
SIGTARP estimates of $590.4 billion in TARP funds already committed.72
b. Federal Reserve Board Facilities
The Federal Reserve Board is taking a similarly unprecedented
set of steps to stabilize the financial system and restart credit markets under its emergency powers.73 As of April 1, 2009, the Federal
Reserve Board has extended almost $1.5 trillion in credit to financial institutions independent of normal open market operations.74
These credit extensions, including special credit facilities established under its 13(3) emergency authority, enabled the Federal
66 March

GAO Report, supra note 37, at 9.
GAO Report, supra note 37, at 9.
GAO Report, supra note 37, at 9. Treasury also anticipates spending only $55 billion
in TALF funding as opposed to the $100 billion initially reported. See Figure 1, supra, and accompanying notes.
69 See, e.g., Alex Tanzi and Rebecca Christie, U.S. TARP Funding Remaining Estimated at
$134.5 Billion, Bloomberg (Mar. 30, 2009).
70 See, e.g., id.
71 Maya Jackson Randall, Treasury Has $134.5 Billion Left in TARP, Wall Street Journal
(Mar. 30, 2009) (online at online.wsj.com/article/SB123828522318566241.html) (quoting Secretary Geithner’s appearance on ABC’s This Week).
72 March GAO Report, supra note 34, at 9; Barofsky Testimony, supra note 48, at 12.
73 Emergency Relief and Construction Act of 1932, Pub. L. No. 72–302, at § 210 (amending
Federal Reserve Act, Pub. L. No. 63–43 (1913), at § 13) (codified as amended at 12 U.S.C. § 343).
This power, commonly known as the Federal Reserve’s 13(3) power or lender of last resort
power, enables the Board of Governors to authorize any regional Federal Reserve Bank to loan
money to a nonbank financial institution. 12 U.S.C. § 343. Additional Depression-era legislation
gave the Federal Reserve even broader power to lend outside the financial sector, but Congress
revoked this power in 1958. David Fettig, The History of a Powerful Paragraph: Section 13(3)
Enacted Fed Business Loans 76 Years Ago, Federal Reserve Bank of Minneapolis, The Region
(June 2008) (online at www.minneapolisfed.org/publicationslpapers/publdisplay.cfm?id=3485).
The Federal Reserve used the § 13(3) power in 1991 to loan money to the FDIC’s Bank Insurance Fund as a stopgap measure until Congress could recapitalize the fund; the recapitalization
legislation subsequently granted the Federal Reserve broader § 13(3) power to lend to distressed
securities firms and other financial institutions. Id. The Federal Reserve also used this authority to facilitate the merger of Bear Stearns and JPMorgan Chase. Id. See also David Fettig,
Lender of More Than Last Resort: Recalling Section 13(b) and the Years When the Federal Reserve Banks Opened Their Discount Windows to District Businesses in Times of Economic Stress,
Federal Reserve Bank of Minneapolis, The Region (Dec. 2002) (online at
www.minneapolisfed.org/publicationslpapers/publdisplay.cfm?id=3392).
74 Fed Balance Sheet April 2, supra note 33.
67 March

mstockstill on PROD1PC66 with HEARING

68 March

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00025

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

20
Reserve Board to use the asset side of its balance sheet to provide
liquidity to banks and revive credit markets. These facilities include: the Term Securities Lending Facility, the Primary Dealer
Credit Facility, the Asset-Backed Commercial Paper Money Market
Fund Liquidity Facility, the Commercial Paper Funding Facility,
the loan to Maiden Lane LLC to facilitate the acquisition of Bear
Stearns by JPMorgan Chase, and the lending facilities and Maiden
Lane II and III facilities established for AIG.
In addition, the Federal Reserve Board will initially offer up to
$200 billion in loans to participants and is open to expanding the
program to up to $1 trillion.75 Assuming Treasury funds its guarantees of TALF loans at $55 billion,76 one can expect the Federal
Reserve to ultimately extend up to $550 billion in loans.77
Off balance sheet vehicles such as the Maiden Lane entities and
the entities contemplated by PPIP raise a number of serious issues.
These entities trigger concerns about transparency and accountability, financial structure, and risk associated with high levels of
leverage.

mstockstill on PROD1PC66 with HEARING

c. FDIC Programs
The FDIC supports the government’s financial stabilization efforts through the Temporary Liquidity Guarantee Program (TLGP)
and the temporary increase in deposit insurance coverage to
$250,000 per account. Banks that fail are also put into receivership
by the FDIC, leading to additional costs for the Deposit Insurance
Fund (DIF). The TLGP guarantees newly issued senior unsecured
debt for banks, thrifts, and certain holding companies. The program also provides full coverage of non-interest bearing deposit
transaction accounts, regardless of amount. As of January 31, 2009,
65 financial institutions issued $252.6 billion 78 in debt under the
TLGP and paid $4.5 billion in fees.79
The FDIC advances two strategies for covering its increasing
costs under these programs. First, it has increased deposit insurance premiums paid by banks. Under the increased premiums,
higher-risk banks will pay higher rates. The FDIC has also proposed a special one-time flat-rate assessment to be paid by banks
this year.80 Second, it has requested increased borrowing authority.
Under present law, the FDIC’s borrowing from Treasury is limited
75 U.S. Department of the Treasury, U.S. Treasury and Federal Reserve Board Announce
Launch of Term Asset-Backed Securities Loan Facility (TALF) (Mar. 3, 2009) (online at
treas.gov/press/releases/tg45.htm).
76 March GAO Report, supra note 34; Michael R. Crittenden, Treasury Seeks to Free Up Funds
by Shuffling Spending in TARP, Wall Street Journal (Apr. 2, 2009) (online at online.wsj.com/
article/SB123870719693083971.html) (setting Treasury commitment to TALF at $55 billion,
which represents a reduction from the $100 billion Treasury initially committed to an expanded
TALF).
77 See Figure 1, supra, and accompanying notes.
78 Federal Deposit Insurance Corporation, Monthly Reports on Debt Issuance Under the Temporary Liquidity Guarantee Program: Debt Issuance under Guarantee Program (online at
www.fdic.gov/regulations/resources/TLGP/totallissuance1-09.html) (accessed Apr. 2, 2009).
79 Federal Deposit Insurance Corporation, Monthly Reports on Debt Issuance Under the Temporary Liquidity Guarantee Program: Fees Assessed Under TLGP Debt Program (online at
www.fdic.gov/regulations/resources/TLGP/fees.html) (accessed Apr. 2, 2009).
80 Senate Subcommittee on Financial Institutions, Committee on Banking, Housing and Urban
Affairs, Testimony of Arthur J. Murton, Director, Division of Insurance and Research, Federal
Deposit Insurance Corporation, Current Issues in Deposit Insurance, 111th Cong. (March 19,
2009) (online at www.fdic.gov/news/news/speeches/chairman/spmar1909l2.html) (hereinafter
‘‘Murton Testimony’’).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00026

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

21
to $30 billion.81 This limit has not changed since 1991.82 A bill currently before the Senate would increase the FDIC’s borrowing authority to $100 billion.83 The bill also allows temporary increases
above that amount, to a maximum of $500 billion.84 Also, because
of the large number and dollar amount of recent bank failures, the
Fund’s reserve ratio had fallen below the statutory minimum.85
The FDIC has extended the period of time within which it intends
to return to the statutorily mandated reserve ratio.86
4. MEASURES OF SUCCESS

In its December report, the Panel asked Treasury ‘‘Is the Strategy Working to Stabilize Markets? What specific metrics can Treasury cite to show the effects of the $250B spent thus far on the financial markets, on credit availability, or, most importantly, on the
economy? Have Treasury’s actions increased lending and unfrozen
the credit markets or simply bolstered the banks’ books? How does
Treasury expect to achieve the goal of price discovery for impaired
assets? Why does Treasury believe that providing capital to all viable banks, regardless of business profile, is the most efficient use
of funds?’’ 87
In its response to the Panel, Treasury identified two metrics: (1)
the average credit default swap spread for the eight largest U.S.
banks; and (2) the spread between the London Interbank Offered
Rate (LIBOR) and Overnight Index Swap rates (OIS).88 According
to Treasury, these measures’ retreat from the historic levels they
reached in the fall of 2008 demonstrates that the government’s programs stemmed a series of financial institution failures and made
the financial system fundamentally more stable than it was when
Congress passed EESA.89
As the Panel noted in its January report, measuring the success
of the government’s programs is more complicated. The metrics
Treasury identified offer only a partial view of the effect that TARP
expenditures have had on stabilizing the economy and accomplishing the goals set forth in the EESA.90 Of course, it is impossible to assess how well credit markets and the broader economy
would have fared absent intervention, just as it is impossible to determine if markets responded to specific programs or merely the
implicit guarantee inherent in the responses of Treasury, the Federal Reserve Board, and others in government.91 Nevertheless, the
81 12

U.S.C. § 1824(a) (2009).
Testimony, supra note 80.
Protection Act of 2009, S. 541.

82 Murton

83 Depositor
84 Id.
85 Murton

Testimony, supra note 80.
Testimony, supra note 80.
December Oversight Report, supra note 4, at 4.
88 Panel January Oversight Report, supra note 5, at 9. Of course, credit default swap spreads
for additional banks and other financial institutions may also provide insight into the effectiveness of the government’s program, but Treasury specifically limited its December response to
the eight largest institutions. Treasury December Response to Panel, supra note 7, at 5.
89 Treasury December Response to Panel, supra note 7, at 5.
90 Panel January Oversight Report, supra note 5, at 9–10.
91 The Panel also notes with appropriate caution the difficulty of disaggregating the economic
effects of TARP from the effect of other government responses, including Federal Reserve lending and monetary policy, other Treasury actions, and fiscal stimulus, as well as nongovernment
market pressures. Nevertheless, identifying and monitoring measures of success represents a
crucial task for those charged with making policy as well as those charged with overseeing policy.
86 Murton

mstockstill on PROD1PC66 with HEARING

87 Panel

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00027

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

22
Panel’s review of a broader set of measures reveals a much more
nuanced picture of the government strategy’s impact on the economy.
Finally, these metrics reflect the shifting nature of the challenge
facing the United States and the world economy. We have moved
from an acute crisis of confidence in the financial markets and financial institutions as a whole to an apparently prolonged period
of weakness in financial institutions and in the credit structures
that directly support the real economy. So instead of the LIBOR
spread being impossibly high, we see the repeated return of institutions like Citigroup and Bank of America for further capital injections, as well as rising overall corporate bond spreads.

mstockstill on PROD1PC66 with HEARING

a. Improving Metrics (Good Signs)
The programs initiated by Treasury, alongside those of the Federal Reserve Board and FDIC, merit praise for their ability to revive short-term credit markets that many perceived as in paralysis
during the fall of 2008.92 By a number of measures, the terms on
which capital is available have returned to non-crisis levels, and
markets no longer regard the imminent collapse of many institutions as a real possibility. However, the volatility and upward
trends in these measures indicate that credit markets still have
questions about the health of financial institutions. As such, although Treasury is right to say that the panic atmosphere of October 2008 has subsided, interbank credit market indicators still reflect continued uncertainty and remain well above what had previously been very long-term stable levels.
• Credit Default Swap Spreads. Higher spreads on credit default swaps indicate a willingness to pay more for insurance
against default, so a higher spread on an institution’s credit default
swap means that investors think it is more likely to default on its
obligations. Treasury and the Financial Stability Oversight Board
(FinSOB) have indicated that falling spreads on the credit default
swaps of major financial institutions reflect the perception of a
more stable financial sector in which investors are less fearful of
such institutions collapsing.93 However, although these spreads
have narrowed, they remain volatile.94
• LIBOR–OIS Spread. Again, both Treasury and the FinSOB
have cited the peak of the spread between three-month LIBOR, a
measure of quarterly borrowing costs, over OIS, a measure of ex92 V.V. Chari, Lawrence Christiano, and Patrick J. Kehoe, Facts and Myths about the Financial Crisis of 2008 (Oct. 2008) (Federal Reserve Bank of Minneapolis Research Department
Working Paper No. 666) (online at www.minneapolisfed.org/research/WP/WP666.pdf) (hereinafter ‘‘Minneapolis Fed Paper’’). The Minneapolis Fed Paper found little empirical evidence of
paralyzed credit markets during the height of the perceived crisis in September and October
2008. Id. at 1–3, 11.
93 Financial Stability Oversight Board, First Quarterly Report to Congress Pursuant to Section
104(g) of the Emergency Economic Stabilization Act of 2008, at 24–25 (Jan. 16, 2009) (hereinafter ‘‘FinSOB January Report’’).
94 Id. at 25. For example, credit default swap spreads on Merrill Lynch increased more than
100 basis points after Bank of America CEO Ken Lewis made a comment seemingly endorsing
separation of commercial and investment banking; he later clarified the statement to indicate
no such endorsement. Andrew Edwards, Credit Markets: The Rally That Was, Wall Street Journal (Mar. 27, 2009) (online at online.wsj.com/article/BT-CO-20090327-714105.html); Lizzie
O’Leary and Christine Harper, Bank of America CEO Says He Doesn’t Want Banks Split,
Bloomberg
(Mar.
27,
2009)
(online
at
www.bloomberg.com/apps/news?pid=
20601087&sid=aKlS8qNC2wZo).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00028

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

23
ceedingly short-term borrowing costs, as an appropriate metric for
evaluating the success of Treasury’s efforts on the broader economy.95 This figure peaked on October 10, 2008, the day before
Treasury announced the CPP, and has substantially declined since.
The Financial Stability Oversight Board indicated that this measure also indicates calmer markets that are less fearful of major institution failures. The 1-month LIBOR–OIS spread is below where
it stood for most of 2008, and the 3-month LIBOR–OIS spread is
only slightly above it.96 However, both figures are trending upwards in 2009 and remain well above levels that had been stable
until late 2007.
FIGURE 2: 3-YEAR LIBOR/OIS TREND 97

• TED Spread. The GAO highlights the TED spread, the difference between a LIBOR average and the interest rate on U.S.
Treasuries of the same term, as a credit risk indicator: the higher
the spread, the greater the perceived risk and the tighter the credit
market.98 The TED spread hit its peak in October 2008 but has
since declined to a level near the low for 2008, which was a year
of great volatility in the spread.99
95 FinSOB

January Report, supra note 93, at 24.
3
Mo
LIBOR–OIS
Spread
(online
at
www.bloomberg.com/apps/
quote?ticker=.LOIS3:IND|) (accessed Apr. 3, 2009); Bloomberg, 1 Mo LIBOR–OIS Spread (online
at www.bloomberg.com/apps/quote?ticker=.LOIS1:IND|) (accessed Apr. 3, 2009).
97 Id.
98 Government Accountability Office, Troubled Asset Relief Program: Status of Efforts to Address Transparency and Accountability Issues, at 64 (Jan. 30, 2009) (GAO/09–296) (hereinafter
‘‘January GAO Report’’).
99 Bloomberg, TED Spread (online at www.bloomberg.com/apps/quote?ticker=.TEDSP:IND)
(accessed Apr. 2, 2009).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00029

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert offset folio 35 here 48565A.001

mstockstill on PROD1PC66 with HEARING

96 Bloomberg,

24

mstockstill on PROD1PC66 with HEARING

b. Worsening metrics (bad signs)
Despite several measures that indicate that the government’s responses to the financial crisis relieved a panic atmosphere in October 2008, other measures indicate that there is an ongoing credit
crisis despite extensive expenditures, loans, guarantees, and regulatory forbearance. Credit has become more expensive for both
businesses and individuals, and loan value and volume has declined substantially. Although some contraction of borrowing naturally occurs during economic downturns, the current credit situation continues to inhibit recovery.
• Mortgage Foreclosures/Defaults/Delinquencies. Foreclosure rates represent a key indicator of economic health as well as
a barometer for the success of TARP efforts at meeting their statutory mandate of mitigating foreclosures. As measured by foreclosure initiations or completions, either as a rate or absolutely, or
by delinquent mortgages, this problem continues to worsen.100
• Corporate Bond Spreads. Both GAO and FinSOB monitor
the spread between corporate bonds of varying risk characteristics
and U.S. Treasuries of the same term.101 These spreads have widened following the implementation of the TARP, narrowed during
January and February, but are again widening.102 As GAO noted,
the systematic underpricing of risk in corporate bonds leading up
to the financial crisis may account for some of the widening of such
spreads.103 Furthermore, declining yields on Treasuries may also
artificially increase the spread. However, given that this spread
continued to increase during March,104 the widening would appear
to indicate that medium- and long-term corporate credit is harder
to come by and requires borrowing on less favorable terms.
• Housing Prices. Although largely inflated due to the boom
period preceding the crisis, home values illustrate part of the picture of dire economic circumstances. Nationally, housing prices
have fallen by 29.1 percent since peaking in the second quarter of
2006.105 The S&P/Case-Shiller Composite 20 index showed a decline of 28.5 percent in January 2009 from its peak in May 2006.106
Although some of the drop in real estate value reflects a retreat
from unsustainable bubble levels, the continued drop in housing
prices is a leading contributor to bank asset write downs, recent
99 Bloomberg, TED Spread (online at www.bloomberg.com/apps/quote?ticker=.TEDSP:IND)
(accessed Apr. 2, 2009).
100 See Panel March Oversight Report, supra note 2. See also RealtyTrac, Foreclosure Activity
Increases 81 Percent in 2008 (Jan. 15, 2009) (online at www.realtytrac.com/ContentManagement/
pressrelease.aspx?ChannelID=9&ItemID=5681&accnt=64847); January GAO Report, supra note
98 at 71–73; FinSOB January Report, supra note 93, at 35–37.
101 January GAO Report, supra note 98, at 66; FinSOB January Report, supra note 93, at 26.
102 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release
H.15: Selected Interest Rates: Historical Data (Instrument: Corporate Bonds/Moody’s Seasoned
AAA, Frequency: Weekly) (online at www.federalreserve.gov/releases/h15/data/Weeklyl Fridayl/H15lAAAlNA.txt) (accessed Apr. 2, 2009) (hereinafter ‘‘Fed H.15 a’’); Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release H.15: Selected Interest
Rates: Historical Data (Instrument: Corporate Bonds/Moody’s Seasoned BAA, Frequency: Weekly) (online at www.federalreserve.gov/releases/h15/data/WeeklylFridaylH15l BAAlNA.txt)
(accessed Apr. 2, 2009) (hereinafter ‘‘Fed H.15 b’’); Board of Governors of the Federal Reserve
System, Federal Reserve Statistical Release H.15: Selected Interest Rates: Historical Data (Instrument: U.S. Government Securities/Treasury Constant Maturities/Nominal, Frequency:
Weekly)
(online
at
www.federalreserve.gov/releases/h15/data/WeeklylFridayl/H15l
TCMNOMlY10.txt) (accessed Apr. 2, 2009) (hereinafter ‘‘Fed H.15 c’’).
103 January GAO Report, supra note 98, at 66.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00030

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

25

mstockstill on PROD1PC66 with HEARING

declines in household net worth, and the weakening broader economy.107
• Commercial Real Estate Commitments. Like housing
prices and mortgage measures, commercial real estate commitments illustrate the health of the commercial real estate sector.
The Treasury Monthly Snapshot tracks this figure for the institutions it monitors. It recently reported a decrease in both renewals
and new commitments, in contrast to rising renewal rates at the
end of 2008.108
• Commercial Paper Outstanding. Commercial paper outstanding, a rough measure of short-term business debt, represents
another indicator of the availability of credit for enterprises.109 Financial and asset backed commercial paper dipped to extreme lows
in mid-October, largely recovered as of December 31, plunged again
during February 2009, and recovered slightly during March.110
Nonfinancial commercial paper levels, largely stable until the end
of February, were off more than 10 percent during March.111
• Security Repurchase Agreements. Like commercial paper,
the volume of security repurchase agreements represents another
measure of the availability of short-term credit for businesses. As
measured by both assets and liabilities, total dollar volume
dropped precipitously in Q4 2008.112
• Household/Business Debt Growth. The FinSOB noted that
slowing growth of household and business debt has historically represented economic weakness.113 It reported substantial deceleration
in debt growth between the last quarter of 2008 and the comparable period in 2007. This trend reflects the tightening of credit
markets during the crisis.
• Overall Loan Originations. The total volume of overall loan
originations represents one key measure of the availability of credit. Treasury’s Monthly Snapshot report tracks this indicator for
twenty of the largest CPP recipients, who collectively represent
about 90 percent of the deposits in the banking system. In its most
recent report, Treasury cited rising consumer lending, especially in
mortgages and student loans; however, seasonal changes in student
loan demand and increased refinancing demand largely explain
this increase.114 Commercial and industrial lending both fell con107 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release Z.1:
Flow of Funds Accounts of the United States, Flows and Outstandings Fourth Quarter 2008, at
105 (Mar. 12, 2009) (R.100 Change in Net Worth of Households and Nonprofit Organizations).
108 U.S. Department of the Treasury, Treasury Department January Monthly Lending And
Intermediation Snapshot (Mar. 16, 2009) (hereinafter ‘‘January Treasury Snapshot’’); U.S. Department of the Treasury, Treasury Department Monthly Lending and Intermediation Snapshot:
Summary Analysis for October–December 2008, at 3 (Feb. 18, 2009) (hereinafter ‘‘2008 Treasury
Snapshot’’).
109 FinSOB January Report, supra note 93, at 27.
110 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release:
Commercial Paper Outstanding (online at www.federalreserve.gov/releases/cp/outstandings.htm)
(accessed Apr. 3, 2009).
111 Id.
112 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release Z.1:
Flow of Funds Accounts of the United States, Flows and Outstandings Fourth Quarter 2008, at
41 (Mar. 12, 2009) (F.207 Federal Funds and Security Repurchase Agreements).
113 FinSOB January Report, supra note 93, at 29–30.
114 January Treasury Snapshot, supra note 114; 2008 Treasury Snapshot, supra note 114, at
3.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00031

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

26
siderably.115 The combination indicates that credit markets remain
tight, especially in the business sector.
• Overall Loan Balances. Similarly, the overall volume of loan
balances represents an important credit indicator. Treasury’s
Monthly Snapshot report also tracks this measure for the same set
of CPP recipients. Both residential and corporate loan balances
dropped for the institutions Treasury monitors monthly, indicating
that banks’ loan portfolios are shrinking across the board as what
new lending does take place fails to replace loans coming off the
books or defaulting.116
• Mortgage Rate Spread. Mortgage rates represent an obvious
metric to determine the terms of credit available to qualified homebuyers, and the spread between such rates and comparable Treasuries indicates the risk premium associated with lending to homeowners versus lending to the federal government. GAO has reported that movement in this measure is associated more with the
Federal Reserve Board’s decision to purchase mortgage-backed securities rather than with any TARP-related actions.117 The spread
between conventional 30-year conforming mortgages and 10-year
Treasuries peaked in December 2008; although it has since narrowed slightly, it is still well above historic levels.118 The spread
results from conventional mortgage rates, which hit their lowest
point since 1971 in March, nonetheless lagging behind the drop in
Treasury rates.119 As with corporate bond spreads, although some
of the spread reflects a correction from underpricing of risk leading
up to the crisis, it still reflects problematically tight credit markets.
• Mortgage Originations. Closely related to the risk premium
associated with lending to homebuyers is the overall volume of
such lending. A low risk premium coupled with low mortgage volume indicates substantial tightening of lending standards.120 The
GAO has indicated a substantial drop in this figure, both as measured by originations and applications, since the first quarter of
2008.
c. Indeterminate Metrics (Too Early to Tell)
Some measures of the health of both credit markets and the
broader economy are difficult to evaluate as either improving or
worsening, either because they are too volatile or because they are
contradictory depending on how one examines them.
115 January

Treasury Snapshot, supra note 114; 2008 Treasury Snapshot, supra note 114, at

3.

mstockstill on PROD1PC66 with HEARING

116 January

Treasury Snapshot, supra note 114; 2008 Treasury Snapshot, supra note 114, at
3. The increase in mortgage originations is not inconsistent with falling residential loan balances in light of the ongoing foreclosure crisis.
117 January GAO Report, supra note 98, at 67–68.
118 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release H.15:
Selected Interest Rates (Weekly) (online at www.federalreserve.gov/releases/h15/current/h15.htm)
(accessed Apr. 2, 2009).
119 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release
H.15: Selected Interest Rates: Historical Data (Instrument: Conventional Mortgages, Frequency:
Weekly (Thursday)) (online at www.federalreserve.gov/releases/h15/data/WeeklylThursdayl/
H15lMORTGlNA.txt) (accessed Apr. 2, 2009); Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release H.15: Selected Interest Rates: Historical Data (Instrument: Conventional Mortgages, Frequency: Weekly (Friday)) (online at www.federalreserve.gov/
releases/h15/data/WeeklylFridayl/H15lMORTGlNA.txt) (accessed Apr. 2, 2009); Fed H.15c,
supra note 102.
120 January GAO Report, supra note 98, at 69–70.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00032

