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CONGRESSIONAL OVERSIGHT PANEL

AUGUST OVERSIGHT REPORT *

THE CONTINUED RISK OF TROUBLED
ASSETS

AUGUST 11, 2009.—Ordered to be printed

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

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CONGRESSIONAL OVERSIGHT PANEL AUGUST OVERSIGHT REPORT

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1

CONGRESSIONAL OVERSIGHT PANEL

AUGUST OVERSIGHT REPORT *

THE CONTINUED RISK OF TROUBLED
ASSETS

AUGUST 11, 2009.—Ordered to be printed

U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON

51–601

:

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

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*Submitted under Section 125(b)(1) 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

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DAMON SILVERS

(II)

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CONTENTS

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Page

Executive Summary .................................................................................................
Section One: The Continued Risk of Troubled Assets ..........................................
A. Background ..................................................................................................
B. What is a Troubled Asset? ..........................................................................
C. Estimating the Amount of Troubled Assets ..............................................
D. Current Strategies for Dealing with Troubled Assets ..............................
E. Commercial Real Estate ..............................................................................
F. The Future ....................................................................................................
G. Conclusion ....................................................................................................
Annex to Section One: Estimating the Amount of Troubled Assets—Additional
Information and Methodology .............................................................................
Section Two: Additional Views ...............................................................................
A. Senator John E. Sununu .............................................................................
B. Congressman Jeb Hensarling .....................................................................
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 CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY GEITHNER AND CHAIRMAN BEN BERNANKE,
RE: CONFIDENTIAL MEMORANDA, DATED JULY 20, 2009 ..............
APPENDIX II: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY GEITHNER, RE: TEMPORARY GUARANTEE
PROGRAM FOR MONEY MARKET FUNDS, DATED MAY 26, 2009 ....
APPENDIX III: 2009 LETTER FROM SECRETARY TIMOTHY
GEITHNER IN RESPONSE TO CHAIR ELIZABETH WARREN’S LETTER, RE: TEMPORARY GUARANTEE PROGRAM FOR MONEY
MARKET FUNDS, DATED JULY 21, 2009 ...............................................
APPENDIX IV: LETTER FROM CHAIR ELIZABETH WARREN TO
SECRETARY TIMOTHY GEITHNER AND CHAIRMAN BEN
BERNANKE, RE: BANK OF AMERICA, DATED MAY 19, 2009 ............
APPENDIX V: 2009 LETTER FROM SECRETARY TIMOTHY
GEITHNER IN RESPONSE TO CHAIR ELIZABETH WARREN’S LETTER, RE: BANK OF AMERICA, DATED JULY 21, 2009 ........................
APPENDIX VI: LETTER FROM CHAIR ELIZABETH WARREN AND
PANEL MEMBER RICHARD NEIMAN TO SECRETARY TIMOTHY
GEITHNER, RE: FORECLOSURE DATA, DATED JUNE 29, 2009 .......
APPENDIX VII: LETTER FROM ASSISTANT SECRETARY HERB
ALLISON IN RESPONSE TO CHAIR ELIZABETH WARREN’S LETTER, RE: FORECLOSURE DATA, DATED JULY 29, 2009 .....................
(III)

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AUGUST OVERSIGHT REPORT

AUGUST 11, 2009.—Ordered to be printed

EXECUTIVE SUMMARY*

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In the fall of 2008, the American economy was facing a crisis
stemming from steep losses in the financial sector, and frozen credit markets. Then-Secretary of the Treasury Henry Paulson and
Federal Reserve Board Chairman Ben Bernanke argued that a program of unprecedented scope was necessary to remove hundreds of
billions of dollars in so-called toxic assets from banks’ balance
sheets in order to restore the flow of credit.
By the time the law creating the Troubled Asset Relief Program
(TARP) was signed only a few weeks later, however, the Secretary
had decided, due to a rapid deterioration in conditions, to use another, more direct, strategy permitted under TARP to rescue the financial system, by providing immediate capital infusions to banks
to offset the impact of troubled assets. Now, ten months after its
creation, TARP has not yet been used to purchase troubled assets
from banks, although the capital infusions have provided breathing
space for banks to write-down many of these assets and to build
loss reserves against future write-downs and losses. This report
discusses the implications of the retention of billions of dollars of
troubled assets on bank balance sheets.
In the run-up to the financial crisis, banks and other lenders
made millions of loans to homeowners across America, expecting
that their money would eventually be paid back. It is now clear
that many of these loans will never be repaid.
In some cases, financial institutions packaged these mortgage
loans together and sold pieces of them into the market place as
mortgage-backed securities. In other cases they held the mortgages
* The Panel adopted this report with a 4–1 vote on August 10, 2009. Rep. Jeb Hensarling
voted against the report. Additional views are available in Section Two of this report.

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2
as ‘‘whole loans’’ on their own books. In either case, these mortgages, and the securities based on them, are now said to be ‘‘troubled assets.’’ They are no longer expected to be paid off in full, and
they are very difficult to sell. There is no doubt that the banks
holding these assets expect substantial losses, but the scale of
those losses is far from clear.
As just noted, Treasury’s choice to pursue direct capital purchases resulted in a notable stabilization of the financial system,
and it allowed the write-down of billions of dollars of troubled assets and reserve building. But, it is likely that an overwhelming
portion of the troubled assets from last October remain on bank
balance sheets today.
If the troubled assets held by banks prove to be worth less than
their balance sheets currently indicate, the banks may be required
to raise more capital. If the losses are severe enough, some financial institutions may be forced to cease operations. This means that
the future performance of the economy and the performance of the
underlying loans, as well as the method of valuation of the assets,
are critical to the continued operation of the banks.
For many years, banks were required to mark their assets to
market, meaning they listed the value for many assets based on
what those assets would fetch in the marketplace. In response to
the crisis, banks have been allowed greater flexibility in the way
they value these assets. In most cases we would expect the new
rules to have permitted banks to value assets at a higher level
than before. So long as they do not sell or write-down those assets,
they are not forced to recognize losses on them.
The uncertainty created by the financial crisis, including the uncertainty attributable to the troubled assets on bank balance
sheets, caused banks to protect themselves by building up their
capital reserves, including devoting TARP assistance to that end.
One byproduct of devoting capital to absorbing losses was a reduction in funds for lending and a hesitation to lend even to borrowers
who were formerly regarded as credit-worthy.
The recently conducted stress tests weighed the ability of the nation’s 19 largest bank holding companies’ to weather further losses
from the troubled assets and assessed how much additional capital
would be needed. However, the adequacy of the stress tests and the
resulting adequacy of the capital buffer required for future financial stability depend heavily on the economic assumptions used in
the tests. As more banks exit the TARP program, reliance on
stress-testing for the economic stability of the banking system increases. The Panel’s June report evaluated the adequacy of the
stress tests.
Treasury’s program to remove troubled assets from banks’ balance sheets is the Public Private Investment Program (PPIP). It
has two parts, a troubled securities initiative, administered by
Treasury, and a troubled loans initiative, administered by the Federal Deposit Insurance Corporation (FDIC). Treasury is now moving forward with the troubled securities program. The FDIC has
postponed the troubled loans program, stating that the banks’ recently demonstrated ability to access the capital markets has made
a program to deal with troubled whole loans unnecessary at this
time. (The FDIC is conducting a pilot program for the sale of the
loan portfolios of failed banks.) Whether the PPIP will jump start

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3
the market for troubled securities remains to be seen. It is also unclear whether the change in accounting rules that permit banks to
carry assets at higher valuations will inhibit banks’ willingness to
sell. Similarly, it is unclear whether wariness of political risks will
inhibit the willingness of potential buyers to purchase these assets.
If the economy worsens, especially if unemployment remains elevated or if the commercial real estate market collapses, then defaults will rise and the troubled assets will continue to deteriorate
in value. Banks will incur further losses on their troubled assets.
The financial system will remain vulnerable to the crisis conditions
that TARP was meant to fix.
The problem of troubled assets is especially serious for the balance sheets of small banks. Small banks’ troubled assets are generally whole loans, but Treasury’s main program for removing troubled assets from banks’ balance sheets, the PPIP will at present
address only troubled mortgage securities and not whole loans. The
problem is compounded by the fact that banks smaller than those
subjected to stress tests also hold greater concentrations of commercial real estate loans, which pose a potential threat of high defaults. Moreover, small banks have more difficulty accessing the
capital markets than larger banks. Despite these difficulties, the
adequacy of small banks’ capital buffers has not been evaluated
under the stress tests.
Given the ongoing uncertainty, vigilance is essential. If conditions exceed those in the worst case scenario of the recent stress
tests, then stress-testing of the nation’s largest banks should be repeated to evaluate what would happen if troubled assets suffered
additional losses. Supervisors should continue their increased monitoring of problem banks, and banks too weak to survive writedowns should be required to raise more capital. If PPIP participation proves insufficient, Treasury may want to consider adapting
the program to make it more robust or shifting to a different strategy to remove troubled assets from the banks’ book. Treasury
should also pay special attention to the risks posed by commercial
real estate loans.
Part of the financial crisis was triggered by uncertainty about
the value of banks’ loan and securities portfolios. Changing accounting standards helped the banks temporarily by allowing them
greater leeway in describing their assets, but it did not change the
underlying problem. In order to advance a full recovery in the economy, there must be greater transparency, accountability, and clarity, from both the government and banks, about the scope of the
troubled asset problem. Treasury and relevant government agencies should work together to move financial institutions toward sufficient disclosure of the terms and volume of troubled assets on institutions’ books so that markets can function more effectively. Finally, as noted above, Treasury must keep in mind the particular
challenges facing small banks.
This crisis was years in the making, and it won’t be resolved
overnight. But we are now ten months into TARP, and troubled assets remain a substantial danger to the financial system. Treasury
has taken aggressive action to stabilize the banks, and the steps
it has taken to address the problem of troubled assets, including
capital infusions, stress-testing, continued monitoring of financial
institutions’ capital, and PPIP, have provided substantial protec-

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tions against a repeat of 2008. These steps have also allowed the
banks to take significant losses while building reserves. Nonetheless, financial stability remains at risk if the underlying problem
of troubled assets remains unresolved.

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5
SECTION ONE: THE CONTINUED RISK OF TROUBLED
ASSETS
The precipitous decline in the value of securities backed by pools
of residential mortgages and whole mortgage loans, held by banks
and other financial institutions,1 ignited the financial crisis. The
decline was compounded by the complexity of many of the securities, the lack of accurate information about the underlying mortgages, and the chain-reactions generated by interlocking liabilities
among financial institutions.
The drop in real estate values that began in 2006 undermined
the economic assumptions on which millions of loans had been
made and revealed that many should not have been made under
any circumstances. The same conditions gave a first view of the
size and scope of the potential losses to which the nation’s banks
and other financial institutions could become subject if the asset
values did not stabilize, and the degree to which the capital foundation of even the nation’s largest financial institutions could be
impaired if the trend continued.
A substantial portion of real estate-backed securities and whole
loans remain on bank balance sheets. The success of the financial
stabilization effort continues to depend on how the potential impact
of these assets is managed by Treasury, the Federal Reserve Board
and other financial supervisors, and by the institutions themselves.
In this report, the Panel examines the risks these troubled, or
‘‘toxic,’’ assets continue to pose for the financial system and the
economy, ten months into the financial stabilization effort. Further,
the report discusses the need for, and challenges associated with,
accurate valuation and transparent presentation of troubled asset
holdings, attempts to estimate the size and distribution of the holdings of troubled assets that remain in the U.S. financial system,
discusses Treasury’s strategies, including the design and progress
of the PPIP, and suggests factors that may influence the ability of
the financial system to reduce or magnify the risks troubled assets
continue to pose.
A. Background
1. TREASURY’S FLEXIBILITY IN DEALING WITH TROUBLED ASSETS

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From the outset, the Emergency Economic Stabilization Act
(EESA) 2 has given Treasury a choice about the way to deal
with troubled assets held by financial institutions. Treasury could
buy real estate-based troubled assets directly from the institutions
that held them, or instead put capital directly into those institu1 The Panel’s past reports ordinarily refer to bank holding companies, or BHCs. BHCs are corporations that own one or more banks, but do not themselves carry out the functions of a bank;
they usually also own other non-bank financial institutions. Most large banks are owned by
BHCs; the 19 stress-tested institutions were all BHCs, for example. This report, however, deals
with both large and small banks; many of the latter are not BHCs, so the term ‘‘bank’’ is used
in this report to include both kinds of institutions. In some cases, where discussions refer only
to BHCs, that term continues to be used.
It should be noted that troubled assets are also owned by non-depository institutions and their
holding companies and affiliates, for example by insurance companies, pension funds, trading
houses, hedge funds, governments, etc., and the financial crisis has also affected these institutions, often seriously. The Panel focuses on banks in this report, however, because the TARP
focuses on banks.
2 Emergency Economic Stabilization Act of 2008 (EESA), Pub. L. No. 110–343.

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tions by buying their stock, to counteract the impact of the troubled
assets on the institution’s stability.3
Statements from Treasury before EESA’s passage initially emphasized the need to give Treasury the ability to buy troubled real
estate assets from banks and other financial institutions.4 During
this time, Treasury was exploring methods, including reverse auctions, by which to value and purchase the assets.5
Throughout the legislative process preceding the passage of
EESA, Treasury and the financial sector appear to have resisted allowing the government to take equity positions in financial institutions.6
Nevertheless, the bill was ultimately amended in the Senate,
with Treasury’s apparent support, to widen Treasury’s authority;
that expanded authority was explicitly discussed in the House:
Mr. MORAN of Virginia. I do want to clarify that the intent of this
legislation is to authorize the Treasury Department to strengthen
credit markets by infusing capital into weak institutions in two
ways: By buying their stock, debt, or other capital instruments;
and, two, by purchasing bad assets from the institutions.
Mr. FRANK of Massachusetts. I can affirm that. [T]he Treasury
Department is in agreement with this, and we should be clear, this
is one of the things that this House and the Senate added to the
bill, the authority to buy equity. It is not simply buying up the assets, it is to buy equity, and to buy equity in a way that the Federal Government will able to benefit if there is an appreciation.7

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3 Id.

at 3(9), permitting Treasury to purchase:
(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued
on or before March 14, 2008, the purchase of which the Secretary determines promotes financial
market stability, and
(B) any other financial instrument that the Secretary, after consultation with the Chairman
of the Board of Governors of the Federal Reserve System, determines the purchase of which is
necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.
4 See U.S. Department of the Treasury, Statement by Secretary Henry M. Paulson, Jr. on
Emergency Economic Stabilization Act (Sept. 28, 2009) (online at www.treas.gov/press/releases/
hp1162.htm) (‘‘This bill provides the necessary tools to deploy up to $700 billion to address the
urgent needs in our financial system, whether that be by purchasing troubled assets broadly,
insuring troubled assets, or averting the potential systemic risk from the disorderly failure of
a large financial institution.’’). See also U.S. Department of the Treasury, Fact Sheet, Proposed
Treasury Authority to Purchase Troubled Assets (Sept. 20, 2008) (online at www.treas.gov/press/
releases/hp1150.htm) (‘‘This program is intended to fundamentally and comprehensively address
the root cause of our financial system’s stresses by removing distressed assets from the financial
system.’’); U.S. Department of the Treasury, Statement by Secretary Henry M. Paulson, Jr. on
Comprehensive Approach to Market Developments (Sept. 19, 2008) (online at www.treas.gov/
press/releases/hp1149.htm) (‘‘[I]lliquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions.’’).
5 In a reverse auction, banks would bid down from a reserve price to the lowest price at which
they were each willing to sell a particular asset. Professors Peter Cramton and Lawrence
Ausubel of the University of Maryland worked with Treasury to develop a reverse auction process that the professors believed would be quick to implement and would result in a market price
for the troubled assets being purchased. Peter Cramton and Lawrence Ausubel, A Troubled
Asset Reverse Auction (Oct. 5, 2008) (online at www.cramton.umd.edu/papers2005-2009/ausubelcramton-troubled-asset-reverse-auction.pdf). Professors Cramton and Ausubel have informed
Panel staff that Treasury considered two forms of reverse auctions: dynamic and sealed-bid. The
dynamic auction takes place over a series of rounds, whereas the sealed-bid auction has only
a single round of bidding. In either case, the government is buying toxic assets from the banks,
which is why it is called a reverse auction.
6 See Senate Banking Committee, Testimony of Secretary of the Treasury Henry M. Paulson,
Jr., Turmoil in US Credit Markets: Recent Actions Regarding Government Sponsored Entities,
Investment Banks and Other Financial Institutions, 110th Congress (Sept. 23, 2008) (‘‘Putting
capital into institutions is about failure. This [the Paulson Plan] is about success.’’).
7 Statements of Representatives Moran and Frank, Congressional Record, H10763 (Oct. 3,
2008). Representative Frank continued:

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2. TREASURY’S CHOICE

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Less than two weeks after EESA was signed into law, Secretary
Paulson announced that Treasury would ‘‘purchase equity stakes in
a wide array of banks and thrifts.’’ 8 Treasury later explained that
the change in strategy was motivated both by the severity of the
crisis and the need for prompt action:
Given such market conditions, Secretary Paulson and
Chairman Bernanke recognized that Treasury needed to
use the authority and flexibility granted under the EESA
as aggressively as possible to help stabilize the financial
system. They determined the fastest, most direct way was
to increase capital in the system by buying equity in
healthy banks of all sizes. Illiquid asset purchases, in contrast, require much longer to execute.9
The problems Treasury encountered in October 2008 illustrate
the difficulties that are characteristic of attempts to remove troubled assets directly from bank balance sheets. It is easy to make
direct capital injections, but setting up a structure to buy particular assets or groups of assets in the absence of liquid trading
markets is more difficult. There was no assurance that—in fact no
basis even for guessing whether—the $250 billion immediately
available under EESA would make an appreciable dent in the troubled asset problem, but that amount could stabilize the financial
system to buy time for broader issues to be addressed. No one was
certain that fair values, at which there would be both willing buyers and willing sellers, could be set, at least not quickly; in fact the
complex structure of the assets involved has made it difficult to
this day to figure out their different values. Similarly, there was
no way of knowing whether an auction or reverse auction conducted on an emergency basis would produce the very instability
for the selling banks that Treasury was trying to avoid.
In implementing the powers provided for in the Emergency Stabilization Act of 2008, it is the
intent of Congress that Treasury should use Troubled Asset Relief Program (TARP) resources
to fund capital infusion and asset purchase approaches alone or in conjunction with each other
to enable financial institutions to begin providing credit again, and to do so in ways that minimize the burden on taxpayers and have maximum economic recovery impact. Where the legislation speaks of ‘‘assets’’, that term is intended to include capital instruments of an institution
such as common and preferred stock, subordinated and senior debt, and equity rights. Also, it
is the intent of this legislation that TARP resources should be used in coordination with regulatory agencies and their responsibilities under prompt-corrective-action and least-cost resolution statutes.
Statement of Representative Barney Frank, Congressional Record, H10763 (Oct. 3, 2008).
8 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.treas.gov/press/releases/hp1205.htm).
9 U.S. Department of the Treasury, Responses to Questions of the First Report of the Congressional Oversight Panel for Economic Stabilization, at 4 (Dec. 30, 2008) (online at cop.senate.gov/
documents/cop-010909-report.pdf). Secretary Paulson later testified:
[In] the last few days before we got the TARP legislation which passed on October 3rd and
in the week after we got the TARP legislation, the markets continued to freeze up. We had a
whole series of bank failures overseas. Five or six different countries had intervened to rescue
their banks. Market participants were clamoring for us to do something quickly. We needed to
do something quickly. And the way we were able to do something quickly and make a difference—and make a dramatic difference and prevent something very dire from happening was
to make the change and inject capital.
After the legislation, it was clear that the problem was continuing to get worse. The facts were
changing. Banks were failing around the world. And there was quite a problem. We needed to
move quickly to really put out the fire.
House Oversight and Government Reform Committee, Testimony of Former Treasury Secretary Paulson, Bank of America and Merrill Lynch: How Did a Private Deal Turn Into a Federal Bailout? Part III, 111th Cong. (July 16, 2009).

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The final consideration may be the most significant. The distinction between buying troubled assets and making capital injections
into the institutions that hold them is a matter of strategy in a
time of crisis. The difficulty caused by rapidly declining asset values is the threat of insolvency; even when markets and credit are
frozen, the books of the institution can be rebalanced by increasing
capital through capital injections, Stabilizing the institution can
also give it the time it needs to write-down its assets in an orderly
way.
B. What is a Troubled Asset?
1. GENERAL DEFINITION

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Troubled assets include both securities backed by pools of residential mortgage loans or other assets, and whole mortgage loans
held by banks. (This report focuses on residential loans because
their loss of value is at the heart of the financial crisis; as discussed below, however, there is a serious question whether commercial real estate loans may be about to experience the same drop
in value. In addition, assets such as credit card receivables may be
the basis for asset-backed securities.)
A loan is a transfer of money (principal) from a lender to a borrower who agrees to repay the principal, plus interest on the
amount that has not been repaid, over the term of the loan. 10
The amount of the loan and the interest rate reflect, in addition to
prevailing interest rates when the loan is made, the risk of default
and related risks. If the loan is secured by a piece of property
(often called collateral), as residential or commercial mortgages almost always are, one of the factors taken into account in setting
the amount of the loan and the degree of risk is the value of the
collateral. The value of the loan payments at any particular time
during its term is called the ‘‘discounted present value’’ to reflect
the fact that payments are to be made in the future. 11
A ‘‘troubled asset’’ is a loan or security whose original credit risk
assumptions have come into serious question. Several factors can
cause an asset to become ‘‘troubled,’’ including: (1) the fact that the
‘‘credit risk’’ on which the loan was based has increased, so that the
loan’s value has dropped; and (2) the fact that the borrower on the
underlying loan has actually failed to make a number of required
payments or has stopped making payments altogether. The degree
of non-performance is important because of the effect of accounting
10 Usually, the time for repaying a loan, and for paying interest during the loan term, are predetermined.
11 ‘‘Discounted present value’’ refers to the value of an asset’s hold-to-maturity payoff—future
payment or series of future payments, discounted to reflect the time value of money, represented
by an accepted rate of interest, and other factors such as investment risk—at the time the calculation is made. Standard asset pricing models for mortgage-backed securities, for example,
consider an asset’s present value to be the weighted average sum of the future payoffs of the
underlying assets (e.g., residential mortgages) using an appropriate discount rate based on factors listed below. As such, fair value of these exposures is based on estimates of future cash
flows from the underlying assets. To determine the performance (hence risk-adjusted discount
rate) of the underlying portfolios (e.g., packaged mortgages), entities estimate the prepayments,
defaults and loss severities based on a number of macroeconomic factors, including housing price
changes, unemployment rates, interest rates, and borrower and loan attributes. In addition,
mortgage performance data from external sources such as Treasury’s OCC and OTS Mortgage
Metrics Report are incorporated into the pricing models. Default risk on the underlying asset
is calculated using the ratings distributed by rating agencies such as Moody’s and Standard &
Poor’s. However these agencies have come under heavy criticism as some of the assets that received a ‘‘AAA’’ rating from these agencies ended up with significant default risk.

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rules—which may require a write-down of the value of the loan on
the lender’s books—although the loan may still be performing in
many cases and could be paid-in-full if held to maturity.
Reasons for these situations can include: (1) the nature of the
loan itself (i.e., loan terms the borrower proves unable to meet); (2)
the lender’s acceptance of greater than normal credit risk (e.g.., reduced documentation or inadequate scrutiny of the borrower’s credit history); (3) a change in the economic condition of the borrower
(for example, due to unemployment, disability, or a sudden costly
medical emergency); (4) a decline in the value of the property below
the remaining loan balance owed, that may give a borrower 12—
especially one to whom one of the other reasons also applies—fewer
options moving forward; and (5) borrower fraud.
Even under normal market conditions, a certain number of loans
will be ‘‘troubled,’’ or, to use a more technical term, ‘‘impaired.’’ The
masses of troubled assets that now weigh down the financial system are overwhelmingly residential real estate loans whose loss of
value reflects the continued decline in real estate values and current economic conditions, especially rising unemployment (as discussed below).13 The volume stems from the boom in mortgage
lending produced by the real estate bubble.14
The troubled assets at the heart of the crisis generally fall into
two categories: (1) complex securities, part or all of which were sold
to third parties;15 and (2) whole loans. Within the banking system,
a relatively small number of banks (out of the more than 8,000
U.S. chartered banks) typically own pieces (or all) of the complex
securities. The troubled assets held by smaller and community
banks are likely to be whole loans. Although larger banks also hold
whole loans,16 these smaller and community bank holdings serve
12 In early May 2009, Moody’s Economy.com estimated that of 78.2 million owner-occupied single-family homes, 14.8 million borrowers, or 19 percent, owed more than their homes were worth
at the end of the first quarter, up from 13.6 million borrowers at the end of 2008. This is an
increase of 8.8 percent between the end of 2008 and the close of the first quarter of 2009. Deutsche Bank estimated that in the first quarter of 2011, overall 48 percent of U.S. homeowners
will owe more than their house is worth, including 41 percent of prime conforming loans, 46
percent of prime jumbo loans, 69 percent of subprime loans and 89 percent of options adjustable
rate loans. Karen Weaver and Ying Shen, Drowning in Debt—A Look at ‘‘Underwater’’ Homeowners, Deutsche Bank (Aug. 5, 2009).
13 Loans other than residential mortgage loans, for example, commercial mortgage loans, credit card receivables, automobile loans and student loans, can also face problems relating to performance. Many of these loans are themselves pooled and repackaged as complex securities; a
deeper recession, including rising unemployment and falling real estate values, can change the
repayment expectations attached to those loans as well. As the Panel noted in its May report,
credit card and student loan delinquencies or defaults are increasing. Congressional Oversight
Panel, May Oversight Report: Reviving Lending to Small Businesses and Families and the Impact of the TALF, at 26–30 (May 7, 2009) (online at cop.senate.gov/documents/cop-050709-report.pdf) (hereinafter ‘‘Panel May Report’’). Therefore, a substantial challenge for financial institutions is to determine how much of a capital buffer they should have in place to make up for
these other types of loans that enter into default.
14 After decades of relative stability, the rate of U.S. homeownership began to surge in the
early part of this decade, rising from 64 percent in 1994 to a peak of 69 percent in 2004. Federal
Reserve Bank of San Francisco, FRBSF Economic Letter: The Rise in Homeownership (Nov. 3,
2006) (online at www.frbsf.org/publications/economics/letter/2006/el2006-30.html).
15 As discussed below, vast quantities of these loans were combined into pools that were in
turn fragmented and resold as investments in ways that make valuing either the investments
or the underlying loans difficult or impossible. Moreover, the sale to third parties was in many
cases not complete, as also discussed below, a fact multiplied the ultimate risk of liability involved.
16 Office of the Comptroller of the Currency, Comptroller Dugan Expresses Concern About
Commercial Real Estate Concentrations (Jan. 31, 2008) (online at www.occ.gov/ftp/release/2008–
9.htm) (According to data from the Office of the Comptroller of the Currency, between 2002 and
2008, the ratio of commercial real estate loans to capital at community banks nearly doubled
Continued

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as a powerful reminder that the troubled assets problem extends
far beyond the 19 largest banks subject to the government stress
tests.
2. COMPLEX SECURITIES

Troubled complex securities began as pools of thousands of individual loans (primarily residential) that were securitized for sale to
investors.17 The pools became the basis for a bewildering array of
multi-level investment arrangements that tried to divide the cash
flow from the pools into various degrees of risk and return. These
were based, in turn, on assumptions about the rate at which mortgages would pay off and the level of default the mortgages in the
pool were likely to experience.
The simplest type of structure is illustrated by the following figure.

to a record 285 percent. By early 2008, nearly one-third of all community banks had commercial
real estate concentrations that exceeded 300 percent of their capital.); Maurice Tamman and
David Enrich, Local Banks Face Big Losses, Wall Street Journal (May 19, 2009) (online.wsj.com/
article/SB124269114847832587.html). According to an analysis conducted by the Wall Street
Journal, commercial real estate loans could generate losses of $100 billion by the close of 2010
at more than 900 small and midsize U.S. banks if the recession deepens. Total aggregate losses
could surpass $200 billion during that period, according to the Journal’s analysis, which utilized
the same worst-case scenario that the federal government used in its recent stress tests of the
19 largest banks. In such circumstances, ‘‘more than 600 small and midsize banks could see
their capital shrink to levels that usually are considered worrisome by federal regulators.’’
17 See Panel May Report, supra note 13, at 34-40.
18 This diagram is based on the chart that appears in Janet M. Tavakoli, Structured Finance
and Collateralized Debt Obligations: New Developments in Cash and Synthetic Securitization
(John Wiley and Sons Ltd.), at 71 (2008).

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The levels (or ‘‘tranches’’) that characterize complex securities reflect different degrees of risk and return and have different priorities in receiving interest and principal flows from the underlying
mortgages. The senior level receives its pass-through of interest
and principal payments first, but it receives a relatively lower interest payment to reflect its lower risk. The mezzanine level falls
in the middle—possessing a second call on payments and a higher
interest rate to reflect its higher risk. The junior tranche receives
its portion of the pass-through of interest and principal payments
only after the first two levels receive their portions and would be
the first to suffer upon non-payment or default of the underlying
mortgages. Correspondingly, holders of the junior tranche would receive the highest interest rate—assuming no default—to reflect
their higher risk.

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Super-senior tranches sit above the senior tranche and hence receive their payments before anyone else. But their value was theoretically a sliver of the total value of the pool and they were presumed—incorrectly as it turned out—to be substantially risk-free.
Banks generally kept these securities (or placed them in special
purpose vehicles—SPVs—that they had created); this increased the
relative return on the senior securities by removing the calculation
of that return the slice of the total that had the lowest return because it had the least risk.
In the years preceding the financial crisis, the securitization
market experienced widespread growth and attracted substantial
investor interest. Strong global growth and low interest rates 19
encouraged investors to seek high-yield returns in a deeply liquid
market (which they found in mortgage-related securities), inflating
asset prices and further suppressing interest rates in the process.20
Some banks and other financial institutions, themselves enticed by
the prospect of higher returns and the supposed low-risk of these
types of mortgage-related investments, purchased complex securities for investment purposes.21
In response, the securitization markets became increasingly complex. Different types of structured vehicles were created based upon
underlying assets. At the more senior levels of debt, investors were
able to obtain better yields than those available on more traditional
securities (e.g., corporate bonds) with a similar credit rating.22 Investors, including banks, insurance companies, investment funds,
hedge funds, and wealthy individuals, also perceived added benefits
resulting from the diversification of the complex securities portfolios and the credit support built into the transactions. This increased investor interest prompted the creation of different types of
securities as issuers started looking for new assets to collateralize
or new ways to collateralize them.23 Some of these structured finance developments included:
• Mortgage pools that were combined with separate mortgage
pools.
• Mortgage pools that were combined with pools of loans from
entirely different types of asset pools (i.e., other types of mortgages,
automobile loans, student loans, credit card receivables, small business loans and some corporate loans).
• Complex securities that were created by using existing
tranches of other complex securities as collateral.
Æ In these cases, the underlying pool consisted of interests in
tranches of many different asset-backed securities.
Æ The perception was that having multiple pools of mortgages
reflected in the complex security would provide increased di19 The Federal Funds effective rate remained under three percent from October 2001 until
April 2005. See Board of Governors of the Federal Reserve System, Federal Reserve Statistical
Release H.15: Selected Interest Rates Historical Data (daily) (online at www.federalreserve.gov/
releases/h15/data/Daily/H15—FF—O.txt) (accessed Aug. 2, 2009).
20 Letter from Secretary of the Treasury Timothy F. Geithner to Congressional Oversight
Panel Chair Elizabeth Warren (Apr. 2, 2009).
21 Id.
22 It turned out that the credit ratings assigned to the complex securities vehicles proved inaccurate.
23 Kenneth E. Scott and John B. Taylor, Why Toxic Assets Are So Hard to Clean Up, Wall
Street Journal (July 20, 2009) (online at online.wsj.com/article/SB124804469056163533.html)
(hereinafter ‘‘Why Toxic Assets Are So Hard to Clean Up’’).

