The Troubled Asset Relief Program ( TARP ) is a program of the United States government to purchase assets and equity from financial institutions to strengthen its financial sector. It is the largest component of the government's measures in 2008 to address the subprime mortgage crisis.
Purpose
TARP allows the United States Department of the Treasury to purchase or insure up to $700 billion of "troubled" assets. "Troubled assets" are defined as "(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."
In short, this allows the Treasury to purchase illiquid, difficult-to-value assets from banks and other financial institutions. The targeted assets can be collateralized debt obligations, which were sold in a booming market until 2007 when they were hit by widespread foreclosures on the underlying loans. TARP is intended to improve the liquidity of these assets by purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses.
TARP does not allow banks to recoup losses already incurred on troubled assets, but officials hope that once trading of these assets resumes, their prices will stabilize and ultimately increase in value, resulting in gains to both participating banks and the Treasury itself. The concept of future gains from troubled assets comes from the hypothesis in the financial industry that these assets are oversold, as only a small percentage of all mortgages are in default, while the relative fall in prices represents losses from a much higher default rate.
The Act requires financial institutions selling assets to TARP to issue equity warrants (a type of security that entitles its holder to purchase shares in the company issuing the security for a specific price), or equity or senior debt securities (for non-publicly listed companies) to the Treasury. In the case of warrants, the Treasury will only receive warrants for non-voting shares, or will agree not to vote the stock. This measure is designed to protect taxpayers by giving the Treasury the possibility of profiting through its new ownership stakes in these institutions. Ideally, if the financial institutions benefit from government assistance and recover their former strength, the government will also be able to profit from their recovery.
Another important goal of TARP is to encourage banks to resume lending again at levels seen before the crisis, both to each other and to consumers and businesses. If TARP can stabilize bank capital ratios, it should theoretically allow them to increase lending instead of hoarding cash to cushion against future unforeseen losses from troubled assets. Increased lending equates to "loosening" of credit, which the government hopes will restore order to the financial markets and improve investor confidence in financial institutions and the markets. As banks gain increased lending confidence, the interbank lending interest rates (the rates at which the banks lend to each other on a short term basis) should decrease, further facilitating lending.
The TARP will operate as a “revolving purchase facility.” The Treasury will have a set spending limit, $250 billion at the start of the program, with which it will purchase the assets and then either sell them or hold the assets and collect the 'coupons'. The money received from sales and coupons will go back into the pool, facilitating the purchase of more assets. The initial $250 billion can be increased to $350 billion upon the President’s certification to Congress that such an increase is necessary. The remaining $350 billion may be released to the Treasury upon a written report to Congress from the Treasury with details of its plan for the money. Congress then has 15 days to vote to disapprove the increase before the money will be automatically released.. The first $350 billion was released on October 3, 2008, and Congress voted to approve the release of the second $350 billion on January 15, 2009. One way that TARP money is being spent is to support the "Making Homes Affordable" plan, which was implemented on March 4, 2009, using TARP money by the Department of Treasury. Because "at risk" mortgages are defined as "troubled assets" under TARP, the Treasury has the power to implement the plan. Generally, it provides refinancing for mortgages held by Fannie Mae or Freddie Mac. Privately held mortgages will be eligible for other incentives, including a favorable loan modification for five years.
The authority of the United States Department of the Treasury to establish and manage TARP under a newly created Office of Financial Stability became law October 3, 2008, the result of an initial proposal that ultimately was passed by Congress as H.R. 1424, enacting the Emergency Economic Stabilization Act of 2008 and several other acts.
Timeline of changes to the initial program
On October 14, 2008, Secretary of the Treasury Paulson and President Bush separately announced revisions in the TARP program. The Treasury announced their intention to buy senior preferred stock and warrants in the nine largest American banks. The shares would qualify as Tier 1 capital and were non-voting shares. To qualify for this program, the Treasury required participating institutions to meet certain criteria, including: "(1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on the financial institution from making any golden parachute payment to a senior executive based on the Internal Revenue Code provision; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive." The Treasury also bought preferred stock and warrants from hundreds of smaller banks, using the first $250 billion dollars allotted to the program.
The first allocation of the TARP money was primarily used to buy preferred stock, which is similar to debt in that it gets paid before common equity shareholders. This has led some economists to argue that the plan may be ineffective in inducing banks to lend efficiently.
In the original plan presented by Secretary Paulson, the government would buy troubled (toxic) assets in insolvent banks and then sell them at auction to private investor and/or companies. This plan was scratched when Paulson met with England's Prime Minister Gordon Brown who came to the White House for an international summit on the global credit crisis. Prime Minister Brown, in an attempt to mitigate the credit squeeze in England, merely infused capital into banks via preferred stock in order to clean up their balance sheets and, in some economists' view, effectively nationalizing many banks. This plan seemed attractive to Secretary Paulson in that it was relatively easier and seemingly boosted lending more quickly. The first half of the asset purchases may not be effective in getting banks to lend again because they were reluctant to risk lending as before with low lending standards. To make matters worse, overnight lending to other banks came to a relative hault because banks did not trust each other to be prudent with their money.
On November 12, 2008, Secretary of the Treasury Henry Paulson indicated that reviving the securitization market for consumer credit would be a new priority in the second allotment.
On December 19, 2008, President Bush used his executive authority to declare that TARP funds may be spent on any program he personally deems necessary to avert the financial crisis, and declared Section 102 to be nonbinding. This has allowed President Bush to extend the use of TARP funds to support the auto industry, a move supported by the United Auto Workers.
On January 15, 2009, the Treasury issued interim final rules for reporting and record keeping requirements under the executive compensation standards of the CPP.
On January 21, 2009, the Treasury announced new regulations regarding disclosure and mitigation of conflicts of interest in its TARP contracting.
On February 5, 2009, the Senate approved changes to the TARP that prohibit firms receiving TARP funds from paying bonuses to their 25 highest-paid employees. The amendment was proposed by Christopher Dodd of Connecticut as an amendment to the $900 billion economic stimulus act yet to be passed.
On February 10, 2009, the newly confirmed Secretary of the Treasury Timothy Geithner outlined his plan to use the $300 billion or so dollars remaining in the TARP funds. He intended to use $50 billion for foreclosure mitigation and use the rest to help fund private investors to buy toxic assets from banks. Nevertheless, this highly anticipated speech coincided with a nearly 5 percent drop in the S&P 500 and was criticized for being short on details.
On March 23, 2009, U.S. Treasury Secretary Timothy Geithner announced a Public-Private Investment Program (P-PIP
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