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

27
• Spreads on Overnight Commercial Paper. Like the
amount outstanding on commercial paper, the yield associated with
it as compared to the yield of other modes of short term borrowing
constitutes another short-term commercial credit indicator. The
FinSOB tracks this figure relative to the AA nonfinancial commercial paper rate. The spread for asset-backed paper has come down
dramatically, but the spread for lower-grade paper remains
high.121 It is not immediately clear whether these developments indicate an appropriate response to underpricing of risk in the runup to the financial crisis or an overcorrection that indicates excessively tight credit inhibiting economic recovery.
• Credit Card Borrowing. The total balance outstanding on
credit cards and the total unused credit available on credit cards
marks another indicator of the availability of liquidity to consumers and small businesses. The Treasury Monthly Snapshot
tracks this data for its institutions. Overall for these institutions,
credit card lending has changed little since the end of 2008.122 This
measure may reflect increased household savings rates and weakening consumer demand in response to the weakening economy, or
it may indicate a lack of credit available on sufficiently favorable
terms.
• Perceptions of Lending Practices. The Board of Governors
of the Federal Reserve Board conducts quarterly surveys of senior
bank loan officers’ perceptions of their respective institution’s lending practices. Although these surveys ask for subjective evaluations, tracking their evolution over time illustrates how bankers’
personal views of the economy and credit markets have changed in
response to market events. The Fed’s most recent survey, in January 2009, shows that, while the number of lenders tightening loan
standards has declined from its October 2008 peak, the number remains above its historical average.123 Similarly, although the results indicate a small uptick in demand for loans and in willingness to make loans, the numbers still stand below their historical
averages.124
These measures indicate that, although credit markets no longer
face an acute systemic crisis in confidence that threatens the functioning of the economy, the underlying financial crisis is far from
over and appears to be taking root in the larger economy. Furthermore, Treasury has yet to identify the metrics by which they will
measure the ultimate success of the programs they have implemented and are implementing, making it difficult to assess performance.
B. Historical Approaches and Lessons
This report seeks to examine issues of strategy associated with
the federal government’s use of the powers granted to it by the
121 FinSOB

mstockstill on PROD1PC66 with HEARING

122 January

January Report, supra note 93, at 27.
Treasury Snapshot, supra note 114; 2008 Treasury Snapshot, supra note 114, at

3.
123 Board of Governors of the Federal Reserve System, The January 2009 Senior Loan Officer
Opinion Survey on Bank Lending Practices, at 8–11 (Feb. 2, 2009) (online at
www.federalreserve.gov/boarddocs/SnLoanSurvey/200902/fullreport.pdf).
124 Id.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00033

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

28
EESA. Part of that exercise must be to examine the experience of
the United States and other countries that have faced similar financial crises in the modern era. In this section of this report, we
will look at four major examples of public policy responses to financial crises: The Great Depression in the United States, the savings
and loan collapse in the United States, the Swedish banking crisis
of the early 1990s, and Japan’s banking crisis associated with the
‘‘lost decade.’’ In addition, we will briefly survey several lesser
banking problems that have arisen in the United States since 1980.
1. THE U.S. DEPRESSION OF THE 1930S AND THE FEDERAL RESPONSE

mstockstill on PROD1PC66 with HEARING

The 1929 stock market crash, the ensuing collapse of production
and wealth, and the continued volatility of the markets in the
1930s led consumers and businesses to reduce spending dramatically, caused extraordinarily high bankruptcy rates, and brought
about the failure or disappearance of nearly half of all American
financial institutions.125 During the period between 1929 and 1933
alone, the number of banks in the U.S. declined by one-third, from
24,633 to 15,015, with three waves of crises—October 1930, March
1931, and January 1933—rocking the financial system.126
The causes of the Great Depression and the corresponding crisis
in the U.S. financial system were complex and numerous, with the
debate among economists and economic historians focusing primarily on the extent to which monetary versus nonmonetary factors influenced the onset and worsening of the Depression.127
Nonetheless, there is a general consensus that the contractionary
monetary policies that the Federal Reserve Board pursued at the
time were a significant contributing factor to the banking crisis of
the early 1930s.128 These monetary policies were a response to the
return to the gold standard on the part of numerous countries during the 1920s, which led to a shrinking of the world’s money supply, as central banks around the world scrambled to hoard gold.129
The U.S. government’s insistence on maintaining the gold standard, coupled with the contractionary actions taken by the Federal
Reserve Board, spurred dramatic deflation, with prices of goods
falling approximately 25 percent between 1929 and 1933.130 The
resultant debt deflation, a phenomenon by which the collateral underlying loans shrinks in value, causing the real burden of debt to
rise, led the economy to spiral further downward, with consumers
and businesses across the country oftentimes owing more than the
collateral itself was worth, much as we have seen in recent months
with a significant proportion of U.S. households owing more on
125 Christina D. Romer, The Great Crash and the Onset of the Great Depression, at ii (June
1988) (National Bureau of Economic Research Working Paper No. 2639) (online at
papers.ssrn.com/sol3/papers.cfm?abstractlid=262094).
126 Randall Kroszner, The Political-Economy of the Reconstruction Finance Corporation’s BailOut of the U.S. Banking System during the Great Depression (Apr. 1994) (University of Chicago
Working Paper).
127 Ben S. Bernanke, Essays on the Great Depression, at 7 (2000).
128 Christina Romer, Prepared Remarks to be Presented at the Brookings Institution, Washington, DC: Lessons from the Great Depression for Economic Recovery in 2009, at 5 (Mar. 9,
2009) (hereinafter ‘‘Romer Brookings Remarks’’); Charles Calomiris and Joseph Mason, How to
Restructure Failed Banking Systems: Lessons from the U.S. in the 1930s and Japan in the 1990s,
at 17 (Apr. 2003) (National Bureau of Economic Research Working Paper No. 9624); Bernanke
supra note 127.
129 Calomiris and Mason, supra note 128, at 17.
130 Romer Brookings Remarks, supra note 128, at 6.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00034

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

29

mstockstill on PROD1PC66 with HEARING

their mortgages than their homes are worth.131 Further, high real
rates of interest reduced consumption and investment throughout
the economy.132
In a parallel that makes the Great Depression quite relevant to
the current crisis, many economists also cite the collapse of the real
estate bubble in the second half of the 1920s as a major contributing factor to the stock market crash, the collapse of the banks,
and the Great Depression.133 Existing problems in the housing
market were amplified by the debt deflation of 1929–1933, which
increased the real value of repaying mortgage loans, and rising unemployment rates and falling incomes, which made it increasingly
difficult for homeowners to repay their debts.134 Borrowers were
unable to make their payments, the value of banks’ securities fell,
many banks were unable to meet the needs of their depositors, and
a lack of confidence in the remaining banks led to a general state
of panic. The fact that consumer bank deposits were not insured at
this time further contributed to the sense of uncertainty that pervaded the country, leading to historic levels of bank runs and magnifying the effects of those runs.135
In an initial effort to prevent banks from failing, President Hoover and Treasury Secretary Andrew Mellon organized a conference
in the fall of 1931, at which prominent bankers agreed to form a
private lending institution, the National Credit Corporation (NCC).
The NCC was designed to serve as a supplement to the Federal Reserve Board by making loans to banks struggling to meet their obligations that did not have sufficient ‘‘eligible’’ securities to serve as
collateral receive loans from the Fed.136 While this effort did lead
to a short-term boost in confidence, by late 1931, it was clear to
President Hoover that the NCC would be insufficient. In response,
Hoover submitted a bill to Congress on December 7, 1931, that
would create the Reconstruction Finance Corporation (RFC) to
make loans to banks (as well as to railroads and state and local
governments) and relax the collateral requirements for borrowing
from the Fed.
From its establishment in February 1932 until March 1933, the
RFC was not authorized to make capital investments in troubled
banks but rather provided support in the form of fully secured,
short-term loans.137 By the end of 1932, the RFC had authorized
131 Calomiris and Mason, supra note 128, at 17; Irving Fisher: Out of Keynes’s Shadow, The
Economist (Feb. 12, 2009).
132 Congressional Oversight Panel, Testimony of Eugene White, Learning from the Past—Lessons from the Banking Crises of the 20th Century, at 3 (Mar. 19, 2009) (hereinafter ‘‘White Panel
Testimony’’).
133 Robert J. Shiller, The Subprime Solution: How Today’s Global Financial Crisis Happened,
and What to Do About It, at 14 (2008).
134 White Panel Testimony, supra note 132, at 8.
135 The debate over the creation of the FDIC was quite contentious. For years prior to the
onset of the Great Depression, there was little support for nationwide deposit insurance, due
in large part to lessons learned from prior failures of state-based deposit insurance systems, as
well as concerns about moral hazard. However, in the aftermath of the calamitous bank runs
of the early 1930s, proponents of Federal deposit insurance were able to pass a measure temporarily instituting a government deposit insurance program as part of the Banking Act of 1933
(the Glass-Steagall Act). The system was made permanent in 1935. Eugene N. White, Deposit
Insurance, in Gerard Caprio, Jr. and Dimitri Vittas, Reforming Financial Systems: Historical
Implications for Policy, at 90–93 (1997).
136 Kroszner, supra note 126, at 3.
137 William Keeton, The Reconstruction Finance Corporation: Would It Work Today? Economic
Review, at 38 (First Quarter 1992).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00035

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

30

mstockstill on PROD1PC66 with HEARING

approximately $1.6 billion in loans, nearly $1.3 billion of which was
provided in loans to banks.138 However, the shortcomings of this
approach quickly became clear, as these secured loans represented
a senior claim on bank assets relative to depositors, effectively
worsening the default risk faced by junior depositors and providing
little help to unhealthy banks.139 Indeed, some scholars have contended that receiving a loan from the RFC may have actually increased the probability of bank failure (controlling for exogenous
differences among banks).140 A complicating factor was that the
names of banks receiving funds from the RFC often became public,
which, in turn, led to a further drop in confidence in those banks.
According to Jesse Jones, the Texas banker who became the Chairman of the RFC under Roosevelt, ‘‘[i]t became increasingly evident
to us that loans were not an adequate medicine to fight the epidemic. What the ailing banks required was a stronger capital structure.’’ 141 The matter of determining whether liquidity or solvency
represented the principal problem for struggling financial institutions and of using that determination to guide policy choices is one
with distinct relevance to the current crisis.
While President Hoover was hesitant to institute stronger programs, President Roosevelt took swift action upon becoming president in March 1933, instituting a nation-wide bank holiday on
March 3 and signing into law the Emergency Banking Act on
March 9. This Act legalized the banking holiday, authorized the
RFC to make preferred stock investments in financial institutions,
instituted procedures for reopening sound banks and resolving insolvent banks, and further broadened the range of assets that
would be acceptable to the Fed.142 Critical to restoring confidence
in the banking system was ensuring that only banks liquid enough
to do business were re-opened when the banking holiday was lifted.
Therefore, banks were separated into three categories, based on an
independent valuation of assets conducted by teams of bank examiners from the RFC, Federal Reserve Banks, Treasury, and the
Comptroller of the Currency: (1) Banks whose capital structures
were unimpaired, which received licenses and re-opened when the
holiday was lifted; (2) banks with impaired capital but with assets
valuable enough to re-pay depositors, which remained closed until
they could receive assistance from the RFC; and (3) banks whose
assets were incapable of a full return to depositors and creditors,
which were placed in the hands of conservators who could either
reorganize them with RFC assistance or liquidate them.143
The banks that did not initially receive licenses to re-open were
further scrutinized in order to determine if they could re-open at
a later date without reorganization and without major assistance
from the RFC, if they could re-open only after receiving significant
aid from the RFC and possibly being reorganized, or if they had to
be liquidated.144 It is important to note that financial institutions
138 James S. Olson, Saving Capitalism: The Reconstruction Finance Corporation and the New
Deal, 1933–1940, at 23 (1988).
139 Calomiris and Mason, supra note 128, at 20.
140 Calomiris and Mason, supra note 128, at 21.
141 Kroszner, supra note 126, at 4.
142 Keeton, supra note 137, at 38.
143 Olson supra note 138, at 64.
144 Olson supra note 138, at 70.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00036

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

31
that were allowed to re-open were nonetheless encouraged to participate in the government preferred stock program, in order to
strengthen their capital position and to allow them to expand commercial credit.145 However, these banks were slow to participate in
the preferred stock program, due in large part to the stringent conditions that were placed on banks that sold preferred stock to the
government, including the provision that granted the government
voting rights and the ability to elect directors in proportion to its
stock ownership.146 Bankers also worried that news of the banks’
receipt of government aid would become public, worsening their
solvency and liquidity problems rather than helping to cure them.
In June 1933, Congress passed the Banking Act of 1933, which
established the FDIC and restricted initial participation to solvent
banks upon FDIC’s January 1, 1934 launch.147 Since many banks
that had been allowed to re-open following the bank holiday were
still in a precarious financial position, fears that they would be rejected from the FDIC, destroying market confidence in their institutions and leading to bank runs, coupled with cajoling on the part
of RFC and administration officials likewise concerned that banks
being rejected from the FDIC would worsen the crisis, led banks
to begin applying at a much higher rate for the RFC preferred
stock program. Ultimately, the RFC invested roughly $1.7 billion in
6,104 banks through its preferred stock program.148 At one point
in 1933, the RFC held capital in more than 40 percent of all banks,
representing one-third of total bank capital according to some estimates.149
In exchange for this government support, the RFC exercised its
control of the banks by replacing senior management at some
banks and forcing a change in business practices when it determined that changes were needed.150 The RFC also used its power
to negotiate and reduce the salaries of bank managers and executives.151 The RFC preferred stock had a senior claim on bank earnings and common stock dividend payments were strictly limited to
a specified maximum until the government investment was repaid,
with any remaining earnings going towards a preferred stock retirement fund.152 In fact, the RFC reserved the right to take virtually complete control of any bank that missed dividend payments
on the preferred stock (payments that amounted to 6 percent initially but that were later reduced to 4 percent or as low as 3.5 percent).153 However, the goal of these government takeovers was to
steer the banks back toward profitability—not to maintain longterm government control. As RFC head Jesse Jones noted at the
145 Olson

supra note 138, at 82.
supra note 126, at 5.
Banking Act of 1933 established the FDIC as a temporary government agency and insured up to $2,500. The Banking Act of 1935 ultimately made the FDIC permanent and insured
commercial deposits up to $5,000.
148 Jesse Jones, Fifty Billion Dollars, at 25–26 (1951).
149 Federal Reserve Bank of Kansas City, Speech by President Thomas Hoenig: Too Big Has
Failed (Mar. 6, 2009) (online at www.kc.frb.org/speechbio/hoenigPDF/Omaha.03.06.09.pdf).
150 Calomiris and Mason, supra note 128, at 23.
151 Walker F. Todd, History of and Rationales for the Reconstruction Finance Corporation, Federal Reserve Bank of Cleveland Economic Review, at 26 (Fourth Quarter 1992).
152 Calomiris and Mason, supra note 128, at 23.
153 Joseph R. Mason, Reconstruction Finance Corporation Assistance to Financial Intermediaries and Commercial & Industrial Enterprise in the U.S., 1932–1937, at 20 (Jan. 17, 2000)
(online at papers.ssrn.com/sol3/papers.cfm?abstractlid=1337171).
146 Kroszner,

mstockstill on PROD1PC66 with HEARING

147 The

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00037

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

32
time, he had ‘‘no desire to control or manage the banks;’’ rather,
he simply sought to protect the government’s (and, consequently,
the taxpayer’s) investment as best as he could.154
While there were relapses and the Great Depression persisted for
some time, it is generally agreed that the RFC played a major role
in helping to restore the health of the American banking system.155
The key steps it followed in resolving failing banks are often cited
as the model for dealing with such situations: (1) write down a
bank’s bad assets to realistic economic values; (2) judge the character and capacity of bank management and make any needed and
appropriate changes; (3) inject equity in the form of preferred stock
(but, critically, not until the write-downs have taken place); and (4)
receive the dividends and eventually recover the par value of the
stock as the bank returns to profitability and full private ownership.156
It should be noted that the RFC valued banks’ assets varied over
the life of the RFC. At the outset, RFC examiners evaluated assets
at their fair market value, using this determination to guide them
in deciding if an institution was viable, if it could re-open with RFC
investment, or if it needed to be liquidated; however, toward the
end of 1933, the RFC changed its valuation standards for the purposes of the preferred stock program, giving book value to the highest grade bonds, market value for bonds in default, face value for
assets that were fundamentally sound but that could not be converted immediately into cash, and a reasonable valuation for doubtful assets, often including assets derived from real estate.157 How
such a ‘‘reasonable valuation’’ for the banks’ ‘‘doubtful’’ or bad assets was made, however, is not well documented but appears to
have relied heavily upon the experience and judgment of federal
and state bank examiners. Consequently, scholars have noted that
the underlying assumptions with regard to future market conditions that guided the RFCs’ valuations and decisions on banks’ solvency ‘‘were (and still are) difficult or impossible to quantify.’’ 158
Among the major reasons cited for the relative success of the
RFC were that: (1) it required banks to submit their regulatory examinations for inspection and rejected hopelessly insolvent banks;
(2) the RFC was a separately capitalized institution with financial
and political independence to make decisions as it deemed them
necessary; and (3) restrictions on recipients of RFC assistance reduced moral hazard and ensured that banks would not take advantage of the program. Among these restrictions were the voting
rights that the government gained, the influence the RFC had over
personnel matters, and the seniority of RFC dividends to all other
stock dividends.159
Nonetheless, whether measured by the number of banks that
failed, the losses suffered by bank investors and depositors, or the
extent to which credit contracted, the Great Depression was the
most significant crisis in the U.S. banking system at the time it occurred, and it remains a key point of reference for assessing the se154 Olson,

supra note 138, at 125.
supra note 137, at 47.
supra note 149.
157 Olson, supra note 138, at 80.
158 Mason, supra note 153, at 1.
159 Calomiris and Mason, supra note 128, at 23.
155 Keeton,

mstockstill on PROD1PC66 with HEARING

156 Hoenig,

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00038

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

33
verity of the current crisis.160 In this regard, it is important to emphasize that, while the RFC contributed to the stabilization of the
financial system at a time of great crisis, it certainly did not prevent the failure of many financial institutions, nor did it necessarily preserve the deposits individuals had in these failed institutions in the pre-FDIC era. Indeed, considering that the RFC
made a point not to invest in hopelessly insolvent banks and, likewise, the FDIC, when established in 1934, did not insure the deposits of insolvent banks, the result was that all stakeholders in
failed banks—stockholders, bondholders, and depositors—shared in
absorbing the losses.161 Equity in failed banks was wiped out and
depositors and non-depository debt holders were paid on a pro rata
basis as the liquidation of the assets of failed banks proceeded.162
Specifically, between 1930 and 1933, 10.7 percent of commercial
banks in the U.S. failed outright, and, by 1933, debt and equity
losses to private investors, bondholders, and depositors totaled $2.5
billion (approximately 2.4 percent of GDP in 1933).163
2. CONTINENTAL ILLINOIS

Following the banking reforms of the 1930s, including the institution of deposit insurance, the Glass-Steagall Act, and others, the
financial sector entered into a long period of tranquility.164 Bank
failures slowed to a trickle as bank regulatory policy focused
strongly on maintaining regulatory safe zones of the kind discussed
in the Panel’s Regulatory Reform Report.165 Moreover, when failure did happen, the automatic regulatory machinery worked as designed: either the regulators sold the bank successfully or they liquidated the institution, made good on deposit insurance promises,
and wiped out the uninsured depositors and other creditors.
Occasionally, bank failures were resolved using the FDIC’s ‘‘essentiality’’ authority, but, even then, these failures involved comparatively small investments. Into the 1970s, federal regulators
wrung their hands over transactions as small as a $1.5 million loan
to save a troubled $11 million institution.166 However, until the
1980’s, the federal government did not rescue any bank out of a
fear that the institution’s failure would pose systemic risk or that
160 Calomiris

and Mason, supra note 128, at 8.
Panel Testimony, supra note 132, at 1.
and Mason, supra note 128, at 16.
163 White Panel Testimony, supra note 132, at 4; Keeton, supra note 137, at 38.
164 Many sources have commented on this period. See, e.g., David Moss, An Ounce of Prevention: The Power of Sound Risk Management in Stabilizing the American Financial System (2009)
(Harvard Business School Working Paper 09–087) (online at www.hbs.edu/economic-crisis/docs/
management-in-stabilizing-the-financial-system.pdf).
165 Congressional Oversight Panel, Special Report on Regulatory Reform: Modernizing the
American Financial Regulatory System: Recommendations for Improving Oversight, Protecting
Consumers, and Ensuring Stability (Jan. 29, 2009) (hereinafter ‘‘Panel Regulatory Reform Report’’).
166 The FDIC authorized such expenditures under its ‘‘essentiality’’ authority granted in the
Federal Deposit Insurance Act of 1950 (FDIA), Pub. L. No. 81–797. A bank whose operations
the FDIC deemed ‘‘essential to the community’’ could continue to operate with direct infusions
of capital rather than being liquidated. FDIA at 13(c). When the FDIC rescued institutions
under this provision during the 1970s, it did so to avert unique problems rather than to stem
systemic crises; the threat of urban riots hung over the rescue of minority-owned First Unity
Bank of Boston, and a local municipal bond collapse looked imminent if Michigan’s Bank of the
Commonwealth failed. See Irvine H. Sprague, Bailout: An Insider’s Account of Bank Failures
and Rescues, at 35–76 (1986).
161 White

mstockstill on PROD1PC66 with HEARING

162 Calomiris

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00039

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

34

mstockstill on PROD1PC66 with HEARING

the firm was ‘‘too big to fail.’’ 167 During the 1982 failure of Penn
Square Bank, N.A., federal regulators explicitly chose to liquidate
the bank rather than expend the funds necessary to protect some
of the nation’s largest banks, which had sizeable claims against
Penn Square.168
The bank run on Continental Illinois National Bank and Trust
Company (Continental Illinois) was a watershed event that produced a major change in the federal government’s response to a
failing bank. Continental Illinois enjoyed high growth and the envy
of its competitors throughout the late 1970s and early 1980s.169
However, losses on non-performing loans concentrated in the energy sector and in less-developed-countries (LDC) soared from 1982
through the first quarter of 1984.170 Continental Illinois had made
many of these energy and LDC investments alongside or through
Penn Square.171 Because of its substantial investments, Continental Illinois’ troubles began with the Penn Square failure, which
almost singlehandedly halved its stock price, prompted downgraded
credit ratings, and caused its sources of capital to dry up.172 Continental Illinois had to borrow on less and less favorable terms just
to keep itself afloat.173
In May 1984, Continental Illinois’s situation became untenable
and a potentially catastrophic bank run started.174 In two days, the
bank needed to borrow $3.6 billion from the Federal Reserve
Board’s discount window in order to meet its obligations on deposit
withdrawals.175 The announcement of $4.5 billion in loans from
other banks did not stop the bleeding.176
Regulators paid close attention to the run; more than two thousand banks had investments in Continental Illinois, and almost
two hundred of them had more than half of their equity capital invested.177 There was serious concern that the bank’s failure could
have left uninsured depositors and creditors exposed, causing many
more failures in its wake and spawning a financial crisis.178
As a result, in order to stave off a systemic crisis, federal regulators acted quickly by announcing $2 billion in immediate assist167 Sprague, supra note 166, at 86–91. The rescue of First Pennsylvania Bank constitutes regulators’ first recognition of what was then termed the ‘‘domino effect,’’ the phenomenon of one
bank failure causing trouble at other institutions and touching off a banking crisis. However,
in First Pennsylvania’s case, regulators feared at worst a regional crisis precipitated by the effect First Pennsylvania’s failure would have on the already weak mutual savings banks concentrated in the Northeast. See Sprague, supra note 166, at 77–106.
168 Federal Deposit Insurance Corporation, History of the Eighties—Lessons for the Future:
Volume I: An Examination of the Banking Crises of the 1980s and Early 1990s, at 241 (Dec.
1997) (online at www.fdic.gov/bank/historical/history/vol1.html) (hereinafter ‘‘FDIC History: Volume I’’).
169 See, e.g., Banker of the Year, Euromoney, at 134 (Oct. 1981); Here Comes Continental,
Dun’s Review, at 42–44 (1978) (Vol. 112, No. 6).
170 Sprague, supra note 166, at 150–51.
171 Sprague, supra note 166, at 150–51.
172 Sprague, supra note 166, at 150–51.
173 Sprague, supra note 166, at 151–52.
174 Sprague, supra note 166, at 152–56.
175 FDIC History: Volume 1, supra note 168, at 243. The speed of the run both surprised and
troubled regulators; it represented the first run of such scope on a modern, technologically interconnected bank. Sprague, supra note 166, at 152–56.
176 FDIC History: Volume 1, supra note 168, at 243–44.
177 FDIC History: Volume 1, supra note 168, at 250.
178 A deposit payoff may not have been an option at all for Continental Illinois; after the fact,
Comptroller of the Currency Todd Conover told Congress that the FDIC did not have the funds
to conduct a deposit payoff for any one of the nation’s eleven largest banks should any of them
fail. FDIC History: Volume 1, supra note 168, at 251. Continental Illinois was the nation’s seventh largest bank in 1984. FDIC History: Volume 1, supra note 168, at 236.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00040

