September 26, 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.
What follows is our latest in a series of updates on key regulatory and legislative issues.
Debate on the Hill
In contrast to yesterday’s public display of political and policy wrangling, today’s activity was largely behind the scenes as designated negotiators worked to hash out the details of a rescue plan. Though congressional leaders reported yesterday that they had reached a compromise agreement, Republicans announced that they had developed a competing proposal late Thursday night. House Minority Leader John Boehner wrote Speaker Pelosi today to express concern that the Democrats had not addressed many of the issues Republicans had raised about the proposal before declaring that the two parties had reached a consensus. He said that he and many other Republican members could not support Secretary Paulson’s plan until more taxpayer protections and free market principles had been incorporated into the legislation. Members from both sides of the aisle, however, have announced that they are working together to reach an agreement quickly.
The Republicans’ alternative proposal purports to place less risk on taxpayers than the Treasury and Democrats’ proposals and to incentivize private companies to finance much of the recovery. The plan would entail the government insuring mortgage-backed securities, as opposed to purchasing them outright. Holders of the MBS would be required to pay for the insurance premiums rather than placing that burden on taxpayers, and holders of the troubled assets would pay a higher risk-based premium. Through tax incentives and regulatory measures, the proposal is designed encourage private companies, instead of taxpayers, to inject capital into the markets.
Like the Democrats’ plan, the Republicans’ proposal calls for more transparency and oversight than did the initial Treasury request. Participating firms would have to disclose the value of their mortgage assets to Treasury, as well as the value of bids within the last year for those assets and their most recent audit report. Under the plan, the SEC would audit failed companies and would review the performance of the Credit Rating Agencies. The Republicans also seek to impose greater restrictions on government sponsored enterprises, forbidding them to securitize any unsound mortgages. Finally, the Republican plan would create a blue ribbon panel to assess the country’s financial situation and to suggest reforms for the market by January 1, 2009.
Republicans also have suggested including a "pay to play" provision, which would require participating firms to pay a set amount of money based on the amount of assets Treasury purchases, as well as creating an independent government corporation to purchase the troubled assets instead of Treasury, which would have congressional accountability and would minimize taxpayer exposure.
Key Points in the Latest Draft
A new draft of the rescue bill, dated September 25, 2008, includes new provisions and adds texture and detail to provisions of earlier drafts. Key provisions in this draft include the following:
- limit participating financial institutions to United States institutions, meaning that they must be organized under United States law and must have significant operations in the States;
- defines the “troubled assets” eligible for Treasury purchase as those assets based on or related to residential or commercial mortgages which were originated or issued on or before March 14, 2008;
- creates an Office of Financial Stability within the Office of Domestic Finance of the Department of Treasury, through which the Secretary will implement these programs;
- requires that the Secretary publish program guidelines either within two days of exercising this authority or within thirty days of enactment of the legislation. These guidelines will define how the assets will be priced and purchased and how asset managers will be selected;
- establishes the Financial Stability Oversight Board, which will review the Secretary’s exercise of authority and will be composed of the Federal Reserve chairman, the Federal Deposit Insurance Corporation chairman, and the SEC chairman, as well as two other members who are not governmental employees, one of whom will be appointed by the majority leader of the Senate and Speaker of the House, and one of whom will be appointed by the Senate and House minority leaders;
- requires the Secretary to report to Congress 60 days after the programs are initiated and every 30 days thereafter, as well as to make public the total amount of assets purchased and sold each week;
- mandates that the Secretary review the financial markets and submit an improvement plan to Congress by April 30, 2009;
- requires that at least 20 percent of any profit realized from the program be deposited into federal programs: 65 percent of that amount will be deposited into the Housing Trust Fund, and 35 percent into the Capital Magnet Fund;
- authorizes the Secretary to contract for services through a streamlined process not subject to the Federal Acquisition Regulation. Sets out principles for awarding contracts, including contracts to asset managers. The principles require the Secretary:
- to solicit proposals from a broad range of vendors;
- to ensure the inclusion of minority- and women-owned businesses in the contracting process;
- to consider the FDIC in the selection of asset managers.