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versification benefits along with loss mitigation if a small number of mortgages were to become nonperforming.
This list is only illustrative. There are even more complicated
variations.
However, the structures unwound quickly—or at least appeared
to do so—for what are, at bottom, simple reasons. Once rates of default on subprime and other mortgages began to increase and real
estate prices began to drop steeply, it increasingly appeared that
the rate of return, and thus the value of these structured investments, reflected faulty assumptions about risk. The complexity of
the structured vehicles surrounding securitization and the lack of
distribution and disclosure of information about the terms of the
underlying loans, coupled with uncertainty about future performance, made the challenges associated with asset valuation and liquidity quickly apparent.
As the economic assumptions about property values and default
rates reflected in these securities proved increasingly inaccurate,
the securities’ values dropped precipitously, and no one could agree
on what they were worth. Any price-discovery mechanism for these
assets was frozen because most investors or traders would not take
the risk of purchasing them under any circumstances. The more
defaults increased and home prices dropped, the more the assets
became—in the popular term—‘‘toxic,’’ and the more difficult it was
to turn the assets into cash. In other words, the more illiquid the
market for them became, the more attention began to turn to the
risks they posed for their holders, especially banks.
As the security structures became more removed from the original pools that ostensibly supported them, the valuation, and even
the awareness of the degree of risk carried by the securities for either their originators or their investors, became more and more difficult, and ultimately almost impossible, to estimate.
Banks could have exposure in several ways to these fluctuations
in value:
1. A bank could have originated the sale of the securities and retained a portion of one or more of the tranches in connection with
their origination by the bank, to facilitate the sale of the securities
in general, or to meet related capital requirements. This proved to
be most serious in the case of the super-senior tranches banks retained. As credit rating agencies recognized that they had been ‘‘far
too generous with their ratings of securities based on subprime
mortgages, including their triple-A ratings of super-senior tranches
of [certain asset-backed complex securities],’’ they issued ‘‘sudden,
multi-notch downgrades in massive and historically unprecedented
proportions.’’ 24 These substantial downgrades caused ‘‘huge markto-market losses’’ on super-senior tranches held by nearly all large
financial institutions,25 with resulting reductions in bank capital in
at least some cases.
2. A bank could have retained a direct or indirect monetary commitment to the investors in the securities it originated. Because
most securitized investments must be bankruptcy remote,
24 Office of the Comptroller of the Currency, Remarks of John C. Dugan, Comptroller of the
Currency, Before the Global Association of Risk Professionals, New York, NY, at 7 (Feb. 27, 2008)
(online at www.occ.treas.gov/ftp/release/2008-22a.pdf).
25 Id. at 8.

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securitization transactions are routed through SPVs. The loans are
sold to the SPVs and then investors purchase securities issued by
the SPVs. As discussed below, new accounting rules will require
the value of these assets to be restored directly to bank balance
sheets beginning in 2010 under many circumstances—a change
that will further increase bank exposure.26
In addition, a feature of the present troubled securities was a socalled ‘‘bank buy-back’’ feature that entitled holders to give the securities back to the bank upon a triggering event such as economic
decline, at a premium to the current market price. This is much
like a money-back guarantee to the buyer of the loan if the debtor
defaults. As defaults increased, institutions with such obligations
faced a double-edged sword because these assets moved back onto
their balance sheets, while these institutions wound up paying a
premium price for them even though they were worth significantly
less due to market conditions.
3. A bank could have bought securities originated by other banks,
for trading or investment. Banks that had purchased complex securities, either to trade or hold, were faced with a direct problem—
how to value those securities in their various asset accounts. These
issues are discussed below.
4. A bank could have issued or held a credit default swap 27 relating to a particular complex security or held a share in a pool of
credit default swaps based on the underlying value of other complex securities. In either case, a decline in the value of the complex
securities underlying the swap, or pool of swaps, would likely flow
through to the bank’s balance sheet because the bank either was
called upon to make good or post additional collateral on swaps it
had written, or saw the value of its own swap or interest in a swap
pool decline.
3. WHOLE LOANS

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A whole loan is a single loan recorded on the books of the bank
that made it. A loan becomes troubled if the likelihood that it will
be repaid has declined below the amount of the bank’s loan loss reserve for that loan. The reasons for the decline are no different
than those that affect the worth of mortgages underlying complex
securities, but the decline in the value of whole loans does not set
off the sort of chain reaction created by troubled securities.
The impairment of whole loans may be structurally less complicated than the impairment of complex securities, but its potential impact is no less difficult or important. The growing number
of unpaid whole loans is also worrisome. For example, recent reports and statistics published by the FDIC indicate that overall
loan quality at American banks is the worst in at least a quarter
26 Based on information submitted by the BHCs, bank supervisors predict that this change
alone could result in approximately $900 billion in assets being brought back onto the balance
sheets of these institutions. Board of Governors of the Federal Reserve System, The Supervisory
Capital Assessment Program: Design and Implementation, at 16 (Apr. 24, 2009) (online at
www.federalreserve.gov/newsevents/press/bcreg/bcreg20090424a1.pdf) (hereinafter ‘‘SCAP Design Report’’).
27 Credit default swaps are a way of managing debt. The issuer of the swap agrees to pay
the holder (the issuer’s counter party) the amount of a debt that the counterparty is owed by
a third party, if the third party fails to do so. For example, the holder of a corporate bond may
hedge its exposure by entering into a CDS contract as the buyer of protection. If the bond goes
into default, the proceeds from the CDS contract will cancel out the losses on the underlying
bond.

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century, and the quality of loans is deteriorating at the fastest pace
ever. Of the total book of loans and leases at all banks, totaling
$7.7 trillion at the end of March 2009, 7.75 percent were showing
signs of distress—a total of $596.75 billion.28 The percentage of
loans at least ninety days overdue, or on which the bank has
ceased accruing interest or has written-off, is also at its highest
level since 1984, when the FDIC first began collecting such statistics.29
The predominance of whole loans, not only in residential real estate but in areas such as commercial real estate, further underscores the importance of those loans to bank balance sheets. The
consequences of defaults of course spread into the real economy,
and by reducing, for example, employment in construction and related fields, have a redoubled effect on the default rate in whole
loans. But the range of potential harm goes even beyond that; defaults on commercial loans that support multi-family housing can
lead to deterioration in building maintenance and ultimately to displacement of tenants.
The threat of growing waves of whole loan defaults can cause
more significant problems for small and midsize institutions than
for large ones.30 Smaller institutions are less able to tap capital
markets than their larger rivals, increasing their need for government assistance to help counteract the impact of the defaulted
loans on their balance sheets. As of August 7, 72 banks, most of
them community institutions, had failed since the beginning of
2009.31 This is in addition to the 26 banks that failed during the
course of 2008.32 The recent release of quarterly results from regional banks provides a sobering portrayal of the potential pitfalls
in the future.33 These problems highlight the substantial gap between large banks, some of which have recently announced profits
in investment banking and trading, and small and midsize banks
that rely on more traditional transactional services such as accepting deposits and issuing loans.34 Such problems are expected to
worsen as commercial real estate loans continue to decline.
4. TROUBLED LOANS, BANK BALANCE SHEETS, AND BANK CAPITAL

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Troubled loans have a significant negative effect on the capital
of the banks that hold them; the two operate jointly. Although
28 Federal Deposit Insurance Corporation, Quarterly Banking Profile (First Quarter 2009), at
5–13 (online at www2.fdic.gov/qbp/2009mar/qbp.pdf).
29 Id. One banker has said that ‘‘[t]he financial system is weighed down by trillions of loans
that cannot possibly be repaid.’’ Daniel Alpert, No Good Deed Goes Unpunished: How Bank Bailouts Have Threatened the Resolution of the Debt Crisis, Westwood Capital LLC Research (July
8,
2009)
(online
at
www.westwoodcapital.com/opinion/images/stories/articlesljan09/
nogooddeedgoesunpunished.pdf).
30 Richard Parkus and Jing An, The Future Refinancing Crisis in Commercial Real Estate,
Part II: Extensions and Refinements, at 23 (July 15, 2009) (hereinafter ‘‘Parkus July Report’’)
(‘‘[E]xposure [to commercial real estate loans] increases markedly for smaller banks. For the
four largest banks (on the basis of total assets), this exposure is 12.3%, for the 5–30 largest
banks, the exposure is 24.5%, while for the 31–100 largest banks, the exposure grows to
38.9%.’’).
31 Federal Deposit Insurance Corporation, Failed Bank List (online at www.fdic.gov/bank/individual/failed/banklist.html) (accessed Aug. 9, 2009).
32 Id.
33 Andrew Martin, Regional Banks’ Profits Are Hurt by Loan Losses, New York Times (July
23,
2009)
(online
at
www.nytimes.com/2009/07/23/business/
23bank.html?lr=1&scp=1&sq=regional%20banks’%20profits&st=cse) (noting how KeyCorp of
Cleveland is preparing for losses on commercial real estate loans and SunTrust Banks and Wells
Fargo remain very concerned about residential real estate loans).
34 Id.

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bank capital computations are often very technical and complicated, the core of the rules can be stated simply. A bank’s capital
strength is generally measured as the ratio of specified capital elements on the firm’s consolidated balance sheet (for example, the
amount of paid-in capital and retained earnings) to its total assets.35 Decreases in the value of assets on a bank’s balance sheet
change the ratio by requiring that amounts be withdrawn from
capital to make up for the losses. Losses in asset value that are
carried directly to an institution’s capital accounts without being
treated as items of income or loss have the same effect.36
During the financial crisis, all of these steps accelerated dramatically. A plunge in the value of a bank’s loan portfolio that has a
significant impact on the value of the bank’s assets—as it usually
will—triggers a response by the bank’s supervisor, one that usually
requires the institution to raise additional capital or even pushes
a bank into receivership. Otherwise, the bank’s assets simply cannot support its liabilities and it is insolvent. The TARP attempted
to restore a balance by shoring up bank capital directly 37—this
was one of the reasons for Treasury’s decision in the late fall of
2008 that only capital infusions made sense.
The problem of unresolved bank balance sheets is intertwined
with the problem of lending, as the Panel has observed before.38
Uncertainty about risks to bank balance sheets, including the uncertainty attributable to bank holdings of the toxic assets, caused
banks to protect themselves by building up their capital reserves,
including devoting TARP assistance to that end. One consequence
was a reduction in funds for lending and a hesitation to lend even
to borrowers who were formerly regarded as credit-worthy.
5. LOAN LOSS RESERVES

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The effect of the loan losses that unbalanced the relationship between bank assets and liabilities passed through banks’ loan loss
reserves to their income statements and on to their balance sheets.
Loan loss reserves are accounts set aside by entities to cover probable loan losses.39 Each quarter a bank charges off losses incurred
during the past quarter, thereby reducing the allowance for loan
losses (i.e., the account). It also makes a provision (‘‘provides,’’ adding to the allowance) for future loan losses based on the losses that
35 The value of the assets is generally ‘‘risk-weighted,’’ that is, determined based on the risk
accorded the asset.
36 Although these losses are carried directly to the capital account they have no effect on regulatory capital calculations when recorded in the other-comprehensive-income account.
37 Congressional Oversight Panel, Testimony of Assistant U.S. Treasury Secretary for Financial Stability Herbert Allison, (June 24, 2009) (hereinafter ‘‘Allison Testimony’’) (Treasury seeks
to enable banks ‘‘to sell marketable securities back into [the] market and free up balance sheets,
and at the same time [to make] available, in case it’s needed, additional capital to these banks
which are so important to [the] economy’’); See also Id. (‘‘Treasury . . . is providing a source
of capital for the banks and capital is essential for them in order that they be able to lend and
support the assets on their balance sheet and there has been—there was an erosion of capital
in a number of those banks.’’).
38 See, e.g., Congressional Oversight Panel, June Oversight Report: Stress-Testing and Shoring
Up Bank Capital, at 6, 11–12 (June 9, 2009) (online at cop.senate.gov/documents/cop-060909-report.pdf) (hereinafter ‘‘Panel June Report’’).
39 This reserve is an estimate of uncollectible amounts and is used to reduce the book value
of loans and leases to the amount that is expected to be collected. To establish an adequate allowance, a bank must be able to estimate probable credit losses related to specifically identified
loans as well as probable credit losses inherent in the remainder of the loan portfolio that have
been incurred as of the balance sheet date. Thus, the amount of a bank’s loan loss reserves
should be based on past events and current economic conditions.

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are reasonable and estimable at that point in time. Such provisions
are derived from macroeconomic conditions, loan and portfolio specific conditions (results of internal loan reviews),40 and recent
charge-off history. Because no one can foretell the future, the adequacy of loss reserves are reevaluated continuously, hence new provisions are made each quarter. Banks have both specific reserves
(linked to individual assets) and general reserves (linked to portfolios, i.e., consumer loans, or generally available).
Loan loss reserve adjustments reflect the carrying value of bank
loan portfolios and the allowance must be maintained at a level
that is adequate to absorb all estimated probable inherent losses
in the loan and lease portfolio as of its evaluation date.41 The provision for loan losses is a necessary feature of accrual accounting
under generally accepted accounting principles (GAAP) to present
the financial outlook of the bank.42 However, if the institution then
suffers additional credit losses and must increase its reserves, the
increase will reduce current earnings and may ultimately produce
a reduction in equity capital. Thus, building accurate reserves
against losses is a critical part of avoiding the negative impact of
excessive losses on bank solvency.
Loan loss reserves were upset by the uncertainties, lack of information, and fear verging on panic that characterized 2008. To
make matters worse, the linkage between various assets and institutions produced calls on various forms of back-up guarantees such
as credit default swaps, or forced banks to take back obligations
onto their balance sheets, further straining their capital.
Therefore, many financial institutions did not allocate sufficient
reserves during countercyclical periods (periods of earnings growth)
before the financial meltdown of 2008 for future loan losses. As an
example, Figure 2 is an excerpt from the 2008 Bank of America
10–K—Notes on Financial Statements—Allowance for Credit
Losses. This note highlights the significant increase in charge-offs
in 2008, relative to 2007 and 2006, and the resulting need for a significant increase in the bank’s provision for loan losses. Figure 2
highlights that Bank of America added $26.9 billion of provision for
loan loss during 2008 and $13.4 billion in the first quarter of
2009—a total of $40 billion to bring its loan loss reserves (net of
loan loss charges) to $30.4 billion at the end of first quarter 2009.
40 An effective loan review system and controls that identify, monitor, and manage asset quality problems in an accurate and timely manner are essential. These systems and controls must
be responsive to changes in internal and external factors affecting the level of credit risk and
ensure the timely charge-off of loans, or portions of loans, when a loss has been confirmed.
41 Financial Accounting Standards Board, Statement of Financial Accounting Standards No.
5: Accounting for Contingencies (FAS No. 5), at 3 (Mar. 1975) (hereinafter ‘‘FAS No. 5’’).
42 From an accounting perspective, loan loss reserves guidance is provided by the Financial
Accounting Standards Board. See FAS No. 5, supra note 41; Financial Accounting Standards
Board, Statement of Financial Accounting Standards No. 114: Accounting by Creditors for Impairment of a Loan, an Amendment of FASB Statements No. 5 and 15 (FAS No. 114) (May
1993). Paragraph 8 of FAS No. 5 stipulates the following two conditions for a firm to record
a provision for loan loss:
1. Information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial
statements. It is implicit in this condition that it must be probable that one or more future
events will occur confirming the fact of the loss.
2. The amount of loss can be reasonably estimated.
Paragraph 20A of FAS No. 114 stipulates:
For each period for which results of operations are presented, a creditor also shall disclose
the activity in the total allowance for credit losses related to loans, including the balance in the
allowance at the beginning and end of each period, additions charged to operations, direct writedowns charged against the allowance, and recoveries of amounts previously charged off.

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During the same period, Bank of America incurred $16.2 and $6.9
billion of net loan losses respectively—a total of $23 billion. Increasing provisions for loan losses reduces earnings and adds significant strain to institutions during cyclical periods.
The following table summarizes the changes in the allowance for
credit losses for 2008, 2007, and 2006.
FIGURE 2: BANK OF AMERICA ALLOWANCE FOR CREDIT LOSSES, 2006–2008 43
(Dollars in millions)
2008

Allowance for loan and lease losses, January 1 ..............................................
Adjustment due to the adoption of SFAS 159 .................................................
Loans and leases charged off ..........................................................................
Recoveries of loans and leases previously charged off ..................................
Net charge-offs .................................................................................................
Provision for loan and lease losses .................................................................
Other (*) ...........................................................................................................
Allowance for loan and lease losses, December 31 ........................................
Reserve for unfunded lending commitments, Jan. 1 .......................................
Adjustment due to the adoption of SFAS 159 .................................................
Provision for unfunded lending commitments .................................................
Other .................................................................................................................
Reserve for unfunded lending commitments, Dec. 31 ....................................
Allowance for credit losses, December 31 .......................................................

$11,588
.....................
(17,666)
1,435
(16,231)
26,922
792
23,071
518
.....................
(97)
.....................
421
$23,492

2007

2006

$9,016
(32)
(7,730)
1,250
(6,480)
8,357
727
11,588
397
(28)
28
121
518
$12,106

$8,045
.....................
(5,881)
1,342
(4,539)
5,001
509
9,016
395
.....................
9
(7)
397
$9,413

* The 2008 amount includes the $1.2 billion addition of the Countrywide allowance for loan losses as of July 1, 2008. The 2007 amount
includes the $725 million and $25 million additions of the LaSalle and U.S. Trust Corporation allowance for loan losses as of October 1,
2007 and July 1, 2007. The 2006 amount includes the $577 million addition of the MBNA allowance for loan losses as of January 1, 2006.
43 The data used in creating this exhibit were derived from the quarterly and yearly SEC filings of Bank of America from the period 12/31/
08 to 3/31/09 (online at www.secinfo.com/$/SEC/FilingTypes.asp).

FIGURE 3: BANK OF AMERICA ALLOWANCE FOR CREDIT LOSSES, Q12008—Q12009
(Dollars in millions)
2009

Allowance for loan and lease losses, January 1 ........................................................................
Loans and leases charged off ....................................................................................................
Recoveries of loans and leases previously charged off .............................................................
Net charge-offs ............................................................................................................................
Provision for loan and lease losses ............................................................................................
Allowance for loan and lease losses, March 31 .........................................................................
Reserve for unfunded lending commitments, January 1 ............................................................
Allowance for credit losses, March 31 ........................................................................................

2008

$23,071
($7,356)
$414
($6,942)
$13,352
($433)
$29,048
$421
$30,405

$11,588
($3,086)
$371
($2,715)
$6,021
($3)
$14,891
$518
$15,398

6. ACCOUNTING FOR TROUBLED ASSETS

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a. Fair Value Accounting for Debt and Equity Securities

The method for valuation of loans is set by the Financial Accounting Standards Board (FASB) as part of its promulgation of
generally accepted accounting principles (GAAP). Particular principles are embodied in particular Financial Accounting Standards
(FASs).
Prior to 1993, assets such as mortgages and mortgage-backed securities were generally carried on bank books according to the
original loan amount. A new value would not be implemented until
after the asset was sold. Under the basic standard issued and implemented in 1993 (FAS 115), the manner in which debt and equity
securities are valued depends on whether those loans are held on
the books of a financial institution in its (1) trading account (an ac-

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count that holds debt and equity securities that the institution intends to sell within a year), (2) available-for-sale account (an account that holds debt and equity securities that the institution does
not necessarily intend to sell, certainly in the near term), or (3)
held-to-maturity account (an account, as the name states, for debt
securities that the institution intends to hold until they are paid
off).
Assets in a trading account are bought and sold regularly in a
liquid market, such as the New York Stock Exchange or the various exchanges on which derivatives and options are bought and
sold, that sets fair market values for these assets. The bank designates assets that are readily tradable in the near future by
classifying these assets in a trading account. By definition, there
is no debate about market value; the worth of the assets in that
classification must be adjusted to reflect changes in prices recorded
in the liquid buyers and sellers market, whether or not those losses
have been realized by an actual sale. The adjustments affect earnings directly.
Assets in an available-for-sale account are carried at their ‘‘fair
value.’’ In this case, any changes in value that are not realized
through a sale do not affect earnings, but directly affect equity on
the balance sheet (reported as unrealized gains or losses through
an equity account called ‘‘Other Comprehensive Income’’). However,
unrealized gains and losses on available-for-sale assets are not included as part of regulatory capital. Assets that are regarded as
held-until-maturity are valued at cost minus repaid amounts (an
‘‘amortized basis’’).
These rules change if assets in either an available-for-sale or a
held-to-maturity account become permanently impaired.44 In the
former case, the write-down had to be reflected through earnings;
in the latter, the write-down had to be carried to the balance sheet
(as opposed to not having any effect).
b. Impact of New Mark-to-Market Accounting Rules

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FAS 115 was implemented before financial innovation spawned
complex securitization products that were more difficult to price. To
deal with the complexity problem, the accounting rules were
changed in 2006.45 FAS 157, implemented in 2006, was meant to
44 Credit impairment is assessed using a cash flow model that estimates cash flows on the
underlying mortgages, using the security-specific collateral and transaction structure. The model
estimates cash flows from the underlying mortgage loans and distributes those cash flows to
various tranches of securities, considering the transaction structure and any subordination and
credit enhancements that exist in the structure. It incorporates actual cash flows on the mortgage-backed securities through the current period and then projects the remaining cash flows
using a number of assumptions, including default rates, prepayment rates, and recovery rates
(on foreclosed properties). If cash flow projections indicate that the entity does not expect to recover its amortized cost basis, the entity recognizes the estimated credit loss in earnings.
45 Financial Accounting Standards Board, Statement of Financial Accounting Standards No.
157: Fair Value Measurements (FAS 157) (September 2006) (hereinafter ‘‘FAS 157’’). FAS 157
specifies a hierarchy of valuation techniques based on whether the inputs to those valuation
techniques are observable or unobservable. Observable inputs reflect market data obtained from
independent sources, while unobservable inputs reflect the entity’s market assumptions. FAS
157 requires entities to maximize the use of observable inputs and minimize the use of
unobservable inputs when measuring fair value of assets. These two types of inputs have created a three fair value hierarchy: Level 1 Assets (mark-to-market), Level 2 Assets (mark-to-matrix), and Level 3 Assets (mark-to-model).
Level 1—Liquid assets with publicly traded quotes. The financial institution has no discretion
in valuing these assets. An example is common stock traded on the NYSE.
Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical
or similar instruments in markets that are not active; and model-derived valuations in which

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provide a clear definition of fair value based on the types of metrics
utilized to measure fair value (market prices and internal valuation
models based on either observable inputs from markets, such as
current economic conditions, or unobservable inputs, such as internal default rate calculations). In effect, the new rules governed
when a permanent impairment had to be recognized by a bank
holding the asset. When mortgage defaults rose in 2007 and 2008,
the value of underlying assets, such as mortgage loans, dropped
significantly, causing banks to write-down both whole loans and
mortgage-related securities on their balance sheets through unrealized losses on their income statements. Many banks expressed displeasure, arguing that the available market prices were misleading
because they reflected the values that would have been obtained
through forced sales within a distressed market when no such sales
were taking place. Banks claimed that the rule distorted their financial positions because they were not in fact selling the assets
in question and in fact might well recover more than the fire sale
write-down price.46 The banks also claimed that the distortions had
an immediate effect on available required capital and the stock
prices of the institutions involved, both as a result of shareholder
sales and market speculation.47
In April 2009, FASB again adjusted the accounting rules to loosen the use of immediate fair value accounting. It adjusted markingto-market guidance in circumstances when fair value indicates a
necessary adjustment to reflect a permanent impairment. One of
the new rules suspends the need to apply fair value principles for
securities classified under available-for-sale or held-to-maturity if
market prices are either not available or are based on a distressed
market.48 The rationale for this amendment is that security investall significant inputs and significant value drivers are observable in active markets. The frequency of transactions, the size of the bid-ask spread and the amount of adjustment necessary
when comparing similar transactions are all factors in determining the liquidity of markets and
the relevance of observed prices in those markets.
Level 3—Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. If quoted market prices are not available,
fair value should be based upon internally developed valuation techniques that use, where possible, current market-based or independently sourced market parameters, such as interest rates
and currency rates.
46 John Heaton, Deborah Lucas, and Robert McDonald, Is Mark-to-Market Accounting Destabilizing? Analysis and Implications for Policy, University of Chicago and Northwestern University, at 3 (May 11, 2009) (hereinafter ‘‘Mark-to-Market Analysis’’).
47 Id.
48 Financial Accounting Standards Board, FASB Staff Position: Determining Fair Value When
the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly (FSP FAS 157–4) (Apr. 9, 2009) (hereinafter
‘‘FSP 157–4’’). FSP 157–4 relates to determining fair values when there is no active market or
where the price inputs being used represent distressed sales. For this the FSP establishes the
following eight factors for determining whether a market is not active enough to require markto-mark accounting:
1. There are few recent transactions.
2. Price quotations are not based on current information.
3. Price quotations vary substantially either over time or among market makers.
4. Indexes that previously were highly correlated with the fair values of the asset or liability
are demonstrably uncorrelated with recent indications of fair value for that asset or liability.
5. There is a significant increase in implied liquidity risk premiums, yields, or performance
indicators (such as delinquency rates or loss severities) for observed transactions or quoted
prices when compared with the reporting entity’s estimate of expected cash flows, considering
all available market data about credit and other nonperformance risk for the asset or liability.
6. There is a wide bid-ask spread or significant increase in the bid-ask spread.
7. There is a significant decline or absence of a market for new issuances for the asset or
liability or similar assets or liabilities.
8. Little information is released publicly.

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ments held by an entity without the intent to sell can distort earnings in an adverse market climate.
The second new rule (FAS 115–2) applies to permanently impaired assets classified as available-for-sale or held-to-maturity,
that the holder does not intend to sell, or believes it will not be
forced to sell, before they mature.49 Under the new rule, the part
of the permanent impairment that is attributable to market forces
does not reduce earnings and does not reduce regulatory capital;
under the old rule, the part of the permanent impairment attributable to market forces does reduce earnings and regulatory capital. Banks argued that the market prices for many asset-backed
debt securities had fallen sharply due to adverse market conditions
despite the underlying loans backing the securities continuing to
pay as expected. Hence the rule change protects bank capital from
changes in the market value of impaired assets that the bank decides to hold in the hope of eventual recovery.
The changes in these accounting rules are the subject of a continuing debate on which the Panel takes no position. First, although the new interpretation was issued at the beginning of April,
it was made retroactive to the beginning of 2009 for firms that
elected early adoption and wished to restate their financial reports.
For example, Bank of New York Mellon experienced a one-time increase in their first quarter 2009 earnings of $676 million (aftertax) 50 on net income of $322 million as a result of retroactively implementing the new mark-to-market FASB rules.
Second, institutions moved securities from their trading account
to available-for-sale and held-to-maturity accounts to take them out
of an automatic mark-to-market classification and into classifications that fall under the new rule.
Third, the new rule reduces investor transparency as institutions
are not required to use observable market inputs if the bank managers consider the market to be ‘‘distressed.’’ 51 As such, investors
have difficulty valuing assets that fall under the new rule.52
The details of these accounting issues are less important than
their impact. As a result of the crisis, asset values are uncertain.
By increasing bank managements’ use of discretion in valuing assets, the new rules reinforce the underlying uncertainty in valuation, especially because banks may not apply the rules in a uniform way. Thus, there is no way of knowing whether a bank’s assets are of a sufficient realizable value to support the bank’s liabil49 Financial Accounting Standards Board, FASB Staff Position: Recognition and Presentation
of Other-Than-Temporary Impairments (FSP No. FAS 115–2 and FAS 124–2) (hereinafter ‘‘FSP
FAS 115–2’’). This FASB Staff Position (FSP) amends the recognition guidance for the otherthan-temporary impairment (OTTI) model for debt securities and expands the financial statement disclosures for OTTI on debt securities. Under the FSP, an entity must distinguish debt
securities the entity intends to sell or is more likely than not required to sell the debt security
before the expected recovery of its amortized cost basis. The credit loss component recognized
through earnings is identified as the amount of principal cash flows not expected to be received
over the remainder term of the security as projected based on the investor’s projected cash flow
projections using its base assumptions. Part of the entity’s required expansion in disclosure includes detailed explanation on the methodology utilized to distinguish securities to be sold or
not sold and to separate the impairment between credit and market losses. FSP FAS 115–2 does
not change the recognition of other-than-temporary impairment for equity securities.
50 The Bank of New York Mellon Corporation, First Quarter 2009 Form 10 Q (Apr. 8, 2009),
at
46
(online
at
www.sec.gov/Archives/edgar/data/1390777/000119312509105511/
d10q.htm#tx88461l27).
51 FSP 157–4, supra note 48, at 16.
52 Mark-to-Market Analysis, supra note 46, at 12.

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21
ities, let alone to preserve the capital necessary to support lending.
To lower the risk of this uncertainty, banks, especially large banks,
have reduced participation in the credit markets. Whatever the
merits of the new accounting rules, their application adds to the
sort of uncertainty on which financial crises feeds.
C. ESTIMATING THE AMOUNT OF TROUBLED ASSETS
The risks troubled assets continue to pose for the banking system
depend on how many troubled assets there are. But no one appears
to know for certain. To frame the discussion in the report, this section provides readers with a perspective on the size and current
state of the troubled assets pool.
Some caveats are in order at the outset. It is impossible to ever
arrive at an exact dollar amount of troubled assets, but even the
challenges of making a reliable estimate are formidable. There are
several reasons. No agreed-upon definition of ‘‘troubled asset’’ (or of
asset subcategories) exists.53 It is difficult to assemble relevant
(and reliable) numbers from publicly-available information. Values
and asset quality fall along a constantly changing continuum. The
relevant markets are huge, complex, and global. It is often difficult
to distinguish troubled assets from assets that have already been
written-down to reflect current conditions. Finally, the effect of future conditions on the asset pool can only be projected, and loss estimates are no better than the projections themselves, a fact reflected in the steep drop in the value of troubled complex securities
once the wave of subprime loan defaults began. However, meaningful estimates can still be derived to help inform this discussion.
This section reflects several approaches. First, it assembles information from the financial statements for the 19 stress-tested bank
holding companies. Second, it examines the data on loans from
these same BHCs that are more than 90 days past due. Next it discusses the credit default exposure of these same BHCs. Finally it
models prospective losses on whole loans for all BHCs with over
$600 million in assets, thus including smaller national and regional
BHCs and the largest community banks that are BHCs. (A more
in-depth discussion of the techniques used can be found in the
Annex to Section One of this report.)
In publicly-available data reviewed by the Panel, the 19 stresstested BHCs have reported:
• $657.5 billion in Level 3 assets;54
• $132.9 billion in annualized loan losses; 55
• $264.6 billion in past due loans; and 56
• $8.9 trillion in credit default sub-investment grade exposure.57

53 There

are, however, accepted definitions of degrees of loan impairment.
As of March 31, 2009. Level 3 assets are described supra note 45.
55 As of June 30, 2009.
56 As of March 31, 2009.
57 As of March 31, 2009.

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54

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1. INFORMATION FROM COMPANY FINANCIAL STATEMENTS AND
FEDERAL RESERVE BHC REPORTS 58

The Panel has aggregated information from public financial
records by summing the values of the appropriate line items from
each bank’s financial statements as reported to the SEC and the
Federal Reserve Board. The usefulness of public financial records
is limited, though, by a lack of uniformity in reporting and formatting and a lack of granularity.59 The Panel is not trying to determine the correct valuation of any of these assets, simply to
reach an estimate of their size based on the values banks assigned
to them.
a. Level 3 Assets

The Panel first examined Level 3 assets which are required to be
reported and disclosed by the Financial Accounting Standards
Board (under FAS No. 157) and the Federal Reserve Board.60 Level
3 assets include assets for which it is difficult to find reliable external indicators of value.61 Because many toxic assets are inherently
difficult or impossible to model, they are most likely to be found on
a bank’s balance sheet as Level 3 assets, thus this number is instructive. Given the complexity of the packaging of certain real estate-related securities and the illiquidity in the markets, certain
assets that fall under the Level 3 category are not non-performing
assets, and certain assets that fall within the Level 2 assets (and
occasionally even Level 1) may also ultimately prove troubled.
According to first quarter 2009 financial statements, the 19
stress-tested financial institutions held approximately $657.5 billion of Level 3 assets.62 This was a 14.3 percent increase in Level
3 assets compared to three months prior (December 31, 2008). In
addition, certain financial institutions such as Bank of America,
PNC Financial, and Bank of New York Mellon had twice as many
assets (in terms of dollars) classified as Level 3 in the first quarter
of 2009 compared to year-end 2008. BHCs such as Morgan Stanley
had more than ten percent of their total assets categorized as Level
3.
FIGURE 4: LEVEL 3 ASSET EXPOSURES 63
Quarter ended March 31, 2009—(USD in billions)
MBS

Bank of America .............
Bank of New
York-Mellon
BB&T ..............
Capital One
Financial ....
Citigroup ........