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

35
ance to stop the run.179 Furthermore, the Federal Reserve Board
promised to meet any liquidity needs, and the FDIC promised to
protect all of Continental Illinois’s depositors and general creditors.180 Finally, a group of major financial institutions put up $5.3
billion in unsecured credit.181 With these guarantees, the run
stopped and the crisis subsided.
However, having already determined that a deposit payoff would
result in a systemic crisis, the government needed to merge the
bank with another institution or bail out the bank and reconstitute
it with new leadership.182 Regardless of the outcome, Continental
Illinois would have new managers; either the acquirers or an
FDIC-selected team would operate the bank going forward.183
After two months of searching for a merger partner and evaluating many proposals, no viable acquirer emerged.184 As a result,
the FDIC instituted a good-bank-bad-bank restructuring of Continental Illinois. The FDIC took responsibility for $4.5 billion in bad
loans at a price of $3.5 billion, paid by assuming Continental’s debt
to the Federal Reserve Board.185 The FDIC offset the $1 billion
write-off this transaction prompted with a $1 billion investment
into Continental Illinois’s holding company, Continental Holding
Corporation, and required the holding company to push the capital
downstream to the bank.186 In exchange for its investment, the
FDIC received an 80 percent stake, composed of junior preferred
stock, in the holding company.187
The FDIC replaced top management, bringing in a new chairman, former Standard Oil of Indiana chairman John Swearingen,
and a new CEO, former Chase CFO Bill Ogden.188 The FDIC also
dismissed members of Continental Illinois’s board of directors who
had come on before 1980 and had presided over the operations that
got the bank in trouble.189 The bank’s remaining shareholders approved the plan in September 1984.190 Although Continental Illinois did return to viability, it remained closely watched by regulators; FDIC did not sell its last equity stake until 1991.191
Continental Illinois was the first rescue of the entire creditor
class of a financial institution since the Depression. However, the
stockholders of Continental Illinois were diluted when, in exchange
for FDIC support, the FDIC took an 80 percent equity stake in the
bank. This stake granted FDIC most of the upside potential and
control of the governance of Continental Illinois.
179 Sprague,

supra note 166, at 160.
History: Volume 1, supra note 168, at 244.
History: Volume 1, supra note 168, at 244.
182 Sprague, supra note 166, at 165–67, 170.
183 Sprague, supra note 166, at 200–201.
184 Sprague, supra note 166, at 180–81.
185 Sprague, supra note 166, at 209–10.
186 Sprague, supra note 166, at 209–10; FDIC History: Volume 1, supra note 168, at 244.
187 Sprague, supra note 166, at 209–10; FDIC History: Volume 1, supra note 168, at 247–48.
These terms bear many similarities to the government’s present interest in AIG; Treasury does
not have a similar equity stake in any of the over 500 recipients of TARP assistance.
188 Sprague, supra note 166, at 200–209.
189 Sprague, supra note 166, at 215–17.
190 Sprague, supra note 166, at 214.
191 The Wharton School Financial Institutions Center, University of Pennsylvania, The Collapse of Continental Illinois National Bank and Trust Company: The Implications for Risk Management and Regulation, at 3 (online at fic.wharton.upenn.edu/fic/case%20studies/
continental%20full.pdf) (accessed Apr. 2, 2009).
180 FDIC

mstockstill on PROD1PC66 with HEARING

181 FDIC

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00041

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

36
3. SAVINGS AND LOAN CRISIS/RESOLUTION TRUST CORPORATION

mstockstill on PROD1PC66 with HEARING

Unlike commercial banks, savings and loan associations (‘‘S&Ls’’
or ‘‘thrifts’’) faced increasingly difficult financial circumstances
starting in the late 1960s. From the 1930s onward, thrifts made
money by paying out on short-term deposits less than they collected on long-term loans, mostly 30-year fixed-rate mortgages. As
long as short-term interest rates stayed low, this business model
remained extremely profitable.192
However, the U.S. economy started to overheat and the Federal
Reserve Board raised short-term interest rates beginning in the
late 1960s to combat the resulting inflation. High short-term interest rates undermined the thrift business model by forcing the thrift
to pay out more on short-term deposits than it collected on longterm fixed-rate loans. The Federal Reserve Board responded by imposing Regulation Q, a provision that capped the rate at which
thrifts and banks could pay out interest on deposits.193 Because the
federal government insured S&L deposits through the Federal Savings and Loan Insurance Corporation (FSLIC, the thrifts’ equivalent of the commercial banks’ FDIC), the interest rate cap did not
result in mass deposit defection to higher yielding, uninsured investments.194
However, in the late 1970s the Federal Reserve Board took further action to combat inflation by sharply increasing short-term interest rates.195 As their customers accelerated their deposit withdrawals to pursue higher interest rates elsewhere through alternative investments, the thrifts clamored for the ability to pursue
capital that fled to savings alternatives not affected by Regulation
Q caps.196 Congress eventually responded by allowing S&Ls to pay
much higher rates on deposits.197
While higher payouts stopped the problem of deposit flight, higher costs threatened to bleed the S&Ls to death unless they could
find sources of income beyond the single-digit returns on traditional 30-year fixed-rate mortgages. As a result, authorities began
stripping away the regulations that had governed thrifts’ operations since the Great Depression. The Federal Home Loan Bank
Board (FHLBB) permitted the thrifts to begin issuing adjustable
rate mortgages in 1979.198 Congress endorsed this diversification 199 and explicitly authorized further steps, including greater
involvement in consumer lending and commercial real estate.200 Simultaneously, many states dramatically relaxed the rules that governed the investments their state-chartered thrifts could make, al192 Barbara Rudolph et al., Special Report: The Savings And Loan Crisis, Time (Feb. 20,
1989). Savings and loan bankers were said to operate on the ‘‘3–6–3 rule’’: they could pay out
3 percent on deposits, collect 6 percent on loans, and make it to the golf course by 3 every afternoon. Id.
193 Lawrence J. White, The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation, at 62–65 (1991).
194 White, supra note 193, at 62–65.
195 White, supra note 193, at 67–72.
196 White, supra note 193, at 67–72.
197 Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA), Pub.
L. No. 96–221, at §§ 202–210.
198 White, supra note 193, at 72–73.
199 Federal Deposit Insurance Corporation, The S&L Crisis: A Chrono-Bibliography (online at
www.fdic.gov/bank/historical/s&l/index.html) (accessed Apr. 2, 2009) (hereinafter ‘‘FDIC Bibliography’’).
200 DIDMCA at § 401, See also FDIC Bibliography, supra note 199.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00042

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

37
lowing the thrifts to get directly involved in similarly unfamiliar,
risky investments.201
At the same time as thrift regulators began eliminating restrictions on the thrifts’ asset options, the regulators also relaxed safety
and soundness regulation.202 Federal and state regulators stripped
down the net worth requirements that S&Ls had to meet, allowing
them to hold less and less capital to support the same amount in
deposits.203 The new net worth guidelines permitted thrifts to substitute net worth certificates from the FSLIC for real capital in the
regulator-mandated calculations.204 Changes in accounting rules
made it even easier to meet the new lower net worth requirements.205 Finally, the FHLBB made it significantly easier for
thrifts to expand through acquisitions by eliminating restrictive
stock ownership regulations.206
At the same time that policymakers expanded thrifts’ investment
options, they subjected the thrifts to reduced examination and oversight; thrift examinations fell nationwide during the early 1980s.207
Examinations and FHLBB activity fell even further in the southwest, the region that would become the epicenter of the S&L crisis.208
The combination of the need for greater returns on loans and assets in order to cover the higher deposit interest rates and the new
regulatory freedom to undertake a much wider range of investments led to dramatic expansion of the thrift industry. Economic
conditions, especially booms in oil prices and real estate created an
environment in which high-yield investments constantly tempted
the thrifts.209 This expansion was concentrated in the Sun Belt and
in those states with fewer regulatory restrictions.210
However, as the 1980s wore on, the thrifts’ fortunes started to
change. Oil prices began declining to levels that made boom-time
investments unprofitable.211 Further, Congress eliminated many of
the tax benefits for real estate that had led to the building spurt
of the early part of the decade.212 As a result, by 1985, it became
clear that the thrift industry faced serious trouble. Enough S&Ls
had folded or were in danger of folding that the FSLIC was insolvent.213
Thrift failures increased during 1987 and into 1988, but the insolvency of the FSLIC meant that rescuing troubled thrifts would
cost more than the FSLIC had available in its insurance fund. As
a result, the regulators could not intervene in S&Ls that had more
in liabilities than assets. This situation left hundreds of institu-

mstockstill on PROD1PC66 with HEARING

201 FDIC

Bibliography, supra note 199.
202 Many scholars have pointed to this failure as the critical moment that precipitated the
S&L crisis. See, e.g., White, supra note 193, at 74–82.
203 White, supra note 193, at 82–84.
204 White, supra note 193, at 83.
205 White, supra note 193, at 84–87.
206 FDIC Bibliography, supra note 199.
207 White, supra note 193, at 88–90.
208 White, supra note 193, at 89–90. The southwest here refers to the FHLBB’s Ninth District,
encompassing Arkansas, Louisiana, Mississippi, New Mexico, and Texas.
209 White, supra note 193, at 109–111; FDIC Bibliography, supra note 199.
210 White, supra note 193, at 89–90.
211 White, supra note 193, at 111.
212 White, supra note 193, at 109–111.
213 Timothy Curry and Lynn Shibut, The Cost of the Savings and Loan Crisis: Truth and Consequences, FDIC Banking Review, at 27 (Dec. 2000) (online at www.fdic.gov/bank/analytical/
banking/2000dec/brv13n2l2.pdf).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00043

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

38

mstockstill on PROD1PC66 with HEARING

tions in what came to be characterized as a ‘‘zombie’’ stage.214 A
zombie thrift, one which was insolvent but continued to operate because the FSLIC had not yet intervened to liquidate or sell it,
posed a significant asymmetric risk problem. These thrifts had dramatic incentives to take on greater and greater risk in order to
generate the returns they needed to reverse their fortunes. At the
same time, they had little or no capital of their own left and faced
the prospect of imminent closure.215 Hence, the taxpayer bore tremendous exposure to the risks undertaken by these zombie institutions.216 Thrifts continued to pursue risky strategies long after the
need to take them over became apparent and this ultimately added
to the total cleanup costs.
Although the FSLIC fund was almost $10 billion underwater in
1985, when the scope of the crisis had still not become apparent,
Congress waited until 1987 to pass the initial recapitalization legislation.217 The new law permitted the FSLIC to borrow against its
future deposit insurance premium revenue in order to resolve insolvent thrifts immediately.218 However, it limited the funds the
FSLIC could raise through this authority during any given year.219
Nonetheless, the FSLIC began using its newfound borrowing authority to start disposing of the most problematic thrifts by liquidating or forcing them into mergers, paying out insured deposits,
and trying to find new buyers for problematic assets. In these
transactions, only the insured depositors had full protection. Bondholders and equity holders took losses that depended on the value
that the thrift itself or its disaggregated assets demanded on the
open market; in some cases, debt and equity holders saw their investments wiped out entirely.220
The FSLIC resolutions cost a great deal of money, and reporting
about the scandal increased dramatically. Pressure on legislators
increased as well, and Congress passed the Financial Institutions
Reform Recovery and Enforcement Act (FIRREA) in 1989.221
FIRREA abolished the FHLBB and shifted regulation of S&Ls to
the Office of Thrift Supervision (OTS),222 transferred the thrifts’
deposit insurance function from the FSLIC to the FDIC,223 and reinstituted many of the regulatory provisions that had been weakened during the previous decade.224 Finally, FIRREA created the
214 James R. Barth, Susanne Trimbath, Glenn Yago, The Savings and Loan Crisis: Lessons
from a Regulatory Failure, at 117–18 (2004).
215 Id.
216 Id.
217 Competitive Equality Banking Act of 1987 (CEBA), Pub. L. No. 100–86.
218 Id. at § 302.
219 Id. at § 302(e).
220 White, supra note 193, at 147–170.
221 Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), Pub. L.
No. 101–73.
222 Id. at §§ 401–403.
223 Id. at §§ 201–226. From the passage of FIRREA until 2004, FDIC maintained the Bank
Insurance Fund (BIF) for commercial banks and the Savings Association Insurance Fund (SAIF)
for thrifts. This arrangement ended with the Federal Deposit Insurance Reform Act of 2005,
Pub. L. No. 109–171, and the creation of the Deposit Insurance Fund to replace the BIF and
the SAIF.
224 Among these provisions were mandates for the percentage of lending devoted to housing
investments, greater net worth requirements, a minimum regulatory floor that applied to state
and federally chartered thrifts, and new criminal and civil enforcement mechanisms. See White,
supra note 193, at 178–80.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00044

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

39
Resolution Trust Corporation (RTC) to address the insolvent
S&Ls.225
The RTC fell under the control of the FDIC and was funded by
$20 billion worth of taxpayer funds and $30 billion borrowed
through a new entity, the Resolution Finance Corporation
(REFCORP).226 FIRREA also mandated that thrifts contribute substantial upfront funding to REFCORP and pay greater deposit insurance premiums.227 Three subsequent pieces of legislation increased the total funding available to the RTC to $105 billion, of
which it received $91 billion.228 Using this funding, by the time its
statutory authorization finally ran out, the RTC resolved 747
thrifts at a total cost of over $150 billion, over $120 billion of which
came from the federal treasury.229
The failed thrifts themselves were subject to the FDIC resolution
process, which universally wiped out the equity holders and put
creditors other than insured depositors through a bankruptcy-like
process in which there was no guarantee of full recovery. Obviously, this process involved the FDIC taking full control of failed
institutions until the institutions’ assets or businesses were sold
off.
The RTC had responsibility for all the assets of insolvent thrifts.
Good assets, loans, and investments which were sound and held
their value found buyers relatively quickly. But the RTC also inherited a diverse set of troubled assets, and experts expressed
great skepticism about the agency’s ability to liquidate them.230
First, the RTC would have to confront an enormous volume of assets, the troubled investments of hundreds of failing thrifts.231 Second, the RTC would have to dispose of an enormous variety of assets, including complex commercial ventures and projects where
other viable investors remained.232 Finally, and most problematically, many of the assets were in serious financial trouble, having
already defaulted or requiring credit restructuring.233 Nobody
knew if these assets were worth anything, much less if the RTC
could successfully tap into what market might exist.
But despite the challenges it faced, the RTC disposed of the
thrifts’ bad assets with far less fanfare than many observers had
anticipated. In this effort, the RTC benefitted from most thrifts
holding tangible, albeit troubled, assets.234 While a half-finished
real estate development or office building, or a project funded by
a loan in default represents a valuation challenge, especially when
225 FIRREA,

supra note 221, at § 501.
supra note 221, at §§ 511–12.
supra note 193, at 176–79.
228 Curry and Shibut, supra note 213, at 29. See also Lee Davison, The Resolution Trust Corporation and Congress, 1989–1993, Part II: 1991–1993, FDIC Banking Review (2006) (online at
www.fdic.gov/bank/analytical/banking/2007apr/br18n3full.pdf).
229 Curry and Shibut, supra note 213, at 27.
230 See, e.g., Bert Ely, The Resolution Trust Corporation in Historical Perspective, Housing Policy Debate (1990) (online at www.mi.vt.edu/data/files/hpdl1l1/hpdl0101lely.pdf).
231 Id. at 56–58.
232 Id. at 58–60.
233 Id. at 59–60.
234 In this respect, the resolution of troubled assets in the present crisis represents a much
greater challenge. Not only do the underlying assets face similar valuation problems to what
the RTC had to address, but because each step removed from the underlying asset compounds
the valuation problem, pooling and securitization make valuation dramatically harder.
226 FIRREA,

mstockstill on PROD1PC66 with HEARING

227 White,

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00045

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

40
it involves other investors of varying financial health, it is a solvable one.235
Other innovations and strategies helped the RTC. It discovered
a new market for problematic loans securitized into more palatable
chunks.236 It also found that employing sealed-bid, bulk auctions to
dispose of its immense inherited real estate holdings attracted investors looking for bargain-basement prices.237 The RTC promoted
the stories of buyers who made money from purchases of their assets in the hope that more investors would follow.238 Although commentators largely panned this strategy,239 buyers quickly materialized and the RTC managed to dispose of the questionable assets
under its control quicker and at less cost to the taxpayer than
many anticipated.240 As a result, most modern commentators regard the RTC as a successful enterprise.241
4. RECAPITALIZATION OF THE FDIC BANK INSURANCE FUND/FDICIA

Although insulated from the interest rate shocks that created
problems for the thrift industry, commercial banks also faced problems during the 1980s. The same economic conditions that so
threatened the S&Ls, namely the end of the real estate boom and
the collapse of the price of energy, impacted many viable commercial bank investments as well.242 FDIC interventions in commercial
banks topped 250 each year from 1987 to 1989.243 In all, over 1500
commercial banks failed between 1980 and 1992.244 As a result,
the FDIC’s Bank Insurance Fund, like the FSLIC before it, did not
have the resources to resolve all the troubled institutions.245
In the wake of the Continental Illinois bailout, where the FDIC
had to take an equity stake in the institution because it lacked the
funds to resolve it, and the S&L crisis, where the FSLIC’s insolvency increased the debacle’s ultimate costs, pressure mounted to
create greater bank rescue authority that would avoid future taxpayer expense. As such, Congress passed the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA).246
FDICIA allocated funds to recapitalize the FDIC’s Bank Insurance
235 Ely,

supra note 230, at 71–74.
W. Markham, A Financial History of the United States, Volume III: From the Age
of Derivatives into the New Millennium (1970–2001), at 172–73 (2002).
237 Kerry D. Vandell and Timothy J. Riddiough, On the Use of Auctions as a Disposition Strategy for RTC Real Estate Assets: A Policy Perspective, Housing Policy Debate, at 118–19 (1992)
(online at www.mi.vt.edu/data/files/hpd%203(1)/hpdl0301lvandell.pdf).
238 Id. at 119 (citing a Wall Street Journal piece from October 3, 1991 that quotes RTC deputy
director Thomas Horton as saying, ‘‘We think it’s the best thing in the world if someone makes
money off us. Smart money follows smart money.’’).
239 See, e.g,. id. at 117.
240 Mark Cassell, How Governments Privatize: The Politics of Divestment in the United States
and Germany, at 4–8, 26–33 (2003).
241 See, e.g., id.; Markham, supra note 236, at 173 (describing the RTC as a ‘‘qualified success’’).
242 George J. Benston and George G. Kaufman, FDICIA After Five Years: A Review and Evaluation, at 7–8 (June 11, 1997) (Federal Reserve Bank of Chicago Working Paper Series, Issues
in Financial Regulation WP–97–1) (online at www.chicagofed.org/publications/workingpapers/
papers/wp97l1.pdf).
243 Federal Deposit Insurance Corporation, Failures and Assistance Transactions, Number of
Institutions, United States and Other Areas: 1934–2009 (online at www2.fdic.gov/hsob/
HSOBSummaryRpt.asp?BegYear=1934&EndYear=2009&State=1) (accessed Mar. 23, 2009).
244 George G. Kaufman, FDIC Losses in Bank Failures: Has FDICIA Made a Difference?, Federal Reserve Bank of Chicago Economic Perspectives, at 16 (Third Quarter 2004) (online at
www.chicagofed.org/publications/economicperspectives/epl3qtr2004lpart2lKaufman.pdf).
245 Benston and Kaufman, supra note 242, at 8.
246 Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), Pub. L. No.
102–242.

mstockstill on PROD1PC66 with HEARING

236 Jerry

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00046

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

41
Fund (BIF) and implemented substantial regulatory and deposit insurance reforms.
FDICIA significantly altered the FDIC’s ability to borrow and
raise capital in order to address problem institutions. The Act substantially increased the FDIC’s borrowing authority to up to $30
billion and allowed for it to raise emergency funds by borrowing
against the proceeds from selling the assets of failed banks.247
FDICIA also set a target and a timeline for the FDIC’s insurance
funds to meet designated capital ratios.248 These provisions, taken
together, substantially increased the resources which FDIC could
use to step in and close zombie institutions instead of allowing
them to continue pursuing risky strategies.249
The legislation also established a set of new regulatory frameworks centered around capital requirements. Congress required the
FDIC to classify banks according to their capitalization status; a
decrease in a bank’s capitalization status would increase the regulatory tools available to the FDIC to address the situation.250 This
policy, dubbed the Structured Early Intervention and Resolution
(SEIR) framework, aimed to resolve institutions before they become
problematic.251 The legislation also sought to make deposit insurance act more like insurance by charging institutions variable premiums based on the likelihood that the FDIC would have to spend
money to honor their depository obligations.252
Finally, FDICIA explicitly endorsed the concept of systemic risk
as a justification for taking extraordinary actions. Although mandating that the FDIC, under ordinary circumstances, had to resolve
an institution using the least costly method, be it sale, liquidation,
receivership, or some other means, FDICIA permitted a waiver of
this provision if federal banking regulators reached the conclusion
that the institution posed a systemic risk.253 Although intended to
reduce the specter of systemic risk by systematizing the conditions
under which it could justify action, FDICIA did represent Congress’
endorsement of the concept as something which justified its own
set of rules.
5. SWEDEN

Like the savings and loan and subprime mortgage crises in the
United States, the Swedish banking crisis of the early 1990s arose
from a real estate bubble that was brought on principally by deregulation in the financial markets. Sweden’s banking system was
highly concentrated, with the seven largest banks accounting for 90
percent of the market.254 The prior decade of the 1980s was
‘‘marked by economic deregulation, the removal of cross-border restrictions on capital flows, financial innovation, and increased com-

mstockstill on PROD1PC66 with HEARING

247 FDIC

History: Volume 1, supra note 168, at 103.
248 FDIC History: Volume 1, supra note 168, at 103. The Act mandated that the BIF meet
its target within 15 years, while allowing the SAIF an open-ended timeframe.
249 Lawrence H. White, Introduction, in The Crisis in American Banking, at 5 (Lawrence
White, ed.) (1995).
250 FDIC History: Volume 1, supra note 168, at 103.
251 Benston and Kaufman, supra note 242, at 10–11.
252 FDIC History: Volume 1, supra note 168, at 104.
253 FDIC History: Volume 1, supra note 168, at 104.
254 Congressional Oversight Panel, Testimony of Bo Lundgren, Learning from the Past: Lessons from the Banking Crises of the 20th Century (Mar. 19, 2009). In 1994, there were 91 savings banks and 23 commercial banks in the country. Sweden: Economic Infrastructure, The
Economist (1996).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00047