- requires the Secretary to develop conflict of interest standards;
- charges the Secretary with a duty to assist homeowners and reduce foreclosures and requires the Secretary to alter mortgage terms when such requests are “reasonable”;
- implements corporate governance and executive compensation standards that would be effective for two years after a corporation enters the program. These standards leave much to the Secretary’s discretion, placing limits on compensation which will exclude incentives for officers to take risks that the Secretary deems “inappropriate” or “excessive. The standards also prohibit golden parachute;
- implements additional corporate governance standards for those institutions from which the Secretary makes a direct purchase, including proxy access for any shareholder or shareholder group representing 3 percent or more of the institution’s equity securities and a mandatory opportunity for shareholders to cast a non-binding vote on the institution’s executive compensation during any annual proxy solicitation and shareholder vote;
- requires the Secretary to maximize the taxpayer investment by using market mechanisms, such as auctions or reverse auctions, but allows the Secretary to make direct purchases where appropriate;
- requires the Secretary to obtain a warrant giving the Secretary the right to receive non-voting common stock from any institution from which the Secretary purchases troubled assets, which the Secretary may transfer freely, and which are protected from dilution by stock splits, distributions, dividends, or corporate reorganizations;
- limits the Secretary’s purchasing authority to $700 billion, which will be granted to the Secretary in tranches. The initial authority will be limited to $250 billion; after a request to Congress, the authority will be limited to $350 billion; and after a final request and written report to Congress, the authority will be limited to $700 billio;
- grants the Comptroller General of the United States oversight of the TARP program;
- establishes the Office of the Special Inspector General for the Troubled Asset Relief Program;
- raises the public debt limit to $11.315 trillion;
- authorizes the Secretary to establish a temporary guaranty program for money market mutual funds; and
- limits tax deductions for participating institutions for executive compensation to no more than $400,000 a year per executive.
We note that, it’s not clear who supports this draft as it now stands. What is clear is that this draft will change – indeed, likely has changed – before it is voted on by the House and Senate.
Timing and Procedure
There is a desire among bill negotiators and others to reach agreement by the end of the weekend. One scenario would have the House and Senate voting on a rescue plan – either as a standalone measure or as an amendment to the Continuing Resolution (CR) – this weekend or possibly Monday morning. Another, perhaps more likely at this point, would have Congress coming back after Rosh Hashanah to finish up on Wednesday.
Various sources have reported that Treasury hopes to have the program functioning within 3-4 weeks.
On a procedural note, Senator Majority Leader Harry Reid filed cloture on the motion to proceed to the Continuing Resolution (CR) yesterday. Cloture will ripen tomorrow. This is significant in terms of timing because that means the CR may well serve as the vehicle to move (or at least vote on) the rescue bill (as will a second "stimulus" package).
WMBank Goes Into Receivership: Assets Sold to JP Morgan Chase
After close of business last night, the banking operations of Washington Mutual, Inc — Washington Mutual Bank, Henderson, NV and its subsidiary, Washington Mutual Bank, FSB, Park City, UT (together, WMBank ) — were sold in a supervisory transaction. WMBank was closed by the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation (FDIC) was named receiver. Washington Mutual, Inc., the holding company for WMBank, and the interests of equity, debt holders or other creditors of Washington Mutual, Inc., are not included in the closure or receivership of WMBank. The FDIC announced that all depositors, insured and uninsured, are fully protected and that the closure will result in no cost to the Deposit Insurance Fund. WMBank (including its subsidiary) had combined assets of $307 billion and total deposits of $188 billion.
Subsequent to the closure, JPMorgan Chase acquired the assets and most of the liabilities, including covered bonds and other secured debt, of WMBank from the FDIC as Receiver. JPMorgan Chase acquired the assets, assumed the qualified financial contracts and made a payment of $1.9 billion. Claims by equity, subordinated and senior unsecured debt holders of WMBank were not acquired.
The holders of equity, subordinated and senior unsecured debt in WMBank are now creditors of the receivership for WMBank. The FDIC indicates they may file claims in the receivership for recovery of any amounts that may be due to them. However, the FDIC also stated that under 12 U.S.C. § 1821(d)(11) claims by equity and subordinated debt holders are subordinated to claims by general creditors of the institution, with the result that equity and subordinated debt holders of the bank are expected to receive no recovery on their claims.
The FDIC also addressed existing contracts with WMBank in its release. It stated: "By operation of law, parties to agreements by Washington Mutual Bank may not exercise any contractual or other rights to trigger termination, acceleration, default, or other actions based upon the insolvency, the appointment of the FDIC as receiver, or the transfer of such agreements to JPMorgan Chase. The Federal Deposit Insurance Act, 12 U.S.C. §§ 1821(d) and (e)(13), prohibits the exercise of such contractual or other rights in order to promote an orderly resolution of insured depository institutions."