$10.4

ABS

$9.6

Loans

$14.3

Mortg.
serv.

Other
assets

Deriv.

AFS sec.

Corp.
debt

Other
sec.

%
change

Total

$14.1

$6.1

$41.8

$11.9

$18.7 $126.9

127%

5%

$0.2
$0.2

$0.1

$0.4

$0.3
$1.0

$3.7
$1.6

441%
3%

2%
1%

$0.3
$5.5

$2.2
$2.5

$0.7
$49.9

$2.3

$5.4
$20.9 $123.6

30%
–15%

3%
7%

$3.1

$18.5

$26.1

$0.2

58 See

Annex to Section One for details on sourced data.
Annex to Section One for further discussion.
Federal Financial Institutions Examination Council, Instructions for Preparation of Consolidated Reports of Condition and Income, at 424–25 (June 2009) (online at www.ffiec.gov/PDF/
FFIEClforms/FFIEC031lFFIEC041l200906li.pdf).
61 See supra note 45.
62 Does not include American Express which did not report Level 3 Asset data in its SEC filings.
59 See
60 See

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% of
Total
assets

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23
FIGURE 4: LEVEL 3 ASSET EXPOSURES 63—Continued
Quarter ended March 31, 2009—(USD in billions)
MBS

Fifth Third
Bank ..........
GMAC .............
Goldman
Sachs .........
JPMorgan
Chase ........
KeyCorp ..........
MetLife ...........
Morgan Stanley ..............
PNC Financial
Regions Financial ............
State Street ....
SunTrust
Banks ........
U.S. Bancorp ..
Wells Fargo ....

ABS

Loans

$0.0
$1.0

$1.7

$11.6

$3.0

Other
assets

$9.9

$38.7

Mortg.
serv.

$0.8

$2.0

$2.6

$0.0
$0.5

Deriv.

AFS sec.

$0.2

$0.4

$1.2

$1.1

$10.6
$1.1

$8.8
$1.6

$69.4
$0.0
$3.4
$26.0
$0.2

$1.4
$3.6
$10.2

$0.7
$4.5

$1.2
$12.4

% of
Total
assets

24%
–9%

0%
4%

$7.6

$13.6

$54.7

–8%

6%

$10.9

$0.8
$1.5

$144.8
$1.9
$19.2

33%
–8%
–13%

7%
2%
4%

$31.5

$1.0

$67.3
$18.5

–22%
163%

11%
6%

$0.2
$0.1

$0.3
$10.5

–50%
14%

0%
7%

$26.7

$3.9
$7.0
$61.7

6%
47%
47%

2%
3%
5%

$12.5

$14.4

$0.6

$0.6

%
change

Total

$0.2
$6.6

$0.1
$9.8

Other
sec.

$0.2
$0.4

$0.3
$12.0

$10.6

Corp.
debt

$0.4
$1.6

$1.4
7.8

Total ......

$657.5

63 The

data used in creating this chart is derived from the quarterly and yearly SEC filings of the following companies from the period 12/
31/08 to 3/31/09: Bank of America; Bank of New York Mellon; BB&T; Capital One Financial; Citigroup; Fifth Third Bank; GMAC; Goldman
Sachs; J.P. Morgan Chase; KeyCorp; MetLife; Morgan Stanley; PNC Financial; Regions Financial; State Street; SunTrust Bank; U.S. Bancorp.
Analysis does not include American Express which did not report Level 3 Asset data in its SEC filings.

b. Loan Losses and Non-Performing Loans 64

The Panel conducted an analysis of loan losses and non-performing loans based on data from the financial statements from
year-end 2007 through the second quarter of 2009 for the 19 stresstested BHCs. As of the second quarter of 2009, the 19 stress-tested
BHCs had $132.9 billion in annualized loan losses. With a combined loan loss cumulative annual growth rate during this period
of 56.6 percent, the stress-tested BHCs continue to experience substantial whole loan write-downs on their balance sheets. Further,
non-performing loans increased significantly for all the stress-tested BHCs between the second quarters of 2008 and 2009.
c. 90+ Day Past Due Loans 65

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Exposure to past due securitization assets for the 19 largest
BHCs increased from $23.2 billion year-end 2007 to $264.6 billion
as of the end of the first quarter 2009. Past due securitization assets increased eleven times in 15 months. For example, Bank of
America had $5.0 billion of past due securitization assets 66 on its
balance sheet at the end of 2007, but that number ballooned to
$141.7 billion at the end of March 2009 (some of this resulted from
its acquisitions of Countrywide and Merrill Lynch).
64 Analysis on loan losses does not include GMAC which did not report loan losses in its SEC
filings. Analysis on non-performing loans does not include American Express, GMAC, and
MetLife which did not report loan losses in their SEC filings.
65 Analysis does not include GMAC and MetLife, which did not report 90+ Day Past Due
Loans data in its FED Y–9Cs.
66 Includes direct positions only.

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d. Credit Default Sub-Investment Grade Exposure 68

67 The data used in creating this chart came from the quarterly Federal Reserve Bank Holding
Company Performance Reports of the following companies from the period 12/31/07 to 3/31/09:
Bank of America; Bank of New York Mellon; BB&T; Capital One Financial; Citigroup; Fifth
Third Bank; Goldman Sachs; J.P. Morgan Chase; KeyCorp; Morgan Stanley (online at
www.ffiec.gov/nicpubweb/nicweb/Top50Form.aspx).
This graph present two very different sets of values given the amount of Past Due 90+ Loans
held by the various banks differs substantially. Presenting the data in this way reflects each
bank’s holdings on a percentage basis as each.
68 This analysis does not include American Express, GMAC, and MetLife which did not include Credit Derivative Sub-Investment Grade data per their FED Y–9Cs.

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Credit derivatives on sub-investment grade assets create large
amounts of unregulated exposure to potential defaults on lower
quality loans, amplifying the effect of defaults. Similar to past due
securitization assets, credit derivative exposure for sub-investment
grade assets experienced a significant uptick in the same period.
Sub-investment grade credit derivative exposure for the 19 largest
BHCs grew from $1.6 trillion in year end 2007 to $8.9 trillion in
the first quarter of 2009 as a result of downgrades.

69 The data used in creating these graphs were derived from the quarterly Federal Reserve
Bank Holding Company Performance Reports of the following companies from the period 12/31/
07 to 3/31/09: Bank of America; Bank of New York Mellon; BB&T; Capital One Financial;
Citigroup; Fifth Third Bank; Goldman Sachs; J.P. Morgan Chase; KeyCorp; Morgan Stanley;
PNC Financial; Regions Financial; Sun Trust Banks; U.S. Bancorp; Wells Fargo (online at
www.ffiec.gov/nicpubweb/nicweb/Top50Form.aspx).
These graphs presents two very different sets of values given the amount of Sub-investment
Grade Credit Derivative held by the various banks differs substantially. Presenting the data in
this way reflects each bank’s holdings on a percentage basis as each.
As the data collected for this graph is driven by filings that are required of BHCs, no data
is available prior to the first quarter of 2009 for Goldman Sachs and Morgan Stanley (which
only recently became BHCs).

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25

26

2. MODELING LOAN LOSSES 70

Whole loans have been the primary source of income for traditional banks for more than 100 years, and remain such for many
of the smaller banks in the United States. A loan is simply modeled by discounting its expected cash flows to the present, while
along the way applying some default and recovery assumptions.
Given knowledge about the individual or entity that the loan was
made to, and the value of its collateral, it is fairly simple to calculate default and recovery rates.71 For these reasons, the Panel focused its quantitative efforts on modeling losses in whole loans, assets which represent over $5.9 trillion in the 719 banks modeled by
the Panel.72 The Panel also chose to model only whole loans because they are the only troubled asset for which sufficient information is available to create a reasonable model with few assumptions
that can be tested under a number of different scenarios. As a result, the Panel’s modeling is of greatest relevance to banks that
have invested a larger portion of their assets in whole loans, which
tend to be smaller banks. It should be remembered that this does
not portray the whole problem for larger banks because it does not
include their exposure to losses on account of complex securities.
70 See

Annex to Section One for a more thorough discussion of the Panel’s model.
with this information, however, default rates cannot be predicted with perfect accuracy. Importantly, such predictions are based on the assumption that the information passed
on by the originator of the loan is absolutely correct, an assumption which, especially in 2006
and 2007, was not always true. Moreover, default rates are typically based on historical experience, which is an unreliable guide after the bursting of an unprecedented bubble.
72 Data was obtained from Bank Holding Company Consolidated Financial Statements, also
known as Federal Reserve Form Y–9C (online at www.ffiec.gov/nicpubweb/nicweb/
NicHome.aspx).

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71 Even

27
a. Modeling

The Panel used a model developed by SNL Financial 73 to assess
whole loan losses and potential capital shortfalls for all BHCs with
over $600 million in assets.74 This group includes the stress-tested
BHCs, national BHCs that were not stress tested, but more significantly includes medium to large regional BHCs.
The model tested the banks against two scenarios: it began with
the ‘‘starting point’’ assumptions used similar to the Federal Reserve Board in its analysis, and then used assumptions that were
20 percent more negative.75 These assumptions were used to
project loan losses 76 and BHCs’ net revenue, before subtraction for
loan loss reserves, for the next two years.77 Using this information
and data on the BHCs’ loan loss reserves, the model was then able
to calculate the amount of capital necessary for each BHC to recapitalize after the losses it sustained in the scenario.
b. Results of the Panel’s Analysis of Loan Losses 78

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The Panel’s analysis shows that given the necessary capital additions raised since May 2009, the 18 largest BHCs 79 would be able
to deal with projected losses in their whole loan portfolios. This
strength is, in large part, due to the rebound in earnings of banks
in the first quarter of 2009; those earnings increased even if one
excludes one-time accounting adjustments. This is very encouraging, especially considering the recent trends in the Case-Shiller
index, which showed that housing prices may be rebounding.80 But
again, this analysis deals only with whole loans; it does not include
the risks these large banks face from their holdings of complex securities. The Panel has not analyzed how the interaction of whole
loans and complex security holdings could affect large banks.
The Panel’s analysis of troubled whole loans suggests they pose
a threat to the financial health of smaller banks (‘‘$600 million to
$100 billion group’’).81 Using the same assumptions, it looks as if
banks in the $600 million to $100 billion group will need to raise
significantly more capital, as the estimated losses will outstrip the
73 Based in Charlottesville, Virginia, SNL Financial provides news, data, and analysis on various business sectors, including banking and other financial institutions.
74 Excluding 66 banks which did not supply enough information to calculate Tier 1 common
capital for the period ending March 31, 2009.
75 See SCAP Design Report, supra note 26.
76 Loan losses are calculated as the product of the loan loss rate as dictated by the scenario,
with the total loans of that type held by each bank. The Panel used two methods to calculate
loan losses: a standard and a customized. The standard method used the loan loss rates stated
in the stress test and uniformly applied them across all of the BHCs considered. The customized
approach attempted to tailor these aggregate loan loss rates to individual banks, on the basis
of their past performance. Thus for banks whose loans consistently outperformed the market,
their loan loss rate was lowered, while banks that consistently hold lower quality loans had
their loan loss rates raised.
77 Calculated based on data from the past two years.
78 To test the accuracy of its estimates, the Panel calibrated its model to the results of the
stress tests. In doing so, it simply used the results as a baseline and did not mean to accept
or reject the assumptions made there. The median result reached by the Panel in calibrating
its results was 2.5 percent higher than the stress tests; the difference was most likely the result
of the portions of the stress tests that cannot be independently replicated.
79 Excludes GMAC due to no reported data in the FED Y9–C reports.
80 See, e.g., Standard & Poor’s, Home Price Declines Continue to Abate According to the S&P/
Case-Shiller Home Price Indices (July 28, 2009) (online at www2.standardandpoors.com/spf/pdf/
index/CSHomePricelReleasel072820.pdf) (‘‘[T]he 10-City and 20-City [Case-Shiller] Composites reported positive returns for the first time since the summer of 2006.’’). This figure is not
seasonally adjusted.
81 $600 million was chosen as the floor asset level because it is the lowest at which the requisite information for modeling the loan losses and revenues was present in public filings.

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28
projected revenue and reserves. Under the ‘‘starting point’’ scenario, this second group of banks will need to raise $12–14 billion
in capital to offset their losses, while in the ‘‘starting point + 20%’’
scenario, non-stress-tested banks are expected to have to raise $21
billion in capital to offset their losses. The capital shortfall for
those relatively smaller banks, as shown below in Figure 8, is primarily due to the lack of reserves, which on average account for
only 25 percent of the expected loan losses.
FIGURE 7: LOAN LOSSES PROJECTED FROM Q1 2009 INFORMATION
[Dollars in millions]
Starting Point
Standard

Starting Point + 20%

Customized 82

Standard

Customized

Top 18 BHCs 83 ..............................................................
All Banks with Assets $100B to $600M 84 ...................

486,458
152,134

504,083
123,069

583,749
182,560

604,804
146,560

Total (All banks $600M+) ....................................

638,591

627,152

766,309

751,364

82 See supra, note 74. See also Annex to
83 Stress-tested BHCs excluding GMAC.
84 Excluding Keycorp, which is one of the

Section One of this report.
18 BHCs, but whose assets have fallen below $100 billion.

FIGURE 8: CAPITAL SHORTFALLS PROJECTED FROM Q1 2009 INFORMATION
[dollars in billions]
Starting Point
Standard

Starting Point + 20%

Customized

Standard

Customized

Top 18 BHCs 85 ..............................................................
All Banks with Assets $100B to $600M 86 ...................

0.0
11.70

0.0
13.99

8.71
21.45

2.33
21.25

Total (All banks $600M+) ....................................

11.70

13.99

30.16

23.57

85 Stress-tested BHCs, excluding GMAC.
86 Excluding Keycorp, which is one of the

18 BHCs, but whose assets have fallen below $100 billion.

The calculations performed by the Panel imply that while the 18
largest BHCs are sufficiently capitalized to deal with whole loan
losses, the relatively smaller BHCs, i.e., those in the $600 million
to $100 billion group, are not, and are going to require additional
capital given more severe economic conditions. The Panel sees the
undercapitalization of the BHCs in the latter group as a serious
issue; those banks may have access to a comparatively smaller pool
of investors, and could face significant challenges in raising the
necessary capital.

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3. ESTIMATES FROM OTHER SOURCES

The Federal Reserve, IMF, Goldman Sachs and RGE Monitor
have each performed independent analyses of expected loan losses
and complex securities write-downs across U.S. banks. These analyses looked at the entirety of bank portfolios, not just whole loans.
Although none of these organizations made public the models they
used, it is useful to compare their results to gain a sense of the
scale of the troubled asset problem. It is important to remember
that while the IMF, Goldman Sachs and RGE Monitor estimates
were based on neutral projections of the future, the Federal Reserve estimate was based on a downside, or stressed, projection. It
should be noted that the Panel’s analysis of whole loans is a subset
of the universe of assets these estimates looked at, and so the Pan-

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el’s estimates of troubled whole loan exposure should not be directly compared to these estimates.
FIGURE 9: COMPARISON OF 2009–10 WRITE-DOWN ESTIMATES FOR U.S. BANKS
Test

Banks Measured

Federal Reserve Stress
Test (Adverse Case).
IMF ...................................
Goldman Sachs ...............
RGE Monitor 89 .................

19 largest U.S.
BHCs 88.
All U.S. Banks ........
All U.S. Banks ........
All U.S. Banks ........

Assumed Peak to
Trough House
Price Decline 87

Date

Total
Write-downs
(2007–10) ($b)

Remaining
Write-downs
(2009–10) ($b)

47%

May 2009 ...............

N/A

$ 599.2

40%
40%
41%

April 2009 ..............
January 2009 .........
January 2009 .........

$ 1,060
$ 960
$ 1,730

$ 550
$ 450
$ 1,220

87 The Case-Shiller 20-City Composite Index shows that housing prices have declined 32 percent from peak to trough as of May 2009.
Standard & Poor’s, S&P/Case-Shiller Home Price Indices (Instrument: Seasonally Adjusted Composite 20 Index) (online at
www2.standardandpoors.com/spf/pdf/index/SAlCSHomePricelHistoryl072820.xls) (accessed Aug. 4, 2009). However, non-seasonally adjusted
home prices increased in May 2009, the first month to see an increase since July 2006, perhaps indicating that the home price slide is beginning to bottom out.
88 These BHCs hold two thirds of U.S. bank assets.
89 RGE Monitor’s remaining write-downs estimate for U.S. banks is significantly higher than the other estimates both because it estimates
a greater amount of credit losses and because it predicts a greater percentage of those losses will be borne by U.S. banks. For example, as
compared to the IMF estimate, RGE Monitor assumes 29 percent greater aggregate credit losses, and assigns 49 percent, as compared to the
IMF’s 39 percent, to U.S. banks.

All of these estimates, including the Panel’s own, suggest that
substantial troubled assets remain on banks’ balance sheets.
D. CURRENT STRATEGIES FOR DEALING WITH
TROUBLED ASSETS
Approaches taken in two prior banking crises are useful in placing current strategies in perspective. Those approaches also suggest some possible steps to address the current situation.
1. PAST APPROACHES
a. Less Developed Country (LDC) Crisis

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Beginning in the early 1970s, Latin American countries’ borrowing increased significantly. At the end of 1970, outstanding debt
from all sources totaled $159 billion.90 By 1978, it had risen to
$506 billion, and in 1982 it totaled $722 billion.91 The eight largest
money-center banks held $121 billion of this debt.92 By the early
1980s, money-center banks carried high exposure to the risks of
these loans—the average money-center bank carried an LDC loan
to total capital and reserves concentration of 217 percent.93 In August of 1982, Mexico was the first country to announce that it could
no longer make interest payments on the debt. By the end of that
year, approximately 40 other countries had joined it in failure to
meet debt service obligations.94
From 1983 through 1989, the banks and countries negotiated to
reschedule and restructure the debt. At the same time, banks increased loan loss reserves; by the end of 1989, banks’ loan loss reserves totaled nearly 50 percent of their outstanding LDC loans. In
90 All dollar values in this section are adjusted for inflation, as measured by the consumer
price index (CPI), to reflect their approximate current-dollar value. See U.S. Department of
Labor, Bureau of Labor Statistics, CPI Detailed Report, Data for June 2009, at 72, 74 (July 15,
2009) (online at www.bls.gov/cpi/cpid0906.pdf).
91 Federal Deposit Insurance Corporation, History of the Eighties—Lessons for the Future, Ch.
5: The LDC Debt Crisis, at 199 (online at www.fdic.gov/bank/historical/history/191l210.pdf)
(accessed Aug. 3, 2009) (hereinafter ‘‘History of the Eighties’’).
92 Id.
93 Id. at 199.
94 Id. at 206.

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1989, Treasury Secretary Nicholas Brady developed a plan to convert the non-performing LDC debt into tradable, dollar denominated bonds. Because these bonds, called Brady Bonds, were
tradable, they allowed banks to get the debt off their balance
sheets, thus reducing the concentration risk. It also amounted to
a forgiveness of approximately one third of the $328 billion in outstanding debt.95
The success of the work-outs in this situation raises the question
whether a series of work-outs shaped to the current crisis would
help alleviate the situation. Indeed, Treasury, the Federal Reserve
Board, and the Federal Reserve Bank of New York have taken
something of this approach in dealing with AIG.96 Treasury has indicated its view that such work-outs cannot play more than a limited role now, 97 but repayment of TARP assistance by many institutions and the hoped for restarting of the markets for troubled securities make supervised work-outs a matter worth exploring.
b. The Resolution Trust Corporation

A few years later, the banking industry faced a domestic asset
quality crisis. In the late 1980s, over one thousand savings and
loan institutions (or ‘‘thrifts’’) failed.98 In 1989, Congress created
the Resolution Trust Corporation (RTC) to aid the FDIC in the
process of resolving failed savings and loan institutions.99 The
RTC’s role was to take control of the assets, both sound and troubled, of any thrift the FDIC placed in receivership, and eventually
sell them on the market. The RTC sold the assets of 747 failed institutions with total assets of approximately $400 billion.100 It disposed of 95 percent of the thrifts’ overall assets, with a recovery
rate of approximately 85 percent of the value of the assets it acquired.
The RTC experience presents an example of one course the government can take to resolve failed banks and their troubled loan
portfolios. In contrast to assisting banks that remain open for business, with or without some amount of government ownership, the
RTC dealt with only closed institutions and their assets. In its operations, the RTC attempted to sell as many whole thrifts as pos95 Id.

at 209.
example of a work-out in the current crisis is the use of two entities (Maiden Lane
LLC II and III) organized by the Federal Reserve Bank of New York (the Bank) to buy toxic
assets held by AIG or its counterparties. Maiden Lane II bought $20.8 billion of toxic residential
mortgage-backed securities from AIG using in part a $19.5 billion loan from the Federal Reserve
Bank; Maiden Lane III bought from counterparties of AIG approximately $29.6 billion of complex securities backed by a number of asset types, using in part a $24.3 billion loan from the
Federal Reserve Bank.
97 See U.S. Department of the Treasury, Financial Regulatory Reform, A New Foundation: Rebuilding Financial Supervision and Regulation at 76 (June 2009) (online at
www.financialstability.gov/docs/regs/FinalReportlweb.pdf) (‘‘Thus, if a large, interconnected
bank holding company or other nonbank financial firm nears failure during a financial crisis,
there are only two untenable options: obtain emergency funding from the US government as in
the case of AIG, or file for bankruptcy as in the case of Lehman Brothers. Neither of these options is acceptable for managing the resolution of the firm efficiently and effectively in a manner
that limits the systemic risk with the least cost to the taxpayer.’’).
98 See Congressional Oversight Panel, April Oversight Report: Assessing Treasury’s Strategy:
Six Months of TARP, at 44–50 (April 7, 2009) (online at cop.senate.gov/documents/cop-040709report.pdf).
99 See Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), Pub.
L. No. 101–73, at § 501.
100 Government Accountability Office, Financial Audit: Resolution Trust Corporation’s 1995
and 1004 Financial Statements, at 8 (July 1996) (online at www.gao.gov/cgi-bin/getrpt?AIMD96-123) (hereinafter ‘‘GAO Audit’’).

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sible, which had the effect of passing along both the assets and liabilities of a failed institution. Investors contemplating bidding for
any particular institution would have to exercise substantial due
diligence in reviewing a failed thrift’s assets to estimate reasonably
their salvageable value, including the ability to readily foreclose on
defaulted loans and acquire the underlying collateral. In practice,
this meant that the bids the RTC received, especially early on, reflected a substantial risk premium.
Not all of the failed savings and loans assigned to the RTC could
be resolved using the whole thrift transaction process. The FDIC
often shut the thrift down and paid off the depositors. The RTC
would then sell the assets.101 The RTC used three methods for disposing of assets. It sold the majority of the assets through auctions,
but assets were also disposed of through equity partnerships and
securitization. At least $232 billion of assets were sold using these
three methods.102
Auctions were the most common method that the RTC used to
dispose of assets. Initially it sold assets one by one, but by mid1990 it began to use bulk sales of packaged assets. The auctions
were either sealed-bid auctions or ‘‘open outcry’’ auctions, using an
auctioneer and often held near the location of the assets.
The RTC used equity partnerships in situations where the market price for a bulk sale was significantly less than what the RTC
hoped to obtain for the assets. These partnerships involved a private sector partner 103 that would obtain a partial interest in the
group of assets, while the RTC retained an equity interest. The private sector partner would manage the assets and the sale of the
assets, providing the RTC with distributions from the proceeds of
the sales. In addition the RTC used securitization as a method to
dispose of commercial and multi-family loans. It is seen as a pioneer in this field.
The RTC is widely regarded as having been a success. But that
success was in large measure a function of the nature of the institutions it resolved and the composition and relative transparency
of their loan portfolios. The resolution of a failed institution is a
very different task than attempting to coax a solvent firm to take
significant write-downs by selling its loans at a discount. The RTC
had two other important differences from the current situation.
First, the RTC sold assets held by bankrupt thrifts that had been
seized by regulators. Second, it was selling assets, not buying them
(albeit a subsidy was provided in both cases). In contrast to certain
types of troubled assets held by troubled financial institutions in
the current financial crisis, the underlying properties on which
thrifts had made loans were easily identifiable and were often large
projects that could be appraised and for which completion costs
could be readily estimated. Whether investors acquired these tangible assets directly from the RTC or as collateral for the troubled
loans of the institutions on which they were successful bidders, the
101 In addition, on some occasions, the FDIC stripped out certain assets before placing the institution up for auction.
102 GAO Audit, supra note 100, at 9.
103 Section 21A(b)(II)(A)(ii) of the Federal Home Loan Bank Act of 1932 required the RTC to
use private sector resources to the extent that it was ‘‘practicable and efficient.’’

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ability of the market to value these assets to the satisfaction of
buyers and sellers was a key factor in the RTC’s successful sales.
2. TREASURY’S PRESENT STRATEGY

Treasury’s policies to date have indicated its awareness of the
problems posed by the continued presence of troubled assets in the
banking system. It has recognized that valuation directly affects
bank solvency and ability to lend. Treasury’s implementation of the
TARP—especially its capital injection policy and the related implementation of the stress tests by the Federal Reserve Board—combines a variety of approaches toward protecting the financial system against the threat posed by troubled assets and weak balance
sheets. Those approaches are promising, but they also face obstacles.
a. The Capital Purchase and Capital Assistance Programs

Treasury can inject further capital assistance into banks under
the original Capital Purchase Program or the Capital Assistance
Program (CAP).104 Thus, Treasury retains the option to follow the
strategy it used at the beginning of the crisis: shoring up bank capital directly to offset losses derived from troubled assets. It may
prove that this capacity is important, to assist smaller banks, as
well as to continue to support larger institutions that prove to still
be at risk. Approximately 445 banks have received capital assistance since January 1, 2009.105 However, this type of assistance has
in the past raised issues as to whether the transactions maximized
taxpayer value (see February report).
b. The PPIP

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Treasury’s Public-Private Investment Program (PPIP) is aimed
directly at troubled assets. Treasury has worked to build a structure that it believes can restart the market, and encourage price
discovery, for those assets, and thus go a long way to resolving uncertainty about the way banks should value the assets.
The PPIP was originally created with two sub-programs: a legacy
securities program, aimed at complex securities, and a legacy loans
program, aimed at troubled whole loans.
The legacy loans program was designed to create Public-Private
Investment Funds (PPIFs) using a mix of private and public equity
and FDIC-guaranteed debt that would be created to buy and manage pools of mortgages and similar assets. A bank, in consultation
with its primary regulators, Treasury, and the FDIC, would identify assets, typically a pool of loans that the bank would like to sell.
Then the FDIC would analyze the asset pool to determine the appropriate guaranteed debt-to-equity ratio that could be supported
by the pool for the PPIF that would buy the loans, guided by a
third party valuation firm. The highest ratio permitted would be a
six-to-one debt-to-equity ratio. The debt would be guaranteed by
the FDIC on a non-recourse basis, so that the borrower had no additional liability; Treasury, using TARP funds, and the private in104 U.S. Department of the Treasury, TARP Transactions Report For Period Ending July 31,
2009 (Aug. 4, 2009) (online at www.financialstability.gov/docs/transaction-reports/transactionsreportl08042009.pdf) (hereinafter ‘‘July 31 TARP Transactions Report’’). This excludes Bank of
America.
105 Id.

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vestors would split the remaining equity investment.106 Investors
would be sought via auction for a transaction structured in this
fashion.
The legacy securities program was designed to buy mortgagebacked securities by creating funds managed by private fund managers selected by the government to act on behalf of Treasury and
private investors. The fund managers were to raise $500 million in
private equity, which would then be matched by an equal amount
of Treasury equity. The fund thus created would then be able to
obtain up to an additional $1 billion in Treasury financing, bringing the total amount available to as much as $2 billion.107
In announcing the PPIP in February, the Administration cited
the need to provide greater means for financial institutions to
cleanse their balance sheets of both types of what it calls ‘‘legacy
assets.’’ 108 In a follow-up March press release, Treasury emphasized one of the major points of this report, namely, that troubled
assets, ‘‘create uncertainty around the balance sheets of . . . financial institutions, compromising their ability to raise capital and
their willingness to increase lending.’’ 109 Treasury reaffirmed and
expanded on these themes in the white paper accompanying the
March 23, 2009 press release announcing the details of the program:
A variety of troubled legacy assets are currently congesting
the U.S. financial system. An initial fundamental shock associated with the bursting of the housing bubble and deteriorating economic conditions generated losses for leveraged investors including banks. This shock was compounded by the fact that loan underwriting standards used
by some originators had become far too lax and by the proliferation of structured credit products, some of which were
ill understood by some market participants.
The resulting need to reduce risk triggered a wide-scale
deleveraging in these markets and led to fire sales. As
prices declined further, many traditional sources of capital
exited these markets, causing declines in secondary market liquidity. As a result, we have been in a vicious cycle
in which declining asset prices have triggered further
106 Treasury provided the following example in its press release announcing the program:
If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest,
the bank would approach the FDIC. The FDIC would determine, according to the above process,
that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio. The pool would
then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest
bid from the private sector—in this example, $84—would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages. Of this $84 purchase price, the
FDIC would provide guarantees for $72 of financing, leaving $12 of equity. The Treasury would
then provide 50 percent of the equity funding required on a side-by-side basis with the investor.
In this example, Treasury would invest approximately $6, with the private investor contributing
$6. The private investor would then manage the servicing of the asset pool and the timing of
its disposition on an ongoing basis—using asset managers approved and subject to oversight by
the FDIC.
U.S. Department of the Treasury, Treasury Department Releases Details on Public Private
Partnership Investment Program (Mar. 23, 2009) (online at www.financialstability.gov/latest/
tg65.html) (hereinafter ‘‘PPIP March Release’’).
107 PPIP March Release, supra note 106.
108 U.S. Department of the Treasury, Public-Private Investment Program (online at
www.treas.gov/press/releases/reports/ppiplwhitepaperl032309.pdf) (accessed Aug. 3, 2009)
(hereinafter ‘‘PPIP White Paper’’).
109 PPIP March Release, supra note 106.