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

42

mstockstill on PROD1PC66 with HEARING

petition in financial services.’’ 255 While Swedish banks had previously been required to invest more than half of their assets in
low-interest bonds and had been subject to interest rate caps, these
regulations were lifted during the period between 1983 and 1985.
Lending subsequently increased by 73 percent in real terms.256 The
household debt-to-assets ratio grew from 35.8 percent in December
1985 to 38 percent in December 1988.257 This was accompanied by
a growth in the corporate debt-to-asset ratio from 65.5 percent to
68.2 percent.
Tax and exchange rate policies also appear to have contributed
to the boom. In the late 1980s, ‘‘[h]igh inflation interacted with a
nominal tax system with full deductibility of interest payments
* * * making real after-tax interest rates low or even negative.’’ 258
With such low interest rates and restrictions on lending and capital
flows removed, borrowers took on unaffordable amounts of debt.
Banks lacked sufficient internal controls to counteract the borrowers’ and lenders’ newfound appetite for risk. Government regulators facilitated the bubble with a hands-off approach to real estate and foreign currency lending.259
The danger of these factors was fully exposed when the fixed exchange rate forced Sweden to increase its real interest rates following German re-unification. High interest rates curtailed the demand for real estate and the bubble burst. Between 1990 and 1995,
residential real estate values dropped 25 percent and commercial
real estate values dropped 42 percent.260 Matters were made worse
when the krona was taken off the fixed exchange rate. Its value
plummeted 20 percent between November 19 and December 31,
1992. Many Swedish debtors found themselves unable to meet their
obligations since 47.5 percent of loans made in 1990 were in foreign
currency.261 By 1993, domestic non-performing loans had reached
11 percent of GDP.
The impact of the economic downturn was already in evidence in
the financial sector in 1991 when one of Sweden’s largest banks,
Nordbanken, announced that it could no longer meet its eight percent capital requirement. Two other major institutions, Forsta
Sparbanken and Gota soon found themselves in similar situations.
In total, Sweden’s banks faced bad debt charges averaging 6.3 percent of total loans in 1992 and 5.6 percent the following year, up
from only 0.3 percent in 1989.262 From 1990 through 1993, loan
losses were close to 17 percent of total lending.263
The government responded by taking full ownership of
Nordbanken, the majority of which was already owned by the state,
255 Burkhard Drees and Ceyla Pazarbasioglu, The Nordic Banking Crises, Pitfalls in Financial
Liberalization? at 1 (Apr. 1998) (International Monetary Fund Working Paper Series, 95/61).
256 This number may slightly overstate the increase because it includes an unknown number
of loans between private parties that were converted to bank loans. Peter Englund, The Swedish
Banking Crisis: Roots and Consequences, Oxford Review of Economic Policy, at 84 (1999).
257 Id. at 85.
258 Id. at 81.
259 Drees and Pazarbasioglu, supra note 255, at 4–8.
260 O. Emre Egrungor, On the Resolution of Financial Crises: The Swedish Experience, at 5
(June 2007) (Federal Reserve Bank of Cleveland Policy Discussion Paper Series, No. 21) (online
at www.clevelandfed.org/research/PolicyDis/pdp21.pdf).
261 Englund, supra note 256, at 85.
262 Citigroup Global Markets, Swedish Models: Banking Crisis and Recovery in the Early
1990s, at 12 (Feb. 23, 2009); Drees and Pazarbasioglu, supra note 255, at 1.
263 This includes ‘‘reservations for future losses for loans that were still performing.’’ Englund,
supra note 256, at 90.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00048

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

43

mstockstill on PROD1PC66 with HEARING

and Gota. A loan guarantee was provided to Forsta Sparbanken to
help keep it afloat. The acquisitions of Nordbanken and Gota left
the government holding 22 percent of the nation’s banking assets.
These moves naturally shook the faith of foreign creditors in the
Swedish economy. To restore confidence, the Riksbank, the Swedish central bank, issued a blanket guarantee to all creditors and
depositors on all non-equity claims in Swedish banks in December
1992. The guarantee gave the Swedish parliament, the Riksdag,
the breathing room it needed to devise an action program for removing the non-performing loans from the banks’ balance sheets.
To ensure maximum transparency and independence, the
Riksdag created the Bank Support Authority, an entity separate
from the Ministry of Finance and Riksbank, and vested it with the
authority to evaluate the financial condition of the struggling
banks and recommend an appropriate course of action for each.
The Bank Support Authority followed a three-part sequence:
• First, it audited the books of the banks to determine their
health;
• Second, it installed state representatives on the boards of
banks that required new capital and replaced top management
of banks that were nationalized;
• Third, it provided capital injections to banks that were
undercapitalized.
In the spring of 1993, the Bank Support Authority set about
triaging Swedish banks into three categories. The approach was
grounded in the central principle that all capital losses, regardless
of size, had to be covered to revive the banking sector.264 The three
categories included: 265
• ‘‘Category A.’’ These banks were the healthiest, with capital adequacy of at least eight percent. These banks were expected to require minimal public assistance, such as temporary
guarantees;
• ‘‘Category B.’’ These banks were those that might fall
below eight percent capital but were expected to survive with
the help of public capital contributions (in exchange for preferred stock) or loans. Banks in this category were also required to raise private capital.266 ‘‘B’’ banks were required to
comply with rules on capital use;
• ‘‘Category C.’’ These banks were those that were not expected to survive in their current form. Banks in this category,
which included Nordbanken and Gota, were nationalized and
their assets were divided between good and bad (legally separate work-out units) by the Valuation Board, a body of expert
auditors set up by the Bank Support Authority.
The good assets of the ‘‘C’’ banks were consolidated under the
Nordbanken name. The bad assets were transferred to two asset
management companies (AMCs): Securum and Retriva. This model
was derived from the Resolution Trust Corporation of the U.S. sav264 Stefan Ingves and Goran Lind, The Management of the Bank Crisis—In Retrospect, Quarterly Review, at 12 (Jan. 1996).
265 Lundgren, supra note 254.
266 Hoenig, supra note 149, at 6.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00049

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

44
ings and loan crisis. The two AMCs were deliberately over-capitalized, allowing them to perform their salvage operations autonomously without the need to return to the Riksdag for more funding,
which would have exposed them to political pressures. In many
cases, the AMCs had to take over defaulting companies and assume typical management responsibilities, including hiring and firing management, managing and rehabilitating property, and adjusting business strategies. The government originally estimated
that the liquidation operations of the AMCs would take 10 to 15
years to complete. However, better than expected macroeconomic
conditions helped to expedite the process and, by 1997, the liquidation was complete.267 Initially, Sweden’s efforts to rescue the financial sector cost it approximately 65 billion kronor, the equivalent
of slightly more than four percent of GDP at the time. Most of that
expenditure was recovered via proceeds from Securum and Retriva
and the partial privatization of Nordbanken. Estimates of the net
cost of the government intervention range from zero to two percent
of GDP.268
Two features of the Swedish strategy are particularly noteworthy. The first is transparency. As Bo Lundgren noted in his testimony before the Panel, a ‘‘key objective was to ensure that our
crisis management would be characterized by the greatest possible
transparency’’ in order to bolster confidence in the financial sector.269 Sweden effectively accomplished this by requiring banks to
open their books, reveal all potential write-downs, and isolate them
via separate good and bad aggregator banks. In addition, the blanket guarantee on all bank liabilities helped calm investors while
this program was in progress. The Swedes complemented these
policies with a public relations campaign that sent officials from
the financial agencies to the world’s various financial centers to explain the strategy and instill confidence in investors.
Second, the Swedes made an effort to ensure that the executors
of the program enjoyed political and financial independence. The
creation of the Bank Support Authority was a necessary step to
avoid any potential conflicts of interest. It begat the Valuation
Board and the AMCs, which managed to successfully absorb 7.7
percent of the assets of the financial system (equal to eight percent
of GDP) and dispose of them in much less time that had been initially projected.270
6. JAPAN

In the decades after the Second World War, the Japanese economy underwent an unprecedented economic recovery. By the mid–
1970s, it had become the world’s largest exporter of steel and automobiles. Japan’s remarkable post-war growth was guided by government protection of emerging domestic industries, which led to
their becoming highly competitive in global markets.271 In the
1980s, financial deregulation, low interest rates, and the apprecia267 Egrungor,

supra note 260, at 6.
F. Cooley, Swedish Banking Lessons, Forbes (Jan. 28, 2009).
supra note 254.
270 Daniela Klingebiel, The Use of Asset Management Companies in the Resolution of Banking
Crises Cross-Country Experiences, at 9 (Feb. 2000) (World Bank Policy Research Working Paper
Series, No. 2284) (online at papers.ssrn.com/sol3/papers.cfm?abstractlid=282518).
271 Paul Krugman, The Return of Depression Economics and the Crisis of 2008 (2008).
268 Thomas

mstockstill on PROD1PC66 with HEARING

269 Lundgren,

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00050

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

45

mstockstill on PROD1PC66 with HEARING

tion of the yen gave rise to a substantial excess of savings and liquidity in Japan. This, in turn, supported increased consumer
spending and speculation in the stock and real estate markets,
which then led to rapid run-up in asset values.
The bubble finally burst in 1991 as real estate values dropped by
500 trillion yen (US$4.5 trillion) and the total value of shares lost
300 trillion yen (US$2.7 trillion).272 This helped set Japan on
course for a decade-long ‘‘growth recession’’ that came to be known
as the ‘‘Lost Decade.’’ During this period—which actually spanned
at least a dozen years—the economy experienced only two years of
negative growth. But the protracted economic stagnation was a
dramatic reversal from the previous decade, when annual GDP
growth averaged almost 4 percent. From 1991 to 2003, GDP grew
at an annual average of just over 1 percent, well below the growth
rates of every other major industrialized country during this period.273
Japanese policymakers failed to appreciate early on just how significant the impact of the asset devaluation would be on the financial sector. Bank lending had doubled between 1985 and the first
half of the 1990s, with most loans geared toward the real estate
market.274 Deregulation had eased restrictions on corporate access
to capital markets, giving large businesses new alternatives to the
banks as sources of capital. Banks were forced to seek new customers, particularly in small business and real estate, which
proved to be far riskier business partners than Japan’s established
corporations.275 As real estate values continued to slide in the mid1990s, non-performing loans (NPLs) became a growing problem for
Japan’s banks. According to one estimate, Japan’s banks were holding 50 trillion yen (US$450 billion) in non-performing loans immediately after the burst of the bubble in 1993, which rose to nearly
100 trillion yen (US$910 billion) by 1996.276
At the outset of the crisis, the Ministry of Finance lacked the
legal authority to take banks facing bankruptcy into receivership.
Thus, its initial response was to create stability by orchestrating
mergers or asset takeovers by other banks. This included the establishment of both private and public asset management companies
to help banks clear their balance sheets. But Japanese authorities
pinned their hopes on a macroeconomic recovery that would restore
the full value of assets and avoid costly writedowns.277 Regulators
permitted lax accounting practices that allowed banks to book the
value of their loan assets based on how much they could spare
within the capital adequacy ratio. The real financial condition of
the borrowers was seldom accurately reflected on the bank balance
sheet. The same borrower could have different credit ratings from
different banks depending on the level or risk each bank could sus272 Koyo Ozeki, Responding to Financial Crises: Lessons to Learn from Japan’s Experience,
Japan Credit Perspectives (Aug. 2008) (online at europe.pimco.com/LeftNav/Global+Markets/
Japan+Credit+Perspectives/2008/Japan+Credit+Perspectives+Koyo+Ozeki+Responding+to+
Financial+Crises+August+2008.htm).
273 Charles Yuji Horioka, The Causes of Japan’s ‘‘Lost Decade’’: The Role of Household Consumption, (Nov. 2006) (National Bureau of Economic Research Working Paper No. 12142).
274 Ozeki, supra note 272.
275 Japan’s Financial Crisis and its Parallels to US Experience, Institute for International Economics, at 6 (Adam Posen and Ryoichi Mikitani, eds.) (Sept. 2000).
276 Id.
277 Richard Katz, Japan’s Phoenix Economy, Foreign Affairs (Jan./Feb. 2003) (online at
www.foreignaffairs.com/articles/58624/richard-katz/japans-phoenix-economy).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00051

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

46

mstockstill on PROD1PC66 with HEARING

tain. Such accounting machinations were tolerated in part due to
their political consequences. Leaders of Japan’s dominant LiberalDemocratic Party sought to protect their powerful construction,
real estate, and farming constituencies that were on the other end
of the problematic NPLs. As economist Adam Posen notes, ‘‘the ongoing political pressures for the rollover (evergreening) of loans to
politically favored but bankrupt enterprises, in hopes of preserving
jobs, and the near total erosion of bank capital between loan and
equity losses created incentives for the problem to keep growing.’’ 278
In late 1997, with the failure of a major bank, Hokkaido
Tokushoku, and a major securities firm, Yamaichi Securities, the
problems in the financial sector reached the level of systemic risk.
There were indications in the interbank loan market that a number
of other major banks were in trouble as well.279 In February 1998,
the Japanese parliament or Diet passed the Financial Function
Stabilization Act which provided for capital injections in major
banks. The government then purchased 1.8 trillion yen (US$16 billion) in subordinated debt and preferred shares in 21 major banks
that were undercapitalized but officially classified as solvent.
These efforts failed to stabilize the situation and bank lending
remained stagnant. Under new authorities granted by the Financial Function Stabilization Act, the Financial Services Authority
(FSA) was created and vested with the power to temporarily nationalize banks. In late-1998, the FSA exercised this authority for
the first time and nationalized two major banks, Long-Term Credit
Bank of Japan (LTCB) and Nippon Credit Bank (NCB), fully guaranteeing their debt to all creditors. This was followed by a second
recapitalization effort in March 1999 that injected 7.5 trillion yen
(US$71 billion) into 15 banks. The trend of small-scale recapitalization programs continued for the next several years, but the problem of chronic capital shortage persisted, in part because the size
of the recapitalizations was simply insufficient. According to an
analysis by economist Mitsuhiro Fukao, as late as March 2002,
Japanese banks collectively had only 29.3 trillion yen of core capital to buffer the risks associated with assets of 744.8 trillion and
loans of 440.6 trillion, meaning that stated capital was only 3.9
percent of assets and 6.7 percent of loans.280 Furthermore, FSA’s
apparent weak enforcement of the conditions attached to participation in the program ensured that the balance sheet problems would
persist. Even after LCTB and NCB were nationalized, FSA permitted banks to continue to operate with large amounts of non-performing loans on their books.281
Japan’s financial sector did not turn the corner until the introduction of the Financial Revitalization Program in late 2002, under
financial services minister Heizo Takenaka. Takenaka believed
that honesty in bank balance sheets was the most important source
278 Adam Posen, What Went Right in Japan, at 6 (Nov. 2004) (Peterson Institute for International Economics: Policy Briefs in International Economics, No. PB4–6).
279 Takeo Hoshi and Anil K. Kashyap, Will the U.S. Bank Recapitalization Succeed? Lessons
from Japan (Dec. 2008) (National Bureau of Economic Research Working Paper Series, No.
14401).
280 Id. at 13.
281 Id. at 14.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00052

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

47

mstockstill on PROD1PC66 with HEARING

of stability in financial markets.282 Thus, what became known as
‘‘Takenaka Plan’’ called for: (1) more rigorous evaluation of bank
assets; (2) increased bank capital; and (3) strengthened governance
for recapitalized banks.283 Takenaka’s predecessor, Hakuo
Yanagisawa, had initiated a program of special inspections of major
banks aimed at uncovering the true health of the financial institutions and their debtors in 2001. Yet this commitment to transparency was not accompanied by rigorous enforcement until
Takenaka took the helm at FSA. Under Takenaka, the special inspections resumed but with more rigorous enforcement of the auditing rules: assets were evaluated using discounted expected cash
flows for NPLs; borrowers were investigated to ensure consistent
and reliable classifications across all major bank balance sheets;
and deferred tax assets were prohibited from being counted toward
tier-I capital. Discrepancies between the banks’ self-evaluations
and FSA’s evaluations were released to the public. Where these
special inspections identified a need for capital, it was injected on
the condition that the banks abide by business improvement orders.284
Within a year, signs of progress were already evident. The
Takenaka Plan was forcing banks to aggressively cut costs, write
off non-performing loans and sell their stockholdings.285 In March
2003, Resona Bank was prohibited from counting five years’ worth
of tax deferred assets as capital, an accounting tactic many banks
had previously used to avoid exposure of their vulnerable capital
positions. The government rescued the bank with a public capital
injection and used its new majority interest to install new management.286 In August, FSA issued ‘‘business improvement orders’’ to
15 recapitalized financial institutions for failing to meet their profit
goals for the first quarter of 2003. These orders required the institutions to file business improvement plans and to report their
progress to the FSA on a quarterly basis. Those institutions that
failed to reform and meet their profit goals were forced to reduce
the compensation of top management. One conglomerate, UFJ
Holdings, was forced to remove three of its CEOs. Japan was finally holding banks accountable after more than a decade of avoiding the problems in its financial sector.287
In retrospect, most informed observers believe that Japan’s
greatest mistake was its excessive regulatory forbearance—allowing banks to carry NPLs rather than demanding write-downs.
Economists Takeo Hoshi and Anil Kashyap contend that the Japanese officials were in denial about the extent of the problems in the
financial sector for most of the 1990s.288 The recapitalization efforts that the government did initiate were insufficient and still
failed to require banks to write-down losses on non-performing
loans. The only objective pursued forcefully in the recapitalization
efforts was increasing loan volumes. However, this only served to
282 Heizo Takenaka, Lessons from Tokyo, Wall Street Journal (Oct. 22, 2008) (online at
online.wsj.com/article/SB122462152605355599.html).
283 Id.
284 Id.
285 Ken Belson, Persistence Pays: Japan’s Bank Regulator Makes Gains, New York Times
(Sept. 30, 2009).
286 Hoshi and Kashyap, supra note 279, at 16.
287 Hoshi and Kashyap, supra note 279, at 16.
288 Hoshi and Kashyap, supra note 279.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00053

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

48
keep bad debtors and ‘‘zombie’’ banks alive to throw good money
after bad. The consensus view among economists who have studied
Japan’s economy during this period is that Japan simply kept
banks in business for far too long with insufficient capital. The unwillingness to acknowledge the harsh reality of the asset bubble
burst in the short-term contributed to the very sluggish growth
rate of the Japanese economy that lasted for more than a decade.
FIGURE 3: COMPARATIVE ANALYSIS OF GOVERNMENT RESOLUTION OF NATIONALIZED ENTITIES
Shareholder protection

Bondholder protection

Depositor protection

Method of asset
valuation

Great Depression and
Reconstruction Finance Corporation
1930s.

Unsecured. Bank failures wiped out
shareholders, and
state laws often
imposed double liability. Shareholders at banks
that received RFC
investment saw
their shares diluted.

Unsecured. Bondholders suffered
substantial losses;
no consistent policy
existed for dealing
with bondholders
when reorganizing
or liquidating
banks.

Administrative valuation. Bank examiners from the RFC,
Federal Reserve
Banks, Treasury,
and the Comptroller of the Currency conducted
valuation of seized
assets.

Continental Illinois .....

Unsecured. Equity
stake diluted by 80
percent FDIC stake
resulting from $1
billion investment
in Continental Illinois’ holding company.
Unsecured. Received
equity remaining
after sale of thrift
operations or, in
liquidation, sale of
thrift’s remaining
assets. Substantial
losses incurred.

Although unsecured,
the FDIC rescue
plan prevented default on outstanding obligations, thus protecting creditors.

Unsecured. Paid on a
pro rata basis as
the liquidation of
failed banks proceeded. The FDIC,
when created in
1933, insured deposits at solvent
banks up to $2,500
(this increased to
$5,000 with the
passage of the
Banking Act of
1935)
Secured. Fully insured
by FDIC.

Savings and Loan Crisis/Resolution Trust
Corporation.

mstockstill on PROD1PC66 with HEARING

Sweden 1990s .............

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

At the two banks that
were nationalized,
some shareholders
were wiped out (at
Gota) and others
(at Nordbanken)
were bought out at
the price of the
previous rights
issue. At banks
that recapitalized
privately, owners
saw their shares
diluted.

PO 00000

Frm 00054

Unsecured. Received
debt payments remaining after sale
of thrift operations
or, in liquidation,
sale of thrift’s remaining assets.
Substantial losses
incurred.
Secured. Creditors
were covered by a
government guarantee.

Fmt 6602

Sfmt 6602

Administrative valuation. FDIC took
control of bad assets at non-market-determined
prices.

Secured. Fully insured
by FSLIC.

Market valuation.
Thrifts or
disaggregated assets sold on openmarket by FSLIC,
FDIC, or RTC.

Secured. Depositors
were protected by a
government guarantee.

Administrative valuation. The Bank
Supervisory Authority established an
independent Valuation Board comprised of real estate experts to assign asset values.

E:\HR\OC\A565.XXX

A565

49
FIGURE 3: COMPARATIVE ANALYSIS OF GOVERNMENT RESOLUTION OF NATIONALIZED ENTITIES—
Continued
Shareholder protection

Japan 1990s ................

Bondholder protection

Unsecured. Shareholder capital was
drawn on first before using deposit
insurance funds.
Thus, most shareholder equity in
nationalized banks
was wiped out.

Secured. Creditors
were covered by a
government guarantee.

Method of asset
valuation

Depositor protection

Secured. A temporary
guarantee was instituted in 1996. In
2005, a cap of 10
million yen per depositor was reinstituted.

