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2008 Emergency Economic Stabilization Act

By James C. Ricca

In response to the recent financial crisis, the $700 Billion Emergency Economic Stabilization Act of 2008 (the “Act”) was signed into Law by President Bush October 3, 2008, which established the Troubled Asset Relief Program (“TARP”) authorizing the Secretary of the Treasury to purchase “troubled assets” from participating financial institutions.

The stated purposes of the Act are to immediately give the Secretary of the Treasury funds he can use to restore liquidity and stability to the economy; and to insure that funds are used to protect home values, savings accounts, retirement accounts, college funds, and to promote jobs and economic growth.

The Act includes additional measures intended to act as economic stimuli and boost investor and consumer confidence, including increases in FDIC deposit insurance from $100,000.00 to $250,000.00; tax incentives for sale of certain preferred stock (to be treated as ordinary income or loss, not capital gain); and tax disincentives for financial institutions participating in TARP regarding “excessive” executive compensation or retirement benefits.

In practical terms, Congress gave the Secretary of the Treasury, Henry Paulson, one-half of the fund, $350 Billion, to purchase “troubled assets” (non performing mortgage loans), from participating financial institutions. The theory was to buy nonperforming loans, mostly from banks, thereby providing banks with cash that they could put into circulation in the form of business and consumer loans, thereby restoring liquidity to our financial system and re-casting mortgage terms to more manageable payments for distressed homeowners.

However, the original strategy behind the rescue has been scuttled. Secretary Paulson announced in October that the program will instead focus on infusing capital into banks by buying bank stock. Critics fear the original strategy of foreclosure mitigation has been lost, including FDIC chairman Sheila Blair, who continues to press for using $24 Billion of the TARP money to help American households avoid foreclosure.

Alternatively, supporters, including economist Nobel Laureate Paul Krugman, endorse Paulson's new strategy, comparing it to the 1990's Swedish banking rescue. Paulson also has the support of the Chairman of the Federal Reserve, Ben Bernanke, who has appeared before the Congressional Oversight Committee to present the plan for the new strategy.

In connection with the stock purchase program, the Treasury Department required nine of the nation's largest financial services companies to sell a total of $125 billion in preferred stock to the Government. Presently, there are 64 firms participating in TARP. A.I.G, Wells Fargo & Co., JPMorgan Chase & Co, Citigroup Inc. and Bank Of America Corp are among the top five companies participating, receiving between $15 and $40 Billion each. It should be emphasized that not all banks participating in the TARP program are suffering from liquidity problems and they should not be lumped in or characterized as troubled companies like A.I.G.

Nearly ninety percent of institutions surveyed said that lack of clarity concerning the way TARP works is making them less willing to participate. There is also apprehension among nonparticipating financial institutions regarding ramifications of issuing preferred stock to the Department of Treasury. Under TARP, applicants are required to meet standards established by the Treasury for executive compensation for senior officers. The applicants also cannot increase common share dividend payments, or repurchase or redeem any junior preferred shares without permission from the Treasury for the first three years the Treasury owns stock.

Another criticism of the Act is that the Secretary has too much of a free hand in distributing TARP funds, without enough accountability. The Act does have a component of congressional oversight, consisting of a panel of five members appointed by the majority and minority leaders of the House and Senate. They report to Congress on the activity and performance of the Secretary relating to foreclosure mitigation and TARP'S impact on financial markets. In reality, the Act only gives Congress authority to review Secretary Paulson's actions, without having authority to suspend funds or take corrective action. Representative Brad Sherman (D. Calif.) stated “This is a critique board, not a control board. This board can issue press releases and write op-eds. It can't delay, halt or reverse any action taken by Paulson.”

Thus far the Treasury Department has pledged $250 billion for banks and has agreed to devote $40 billion to A.I.G. (the first funds going to a company other than a bank). That leaves $60 billion available as a first bailout installment of the initial $350 billion. Secretary Paulson said he is not planning to initiate another capital injection program beyond those already announced. It is therefore unlikely that the remaining $350 billion will be advanced during the Bush administration, leaving office January 20, 2009. The incoming administration of President-elect Barack Obama will have to decide whether and how the money in TARP will be spent.

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