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deleveraging and reductions in market liquidity, which in
turn have led to further price declines. While fundamentals have surely deteriorated over the past 18–24 months,
there is evidence that current prices for some legacy assets
embed substantial liquidity discounts.110
The crucial elements of the program, according to Treasury, are:
(1) ‘‘maximizing the impact of each taxpayer dollar’’ by using private capital to leverage public financing;111 (2) shifting some of the
risk onto the private sector by using private capital; and (3) using
market competition to assist in setting prices.112
The proper balance of risk and reward between the public and
private investors is key to the PPIP’s success. Treasury has said
that ‘‘[t]his approach is superior’’ to the alternatives because
‘‘[s]imply hoping for banks to work legacy assets off over time risks
prolonging a financial crisis,’’ while government action alone would
require taxpayers to ‘‘take on all the risk of such purchases—along
with the additional risk that taxpayers will overpay if government
employees are setting the price for those assets.’’113 Alternative options for tackling this problem relied solely on public funds and did
not sufficiently address the pricing issues plaguing these markets.114
A key aspect of the PPIP is its purported ability to use the markets to provide some form of reliable valuation for these assets.
Treasury believes the PPIP can create a ‘‘market pricing mechanism.’’115 The PPIP is designed to give investors an incentive, in
the form of risk sharing with and financing guaranteed by the government, to compete to buy legacy securities; the more money that
flows into the markets because of this competition and the more
auction results indicate asset prices, the more the markets will
open and banks have objective indicators to firm up accurate val110 PPIP

White Paper, supra note 108.
the securities portion of the PPIP is structured, the amount of risk the public sector
may bear depends on how the individual fund manager chooses to provide funding to the fund.
The fund manager may choose to create a $1 billion fund with $500 million of private equity
and $500 million of public (Treasury) equity, in which case the private investors and the public
have half the risk and half the reward. The fund manager may alternatively seek to create a
fund of up to $2 billion by accepting $1 billion in public financing in the form of secured nonrecourse loans from Treasury. Under this scenario, the public is at risk for 75 percent of the
downside and 50 percent of the upside.
The fund managers may also use the TALF to shift even more of the downside risk to the
public. Treasury has explicitly stated that it anticipates that fund managers will seek TALF financing to purchase eligible CMBS.
In this case, a fund manager would request a TALF loan to pay the $500 million private equity portion of the PPIP fund (or PPIF). Assuming a haircut of 15 percent, the Fund would receive a TALF loan of $425 million and would therefore need to raise only $75 million in the
capital markets. The private sector would have only 3.75 percent of the downside while still retaining the right to 50 percent of the upside.
Under the loan program, the private investor may buy at up to a six-to-one-debt-to-equity
ratio. And the equity is contributed in equal parts by the private investor and Treasury. Since
the financing is provided in the form of non-recourse loans, the public could be responsible for
up to 90 percent of the downside risk for each investment while sharing in only 50 percent of
the potential profit.
Although the current allocation places the heavier risk on the public, Treasury has noted that
the risk allocation under the PPIP is more favorable to taxpayers than an alternative that would
require the U.S. government to purchase assets directly and therefore bear all of the risk.
112 PPIP March Release, supra note 106.
113 PPIP March Release, supra note 106. Treasury has the right to terminate a fund in several
situations to protect the taxpayers’ investments from changes in circumstance. Several rules assure that Treasury will share equally in all distributions. All of the investment funds must report to Treasury each month.
114 PPIP March Release, supra note 106.
115 PPIP White Paper, supra note 108.

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ues for the assets they retain on their balance sheets. Although the
current funding structure of the legacy securities program involves
a degree of subsidization, Treasury has noted that the ability to
share equally in asset price increases (as well as losses) is a critical
program feature and is far preferable to a situation in which the
government is forced to purchase all of the risk of direct asset purchases.116 In addition to this risk sharing, Treasury has built the
legacy securities program to help create market demand—and
hence liquidity—by encouraging competition among the funds created under the program. It hopes that the presence of nine (or potentially more) funds created for the sole purpose of buying legacy
securities will create incentives to raise price levels as the funds
compete until prices reach a level at which banks are willing to
sell.117
In building the PPIP, Treasury’s strategy resembles its strategy
for the TARP generally. It does not seek to ‘‘clear’’ all troubled assets from bank balance sheets, or to have a stake in buying all
troubled assets, any more than it wants to own permanent stakes
in banks. Instead it hopes to reinvigorate the markets so that normal market processes can again operate; if investors become confident that troubled assets carried on bank balance sheets can be
reliably priced, the system again becomes self-supporting, subject
to normal supervisory oversight. Treasury remains ready to inject
more money into the program if further ‘‘pump-priming’’ is necessary to accomplish that objective.
Assistant Secretary of the Treasury for Financial Stability Herbert Allison explained Treasury’s view of PPIP in his testimony before the Panel on June 24, 2009:
It’s our belief that when markets are illiquid and a bank
tries to sell assets, they’re selling at fire sale prices because it’s a highly-inefficient market. The idea is that if we
increase liquidity, if we can act as a catalyst to get these
markets going, we will see the spreads between bid and
ask declining and there will be more activity, more sales
by banks, more investment by individuals in a self-reinforcing process, but we have to, we think, play a role in
jumpstarting sectors of the securitization market so that
can happen.118
The success of the PPIP as described by Treasury depends on
whether the circumstances in which it operates enable it to restart
the markets in a way that leads to accurate price discovery and
creates an upward spiral (more accurate pricing, more investors,
and so forth) to replace the downward spiral of 2008. Several obstacles lie in the way. It is not necessary that they be eliminated all
116 PPIP March Release, supra note 106. Obviously, such a situation would also provide the
public with the opportunity to reap 100 percent of any upside as well.
117 Competition among applicants for selection as fund managers is also important. The application process includes a review of the applicant’s experience managing assets such as the ‘‘legacy’’ securities, the value of the applicant’s current assets under management, and other related
qualifications. Treasury has reported receiving more than 100 applications for the limited number of positions. To the extent this process awards fund manager status to only the most highly
qualified, Treasury believes it has the advantage of retaining top talent for the task of valuing
and purchasing assets through a mechanism that may be more effective than hiring such qualified investors as government employees as would be necessary to enable the government to buy
the assets on its own.
118 Allison Testimony, supra note 37.

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at once; in fact it is in the nature of an effort such as this that
progress will at first perhaps be incremental.
There is a question as to whether the PPIP produces true price
discovery because of the degree of government subsidization involved. The value of an asset is discounted by the magnitude of the
risk, but the intention of the program is to reduce the risk and
therefore reduce the discount required by the buyer. The risk does
not evaporate but is instead being absorbed by the government.
This is likely the reason that Treasury is emphasizing the return
of liquidity to the markets once initial purchases are made on a
subsidized basis; market participants can determine a nonsubsidized price to keep the market going—the key is to bring the
first investors back into the markets so that the process can start.
The next problem is more serious. Once a bank sells a legacy security or legacy loan, it must book the sale value, but if the bank
holds the asset, it may continue to mark the asset at the higher
value permitted by the new rule. Thus any sale at less than amortized cost value would forgo the benefit of being able to avoid distress pricing and force perhaps substantial write-downs. In addition, the acceptance of accurate pricing in the market may require
banks to write-down even the holdings they retain. At the same
time, of course, banks can book a profit, especially if they have already written-down the asset in question, and then sell it for more
than its carrying value.
But the central issue underlying the PPIP is the same as the
question underlying virtually all discussions of troubled assets:
valuation. As discussed above, the program may start an upward
cycle to start the markets flowing (although that objective is in
itself not without some risk to banks if it forces downward valuation of assets that remain on balance sheets). But the converse is
also possible, namely that the market will not function because
prospective buyers will value such assets only at prices at which
institutions holding them will not sell, either because to do so will
require them to record write-downs on their books—reducing operating income and ultimately capital—or because they believe that
the economic value at which they are carrying the loans is accurate
and reflects economic conditions they expect to improve, or both.119
As with all TARP programs, there is a risk that banks and investors may be wary of the program because of fears that participation
will subject them to statutory restrictions, including those that
they cannot anticipate. Government involvement has been viewed
by many institutions as subject to unpredictable change.120 The
119 It is unlikely that the distinction between liquidity and price is absolute. Thus, the market
for legacy securities may be characterized in part by an absence of liquidity (for example, because investors are unwilling to commit themselves for more than a short period given anticipated changes in interest rates, others may remain wary of pricing uncertainty). As indicated
in the text, this distinction can put something of a ceiling on the degree to which the PPIP can
attack the problem. Lucian Bebchuck, Buying Troubled Assets (Apr. 2009) (online at
www.law.harvard.edu/programs/olinlcenter/papers/pdf/Bebchukl636.pdf).
120 In a recent newsletter, banking and finance lawyer Harold Reichwald of the law firm
Manatt, Phelps & Phillips noted that a provision of the newly enacted Helping Families Save
Their Homes Act of 2009 would require certain participants in the PPIP loans program to provide government access to financials and other information. The newsletter notes that, without
further clarity from the FDIC and Treasury on the execution of this provision, ‘‘there is a considerable risk that potential purchasers may decide it is better to simply sit on the sidelines without have an audit spotlight on them.’’ Harold Reichwald, PPIP and TARP Transparency (May
21, 2009) (online at www.manatt.com/news.aspx?id=9498).

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public outrage that followed the disclosure of bonus plans of various firms that have previously received TARP assistance has highlighted the public’s expectations and may have exacerbated the
problem.121
Although Treasury has attempted to build into the program a
number of protections for the public, including conflict of interest
rules for the selection and operation of fund managers, the Special
Inspector General for TARP (the SIGTARP) described continuing
concerns regarding those protections in its July 21, 2009 quarterly
report to Congress.122 In its April 2009 report, the SIGTARP noted
a number of concerns, including concerns regarding conflicts of interest, collusion among fund managers, money laundering, and increased government exposure through the use of the Term AssetBacked Loan Facility (TALF) and PPIP in conjunction with one another.123 These issues, the July report found, have been largely
ameliorated. The SIGTARP found, however, that several concerns
remain unaddressed. First, the SIGTARP is concerned that Treasury has not mandated strong ‘‘walls’’ between PPIFs and the other
funds managed by fund managers. Treasury has resisted stronger
‘‘walls,’’ citing funds’ inability to use a firm’s best talent if those
employees would be walled off from any other firm work, statements by various pre-qualified fund managers that they would
withdraw if required to implement such walls, and lack of necessity
since PPIF managers would, according to Treasury, not have material non-public information from Treasury. These and other factors
are, in Treasury’s view, sufficient to mitigate the potential harm.124
The SIGTARP believes such walls are nonetheless necessary to protect against improper transfer of information within firms.
Other issues that still concern the SIGTARP include the
SIGTARP’s requests that Treasury: (1) provide regular disclosures
to the SIGTARP (which may be then disclosed to the public) of
President of the Federal Reserve Bank of New York, William Dudley, has also recently attributed a relatively low participation rate in the TALF program to such concerns:
One reason why the TALF has gotten off to a relatively slow start is the reluctance of investors to participate . . . Some investors are apparently reluctant not because the economics of
the program are unattractive, but because of worries about what participation might lead to.
The TARP loans to banks led to intense scrutiny of bank compensation practices given that
TALF loans are ultimately secured by TARP funds, investor anxiety about using the program
has risen.
Federal Reserve Bank of New York, Remarks as Prepared for Delivery by President and Chief
Executive Officer of the New York Federal Reserve Bank William C. Dudley at Vanderbilt University: The Federal Reserve’s Liquidity Facilities (Apr. 18, 2009) (online at www.newyorkfed.org/
newsevents/speeches/2009/dud090418.html) (characterizing fears expressed by some investors
that participation in TALF may lead to increased regulation of investor practices as ‘‘misplaced’’
but ‘‘understand[able] . . . given the political discourse’’ and the ‘‘intense scrutiny of bank compensation practices’’ that arose from TARP investments in financial institutions).
121 As the American Bankers Association explained in a letter sent to the House of Representatives opposing additional restrictions on executive compensation for CPP recipients because of
the impact of uncertainty on business operations, ‘‘the risk of unilateral changing of the rules
at any time . . . is extremely disruptive to sound business planning.’’ Memorandum from Floyd
Stoner, American Bankers Association to Members of the House of Representatives (March 30,
2009) (online at www.aba.com/NR/rdonlyres/76DCD307-2D7E-48A6-A10F-623175F0AEAD/
59034/ExecComplABAHouseLetterl033009.pdf).
In a Gallup poll of just over 1,000 Americans taken on March 17, 2009, 76 percent said that
the government should take action to block or recover the bonuses American International
Group (AIG) paid to its executives and 59 percent said that they were personally ‘‘outraged’’ by
AIG actions in awarding the bonuses. Lymarie Morales, Outraged Americans Want AIG Bonus
Money Recovered (Mar. 18, 2009) (online at www.gallup.com/poll/116941/outraged-americans-aigbonus-money-recovered.aspx).
122 SIGTARP, Quarterly Report to Congress (July 21, 2009) (online at www.sigtarp.gov/reports/
congress/2009/July2009lQuarterlylReportltolCongress.pdf).
123 Id.
124 Id. at 175–179.

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PPIF trading activity;125 (2) implement a system of metrics by
which to measure PPIF performance and that would provide a
benchmark for determining whether the manager of an under-performing PPIF may be removed for cause;126 (3) require fund managers to disclose to Treasury information about holdings in eligible
assets and in related assets or exposures to related liabilities;127
and (4) require the disclosure by the fund managers of beneficial
ownership of the PPIFs.128
Although on its way to becoming operational, the current PPIP
represents a significantly scaled-down version of the $75–100 billion program originally outlined for the securities and loan programs combined. Instead, Treasury has announced that it will commit $30 billion to this program. Treasury has stated that the larger
program is no longer needed because of improvements in the financial sector and in banks’ ability to raise capital, but that the program could be expanded later if necessary.129
At present, only one of the two sub-programs—the legacy securities program—is on the path to becoming fully operational. On July
8, 2009, Treasury announced that it had pre-qualified nine fund
managers.130 When the Program was announced in late March,
Treasury stated that it expected to pre-qualify at least five fund
managers, but that it would select more if the pool of applicants
proved to be sufficiently strong.131 The fact that almost twice the
planned number of fund managers was selected is encouraging as
it reflects both the level of interest among serious contenders and
the quality of the applicants. Furthermore, a larger number of fund
managers means a larger number of buyers competing in the marketplace for the same legacy assets, which, as discussed above,
should have a positive impact on the market’s ability to assign
value to the assets. As of the date of this report, the selected firms
have until early October to raise $500 million in capital. Treasury
expects that some of the firms will have done so, and that the first
legacy securities transactions will close in August.
The legacy loan program, however, has been postponed. On June
3, 2009, the FDIC announced that it would postpone the loan program until further notice. A press release from the FDIC stated
that ‘‘development of the Legacy Loans Program (LLP) will continue, but that a previously planned pilot sale of assets by open
banks will be postponed.’’ 132 The press release continued, quoting
FDIC chairman Sheila Bair as saying that ‘‘[b]anks have been able
to raise capital without having to sell bad assets through the LLP,
which reflects renewed investor confidence in our banking sys125 Id.

at 179.
at 182.
at 182–183.
128 Id. at 183.
129 U.S. Department of the Treasury, Joint Statement by Secretary of the Treasury Timothy
F. Geithner, Chairman of the Board of Governors of the Federal Reserve System Ben S.
Bernanke, and Chairman of the Federal Deposit Insurance Corporation Sheila Bair: Legacy Asset
Program (July 8, 2009) (online at www.financialstability.gov/latest/tgl07082009.html) (hereinafter ‘‘Legacy Asset Program Statement’’).
130 The nine firms selected are: BlackRock Inc., Invesco Ltd., AllianceBernstein LP, Marathon
Asset Management, Oaktree Capital Management, RLJ Western Asset Management, the TCW
Group Inc., Wellington Management Co., and a partnership between Angelo, Gordon & Co. LP,
and GE Capital Real Estate. Id.
131 PPIP March Release, supra note 106.
132 Federal Deposit Insurance Corporation, FDIC Statement on the Status of the Legacy Loans
Program (June 3, 2009) (online at www.fdic.gov/news/news/press/2009/pr09084.html).
126 Id.

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127 Id.

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tem.’’ 133 Instead, the FDIC plans to ‘‘test the funding mechanism
contemplated by the LLP in a sale of receivership assets this summer.’’ On July 31, the FDIC indicated that it ‘‘would continue to
develop this program by testing the LLP’s funding mechanism
through the sale of receivership assets,’’ and that this step will
allow the FDIC to be ready to offer the LLP to open banks ‘‘as
needed.’’ 134
While the current strategy for the legacy securities program may
be appropriate, the delay in the legacy loan program may be problematic. As indicated above, many smaller and community banks
continue to hold whole loans. As the effects of the economic downturn have rippled through every layer of the nation’s financial system, unemployment continues to climb and smaller businesses to
falter, these local banks have faced ever increasing default levels.
Unlike large banks that can sustain a certain number of defaults,
even of large commercial loans, smaller banks may have far more
difficulty in absorbing more than a few large loan losses. The
FDIC’s statement that ‘‘[b]anks have been able to raise capital
without having to sell bad assets through the LLP’’ may not reflect
the reality for these banks.
Moreover, the FDIC pilot program may not provide a complete
picture of the issues that will be encountered in extending the legacy loans program to solvent banks. Under that program, as indicated above, a bank may not want to sell. But the FDIC does have
an incentive to sell because it wishes to dispose of assets it obtained in its receivership capacity. It may be willing to sell assets
at a lower price than an operating bank, for the reasons discussed
above. And an auction that sets a low price under these circumstances may trigger the sort of downward cycle that is the opposite of the PPIP’s objective.
In the end, it may be best to evaluate the PPIP not in terms of
the number of assets its partnerships purchase, but in terms of
whether the program actually creates price discovery for assets
where currently no transactions are occurring and that transactions then occur without federal support. Treasury believes that
the programs can push the markets in that direction and that this
push would make the PPIP a success.135 At the end of the day,
banks may or may not be pleased by a return to market pricing for
assets for which there were previously no transactions, but the
problem of troubled assets cannot be resolved until such pricing returns. A key question is whether the PPIP is properly designed
and/or robust enough to produce that result.
Either way, one barrier to the success of the PPIP is a simple
lack of information. There remains only fragmentary knowledge
about the size of the supply pool for legacy securities because there
is little or no transparency in the troubled asset markets.136 The
published stress test results gave no information about the total
holdings of potentially troubled assets on the books of the banks
tested. But markets need information to retain liquidity and function efficiently.
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133 Id.
134 Legacy

Asset Program Statement, supra note 129.
May Report, supra note 13.
Toxic Assets Are So Hard to Clean Up, supra note 23.

135 Panel
136 Why

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The question is whether steps could be taken to increase the
level of information about troubled assets on bank balance sheets,
to facilitate the success of the legacy loan and securities programs,
without creating a risk of market instability. Treasury and relevant
government agencies should work together to move financial institutions toward sufficient disclosure of the terms and volume of
troubled assets on banks’ books so that markets can function more
effectively. For example, the agencies could explore a uniform definition of troubled securities and uniform rules for balance sheet
presentation, as a means to creating a database of the available information.137 This approach would not encompass the universe of
legacy securities, many of which are held by non-banks, but it
could assist the legacy loans program more successfully because
that program only applies to the purchase of loans from banks.
b. The Stress Tests

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One of Treasury’s strategies for addressing the impact of troubled assets on BHCs’ balance sheet was stress tests.138 The stress
tests estimated the losses that the 19 largest BHCs would suffer
through the end of 2010, based on specified economic assumptions,
resulting from debtors defaulting on the loans made by those
BHCs, decreases in value of the securities the BHCs held as investments (for the BHCs with the largest trading portfolios), and losses
on the trading of securities.
The loss totals for the relevant classes of assets were:
• Mortgages (first & second lien, junior)—$185.5 billion;
• Commercial & Industrial Loans (including real estate)—
$113.1 billion;
• Securities (AFS and HTM), Trading & Counterparty—$134.5
billion; and
• Credit Card Loans & Other—$166.1 billion.
The tests then projected how much capital the BHCs would need
in order to absorb those losses.
The stress tests were designed to extend the stabilization of the
banking system through 2010 based on certain assumptions about
the current value and likely losses of troubled assets.139 In their
conception and execution, they indicate an evolution of Treasury’s
original capital infusion strategy. Once again, Treasury and the supervisors stated that their purpose was to ensure that the tested
banks have enough capital to balance the potential impact of any
losses,140 including those derived from existing troubled assets and
attempts to work out the problem by the banks involved; for that
reason 10 of the tested banks had to increase their capital base to
have enough capital on hand. The process required that banks attempt to increase their capital with privately-raised equity or debt,
rather than with additional funds supplied by the taxpayers. Taxpayer funds could only be obtained if private funding was unavail137 The supervisors would not have to require the banks to adopt uniform valuation methods
within the FASB’s expanded rules.
138 Panel June Report, supra note 38.
139 In its June report, the Panel discussed in detail criticisms and differing viewpoints on the
stress tests. See Panel June Report, supra note 38.
140 Allison Testimony, supra note 37 (June 24, 2009) (‘‘[T]he stress tests were aimed at assuring that the major banks, the largest banks, will have adequate capital if they undergo additional stress out in the marketplace because of continued difficulties in the economy.’’).

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able, at the cost of issuance of additional stock (potentially common
stock) to Treasury.
It is also significant that the stress tests are ‘‘forward-looking,’’
as the banking supervisors have emphasized. Rather than waiting
to respond to events, the supervisors have used the tests to require
capital buffers to be built in advance of any problem, based on projections about the economy and its impact on bank operating results. Finally, the forward-looking nature of the stress tests can
have a corollary impact on the troubled assets problem. It may provide a breathing period that allows the tested banks to dispose of
their troubled assets in an orderly way, without imposing extreme
effects on their operating results in any one period.141
At the same time, the protection the stress tests provide for
banks may not extend past 2010; the Federal Reserve Board has
said that reduction of capital to normal levels after 2010 is permitted. ‘‘[i]f the economy recovers more quickly than specified in
the more adverse scenario, firms could find their capital buffers at
the end of 2010 more than sufficient to support their critical intermediation role and could take actions to reverse their capital buildup.’’ 142 The supervisors should be careful to assure that the timing
of any such reduction does not leave bank balance sheets exposed
to a sudden economic turnabout.
An additional caution is that the stress tests only apply to the
nation’s 19 largest institutions. Smaller banks are not subject to
the same degree of protection. Attempting to ameliorate that difference is discussed below.
Finally, it should be noted that the stress test process was built
on existing regulatory and accounting requirements and did not introduce new measures of risk or change the way banks’ risk was
measured. The tests were affected only to a limited extent by new
accounting rules. Recent accounting guidance that allows more
flexibility in calculating the value of securities portfolios was not
taken into account in estimating losses. On the other hand, accounting rules not yet in effect that will require off-balance sheet
assets (such as special-purpose vehicles formed to securitize banks’
assets) to be brought onto banks’ balance sheets were treated as already in effect, resulting in a more conservative calculation.
c. Conditions for Exit from the TARP

When Treasury and the bank regulators allow an institution to
repay its TARP assistance, they have made a judgment that it no
longer requires the boost to its balance sheet that the initial assistance provided at the deepest part of the financial crisis. An implicit
conclusion is that the risk of troubled assets on a particular institu141 At

the same time, the stress tests applied only to the nation’s 19 largest BHCs.
Design Report, supra note 26, at 5. In its paper discussing the results of the stress
tests, the Board stated that: ‘‘Specifically, the stress test capital buffer for each BHC is sized
to achieve a Tier 1 risk based ratio of at least 6 percent and a Tier 1 Common capital ratio
of at least 4 percent at the end of 2010 under the more adverse macroeconomic scenario. By
focusing on Tier 1 Common capital as well as Tier 1 capital, the stress tests emphasized both
the amount of a BHC’s capital and the composition of its capital structure. Once the stress test
upfront buffer is established, the normal supervisory process will continue to be used to determine whether a firm’s current capital ratios are consistent with regulatory guidance.’’ Board of
Governors of the Federal Reserve System, The Supervisory Capital Assessment Program: Overview of Results, at 14 (May 7, 2009) (online at www.federalreserve.gov/newsevents/press/bcreg/
bcreg20090507a1.pdf) (hereinafter ‘‘SCAP Results’’).

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142 SCAP

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tion’s balance sheet is not more than its own capital base can support.
The terms for approval of repayment require this conclusion:
[Bank] supervisors will weigh an institution’s desire to
repay its TARP assistance against the contribution of that
assistance to the institution’s overall soundness, capital
adequacy and ability to lend.143 BHCs must also have a
comprehensive internal capital assessment process.144 In
addition, prior to repayment, the eighteen stress-tested
BHCs that received TARP funds must have a post-repayment capital base consistent with the stress test capital
buffer, and must demonstrate their financial strength by
issuing senior unsecured debt for terms greater than five
years, not backed by FDIC guarantees, and in amounts
sufficient to demonstrate a capacity to meet funding needs
independently.145
This statement indicates that the supervisors see the stress tests
and the repayment of assistance as working together to protect
bank balance sheets. But supervisory flexibility underlies the stress
test’s assumptions. The supervisors’ administration of these conditions should take account of the possibility of greater losses on
those assets than are anticipated by the stress tests and the current value at which those assets are carried on the balance sheets
of the banks they supervise.
d. Economic Improvement

In the end, as Treasury has recognized, nothing will help control
the risks of troubled assets as much as economic improvement, and
nothing will increase those risks as much as deterioration in economic conditions. A consequence of a more robust economy should
be an increase in property values, stabilization and then steady decrease in unemployment, and a slowing of mortgage defaults. But
whether deteriorating conditions will worsen the problem of troubled assets depends on the extent to which those assets have been
already written-down on balance sheets. As the report indicates, it
is likely that some write-downs in the value of complex securities
have occurred, although the write-down rate for whole loans may
be less. Thus management of the economy goes hand-in-hand with
specific supervisory measures to limit the damage troubled assets
can cause.
e. Treasury Strategy: A Summary

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Treasury has built a set of interlocking measures to deal with
troubled assets. It hopes to build capital protections going out 18
months through the stress tests, require supervisory approval before banks can pay back their TARP assistance, and use the PPIP
to get the market for troubled assets going again.
143 Board of Governors of the Federal Reserve System, Joint Statement by Secretary of the
Treasury Timothy F. Geithner, Chairman of the Board of Governors of the Federal Reserve System Ben S. Bernanke, Chairman of the Federal Deposit Insurance Corporation Sheila Bair, and
Comptroller of the Currency John C. Dugan on the Treasury Capital Assistance Program and
the Supervisory Capital Assessment Program (May 6, 2009) (online at www.federalreserve.gov/
newsevents/press/bcreg/20090506a.htm).
144 Id.
145 Id.

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All of these steps reflect a desire to resolve the troubled assets
problem and return to a strengthened financial sector, subject to
careful supervision and retention of the capacity to intervene again
if conditions worsen. The steps indicate that Treasury, the supervisors, and, hopefully, the banks themselves, have learned from the
crisis, but the success of those steps also depends on the degree to
which that education has taken place. The question remains
whether Treasury’s assumptions are correct, and whether the protections they have built into the system are sufficient.
E. Commercial Real Estate
The future of commercial real estate values may prove to be an
important factor for the maintenance of stability in the banking
sector. Like residential property, commercial property is held both
in the form of complex securities and whole loans, and a similar
crisis in that sector could trigger losses of its own.146 Before turning to a discussion of the future of the toxic assets problem, the report briefly reviews the state of the market for commercial real estate.
1. COMMERCIAL MORTGAGE-BACKED SECURITIES

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Bank troubles with CMBS are two-pronged: defaults are rising,
suggesting eventual write-downs of ownership stakes, and the new
issuance market remains nearly completely silent. By one estimate,
CMBS trusts hold 45 percent of outstanding U.S. commercial mortgages.147 The CMBS market has been virtually frozen since the
spring of 2008.148 (No CMBS were issued from January 2009
through May 2009.) During its last active period, the spring of
2008, banks were estimated to hold an estimated 23 percent portion of total CMBS investments.149 These CMBS investors are now
holding asset pools with a delinquent unpaid balance of $28.85 billion, an alarming 585 percent increase over the June 2008 delinquent unpaid balance of $4.18 billion.150 In line with this sharp
jump, CMBS pools held as collateral 54 percent of all commercial
loans that moved from delinquency to outright default.151 The
number of CMBS pool loans either 90 days delinquent or already
foreclosed (thus in default or on the cusp of default) rose 32 percent
from May to June and is up 411 percent versus June 2008.152
Bank CMBS holdings represent nearly a quarter of an increasingly troubled overall CMBS market whose now diminished value
146 The stress tests indicate potential losses for commercial real estate loans for the 19 stresstested institutions of $53.0 billion through 2010. SCAP Results, supra note 142.
147 Commercial Mortgage Securities Association, Compendium of Statistics: Exhibit 20: Holders of Commercial & Multifamily Mortgage Loans, Percentage Distribution (June 16, 2009) (online at www.cmsaglobal.org/uploadedFiles/CMSAlSitelHome/IndustrylResources/Research/
IndustrylStatistics/CMSAlCompendium.pdf) (hereinafter ‘‘CMSA Statistics Compendium’’).
148 Id. at Exhibit 1, CMBS Issuance by Month: 2006–2009.
149 Commercial Mortgage Securities Association, Investors of CMBS in 2008 (accessed July 29,
2009) (online at www.cmsaglobal.org/uploadedFiles/CMSAlSitelHome/IndustrylResources/
Research/IndustrylStatistics/Investors.pdf).
150 Realpoint Research, Monthly Delinquency ReportlCommentary (July 2009) (online at
www.federalreserve.gov/FOMC/Beigebook/2009/20090729/FullReport.htm)
(hereinafter
‘‘Realpoint Report’’).
151 As recently as year-end 2008, CMBS collateral represented only 30 percent of all distressed
CRE loans. Real Capital Analytics, Capital Trends Monthly: Office, at 5 (July 2009) (hereinafter
‘‘Real Capital Report’’).
152 Realpoint Report, supra note 150, at 1.

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is still nevertheless a substantial $750 billion.153 Banks do generally report their CMBS holdings on quarterly filings.154 But, as
with other possibly troubled assets, it is an open question as to
when or if a bank chooses to write off a troubled asset, whether
commercial or otherwise. Regardless of whether this write-off occurs, though, testimony at the Panel’s hearing in New York on
commercial real estate suggests continued losses in commercial
real estate (CRE) asset value over the next several years as the
pools containing the most troubled loan vintages face high rates of
term default.155
2. WHOLE LOANS 156

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While CMBS problems are undoubtedly a concern, the Panel
finds even more noteworthy the rising problems with whole commercial real estate loans held on bank balance sheets. These bank
loans tend to offer a riskier profile as compared to CMBS,157 suggesting high term default rates while the economy remains weak.
Another worrying and salient feature of these loans is that they are
held in a higher proportion by super-regional, regional and smaller
banks as opposed to larger money center banks.158 In a recent
speech, Janet L. Yellen, the President of the San Francisco Federal
Reserve Bank stated that ‘‘[t]o date, the community banks under
greatest financial stress are those with high real estate concentrations in construction and land development lending.’’159 Under its
worst case scenario, the Panel’s model of whole loan losses estimates potential core CRE and construction loan losses through
2010 of $81.1 billion at 701 banks with assets between $600 million
and $80 billion.160
Term defaults of these bank loans present a near term problem.
But another obstacle looms if a loan is able to escape term default
and reach maturity. The Panel, informed by the testimony of a
prominent CRE market analyst, took note of this issue in its June
Report:
153 CMSA Statistics Compendium, supra note 147, at 14, Exhibit 11: CMBS Breakdowns by
Deal and Property Type.
154 See ,e.g., J.P. Morgan Chase & Co., Form 10–Q for the Quarterly Period Ended March 31,
2009 (May 7, 2009) (online at www.sec.gov/Archives/edgar/data/19617/000095012309008271/
y76962e10vq.htm).
155 A recent report notes that ‘‘[l]enders have been slow to foreclose on assets and the phrase
‘‘pretend & extend’’ has recently entered the vernacular.’’ Real Capital Report, supra note 151,
at 15. The Panel heard testimony in May indicating that not all future CRE losses of this sort
were taken into account by the bank supervisors’ stress tests, to the extent such losses might
occur in 2011 or later. See Congressional Oversight Panel, Transcript of COP Field Hearing in
New York City on Corporate and Commercial Real Estate Lending, at 57–58 (May 28, 2009).
156 See Part B(3) of Section One of this report for a discussion of whole loans as they relate
to troubled assets generally.
157 Bank loans, especially those originated during the period from 2004–2007 when underwriting standards were most lacking, tended to be more heavily tilted toward much riskier construction and development loans as opposed to core commercial real estate loans. Parkus July
Report, supra note 30.
158 Parkus July Report, supra note 30.
159 Federal Reserve Bank of San Francisco, Presentation to the Oregon Bankers Association
Annual Convention with the Idaho Bankers Association, at 12 (July 28, 2009) (online at
www.frbsf.org/news/speeches/2009/0728.pdf).
160 When potential multifamily residence loan losses are added to core CRE and construction
loan losses, the estimate rises to $87.7 billion through 2010. See supra, section C(2) for a complete discussion of the Panel’s model methodology and results. See also Maurice Tamman and
David Enrich, Local Banks Face Big Losses, Wall Street Journal (May 19, 2009) (online at online.wsj.com/article/SB124269114847832587.html) (presenting an analysis suggesting the possibility of $99.7 billion in CRE loan losses through 2010 at 900 small and midsize banks).