Administrative valuation. Financial
Service Authority
conducted inspections of bank balance sheets.

mstockstill on PROD1PC66 with HEARING

C. Europe: Current Crises and Response
Late 2008 saw many of Europe’s largest and fastest-growing
economies scrambling to implement bank rescue plans. While each
country’s plan has its own unique features, most included plans to
guarantee bank deposits and provide some type of cash infusion for
financial institutions. Nationalization of all or select banks often
followed but was almost uniformly viewed as an option of last resort and often was confined to only those institutions whose failure
was likely to have serious ramifications for the entire economy. As
may be anticipated, the aggressiveness of the plan usually tracked
the intensity of the country’s crisis, which, in turn, was often directly proportional to that country’s economic climb over the last
decade—i.e., the highest climbers had the sharpest falls.
While the effects of the current downturn are widespread, there
are certain differences between the American and European experiences that make some comparisons inapplicable. Most notably,
many European countries are struggling with currency issues. As
banking across borders has become increasingly feasible even for
the average worker, cheap credit and lax lending standards in one
part of Europe provides cheap and easy credit for almost any part
of Europe. Many Europeans and European institutions, especially
those in non-Eurozone countries, took out loans in foreign currencies. Now that the borrowers’ home economies and currencies
are faltering, the loans have become increasingly difficult to repay.
The result is that both borrowers and lenders are damaged.
Iceland, which is among the countries hardest hit by the current
downturn, has been deeply impacted by such foreign currency exposure; however, its problems can also be attributed to the ease with
which its relatively youthful financial institutions entered these
cross-border markets despite a lack of reserves to backstop the nation’s banking sector. Ireland, another country that has been profoundly affected by the crisis, has meanwhile avoided vulnerability
to cross-market currency fluctuations by adopting the Euro. Adoption of the Euro was not without cost, however, as having the Euro
as its currency provided the Irish with widespread access to credit
with extraordinarily low interest rates, which has been linked to
the Irish economy’s current difficulties.
Although the U.S. is not plagued by the same currency issues as
many European countries, Americans and Europeans alike are
struggling with the same problems of mounting debt and mounting

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00055

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

50
unemployment while property values are down throughout both the
U.S. and Europe. A newly burst housing bubble has a central place
in almost every troubled economy’s crisis. And the ubiquitous easy
access to cheap credit is likewise at the center of each bubble. Certain economies became housing-focused in part because a rising
tide of workers, either foreigners arriving for the first time or native-born citizens returning from abroad, flooded the then-lush job
market and needed homes. But the influx of workers in those areas
merely seems to have exacerbated, not caused, the bubble, which,
in most cases, was a response to easy availability of credit.
Although the British economy is suffering from its own burst
housing bubble, its experience is somewhat different from its neighbors’. Unlike Ireland and Iceland, where ready access to mortgage
credit led to overbuilding, UK builders failed to keep pace with the
housing demand fueled by cheap credit. The combination of high
demand and lagging supply soon led housing prices to outstrip
wage increases. Subsequently, as credit contracted worldwide, the
UK housing bubble burst.
The UK, as home to a global financial center in London, also suffered from economic downturns among its business partners overseas. The sub-prime housing crisis in the U.S. quickly triggered
aftershocks in the UK markets as banks such as the Royal Bank
of Scotland stumbled under the weight of the U.S. asset-backed securities still on their books.
Finally, the Europeans must contend not only with the issues
arising out of linked currencies, but also with the issues arising out
of their linked economies. Germany has been the most vocal regarding concerns that they will be asked not only to provide rescue
packages for their own financial services industry, but for those of
their poorer neighbors as well.
1. ICELAND

mstockstill on PROD1PC66 with HEARING

Iceland has experienced both rapid economic expansion and
sharp economic contraction. Following de-regulation in the early
2000s, the Icelandic banking sector expanded quickly, investing
heavily in foreign currency loans.289 As a result, the foreign exposure of its major banks totaled 10 times the country’s GDP as of
the end of 2008.290 With the downturn in the financial markets
worldwide, Iceland’s three largest banks collapsed in late 2008. The
´
Icelandic krona plummeted, ranking just above the Zimbabwean
dollar as of October 2008.291
The devaluation had harsh implications for any institution, or
household, with foreign currency exposure, and many Icelandic
households had such exposure. The relative cheapness of credit in
Japanese Yen or Swiss Francs led many average Icelanders to finance their homes and cars in foreign currency instead of their na´
tive kronur.292 Additionally, principal payments on local currency
289 U.S. Central Intelligence Agency, CIA World Fact Book (online at www.cia.gov/library/
publications/the-world-factbook/geos/ic.html) (accessed Apr. 2, 2009).
290 Id.
291 Tracy McVeigh, The Party’s Over for Iceland, the Island That Tried to Buy the World, The
Observer (Oct. 5, 2008) (online at www.guardian.co.uk/world/2008/oct/05/iceland.creditcrunch).
292 Cracks in the Crust: Iceland’s Banking Collapse Is the Biggest, Relative to the Size of an
Economy, That Any Country Has Ever Suffered. There Are Lessons to Be Learnt Beyond Its
Shores, The Economist (Dec. 11, 2008) (online at www.economist.com/world/europe/
displayStory.cfm?storylid=12762027) (hereinafter ‘‘Cracks in the Crust’’).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00056

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

51
mortgages are indexed to inflation, which is projected to rise to 20
percent this year. The combination of devaluation and inflation has
doubled the amount of debt many Icelandic families are carrying.293
The economic crisis has prompted demonstrations and other
types of protest that are typically alien to the country.294 Some Icelanders have expressed frustration with the banks for soliciting foreign depositors to whom the whole country is now liable.295 Others
have expressed anger with their government for the way it has
handled the crisis, successfully calling for the resignation of the
head of Iceland’s central bank, David Oddsson, through continued
protests in downtown Reykjavik late last year.296 While some believe Iceland would have better weathered the last few months if
it had adopted the very durable Euro instead of relying on its own
´
krona, there is still some hostility toward the notion of joining the
E.U., both because of the cultural implications of such integration
with continental Europe (Iceland only just obtained its full independence from Denmark in 1944) and because of the impact some
believe it would have an Iceland’s fishing quotas.297
The Icelandic bank rescue plan has included nationalization of
its major banks and, in an unusual move for an industrialized
country, negotiating $10 billion in loans from the International
Monetary Fund (IMF).298
In nationalizing the banks, Reykjavik used its newly granted
power under an act providing authority reserved for ‘‘Unusual Financial Market Circumstances’’ to purchase a 75 percent stake in
each of its three major banking groups, Landsbanki, Glitnir, and
Kaupthing (the ‘‘banks’’).299 Under the new act, Iceland’s treasury
may inject up to 20 percent of the book value of a bank’s equity
in return for voting shares in the bank that are equal in value to
the treasury’s capital contribution. The act also granted authority
to the Financial Services Authority (FSA) 300 to assume the power
vested in each institution’s shareholders’ meeting and to appoint
receivership committees to take over the functions of the firms’
boards of directors. These committees immediately stopped payment on claims other than priority claims at each institution. The
banks’ receivership committees then created new, governmentowned entities (‘‘new banks’’) that assumed each bank’s domestic
operations. The result was equity dilution and assumption of government control similar to that in Continental Illinois, but tougher
293 Id.

mstockstill on PROD1PC66 with HEARING

294 Id.
295 See Sarah Lyall, Icelanders Struggle After a Banking Boom Ended with a Thud, New York
Times (Nov. 9, 2008).
296 Id.
297 Derek Scally, Iceland Attempts to Avoid Financial Meltdown, Irish Times (Oct. 24, 2008)
(online at www.irishtimes.com/newspaper/finance/2008/1024/1224715113228.html).
298 Jon Danielsson, Why Raising Interest Rates Won’t Work, BBC (Oct. 28, 2008) (online at
news.bbc.co.uk/2/hi/business/7658908.stm) (noting that Iceland is the first industrialized country
to request IMF assistance in more than 30 years).
299 On March 9, 2009, Straumur, Iceland’s only pure investment bank, was also put into receivership. It is currently closed as the receivership committee unwinds its assets.
300 The FSA is an independent state authority charged with regulating and supervising Iceland’s credit, insurance, securities, and pension markets.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00057

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

52

mstockstill on PROD1PC66 with HEARING

treatment of non-priority creditors. Domestic customers, employees,
and bondholders were not to be affected by the acquisition.301
Key to the nationalization of the banks was the intent to keep
domestic operations functioning. The banks’ web-sites reassured
customers that business would continue as usual, with access to
online accounts, ATM service, and debit card functionality available without interruption.302
The plans did not, however, provide for continued access to deposits for foreign depositors. In the years leading up to the banking
crisis, Icelandic banks offered highly attractive interest rates for
savings accounts, prompting many Europeans and European entities, such as municipalities, to keep their cash in Icelandic accounts.303 The accounts were typically set up and managed online,
with the savings in overhead used to improve the interest rates.304
Cross-border banking has become increasingly common in Europe
and worldwide. As in the case of the Icelandic banks, a bank in a
relatively small country can hold funds of hundreds of thousands
of depositors worldwide, creating a considerable problem for the
country if that bank fails.
A minority of analysts sounded the alarm early, noting that credit-default swap rates for Icelandic banks were rising steadily, signaling instability.305 In addition to instability caused by the weakening global economy, there was a greater issue—the Icelandic central bank did not have sufficient reserves to serve as a credible
lender of last resort in the event of a run on the banks.306 While
some investors pulled their funds out before the crisis, most did
not.
When the new bank entities were created by the receivership
committee, the banks’ foreign subsidiaries and foreign branches
were not merged into the new entities.307 Negotiations for the IMF
loan stalled late last year as Iceland ironed out disagreements with
the Dutch, British, and other European governments over the status of savings accounts in Icelandic banks held by those countries’
citizens.308 The stand-off over the IMF loan was ultimately resolved when several governments loaned money to Iceland to provide payment to these depositors, opening the door to Iceland’s re301 Glinir, The Government of Iceland Acquires 75 Percent Share in Glitnir Bank (online at
www.islandsbanki.is/english/about=islandsbanki/news/detail/item14983/Thelgovernmentlofl
Icelandlacquiresl75lpercentlsharelinlGlitnirlBank/) (accessed Mar. 30, 2009).
302 Landsbankinn, New Landsbanki Islands hf. Established (online at www.landsbanki.is/
english/aboutlandsbanki/pressreleases/?GroupID=720&NewsID=13358&y=0&p=1)
(accessed
Mar. 30, 2009); Islandskani, Glitnir’s Operations Continued (online at www.islandsbanki.is/
english/about-islandsbanki/news/detail/item15927/Glitnir’slOperationslContinued/) (accessed
Mar. 30, 2009); Kaupthing, New Kaupthing Bank Takes Over Domestic Operations of Kaupthing
banki hf. (online at www.kaupthing.com/pages/164?path=K/133944/PR/200810/1262007.xml)
(accessed Mar. 30, 2009). See also Icelandic Financial Supervisory Authority, Based on New Legislation, the Icelandic Financial Supervisory Authority (IFSA) Proceeds to Take Control of
Landsbanki to Ensure Continued Commercial Bank Operations in Iceland (online at
www.landsbanki.is/Uploads/Documents/Frettir/fmelannouncement.pdf) (accessed Mar. 30,
2009).
303 Id.; Icelandic Saga; Cash and Local Councils, The Economist (Nov. 15, 2008).
304 David Jolly, Bailout of Iceland Held Up by Disputes Over Compensating Foreign Savers,
New York Times (Nov. 13, 2008).
305 Icelandic Saga; Cash and Local Councils, supra note 303.
306 Cracks in the Crust; Iceland, supra note 292.
307 Certain other liabilities also remain in the old banks. These are: certain securities issues;
subordinated debt; income tax liabilities; and derivative contracts.
308 Jolly, Bailout of Iceland Held Up, supra note 304.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00058

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

53
ceipt of the IMF funds.309 There has been no clear discussion of
how or when Iceland will repay the loans to the individual governments.
Additionally, as part of its stand-by agreement with the IMF, the
creditors of the Icelandic banks have agreed to delay the sale of
any of the banks’ assets, essentially placing a moratorium on payments to creditors. Under the FSA’s plan, the receivership committee of each bank has appointed an appraiser to determine the
value of each banks’ assets. This process has taken longer than expected and many creditors have disagreed with the appraisers’
valuations, creating further delays. Once the process has been completed, the plan contemplates a settlement under which the new
banks will provide ‘‘market value’’ compensation to the old banks
for the assets that have been transferred.
2. IRELAND

mstockstill on PROD1PC66 with HEARING

Ireland similarly experienced an economic expansion in the
1990s and early 2000s. Nicknamed the ‘‘Celtic Tiger’’ in reference
to its ability to attract technology giants such as Dell, Microsoft,
and Intel through the promise of low taxes, relatively low wages,
and a highly-educated, English-speaking workforce, Ireland’s GDP
grew at an average of 6 percent during the years between 1995 and
2007, changing the country from one of Western Europe’s poorest
into one of its richest.310 By December 2008, however, the global
economic crisis had many worried that Ireland would soon take Iceland’s path.311 Unlike American banks, Irish banks are in trouble
not because of loans to individuals, but because of massive growth
in lending to property developers spurred into rapid expansion by
substantial tax incentives.312
The Irish government has taken a three-pronged approach to addressing its crisis. First, on September 29, 2008, the government
became the first in Europe to guarantee all bank deposits, announcing that it had entered agreements with six major banks to
guarantee all deposits, covered bonds, senior debt, and dated subordinated debt in exchange for a fee (of undisclosed value) from the
banks.313 The plan is estimated to cover approximately (485 billion
in liabilities.314
Second, the government provided a capital infusion to certain financial institutions. On December 14, 2008, the government announced that it would provide Core Tier 1 capital infusions into
several banks as a means of ensuring access to credit for con309 David Jolly, Concession by Iceland Clears Path for I.M.F. Aid, New York Times (Nov. 17,
2008).
310 Tiger, Tiger Burning Bright, The Economist (Oct. 14, 2004) (online at www.economist.com/
surveys/displaystory.cfm?storylid=E1lPNGTDQS).
311 Paul Cullen, Developer Says Ireland Risks Iceland-like Financial Crisis, Irish Times (Dec.
1, 2008) (online at www.irishtimes.com/newspaper/ireland/2008/1201/1227910421590.html). Despite a local joke predicting that Ireland will become the next Iceland, Ireland has the advantage over its Scandinavian neighbor in that its currency is the Euro and therefore is unlikely
to suffer the extreme devaluation that the krona has seen, and, despite the crisis in the Irish
banking system, Irish banks are still not nearly as exposed as the Icelandic banks.
312 Landon Thomas, Jr., The Irish Miracle Fizzles, New York Times (Jan. 4, 2009).
313 On October 9, 2008, the government announced it would extend the program to cover an
additional five banks. Ultimately, however, those banks opted out of the program.
314 National Treasury Management Agency, Bank Guarantee Scheme & Recapitalisation (online at www.ntma.ie/IrishEconomy/bankGuaranteeScheme.php) (accessed Apr. 2, 2009).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00059

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

54
sumers and businesses.315 On December 21, 2008, the government
released a detailed plan naming specific banks and the terms on
which those banks would receive funds.316 The two banks that received funding through the plan were Bank of Ireland and Allied
Irish Bank.317 Each institution issued (2 billion in perpetual (nonconverting) preferred stock with fixed annual dividends of 8 percent. The shares carried all voting rights on questions of change of
control or change in capital structure, and 25 percent of voting
rights on appointment of directors, including the right to appoint
25 percent of board members. The banks were permitted to redeem
their preference shares within five years at the issue price, or at
125 percent of the issue price any time after five years had passed.
The recapitalization was accomplished through purchase of preferred stock. Banks receiving capital were required to implement
various programs including: (1) restrictions on executive pay, (2)
forbearance on foreclosures of primary residences, and (3) increasing lending to consumers and small businesses.318
Finally, the government nationalized the bank that posed the
greatest threat to the stability of the Irish economy. On January
15, 2009, the government determined that recapitalization was no
longer appropriate for Anglo Irish Bank.319 The decision to nationalize Anglo Irish Bank seems to have stemmed from the interplay
between the fact that the bank had been determined to be systemically significant (i.e., too big to fail) and the revelation that the
bank’s chief executive and chairman had enabled the bank to provide (400 million in undisclosed loans to certain hand-picked developers, leading to a crisis of confidence in the bank.320 That is, absent the (400 million scandal, it is not clear that the Irish government would have made the decision to nationalize the bank. And,
obviously, had the bank posed a smaller risk to the economy as a
whole, it is also unlikely the government would have seen the need
to step in.
The government effected the nationalization by mandating the
transfer of 100 percent of the bank’s stock to the minister of finance or his nominee. The government also stated that an assessor
would be appointed to assess whether compensation should be paid
to shareholders and, if so, what the amount of that compensation
should be.321 The bank’s recently-appointed chairman was kept on,
but the CEO and Finance Director were replaced and the board
itself restructured. The bank’s board and management retain dayto-day control of the bank, but the overall business model is deter315 Id.

mstockstill on PROD1PC66 with HEARING

316 Id.
317 Although the release included the terms of a complex plan for providing capital to Anglo
Irish Bank, including a (1.5 billion infusion via purchase of preferred shares with certain attached voting rights, the plan was never implemented as the bank was nationalized less than
a month later.
318 National Treasury Management Agency, Government Announcement on Recapitalisation
(Dec. 21, 2008) (online at www.ntma.ie/Publications/2008/govtlrecaplplanldec08PDF.
319 National Treasury Management Agency, Minister’s Statement Regarding Anglo Irish Bank
(Jan.
15,
2009)
(online
at
www.ntma.ie/Publications/2009/MinisterlStatementl
-AnglolIrishlBank.pdf).
320 See Landon Thomas, Jr., As Iceland Goes, So Goes Ireland?, New York Times (Feb. 28,
2009).
321 Anglo-Irish
Bank, General Information on the Nationalisation, (online at
www.angloirishbank.us/YourlQuestionslAnswered/GenerallInformationlonlthel
Nationalisation.html) (accessed Mar. 22, 2009). As of April 1, 2009, no assessor had been appointed.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00060

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

55
mined by the board and management in consultation with the Minister of Finance and the Financial Regulator.322 The bank has continued as a ‘‘covered institution’’ under the Credit Institutions (Financial Support) Scheme 2008, meaning that ‘‘covered liabilities’’
remain guaranteed by the Irish government until September 29,
2010.323 The bank’s ‘‘covered liabilities’’ are: (1) all retail and corporate deposits, (2) interbank deposits; (3) senior unsecured debt,
(4) covered bonds (including asset covered securities), and (5) dated
subordinated debt.324
3. UNITED KINGDOM

While not in the same position as either Iceland or Ireland, the
United Kingdom has also implemented a substantial economic rescue plan to respond to its own credit crunch.
The UK Bank Rescue Plan has a number of key pieces:
First, a Special Liquidity Scheme was announced on April 21,
2008. Under this program, the government made λ200 billion available in short term loans for financial institutions to use in swapping out illiquid assets (mostly UK or EU mortgage-backed securities) for UK Treasury bills.325 The plan was slated to last six
months but was extended in September 2008.
Second, in October 2008, the government announced a number of
initiatives. On October 8, 2008, it was announced that the government would purchase £50 billion in preferred stock (non-voting,
first paying) from eight major UK banks, and that it would provide
£250 to guarantee bank debts.326 Later that month, on October 13,
the government provided an additional cash infusion of £37 billion
to purchase ordinary shares in the Royal Bank of Scotland and
Lloyds TSB–HBOS.327 The process by which the UK government
acquired an interest in the banks began with the banks’ open offers
to their existing shareholders to purchase additional stock. The
government agreed in advance to purchase any shares that were
not purchased by the shareholders. In fact, very few shareholders
showed any interest in purchasing the stock and the British government purchased almost all of the ordinary shares offered. As a
result of these transactions, the UK government owns 57.9 percent
of one bank and 43.4 percent of the other.
In order to secure the assistance of the UK government in purchasing common equity, the banks were required to agree to certain covenants mandating, inter alia, that the banks maintain
lending to the mortgage and small business markets at 2007 levels,
submit restructuring plans to the government, and refrain from
paying dividends on ordinary shares. To the extent the government
received preferred stock from any banks, the covenants accompanying those transactions provided for the stockholder (i.e., the
government) to have the right to appoint a certain number of direc322 Id.
323 Id.

mstockstill on PROD1PC66 with HEARING

324 Id.
325 Bank
of England, Special Liquidity Scheme (Apr. 21, 2008) (online at
www.bankofengland.co.uk/publications/news/2008/029.htm).
326 Bank of England, Recapitalisation of the UK Banking System (Oct. 8, 2008) (online at
www.bankofengland.co.uk/publications/news/2008/066.htm).
327 HM Treasury, Treasury Statement on Financial Support to the Banking Industry (Oct.13,
2008) (online at www.hm-treasury.gov.uk/pressl105l08.htm).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00061

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

56
tors and to receive certain voting rights if the shares did not pay
dividends for a number of quarterly periods.328
On October 16, the UK’s central bank, the Bank of England, announced it would change certain disclosure rules to enable banks
to borrow funds without having to disclose the loan.329 The Bank
of England also created a Discount Window Facility that allows
distressed banks to swap illiquid assets at a discount.330
In November 2008, the government created a new agency, UK Financial Investments, to manage the government’s stakes in RBS
and Lloyds, and in any other banks the government subsequently
purchases.331
In January 2009, a second bank rescue was announced. This
Asset Protection Scheme would provide insurance to banks for future credit risk and would provide a £50 billion infusion for purchase of private sector assets.332 The Enterprise-Finance Guarantee (EFG) scheme, launched January 14, provides a guarantee
for up to 75 percent of a bank loan to a business with up to £25
million in revenue.333 The UK has also announced a Homeowner
Mortgage Guarantee Scheme to provide a bridge for homeowners
who are in danger of foreclosure due to a temporary loss of income.334
Thus far, Britain’s multi-faceted plan of attack closely mirrors
that of the U.S., and the UK is facing many of the same challenges
that have dogged the American plan.335 The British have taken
steps to encourage banks to resume lending through the EFG, but
have had only limited success in encouraging banks to actually
make use of the plan, even in the case of banks in which the government owns a controlling stake.336 The UK has also had its
share of bank bonuses scandalizing the public,337 and it has had
difficulty making sense of many of the more complex components
of the current financial system, stymieing efforts to unwind the
most troublesome sectors.338

mstockstill on PROD1PC66 with HEARING

328 See

Panel February Oversight Report, supra note 6.
329 Bank of England, Operational Standing Lending and Deposit Facilities; Discount Window
Facility (Oct. 20, 2008) (online at www.bankofengland.co.uk/markets/marketnotice081020.pdf).
330 Id.
331 The Go-Between: Can a New Agency Put the Banks Back on Track?, The Economist (Mar.
5, 2009) (online at www.economist.com/world/britain/displaystory.cfm?storylid=13248185)
(hereinafter ‘‘Go Between’’).
332 Graeme Wearden, Bank Bailout: Key Points of the Government’s Statement, The Guardian
(Jan. 19, 2009) (online at www.guardian.co.uk/business/2009/jan/19/credit-crunch-bank-bailout).
333 Good Sport: Banks Are Getting By; a Pity About the Customers, The Economist (Mar. 12,
2009) (online at www.economist.com/world/britain/displaystory.cfm?storylid=13278900) (hereinafter ‘‘Good Sport’’).
334 HM Treasury, New Scheme to Help People at Risk of Repossession (Dec. 3, 2008) (online
at www.hm-treasury.gov.uk/pressl132l08.htm).
335 As the legal analysis accompanying the Panel February Oversight Report noted, ‘‘[t]here
are differences in government policies and political environments, regulatory structures and corporate law and practice, among other things,’’ which have shaped the UK’s approach thus far
and that therefore make comparisons between U.S. and UK government actions of somewhat
limited use. Notably, the British government’s decisions may have been impacted by the need
to comply with certain European Commission requirements regarding the provision of state aid
to private entities, a concern that obviously is inapplicable to the American decision-making
process. Timothy G. Massad, Legal Analysis of the Investments by the U.S. Department of the
Treasury in Financial Institutions under the Troubled Asset Relief Program (Feb. 4, 2009) (online at cop.senate.gov/documents/cop-020609-report-dpvaluation-legal.pdf).
336 Good Sport, supra note 333.
337 Go-Between, supra note 331.
338 The Spiral of Ignorance: Lack of Understanding of the Credit Crunch Is Magnifying Its
Damage, The Economist (Feb. 19, 2009) (online at www.economist.com/world/britain/
displaystory.cfm?storylid=13144829).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00062

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

57
4. OTHER EUROPEAN COUNTRIES

Several other European countries, including Spain, Germany,
and Italy, have implemented measures to address weaknesses in
their banking systems and loosen the stranglehold that has persisted on credit markets worldwide. For example, Spain has committed up to Ö200 billion to guarantee interbank lending 339 and
has created a Financial Asset Acquisition Fund to purchase highquality asset-backed securities.340 At this point, Spain has stated
it sees no need for recapitalization of any financial institutions.
Italy has provided Ö40 billion to buy bank debt and has guaranteed
individual bank deposits up to Ö103,000.341 Italy has also said that
it is prepared to provide capital to banks through the purchase of
preferred (non-voting) stock.342 And Germany has announced a
Ö500 billion plan that includes guarantees for private savings and
debt guarantees for two of Germany’s largest banks, IKB and
NordLB.343
Germany, however, has been more reluctant than other nations
to provide capital infusions or similar aid to its or other European
institutions due in large part to concerns regarding the so-called
‘‘no bailout rule’’ of the Treaty of Maastricht, which provides that
EU Member States are not to be held liable for the debts of other
Member States.344 Nonetheless, despite previously dismissing
France’s proposed bank rescue fund, German Finance Minister
¨
Peer Steinbruck now concedes that if one of the seriously troubled
member nations were to default, ‘‘the collective would have to
help.’’ 345 France has been similarly cautious, although there are indications that this stance is not widely popular among the French
people, as evidenced by a national strike by the trade unions on
March 19, protesting French President Nicolas Sarkozy’s current
fiscal policies.346
D. Taking Stock: Options for Moving Forward

mstockstill on PROD1PC66 with HEARING

Disagreement exists among Panel members regarding the need
for, and appropriateness of, discussing potential alternative courses
for Treasury to take to restore financial stability. This section of
the report is nevertheless offered to provide context to Treasury’s
current efforts and to highlight the considerations involved in
choosing potential alternative paths.
339 Sharon Smyth, Spain Said to Plan Savings Bank Bailout to Aid Merger, Bloomberg (Mar.
6, 2009) (online at www.bloomberg.com/apps/news?pid=20601085&sid=a2NQavmsRt7Y#).
340 Paul Day, Spain Bank Rescue Fund to Include All Big Lenders, Reuters (Oct. 22, 2008)
(online
at
www.reuters.com/article/rbssFinancialServicesAndRealEstateNews/
idUSLM8371720081022).
341 Raf Casert, EU Approves Bank Rescue Packages, Associated Press (Dec. 23, 2008).
342 Id.
343 Jann Bettinga and Oliver Suess, Commerzbank Gets Fresh Bailout as Germany Takes
Stake,
Bloomberg
(Jan.
8,
2009)
(online
at
www.bloomberg.com/apps/news?pid=
newsarchive&sid=aEmWlKXc8q4c).
344 Mark Thoma, Should the EU Let a Member Government Default? RGE Monitor (Feb. 21,
2009) (online at www.rgemonitor.com/euro-monitor/255676/shouldltheleulletlalmemberl
governmentldefault).
345 Europe’s Reluctant Paymaster: The German Government May Have to Concede, Through
Gritted Teeth, That it Cannot Avoid Helping Financially Strapped Governments in Europe, The
Economist
(Feb.
26,
2009)
(online
at
www.economist.com/world/europe/
displaystory.cfm?storylid=13184821).
346 Ben Hall, French Protesters Take to the Streets, Financial Times (Mar. 19, 2009).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00063