This transaction is noteworthy in several respects:
(1) This was by far the largest failure of a U.S. depository institution (almost ten times the size of IndyMac Bank, closed in July).
(2) Nevertheless, it was able to be resolved without any cost to the FDIC. Since WMBank was one of the 10 largest banks in the country and had very extensive mortgage operations, there had been concern that its failure would be very costly to the FDIC. The FDIC estimated the IndyMac failure would cost the FDIC Fund $4 to 8 billion.
(3) It has been reported that WMBank experienced a loss of deposits in excess of $15 billion in recent weeks. The urgency of WMBank’s condition is suggested by the fact that FDIC acted to take it over midweek. Typically, banks are closed over a weekend. The FDIC did not comment on what factors led it to make this transaction when it did.
(4) All uninsured depositors were protected in the transfer to JPMorganChase (because the JPMC paid a premium and there thus was not cost to the FDIC). The FDIC did not announce the amount of uninsured deposits of WMBank; IndyMac Bank had about $1 billion of uninsured deposits, and those depositors are now claimants in that receivership.
Gibson Dunn will make available subsequently to its clients and friends an overview of the receivership and conservatorship authority of the Federal Deposit Insurance Corporation.
Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above. Please contact Michael Bopp (202-955-8256, [email protected]) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group:
Public Policy Expertise
Mel Levine – Century City (310-557-8098, [email protected])
John F. Olson – Washington, D.C. (202-955-8522, [email protected])
Amy L. Goodman – Washington, D.C. (202-955-8653, [email protected])
Alan Platt – Washington, D.C. (202- 887-3660, [email protected])
Michael Bopp – Washington, D.C. (202-955-8256, [email protected])
Securities Law and Corporate Governance Expertise
Ronald O. Mueller – Washington, D.C. (202-955-8671, [email protected])
K. Susan Grafton – Washington, D.C. (202- 887-3554, [email protected])
Brian Lane – Washington, D.C. (202-887-3646, [email protected])
Lewis Ferguson – Washington, D.C. (202- 955-8249, [email protected])
Barry Goldsmith – Washington, D.C. (202- 955-8580, [email protected])
John H. Sturc – Washington, D.C. (202-955-8243, [email protected])
Alan Bannister – New York (212-351-2310, [email protected])
Financial Institutions Law Expertise
Chuck Muckenfuss – Washington, D.C. (202- 955-8514, [email protected])
Christopher Bellini – Washington, D.C. (202- 887-3693, [email protected])
Amy Rudnick – Washington, D.C. (202-955-8210, [email protected])
Corporate Expertise
Howard Adler – Washington, D.C. (202- 955-8589, [email protected])
Richard Russo – Denver (303- 298-5715, [email protected])
Dennis Friedman – New York (212- 351-3900, [email protected])
Stephanie Tsacoumis – Washington, D.C. (202-955-8277, [email protected])
Robert Cunningham – New York (212-351-2308, [email protected])
Joerg Esdorn – New York (212-351-3851, [email protected])
Stewart McDowell – San Francisco (415-393-8322, [email protected])
C. William Thomas, Jr. – Washington, D.C. (202-887-3735, [email protected])
Real Estate Expertise
Jesse Sharf – Century City (310-552-8512, [email protected])
Alan Samson – London (+44 20 7071 4222, [email protected])
Andrew Levy – New York (212-351-4037, [email protected])
Dennis Arnold – Los Angeles (213-229-7864, [email protected])
Andrew Lance – New York (212-351-3871, [email protected])
Crisis Management Expertise
Theodore J. Boutrous, Jr. – Los Angeles (213-229-7804, [email protected])
Bankruptcy Law Expertise
Michael Rosenthal – New York (212-351-3969, [email protected])
Tax Law Expertise
Arthur D. Pasternak – Washington, D.C. (202-955-8582, [email protected])
Paul Issler – Los Angeles (213-229-7763, [email protected])
Executive and Incentive Compensation Expertise
Stephen W. Fackler – Palo Alto (650-849-5385, [email protected])
Michael J. Collins – Washington, D.C. (202-887-3551, [email protected])
Sean C. Feller – Los Angeles (213-229-7579, [email protected])
© 2008 Gibson, Dunn & Crutcher LLP
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