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[P]oorly underwritten CRE loans made in the easy credit
years (e.g., 2005–2007) will reach maturity and will in
many instances fail to qualify for refinancing. As the
[Deutsche Bank] report explains, the high percentage of
loans not qualifying for refinancing, and hence in danger
of default without significant injections of new equity, is
attributable to the combined effects of stricter underwriting standards, steep declines in property values, and
reduced income streams to finance the loans because of
lower rents and increased vacancies. The findings are
based on quantitative data for commercial mortgagebacked securities (CMBS), which constitute 25 percent of
the core CRE market. While the authors of the report state
that there was insufficient data to perform a detailed
study in the larger non-CMBS sector, the authors say they
expect a similar if not higher level of maturity defaults on
non-securitized CRE bank portfolio loans because portfolio
loans typically have shorter maturities (which would not
allow sufficient time for property values to recover from
their present depressed levels) and higher risk profiles
than CMBS.161
If the heaviest losses were still solely on the horizon, it is possible that intervening actions might function to prevent the worst
loss predictions. Banks might be able to restructure problem CRE
loans with more success than they have found in the residential
mortgage sector. Property values could stabilize, moderating the
issue of negative equity. But what seems to have occurred between
May and July 2009 is a growing recognition that loan losses are
both occurring now in greater numbers even while maturity losses
still loom in the future. Second quarter 2009 earnings releases already reflect mounting commercial property write-downs.162 This
reflects the significant rise in term defaults occurring now; maturity defaults will enter the picture beginning in 2010 when the first
wave of troubled bank loan vintages mature. Because the CMBS
market remains substantially impaired,163 banks are also generally
unable to distribute the risk of their current portfolios through
packaged securities.164
The data above raise several concerns as to how the commercial
property market will affect the larger issue of troubled assets.
Troubled commercial real estate loans can themselves be considered a type of troubled asset. Significant write-downs of these loans
may make it more difficult for banks to remain healthy without removing other troubled assets from their balance sheets. Most concerning is the speed with which the commercial market has dete161 Panel

June Report, supra note 38; Parkus July Report, supra note 30.
Fargo reported non-performing CRE loans jumped 69 percent in second quarter
2009. Wells Fargo & Company, Wells Fargo Reports Record Net Income (July 22, 2009) (online
at www.wellsfargo.com/pdf/press/2q09pr.pdf). Morgan Stanley wrote down $700 million out of its
$18 billion CRE and CMBS portfolio. See Morgan Stanley, Financial Supplement—2Q 2009, at
16 (July 22, 2009) (online at www.morganstanley.com/about/ir/earnings—releases.html).
163 Wharton School of the University of Pennsylvania, On Shaky Ground: Commercial Real Estate Faces Financial Tremors (July 22, 2009) (online at knowledge.wharton.upenn.edu/article.cfm?articleid=2296).
164 The Federal Reserve’s Term Asset Lending Facility (TALF) is meant to address this issue
and was recently opened up to both new CRE loans as well as existing CMBS. It is unclear
as to whether TALF will be successful at unfreezing the CMBS market.

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162 Wells

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riorated in 2009. If consumer lending and residential mortgages
also remain weak, banks may face additional losses in asset value.
Both banks and regulators will be forced to face this issue in the
larger context of addressing a solution for bank troubled assets.
F. The Future

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The nation’s banks continue to hold on their books billions of dollars in assets about whose proper valuation there is a dispute and
that are very difficult to sell without banks experiencing substantial write-downs that can trigger a return to financial instability.
Whatever values are assigned to these troubled assets for accounting purposes, their actual value and their potential impact on the
solvency of the banks that hold them are uncertain and will likely
remain so for some time; the degree of uncertainty is difficult for
anyone to estimate confidently. Treasury’s strategy works to control the impact of the uncertainty, and it has stabilized the financial situation effectively, but the impact of the strategy may be less
strong if present conditions change.
There are a number of reasons that present conditions may worsen:
1. Unemployment continues to rise,165 and both government and
private economists have noted that an improvement in employment
may lag several years behind the return of economic growth generally, as is true in most recoveries and has been noted as a potential problem for this recovery.
2. Bank lending has not recovered.166
3. Both large BHCs, somewhat smaller regional BHCs, and small
banks are increasingly at risk from troubled whole loans, as discussed above.
4. The plunge in values that affected the residential real estate
market may be moving to the commercial real estate market as
properties come up for refinancing and that financing is unavailable because of the drop in commercial and retail activity arising
165 See, e.g., House Committee on Financial Services, Testimony of Chairman of the Board of
Governors of the Federal Reserve System Ben Bernanke, Hearing on the Semi-Annual Report
of the Federal Reserve on Monetary Policy, 111th Cong. (July 21, 2009) (‘‘Even though—if the
economy begins to turn up in terms of production, unemployment is going to stay high for quite
a while. And so, it’s not going to feel like a really strong economy.’’); Phil Izzo, Few Economists
Favor
More
Stimulus
(July
10,
2009)
(online
at
online.wsj.com/article/
SB124708099206913393.html) (‘‘ ‘The mother of all jobless recoveries is coming down the pike,’
said Allen Sinai of Decision Economics.’’). See Allison Testimony, supra note 37, at 15:20–23
(‘‘[O]ur financial system and our economy remain vulnerable, with unemployment still rising,
house prices falling, and pressure on commercial real estate continuing to build.’’).
166 See, e.g., U.S. Department of the Treasury, Treasury Department Monthly Lending and
Intermediation Snapshot: Summary Analysis for May 2009 (Aug. 4, 2009) (online at
www.financialstability.gov/docs/surveys/Snapshot_Data_May2009.pdf) (Showing the 21 largest
CPP recipients made $200 billion in loans during May 2009, compared to $218 billion in new
loans during October 2008); Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release H.8: Assets and Liabilities of All Commercial Banks in the United States: Historical Data (online at www.federalreserve.gov/datadownload/Choose.aspx?rel=H.8) (accessed
Aug. 4, 2009) (for all domestically chartered commercial banks, $6.957 trillion in outstanding
loans and leases as of July 22, 2009 compared to $7.281 trillion in outstanding loans and leases
on October 1, 2008); Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release H.3: Aggregate Reserves of Depository Institutions and the Monetary Base (Instrument: Reserves of Depository Institutions, Excess, NSA) (July 30, 2009) (online at
www.federalreserve.gov/releases/h3/current/) (accessed Aug. 4, 2009) (Demonstrating that, for a
variety of reasons, banks hold $740 billion in reserves in excess of required levels, compared
to under $2 billion in August 2008. The fact that these funds are not being used to make new
loans indicates substantial unused capacity in the banking system).

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from the economic downturn.167 Like residential property, commercial property is held both in the form of complex securities and
whole loans, and a similar sell-off in that sector could trigger losses
of its own and a more general renewed pressure on bank balance
sheets that would again call into question the true value of residential mortgage loans.168
5. To the extent banks have not written-down troubled assets,
they are in effect continuing to invest in those assets by holding
them for a future return.169 That is not an unreasonable strategy
in itself. But it only postpones the day of reckoning if it turns out
that, rather than appreciating, the assets depreciate.
As the report has discussed, Treasury’s strategy has stabilized
the system. There are several additional measures that Treasury
should consider to supplement that strategy in certain circumstances.
Continued Stress-Testing. First, as the Panel recommended in
June and Assistant Treasury Secretary Allison agreed,170 the Federal Reserve Board should repeat the stress tests, looking forward
two years, if economic conditions worsen to the point that they exceed the adverse economic scenario used in the tests. In addition,
stress-testing should be a regular feature of the 19 BHCs’ examination cycles so long as an appreciable amount of troubled assets remain on their books, economic conditions do not substantially improve, or both.
It is important to recognize that only the nation’s 19 largest institutions have been stress-tested. There are approximately 7,900
other banks, some large national institutions, some smaller regional institutions, and many small and community banks, and
more than 350 of those banks also received capital infusions under
the TARP. More important, many of the smaller institutions may
be especially at risk if the economy does not improve.
Resource considerations would likely bar stress-testing for these
institutions in the same manner as the prior tests. But it may be
that sample testing, rules for self-testing, or general templates
could provide a reasonable approximation of the direction given to
the large banks by the stress tests, and perhaps lead to a general
formula for determining whether additional capital buffers were required.
Continued Monitoring. Supervisors are already monitoring potential problem banks at an increasing rate. For example, the Federal
Reserve Board, Office of the Comptroller of the Currency, and
FDIC are issuing supervisory memoranda (requiring capital or
similar actions by particular banks), at a rate that would exceed
167 See Allison Testimony, supra note 37, at 59:20–23 (‘‘[M]uch of the commercial real estate
financing in recent years has been through the securitization markets which for some time were
pretty much shut down.’’).
168 See Part E of Section One of this report.
169 There is evidence of widespread write-downs of the most toxic assets, but it is unclear how
many written-down assets may have been shifted back to held-for-sale from trading accounts
and revalued.
170 Allison Testimony, supra note 37 at 22:17–20 (June 24, 2009) (‘‘Treasury agrees that over
time, especially for the larger banks, there should be periodic stress-testing by the regulators,
and I’d be fairly confident that that’s going to be taking place over time.’’); See also Id. (‘‘I would
agree with [Chairwoman Warren], that there’s a need for ongoing stress-testing, especially of
the larger banks.’’).

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the rate for 2008 by about 50 percent.171 The review of conditions
for repayment of TARP assistance also represent a careful type of
monitoring, in line with the objectives of the stress tests.
An important part of the necessary monitoring, as the supervisors have recognized, will involve a review of the way banks
themselves model the risk from the assets they hold, as part of
their balance sheet and reporting determinations. Especially after
hundreds of billions of dollars of TARP assistance, the banks themselves must assume a heavy responsibility for better risk management and capital protection.
A Balance Between Credit and Protection. One of the most serious consequences of the crisis was the bank pull-back from lending
as capital was devoted to strengthening balance sheets. It is important that capital is raised to levels at which the two objectives do
not compete; otherwise, the economic recovery—and with it the
slow resolution of the problem of troubled assets will be stopped,
if not reversed.
Careful Calibration of the Legacy Loans and Legacy Securities
Programs. PPIP should be monitored closely to determine whether
it is fulfilling its purpose. Even given its use to restart the markets
rather than to take large numbers of troubled assets off bank balance sheets, Treasury should consider whether the PPIP legacy securities program should be expanded if the markets would appear
to benefit from additional ‘‘pump-priming.’’ If the program is not
working, Treasury should consider adopting a different strategy to
remove the troubled assets from banks’ books.
The future of the legacy loans program is more important. Given
the growing problem of whole loan defaults and the way in which
those defaults affect smaller banks that were not stress tested, it
is difficult to understand why the same approach should not be applied to whole loans as is to be applied to legacy securities. As the
only initiative designed specifically to reopen the market for troubled whole loans, failure to start the legacy loan program raises
concerns about whether Treasury has a workable strategy to deal
with banks’ troubled loans.
Increased Disclosure. In order to advance a full recovery in the
economy, there must be greater transparency, accountability, and
clarity, from both the government and banks, about the scope of
the troubled asset problem. Treasury and relevant government
agencies should work together to move financial institutions toward sufficient disclosure of the terms and volume of troubled assets on banks’ books so that markets can function more effectively.
The events of September 2008 and the course of previous financial crises are a reminder that, despite all of these steps, the risks
exist that current strategies will not suffice.172 If that were so, re171 Damien Paletta and Dan Fitzpatrick, Regulators Are Getting Tougher on Banks, Wall
Street Journal, (July 31, 2009) (online at online.wsj.com/article/SB124900956863596085.html).
172 It is worth remembering that the years 1930–1933 were marked not by one, but by several
banking crises. The first occurred in 1930, and was noted by the failures of Caldwell and Company and the Bank of the United States. Caldwell and Company was a prominent Tennessee
bank, whose failure sparked a series of bank failures in the Southeast. The Bank of the United
States was the fourth largest bank in New York City, whose failure induced a panic in the
Northeast. The second crisis occurred in 1931, and hit mainly the Chicago and Cleveland areas.
The third crisis also occurred in 1931 after Britain abandoned the gold standard. In the U.S.,
the crisis was notable in three cities, Pittsburgh, Philadelphia and again Chicago. The final crisis hit in 1933 and involved multiple bank failures.

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course to additional capital infusions could again arguably be the
best way to stabilize the system (assuming of course that any infusions were backed by adequate protections for the taxpayers). But
unless Congress extends the authority of Treasury to enter into
new TARP commitments, more capital infusions may not be possible because Treasury’s ability to make such commitments expires
no later than October 2010.173
In that circumstance, a great share of the burden may fall on the
FDIC. During the early days of the crisis, the FDIC sold either the
assets it assumed in resolving a bank failure or the failed institution itself in transactions that cost the insurance fund billions of
dollars. The FDIC lost $10.7 billion in resolving the failure of
IndyMac,174 and $4.9 billion in resolving the failure of Bank
United.175 It could do so again, but such losses could be on an even
greater scale, and they would mean that the FDIC and ultimately
the taxpayer absorb the asset pricing uncertainties that have infected the system all along.
If no additional TARP funding were available, the government
might consider the costs and benefits of using an RTC-like strategy
to purchase for eventual resale potentially troubled assets from
open banks meeting certain capital standards, in order to maintain
the health of those banks. Such an approach would require careful
structuring, and it would, again, shift, but not eliminate the problems of value and pricing of the purchased assets. It would also entail substantial funding both to purchase the assets and to pay for
operating costs, including the hiring of experienced personnel to
manage the loan purchase and resale program. The funding might
be provided by the issuance of bonds by the entity (as was the case
with the RTC). The Panel is not recommending this alternative,
merely suggesting its consideration by policy-makers.
G. CONCLUSION
Troubled assets were at the heart of the crisis that gathered
steam during the last several years and erupted in 2008. The stabilization of the financial system is a significant achievement, but
it does not mark an end to the crisis. One continuing uncertainty
is whether the troubled assets that remain on bank balance sheets
can again become the trigger for instability.
It is impossible to resolve the argument about whether banks are
or are not solvent because of the uncertain value of their loans. The
importance of that question will be reduced substantially if the
economy improves and unemployment drops. However, the acid
test will come if unemployment remains high and residential and
commercial mortgage defaults increase. Moreover, such instability
may not emerge until the full extent of any coming crisis in commercial mortgages is fully felt or banks can evaluate the experience
of loans that come due after the 2009–10 stress test period.

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173 EESA

120(b).
174 FDIC, FDIC Closes Sale of Indymac Federal Bank, Pasadena, California (Mar. 19, 2009)
(online at www.fdic.gov/news/news/press/2009/pr09042.html).
175 FDIC, BankUnited Acquires the Banking Operations of BankUnited, FSB, Coral Gables,
Florida (May 21, 2009) (online at www.fdic.gov/news/news/press/2009/pr09072.html). The FDIC
estimates this to the cost to the Deposit Insurance Fund.

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Treasury has adopted a strategy that it hopes will strengthen at
least the nation’s largest banks to withstand a return instability.
Several supplemental steps may help reduce the risks that this
could occur:
1. As recommended by the Panel in June, supervisors should repeat the stress tests if economic conditions worsen beyond the adverse economic scenario originally used.
2. Treasury must assure robust legacy securities and legacy loan
programs or consider a different strategy to do whatever can be
done to restart the market for those assets.
3. Treasury and relevant government agencies should work together to move financial institutions toward sufficient disclosure of
the terms and volume of troubled assets on banks’ books so that
markets can function more effectively.
4. Treasury must be prepared to turn its attention to small
banks in crafting solutions to the growing problem of troubled
whole loans. Those banks face special risks with respect to problems in the commercial real estate loan sector. As one example, the
methodology and capital buffering involved in the stress tests could
be extended to the nation’s smaller banks on a forward-looking
basis.
Ultimately, everything depends on the care and responsibility exercised by both banks and supervisors in carefully controlling risk
and watching for signs of trouble. There is no substitute for acting
in advance of a crisis, especially now that some of the signals of
potential concern should be clear.
The problem of troubled assets was long in the making, and it
would be foolish to think that it could be resolved overnight, or
that doing so would not involve balancing equally legitimate considerations affecting the banking industry and the public interest.
But it would be equally foolish to think that the risk of troubled
assets has been mitigated or that it does not remain the most serious risk to the American financial system.

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ANNEX TO SECTION ONE: ESTIMATING THE
AMOUNT OF TROUBLED ASSETS—ADDITIONAL INFORMATION AND METHODOLOGY
A. Caveats in Assessing the Amount of Troubled Assets
1. FINDING TROUBLED SECURITIES IN FINANCIAL STATEMENTS

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In its search for the value of U.S. bank held troubled assets, the
Panel found that the information required in regulatory filings is
insufficient for fully assessing the value of troubled assets. The two
main issues the Panel had to navigate were the lack of uniformity
and the lack of granularity in the public statements of these institutions.
The lack of uniformity in financial reporting precludes almost
any attempt to aggregate data across institutions. While some institutions provide very detailed statements, which break down
asset items to reasonable levels of classification, other institutions
provide almost no detailed data at all, leaving the reader to guess
at line items that incorporate a number of sometimes very dissimilar items. As a result of these classification differences, when
aggregating, the Panel was forced to use only the least detailed
company’s categories, thus rendering an enormous amount of information unusable.
Even the formatting of the financial statements is entirely different across banks. As a result of these classification differences,
even finding the line item in each statement is a difficult task, requiring a long search through reports which can be over 300 pages.
Because of the change in accounting rules brought about by FAS
157–4, assets which were formerly held in the trading account, and
thus marked-to-market, can be transferred out, labeled as held-tomaturity, and marked-to-model.176 As a result of differing policies
regarding early adoption of FAS 157–4, the statements for individual companies use a different methodology from the fourth quarter of 2008 to the first quarter of 2009, making comparisons problematic from one quarter to the next.
The lack of granularity means that even at the most detailed
level presented, the information provided is not rich enough to determine the amount of troubled assets. For example, Citigroup, in
which the government has a very large equity stake (34 percent),
prepares extraordinarily comprehensive financial statements, showing a great deal of information at very detailed levels.177 However,
even Citigroup, in the 10–Q from the first quarter of 2009, presents
only a blanket number of $49.9 billion in Level 3 derivatives.178
Obviously derivatives come in many shapes and sizes, but
Citigroup provides no information on the nature of this nearly $50
176 Financial Accounting Standards Board, Determining Fair Value When the Volume and
Level of Activity for the Assets or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (Apr. 9, 2009) (FSP FAS 157–4).
177 Citigroup Inc., Citi Announces Final Results of Public Share Exchange and Completes Further Matching Exchange with U.S. Government (July 30, 2009) (online at www.citigroup.com/citi/
press/2009/090730b.htm).
178 Citigroup Inc., First Quarter of 2009—Form 10–Q, at 124 (May 11, 2009) (online at
www.citigroup.com/citi/fin/data/q0901c.pdf?ieNocache=52) (hereinafter ‘‘Citigroup First Quarter
2009 10–Q’’).

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billion line item.179 Furthermore, it is unclear how much of this
Level 3 exposure is netted out.180 As Citigroup aggregates
amounts, almost $1 trillion was netted out of derivatives Levels 1
through 3.181 This means that Citigroup could have anywhere from
$0 to $50 billion dollars in Level 3 derivatives exposure.182
In addition, it is common knowledge among market participants
that loans that originated in 2006 and 2007 were created under relatively lenient lending practices, meaning that many of the loans
from this period, and the securities based on them, are more likely
to default.183 It would therefore be useful for the BHCs to break
out their loan and MBS numbers by vintage, allowing investors to
judge for themselves how much they trust the securities’ ratings.
In the search for troubled assets, failure to identify these items
causes troubled and non-troubled assets to be placed on the same
line, making it impossible to differentiate the two types of assets.
Finally, and most importantly, each bank uses a different, undisclosed method to calculate the value of the items in their financial
statements; all of these models however must conform to GAAP
and their results must be reviewed by the banks independent public accounting firm. Still, because troubled assets are, by their nature, Level 3, and therefore marked-to-model, it is impossible with
reasonable confidence to compare the values of troubled assets
across banks. For example, Bank of America might hold a set of derivatives that it values at $100 billion under its valuation model,
but that Citigroup, if it held those same derivatives, may value
them at $50 billion under its valuation model. The differences in
modeling techniques of different banks, combined with the fundamentally difficult issues in modeling these securities, even assuming access to the relevant data, makes it impossible to fully assess the value of troubled assets based on the public disclosures of
the banks.
2. DIFFICULTIES IN MODELING TROUBLED SECURITIES AND CREDIT
DEFAULT SWAPS184

There are a number of different types of troubled assets, each
with its own degree of modeling difficulty. The simplest is a loan.
The relative ease in modeling whole loans reflects the fact that
their payouts, and hence their value, are only based on one security, the loan itself. Mortgage backed securities (MBS), on the other
hand, group together larger numbers of loans whose future values
were deemed to depend on one another only to a small degree.

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179 Id.
180 Netting is the accounting process that lets institutions remove opposing positions from
their balance sheet. The concept behind this is that if a bank simultaneously holds two opposite
positions, for all intents and purposes, the two cancel each other out.
181 Citigroup First Quarter 2009 10–Q, supra note 178, at 125.
182 Citigroup First Quarter 2009 10–Q, supra note 178.
183 See, e.g., Chris Mayer, Karen Pence, and Shane M. Sherlund, Board of Governors of the
Federal Reserve System, The Rise in Mortgage Defaults, Finance and Economics Discussion Series (Nov. 20, 2008) (online at www.federalreserve.gov/pubs/feds/2008/200859/200859pap.pdf);
Office of the Comptroller of the Currency, Comptroller Dugan Tells Lenders that Unprecedented
Home Equity Loan Losses Show Need for Higher Reserves and Return to Stronger Underwriting
Practices (May 22, 2008) (online at www.occ.treas.gov/ftp/release/2008-58.htm).
184 Inherent in this discussion is the assumption that all of the information required to model
a security is available; however, for the outside observer, this simply is not true. As shown in
Part 1 above, the financial statements provide almost no useful information to be used as a
basis for a model. This information does exist, in proprietary products which are offered by research firms.

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Banks pooled many whole loans into an SPV, and then defined a
set of rules governing tranches which they issued. The set of rules
was structured so that the vast majority of the purchased tranches
would be investment grade, and all of the risk would be associated
with the subordinate tranches. Thus, for a large group of randomly
collected loans, it seemed exceedingly unlikely that a large percentage of them would default. The pricing, and rating, of these securities required assumptions about the default correlations between
each of the mortgages in the pool. With pools containing thousands
of whole loans, such an assessment is nearly impossible.
Estimates of correlation have an enormous effect on the rating,
and thus the estimated likelihood of default of a complex security.
A correlation of 1.0 would imply that all of the securities would fail
at once, meaning that the entire pool retained the default probabilities of the loans of which it was composed. If, on the other
hand, the correlation was 0, then the failure of one loan would be
independent of the failure of another loan, making the probability
that the entire pool would default the product of the default probabilities from each individual loan. These two results are clearly divergent, and a slight variation in the estimated correlation can
have a large effect on the credit rating, and therefore the value of
a loan. One of the main reasons that these securities are now troubled is that the banks and rating agencies under-estimated the correlative effect of a systemic shock. In other words, in a recession,
mortgage default rates rise, causing many loans to default at the
same time that would otherwise not do so. As a result, the diversification which the banks had relied on to strengthen the credit
of their MBSs disappeared, vastly lowering the credit rating, and
thus the value of these securities.
The issue of measuring correlations within a mortgage pool
grows more complicated when we consider CDOs, which packed
many MBS together from different mortgage pools. In this case, the
payouts can be tied to so many whole loans at their base that it
is impossible to model the correlations between all of these loans,
or even to figure out which loans are backing the payments. The
more complicated the structures became the more difficult it became to model the correlations. At this point it becomes nearly impossible to sort through all of the securities that a tranche is dependent upon, or the correlation between all of the securities.
Credit Default Swaps (CDS) can be purchased on many different
debt securities, from residential real estate loans to bonds.185 Essentially, the value of a credit default swap is based on two main
features of a debt product, its default and recovery rates. Thus, the
value of a credit default swap is the difference between the payments made by the buyer and the expected payout of the seller.
The default rate determines how likely it is that the seller will be
forced to pay, and the recovery rate determines how much. CDSs
are more difficult to value than loans, because inherently their values are based off the prediction of low-probability large payouts,
much like other forms of insurance. This is further complicated by
185 CDS can be sold on any debt based product, such as CDOs or CLOs. Whereas the inherent
structure of the CDO or CLO complicates the modeling of these instruments, it is the inherent
properties of the underlying that present issues when valuing CDS securities. The structure of
the CDS is in most cases very simple.

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54
the fact that a CDS is based solely on the two most difficult pieces
of a debt product to predict, its default and recovery rates.
To summarize, modeling the performance of complex securities,
based on the performance of thousands of loans, is like trying to
model large chunks of the mortgage market, and then trace all of
the payments from individual loans through layers of rules governing payouts, until you reach the top. Further, this task is made
less possible by the amplification of the issues with modeling the
securities at the lower levels. For example, the difficulties in modeling the default rate for a loan are multiplied over the enormous
number of loans that feed into the more complex securities. Thus
it seems that the only products on which an outside observer can
attempt to make a good faith valuation are whole loans, a fact confirmed to the Panel by more than a dozen academics.
B. Troubled Assets from Financial Statements
Although somewhat limited, meaningful estimates can still be
derived from public documents to help inform the scope of troubled
assets. Figure 10 below highlights Level 3 assets for the stress-tested BHCs as of December 31, 2009 which includes assets that are
difficult to find reliable external indicators of value. This illustrates
the dollar amount of Level 3 assets as a percentage of total assets.
FIGURE 10: LEVEL 3 ASSET EXPOSURES 186
Quarter ended December 31, 2009—(USD in billions)
MBS

Bank of America ...........
Bank of New York-Mellon ............................
BB&T .............................
Capital One Financial ...
Citigroup .......................
Fifth Third Bank ...........
GMAC ............................
Goldman Sachs .............
JPMorgan Chase ...........
KeyCorp .........................
MetLife ..........................
Morgan Stanley .............
PNC Financial ...............
Regions Financial .........
State Street ...................
SunTrust Banks ............
U.S. Bancorp .................
Wells Fargo ...................

ABS

Loans

$7.3 ............
............
$0.004
............
$50.8
............
$1.5
$15.5
$12.9
............
$0.9
............
............
............
............
$1.4
$1.8
............

............
............
............
............
............
............
............
............
............
$2.5
............
............
............
$8.7
............
............
............

Mortg.
Serv.

Other
Assets

Deriv.

$5.4

$12.7

$3.6

$8.3

............
$0.0
............
$0.2
$0.007
$1.9
$12.0
$19.8
............
............
............
$1.4
............
............
$0.8
............
$4.7

............
$0.4
$0.2
$5.7
............
$2.8
............
$9.4
............
$0.2
............
............
............
............
............
$1.2
$14.7

$0.2
............
$1.5
$0.4
$0.03
$0.04
............
$11.4
$1.1
............
$9.5
$0.7
............
$0.4
............
$1.7
$2.0

$0.08
$0.04
$0.06
$60.7
............
$0.1
$8.5
$31.8
$0.0
$3.0
$40.9
$0.1
$0.1
............
............
............
$7.9

AFS Sec.

Corp.
Debt

Other
Sec.

Total

$18.7 ............ ............
$0.4
$1.1
$2.4
$28.3
$0.1
$0.8
............
$12.4
............
............
............
$4.8
$0.1
............
$1.5
............
$22.7

............
............
............
............
............
............
$7.6
$6.5
............
$13.4
$34.5
............
............
............
............
............
............

% of
Total
Assets

$56.0

3%

............
$0.7
............
$1.5
............
$4.2
............ $146.0
$0.0
$0.2
............
$7.2
$16 $59.6
$4.9 $109.0
$0.9
$2.0
$2.0 $22.0
$1.1 $85.9
............
$7.0
$0.4
$0.5
$0.2
$9.2
............
$3.6
............
$4.8
$3.5 $55.5

0%
1%
3%
8%
0%
4%
7%
5%
2%
4%
13%
2%
0%
5%
2%
2%
4%

Total ..................... ............ ............ ............ ............ ............ ............ ............ ............ ............ $575.1
186 The

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data used in creating this chart is derived from the quarterly and yearly SEC filings of the following companies from the period 12/
31/08 to 3/31/09: Bank of America; Bank of New York Mellon; BB&T; Capital One Financial; Citigroup; Fifth Third Bank; GMAC; Goldman
Sachs; J.P. Morgan Chase; KeyCorp; MetLife; Morgan Stanley; PNC Financial; Regions Financial; State Street; SunTrust Bank; U.S. Bancorp.
Analysis does not include American Express (AXP) which did not include Level 3 Asset data in its SEC filings.

Figure 11 below illustrates the change in dollar amount of the
loan losses (net charge-offs) and loan loss reserves for the stresstested BHCs over an eighteen month period (January 1 2007—June
30 2009). This highlights the significant increase in loan losses recognized over this period for all the stress-tested banks.

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55
FIGURE 11: LOAN LOSSES AND LOAN LOSS RESERVES 187
[Dollars in billions]
Quarter Ended
6/30/2009
Net
ChargeOffs

American Express ................
Bank of America ..................
Bank of New York Mellon ....
BB&T ....................................
Capital One Financial ..........
Citigroup ..............................
Fifth Third Bank ..................
GMAC LLC ............................
Goldman Sachs ....................
JPMorgan Chase ..................
KeyCorp ................................
MetLife Inc. ..........................
Morgan Stanley ....................
PNC Financial Services ........
Regions Financial ................
State Street ..........................
SunTrust Banks ...................
U.S. Bancorp ........................
Wells Fargo & Co. ................

*
34.80
0.22
1.68
4.48
33.42
2.50
*
*
24.08
2.16
*
*
3.18
1.96
*
3.20
3.72
17.54

Loan
Loss
Resrv.

*
33.75
0.43
2.15
4.48
35.94
3.49
*
*
29.03
2.50
*
*
4.57
2.28
*
2.90
4.38
23.53

Quarter Ended
3/31/2009
Net
ChargeOffs

Year Ended
12/31/2008

Loan
Loss
Resrv.

5.14
27.77
0.20
1.55
4.55
29.13
1.96
*
0.00
17.58
1.96
0.32
0.02
1.72
1.56
0.03
2.44
3.15
13.03

Net
ChargeOffs

3.86
29.05
0.47
1.87
4.65
31.70
3.07
*
0.00
27.38
2.19
0.49
0.15
4.30
1.86
0.09
2.74
3.95
22.80

*
16.23
0.07
0.85
3.47
19.02
2.71
*
*
9.84
1.26
0.16
*
0.54
1.55
0.00
1.56
1.82
7.84

Loan
Loss
Resrv.

Year Ended
12/31/2007
Net
ChargeOffs

*
23.07
0.42
1.57
4.52
29.62
2.79
*
*
23.16
1.80
0.32
*
3.92
1.83
0.02
2.35
3.51
21.01

*
6.48
0.06
0.34
1.96
10.45
0.46
*
*
4.54
0.28
0.05
*
0.20
0.29
0.00
0.42
0.79
3.54

Net
Loan Loss
ChargeOffs CAGR Resrv.CAGR

Loan
Loss
Resrv.