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

58
1. LESSONS LEARNED

mstockstill on PROD1PC66 with HEARING

Although diverse in cause, scope, and solution, previous financial
crises provide important insights for contemporary policymakers.
In particular, past experience suggests that effective solutions for
banking crises often have in common certain characteristics without which a bank crisis may well persist or worsen:
• Transparency. Swift action to ensure the integrity of bank
accounting, particularly with respect to the ability of regulators to
ascertain the value of bank assets and hence assess bank solvency.
• Assertiveness. Willingness to take aggressive action to address failing financial institutions by (1) taking early aggressive action to improve capital ratios of banks with declining performance
and (2) shutting down those banks that are irreparably insolvent.
• Accountability. Willingness to hold management accountable
and to prevent excessive risk-taking in the future; also, to build
public trust that any taxpayer support is designed to protect the
system by replacing—and, in cases of criminal conduct, prosecuting—failed managers. Accountability for managers appears
critical both in terms of public support and in terms of facilitating
an accurate assessment of the financial status of sick financial institutions.
• Clarity. Build support by providing a clear roadmap for the
government response with forthright measurement and reporting of
all forms of assistance being provided, and clear criteria for the use
of public sector funds. This clarity will provide investors, businesses and households with the predictability of government action
needed to return to healthy levels of spending and investment.
The successful financial recovery programs on which we focused
involved the following steps:
The first step was to assume a level of bank oversight robust
enough to hold failed management accountable and to ensure an
objective process for valuing bank assets.
The second step was to provide an objective valuation. In the
cases we have reviewed, valuations were either conducted on an
administrative basis, as in the RTC and, ultimately, in Japan, or
through genuine market processes, as in the case of Sweden and
the RTC; either way, confidence in the accuracy of the valuation
was critical to restarting normal credit functioning. The current
crisis in the United States has become protracted at least in part
because both the markets and public sector regulators are unable
or unwilling to value such assets, which were ultimately financed
by complex financial instruments. Treasury views PPIP as an effort
to promote price discovery. Some would argue that an effective
price discovery process cannot be achieved when some participants
are being subsidized by the government.347
The third step was recapitalization, which, of course, cannot be
accomplished without confidence in bank asset valuations. The
wide range of approaches to the treatment of debt holders in recapitalizations indicates the importance of careful attention to the
particular circumstances of a given crisis in determining government policies toward debt holders. By contrast, in every case the
347 U.S. Department of Treasury, Public-Private Investment Program (updated Mar. 30, 2009)
(online at www.financialstability.gov/roadtostability/publicprivatefund.html).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00064

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

mstockstill on PROD1PC66 with HEARING

59
Panel looked at, equity holders were either eliminated entirely or
heavily diluted by ratios of 3–1 or more.
The process of recapitalization of banks contributes to the restoration of investor confidence through clear identification of which
institutions are healthy and which are not. The absence of such reliable determinations can imperil even healthy institutions in a crisis. The U.S. government and the RFC closed all banks during the
Great Depression and permitted only the certified-healthy banks to
reopen. While aggressive, this tactic proved successful in restoring
much-needed confidence that the banking system was sound and
that new investments would not be lost in insolvent banks.
Actions such as the establishment of the FDIC/RTC and the creation of the bad banks Securum and Retriva in Sweden had a
somewhat different purpose, which was to separate the management of bad assets from those banks that had the capacity to prosper after restructuring. The goal was not financial but managerial—ensuring that the management of reorganized banks focused
on their institutions’ ongoing business.
Treasury’s stress-testing appears motivated by the desire to sort
out healthy from non-healthy banks. In this respect, it is distinctly
different from the approach taken by the Bush Administration,
which obscured such distinctions through decisions such as the
choice to sell preferred stock on the same terms to banks of greatly
varying creditworthiness. The latter strategy led to the Panel’s discovering that the taxpayers received stock worth 33 percent less
than what they paid for it.
In this regard, it is noteworthy that success in Japan did not result from loosely-targeted capital infusions or from deferring to the
incumbent management of troubled banks about key decisions such
as asset valuation, but occurred when banking authorities did their
own valuation of bank assets and forced balance sheet restructurings reflecting the real value of those assets.
Clear guidelines about the scope, scale, conditionality, and duration of government intervention in the economy are also critical to
promoting private sector long-term investment planning and restoring stability to capital markets. The Japanese case demonstrates
the hazards of open-ended government assistance. Without predictable limits or a known exit strategy, investors suspected, rightly,
that they could continue to rely on capital infusions to large, powerful institutions indefinitely. Important economic actors lacked the
incentive to accept their losses, accurately value assets, and put the
assets back into their most productive use. Notably, the Japanese
system began to recover only after reporting requirements, stricter
valuation methods, and other conditions accompanied capital injections.
Finally, the ultimate cost to the public of resolving bank crises
depends to a very large degree on the amount of upside the public
obtains either in the banks themselves or in the assets of failed
banks. The RTC attempted to recover as much as possible for the
public and other creditors on the assets the RTC held. In Sweden,
the government took all of the upside on the two banks that were
nationalized; if the banks survived, the benefits would go entirely
to the taxpayers that had rescued them. The result was that net
costs for the Swedish government were no more than 2 percent of

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00065

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

60
GDP. By comparison, our valuation report estimated a net subsidy
to shareholders of TARP banks in the initial round of TARP transactions as 0.5 percent of GDP. TARP outlays, actual and expected,
to date are approximately 4 percent of GDP, and total resources
provided by all government agencies in conjunction with the current financial rescue plan could potentially amount to approximately 25 percent of GDP. As our valuation report showed, it is difficult to secure fair treatment for the public as an investor in sick
banks without insisting on the public receiving a substantial portion of the upside in the rescued firm in the form of common stock,
warrants on common stock, or other equity appreciation rights.
While history provides important lessons, every situation is different from its historical precedents and judgment is always required in applying any lessons. In this particular case, consolidation among the nation’s money-center banks makes that critical
part of the system look more like the concentrated systems in Sweden and Japan than the decentralized U.S. system of the Depression era or even the late 1980s. Of course, the U.S. system nonetheless differs considerably from those nations as well. The U.S.,
for example, can borrow cheaply in a manner that was not available to Sweden during its banking crisis. At the same time, we cannot rely on someone else’s consumer demand to rescue us—as to
some extent it seems both Japan and Sweden were able to rely on
U.S. consumers to rescue them. The implication of this point is that
we may in fact be more economically vulnerable to a weakened financial system than either Sweden and Japan were because we
cannot rely on some larger economy to generate consumer demand
for our goods and services.
2. TREASURY’S APPROACH 348

mstockstill on PROD1PC66 with HEARING

Uncertainty in the credit markets intensified with the failure of
Bear Stearns and Lehman Brothers. The equity markets subsequently reflected accelerating uneasiness for some time. Between
the beginning of January 2008 and September 18 of that year, the
Dow Jones Industrial Average declined by 15.22 percent (or 1,985
points), the NASDAQ National Market declined by 15.4 percent (or
401.7 points) and the S&P 500 declined by 16.2 percent (or 233.6
points). While public attention during this period was focused on
the equity markets, financial policy makers rightly focused on the
status of the much larger global debt markets.
Behind these capital market developments lay the bursting of the
real estate bubble and a tidal wave of residential mortgage foreclosures unheard of in the United States since the Great Depres-

348 An overview of ‘‘An Examination of Treasury’s Strategy’’ and ‘‘Federal Government Efforts’’
appear in Parts A2 and A3 of Section One, supra.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00066

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

61

mstockstill on PROD1PC66 with HEARING

sion.349 Congress subsequently passed EESA 350 in an attempt to
alleviate these issues. That Act gave Secretary Paulson the authority he had sought to buy ‘‘troubled assets.’’ But it also gave the Secretary of the Treasury more sweeping general authority to purchase (after consultation with the Chairman of the Federal Reserve
Board) ‘‘any other financial instrument * * * the purchase of
which is necessary to promote financial market stability.’’ 351
The EESA became law on October 3, 2008. Five days later, however, Secretary Paulson indicated his intention to use the more
general EESA authority to make capital infusions directly into financial institutions without purging their balance sheets of assetbacked securities (ABSs) or collateralized debt obligations
(CDOs).352 The day before the Paulson statement, British Prime
Minister Gordon Brown had announced that the UK would commit
up to £50 billion to rescue British banks. In some quarters, the
Paulson reversal was seen as a reaction to the Brown decision,
made to prevent U.S. capital from flowing to the UK.353
The new capital infusion program involved the transfer of funds
to financial institutions in exchange for preferred stock, and warrants to purchase common stock, of the institution involved.354 In
its third report, the Panel commissioned a valuation of these securities by the independent valuation firm of Duff and Phelps, in consultation with Professors William N. Goetzmann and Deborah J.
Lucas and Managing General Partner of Blue Wolf Capital Management and former First Deputy Comptroller of the City of New
York, Adam Blumenthal. Duff and Phelps found that the average
discount for securities issued under other programs was 69 percent,
349 As the Panel noted in its last report, over a million homes entered foreclosure in 2007 and
another 1.7 million in the first three quarters of 2008. Over half a million homes were actually
sold in foreclosure or otherwise surrendered to lenders in 2007, and over 700,000 were sold in
foreclosure in the first three quarters of 2008 alone. At the end of the third quarter of 2008,
one in ten homeowners was either past due or in foreclosure, the highest levels on record.
RealtyTrac, U.S. Foreclosure Activity Increases 75 Percent In 2007 (Jan. 29, 2008) (online at
www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=3988&accnt=
64847); HOPE NOW, Workout Plans (Repayment Plans + Modifications) and Foreclosure Sales,
July
2007–November
2008
(online
at
www.hopenow.com/upload/data/files/
HOPE%20NOW%20Loss%20Mitigation%20National%20Data%
20July%2007%20to%20November%2008.pdf). See also Chris Mayer et al., The Rise in Mortgage
Defaults, Journal of Economic Perspectives (2009) (forthcoming) (reporting 1.2 million foreclosure starts in first half of 2008); HOPE NOW, supra note 13; Adam J. Levitin, Resolving the
Foreclosure Crisis: Modification of Mortgages in Bankruptcy, Wisconsin Law Review (2009) (online at papers.ssrn.com/sol3/papers.cfm?abstractlid=1071931).
350 EESA, supra note 1.
351 EESA, supra note 1.
352 U.S. Department of the Treasury, Statement by Secretary Henry M. Paulson, Jr. on Financial Markets Update (Oct. 8, 2008) (online at www.treas.gov/press/releases/hp1189.htm).
353 Landon Thomas, Jr. and Julia Werdigier, Britain Takes a Different Route to Rescue Its
Banks, New York Times (Oct. 8, 2008) (online at www.nytimes.com/2008/10/09/business/
worldbusiness/09pound.html) (‘‘In a bold move to restore confidence, Britain announced an unprecedented £50 billion government lifeline for the nation’s banks Wednesday that it hailed as
a quicker solution to the credit crisis than a $700 billion American plan to buy impaired mortgage assets from troubled financial institutions’’); Parmy Olson, Brown Resurgent: The Credit
Crisis Has Galvanized British Prime Minister Gordon Brown As He Urges the World To Follow
His Bank Bailout, Forbes (Oct. 12, 2008) (online at www.forbes.com/2008/10/12/brown-bailoutcredit-biz-cxlpol1012brown.html) (‘‘The recapitalization package that Brown and his finance
minister, Alistair Darling, announced last Wednesday * * * puts Britain ahead of the U.S. on
dealing with the crisis. The United States Treasury has since said that it will mimic the British
approach and buy stakes in banks.’’)
354 Panel December Oversight Report, supra note 4, at 6. Government Accountability Office,
Troubled Asset Relief Program: Additional Actions Needed to Better Ensure Integrity, at 15–16
(Dec. 2008) (GAO/09–161) (online at www.gao.gov/new.items/d09161.pdf); U.S. Department of
the Treasury, Statement by Secretary Henry M. Paulson, Jr., on Actions to Protect the U.S. Economy (Oct. 14, 2008) (online at www.treasury.gov/press/releases/hp1205.htm).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00067

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

62
for an overall average discount of about 31 percent.355 This means,
in effect, that for every $100 dollars invested in the combined programs, the market valuation of the securities purchased was only
$66 dollars.
Since October, approximately $280 billion of capital infusions
have been made with TARP funds. Nonetheless, losses on impaired
assets have continued to weaken the balance sheets of banks and
foster uncertainty in the financial markets.
There is no question that the public is well served by effective
government strategies for addressing financial crises. The historical
case studies reviewed in Part B of this section of the report demonstrate that proposition clearly. Inaction in the face of systemic financial crisis can be enormously costly—economically, politically
and socially. But failed action can be equally costly. Wrong steps
not only cost time and money, but they also deprive policy makers
of the sustained public support necessary to carry out a successful
stabilization program.
As discussed in Part A of this section of the report, Treasury’s
current approach aims to both restore credit market activity broadly and stabilize particular financial institutions, especially the few
institutions that it deems systemically significant. The recently announced Public-Private Investment Fund focuses directly on the
problem of impaired assets; that initiative reflects the working
premise that it is possible through government-subsidized, highly
leveraged asset purchase vehicles to obtain valuations for non-performing or otherwise troubled assets, sell those assets at those values to willing buyers, and perhaps avoid the need for the reorganization or even the break-up of systemically significant financial
institutions.356 Treasury has not explained its assumption that the
proper values for these assets are their book values—in the case,
for example, of land or whole mortgages—and more than their
‘‘mark-to-market’’ value in the case of ABSs, CDOs, and like securities; if values fall below those floors, the banks involved may be insolvent in any event. Treasury has also failed to explain its assumptions about the economic events that would cause investors to
default or how long it believes assets will have to be held to
produce a reasonable return for private investors. Without non-subsidized buyers, market functioning is an illusion. As some observers have indicated,357 the issue of asset valuation is now as critical
to the recovery of the financial system as the precise strategy the

mstockstill on PROD1PC66 with HEARING

355 See

Panel February Oversight Report, supra note 6.
356 U.S. Department of the Treasury, White Paper: Public-Private Investment Program (Mar.
23, 2009) (online at www.treas.gov/press/releases/reports/ppiplwhitepaperl032309.pdf) (‘‘This
program should facilitate price discovery and should help, over time, to reduce the excessive liquidity discounts embedded in current legacy asset prices. This in turn should free up capital
and allow U.S. financial institutions to engage in new credit formation. Furthermore, enhanced
clarity about the value of legacy assets should increase investor confidence and enhance the ability of financial institutions to raise new capital from private investors.’’); Treasury has also not
explained its assumptions that (i) a number of years are available in which to accomplish these
goals without simply transferring losses to the taxpayer, and (ii) it is unnecessary or inappropriate to require that common shareholders (except for dilution) and bondholders accept losses
on their stakes in bank capital structures.
357 See Ricardo J. Caballero, Nationalisation Without Prices: A Recipe for Disaster, Financial
Times (Feb. 17, 2009); Charles W. Calomiris, The U.S. Government Must Take Risks, Financial
Times (Feb. 19, 2009); Douglas J. Elliott, The Public-Private Investment Program: An Assessment, Brookings Institution (March 23, 2009) (online at www.brookings.edu//media/Files/rc/papers/2009/0323linvestmentlprogramlelliott/0323linvestmentlprogramlelliott.pdf);
Matthew Richardson, The Case for and Against Bank Nationalization (February 26, 2009) (online
at http://www.voxeu.org/index.php?q=node/3143).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00068

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

mstockstill on PROD1PC66 with HEARING

63
federal government follows. There is another reason why this is so.
A great part of the financing done in the markets today either
flows through the banking system directly to investors or bypasses
banks altogether through the same mechanisms of securitization
used for mortgage lending. As the TALF program indicates,
securitization is especially important for the financing of credit
card, automobile, small business, and student loans. Markets for
those pools of loans have also dried up because of fears that unexpected default rates will deflate and freeze at a deflated level the
value of those pools. If Treasury’s initiative can show that the problems with the ABS markets were liquidity rather than inherent
value issues, it would be possible to restore the other markets without the need for the overwhelming commitment of taxpayer funds
that the TALF contemplates. While the Panel has previously argued for reform of the securitization process, the Panel has not
reached a consensus as to whether it is necessary to revive
securitization markets in the interim in order to restart lending in
the short-term future.
On the other hand, the frozen ABS markets raise several issues
discussed earlier in this report. First, to what degree is the freeze
a rational reaction to the problems of over-leverage, opacity, and
lack of intermediaries’ money being truly at risk that were endemic
in these markets during the bubble years? Second, should government seek to restart these markets before reforms necessary to
solve those problems (for example, increased capital requirements,
increased transparency, and reasonable controls on the structure
and economics of securitization vehicles) can be implemented?
Third, how critical will the securitization system continue to be in
financing our economy? Treasury must address these questions in
the coming weeks as it discusses its program for modernizing financial regulation to assure markets that it recognizes the importance of such reforms to preventing future crises.
The debate over the ultimate effectiveness of efforts designed to
utilize market mechanisms to restore the values of impaired assets
turns on whether current prices, particularly for mortgage-related
assets, reflect fundamental values or whether prices are artificially
depressed by a liquidity discount due to the market strain. If the
liquidity discount is real, public-private sector solutions are not
only viable but preferable, as they avoid creating new and unpredictable risks that arise from preemptive government seizure of
private interests. It is reasonable to assume that a liquidity discount is impairing these assets, for which there is limited trading.
Current prices cannot be fully explained without the liquidity factor. Even in areas of the country where home prices have declined
precipitously, the collateral behind mortgage-related assets still retains substantial value. In a liquid market, even undercollateralized assets should not be untradable or trading at pennies
on the dollar. Prices are being partially subjected to a downward
self-reinforcing cycle.
In the view of some, it is this notion of a liquidity discount that
supports the potential of future gain for taxpayers and makes
transactions under the CAP and the PPIP investments, and not
subsidies in the usual sense. This is an issue that will continue to
divide observers of Treasury’s actions, and ultimately events will

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00069

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

64
bear out whether this approach will work. The Panel notes that
Treasury’s approach may prove to be a viable and successful strategy, and offers historical context and the discussion of alternate approaches in the event that changes to Treasury’s current plans become necessary. The Panel has not reached agreement as to whether a change in strategy is currently needed.
3. OPTIONS FOR FUTURE ACTION

Lessons from this report’s historical examination of previous efforts at addressing banking crises highlight several paths Treasury
can take if future course changes become necessary.

mstockstill on PROD1PC66 with HEARING

a. Prologue—Understanding the FDIC’s Resolution Authority in the Context of Banks and Bank Holding Companies Facing Distress
When faced with a distressed bank in the current regulatory system,358 the federal government has several options. The options
can be characterized as liquidation (after the FDIC has become the
bank’s receiver); reorganization (after the FDIC has become the
bank’s conservator); or subsidization either through the FDIC or
from taxpayer funds.359
Most large banks are owned by bank holding companies or
‘‘BHCs.’’ The BHC issues stock and debt obligations to investors to
raise money for the bank and other companies that the BHC owns.
For the most part, only the banks are subject to supervisory and
regulatory authority by the FDIC and other federal financial supervisors; the Federal Reserve Board regulates BHCs, although as a
practical matter few important decisions are taken about banks
owned by holding companies without the concurrence of the Federal Reserve Board. The FDIC ensures bank deposits and, when
necessary, takes over those banks that fail. The FDIC’s takeover
powers relate to banks, not to their parent bank holding companies. When the FDIC has taken over sick banks, it has done so
with an eye toward assuring that depositors’ money is safe and
that the FDIC’s own insurance fund will remain solvent.
The accounts that are insured by the FDIC are guaranteed up
to a specified limit 360 without using general taxpayer revenues (except possibly in extreme cases caused by an overwhelming financial
collapse or the distress of a single massive institution). The FDIC
can place insured deposit accounts with other institutions. In some
cases, it can transfer both accounts and branch operations over a
weekend.
Historically, only banks, not investment banks like Bear Stearns
and Lehman Brothers, have been rescued by the federal government. The failure to rescue Lehman Brothers is only anomalous
358 In this discussion, the term ‘‘bank’’ includes all insured depository institutions. Treasury
is now proposing to give the FDIC ‘‘resolution authority’’ of the type described in this part of
the report covering systemically significant non-bank financial institutions. Geithner Financial
Services Committee Testimony, supra note 3.
359 Although the power of the FDIC is not limited to seizure of systemically significant institutions, the FDIC may be able to define the terms for such failure on a different basis than for
other institutions, or additional legislation may clarify its authority to do so.
360 Currently, individual accounts are insured up to $250,000. This ceiling is temporary; on
January 1, 2010 it will revert back to the previous limit of $100,000 other than for retirement
accounts, which will continue to be insured up to $250,000. Business accounts are also insured
up to the $250,000 limit.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00070

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

65

mstockstill on PROD1PC66 with HEARING

against this backdrop of extensive government interventions in failing non-deposit taking institutions. Government non-intervention
in the collapse of Lehman Brothers was consistent with 70 years
of government policy.
However the failure to rescue Lehman Brothers was not consistent with the involvement of Treasury and the Federal Reserve
Board in the rescue of Bear Stearns and its acquisition by JP Morgan Chase in March 2008; the Bear Stearns action marked a new
degree of public governmental involvement in the rescue of a nondepository institution. But even if the Bear Stearns rescue was unprecedented (because Bear Stearns was not a bank), the economic
result resembled the economic result of the rescue of Continental
Illinois in the mid-1980s—in both cases the shareholders of the
company received relatively little and the focus was on ensuring
that the institution (in the latter case, Bear Stearns) met its fixed
obligations.
Subsequent government interventions in Wachovia and AIG followed this pattern. At the same time, the liquidations of the truly
insured thrifts—Washington Mutual and IndyMac—by the FDIC
followed the same pattern of protecting depositors and wiping out
investors.
It is helpful to keep the structure and history of the U.S. banking
industry in mind as a backdrop against which to assess the options
for dealing with distressed banks.
Option A: Liquidation: Receivership and Breakup or Sale
of Distressed Banks.
Rather than subsidizing large distressed banks as going concerns
through government investment under the TARP, critically undercapitalized banks could be selected for effective liquidation by being
placed into the receivership of the FDIC. Then the FDIC would
help resolve the failure, as it has done more than a dozen times
already this year.361
As receiver, the FDIC could place the bank in liquidation—sell
any or all of the bank’s assets, organize a new bank containing assets of the bank, merge all or part of the bank into another bank,
or transfer assets or liabilities of the bank to another bank. As it
did in the savings and loan crisis of the late 1980s and as it has
done when individual banks have failed in the past, the government would continue to protect savings and checking account holders by moving those accounts to another bank or by paying
amounts in FDIC-insured accounts directly to the account-holders.
At the same time, the BHC that owns the large bank would almost certainly enter bankruptcy under Chapter 7 or 11 of the federal Bankruptcy Code. (The bankruptcy proceeding would determine the fate of the securities firms and other financial companies
owned by the BHC). The result of the receivership and bankruptcy
proceedings would likely be to wipe out the interests of the BHC’s
361 See Congressional Research Service, The Federal Deposit Insurance Corporation (FDIC):
Summary of Actions in Support of Housing and Financial Markets (Mar. 5, 2009) (CRS/7–5700)
(hereinafter ‘‘CRS FDIC Report’’).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00071

