Financial Markets in Crisis: TARP Roadmap Revised

November 13, 2008

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets.

We are providing updates on key regulatory and legislative issues, as well as information on legal issues that we believe could prove useful as firms and other entities navigate these challenging times.

This update focuses on the announcement of a new streamlined loan modification program, Secretary Paulson’s announcements about the TARP, and the release of additional details about the Fed’s Money Market Investor Fund Facility.

Streamlined Loan Modification Program

On Tuesday, the Department of Housing and Urban Development (HUD), the Federal Housing Finance Agency (FHFA), the GSEs, the HOPE NOW Alliance, and the Treasury Department announced a streamlined mortgage modification program to help struggling homeowners.[1]  FHFA Director James Lockhart emphasized the pressing need for these modifications, stating that mortgage delinquencies have tripled since the markets began to falter.  He called on private label MBS servicers and investors to adopt the same standards as Fannie Mae and Freddie Mac to make this program the industry standard. 

The modification program is targeted at those homeowners who have missed at least three monthly payments on their Freddie Mac, Fannie Mae or portfolio loan, but who have not filed for bankruptcy.  Under the program, the homeowner’s mortgage payments would be reduced to an "affordable" amount, defined as no more than 38 percent of the household’s monthly income.  The 38 percent goal will be achieved by a  combination of strategies, including reducing the interest rate, extending the life of the loan, and delaying principal payments.  These modifications will be "streamlined" because they will require "less documentation and less processing."[2]  The program is expected to be operational by December 15, 2008.  Critics of the program have claimed that the standards will be challenging to adopt across the industry because most mortgages have been divided and repackaged into mortgage backed securities and sold to investors, making it difficult to alter contract terms.[3]

This new program, to be administered by loan servicers, adds to the two Federal Housing Administration programs for distressed homeowners (FHA Secure and Hope for Homeowners), the Treasury-led, voluntary, industry program, HOPE NOW, and, no doubt, the confusion of homeowners seeking assistance.  Moreover, in his remarks on Wednesday, Secretary Paulson indicated that "Treasury and others in the Administration continue to discuss" the more aggressive proposal floated by the FDIC.

Beyond loan modifications, HUD and other housing organizations have been making strides to improve the home-purchasing process through increased availability of credit counseling and regulatory reform.  Today, HUD announced new Real Estate Settlement Procedure Act (RESPA) regulations that will require lenders and mortgage brokers to provide potential homebuyers a standard Good Faith Estimate (GFE) disclosing important loan terms and closing costs.  Specifically, the GFE will disclose the term of the loan, whether the interest rate is fixed or variable, any pre-payment penalties if the borrower chooses to refinance, balloon payments, and total closing costs.  The new forms implementing these changes will not be required to be used in closings until January 1, 2010.[4]

TARP Updates

On Wednesday, Treasury Secretary Paulson held a press conference addressing the state of the economy and the Troubled Asset Relief Program’s (TARP) implementation under the Emergency Economic Stabilization Act.[5]  Perhaps most notably, Paulson indicated that Treasury no longer plans to purchase troubled mortgage-backed assets, which was clearly contemplated by both Congress and the Administration when they passed and enacted the bill creating TARP.  Treasury now is focusing its efforts on directly injecting capital into the markets, as it recently has with the Capital Purchase Program, through which it provides capital investments in financial institutions.  Paulson noted that "non-banks", which "provide credit that is essential to U.S. businesses and consumers" also have capital needs.  However, he also cautioned that the relative lack of regulation over non-banks would make it difficult to protect taxpayers adequately.  In an effort headed by House Speaker Nancy Pelosi, several members of Congress have pressed Treasury to use the money to aid the struggling automobile industry.[6]  The Administration thus far has refused to support using TARP funds for this purpose.

Regarding the TARP’s future, Paulson identified three priorities.  First, he stated, the government must continue to support the financial system to maintain stability.  Second, consumer lending markets, including credit cards, automobile loans, and student loans, need reinforcement.  Third, he addressed the need to prevent foreclosures.

Secretary Paulson announced that Treasury was investigating the possibility of requiring companies which receive future investments of taxpayer money to raise funds privately, as well.  Proponents of this plan believe that a company’s ability to attract private funds will provide a helpful indicator of the market’s evaluation of the company.

Secretary Paulson also stated that Treasury and the Federal Reserve are looking into ways to use the TARP to create a liquidity facility for highly rated AAA asset-backed securities to increase taxpayer access to credit.

Money Market Investor Fund Facility

Also on Tuesday, the Federal Reserve Bank of New York released the Terms and Conditions of its Money Market Investor Fund Facility (MMIFF).[7]  It will begin funding purchases of eligible instruments around November 24, 2008.  The facility will provide funding to special purpose vehicles established by the private sector (PSPVs) to purchase short term certificates of deposit, bank notes, and commercial paper issued by ten specified financial institutions.  The PSPVs will fund the purchases by selling asset-backed commercial paper and by borrowing under the MMIFF.  Unless extended by the Federal Reserve Board, the program will cease purchasing assets on April 30, 2009.

The link that follows will take readers to a prior Gibson Dunn alert on the Federal Reserve’s three funding facilities: 
http://gibsondunn.com/Publications/Pages/FinancialMarketsinCrisis-FedThirdFundingFacility.aspx