*
11.59
0.33
1.00
2.96
16.12
0.94
*
*
9.23
1.20
0.21
*
0.83
1.32
0.02
1.28
2.06
5.31

*
75.1%
55.9%
70.8%
31.7%
47.3%
75.5%
*
*
74.4%
98.7%
*
*
151.0%
89.2%
*
96.4%
67.4%
70.5%

*
42.80%
9.9%
28.8%
14.8%
30.6%
54.9%
*
*
46.5%
27.7%
*
*
76.6%
18.7%
*
31.2%
28.6%
64.3%

* Data not available
187 The data used in creating this chart were derived from models prepared by the Panel staff in conjunction with information from the
quarterly and yearly SEC filings, and company earnings reports of the following companies from the period 12/31/07 to 6/30/09: American Express; Bank of America; Bank of New York Mellon; BB&T; Capital One Financial; Citigroup; Fifth Third Bank; GMAC; Goldman Sachs; J.P. Morgan Chase; KeyCorp; MetLife; Morgan Stanley; PNC Financial; Regions Financial; State Street; SunTrust Bank; U.S. Bancorp; Wells Fargo.
Analysis does not include GMAC which did not include loan losses and non-performing loans data in its SEC filings.

Figure 12 below illustrates the significant increase in non-performing loans as a percentage of total loans for the stress-tested
BHCs over a one year period (June 30 2008—June 30 2009). This
highlights the significant increase in non-performing loans on the
banks’ balance sheets over this period.
FIGURE 12: NON-PERFORMING LOANS 188
[Dollars in millions]
Q2 2009

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Bank of America ..............................
Bank of NY Mellon ...........................
BB&T ................................................
Capital One ......................................
Citigroup ..........................................
Fifth Third ........................................
Goldman Sachs ................................
JPMorgan Chase ..............................
KeyCorp ............................................
Morgan Stanley ................................
PNC Financial Services ....................
Regions ............................................
State Street ......................................
SunTrust ...........................................
U.S. Bancorp ....................................
Wells Fargo ......................................

Q2 2008

Total Loans
Q2 2009

Total Loans
Q2 2008

% of Total
Loans 2Q09

% of Total
Loans 2Q08

% Change

$29,181
$372
$2,091
*
$28,246
$2,587
*
$14,785
$2,188
*
$4,032
$2,618
*
$5,504
$3,014
$15,798

$9,156
$273
$1,016
*
$11,626
$1,726
*
$5,273
$814
*
$695
$1,410
*
$2,625
$971
$4,073

$942,248
$32,895
$100,334
$146,555
$641,700
$81,573

$870,464
$39,831
$95,715

3.10
1.13
2.08

1.05
0.69
1.06

294.43
165.00
196.33

$746,800
$83,537

4.40
3.17

1.56
2.07

282.75
153.49

$680,601
$70,803

$538,029
$75,855

2.17
3.09

0.98
1.07

221.43
287.98

$168,888
$96,149
$9,365
$124,100
$173,177
$821,614

$72,828
$98,267
$10,643
$125,200
$163,070
$399,237

2.39
2.72

0.95
1.43

250.17
189.76

4.44
1.74
1.92

2.10
0.60
1.02

211.53
292.29
188.47

* Data not available
188 The data used in creating this chart were derived from models prepared by the Panel staff in conjunction with information from the
quarterly and yearly SEC filings, and company earnings reports of the following companies from the period 12/31/07 to 6/30/09: Bank of
America; Bank of New York Mellon; BB&T; Capital One Financial; Citigroup; Fifth Third Bank; Goldman Sachs; J.P. Morgan Chase; KeyCorp;
Morgan Stanley; PNC Financial; Regions Financial; State Street; SunTrust Bank; U.S. Bancorp; Wells Fargo.

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56
Does not include American Express, GMAC and Metlife which did not include loan losses and non-performing loans data in their SEC filings.

Thus, by several different estimates from publicly available information, significant amounts of troubled assets appear to remain on
banks’ balance sheets.
C. The Panel’s Model of Loan Losses and Capital Shortfalls
1. INTRODUCTION

The Panel’s quantitative efforts focused on modeling losses in
whole loans, assets which represent over $5.9 trillion in the 719
banks modeled by the Panel.189 Such loans are the only troubled
asset for which sufficient information is available to create a reasonable model with few assumptions that can be tested under a
number of different scenarios.
2. METHODS

SNL Financial developed a model for assessing loan losses and
capital requirements for banks that was modified by the Panel for
scenario testing.190 The model tests all BHCs 191 which have assets
greater than $600 million, a group that includes the stress-tested
and other large BHCs and medium to large regional BHCs, against
more severe economic scenarios, similar to the Federal Reserve
Board in its analysis. Loan losses are calculated as the product of
the loan loss rate as dictated by the scenario, with the total loans
of that type held by each BHC. This number is combined with an
estimate of the company’s Pre-Provision Net Revenue (PPNR) for
the next two years, a number which is calculated from the past two
years, and the company’s loan loss reserves to yield the amount of
capital necessary for the bank to be recapitalized after the losses
sustained in the scenario.
The Panel used two methods to calculate loan losses: a standard
and a customized. The standard method used the loan loss rates
similar to the Federal Reserve Board in its analysis and uniformly
applied them across all of the BHCs considered. The customized
approach attempted to tailor these aggregate loan loss rates to individual banks, on the basis of their past performance. Thus for
banks whose loans consistently outperformed the market, their
loan loss rate was lowered, while BHCs that consistently hold
lower quality loans had their loan loss rates raised.192
Two scenarios were analyzed by the Panel. In each scenario, the
only modifications were in the loan loss expectations. The loan loss
assumptions in the two scenarios were:
FIGURE 13: ASSUMED LOAN LOSS RATES
Starting
Point 193
(Percent)

First lien mortgages ................................................................................................................
Closed-end junior lien mortgages ...........................................................................................

Starting
Point
+ 20 percent 194

8.5
25.0

189 Data

from BHC Y–9Cs.
Part E of this Annex to Section One for a detailed discussion of SNL’s methods.
66 banks which did not supply enough information to calculate Tier 1 common
capital for the period ending March 31, 2009.
192 This calculation would not have resulted in any net change in the aggregate loan loss numbers; however, the panel imposed a floor of 25% and a cap of 200% on these modifications.
190 See

191 Excluding

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10.2
30.0

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57
FIGURE 13: ASSUMED LOAN LOSS RATES—Continued
Starting
Point 193
(Percent)

Home equity lines of credit (HELOC) ......................................................................................
Commercial & industrial loans ...............................................................................................
Construction & land development loans .................................................................................
Multifamily loans .....................................................................................................................
Commercial real estate loans (nonfarm, nonresidential) .......................................................
Credit card loans .....................................................................................................................
Other consumer loans .............................................................................................................
Other loans ..............................................................................................................................

Starting
Point
+ 20 percent 194

11.0
8.0
18.0
11.0
9.0
20.0
12.0
10.0

13.2
9.6
21.6
13.2
10.8
24.0
14.4
12.0

193 Loan loss rates were taken from the stress test’s ‘‘more adverse’’ scenario. Federal Reserve Board, The Supervisory Capital Assessment
Program Overview of Result, at 5 (May 7, 2007) (online at www.federalreserve.gov/newsevents/press/bcreg/bcreg20090507a1.pdf).
194 Loan loss rates were calculated as 1.2 times the rates from the ‘‘starting point’’ scenario.

D. Results195
The Panel’s analysis shows that although the stress-tested BHCs
may be sufficiently capitalized to deal with losses in their whole
loan portfolios, BHCs in the $600 million to $100 billion range will
likely need to raise significantly more capital if they experience increased loan losses due to an economic downturn. As shown by the
following graph, smaller banks have fewer reserves to absorb
losses.
FIGURE 14: LOAN LOSSES PROJECTED FROM Q1 2009 INFORMATION
[Dollars in millions]
Starting Point
Standard

BHCs 196

Top 18
.....................................
All Banks with Assets $100B to
$600M 197 ..........................................
Total (All banks $600M+) ............
196 Stress

Starting Point + 20%
Customized

Standard

Customized

486,458

504,083

583,749

604,804

152,134
638,591

123,069
627,152

182,560
766,309

146,560
751,364

tested BHCs excluding GMAC.
Keycorp, which is one of the 18 BHCs, but whose assets have fallen below $100B.

197 Excluding

FIGURE 15: CAPITAL SHORTFALLS PROJECTED FROM Q1 2009 INFORMATION
[Dollars in billions]
Starting Point
Standard

Top 18 BHC 198 ......................................
All Banks with Assets $100B to
$600M 199 ..........................................
Total (All banks $600M+) ............
198 Stress

Starting Point + 20%
Customized

Standard

Customized

0.0

0.0

8.71

2.33

11.70
11.70

13.99
13.99

21.45
30.16

21.25
23.57

tested BHCs excluding GMAC.
Keycorp, which is one of the 18 BHCs, but whose assets have fallen below $100B.

tjames on DSKG8SOYB1PROD with REPORTS

199 Excluding

195 To test the accuracy of its estimates, the Panel calibrated its model to the results of the
stress tests. In doing so, it simply used the results as a base line and did not mean to accept
or reject the assumptions made there. The median result reached by the Panel in calibrating
its results was 2.5% higher than the stress tests, and was most likely the result of the portions
of the stress tests that cannot be independently replicated.

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As evidenced by the graph below, the projected capital shortfall
is concentrated in banks with total assets ranging from $1 billion
to $100 billion. Under both scenarios, the capital shortfall for
banks with less than $100 billion in assets is an order of magnitude greater than the shortfalls for the 18 stress-tested BHCs.
The Panel sees this as a serious issue; smaller banks may have access to a comparatively smaller pool of investors, and could face
significant challenges in raising the necessary capital.

59

E. SNL Financial Model Methodology
1. OVERVIEW

SNL conducted two stress tests on the Tier 1 common capital of
bank holding companies with assets greater than $600 million,
using two different hypothetical loan loss rate methodologies. One
methodology assumed loan losses over the next two years for each
bank by evaluating their current delinquency rates for each loan
type, while the other uniformly applied the more adverse loan loss
rates that were specified in the Supervisory Capital Assessment
Program (SCAP) report, regardless of individual bank delinquency
rates. SNL used regulatory financials as of March 31, 2009, but
Tier 1 common capital was adjusted for common capital offerings
completed between April 1st and July 24th, following the methodology of the SCAP report. All data used in the model is from the
March 31, 2009 bank holding company Y9–C filings with the Federal Reserve.
2. LOAN LOSSES—CUSTOMIZED SCENARIO

200 The starting point + 20% portion of the column represents the marginal increase from the
capital required under the starting point scenario.

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SNL determined hypothetical loan loss rates by adjusting the
SCAP’s adverse loan loss rates for each bank. SNL compared each
bank’s delinquent loans by loan type—defined as loans 30 to 89
days past due and 90–plus days past due, and loans in nonaccrual
status, excluding any government-guaranteed loans—to the aggregate delinquency rate, by loan type, for all of the banks in the anal-

60
ysis and calculated a ratio for each bank (the bank’s individual delinquencies divided by the industry delinquency rate for each loan
type). SNL then applied this ratio to the SCAP’s adverse loan loss
rates to create individualized loss rates for each bank. For instance, if a company had a delinquency rate lower than the industry average, SNL lowered the hypothetical loan loss rate by the
same proportion.
SNL limited the maximum loss rates to the greater of the bank’s
delinquency rates or 4× the SCAP’s more adverse rate (the prorated loss rates were also capped at 100 percent). It also set a minimum loss rate of 25 percent of the SCAP’s more adverse rate. As
such, the aggregate loan loss rates for the banks in this analysis
will not equal the most adverse loan loss rates specified in the
SCAP report due to the caps and floors imposed on the customized
loss rates for each loan type.
3. LOAN LOSSES—STANDARDIZED SCENARIO

Using the ‘‘more adverse’’ loan loss rates from the SCAP report,
SNL uniformly applied these rates to each loan type for each bank
holding company to determine the total losses for each loan portfolio. For example, the SCAP report specified that First Lien Mortgages were stressed under the most adverse scenario at an 8.5 percent loss rate. This rate was then applied to each bank within the
analysis.
Under each scenario, consolidated loans in both foreign and domestic offices for each loan type are used where possible. However,
real estate loan types in the model, such as first lien and closedend junior lien mortgages, home equity lines, multifamily loans,
construction and land development, and commercial real estate
loans, represent the bank’s domestic loans in each category due to
lack of disclosure of consolidated loans. Therefore, the total loans
stress-tested may not equal the total amount of consolidated loans
at each bank holding company.
For both loan loss scenarios, a 35 percent tax rate was applied
to the loss for each bank. The calculated loan losses for each bank
were then applied against the bank’s excess loan loss reserve. SNL
assumed that each bank would have to maintain a one percent loan
loss reserve to total loans ratio. SNL then decreased Tier 1 common capital for the losses not absorbed by the excess reserves.
The loan portfolio detail for each bank holding company used to
calculate loan losses is located in the HC-C schedule (Loans &
Leases) within the bank’s Y–9C filing with the Federal Reserve.

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4. FUTURE EARNINGS

Like the Federal Reserve in its stress test, SNL used pre-provision net revenue to predict 2009 and 2010 earnings for the banks.
SNL predicted pre-provision net revenue for each bank by taking
the average pre-provision net revenue, from each bank’s Y–9C filing, as a percent of average assets for the last twelve months ending March 31, 2009, and the prior twelve months ending March 31,
2008, and projecting that rate forward over two years, based on the
company’s most recent asset size. Pre-provision net revenue was
defined by the Federal Reserve as net interest income plus non-interest income minus non-interest expense, but SNL ‘‘normalized’’

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its predictions by excluding gains on sale of securities (losses were
included), goodwill impairment and amortization of intangibles
from 2007 and 2008 data. For banks that did not have any data
available for the last two years or for any bank with pre-provision
net revenue less than 0.75 percent of assets over the period, SNL
assumed a pre-provision net revenue rate of 0.75 percent of most
recent assets. SNL found that some banks had large losses related
to sale of securities that occurred primarily due to write-downs associated with Fannie Mae’s collapse in 2008. Since these losses
were one-time and were are not recurring, SNL assumed a 0.75
percent rate as a minimum for pre-provision net revenue as that
represented roughly half the mean rate for the banks stress-tested.
A 35 percent tax rate was then applied to each bank’s pre-provision
net revenue.
The income statement detail for each bank holding company used
to calculate pre-provision net revenue is located in the HI schedule
(Income Statement) within the bank’s Y–9C filing with the Federal
Reserve.
5. NET CAPITAL REQUIREMENTS

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SNL calculated Tier 1 common capital for each bank holding
company from their HC-R schedule (Regulatory Capital) of the Y–
9C filing with the Federal Reserve. A total of 66 banks were excluded from the analysis since they did not supply enough information to calculate Tier 1 common capital for the period ending March
31, 2009.
SNL calculated the hypothetical decrease in Tier 1 common capital by netting out the amount of loan losses under each scenario,
assuming that loan loss reserves could be depleted to just one percent of loans, and adding in the expected two-year PPNR, all after
taxes. SNL then added any common capital raised between March
31, 2009, and July 24, 2009.
Those bank holding companies with a pro forma Tier 1 common
capital to risk-adjusted assets ratio less than four percent, the
SCAP capital requirement, were designated as needing additional
capital under an adverse economic environment; the additional capital needed was specified as the amount needed to increase their
Tier 1 common capital levels to equal four percent of their risk-adjusted assets.

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SECTION TWO: ADDITIONAL VIEWS

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A. Senator John E. Sununu
I believe that the purchase of troubled assets as proposed under
the PPIP is an important area of oversight for the Panel. The August Report, however, was affected by many of the same challenges
that have prevented the Panel from achieving a greater level of
consensus in its work to date. These include an approach in early
drafts that is often too broad in its treatment of institutions and
regulators, delays in preparing drafts driven by the significant
changes that must be made, and the inclusion of policy recommendations that are controversial and/or fall outside the Panel’s
statutory mission.
Through extended and extraordinary work, the Panel staff has
been able to incorporate a very large number of requests for
changes to the Report. While the improvements made to the text
of the August Report have been sufficient to allow me to support
its passage, I feel that it is important to highlight and clarify the
areas where problems remain, where consensus has not been
reached, and where the Panel should refocus its oversight efforts.
First, the August Report discusses and pursues specific changes
in or alternatives to existing federal policy. Some proposals are
framed as ‘‘alternatives,’’ others as ‘‘conclusions.’’ These include alternative Strategies for Dealing with Troubled Assets (pp. 36–39),
a discussion of proposals for The Future (pp. 58–60), and a series
of Conclusions (pp. 60–61). Engaging in an extended presentation
of policy alternatives and recommendations is inappropriate for
several reasons:
• Scope. Policy-making falls well outside the primary statutory
mission of the Congressional Oversight Panel. This is the job of
Congress, Treasury, and the responsible regulatory agencies. The
Panel should work to inform policy makers by collecting and presenting information, and providing sound analysis of existing
TARP programs. Good oversight may not always attract the same
headlines as controversial policy proposals, but it is valuable; more
important, this is the task assigned to the Panel.
• Expertise. Several of the assessments and conclusions within
the August Report are based upon the Panel staff performing loan
loss modeling and stress tests on financial institutions (see pp. 33–
35). The economic environment chosen—‘‘20 percent more negative’’—appears to be quite arbitrary, and a broad conclusion is
drawn that ‘‘. . . while the largest BHCs are sufficiently capitalized to deal with whole loan losses, the smaller BHC’s are not (p.
35).’’ These results are then used to suggest a modification or reevaluation of the capital ratios for financial institutions (p. 61, item
4). Conducting stress tests, making conclusions about regulatory
capital, and recommending changes to the capital requirements of
financial institutions are well outside the Panel’s area of responsibility and expertise.
• Timing. Even in a situation where some Panel members feel
that alternatives to existing programs should be discussed, we
should at least provide the opportunity for programs to be established before offering criticism. It is quite premature to consider

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modifications to PPIP, a program that has yet to be fully implemented.
• Costs to Taxpayers. At no point in the presentation of alternatives or conclusions are the potential costs to taxpayers discussed in detail. This includes, for example, a suggestion that
‘‘Treasury must* * *do whatever can be done to restart the market
for those securities’’ (p. 61, item 2) as well as recommendations for
conducting stress tests on smaller banks (p. 61, item 4). It is unwise to include sweeping, and potentially costly, suggestions in a
report that should be focused on basic oversight and program operations.
A second broad concern is that the time and effort devoted to extended discussion of policy alternatives in the August Report (as
well as previous Reports) has limited or even prevented the Panel’s
assessment of several key programs established under the TARP.
Congressman Jeb Hensarling provides a thorough summary of the
need for more oversight in these areas within his own Alternative
Views. Most notably, however, the Panel has yet to formally evaluate the following programs:
• Funding for Systemically Significant Failing Institutions (AIG)
• Funding and Programs affecting Fannie Mae and Freddie Mac
• Funding Provided to Auto Manufacturers, Automotive Parts
Manufacturers, and Automotive Finance Firms
• Portfolio Guarantees provided to Citigroup and Bank of America
These are large programs that consume over twenty percent of
the total funds Congress has authorized under TARP. Congress
and the public would benefit from the Panel’s assessment of their
structure, cost, and implementation to date. Nine months after establishing the Congressional Oversight Panel, this has yet to be
done.
The work of the Congressional Oversight Panel is important to
Congress, the Treasury, and to taxpayers. Our statutory mission
and primary focus should be to provide an independent assessment
of the operation and performance of programs created under the
Troubled Asset Relief Program. Where material weaknesses in programs exist, the Panel should be clear about the need for improvements. The Panel is not, however, a policy-making body. By refocusing effort on the essential oversight of TARP programs, the
Panel can better meet congressional intent and serve the public interest as well.

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B. Rep. Jeb Hensarling
Although I commend the Panel and its staff for their efforts in
producing the August Report, I do not concur with all of the analysis and conclusions presented in the report and cannot support its
approval.
The Panel proposes a number of approaches regarding the problems presented by toxic assets. Although there is no assurance that
any of these alternatives will offer definitive solutions, it is clear
that most of the proposals will require taxpayers to fund significant
amounts either to purchase distressed loans and securities or propup problematic financial institutions. It is possible that the toxic
asset market is already beginning to heal itself and that the inter-

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vention proposed by the Panel could be inappropriate—if not counterproductive. For this reason, I think it premature to endorse one
or more of the approaches proposed by the Panel, but, instead, suggest that Treasury and the Fed continue to monitor the toxic asset
market. If the ‘‘green shoots’’ of economic recovery continue to develop it’s likely that the bid-asked spreads for toxic assets will narrow as the sellers and buyers of those assets regain confidence and
as the inventory of houses and commercial property is absorbed
into the broader economy.201 The process will not proceed as quickly as we would like. In my view, a less than optimal pace of recovery should not be used by the Obama Administration or Congress
to justify additional governmental investment of involuntary taxpayer capital.202
As the report alludes, there is no doubt a need for an ‘‘accurate
valuation’’ of the projected losses and capital shortfalls arising from
the troubled assets that continue to plague the balance sheets and
income statements of both large and small financial institutions.
Were such a valuation accomplished, it would be helpful in assessing systemic financial contagion and establishing a path to economic recovery. Although an interesting and insightful project, this
is a task that I view as almost impossible and one not nearly as
important as providing taxpayers with insight into whether TARP
is actually working and what financial institutions (and even auto
makers) have done with TARP investments.
The Panel originally undertook to model whole loans and
securitized loans, but finally chose to model only projected losses
and capital shortfalls arising from whole loans held by certain
‘‘banks.’’ The Panel started with the ‘‘more adverse’’ assumptions
used by the Federal Reserve Board in conducting the recently completed stress-test analysis and then ran the numbers again based
upon assumptions that were 20 percent more negative. The Panel
concluded that ‘‘while the 18 largest BHCs are sufficiently capitalized to deal with whole loan losses, the . . . smaller BHCs . . . are
not, and are going to require additional capital given more adverse
economic conditions.’’ While I am encouraged by the Panel’s conclusion regarding the 18 largest BHCs, I am not necessarily discouraged by the results for the smaller banks since it is entirely possible that the input assumptions used by the Panel were excessively pessimistic. As with any econometric model, input assumptions drive the output results and it is far from clear that future
economic conditions will be 20 percent more negative than the
‘‘more adverse’’ standard adopted by the Fed for the stress-tests.
Observers should resist the temptation to report the Panel’s finding
in this regard in a simplistic and alarmist manner.
201 See, e.g., Sara Murray, Job Losses Slow as Rate Drops, Wall Street Journal (Aug. 8, 2009)
(online at online.wsj.com/article/SB124964812540714249.html); Peter A. McKay and Donna
Kardos Yesalavich, Job Report Keeps Wind Behind Stocks, Wall Street Journal (Aug. 10, 2009)
(online at online.wsj.com/article/SB124964397459514109.html) (noting that the Dow Jones Industrial Average and S&P 500 rose to their highest levels of 2009); Liam Pleven, AIG Returns
to
a
Tenuous
Profit
(Aug.
10,
2009)
(online
at
online.wsj.com/article/
SB124964014232314037.html).
202 In fact, even the suggestion that the government will somehow come to the rescue regarding losses and capital inadequacies generated by toxic assets may create moral hazard issues,
impede true price discovery and thwart the healing process that appears to have already commenced. That said, it is important to remain vigilant and the Panel should continue to monitor
issues created by distressed whole loans and securitized loans.

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65
When an oversight body attempts to place a price tag on any
group of toxic assets, the implication is that the government must
intervene to either purchase or arrange a purchase of such assets,
which would likely require a generous taxpayer subsidy as an incentive to remove them from the holders’ balance sheets. If assets
like mortgage-backed securities are thinly-traded because spreads
are too wide for a legitimate price discovery process, then a valuation below the reservation price of the financial institutions holding the assets could infer that the government should inject even
more capital into the institutions. A valuation equal to or above the
reservation price of the financial institutions could infer that the
government should subsidize private investors. As I discussed in an
addendum to the Panel’s July Report on TARP warrant repurchases, I am worried that the current report may again attempt to
jumpstart the price discovery process using mechanisms the Panel
or outside experts have developed without understanding the costly
consequences.
In the section of the report dedicated to ‘‘The Future’’ of the Continued Risk of Toxic Assets, the Panel concludes: ‘‘Even given its
use to restart the markets rather than to take large numbers of
troubled assets off bank balance sheets, Treasury should consider
whether the PPIP legacy securities program should be expanded if
the markets would appear to benefit from additional ‘pumppriming.’ If the program is not working, Treasury should consider
adopting a different strategy to remove the troubled assets from
banks’ books.’’ Additionally, in the ‘‘Conclusion’’ section of the current report the Panel states: ‘‘Treasury must assure robust legacy
securities and legacy loan programs or consider a different strategy
to do whatever can be done to restart the market for those assets.’’
Although limited governmental intervention may be merited
under certain circumstances, both of these recommendations seem
to me as advocacy for yet another bailout of failed federal program
with involuntary taxpayer capital while voluntary investor capital
remains on the sidelines—largely due to the uncertainty injected
into the program by the Administration and by Congress. It is
worthwhile to note that private capital has given a lackluster reception to Treasury’s Public-Private Investment Program (PPIP),
citing concerns about ‘‘doing business with the government.’’ Many
investors factor ‘‘Country Risk’’ into investment decisions when
dealing in economies affected by unstable governments. My fear is
now they must now do so when investing in the United States
economy.
If PPIP’s investment vehicles experience high returns, and participants are paid contractually-agreed upon returns, will they be
subject to confiscatory measures if the amounts are considered in
retrospect ‘‘excessive’’? What sort of corporate governance measures
will be required? Could statutory provisions governing TARP be enacted that would apply additional restrictions? The Panel’s report
does not adequately address these issues. With such questions lingering, firms will calculate the risks associated with a program like
PPIP and quite possibly view alternative investments as more favorable undertakings. As I discussed in an addendum to the Farm

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Credit Report,203 it is critical that the Obama Administration and
Congress properly vet all issues of ‘‘political risk’’ 204 that may arise
with respect to any retroactive mandates that are incorporated into
the PPIP program after its launch.205
I am also troubled by the nature of the Panel’s oversight as presented in this report. Once again, the policy recommendations presented in the report is outside the scope of the Panel’s authority
and could diminish the Panel’s ability to discharge its statutory responsibility of investigating current programs in dire need of oversight. TARP has morphed into a complex web of eight official programs, 206 and the Panel should continue to press Treasury for a
legal justification for its authority to recycle TARP funds for other
uses and new programs. In my view, proper oversight should include (1) analyzing programs proposed by Treasury to determine if
they are reasonable, transparent, accountable and properly designed for their intended purpose, (2) determining if the programs
are being properly implemented in a reasonable, transparent and
accountable manner, (3) determining if taxpayers are being protected, (4) determining the success or failure of the programs based
upon reasonable, transparent, accountable and objective metrics,
(5) analyzing Treasury’s exit strategy with respect to each investment of TARP funds, (6) analyzing the corporate governance policies and procedures implemented by Treasury with respect to each
203 My comments on political risk are noted on pages 99–100 of the Farm Credit Report at
cop.senate.gov/documents/cop-072109-views.pdf.
In addition, many recipients have been stigmatized by their association with TARP and wish
to leave the program as soon as their regulators permit. Some of the adverse consequences that
have arisen for TARP recipients include, without limitation, executive compensation restrictions,
corporate governance and conflict of interest issues, employee retention difficulties and the distinct possibility that TARP recipients (including those who have repaid all Capital Purchase
Program advances but have warrants outstanding to Treasury) may be subjected to future adverse rules and regulations. In my opinion the TARP program should be terminated due to,
among other reasons, (1) the clear desire of the American taxpayers for the TARP recipients
to repay all TARP related investments sooner rather than later, (2) the troublesome corporate
governance and regulatory conflict of interest issues raised by Treasury’s ownership of equity
interests in the TARP recipients, (3) the stigma associated with continued participation in the
TARP program by the recipients, and (4) the demonstrated ability of the current Administration
to use the program to promote its economic, social and political agenda. I introduced legislation
(H.R. 2745) to end the TARP program on December 31, 2009. In addition, the legislation (1)
requires Treasury to accept TARP repayment requests from well capitalized banks, (2) requires
Treasury to divest its warrants in each TARP recipient following the redemption of all outstanding TARP-related preferred shares issued by such recipient and the payment of all accrued
dividends on such preferred shares, (3) provides incentives for private banks to repurchase their
warrant preferred shares from Treasury, and (4) reduces spending authority under the TARP
program for each dollar repaid.
204 The report includes the following single reference to ‘‘political risk’’: ‘‘Similarly, it is unclear
whether wariness of political risks will inhibit the willingness of potential buyers to purchase
these assets.’’ This is far too significant of an issue to be brushed aside with such a muted acknowledgement.
205 In addition, I have other concerns with the PPIP program. Will the newly revised markto-market rules discourage holders of distressed securities from selling those securities to a
PPIP partnership or another purchaser? Holders may understandably elect not to dispose of
their distressed securities if the sales would generate accounting losses and increase the holders’
capital requirements. Will the PPIP program create a sufficient market for distressed securities
so as to require holders of such securities to apply mark-to-mark accounting even though they
may have no present intent to sell the securities? If so, many financial institutions may have
to book additional losses and raise new capital. Is the PPIP program simply a subsidy by the
government that finances the purchase of distressed securities at inflated prices? If so, the program may do more harm than good when non-subsidized purchasers refuse to purchase distressed securities at the subsidized prices.
206 The eight official programs are as follows: (1) Capital Purchase Program (initial equity injections to institutions), (2) Automotive Industry Financing Program, (3) Automotive Supplier
Support Program, (4) Targeted Investment Program (Citigroup, Bank of America), (5) Asset
Guarantee Program, (6) Consumer and Business Lending Initiative Investment Program (TALF
cushion), (7) Systemically Significant Failing Institutions (AIG) and (8) Home Affordable Modification Program.

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investment of TARP funds, (7) holding regular public hearings with
the Secretary and other senior Treasury officials as well as with
the senior management of the institutions that received TARP
funds, (8) determining how TARP recipients invested and deployed
their TARP funds, and, most importantly, (9) reporting the results
to the taxpayers in a clear and concise manner. The Panel should
conduct its oversight activity in the most reasonable, transparent,
accountable and objective manner possible with measurable standards that hold Treasury accountable for the statutory mandate of
EESA that taxpayer protection is made an upmost priority.207
In addition to providing ongoing oversight across TARP programs, it troubles me that the Panel does not investigate and report upon the following uses of taxpayer funds, which carry significant exposure to risk, on a more regular basis. The Panel should
rigorously apply the above strategy to ensure complete transparency for the taxpayers.
Systemically Significant Failing Institutions Program: This is the
formal name given to the rescue of AIG using $69.84 billion 208 in
TARP funds.
In April of 2009, Treasury made the decision to add almost $30
billion to the existing $40 billion already provided to AIG in exchange for preferred stock with warrants. The government has a
77.9 percent stake in the insurer. Were it to convert preferred
shares into common equity, as occurred for Citigroup, the nature
of ownership would change and taxpayer risk would be enhanced.
(On top of this, the Federal Reserve has created a $60 billion revolving loan facility for AIG, of which $25 billion will be forgiven
in exchange for preferred interest in two of its life insurance subsidies.209 It also holds $36 billion in AIG mortgage-backed securities through ‘‘Maiden Lane II LLC’’ and ‘‘Maiden Lane III
LLC.’’) 210 Even though AIG just announced that it turned a quarterly profit for the first time in two years, it is still a struggling
company that continues to draw on government loans.211 CEO Edward Liddy has stated that he expects to repay the government in
three to five years,212 although he has provided no detailed plan
on how this will be accomplished.
While it has conducted some meaningful oversight since November, the Panel has provided limited oversight of TARP funds invested in AIG and its affiliates.
207 EESA § 113, ‘‘Minimization of Long-Term Costs and Maximization of Benefits for Taxpayers.’’
208 U.S. Department of the Treasury, Section 105(a) Troubled Assets Relief Program Report to
Congress for the Period June 1, 2009 to June 30, 2009 (July 10, 2009) (online at
www.financialstability.gov/docs/105CongressionalReports/105aReportl07102009.pdf)
(hereinafter July 10 TARP Congressional Report’’).
209 U.S. Department of the Treasury, U.S. Treasury and Federal Reserve Board Announce Participation in AIG Restructuring Plan (Mar. 2, 2009) (online at www.financialstability.gov/latest/
tg44.html).
210 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release
H.4.1: Factors Affecting Reserve Balances (Aug. 6, 2009) (online at www.federalreserve.gov/releases/h41/Current/) (accessed Aug. 10, 2009).
211 David Goldman, AIG logs first quarterly profit since 2007, CNNMoney (Aug. 7, 2009) (online
at
money.cnn.com/2009/08/07/news/companies/aiglearnings/index
.htm?postversion=2009080707&eref=edition).
212 Id.