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

66

mstockstill on PROD1PC66 with HEARING

stockholders; in some cases the holders of debt obligations in the
BHC could recover part of their investment.362
The FDIC’s Temporary Liquidity Guarantee Program would soften the negative impact of increased liquidations on BHC bondholders.363 By guaranteeing senior unsecured bonds (including
some bonds that are convertible into common stock), the FDIC
agreed to treat these bonds more like deposits. This has reduced
the likelihood that liquidations will chill investment or have spillover effects on other banks. The fees that bond-issuers pay under
the program would also mitigate the costs of its operation, although
it is unclear to what extent the FDIC will have the resources to
deal with liquidations of large institutions.364
Treasury could supplement this approach for systemic reasons
with broader protection for bondholders. This was the approach of
the Swedish government, which guaranteed all fixed obligations.
Such a guarantee would be extremely expensive. However, the reason to expand the existing FDIC Guarantee Program would be to
reassure credit markets generally, or, specifically, to avoid a chain
of defaults set off by the consequences of credit default swap obligations coming due as a result of a bond default.
Option B: Receivership.
As an alternative to a windup, the government could place a distressed bank into conservatorship. As conservator, the FDIC would
try to restore the bank’s safe and sound condition (leaving insured
and hopefully other deposit holders in place) and carry on the
bank’s business in the meantime.
In either a receivership or conservatorship, the FDIC can remove
failed managers. It can also sell assets at their current market
value both to raise funds and to remove the bad assets from the
bank’s balance sheet, and it can sell off parts of its business. The
FDIC could also conceivably use this authority to break up one or
more large, systemically significant institutions into several smaller, more manageable banks.365 The preservation of the interests of
existing shareholders is not a constraint on the FDIC’s exercise of
its authority.
This approach is similar to the steps that were taken in countries with crises in relatively concentrated banking sectors in the
recent past, including the United Kingdom currently. It is also
similar to the approach of the Reconstruction Finance Corporation
during the New Deal. The only successful cases noted in Part B of
this section of the report that do not effectively fall into the conservatorship category was the RTC experience, which, of course, involved numerous smaller insolvent institutions that disappeared
during the crisis.
Treasury could obtain FDIC-type powers over institutions that
received TARP funds, similar to the powers the UK government
362 While only bankruptcy courts have the authority to wind down bank-holding companies
and non-bank institutions, Congress could provide that authority to the FDIC or another agency
moving forward. See Panel Regulatory Reform Report, supra note 164.
363 See generally Federal Deposit Insurance Corporation, Temporary Liquidity Guarantee Program (online at www.fdic.gov/regulations/resources/tlgp/index.html) (accessed Mar. 22, 2009);
CRS FDIC Report, supra note 361, at 5–6.
364 See Part A of Section One, supra, for a discussion of the FDIC’s financial condition.
365 Simon Johnson, The Quiet Coup, The Atlantic (May 2009) (online at www.theatlantic.com/
doc/200905/imf-advice).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00072

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

67
has exercised over some banks. Simply by insisting on voting control as the price for further capital infusions, Treasury would be in
a position to exercise more control and to guard the interests of
taxpayers.
Option C: Subsidization of Distressed Banks.
A third option is that, as the crisis spreads and financial institutions are at risk of becoming insolvent, the government can provide
financial resources to keep those institutions afloat (which some
may view as ‘‘subsidization’’). In most cases, before government aid
is delivered to a sick bank, the BHC must first support the bank
itself, but, again, it is likely that, by the time a crisis is reached,
a distressed bank will have already exhausted available assets of
its BHC.
Government financial support may be in the form of a loan, a
guarantee, or a direct infusion of capital, all of which are among
the tools available to Treasury as part of its authority under the
TARP. In addition, asset purchases from banks arranged with government involvement and guarantees can be vehicles for government subsidies. In each case, this assistance means transferring
value from the taxpayer to the financial institution. Such transfer
may be temporary (i.e., when the subsidy must be repaid) or permanent. Subsidization might be provided to all banks that request
it or just the banks that threaten systemic risk. The amounts and
kinds of subsidization are open-ended.
In most cases, the assistance flows to the bank through the BHC,
although some forms of FDIC assistance can flow directly to the
bank. This structure is used because often only the BHC can issue
preferred stock. By funding the corporation that holds the bank as
opposed to the bank itself, the government does not achieve a legal
claim as a bank creditor that could be senior to other creditors. Instead, the government holds senior preferred equity in the BHC,
and is thus at a higher risk of losing its investment in a liquidation
proceeding than other creditors. By lending to BHCs, the government increases the risk of taxpayer non-payment. At present, the
TARP involves two approaches. The first is the provision of capital
for a distressed bank to help it maintain solvency, lending volume,
and financial operations during the current crisis. The second is
purchase of bad (so-called ‘‘toxic’’) assets—as Secretary Paulson initially recommended—to remove the threat those assets pose to
bank solvency. Under this approach, the government could purchase the assets outright or it could purchase the assets as part of
a general restructuring. One restructuring that is widely described
involves placing institutions in conservatorship with the FDIC
transferring the toxic assets to one or more institutions (so-called
‘‘bad banks’’) created specifically to hold and ultimately to sell
those assets for the highest amounts possible. In that case, banks
stripped of their toxic assets would emerge from receivership as
healthier institutions and the separated, bad assets, could be held
until their value increased as the markets recovered.

mstockstill on PROD1PC66 with HEARING

4. ASSESSING THE OPTIONS

The overall objective of the TARP and related actions by the
FDIC and the Federal Reserve Board is to stabilize the financial
system and promote the return of economic growth. The choice of

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00073

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

68
which route to pursue among the options discussed above would
appear to depend upon the relative weight that policymakers assign to several other important considerations.

mstockstill on PROD1PC66 with HEARING

a. Time—Is it on Our Side or Not?
Assuming the most immediate goal is to have functioning major
financial institutions, the question is how to achieve that goal as
quickly as possible, at the lowest cost to the taxpayers, and with
minimal risk to the public interest and the financial system. If,
with the passage of time, assets will be restored to their earlier,
true values and banks will come back to life on their own accord,
then time is on our side. In such a case, the risks of action likely
outweigh the risks of inaction.
On the other hand, if the economy is unlikely to recover quickly,
so that the banks cannot rely on a rising economy to restore their
balance sheets, time is not on our side. The banking system itself
creates a possible timing problem. The existence of weak institutions that are sustained only by taxpayer guarantees and infusions
of cash threatens the health of all banks, drawing off depositors
and undermining public support. Continued operation of systemically significant but weakened institutions at the heart of a nation’s financial system may prevent a robust economic recovery of
the sort that would cause time to be on our side. In such a case,
delay and half steps would seem to be the main enemy.
b. Taxpayer Exposure and Exit Strategy
Subsidization, liquidation, and reorganization all require upfront
outlays by the government, and the greater the desire to protect
one or another class of otherwise uninsured investors, the greater
that initial outlay will be. If Treasury policy was to only protect insured depositors, the costs of either liquidation or reorganization
would be quite low. Ensuring all bondholders is costly, and keeping
equity holders alive is the most expensive of all, because: (1) protecting equity means you must protect all debt holders as well as
the equity holders; and (2) doing so prohibits the public from capturing the upside of a recovered bank.
Under any of the three strategies, the cost to the taxpayer depends not only on which classes of capital policymakers want to
support, but also on precisely how insolvent the applicable institutions may be. In the case of liquidation or reorganization, the cost
to the taxpayer is minimal where assets are adequate to cover deposits and, as necessary, guaranteed debt. The total cost of each of
these strategies also depends on their effectiveness at thawing
credit markets and restoring economic growth. An ineffective strategy is likely to prolong the crisis and require further investment
of taxpayer funds.
With regard to subsidization, capital infusions generally come to
mean equity (or ‘‘common stock’’) investments that increase the
cost to the taxpayer if banks fail or produce gains if the market recovers. Of course, that assumes that the government is focused on
capturing upside opportunities through equity ownership. In the
case of the transactions with shaky financial firms under TARP to
date, with the exception of AIG, Treasury has taken only small
amounts of equity upside in relation to the large risks Treasury

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00074

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

69

mstockstill on PROD1PC66 with HEARING

has assumed through its preferred stock investments and asset
guarantees.
In the case of asset purchases, the bad assets could fail to increase in value, leaving the taxpayers with similar, if not larger,
losses. On the other hand, a very successful government asset purchase program would provide the government with 100 percent of
the upside in those assets. These assets could gain in value as the
market turns around, producing gains to the government upon ultimate disposition. While Swedish authorities were aided by the
rapid recovery of the economy both nationally and globally as they
sought to dispose assets, such economic recovery is uncertain today,
as it was uncertain ex ante in Sweden. Similarly, with regard to
liquidation and reorganization, the disposal of assets in the current
environment may require steep discounts and thus greater taxpayer cost, depending on whether the government, as opposed to
the FDIC, is guaranteeing any particular class of investors in the
firm.
While the total cost of the various options is open to doubt, liquidation provides clarity relatively quickly. In that sense, allowing
institutions to fail in a structured manner supervised by appropriate regulators offers a clearer exit strategy than allowing those
institutions to drift into government control piecemeal.366 Liquidation is less likely to be open-ended and stretch over years, as subsidization did in Japan.
Liquidation is also the option least likely to sap the patience of
taxpayers. It is noteworthy how little controversy has been associated with the FDIC’s windup of numerous banks and thrifts over
the last year. The process for liquidating thrifts such as Washington Mutual and IndyMac has been executed without public
alarm. The confidence in this system seems to be related in part
to the FDIC’s long established role as conservator and, in part, to
the clear rules and purposes the FDIC has in place for its functioning as conservator. By contrast, taxpayers become particularly
impatient when subsidies are used to help banks acquire other
banks, stave off losses by bank shareholders, or serve existing management.
Thus, while liquidation can offer a clear exit strategy, FDIC’s experience with Continental Illinois suggests that reorganization may
not offer quite such a clear ending if the government is committed
both to minimizing the expenditure of government funds and to
making all creditors whole. Unable to find an acquirer, unwilling
to pay bondholders less than the value of the bond, and either unwilling or unable to infuse sufficient capital to bring Continental Illinois back to life, the government was forced to own and operate
the bank for a prolonged period, retaining an equity stake in that
institution for seven years. On the other hand, where there is a
willingness to fund losses or to discount payments made to investors, reorganization has been relatively quick.
Finally, liquidation raises concerns related to enterprise value.
Liquidation typically breaks up the firm. In some cases, that could
involve significant destruction of going concern value. A large multinational institution’s franchise value created by the web of con366 See

VerDate Nov 24 2008

23:21 Apr 22, 2009

Hoenig, supra note 149.

Jkt 048565

PO 00000

Frm 00075

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

70
sumer, corporate, and international banking relationships may be
lost as a result of government seizure and reorganization, a cost
that is not imposed on the economy under open bank assistance.
But liquidation forms are not so limited. Liquidation can mean
a sale of the whole entity to a buyer capable of absorbing and benefiting from the business as a whole. Going concern sales occur with
some frequency outside the banking world, even among very complex institutions. Enterprise value might be more easily preserved
in a conservatorship. By restructuring their balance sheets, writing
down liabilities, and eliminating old equity, such firms might continue in operation and attract significant new capital. It may be
true that some firms are systemically significant, but that does not
mean every slice of their capital structure is systemically significant. In fact, it may be that a restructuring represents the best
way to bring the franchise value back to full life.

mstockstill on PROD1PC66 with HEARING

c. Government Capacity and Expertise
All successful efforts to address bank crises have involved the
combination of moving aside failed management and getting control of the process of valuing bank balance sheets. There are two
models for the independent balance sheet valuation: mark to market (Sweden, RTC), and independent administrative pricing overseen by new management (RFC, ultimately Japan). Reorganization
and subsidization without effective assessment of asset values does
not work, as it can easily lead to the perpetuation of banks in a
weakened condition or to significant government subsidies to private parties.367 History offers no examples in which subsidization
of existing shareholders and management produced effective assessment of asset values.
The prospect of conservatorships at large U.S. banks raises
issues of government capacity to manage such processes at one or
more systemically significant financial institutions. Although the
FDIC has shown skill and professionalism in dealing with failed
banks in the past, it has never seized an institution as complex as
a systemically significant banking institution would necessarily be.
The fact that most such institutions operate in dozens of countries
makes their seizure particularly complex. The government’s capacity to dispose of bad assets could be overwhelmed by the amount
and complexity of the assets held by those institutions.
Some recent large FDIC takeovers may not offer relevant examples. While the FDIC has recent experience acting as the conservator of major financial institutions, that experience does not necessarily translate directly into the complex processes involved in
seizing large, complex holding companies with operations spanning
many countries. In July 2008, for example, the Office of Thrift Supervision closed IndyMac and placed it under an FDIC conservatorship.368 While IndyMac was the one of the largest mortgage originators in the nation, its day-to-day operations were relatively sim367 See Ricardo J. Caballero, Nationalisation Without Prices: A Recipe for Disaster, Financial
Times (Feb. 17, 2009).
368 Federal Deposit Insurance Corporation, Failed Bank Information: Information for IndyMac
Bank, F.S.B., Pasadena, CA (online at www.fdic.gov/bank/individual/failed/IndyMac.html)
(accessed Apr. 6, 2009); Federal Deposit Insurance Corporation, FDIC Establishes IndyMac Federal Bank, FSB as Successor to IndyMac Bank, F.S.B., Pasadena, California (July 11, 2008) (online at www.fdic.gov/news/news/press/2008/pr08056.html).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00076

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

71
ple; at the time of seizure, the thrift had only 33 branches, all of
which were located in California.369 Similarly, when regulators
closed Washington Mutual last September and put it under FDIC
conservatorship, the FDIC was able to facilitate the purchase of the
thrift by JP Morgan immediately, seamlessly, and with relatively
minimal effort.370 While that experience demonstrates how quickly
the FDIC can cleanse the balance sheets of a troubled institution
and return that institution to private hands, Washington Mutual’s
operations were considerably simpler than those of large bank
holding companies. The seizure of a large, systemically significant
institution—let alone of multiple ones at the same time—may create additional and complex policy challenges.
On the other hand, it is not clear whether (1) the resources of
the United States government, including its global reach, are any
less in relationship to its largest banks than the resources of the
Swedish government were to its largest banks, (2) whether the
complexity of a small number of systemically significant financial
institutions is actually greater than the complexity involved in a
massively multi-institution enterprise like the RTC, and (3) whether these concerns suggest that the preferred approach for large institutions is to look to restructure balance sheets in short order
through investor concessions, rather than trying to manage institutions over time to fund complete guarantees for bondholders, which
was the approach in Continental Illinois and in Sweden.
Several further observations on the subject of complexity and liquidation are relevant. First, Treasury and the Federal Reserve
Bank of New York appear to be pursuing a liquidation strategy
with AIG. They appear to be selling off the pieces of that gigantic
conglomerate while making whole all its creditors. It is less clear
what the Administration’s strategy is with Fannie Mae and
Freddie Mac, but it does not appear to be a short-term liquidation
strategy. In neither case does the government’s role appear to be
beyond its organizational capacity, though it appears in all those
cases to be a politically challenging task. In addition, the government would not be limited to current personnel. Among the many
retired banking professionals and those currently operating smaller
banks, there may be substantial talent available to assist in the
management of banks under conservatorships.

mstockstill on PROD1PC66 with HEARING

d. Competitive Impact on Financial Institutions
Subsidization can have a substantial negative impact on the
functioning of competitive markets. It undoes market discipline for
financial institution investors, particularly equity investors, and it
effectively puts the financial power of the government behind some
‘‘private’’ firms and not behind others. While some institutions—
like Lehman Brothers—are left to fail without government assistance, others remain solvent and benefit from increased stock values
that take public subsidization into account.
369 Federal Deposit Insurance Corporation, FDIC Establishes IndyMac Federal Bank, FSB as
Successor to IndyMac Bank, F.S.B., Pasadena, California (July 11, 2008) (online at
www.fdic.gov/news/news/press/2008/pr08056.html).
370 Federal Deposit Insurance Corporation, Bank Acquisition Information: Information for
Washington Mutual Bank, Henderson NV and Washington Mutual Bank, FSB, Park City UT
(online at www.fdic.gov/bank/individual/failed/wamu.html) (accessed Apr. 6, 2009).

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00077

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

72
Perhaps the most pernicious impact of subsidization is its effect
on prudent banks. Institutions that were conservative in their risk
profiles and remained solvent during tough times lose the comparative advantage of that prudence when the government subsidizes
imprudent actors. Although liquidation and reorganization can be
costly and painful, those processes do not raise the same risks of
moral hazard or market distortion that accompany government
subsidization.
While systemically significant institutions will have competitive
advantages over others because of government financial assistance,
if the special protection available to them is not accompanied by
heightened regulatory requirements (relatively stringent capital
and liquidity requirements, an overall maximum leverage ratio,
etc.), then the comparative advantages of size will promote severe
market distortions—and impose growing risks on the taxpayer.371
e. Impact on Investors and Capital Markets
Some investors would nearly always be wiped out under liquidation or reorganization strategies. This is a harsh outcome, but the
investors also reaped profits during the good times, for which they
agreed to take the losses when things went sour. This is the nature
of a market economy, and it certainly is the fate of most business
people who take risks in a market economy. It is also the market
discipline that the leaders of the financial community have urged
on their fellow citizens for decades.
Some concern has been expressed that shareholders may include
pension funds and municipal governments, which would spread the
public costs of liquidation. On the other hand, it would undoubtedly
be less expensive to assist the subset of investors that might deserve protections (such as pension funds or municipal governments), than to continue to support all investors in the hopes that
some portion of the assistance would flow to these groups. In fact,
even when accounting for pension funds, stock ownership is concentrated heavily among higher-income families, which means that
protection of investors involves wealth transfers from all taxpayers
to a wealthier minority.372 This is particularly true for very low
valued stocks and junk bonds, which are typically held by longterm broadly representative investors but which are shifted in a
time of crisis to specialty, risk-friendly investors like vulture funds.
It is also possible that a more aggressive approach toward seizures may further undermine the efforts of banks to attract critical
private capital. On the other hand, with subsidization, private capital must also factor deep uncertainty about how long the subsidies
will last, the underlying value of the assets, and whether taxpayers
will eventually insist that banks be liquidated. The post-reorganization bank has a cleaned up balance sheet that would pose almost no risk and would likely be very attractive to investors bringing new capital.

mstockstill on PROD1PC66 with HEARING

371 See

Panel Regulatory Reform Report, supra note 164, at 23–24.
Ackerman et al., The Political Economy of Inequality (2000).

372 Frank

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00078

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

73

mstockstill on PROD1PC66 with HEARING

f. Asset Price Transparency
Attempting to ensure that the securities issued by an institution
in exchange for a capital infusion are equal in value to that infusion is difficult at best, and some pricing mechanisms are designed
to create hidden subsidies. Valuation issues are even more extreme
when the government purchases bad assets. While the shares of
many larger banks are publicly traded, providing a market price
that can be referenced in setting the terms for capital infusions,
the banks’ assets often have no readily ascertainable market value.
If the government pays for the assets at a distress price, reflecting
the assets’ current market value, the selling institution may be demonstrably insolvent. But if the government pays more for the assets than their current market value, it will simply provide a subsidy to the bank at taxpayer cost. These considerations led to decisions on the one hand to have government initially absorb the
losses associated with mark-to-market accounting for distressed assets, as was the case with the RTC and Sweden, and on the other
hand, to engage in independent administrative valuation of distressed assets, as was the case in the RFC and in the eventual Japanese approach to the crisis.
Liquidation presents its own valuation challenges. If the government takes over a failed bank, it will eventually sell the assets. It
will have to make the decision about how long to hold them and
what price to offer initially. By ‘‘dumping’’ assets too quickly,
Treasury could depress prices and indirectly impose losses upon
other financial institutions, and by holding too long, the taxpayer
could take unnecessary risks. This was the challenge facing the
RTC when it liquidated the assets of failed institutions in the late
1980s and early 1990s. But, as David Cooke testified to the Panel,
the RTC experience is generally viewed as providing lessons in how
to sell off assets effectively and efficiently. Ultimately, the RTC was
able to restore functioning markets for the kinds of assets (defaulted construction loans, mortgages, and real estate) that typically comprise a large portion of the bad assets of even the largest
institutions.
Historical precedents always involve some differences from the
current crises and the turmoil in the global financial system over
the last nearly two years has produced challenges not faced in prior
banking crises. Nevertheless, our review of prior episodes strongly
underscores the importance of reliable asset values, an assertive
government response to failing financial institutions and a willingness to hold management accountable, including replacement of
key officials when necessary. And perhaps most important of all,
clear, consistent communications to the public of the government’s
goals, strategy and progress in achieving its objectives—expressed
in terms the broad public can understand—will continue to be critical to sustained support for the current efforts from American taxpayers.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00079

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

74
SECTION TWO: ADDITIONAL VIEWS
A. Richard H. Neiman and John E. Sununu
The report issued today by the Congressional Oversight Panel
identifies central issues that should frame the public policy debate
on financial stability, including the importance of asset valuation,
the extent to which the current crisis is being driven by liquidity
as well as credit factors, and the proper relationship between the
public and private sectors.
These issues are complex, however, and the Panel did not reach
an agreement on either the economic assumptions underlying strategic choices or on the optimal strategy to pursue. Further, we are
concerned that the prominence of alternate approaches presented
in the report, particularly reorganization through nationalization,
could incorrectly imply both that the banking system is insolvent
and that the new Administration does not have a workable plan.
The stakes for the American people are too high to permit any such
misapprehensions to develop and intrude on successful outcomes
that affect our national financial security.
Therefore, we have issued this Statement of Separate Views, to
highlight what we consider to be the key points and to provide
Congress and the public with a fuller context in which to consider
the Panel’s report.
1. THE PRIMARY MISSION OF THE PANEL IS TO EVALUATE THE
EFFECTIVENESS OF TREASURY’S ACTIONS

First and foremost, the Panel is charged with evaluating the effectiveness of Treasury’s use of the new authority granted it under
the Emergency Economic Stabilization Act. It is not our role to design or approve Treasury’s strategy, nor should the Panel’s mission
be expanded to encroach on that authority.
Advocating an alternative strategy comes within the scope of our
mission only if Treasury either offers no plan, or attempts to proceed with a plan that the Panel determines cannot reasonably be
expected to succeed. As we will describe, neither of these conditions
exists at present. Therefore, to the extent that the Panel report focuses more on alternatives and less on evaluation of current activities through objective metrics, we have missed an opportunity to
closely engage with our primary task.

mstockstill on PROD1PC66 with HEARING

2. THE CURRENT TREASURY STRATEGY ALIGNS WITH
CONGRESSIONAL INTENT

The new Administration has set forth a comprehensive plan, in
particular through the Capital Assistance Program (CAP) and the
Public-Private Investment Program (PPIP). Collectively, these programs deal with the need for banks to engage in controlled
deleveraging by addressing both the equity and the asset challenges to the balance sheet. The combination of these two approaches provides a more comprehensive strategy than either capital infusions or asset purchases alone. The Treasury has further
allocated funds to directly address mortgage modification and foreclosure mitigation efforts for homeowners.
Taken together, these programs comprise a strategy that aligns
with the Congressional intent in passing the TARP legislation.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00080

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

75
They return to the original concept of asset purchases and address
the housing crisis. Furthermore, they embody a preference for
maintaining a private banking system via temporary public support or partnership, which is consistent with this country’s tradition of private rather than government control of business. Congress passed the EESA to protect the American public from financial chaos, and preventing collapse also avoids the subsequent need
for more extensive forms of government intervention in the markets—forms less consistent with our American experience of democratic capitalism.
3. THE CURRENT TREASURY STRATEGY IS REASONABLE AND VIABLE

mstockstill on PROD1PC66 with HEARING

Much of the Panel’s report is premised upon the tension between
subsidization and reorganization through nationalization, in considering which options are preferable. Embedded within this tension
are profound differences in assumptions, both on the origins of the
crisis and on the optimal shape of the financial services industry
that emerges post-crisis.
Some still question the viability of any plan involving public support that does not first divest private ownership; however, less
drastic options such as public-private sector solutions are based on
very reasonable assumptions.
The debate turns on whether current prices, particularly for
mortgage-related assets, reflect fundamental values or whether
prices are being artificially depressed by a liquidity discount due to
the market strain. As stated in the report, one school of thought
focuses on the liquidity factor:
‘‘If the liquidity discount is real, approaches such
as Treasury’s Public Private Investment Partnership (PPIP) are more likely to succeed. Current
prices may, in fact, prove not to be explainable
without the liquidity factor. Even in areas of the
country where home prices have declined precipitously, the collateral behind mortgage-related assets still retains substantial value.’’
We affirm that it is entirely reasonable to assume that a liquidity discount is impairing these assets, and thus that the Treasury
has adopted a viable plan based on this valid assumption. Further,
we believe that a viable plan should be given the opportunity to
work. Speculation on alternatives runs the risk of distracting our
energy from implementation of a viable plan and needlessly eroding market confidence. Market prices are being partially subjected
to a downward self-reinforcing cycle that could be exacerbated by
unwarranted consideration of more radical solutions such as nationalization.
This positive assessment of Treasury’s view on the underlying
causes of the financial crisis is not meant to suggest that the housing bubble should be re-inflated. But we do admit to being confident that the long-term values of mortgage-related assets secured
by American homes remain a good investment.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00081

