Financial Markets in Crisis: Treasury Moves to Implement TARP

October 6, 2008

With the Emergency Economic Stabilization Act (EESA) now law, Treasury is moving quickly to choose advisers, issue regulations, and hire companies to serve as asset managers for the Troubled Asset Relief Program (TARP).

Today, Secretary Paulson announced that he has selected Neel Kashkari to be the interim head of the new Office of Financial Stability, which will implement the Troubled Asset Relief Program.  Kashkari is currently Assistant Secretary for International Economics and Development and has been a key adviser to Secretary Paulson. 

It is our understanding that Secretary Paulson intends to hire a small staff with expertise in asset management, accounting, and legal issues to commence the Troubled Asset Relief Program.

Guidelines Announced by Treasury

Today, Treasury announced a number of interim guidelines relating to the authorities created by the EESA.[1]  These interim guidelines address the hiring of asset managers, conflicts of interest, and procurement authorities and procedures. 

Treasury also issued notices to financial institutions interested in providing any of the following services:  whole loan asset management; securities asset management; and custodian, accounting, auction management, and other infrastructure services.  The deadline for responding to Treasury’s solicitations is 5:00 p.m. EST on October 8, 2008.

Below are brief descriptions of the guidelines issued by Treasury today.  The guidelines and Treasury’s solicitations can be found on the new EESA web page:  http://www.treas.gov/initiatives/eesa/

Asset manager selection guidelines:

• require Treasury to select asset managers of securities separately from asset managers of mortgage whole loans.  The same procedures, however, will apply to both types of managers.
• Securities managers will handle Prime, Alt-A, and Subprime residential mortgage backed securities (MBS), commercial MBS, and MBS collateralized debt obligations.
• Whole loan managers will handle a "range of products," which may include residential first mortgages, home equity loans, second liens, commercial mortgage loans.
• state that the managers will be financial agents of the United States, not contractors, which will impose a fiduciary agent-principal relationship with Treasury on the managers.
• state that "Financial Institutions," as defined by the EESA, will be eligible to be asset managers.
• require Treasury to solicit managers via public notice on the Department’s website, which will include standards for managers.
• require that the selection process involve several phases of evaluations.  Later phases may operate under confidentiality requirements.
• require that Treasury will issue separate notices for minority- and women-owned Financial Institutions which do not meet the qualifications for asset managers under the initial notices and mandates that these institutions will be designated as "sub-managers."
• indicate that the deadlines will be "extremely short" for submitting applications and traveling to Washington, D.C. for meetings and interviews.

Conflict of interest guidelines:

• allow Treasury to obtain non-disclosure agreements and conflict of interest agreements.
• instruct that solicitations for offers should instruct prospective offerors that they must disclose any actual or potential conflicts of interests which could arise, including, in some cases, personal conflicts of interests among employees.
• instruct that the solicitation should identify minimum requirements or standards for conflict of interest mitigation plans.
• instruct that the solicitation should state if the contractor hired will owe a fiduciary duty to Treasury.
• require that solicitations must include non-disclosure provisions.
• mandate that solicitations require offerors to submit a conflict mitigation plan with their initial proposals.  Though these plans may be negotiated, the final plan will be incorporated into a successful offeror’s contract.

Procurement authorities and procedures guidelines:

• indicate that Treasury has two mechanisms for engaging private-sector firms – financial agent authority and procurement under the Federal Acquisition Regulation.
• explain that the EESA expanded Treasury’s existing authority to retain financial agents.  This authority will be used when a firm is needed to conduct transactions on Treasury’s behalf, including when Treasury needs the services of asset managers.
• explain that the Federal Acquisition Regulation also provides authority for Treasury to obtain supplies or services through procurement contracts, typically through a solicitation of offers from all interested parties.[2]

Treasury Authority to Make Equity Investments

A provision of EESA that did not receive much attention during Congressional debate appears to provide the Treasury authority to make equity investments in financial institutions if "necessary to promote financial market stability."  The definition of "troubled asset" in the legislation includes not only mortgages and instruments based on or related to mortgages, but also "any other financial instrument" if the Treasury, in consultation with the Fed, determines that the purchase of the instrument "is necessary to promote financial market stability."  A report must be made to the appropriate Congressional committees if instruments are purchased under this provision.

Although there is yet no gloss on how Treasury might interpret this provision, it appears broad enough to include preferred stock or other equity investments.  Economists and others critical of EESA have stated that to the extent that the Treasury plan focused on buying bad mortgage-related assets, it would not address the additional problem of capital impairment in the banking industry, as institutions recognize their losses from such bad assets or the write-down of their holdings of FNMA and FHLMC preferred stock.  It may be that this "other financial instrument" provision  provides a basis for the Treasury and Fed to address capital weaknesses in banks as the financial crisis evolves.  We will be following closely the Treasury’s views on this provision and report as developments occur.

Action on the Hill

Now that Congress has passed legislation to stabilize the government, it is turning its attention to the underlying causes of the financial markets’ meltdown.  Representative Henry Waxman, Chairman of the House Oversight and Government Reform Committee, has announced a series of hearings to examine Wall Street’s missteps.  Today, the topic was the Lehman bankruptcy filing.  Tomorrow, the committee will focus on AIG .  On Thursday, October 16, the committee will look into hedge funds’ role in the crisis.  On Wednesday, October 22, credit rating agencies will be scrutinized, and on Thursday, October 23, the committee will investigate federal regulatory actions.

The House Financial Services Committee, the House Agriculture Committee, and the House Education & Labor Committee also have scheduled hearings relevant to the market crisis.

Steps Taken by the Fed

This morning, the Federal Reserve Board announced that it will begin to pay interest on depository institutions’ required and excess reserve balances.  The Fed also is increasing the size of its Term Auction Facility Auctions, as well as consulting with market participants to find new ways to support term unsecured funding markets. [3]

Please view Gibson Dunn’s complete series of updates on the financial markets crisis on our website.