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Citigroup and Bank of America: Citigroup has received $45 billion 213 in committed aid through TARP’s Capital Purchase Program and Targeted Investment Program. On top of that, Treasury
and the FDIC have agreed to guarantee about $306 billion 214 in
assets of Citigroup.
Bank of America has received $45 billion 215 in committed aid
through TARP’s Capital Purchase Program and Targeted Investment Program. On top of that, Treasury and the FDIC have agreed
to guarantee about $118 billion 216 in assets, the majority of which
Bank of America acquired through Merrill Lynch.
It is the Panel’s responsibility to shed light into TARP, including
the Citigroup and Bank of America investments. The stress tests
performed by the Federal Reserve assessed the capital needed for
both institutions to survive an additional round of losses or further
deterioration of earnings. It did not, however, fully gauge the
banks’ ability to repay TARP funds or track the ways they channeled the money. The Panel should be conducting ongoing interviews with these and other major recipients of TARP funds to
probe for such information, as well as to hold Treasury accountable
for articulating its exit strategy with respect to each investment.
In addition, I repeat my concerns that no major traditional financial institution has testified before the Panel. In fact, only three
TARP recipients have appeared as hearing witnesses; the largest
was M&T Bank Corporation, which received $600 million in aid.
While it has conducted some meaningful oversight since November, the Panel has provided limited oversight of how taxpayer
funds were spent by financial institutions.
Chrysler and GM: The panel held a field hearing on July 27,
2009 featuring Ron Bloom from the President’s Auto Task Force,
Chrysler and GM officials, bankruptcy experts and a representative
from the Indiana State pension funds, a creditor of Chrysler. No
witness from the UAW, which currently holds a 67.7 percent stake
in Chrysler and a 17.5 percent stake in GM through its retiree benefits trust, was available to testify, despite the Panel’s selection of
a hearing location that was about a 15-minute drive from UAW
headquarters.
Because this is a significant and ongoing issue involving over $80
billion 217 in TARP funds and government ownership—and several
questions remain unanswered about Treasury’s involvement in the
bankruptcy negotiations—it is incumbent upon the Panel to make
oversight of the two automakers a key area of continuing focus beyond the Panel’s report that is scheduled for release in early September.
Here is an overview of the post-bankruptcy allocations of Chrysler and GM.
Chrysler. Pursuant to the Chrysler bankruptcy, the equity of
New Chrysler was allocated as follows:

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213 July

10 TARP Congressional Report, supra note 208.
214 U.S. Department of the Treasury, Joint Statement by Treasury, Federal Reserve and the
FDIC on Citigroup (Nov. 23, 2008) (online at www.financialstability.gov/latest/hp1287.html).
215 July 10 TARP Congressional Report, supra note 208.
216 U.S. Department of the Treasury, Treasury, Federal Reserve and the FDIC Provide Assistance to Bank of America (Jan. 16, 2009) (online at www.financialstability.gov/latest/
hp1356.html).
217 July 10 TARP Congressional Report, supra note 208 $80 billion includes TARP investments in Chrysler Financial Services Americas LLC and GMAC LLC.

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69
1. United States government (9.846 percent initially, but
may decrease to 8 percent),
2. Canadian government (2.462 percent initially, but may decrease to 2 percent),
3. Fiat (20 percent initially, but may increase to 35 percent),
and
4. UAW (comprising current employee contracts and a VEBA
for retired employees) (67.692 percent, but may decrease to 55
percent).
The adjustments noted above permit Fiat to increase its ownership interest from 20 percent to 35 percent by achieving specific
performance goals relating to technology, ecology and distribution
designed to promote improved fuel efficiency, revenue growth from
foreign sales and U.S. based production.
Some, but not all, of the claims of the senior secured creditors
were of a higher bankruptcy priority than the claims of the UAW/
VEBA. The Chrysler senior secured creditors received 29 cents on
the dollar ($2 billion cash for $6.9 billion of indebtedness).
The UAW/VEBA, an unsecured creditor, received (1) 43 cents on
the dollar ($4.5 billion note from New Chrysler for $10.5 billion of
claims) and (2) a 67.692 percent (which may decrease to 55 percent) equity ownership interest in New Chrysler.
GM. Pursuant to the GM bankruptcy, the equity of New GM was
allocated as follows:
1. United States government (60.8 percent),
2. Canadian government (11.7 percent),
3. UAW (comprising current employee contracts and a VEBA
for retired employees) (17.5 percent), and
4. GM bondholders (ten percent).
The bankruptcy claims of the UAW/VEBA and the GM bondholders were of the same bankruptcy priority.
The equity interest of the UAW/VEBA and the GM bondholders
in New GM may increase (with an offsetting reduction in each government’s equity share) to up to 20 percent and 25 percent, respectively, upon the satisfaction of specific conditions. It is important
to note, however, the warrants received by the UAW/VEBA and the
GM bondholders are substantially out of the money and it’s unlikely they will be exercised. As such, it seems most likely that the
UAW/VEBA and the GM bondholders will hold 17.5 percent and
ten percent, respectively, of the equity of New GM.
The GM bondholders exchanged $27 billion in unsecured indebtedness for a ten percent (which may increase to 25 percent) common equity interest in New GM, while the UAW/VEBA exchanged
$20 billion in claims for a 17.5 percent (which may increase to 20
percent) common equity interest in New GM and $9 billion in preferred stock and notes in New GM.
Among others, I have asked that the Administration answer the
following questions for the record:
• Will the Administration provide the Panel with the written criteria the Administration uses to determine which entities or types
of entities are allowed to receive assistance through TARP?
• How much additional funding and credit support does the Administration expect to ask the American taxpayers to provide each
of Chrysler and GM (1) by the end of this year and (2) during each

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70
following year until all investments have been repaid in full in cash
and all credit support has been terminated? What will be the
source of these funds?
• Will the Administration provide the Panel with a formal written legal opinion justifying (1) the use of TARP funds to support
Chrysler and GM prior to their bankruptcies, (2) the use of TARP
funds in the Chrysler and GM bankruptcies, (3) the transfer of equity interests in New Chrysler and New GM to the UAW/VEBAs,
and (4) the delivery of notes and other credit support by New
Chrysler and New GM for the benefit of the UAW/VEBAs?
• Will the Administration agree to provide the American taxpayers with timely reports describing in sufficient detail the full
extent of their investments in Chrysler and GM?
• What is the Administration’s exit strategy regarding Chrysler
and GM?
• When does the Administration anticipate that Chrysler and
GM will repay in full in cash all TARP funds advanced by the
American taxpayers?
• By making such an unprecedented investment in Chrysler and
GM the United States government by definition chose not to assist
other Americans that are in need. Given the economic suffering
that the American taxpayers have endured during the last several
months please tell us why Chrysler and GM merited such generosity to the exclusion of other American taxpayers? In other
words, why would the United States government choose to reward
two companies that have been mismanaged for many years, as evidenced by a protracted deterioration in the financials of both companies, at the expense of hard working American taxpayers? What
information does the Administration possess that proves Chrysler
and GM are both sound investments for the taxpayer?
• TARP funds were used by New Chrysler and New GM to purchase assets of the old auto makers, yet a substantial portion of the
equity in the new entities was transferred to the UAW/VEBAs. As
such, TARP funds were transferred to the UAW/VEBAs. In addition, New Chrysler and New GM entered into promissory notes and
other contractual arrangements for the benefit of the UAW/VEBAs.
Why did the United States government spend billions of dollars of
taxpayer money to give preference to employees and retirees of the
UAW to the detriment of other non-UAW employees and retirees
whose pension funds invested in Chrysler and GM indebtedness?
Why didn’t New Chrysler and New GM transfer some of their equity interests to, or enter into promissory notes and other contractual arrangements for the benefit of, the non-UAW/VEBA creditors
of Old Chrysler and Old GM?
• Given the judicial holdings in the Chrysler and GM bankruptcies, one might expect future firms to face a higher cost of capital, thus impeding economic development at a time when the country can least afford impediments to growth. Did the Administration
consider these consequences when it orchestrated a plan that deprived certain creditors of the benefit of their bargains? How does
the Administration defend the concern that, based on the Chrysler
and GM precedents, the contractual rights of investors may be ignored when dealing with the United States government?

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71
• Will Chrysler and GM promptly disclose all contractual arrangements with (1) the United States government and (2) recipients of TARP funds, together with a detailed description of the contract, its purpose, the transparent and open competitive bidding
process undertaken and the arm’s length and market directed nature of the contract?
• Will Chrysler or GM be able to obtain private or public credit
or enter into other contractual arrangements at favorable rates because of the implicit governmental guarantee of such indebtedness
and contracts?
• How will the United States government resolve any conflict of
interest issues arising from its role as a creditor or equity holder
in Chrysler and GM and as a supervising governmental authority
for Chrysler and GM?
• Did the Administration in any manner pressure or encourage
Chrysler to accept a deal with Fiat?
• Did the Administration in any manner thwart or discourage
any merger or business combination or arrangement between
Chrysler and GM?
• Regarding the reorganization of the auto parts manufacturer,
Delphi, on July 17 The New York Times reported:
Delphi’s new proposal [reached with its lender group] is similar
to its agreement with Platinum [Equity, a private equity firm],
which was announced June 1, the day GM filed for bankruptcy.
But hundreds of objectors, including the company’s debtor-in-possession lenders, derided that proposal as a ‘‘sweetheart deal’’ that
gave the private equity firm control of Delphi for $250 million and
a $250 million credit line.
On June 24 The New York Times reported that ‘‘Delphi worked
with G.M. and the Obama administration to negotiate with Platinum. . .’’
Why would the Administration participate in the negotiation of
a ‘‘sweetheart deal’’ for the benefit of Platinum Equity?
• Thomas E. Lauria, the Global Practice Head of the Financial
Restructuring and Insolvency Group at White & Case LLP, represented a group of senior secured creditors, including the Perella
Weinberg Xerion Fund (‘‘Perella Weinberg’’), during the Chrysler
bankruptcy proceedings.
On May 3, The New York Times reported:
In an interview with a Detroit radio host, Frank Beckmann, Mr. Lauria said that Perella Weinberg ‘‘was directly
threatened by the White House and in essence compelled
to withdraw its opposition to the deal under threat that
the full force of the White House press corps would destroy
its reputation if it continued to fight.’’
In a follow-up interview with ABC News’s Jake Tapper, he identified Mr. [Steven] Rattner, the head of the auto task force, as having told a Perella Weinberg official that the White House ‘‘would
embarrass the firm.’’
At the hearing Mr. Bloom stated that Mr. Rattner denied Mr.
Lauria’s allegations.

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Has any member of the Administration spoken with Mr. Lauria
or representatives of Perella Weinberg regarding this matter?
If so, what did they say? If not, why not?
Does the Administration plan to ask SIGTARP to subpoena Mr.
Rattner, Mr. Lauria and representatives of Perella Weinberg and
ask them to respond under oath? If not, why not?
Expansion of Fannie Mae and Freddie Mac through TARP: Housing government-sponsored enterprises (GSEs) Fannie Mae and
Freddie Mac,218 which currently have books of business totaling
$5.27 trillion, or 72 percent of the housing market, are a centerpiece of Treasury’s ‘‘Making Home Affordable’’ plan. Fifty billion
dollars from TARP has been committed to this loan modification effort, which is being run by the two GSEs. This TARP money will
not be recouped, according to the Congressional Budget Office,
which has assigned a 100 percent subsidy rate to the program. The
largest segment of the plan, the Home Affordable Modification Plan
(HAMP) has so far failed to produce the results the Administration
initially advertised. When it was launched, Treasury said HAMP
would serve three to four million homeowners, but a recent GAO
report indicated it has only helped 180,000 borrowers as of July 20,
2009.219

218 On September 6, 2008, Treasury put the Federal National Mortgage Association [Fannie
Mae] and the Federal Home Loan Mortgage Corporation [Freddie Mac] into conservatorship
under the Federal Housing Finance Agency [FHFA].
219 Government Accountability Office, Troubled Assets Relief Program: Treasury Actions Needed to Make the Home Affordable Modification Program More Transparent and Accountable (July
23, 2009) (GAO09/837) (online at www.gao.gov/new.items/d09837.pdf).

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SECTION THREE: CORRESPONDENCE WITH TREASURY
UPDATE
On behalf of the Panel, Chair Elizabeth Warren sent a letter on
July 20, 2009,220 to Secretary of the Treasury Timothy Geithner
and Chairman Bernanke requesting copies of confidential memoranda of understanding involving informal supervisory actions entered into by the Federal Reserve Board and the Office of the
Comptroller of the Currency with Bank of America and Citigroup.
The letter further requests copies of any similar future memoranda
of understanding executed with Bank of America, Citigroup, or any
of the other bank holding companies that were subject to the Supervisory Capital Assessment Program (SCAP). Finally, the letter
asks that the Panel be apprised of any other confidential agreements relating to risk and liquidity management that Treasury, or
any of the bank supervisors, has or will enter into with any of the
SCAP bank holding companies. The Panel is waiting for Secretary
Geithner’s and Chairman Bernanke’s responses.
On behalf of the Panel, Chair Elizabeth Warren sent a letter on
May 26, 2009,221 to Secretary Geithner requesting information
about Treasury’s Temporary Guarantee Program for Money Market
Funds, which is funded by TARP. The Temporary Guarantee Program uses assets of the Exchange Stabilization Fund to guarantee
the net asset value of shares of participating money market mutual
funds. The letter requests a description of the program mechanics
and an accounting of its obligations and funding mechanisms. On
July 21, 2009, Secretary Geithner responded by letter to this request.222
On behalf of the Panel, Chair Elizabeth Warren sent a letter on
May 19, 2009,223 to Secretary Geithner and Chairman Bernanke
referencing public concern that Treasury and the Board had applied strong pressure on Bank of America to complete its acquisition of Merrill Lynch, despite Bank of America’s concerns about
Merrill Lynch’s deteriorating financial state. The letter cites this
episode as an example of the conflicts of interest that can arise
when the government acts simultaneously as regulator, lender of
last resort, and shareholder. The letter concludes by soliciting Secretary Geithner’s and Chairman Bernanke’s thoughts on how to
manage these inherent conflicts to ensure that similar episodes do
not undermine government efforts to stabilize the financial system
in the future. On July 21, 2009, Secretary Geithner responded by
letter.224 The Panel has not yet received a response from Chairman
Bernanke.
Chair Elizabeth Warren and Panel member Richard H. Neiman
sent a letter to Secretary Geithner on June 29, 2009,225 requesting
assistance with the Panel’s oversight of federal foreclosure mitigation efforts. In order to evaluate the effectiveness of foreclosure
mitigation efforts, the letter requests copies of the data collected
under the Making Home Affordable program, as well as relevant
220 See

Appendix
Appendix
Appendix
223 See Appendix
224 See Appendix
225 See Appendix
221 See

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222 See

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II of this report, infra.
III of this report, infra.
IV of this report, infra.
V of this report, infra.
VI of this report, infra.

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reports, beginning on July 31, 2009, and monthly thereafter. Assistant Secretary for Financial Stability Herbert Allison responded
on July 29, 2009.226 The Panel continues to work with Treasury to
obtain the necessary data and reports.

226 See

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SECTION FOUR: TARP UPDATES SINCE LAST REPORT
A. General Motors Emerges From Bankruptcy
General Motors emerged from bankruptcy on July 10, 2009, as
a new, smaller company with a pared down product line and plans
to cut up to 35 percent of its management-level positions. The
bankruptcy proceedings were completed in less than six weeks. The
federal government holds approximately 60 percent of the outstanding shares of the new GM.
B. TARP Repayment
Financial institutions Goldman Sachs, State Street, BB&T, US
Bancorp, American Express, Bank of New York Mellon and Morgan
Stanley have repurchased all of the outstanding warrants that
were issued by each firm to the U.S. Treasury under the Capital
Purchase Program (CPP) in late 2008. Goldman Sachs paid back
$10 billion in TARP funds, and paid $1.1 billion to repurchase its
outstanding warrants. State Street paid back $2 billion in TARP
funds, and paid $60 million to repurchase its outstanding warrants.
BB&T paid back $3.13 billion in TARP funds, and paid $67 million
to repurchase its outstanding warrants. US Bancorp paid back
$6.599 billion in TARP funds, and paid $139 million to repurchase
its outstanding warrants. American Express paid back $3.389 billion in TARP funds, and paid $340 million to repurchase its outstanding warrants. Bank of New York Mellon repaid $3 billion in
TARP funds, and repurchased its outstanding warrants for $163
million. Morgan Stanley paid back $10 billion in TARP funds, and
paid $950 million to repurchase its outstanding warrants.
JPMorgan has repaid $25 billion but has declined to repurchase its
warrants, instead asking Treasury to sell them at auction. A total
of 33 banks have fully repaid their TARP investment provided
under the CPP to date.
C. CPP Monthly Lending Report
Treasury releases a monthly lending report showing loans outstanding for CPP recipients. The most recent report includes data
up through the end of May 2009 and shows that CPP recipients
had $5.13 billion in loans outstanding as of May 31, 2009. This represents a 0.39 percent decline in loans between the end of April
and the end of May.

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D. Regulatory Reform Proposals
The Obama Administration has sent a series of legislative proposals to Congress over the past several weeks. Among the proposals are legislation to increase the SEC’s authority to regulate investment advisers and broker-dealers, require hedge funds to register with the SEC, provide shareholders with a non-binding ‘‘say
on pay’’ or vote on executive compensation, increase compensation
committee independence, increase the SEC’s authority over rating
agencies, consolidate the Office of Thrift Supervision and the Office
of the Comptroller of the Currency into a new National Bank Supervisor, provide the federal government with emergency authority

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76
to resolve any large, interconnected financial firm in an orderly
manner, and provide Treasury the authority to appoint the FDIC
or the SEC as conservator or receiver for a failing financial firm
that poses a threat to financial stability.
E. Legacy Loan Program (Public Private Investment
Program)
The Legacy Loan Program, which is part of the Public-Private Investment Program, was designed to remove troubled loans from the
balance sheets of banks. In June, the Federal Deposit Insurance
Corporation announced that it would conduct a test pilot of the program with the sale of bank assets in receivership. On July 31,
2009, the FDIC announced that it will conduct its first testing of
the Legacy Loan Program funding mechanism.
Under the pilot program, the receivership will transfer a portfolio
of residential mortgage loans to a limited liability company (LLC)
on servicing basis in exchange for an ownership interest in the
LLC. The LLC will also sell an equity share to investors, who will
be responsible for managing the portfolio. Investors will be offered
two different options. The first option is on an all cash basis with
the FDIC owning an equity share of 80 percent and the investor
owning 20 percent. The second option is a sale with leverage based
on a 50–50 equity split between the FDIC and the investor.
According to the FDIC, the funding mechanism is financing offered by the receivership to the LLC using an amortizing note that
is guaranteed by the FDIC. Financing will be offered with leverage
of either 4–to–1 or 6–to–1, depending upon certain elections made
in the bid submitted by the private investor.’’

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F. Term Asset-Backed Securities Loan Facility (TALF)
The Federal Reserve Bank of New York held its second special
subscription on July 16, 2009, for TALF loans secured by commercial mortgage-backed securities (CMBS). The second subscription
made loans available for both newly issued (issued on or after January 1, 2009) and legacy CMBS (issued before January 1, 2009).
The first subscription had made loans available only for newly
issued CMBS. During the July 16th subscription, $669 million in
TALF loans were requested. All of the loans were requested for legacy CMBS; no loans were requested for newly issued CMBS. The
next subscription for CMBS will occur August 20, 2009.
During the regular TALF subscription on August 6, 2009, $6.9
billion in loans was requested. As a point of comparison, there were
$5.4 billion in loans requested at the July facility, $11.5 billion requested at the June facility, $10.6 billion requested at the May facility, $1.7 billion at the April facility, and $4.7 billion at the March
facility. The August 6th subscription included requests for loans secured by asset-backed securities in the auto, credit card, floor plan,
servicing advances, small business, and student loan sectors. There
were no requests for loans in the equipment, or premium finance
sectors.

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77
G. Home Price Decline Protection Incentives
On July 31, 2009, Treasury announced the Home Price Decline
Protection (HPDP) Program. HDPD is an expansion to the Home
Affordable Modification Program (HAMP). Under the HPDP, Treasury will provide investors additional incentives for loan modifications made under HAMP on homes located in areas where home
prices housing declined. According to Treasury, ‘‘incentive payments will be linked to the rate of recent home price decline in a
local housing market, as well as the unpaid principal balance and
mark-to-market loan-to-value ratio of the mortgage loan.’’ Only
HAMP loan modifications begun after September 1, 2009 are eligible for HPDP payments. Mortgage loans that are owned or guaranteed by Fannie Mae or Freddie Mac are not eligible. Treasury has
allocated up to $10 billion for the new program.
H. Metrics

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The Panel continues to monitor a number of financial market indicators that the Panel and others, including Treasury, the Government Accountability Office (GAO), Special Inspector General for
the Troubled Asset Relief Program (SIGTARP), and the Financial
Stability Oversight Board, consider useful in assessing the effectiveness of the Administration’s efforts to restore financial stability
and accomplish the goals of the EESA. This section discusses
changes that have occurred since the release of the Panel’s July report.
• Interest Rate Spreads. Key interest rate spreads have leveled off following precipitous drops between the Panel’s May and
June oversight reports. Spreads remain well below the crisis levels
seen late last year, and Treasury and Federal Reserve officials continue to cite the moderation of these spreads as a key indicator of
a stabilizing economy.227

227 See Allison Testimony, supra note 37 (‘‘There are tentative signs that the financial system
is beginning to stabilize and that our efforts have made an important contribution. Key indicators of credit market risk, while still elevated, have dropped substantially.’’)

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78
FIGURE 18: INTEREST RATE SPREADS
Current Spread228
(as of 8/05/09)

Indicator

3 Month LIBOR-OIS Spread 229 ................................................................
1 Month LIBOR-OIS Spread 230 ................................................................
TED Spread 231 (in basis points) ............................................................
Conventional Mortgage Rate Spread 232 .................................................
Corporate AAA Bond Spread 233 ..............................................................
Corporate BAA Bond Spread 234 ..............................................................
Overnight AA Asset-backed Commercial Paper Interest Rate Spread 235
Overnight A2/P2 Nonfinancial Commercial Paper Interest Rate
Spread 236 ............................................................................................

Percent Change Since Last
Report (7/9/09)

0.27
0.09
29.26
1.58
1.73
3.24
0.21

¥12.9%
¥18.18%
11.17%
¥0.63%
¥7.49%
¥11.23%
16.67%

.18

¥33.33%

228 Percentage

points, unless otherwise indicated.
229 3 Mo LIBOR-OIS Spread, Bloomberg (online at www.bloomberg.com/apps/quote?ticker=.LOIS3:IND) (accessed Aug. 5, 2009).
230 1 Mo LIBOR-OIS Spread, Bloomberg (online at www.bloomberg.com/apps/quote?ticker=.LOIS1:IND) (accessed Aug. 5, 2009).
231 TED Spread, Bloomberg (online at www.bloomberg.com/apps/quote?ticker=.TEDSP:IND) (accessed Aug. 5, 2009).
232 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release H.15: Selected Interest Rates: Historical Data (Instrument:
Conventional
Mortgages,
Frequency:
Weekly)
(online
at
www.federalreserve.gov/releases/h15/data/WeeklylThursdayl/H15lMORTGlNA.txt) (accessed Aug. 5, 2009); 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
10–Year,
Frequency:
Weekly)
(online
at
www.federalreserve.gov/releases/h15/data/WeeklylFridayl/H15lTCMNOMlY10.txt) (accessed Aug. 5, 2009) (hereinafter ‘‘Fed H.15 10–Year
Treasuries’’).
233 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/WeeklylFridayl/H15lAAAlNA.txt) (accessed Aug. 5, 2009); Fed H.15 10–Year Treasuries, supra
note 232.
234 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/WeeklylFridayl/H15lBAAlNA.txt) (accessed Aug. 5, 2009); Fed H.15 10–Year Treasuries, supra
note 232.
235 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release: Commercial Paper Rates and Outstandings: Data
Download
Program
(Instrument:
AA
Asset-Backed
Discount
Rate,
Frequency:
Daily)
(online
at
www.federalreserve.gov/DataDownload/Choose.aspx?rel=CP) (accessed July 9, 2009); Board of Governors of the Federal Reserve System, Federal
Reserve Statistical Release: Commercial Paper Rates and Outstandings: Data Download Program (Instrument: AA Nonfinancial Discount Rate,
Frequency: Daily) (online at www.federalreserve.gov/DataDownload/Choose.aspx?rel=CP) (accessed Aug. 5, 2009) (hereinafter ‘‘Fed CP AA Nonfinancial Rate’’).
236 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release: Commercial Paper Rates and Outstandings: Data
Download
Program
(Instrument:
A2/P2
Nonfinancial
Discount
Rate,
Frequency:
Daily)
(online
at
www.federalreserve.gov/DataDownload/Choose.aspx?rel=CP) (accessed Aug. 5, 2009); Fed CP AA Nonfinancial Rate, supra note 235.

• Commercial Paper Outstanding. Commercial paper outstanding, a rough measure of short-term business debt, is an indicator of the availability of credit for enterprises. All three measured commercial paper values decreased since the Panel’s July report. Asset-backed, financial and nonfinancial commercial paper
have all decreased since October 2008 with nonfinancial commercial paper outstanding declining by over 44 percent.
FIGURE 19: COMMERCIAL PAPER OUTSTANDING
Current Level
(as of 7/31/09)
(dollars billions)

Indicator

Asset-Backed Commercial Paper Outstanding (seasonally adjusted) 237
Financial Commercial Paper Outstanding (seasonally adjusted) 238 .....
Nonfinancial Commercial Paper Outstanding (seasonally adjusted) 239

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237 Board of Governors of the Federal Reserve System, Federal Reserve
Download
Program
(Instrument:
Asset-backed
Commercial
www.federalreserve.gov/DataDownload/Choose.aspx?rel=CP) (accessed Aug.
238 Board of Governors of the Federal Reserve System, Federal Reserve
Download
Program
(Instrument:
Financial
Commercial
www.federalreserve.gov/DataDownload/Choose.aspx?rel=CP) (accessed Aug.
239 Board of Governors of the Federal Reserve System, Federal Reserve
Download
Program
(Instrument:
Nonfinancial
Commercial
www.federalreserve.gov/DataDownload/Choose.aspx?rel=CP) (accessed Aug.

Statistical
Paper
5, 2009).
Statistical
Paper
5, 2009).
Statistical
Paper
5, 2009).

Percent Change
Since Last Report
(7/9/09)

¥4.15%
¥6.62%
¥11.99%

$437.8
$517.5
$110.4

Release: Commercial Paper Rates and Outstandings: Data
Outstanding,
Frequency:
Weekly)
(online
at
Release: Commercial Paper Rates and Outstandings: Data
Outstanding,
Frequency:
Weekly)
(online
at
Release: Commercial Paper Rates and Outstandings: Data
Outstanding,
Frequency:
Weekly)
(online
at

• Lending by the Largest TARP-recipient Banks. Treasury’s
Monthly Lending and Intermediation Snapshot tracks loan originations and average loan balances for the 21 largest recipients of CPP
funds across a variety of categories, ranging from mortgage loans

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79
to commercial and industrial loans to credit card lines. Mortgage
originations—excluding refinancing—increased by over 8 percent
from April to May; further, mortgage originations have increased
by more than 75 percent since October of 2008. The dramatic drop
in commercial real estate has continued from the previously reported period. The data below exclude lending by two large CPPrecipient banks, PNC Bank and Wells Fargo, because significant
acquisitions by those banks since last October make comparisons
misleading.
FIGURE 20: LENDING BY THE LARGEST TARP-RECIPIENT BANKS 240
Most Recent Data (May
2009) (dollars in millions)

Indicator

Total Loan Originations ..............................
Total Mortgage Origination .........................
C&I New Commitments ...............................
CRE New Commitments ..............................
Mortgage Refinancing .................................
Total Average Loan Balances .....................

Percent Change Since April
2009

$200,298
77,792
$33,482
$2,971
$52,682
$3,337,318

Percent Change Since
October 2008

¥8.19%
75.64%
¥43.20%
¥71.77%
180.71%
¥2.50%

.51%
8.06%
3.06%
¥14.38%
¥7.50%
¥0.62%

240 On July 10, 2009 the Federal Reserve announced that it had made changes to the data in its H.8 release, which has changed previously reported figures. In order to represent measured trends accurately, the Panel has updated its figures to reflect the latest reported Federal Reserve data. See Board of Governors of the Federal Reserve System, H8: Changes to Data and Items Reported on the Release for July 1,
2009 (July 10, 2009) (online at www.tradingurus.com/index2.php?option=comlcontent&dolpdf=1&id=17314).

• Loans and Leases Outstanding of Domestically-Chartered
Banks. Weekly data from the Federal Reserve Board track fluctuations among different categories of bank assets and liabilities.
Loans and leases outstanding for large and small domestic banks
both fell last month.241 Total loans and leases outstanding at large
banks have dropped by over 5.8 percent since last October.242
FIGURE 21: LOANS AND LEASES OUTSTANDING 243
[Dollars in billions]
Current Level (as of 8/05/
09)

Indicator

Large Domestic Banks—Total Loans and
Leases .....................................................
Small Domestic Banks—Total Loans and
Leases .....................................................

Percent Change Since Last
Report (7/9/09)

Percent Change Since ESSA
Signed into Law (10/3/08)

$3,817.8

¥1.41%

¥5.81%

$2,517.4

¥0.63%

¥0.01%

243 These

figures differ from the amount of total loans and leases in bank credit cited in section B of this report because FDIC data include all FDIC-insured institutions whereas the data above measure only the loans and leases in bank credit for domestically chartered commercial institutions.

tjames on DSKG8SOYB1PROD with REPORTS

• Housing Indicators. Foreclosure filings increased by over
four percent from May to June, in turn raising the rate to twenty
percent above the level of last October. Housing prices, as illustrated by the S&P/Case-Shiller Composite 20 Index, continued to
decline in April. The index remains down over ten percent since
October 2008.
241 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release H.8:
Assets and Liabilities of Commercial Banks in the United States: Historical Data (Instrument:
Assets and Liabilities of Large Domestically Chartered Commercial Banks in the United States,
Seasonally adjusted, adjusted for mergers, billions of dollars) (online at www.federalreserve.gov/
releases/h8/data.htm) (accessed Aug.5, 2009).
242 Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release H.8:
Assets and Liabilities of Commercial Banks in the United States: Historical Data (Instrument:
Assets and Liabilities of Small Domestically Chartered Commercial Banks in the United States,
Seasonally adjusted, adjusted for mergers, billions of dollars) (online at www.federalreserve.gov/
releases/h8/data.htm) (accessed Aug. 5, 2009).

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80
FIGURE 22: HOUSING INDICATORS
Most Recent
Monthly Data

Indicator

Monthly Foreclosure Filings 244 .......................................
Housing Prices—S&P/Case-Shiller Composite 20
Index 245 ......................................................................

Percent Change From Data
Available at Time of Last
Report (8/05/09)

Percent Change Since
October 2008

336,173

4.57%

20.25%

140.1

¥0.16%

¥10.82%

244 RealtyTrac,

Foreclosure Activity Press Releases (online at www.realtytrac.com//ContentManagement/PressRelease.aspx) (accessed Aug. 5,
2009). The most recent data available is for June 2009.
245 Standard & Poor’s, S&P/Case-Shiller Home Price Indices (Instrument: Seasonally Adjusted Composite 20 Index) (online at
www2.standardandpoors.com/spf/pdf/index/SAlCSHomePricelHistoryl063055.xls (accessed Aug. 5, 2009). The most recent data available is
for May 2009 (seasonally adjusted).