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

76
4. RESTORING FINANCIAL STABILITY DURING AN EMERGENCY TAKES
PRECEDENCE OVER OTHER POLICY GOALS

In thinking long-term, other issues remain to be considered. The
financial crisis has revealed underlying weaknesses in our regulatory system, and a reform effort will contribute to preventing future crises. Regulatory reform is a process, however, and we should
not withhold access to existing tools for restoring financial stability
while that reform process is in progress.
Two examples of broader issues that should be addressed in the
context of financial stability are (1) the role of securitization in reviving markets, and (2) the need for prudence in setting the degree
of transparency for stress-testing of the major banks in connection
with the CAP.
Reforms are certainly necessary in securitization and secondary
markets, as the Panel has noted on previous occasions. We need to
improve the credit quality of securities issued and better manage
risk going forward, but this does not mean that securitization
should be abandoned in the interim.
The Panel’s report presents a variety of views on the role of
securitization both in a reformed regulatory structure and as a potential tool in reviving markets. We agree with the perspective
which acknowledges that economic recovery depends upon the existence of a functioning secondary market, to re-cycle capital and
support credit access for consumers and businesses.
That is why the Federal Reserve has developed the Term AssetBacked Securities Loan Facility (TALF), in which the Treasury has
chosen to invest limited TARP funds. The secondary market has
been largely frozen for a wide class of assets, including student
loans, auto loans, credit cards, and small businesses credit. An
added safeguard is that the TALF will not accept the more exotic
forms of securitized structures.
On the issue of transparency, specifically in the stress-testing
that federal banking regulators will be performing under the CAP,
results should be held confidential. We believe that government
agencies and officials who monitor the industry have a public trust
and should be held accountable for their oversight. But there is
also a critical difference between public information and confidential information, and respecting this distinction is in our national
interest. Regulatory examination findings for banks are confidential, and this rule should extend to the results of stress-tests to prevent misuse of information and rumors that could place depositors’
funds at risk.

mstockstill on PROD1PC66 with HEARING

5. THE PANEL’S MISSION REMAINS OF CRITICAL IMPORTANCE

There is much serious and constructive work for the Panel to
contribute in evaluating the Treasury’s existing initiatives, including the structure of both the TALF and PPIP, and we should be
zealous in pursuit of our mission. Open issues that need to be addressed in-depth in future Panel reports include:
• Treasury’s decision to limit the number of fund managers
for the PPIP, and the eligibility criteria for fund managers;
• The impact of new FASB rules on mark-to-market accounting;

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00082

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

77
• The implications of redemptions of TARP funds on the design and goals of the program; and,
• Additional metrics to quantify the health of the financial
system.
Congress would be much better served by those lines of inquiry,
which we believe will identify ways in which to maximize the opportunities for success.
And success is achievable. We have the wherewithal not only to
restore financial stability, but to emerge from this crisis in an even
stronger position. Prosperity is not a zero-sum game. It is not the
case that one person or group necessarily prospers at another’s expense. If we stand together in investing in our common future, as
individual and as corporate citizens, we continue in our country’s
tradition of pragmatic optimism and lay the most enduring foundation of all for our lasting economic stability.
B. John E. Sununu

mstockstill on PROD1PC66 with HEARING

In producing monthly reports assessing the performance of programs under the Troubled Asset Relief Program (TARP), the Congressional Oversight Panel has worked effectively to build consensus among panel members. While it is unusual that any single
panel member would fully agree with every sentence and statement
in a comprehensive oversight report, in each previous case, I have
found broad agreement with the sentiment and priorities pursued,
and as a result, voted to support their release.
In reviewing the drafting of the April Oversight Report, however,
it became clear that much of the content pursued topics which
strayed far from the Panel’s core mission. Moreover, the April Report engages in a premature discussion of dramatic changes in
Treasury’s chosen approach to supporting stabilization in the US financial markets. These and other concerns are more fully discussed
in the joint additional views which I have submitted with Richard
Neiman.373 Given the magnitude of these differences, I am unable
to support the full April Oversight Report.
In addition to the concerns expressed in the joint additional
views, I wish to briefly highlight two significant areas of disagreement with the Report’s choice of content and prioritization. In the
end, these differences were simply too great to overcome through
the submission of supplemental views alone.
1. The main element of the April Report, a discussion of alternatives to the programs Treasury has established under the TARP,
takes the Panel too far from its core mission of monitoring and assessing the performance of existing programs and making recommendations for improvement. In utilizing resources to pursue
this lengthy discussion (pp. 70–87), the Panel has lost the opportunity to develop a more in depth assessment of key questions including:
• How much lending and what type of lending has been done
by firms receiving funding under the Bank Capital Program
(CPP)?
373 Part

VerDate Nov 24 2008

23:21 Apr 22, 2009

B of Section 2 of this report, infra.

Jkt 048565

PO 00000

Frm 00083

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

78

mstockstill on PROD1PC66 with HEARING

• What factors have driven roughly 200 financial institutions to decline CPP funding after their applications had been
approved, and what implications does this have for the success
of the program?
• How successful have the initial TALF auctions been, and
what implications does this have for the structure and price
discovery mechanism of the PPIP?
• To what extent has the recent debate and proposed legislation regarding taxation and limitation of executive compensation discouraged firms from participating in CAP, TALF, and
the PPIP?
2. The April Report contains a lengthy discussion (pp. 60–70) of
the unfolding financial crisis in Ireland, Iceland, the United Kingdom, and other European Countries. While a short description of
the steps each nation has taken may be appropriate to the context
of the Report, attempting a detailed analysis of the economic—and
political—response is well outside the core mission of the Congressional Oversight Panel. Given the very dynamic nature of the current crisis, and the relative proximity of recent decisions taken in
these countries, it is of little use to employ these examples to guide
our oversight of the Treasury Programs.
In summary, the central parts of the April Report of the Congressional Oversight Panel is consumed with discussion which, although interesting to many readers, is at the edge of—and outside—the core mission of the Panel. Expending resources to develop
this analysis has precluded a more detailed assessment of the performance of TARP programs to date. Furthermore, the prominence
of alternate approaches could be used incorrectly to suggest that
the Panel believes that existing programs have failed, or that it has
concluded that the Administration Plan is not viable.
Given the weight of these concerns, I am unable to support the
release of the April Oversight Report.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00084

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

79
SECTION THREE: CORRESPONDENCE WITH TREASURY
UPDATE
As Treasury continues to announce new initiatives, the Panel
continues to review and investigate different aspects of the financial crisis and the related programs. Since its first report, the Panel
has requested clarification on Treasury’s strategy. On March 5,
2009,374 Chair Elizabeth Warren replied to Secretary Geithner’s
letter of February 23, 2009, with a request for a direct response to
the Panel’s outstanding questions regarding Treasury’s overall
strategy for combating the financial crisis. The letter requested a
reply by March 20, 2009. On April 2, 2009, Secretary Geithner replied.375
Despite months of requests, the Panel was unable to secure a
commitment from Secretary Geithner to testify at a Panel hearing
regarding Treasury’s strategy. In recent days, a date was finally
set for April 21. The Panel appreciates the commitment, but it is
concerned about the prolonged process.
The Panel was also quite surprised to discover it was excluded
from the PPIP term sheet providing information access to GAO and
SIGTARP. Thus far, Treasury has offered no explanation for why
it would attempt to exclude the Panel from access to this information.
In a letter to Secretary Geithner dated March 25, 2009, the
Panel Chair expressed her concerns on these issues.376 While the
Panel understands the many demands on Treasury at this time,
this delayed response is deeply worrisome. In his April 2 letter,
Secretary Geithner promised regular meetings and briefings before
major announcements. This would be a significant improvement. A
productive working relationship with Treasury would provide
greater transparency to Congress and the public.
TALF Inquiry. Recently, the Oversight Board opened an inquiry
into the TALF.377 Specifically, the Panel is concerned that the
TALF appears to involve substantial downside risk and high costs
for the American taxpayer, while offering substantial rewards to a
small number of private parties. Equally important, the TALF appears to subsidize the continuation of financial instruments and arrangements whose failure was a primary cause of the current economic crisis. The Panel is further concerned because the documents
posted on Treasury’s website describing the terms of operation of
the TALF and press reports about the content of those terms as
they are to be implemented by the Federal Reserve Bank of New
York are contradictory.
To clarify the questions surrounding TALF, the Panel Chair
asked Treasury for more information in her March 20, 2009, letter.
Generally, the Panel is seeking information on a number of points
to better understand what Treasury intends to accomplish with
TALF and why the TALF structure is the most effective way to accomplish that goal. A reply was requested by March 27, 2009, and
374 See

Appendix
Appendix
Appendix
377 See Appendix
375 See

mstockstill on PROD1PC66 with HEARING

376 See

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

VII, infra.
VIII, infra.
IV, infra.
VI, infra.

PO 00000

Frm 00085

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

80
was received as part of the April 2, 2009, letter. The Panel is currently reviewing the letter.
AIG Inquiry. The Panel has also initiated an inquiry into Treasury and Federal Reserve Bank actions to provide continued capital
infusions and other assistance to AIG.378 The Panel has raised a
number of important questions. These include the basis for deciding that AIG posed systemic risk, the economic consequences of the
assistance provided to AIG, the identity of the ultimate beneficiaries of this assistance, and the manner in which Treasury and
the Board have monitored the recipients of taxpayer dollars. The
Panel is particularly concerned that the opaque nature of the relationship among AIG, its counterparties, Treasury, and the Federal
Reserve Banks, particularly the Federal Reserve Bank of New
York, has substantially hampered oversight of the TARP program
by Congress and, equally important, has impaired the understanding of that program by the American people.
In a letter dated March 24, 2009, the Panel Chair requested information from Treasury and the Federal Reserve Board on a number of points related to AIG, including how the assistance was requested and need was analyzed, the assessment of risk to the national and international financial system, any conditions placed on
the assistance, and information about counterparties and credit default swaps. The Panel awaits the requested information from
Treasury.
Capital Assistance Program Inquiry. Most recently, on
March 30, 2009, Chair Elizabeth Warren sent a request to Secretary Geithner regarding the Capital Assistance Program’s stress
tests.379 Because the stress tests represent a key component of the
program, the Panel has undertaken a study of the theories underlying and details of the assessment.
The Panel is hopeful that Treasury will provide a prompt, substantive response to outstanding inquiries. In addition, the Panel
would find it helpful to have a single point of contact within Treasury charged with providing information requested by the Panel.
Without detailed and accurate information, the Panel cannot perform its oversight function as effectively as it should. The Panel is
encouraged by Secretary Geithner’s recent letter, and the Panel
will continue to work with Treasury in the hopes of restoring public
confidence in the recovery process.

mstockstill on PROD1PC66 with HEARING

378 See
379 See

VerDate Nov 24 2008

23:21 Apr 22, 2009

Appendix V, infra.
Appendix III, infra.

Jkt 048565

PO 00000

Frm 00086

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

81

mstockstill on PROD1PC66 with HEARING

SECTION FOUR: TARP UPDATES SINCE LAST REPORT
Since the last report, Treasury, the Federal Reserve Board, and
the FDIC have released details on several programs that were initially announced as part of Treasury’s Financial Stability Plan
(FSP). Additionally, Treasury has begun discussions regarding regulatory reforms to provide a more stable economic system going forward.
Restructuring of Assistance to AIG. On March 2, 2009, the
Federal Reserve Board and Treasury announced that they would be
restricting AIG’s government aid to speed the process of returning
full ownership of the company to the private sector. The restructuring included exchanging the preferred stock the government
held for stock that had characteristics closer to common equity
stock as a means of improving the company’s equity and financial
leverage. Second, Treasury would create a new equity capital facility that would allow AIG to draw down up to $30 billion as another
means to improve the company’s leverage, and to raise its capital
levels. Finally, the Federal Reserve Board announced it would
make certain changes to the $60 billion revolving credit facility
that had been established by the Federal Reserve Bank of New
York, most significantly by reducing the size of the facility to $25
billion.
Term Asset-Backed Securities Loan Facility (TALF). On
March 3, 2009, the Federal Reserve Board and Treasury announced details of a facility, the purpose of which, according to the
White Paper issued by the Federal Reserve Board, is to ‘‘improve
credit market conditions by addressing the securitization markets’’
by stimulating demand for asset-backed securities. Under the
TALF, $200 billion in non-recourse collateralized debt will be made
available through the New York Federal Reserve Bank for the purchase of new, highly-rated asset-backed securities. The smallest
available TALF loans are $10 million; there is no upper limit. The
loans will be collateralized by the securities purchased.
Details for the Making Home Affordable Loan Modification Program. On March 4, 2009, detailed guidelines and instructions were provided to loan servicers to enable them to modify
mortgages under the terms of the Homeowner Affordability and
Stability Plan that was announced as part of FSP in February. On
March 19, 2009, Treasury and the Department of Housing and
Urban Affairs launched a web site, MakingHomeAffordable.gov, to
provide additional guidance and information.
Public-Private Investment Program (PPIP). On March 23,
2009, Treasury and the FDIC announced details of a program intended to target the so-called ‘‘toxic assets,’’ called ‘‘legacy assets’’
in program documents, that remain on many banks’ and other institutions’ books. The PPIP has two parts: (1) the Legacy Loan Program, intended to help banks sell troubled real estate loans by providing buyer assistance in the form of equity contributions from
Treasury and financing through FDIC-guaranteed loans; and (2)
the Legacy Security Program, which designates several asset managers as ‘‘Fund Managers’’ and creates partnerships between

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00087

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

82

mstockstill on PROD1PC66 with HEARING

Treasury and Fund Managers whose purpose is to buy up mortgage-backed securities including those issued prior to 2009.
Framework for Regulatory Reform. On March 26, 2009,
through a press release and testimony by Secretary Geithner before
the House Financial Services Committee, Treasury announced a
proposed framework for reforming financial regulation. The proposal focused on identifying and addressing those institutions that
pose a systemic risk to the U.S. economy, providing protections for
consumers and investors, eliminating gaps in the regulatory structure by means such as requiring hedge funds to register, and coordinating with other nations to improve international regulation.
Additional details are to be forthcoming.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00088

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

83
SECTION FIVE: OVERSIGHT ACTIVITIES
The Congressional Oversight Panel was established as part of
EESA and formed on November 26, 2008. Since then the Panel has
issued four oversight reports, as well as a special report on regulatory reform which came out on January 29, 2009.
Since the release of the Panel’s March oversight report, the following developments pertaining to the Panel’s oversight of the
TARP took place:
• The Panel held a hearing in Washington, DC on March 19, entitled, ‘‘Learning from the Past: Lessons from the Banking Crises
of the 20th Century.’’ At the hearing, the Panel heard testimony
from experts on the banking crises in Japan and Sweden during
the early 1990s, the savings and loan collapse in the 1980s, and the
Great Depression of the 1930s. The historical lessons captured in
this testimony played an important role in the Panel’s evaluation
of Treasury’s current strategy, as reflected in this report.
• Secretary Geithner sent a response letter on April 2, 2009 380
to the Panel in response to letters from Elizabeth Warren sent on
March 5 381 and 20,382 2009. Treasury’s letter provided the Panel
with answers to questions posed in the March 5 letter and directed
the Panel to examine a letter from the New York Federal Reserve
for answers to its TALF questions in the March 20 letter.
• On behalf of the Panel, Elizabeth Warren sent a letter to Secretary Geithner on March 20, 2009,383 requesting clarification on
several aspects of the TALF. Copies of the same letter were also
sent to Chairman of the Federal Reserve Board Ben Bernanke, and
President of the New York Federal Reserve William Dudley, asking
for their comments on the issues raised in the letter. Chairman
Bernanke and Mr. Dudley responded in a joint letter on April 1,
2009.384 The Panel is currently reviewing the specific responses
contained in the letter and expects to provide further analysis in
the next report.
Upcoming Reports and Hearings
• On Tuesday, April 21, Secretary Geithner will make his first
appearance before the Panel at a hearing in Washington, DC.
• On Wednesday, April 29, the Panel will hold a field hearing in
Milwaukee, WI. The purpose of the field hearing will be to explore
the impact of TARP on credit access for small businesses. The
Panel will announce more details in the coming weeks.
• The Panel will release its next oversight report in May, which
will examine the effects of TARP on small business and household
lending. The Panel will continue to release oversight reports every
30 days.

380 See

Appendix
Appendix
Appendix
383 See id.
384 See Appendix
381 See

mstockstill on PROD1PC66 with HEARING

382 See

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

I, infra.
VII, infra.
VI, infra.
II, infra.

PO 00000

Frm 00089

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

84
SECTION SIX: ABOUT THE CONGRESSIONAL OVERSIGHT
PANEL

mstockstill on PROD1PC66 with HEARING

In response to the escalating crisis, on October 3, 2008, Congress
provided the U.S. Department of the Treasury with the authority
to spend $700 billion to stabilize the U.S. economy, preserve home
ownership, and promote economic growth. Congress created the Office of Financial Stabilization (OFS) within Treasury to implement
a Troubled Asset Relief Program. At the same time, Congress created the Congressional Oversight Panel to ‘‘review the current
state of financial markets and the regulatory system.’’ The Panel
is empowered to hold hearings, review official data, and write reports on actions taken by Treasury and financial institutions and
their effect on the economy. Through regular reports, the Panel
must oversee Treasury’s actions, assess the impact of spending to
stabilize the economy, evaluate market transparency, ensure effective foreclosure mitigation efforts, and guarantee that Treasury’s
actions are in the best interests of the American people. In addition, Congress has instructed the Panel to produce a special report
on regulatory reform that will analyze ‘‘the current state of the regulatory system and its effectiveness at overseeing the participants
in the financial system and protecting consumers.’’
On November 14, 2008, Senate Majority Leader Harry Reid and
the Speaker of the House Nancy Pelosi appointed Richard H.
Neiman, Superintendent of Banks for the State of New York,
Damon Silvers, Associate General Counsel of the American Federation of Labor and Congress of Industrial Organizations (AFL–CIO),
and Elizabeth Warren, Leo Gottlieb Professor of Law at Harvard
Law School to the Panel. With the appointment on November 19
of Congressman Jeb Hensarling to the Panel by House Minority
Leader John Boehner, the Panel had a quorum and met for the
first time on November 26, 2008, electing Professor Warren as its
chair. On December 16, 2008, Senate Minority Leader Mitch
McConnell named Senator John E. Sununu to the Panel, completing the Panel’s membership.

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00090

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

85

mstockstill on PROD1PC66 with HEARING

APPENDIX I: LETTER FROM TREASURY SECRETARY MR. TIMOTHY GEITHNER TO CONGRESSIONAL OVERSIGHT PANEL CHAIR
ELIZABETH WARREN, DATED APRIL 2, 2009

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00091

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00092

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 108 48565A.002

mstockstill on PROD1PC66 with HEARING

86

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00093

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 109 48565A.003

mstockstill on PROD1PC66 with HEARING

87

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00094

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 110 48565A.004

mstockstill on PROD1PC66 with HEARING

88

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00095

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 111 48565A.005

mstockstill on PROD1PC66 with HEARING

89

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00096

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 112 48565A.006

mstockstill on PROD1PC66 with HEARING

90

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00097

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 113 48565A.007

mstockstill on PROD1PC66 with HEARING

91

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00098

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 114 48565A.008

mstockstill on PROD1PC66 with HEARING

92

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00099

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 115 48565A.009

mstockstill on PROD1PC66 with HEARING

93

94

mstockstill on PROD1PC66 with HEARING

APPENDIX II: LETTER FROM CHAIRMAN OF
THE FEDERAL RESERVE BOARD OF GOVERNORS MR. BEN BERNANKE TO CONGRESSIONAL OVERSIGHT PANEL CHAIR ELIZABETH WARREN, DATED APRIL 1, 2009

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00100

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00101

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 117 48565A.010

mstockstill on PROD1PC66 with HEARING

95

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00102

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 118 48565A.011

mstockstill on PROD1PC66 with HEARING

96

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00103

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 119 48565A.012

mstockstill on PROD1PC66 with HEARING

97

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00104

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 120 48565A.013

mstockstill on PROD1PC66 with HEARING

98

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00105

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 121 48565A.014

mstockstill on PROD1PC66 with HEARING

99

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00106

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 122 48565A.015

mstockstill on PROD1PC66 with HEARING

100

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00107

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 123 48565A.016

mstockstill on PROD1PC66 with HEARING

101

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00108

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 124 48565A.017

mstockstill on PROD1PC66 with HEARING

102

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00109

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 125 48565A.018

mstockstill on PROD1PC66 with HEARING

103

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00110

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 126 48565A.019

mstockstill on PROD1PC66 with HEARING

104

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00111

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 127 48565A.020

mstockstill on PROD1PC66 with HEARING

105

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00112

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 128 48565A.021

mstockstill on PROD1PC66 with HEARING

106

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00113

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 129 48565A.022

mstockstill on PROD1PC66 with HEARING

107

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00114

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 130 48565A.023

mstockstill on PROD1PC66 with HEARING

108

109

mstockstill on PROD1PC66 with HEARING

APPENDIX III: LETTER FROM CONGRESSIONAL
OVERSIGHT PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY MR. TIMOTHY GEITHNER, DATED MARCH 30, 2009

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00115

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00116

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 132 48565A.024

mstockstill on PROD1PC66 with HEARING

110

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00117

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 133 48565A.025

mstockstill on PROD1PC66 with HEARING

111

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00118

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 134 48565A.026

mstockstill on PROD1PC66 with HEARING

112

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00119

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 135 48565A.027

mstockstill on PROD1PC66 with HEARING

113

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00120

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 136 48565A.028

mstockstill on PROD1PC66 with HEARING

114

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00121

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 137 48565A.029

mstockstill on PROD1PC66 with HEARING

115

116

mstockstill on PROD1PC66 with HEARING

APPENDIX IV: LETTER FROM CONGRESSIONAL
OVERSIGHT PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY MR. TIMOTHY GEITHNER, DATED MARCH 25, 2009

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00122

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00123

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 139 48565A.030

mstockstill on PROD1PC66 with HEARING

117

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00124

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 140 48565A.031

mstockstill on PROD1PC66 with HEARING

118

119

mstockstill on PROD1PC66 with HEARING

APPENDIX V: LETTER FROM CONGRESSIONAL OVERSIGHT PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY MR. TIMOTHY GEITHNER, DATED
MARCH 24, 2009

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00125

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00126

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 142 48565A.032

mstockstill on PROD1PC66 with HEARING

120

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00127

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 143 48565A.033

mstockstill on PROD1PC66 with HEARING

121

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00128

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 144 48565A.034

mstockstill on PROD1PC66 with HEARING

122

123

mstockstill on PROD1PC66 with HEARING

APPENDIX VI: LETTER FROM CONGRESSIONAL
OVERSIGHT PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY MR. TIMOTHY GEITHNER, DATED MARCH 20, 2009

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00129

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00130

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 146 48565A.035

mstockstill on PROD1PC66 with HEARING

124

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00131

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 147 48565A.036

mstockstill on PROD1PC66 with HEARING

125

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00132

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 148 48565A.037

mstockstill on PROD1PC66 with HEARING

126

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00133

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 149 48565A.038

mstockstill on PROD1PC66 with HEARING

127

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00134

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 150 48565A.039

mstockstill on PROD1PC66 with HEARING

128

129

mstockstill on PROD1PC66 with HEARING

APPENDIX VII: LETTER FROM CONGRESSIONAL OVERSIGHT PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY
MR. TIMOTHY GEITHNER, DATED MARCH 5,
2009

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00135

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00136

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 152 48565A.040

mstockstill on PROD1PC66 with HEARING

130

VerDate Nov 24 2008

23:21 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00137

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 153 48565A.041

mstockstill on PROD1PC66 with HEARING

131

132

mstockstill on PROD1PC66 with HEARING

APPENDIX VIII: LETTER FROM CONGRESSIONAL OVERSIGHT PANEL CHAIR ELIZABETH WARREN TO TREASURY SECRETARY
MR. TIMOTHY GEITHNER, DATED JANUARY
28, 2009

VerDate Nov 24 2008

23:59 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00138

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

VerDate Nov 24 2008

23:59 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00139

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 155 48565A.042

mstockstill on PROD1PC66 with HEARING

133

VerDate Nov 24 2008

23:59 Apr 22, 2009

Jkt 048565

PO 00000

Frm 00140

Fmt 6602

Sfmt 6602

E:\HR\OC\A565.XXX

A565

Insert graphic folio 156 48565A.043

mstockstill on PROD1PC66 with HEARING

134


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102