FIGURE 23: ASSET-BACKED SECURITY ISSUANCE 246
[Dollars in millions]
Most Recent Quarterly Data
(2Q 2009)

Indicator (dollars in billions)

Auto ABS Issuance ......................................
Credit Cards ABS Issuance ........................
Equipment ABS Issuance ............................
Home Equity ABS Issuance .........................
Other ABS Issuance ....................................
Student Loans ABS Issuance ......................
Total ABS Issuance .....................................

Data Available at Time of
Last Report (1Q 2009)

$12,026.8
$19,158.5
$2,629.1
$707.4
$6,444
$7,643.8
247 $48,609.6

Percent Change From Data
Available at Time of Last
Report (7/9/09)

$7,574.4
$3,000
$514.7
$782.1
$2,386.5
$1,955.8
$16,213.5

58.8%
538.6%
410.8%
9.55%
170%
290.8%
199.8%

246 Securities
Industry and Financial Markets Association, US ABS Issuance (accessed Aug. 5, 2009) (online at
www.sifma.org/uploadedFiles/Research/Statistics/SIFMAlUSABSIssuance.pdf).
247 Of this amount, $23 billion was supported under the TALF. See Federal Reserve Bank of New York, Term Asset-Backed Securities Loan
Facility: Announcements (accessed Aug. 5, 2008) (online at www.newyorkfed.org/markets/talflannouncements.html).

I. Financial Update
Each month since its April oversight report, the Panel has summarized the resources that the federal government has committed
to economic stabilization. The following financial update provides:
(1) an updated accounting of the TARP, including a tally of dividend income and repayments the program has received as of July
31, 2009; and (2) an update of the full federal resource commitment
as of July 30, 2009.
1. TARP
a. Costs: Expenditures and Commitments 248

tjames on DSKG8SOYB1PROD with REPORTS

Treasury is currently committed to spend $532.8 billion of TARP
funds 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 loans for facilities
designed to restart secondary securitization markets.249 Of this
total, $370.2 billion is currently outstanding under the $698.7 billion limit for TARP expenditures set by EESA, leaving $328.5 billion available for fulfillment of anticipated funding levels of existing programs and for funding new programs and initiatives. The
$370.2 billion includes purchases of preferred shares, warrants
248 Treasury will release its next tranche report when transactions under the TARP reach
$450 billion.
249 EESA, as amended by the Helping Families Save Their Homes Act of 2009, limits Treasury
to $698.7 billion in purchasing authority outstanding at any one time as calculated by the sum
of the purchase prices of all troubled assets held by Treasury. EESA 115(a)–(b); Helping Families Save Their Homes Act of 2009, Pub. L. 111–22, § 402(f) (reducing by $1.26 billion the authority for the TARP originally set under EESA at $700 billion).

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81
and/or debt obligations under the CPP, TIP, SSFI Program, and
AIFP; a $20 billion loan to TALF LLC, the special purpose vehicle
(SPV) used to guarantee Federal Reserve TALF loans; and the $5
billion Citigroup asset guarantee, which has subsequently been exchanged for a guarantee fee composed of additional preferred
shares and warrants.250 Additionally, Treasury has allocated $20
billion to the Home Affordable Modification Program, out of a projected total program level of $50 billion, but has not yet distributed
any of these funds.
b. Income: Dividends and Repayments

The repayments of CPP preferred shares by nine of the large,
stress-tested BHCs has led to a surge this month in amount of
total TARP repayments—from the just under $2 billion reported in
our July report to over $70 billion largely as a result of repayments.251 Several of those BHCs have also repurchased the warrants Treasury received in conjunction with its preferred stock investments. In addition, Treasury is entitled to dividend payments
on preferred shares it has purchased, usually five percent per
annum for the first five years and nine percent per annum thereafter.252 Treasury has begun to report dividend payments made by
CPP participant banks pursuant to a recommendation in GAO’s
March TARP oversight report.253
c. TARP Accounting as of July 31, 2009

FIGURE 24: TARP ACCOUNTING (AS OF JULY 31, 2009)
[Dollars in billions]
Anticipated
Funding

TARP Initiative

Total ..................................................
CPP ....................................................
TIP .....................................................
SSFI Program .....................................
AIFP ...................................................
AGP ....................................................
CAP ....................................................
TALF ...................................................
PPIP ...................................................
Supplier Support Program .................
Unlocking SBA Lending .....................
HAMP .................................................
(Uncommitted) ...................................

Purchase Price

532.8
218
40
69.8
80
5
TBD
20
30
256 3.5
15
50
167.4

442.5
204.3
40
69.8
80
5
0
20
0
3.5
0
258 19.9
N/A

Repayments

72.3
70.2
0
0
2.1
0
N/A
0
N/A
0
N/A
0
N/A

Net Current Investments

Net Available

370.2
134.2
40
69.8
77.8
5
0
20
0
3.5
0
19.9
N/A

328.5
254 13.6

0
0
255 0
0
N/A
0
30
257 0
15
30.1
239.8

254 This figure reflects the repayment of $70.173 billion in CPP funds. Secretary Geithner has suggested that funds from CPP repurchases
will be treated as uncommitted funds upon return to the Treasury. See This Week with George Stephanopoulos, Interview with Secretary
Geithner (Aug. 2, 2009) (online at www.abcnews.go.com/print?id=8233298) (‘‘[W]hen I was here four months ago, we had roughly $40 billion
of authority left in the TARP. Today we have roughly $130 billion, in partly [sic] because we have been very successful in having private capital come back into this financial system. And we’ve had more than $70 billion . . . come back into the government’’). The Panel has therefore presented the repaid CPP funds as uncommitted (i.e., generally available for the entire spectrum of TARP initiatives). The difference between the $130 billion of funds available for future TARP initiatives cited by Secretary Geithner and the $239.8 billion calculated as available
here is the Panel’s decision to classify certain funds originally provisionally allocated to TALF and PPIP as uncommitted and available for
TARP generally. See infra notes xiv and xvi.

250 July

31 TARP Transactions Report, supra note 104.
31 TARP Transactions Report, supra note 104.
e.g., U.S. Department of the Treasury, Securities Purchase Agreement: Standard Terms
(online at www.financialstability.gov/docs/CPP/spa.pdf) (hereinafter ‘‘Securities Purchase Agreement’’).
253 See Government Accountability Office, Troubled Asset Relief Program: March 2009 Status
of Efforts to Address Transparency and Accountability Issues, at 1 (Mar. 2009) (online at
www.gao.gov/new.items/d09504.pdf).
251 July

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252 See,

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82
255 Treasury has indicated that it will not provide additional assistance to GM and Chrysler through the AIFP. See Nick Bunkley, U.S. Likely
to
Sell
G.M.
Stake
Before
Chrysler,
New
York
Times
(Aug.
5,
2009)
(online
at
www.nytimes.com/2009/08/06/business/06auto.html?lr=1&scp=2&sq=ron%20bloom&st=cse) (hereinafter ‘‘U.S. Likely to Sell’’). The Panel
therefore considers the repaid AIFP funds to be uncommitted.
256 On July 8, 2009, Treasury lowered the total commitment amount for the program from $5 billion to $3.5 billion, this reduced GM’s portion from $3.5 billion to $2.5 billion and Chrysler’s portion from $1.5 billion to $1 billion. July 31 TARP Transactions Report, supra note 104.
257 Treasury has indicated that it will not provide additional funding to auto parts suppliers through the Supplier Support Program. See
U.S. Likely to Sell, supra note 255.
258 This figure reflects the cap set on payments to each mortgage servicer. See July 31 TARP Transactions Report, supra note 104.

FIGURE 25: TARP INCOME (AS OF JULY 31, 2009) 259
[Dollars in billions]
TARP Initiative

Repayments

Total ...............................................................................
CPP .................................................................................
TIP ..................................................................................
AIFP ................................................................................
AGP .................................................................................

72.3
70.2
0
2.1
0

Dividends 260

Warrants Repurchased 261

7.3
5.5
1.5
.2
.2

262 1.7

1.7
0
N/A
0

Total

81.3
77.4
1.5
2.3
.2

259 This table only reflects programs that have provided Treasury with reimbursements in the form of investment repayments, warrant repurchases or dividend payments. The table does not include interest payments made by participants in the programs.
260 As of July 31, 2009. This information was provided to the Panel by Treasury staff.
261 This number includes $1.6 million in proceeds from the repurchase of preferred shares by privately-held financial institutions. For
privately-held financial institutions that elect to participate in the CPP, Treasury receives and immediately exercises warrants to purchase additional shares of preferred stock.
262 Two warrant repurchases that were agreed to after July 31, 2009 are not reflected in the $1.7 billion figure. The Bank of New York Mellon Corporation announced on Aug. 5, 2009 that it had repurchased its warrants for $136 million. The Bank of New York Mellon, The Bank of
New
York
Mellon
Repurchases
Warrant
Related
to
TARP
Capital
Investment
(Aug.
5,
2009)
(online
at
bnymellon.mediaroom.com/file.php/715/pr080509.pdf). In addition, Morgan Stanley announced on August 6, 2009 that it had agreed to repurchase its warrants for $950 million. Morgan Stanley, Morgan Stanley Agrees to Repurchase Warrant from the U.S. Government (Aug. 6, 2009)
(online at www.morganstanley.com/about/press/articles/42d008d5–8209–11de-b5d1–6d6288639586.html). Thus, the total anticipated warrant
repurchases through August 6, 2009 are at least $2.28 billion.

2. OTHER FINANCIAL STABILITY EFFORTS

Federal Reserve, FDIC, and Other Programs
In addition to the direct expenditures Treasury has undertaken
through TARP, the federal government has engaged in a much
broader program directed at stabilizing the U.S. financial system.
Many of these initiatives explicitly augment funds allocated by
Treasury under specific TARP initiatives, such as FDIC and Federal Reserve asset guarantees for Citigroup, or operate in tandem
with Treasury programs, such as the interaction between PPIP and
TALF. Other programs, like the Federal Reserve’s extension of
credit through its section 13(3) facilities and SPVs or the FDIC’s
Temporary Liquidity Guarantee Program, operate independent of
TARP.

tjames on DSKG8SOYB1PROD with REPORTS

3. TOTAL FINANCIAL STABILITY RESOURCES (AS OF JULY 31, 2009)

Beginning in its April report, the Panel broadly classified the resources that the federal government has devoted to stabilizing the
economy through a myriad of new programs and initiatives as outlays, loans, or guarantees. Although the Panel calculates the total
value of these resources at over $3.1 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.
With respect to the FDIC and Federal Reserve programs, the
risk of loss varies significantly across the programs considered
here, as do the mechanisms providing protection for the taxpayer
against such risk. The FDIC, for example, assesses a premium of

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83
up to 100 basis points on Temporary Liquidity Guarantee Program
(TLGP) debt guarantees. The premiums are pooled and reserved to
offset losses incurred by the exercise of the guarantees, and are
calibrated to be sufficient to cover anticipated losses and thus remove any downside risk to the taxpayer. In contrast, the Federal
Reserve’s liquidity programs are generally available only to borrowers with good credit, and the loans are over-collateralized and
with recourse to other assets of the borrower. If the assets securing
a Federal Reserve loan realize a decline in value greater than the
‘‘haircut,’’ the Federal Reserve is able to demand more collateral
from the borrower. Similarly, should a borrower default on a recourse loan, the Federal Reserve can turn to the borrower’s other
assets to make the Federal Reserve whole. In this way, the risk to
the taxpayer on recourse loans only materializes if the borrower enters bankruptcy. The only loans currently ‘‘underwater’’—where the
outstanding principal amount exceeds the current market value of
the collateral—are the non-recourse loans to the Maiden Lane
SPVs (used to purchase Bear Stearns and AIG assets).
FIGURE 26: FEDERAL GOVERNMENT FINANCIAL STABILITY EFFORT (AS OF JULY 30, 2009)
[Dollars in billions]
Treasury
(TARP)

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Program

Total ...............................................................................................
Outlays i .................................................................................
Loans .....................................................................................
Guarantees ii ..........................................................................
Uncommitted TARP Funds ....................................................
AIG ..................................................................................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
Bank of America ............................................................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees vi .........................................................................
Citigroup ........................................................................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
Capital Purchase Program (Other) ................................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
Capital Assistance Program ..........................................................
TALF ................................................................................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
PPIP (Loans) xvi ...............................................................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
PPIP (Securities) ............................................................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
Home Affordable Modification Program .........................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................

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Federal
Reserve

698.7
390.3
43.6
25
239.8
69.8
iv 69.8
0
0
45
vii 45
0
0
50
viii 45
0
ix 5
97.8
xii 97.8
0
0
TBD
20
0
0
xiv 20
0
0
0
0
xvii 30
12.5
17.5
0
50
xviii 50
0
0

Sfmt 6602

FDIC

1,608.2
0
1378.4
229.8
0
98
0
v 98
0
0
0
0
0
229.8
0
0
x 229.8
0
0
0
0
0
180
0
xv 180
0
0
0
0
0
0
0
0
0
0
0
0
0

E:\HR\OC\B601A.XXX

Total

836.7
37.7
0
799
0
0
0
0
0
0
0
0
0
10
0
0
xi 10
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0

B601A

iii 3,143.6

425.5
1422
1053.8
239.8
167.8
69.8
98
0
45
45
0
0
289.8
45
0
244.8
97.8
97.8
0
0
xiii TBD
200
0
180
20
0
0
0
0
30
12.5
17.5
0
xix 50
50
0
0

84
FIGURE 26: FEDERAL GOVERNMENT FINANCIAL STABILITY EFFORT (AS OF JULY 30, 2009)—
Continued
[Dollars in billions]
Treasury
(TARP)

Program

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Automotive Industry Financing Program .......................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
Auto Supplier Support Program .....................................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
Unlocking SBA Lending ..................................................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
Temporary Liquidity Guarantee Program .......................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
Deposit Insurance Fund .................................................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
Other Federal Reserve Credit Expansion .......................................
Outlays ..................................................................................
Loans .....................................................................................
Guarantees ............................................................................
Uncommitted TARP Funds .............................................................

Federal
Reserve

77.8
xx 55.2

22.6
0
3.5
0
xxi 3.5
0
15
xxii 15
0
0
0
0
0
0
0
0
0
0
0
0
0
0
xxvi 239.8

FDIC

0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1,100.4
0
xxv 1,100.4
0
0

0
0
0
0
0
0
0
0
0
0
0
0
789
0
0
xxiii 789
37.7
xxiv 37.7
0
0
0
0
0
0
0

Total

77.8
55.2
22.6
0
3.5
0
3.5
0
15
15
0
0
789
0
0
789
37.7
37.7
0
0
1,100.4
0
1,100.4
0
239.8

i The term ‘‘outlays’’ is used here to describe the use of Treasury funds under the TARP, which are broadly classifiable as purchases of
debt or equity securities (e.g., debentures, preferred stock, exercised warrants, etc.). The outlays figures are 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
and GAO estimates. Anticipated funding levels are set at Treasury’s discretion, have changed from initial announcements, and are subject to
further change. Outlays as used here represent investments and assets purchases and commitments to make investments and asset purchases and are not the same as budget outlays, which under section 123 of EESA are recorded on a ‘‘credit reform’’ basis.
ii While many of the guarantees may never be exercised or exercised only partially, the guarantee figures included here represent the federal
government’s greatest possible financial exposure.
iii This figure is roughly comparable to the $3.0 trillion current balance of financial system support reported by SIGTARP in its July report.
See Office of the Special Inspector General for the Troubled Asset Relief Program, Quarterly Report to Congress, at 138 (July 21, 2009) (online
at www.sigtarp.gov/reports/congress/2009/July2009lQuarterlylReportltolCongress.pdf). However, the Panel has sought to capture anticipated exposure beyond the current balance, and thus employs a different methodology than SIGTARP.
iv This number includes investments under the SSFI Program: a $40 billion investment made on November 25, 2008, and a $30 billion investment committed on April 17, 2009 (less a reduction of $165 million representing bonuses paid to AIG Financial Products employees). July
31 TARP Transactions Report, supra note 104.
v This number represents the full $60 billion that is available to AIG through its revolving credit facility with the Federal Reserve ($43 billion had been drawn down as of July 30, 2009) and the outstanding principle of the loans extended to the Maiden Lane II and III SPVs to
buy AIG assets (as of July 30, 2009, $17.2 billion and $20.8 billion respectively). See Board of Governors of the Federal Reserve System, Federal
Reserve
Statistical
Release
H.4.1:
Factors
Affecting
Reserve
Balances
(July
30,
2009)
(online
at
www.federalreserve.gov/releases/h41/Current/) (accessed Aug. 4, 2009) (hereinafter ‘‘Fed Balance Sheet July 30’’). Income from the purchased
assets is used to pay down the loans to the SPVs, reducing the taxpayers’ exposure to losses over time. See Board of Governors of the Federal Reserve System, Federal Reserve System Monthly Report on Credit and Liquidity Programs and the Balance Sheet, at 14–16 (June 2009)
(online at www.federalreserve.gov/newsevents/monthlyclbsreport200906.pdf ).
vi As noted in its previous report, the Panel no longer accounts for the $118 billion Bank of America asset guarantee which, despite preliminary agreement, was never signed. See Congressional Oversight Panel, July Oversight Report: TARP Repayments, Including the Repurchase
of Stock Warrants, at 85 (July 7, 2009) (online at cop.senate.gov/documents/cop-071009-report.pdf) (hereinafter ‘‘Panel July Report’’).
vii July 31 TARP Transactions Report, supra note 104. This figure includes: (1) a $15 billion investment made by Treasury on October 28,
2008 under the 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 TIP on January 16, 2009.
viii July 31 TARP Transactions Report, supra note 104. 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 TIP on December 31, 2008.
ix 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).
x Citigroup Asset Guarantee, supra note ix.
xi Citigroup Asset Guarantee, supra note ix.
xii This figure represents the $218 billion Treasury has anticipated spending under the CPP, minus the $50 billion investment in Citigroup
($25 billion) and Bank of America ($25 billion) identified above, and the $70.2 billion in repayments that will be reflected as uncommitted
TARP funds. This figure does not account for future repayments of CPP investments, nor does it account for dividend payments from CPP investments.
xiii Funding levels for the CAP have not yet been announced but will likely constitute a significant portion of the remaining $239.8 billion of
TARP funds.

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tjames on DSKG8SOYB1PROD with REPORTS

85
xiv This figure represents a $20 billion allocation to the TALF SPV on March 3, 2009. July 31 TARP Transactions Report, supra note 104. In
previous reports, the Panel had projected TALF funding at a total level of $800 billion, comprising $80 billion in Treasury (TARP) guarantees
and $720 billion in Federal Reserve loans. See, e.g., Panel July Report, supra note vi, at 86. However, it now appears unlikely that the program will exceed the initial $200 billion funding level, described infra. As of August 7, 2009, $41.4 billion had been lent out through the
TALF to finance the purchase of ABS. Federal Reserve Bank of New York, Term Asset-Backed Securities Loan Facility: non-CMBS (accessed August 7, 2009) (online at http://www.newyorkfed.org/markets/TALFlrecentloperations.html); Federal Reserve Bank of New York, Term
Asset-Backed
Securities
Loan
Facility:
CMBS
(accessed
August
7,
2009)
(online
at
http://www.newyorkfed.org/markets/CMBSlrecentloperations.html). While TALF subscriptions are expected to increase due to various factors,
including the seasonal nature of student loans, the time required to structure deals related to CMBS (recently made eligible as collateral
under the program), and the financing of PPIP legacy securities purchases, it would require an extremely large increase in the rate of TALF
subscriptions to surpass the $200 billion currently available by year’s end.
xv This number derives from the unofficial 1:10 ratio of the value of Treasury loan guarantees to the value of Federal Reserve loans under
the TALF. See U.S. Department of the Treasury, Fact Sheet: Financial Stability Plan (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 Board for $20 billion of losses on its $200 billion in loans, the Federal Reserve Board’s
maximum potential exposure under the TALF is $180 billion.
xvi It now appears unlikely that resources will be expended under the PPIP Legacy Loans Program in its original design as a joint
Treasury-FDIC program to purchase troubled assets from solvent banks. In June, the FDIC cancelled a pilot sale of assets that would have
been conducted under the program’s original design. See Federal Deposit Insurance Corporation, FDIC Statement on the Status of the Legacy
Loans Program (June 3, 2009) (online at www.fdic.gov/news/news/press/2009/pr09084.html). In July, the FDIC announced that it would rebrand
its established procedure for selling the assets of failed banks as the Legacy Loans Programs. Federal Deposit Insurance Corporation, Legacy
Loans Program—Test of Funding Mechanism (July 31, 2009) (online at www.fdic.gov/news/news/press/2009/pr09131.html). These sales do not
involve any Treasury participation, and FDIC activity is accounted for here as a component of the FDIC’s Deposit Insurance Fund outlays.
xvii U.S. Department of the Treasury, Joint Statement By Secretary Of The Treasury Timothy F. Geithner, Chairman Of The Board Of Governors
Of The Federal Reserve System Ben S. Bernanke, And Chairman Of The Federal Deposit Insurance Corporation Sheila Bair: Legacy Asset Program (July 8, 2009) (online at www.financialstability.gov/latest/tgl07082009.html) (‘‘Treasury will invest up to $30 billion of equity and debt
in PPIFs established with private sector fund managers and private investors for the purpose of purchasing legacy securities’’); U.S. Department of the Treasury, Fact Sheet: Public-Private Investment Program, at 4–5 (Mar. 23, 2009) (online at
www.treas.gov/press/releases/reports/ppiplfactlsheet.pdf) (hereinafter ‘‘Treasury PPIP Fact Sheet’’) (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.
xviii Government Accountability Office, Troubled Asset Relief Program: June 2009 Status of Efforts to Address Transparency and Accountability
Issues, at 2 (June 17, 2009) (GAO09/658) (online at www.gao.gov/new.items/d09658.pdf). Of the $50 billion in announced TARP funding for
this program, $19.9 billion has been allocated as of July 31, 2009, and no funds have yet been disbursed. See July 31 TARP Transactions Report, supra note 104.
xix 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 Making Home Affordable Program, of which the HAMP is a
key component. 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).
xx July 31 TARP Transactions Report, supra note 104. A substantial portion of the total $80 billion in loans extended under the AIFP has
since been converted to common equity and preferred shares in restructured companies. $26.1 billion has been retained as first lien debt
(with $7.7 billion committed to GM and $14.9 billion to Chrysler), which is classified below as loans. See also Government Accountability Office, Troubled Asset Relief Program: June 2009 Status of Efforts to Address Transparency and Accountability Issues, at 43 (June 31, 2009)
(GAO09/658) (online at www.gao.gov/new.items/d09658.pdf).
xxi July 31 TARP Transactions Report, supra note 104.
xxii Treasury PPIP Fact Sheet, supra note xvii.
xxiii 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. $339.0 billion of debt subject to the guarantee has been
issued to date, which represents about 43 percent of the current cap. Federal Deposit Insurance Corporation, Monthly Reports on Debt
Issuance Under the Temporary Liquidity Guarantee Program: Debt Issuance Under Guarantee Program (June 30, 2009) (online at
www.fdic.gov/regulations/resources/TLGP/totallissuance6-09.html) (updated July 16, 2009).
xxiv This figure represents the FDIC’s provision for losses to its deposit insurance fund attributable to bank failures in the third and fourth
quarters of 2008 and the first quarter of 2009. See 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); 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); Federal Deposit Insurance Corporation, Chief Financial Officer’s
(CFO)
Report
to
the
Board:
DIF
Income
Statement
(First
Quarter
2009)
(online
at
www.fdic.gov/about/strategic/corporate/cfolreportl1stqtrl09/income.html).
xxv This figure is derived from adding the total credit the Federal Reserve Board has extended as of July 30, 2009 through the Term Auction
Facility (Term Auction Credit), Discount Window (Primary Credit), Primary Dealer Credit Facility (Primary Dealer and Other Broker-Dealer Credit),
Central Bank Liquidity Swaps, loans outstanding to Bear Stearns (Maiden Lane I LLC), GSE Debt (Federal Agency Debt Securities), Mortgage
Backed Securities Issued by GSEs, Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, and Commercial Paper Funding Facility LLC. See Fed Balance Sheet July 30, supra note ix. The level of Federal Reserve lending under these facilities will fluctuate in response to market conditions.
xxvi In September 2008, 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 (Sep. 29, 2008) (online at www.treas.gov/press/releases/hp1161.htm).
This program uses assets of the Emergency Stabilization Fund (ESF) to guarantee the net asset value of participating money market mutual
funds. Id. In response to an inquiry from the Panel, see Letter from Congressional Oversight Panel Chair Elizabeth Warren to Treasury Secretary Timothy F. Geithner (May 26, 2009) (attached as Appendix I), Treasury has indicated that funds with ‘‘an aggregate designated asset
base on nearly $2.5 trillion calculated as of September 19, 2008’’ were participating in the Program as of May 1, 2009. See Letter from
Treasury Secretary Timothy F. Geithner to Congressional Oversight Panel Chair Elizabeth Warren (July 21, 2009) (attached as Appendix II, hereinafter ‘‘Treasury MMMF Letter’’). In previous reports, the Panel has suggested that Treasury may fund any losses suffered by the ESF under
the program—incurred if payouts on the program guarantees exceed income earned through premiums paid by participants—through the use
of otherwise uncommitted TARP funds. Treasury has determined, however, that section 131 of EESA’s mandate that Treasury reimburse the
ESF ‘‘from funds under this Act’’ does not permit Treasury to use TARP funds, which are reserved for the purchase or insurance of troubled
assets, but instead, by default, directs Treasury to use non-TARP funds made available pursuant to section 118 of EESA, which provides for
the payment of ‘‘actions authorized by this Act, including the payment of administrative expenses.’’ Id. Treasury has indicated that it believes
that it lacks authority to extend the program beyond September 18, 2009, the expiration date of the program under the guarantee agreements
with participants because section 131(b) of EESA prohibits the use of the ESF ‘‘for the establishment of any future guaranty programs for the
United States money market mutual fund industry.’’ Id. In our past reports, we have noted the operation of the program but have not included it in our accounting, in part because of the uncertainty of the extent of Treasury’s exposure. While we now know that Treasury’s exposure theoretically is $2.5 trillion (the amount of the money market mutual funds guaranteed), Treasury is intent on letting the program expire
on September 18, 2009 irrespective of whether it has authority to extend it. Given the program’s imminent expiration, the desire to preserve
comparisons with our earlier accountings, and the unlikelihood of any losses under the program, the Panel will continue to exclude it from its
accounting.

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86
SECTION FIVE: OVERSIGHT ACTIVITIES
The Congressional Oversight Panel was established as part of
Emergency Economic Stabilization Act (EESA) and formed on November 26, 2008. Since then, the Panel has produced eight oversight reports, as well as a special report on regulatory reform,
issued on January 29, 2009, and a special report on farm credit,
issued on July 21, 2009. Since the release of the Panel’s July oversight report on warrant valuation, the following developments pertaining to the Panel’s oversight of the Troubled Asset Relief Program (TARP) took place:
• The Panel held a field hearing on July 27, 2009 in Detroit to
hear testimony on Treasury’s administration of the Automotive Industry Financing Program. The Panel heard testimony from Ron
Bloom, Senior Advisor at the Department of Treasury, Jan Bertsch,
Senior Vice President, Treasurer, and Chief Information Officer at
Chrysler, Walter Brock, Treasurer at General Motors, Sean
McAlinden, Executive Vice President and Chief Economist at the
Center for Automotive Research, and Barry Adler, Charles Seligson
Professor of Law at the New York University School of Law. Written testimony and audio from the hearing can be found on the Panel’s website at http://cop.senate.gov/hearings/library/hearing–
072709–detroithearing.cfm.
• The Helping Families Save Their Homes Act of 2009 (P.L. 111–
22), signed into law on May 20, 2009, required the Panel to
produce a special report on farm loan restructuring. Specifically,
the Panel was asked to analyze the state of the commercial farm
credit markets and the use of loan restructuring as an alternative
to foreclosure by financial institutions receiving government assistance through TARP. Pursuant to the statute, the Panel released
the report on July 21, 2009. A copy of the report can be found on
the Panel’s website at http://cop.senate.gov/documents/cop–072109–
report.pdf.
• In June, the Panel sent a letters to each of the largest mortgage servicing companies that had not signed a contract to formally
participate in the Making Home Affordable foreclosure mitigation
program. The letter inquired, among other things, if the servicer
intends to participate, how it is handling loan modifications, and
what barriers and obstacles might limit participation in the program. The Panel has received a number of responses and is currently reviewing them. This is part of the Panel’s continuing oversight of foreclosure mitigation efforts.
Upcoming Reports and Hearings

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The Panel will release its next oversight report in September.
The report will provide an updated review of TARP activities and
continue to assess the program’s overall effectiveness. The report
will also examine Treasury’s administration of its Automobile Industry Financing Program, which is funded under TARP.

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87
SECTION SIX: ABOUT THE CONGRESSIONAL OVERSIGHT
PANEL
In response to the escalating crisis, on October 3, 2008, Congress
provided 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 instructed the Panel to produce a special report on regulatory reform
that analyzes ‘‘the current state of the regulatory system and its
effectiveness at overseeing the participants in the financial system
and protecting consumers.’’ The Panel issued this report in January
2009. Congress subsequently expanded the Panel’s mandate by directing it to produce a special report on the availability of credit
in the agricultural sector. The report was issued on July 21, 2009.
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.

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ACKNOWLEDGEMENTS

The Panel would like to acknowledge SNL Financial for their
contribution to the modeling section of this report. The Panel would
specially like to acknowledge John-Patrick O’Sullivan, Senior Product Manager, for his time and effort in formulating SNL’s model.
Special thanks also to Professor Clayton Rose (Harvard University), Professor Ken Scott (Stanford University), Professor Simon
Johnson (Massachusetts Institute of Technology), Professor Tyler
Cowen (George Mason University), William M. Issac, Professor
Mark Thoma (University of Oregon), Professor John Geanakoplos
(Yale University), Professor Luigi Zingales (University of Chicago),
´
Professor Joshua Coval (Harvard University), Nicolas Veron, Professor Peter Cramton (University of Maryland), Professor Lawrence
Ausubel (University of Maryland), and Professor Deborah Lucas
(Northwestern University) for their thoughts and suggestions.

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APPENDIX I: LETTER FROM CHAIR ELIZABETH
WARREN
TO
SECRETARY
TIMOTHY
GEITHNER AND CHAIRMAN BEN BERNANKE,
RE: CONFIDENTIAL MEMORANDA, DATED
JULY 20, 2009

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APPENDIX II: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY
GEITHNER, RE: TEMPORARY GUARANTEE
PROGRAM FOR MONEY MARKET FUNDS,
DATED MAY 26, 2009

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APPENDIX III: 2009 LETTER FROM SECRETARY
TIMOTHY GEITHNER IN RESPONSE TO
CHAIR ELIZABETH WARREN’S LETTER, RE:
TEMPORARY GUARANTEE PROGRAM FOR
MONEY MARKET FUNDS, DATED JULY 21,
2009

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APPENDIX IV: LETTER FROM CHAIR ELIZABETH WARREN TO SECRETARY TIMOTHY
GEITHNER AND CHAIRMAN BEN BERNANKE,
RE: BANK OF AMERICA, DATED MAY 19, 2009

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APPENDIX V: 2009 LETTER FROM SECRETARY
TIMOTHY GEITHNER IN RESPONSE TO
CHAIR ELIZABETH WARREN’S LETTER, RE:
BANK OF AMERICA, DATED JULY 21, 2009

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APPENDIX VI: LETTER FROM CHAIR ELIZABETH WARREN AND PANEL MEMBER RICHARD NEIMAN TO SECRETARY TIMOTHY
GEITHNER, RE: FORECLOSURE DATA, DATED
JUNE 29, 2009

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APPENDIX VII: LETTER FROM ASSISTANT SECRETARY HERBERT ALLISON IN RESPONSE
TO CHAIR ELIZABETH WARREN’S LETTER,
RE: FORECLOSURE DATA, DATED JULY 29,
2009

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