Recent Policy by the U.S. Treasury Regarding Troubled Assets - Research Paper Example

Recent Policy by the U.S. Treasury Regarding Troubled Assets Introduction The government of the United States of America under the department of treasury was forced to have a critical look on the global crisis of the year 2008 that threatened to melt down various firms like the General motors, AIG, Citigroup among others. Most of the financial institutions at the Wall Street were not spared including the famous New York Stock exchange. With in-depth analysis from the financial experts, the treasury department came up with a rescue plan dubbed Troubled Assets Relief Program (TARP).This is a strategy by the U.S government under the department of treasury to purchase the so called troubled assets from these firms to enhance its financial sector. This proposal could allow the U.S government to purchase assets worth $700 billon. The purchase must be approved by the congress. TARP aims at liquidating the assets faster hence stabilizing the institution’s balance sheets and preventing further losses. The government hopes that when the prices stabilize and trading of the assets resumes with profits, it will benefit from the gains. An act was enacted that needed these firms to provide the security or equity warrant so as to protect the taxpayers by enabling treasury benefit by ownership of stakes in these firms. TARP also intends to restore the lending capacity of banks to banks or other consumers as well as businesses. Basically, TARP is a revolving fund that is aimed at facilitating or stimulating economic growth. Initially the treasury released $250 billion with an intention to buy the assets then resell them. This amount was to be increased to $350 billion upon the presidential approval to congress. The first $350 billion was released on 3rd October 2008 while the second package was released on 15th January 2009.Making homes affordable plan by the treasury was another way of using TARP money as it was implemented on March 4th 2009 (Landler.M.2008). Purpose of TARP funds Revisions on the TARP program were separately announced by the treasury secretary Paulson and President Bush. The funds were to be used to purchase preferred stocks in the United State’s nine largest banks with some conditions attached to it, but it was seen by some economic experts as inefficient and it was rejected. Consultations pertaining global recession between the Treasury Secretary and the British Prime Minister Gordon Brown led to the rejection of the deal and adoption of the British style of economic stimulation. On November 2008, Paulson indicated that on the second allotment, market security on consumer credit will be considered. On 19th December, President Bush declared that TARP funds can be spent on any program he may suggest to avert the crisis. The ultimate interim rules regarding the record keeping and reporting needs of TARP funds were issued on 15th January 2009.Announcement pertaining conflict mitigation was announced on January 21st 2009.Firms were prevented from paying bonuses to at least 25 of the top most paid employees as proposed by Christopher Dodd and was implemented on 5th of February 2009.Timothy Geithner, a new secretary to the treasury, came up with a plan of spending the remaining $300 billion TARP funds. He suggested using $250 billion to boost private sector by buying toxic assets and $50 billion for foreclosure mitigation but he never succeeded because it was seen as failing to fully address the problem. On March, Geithner announced a public- private investment program to purchase toxic assets from banks. The announcement paved way for the increase in major stock indices by about 6% with bank stocks emerging the best in overall rating (Landler.M. 2008). Administrative structure The conversion of bank bailouts to equity share by the Obama administration was announced on April 19, 2009.The administrative structure involved the following strategies; (1) Mortgage-back securities purchase program whereby they identified the troubled assets, the owner of the asset and the mode of purchasing that asset, (2) a program of purchasing the whole loan by bank regulators who intend to identify the type of loans to buy first, its valuation and the best purchase mechanism, (3) Insurance program on troubled assets to seek a way of insuring troubled assets through innovative measures like how to insure mortgage-backed securities and whole loans, (4) equity buying program is designed in such away that it targets to buy a wide array of financial firms who intend to volunteer,(5) preservation of home ownership is done through the purchase of mortgages to assist home owners and guard the tax payers,(6) executive compensation involves the set of laws on how to compensate institutions that want to use TARP funds and there are three categories as follows: (a) auctioning troubled assets (b) direct or indirect equity purchase program (c) prevention of a significant firm from failure.(7) compliance include establishment of an oversight board, participation onsite regarding general accounts and creating a special general inspector. The post of the Inspector General of the U.S. department of treasury is currently held by Eric Thorson and he is also responsible for the TARP oversight. He has expressed concern over the difficulty of the program referring to it as a mess and later clarified by saying that his office was unable to handle TARP with its ever increasing workload and audit monitoring of some of the affected or failed banks. Eric hinted that plans were under way to select another special Inspector General. By November 2008, Neil Barofsky had been nominated as the Special Inspector General of the special treasury department. Participation criteria Participation criteria-act is not clear and states that only established and regulated financial institutions in regard to the law of the United States will be incorporated in TARP and if they are significantly operating within the country. This therefore necessitated the U.S. department of treasury to define the kind of institutions to be referred to as established and regulated and what constitute their significant operations. The government required warrants from companies selling bad assets to them so that it will benefit the taxpayers in future during the growth of the company. Some of the institutions which were exempted from participating included banks of the United States, branches of foreign banks in U.S.,the credit unions and saving banks in broker dealers within U.S., insurance companies of U.S. mutual funds in the country plus other registered companies which participate in investment activities within the United States among others. A law to cover tax payers’ losses was to be submitted by the president through a fee on financial institutions to take part in the bail out program and also certain companies must limit executive pay and lose some tax gains. The oversight board prevents the treasury from acting arbitrarily with the inspector general protecting against fraud and abuse. The government of the United States uses CAMELS rating to respond to global economic crisis of the year 2008 to decide which banks to help and those not to be helped. This helps in capitalizing as required by the Act of 2008 to classify the country’s 8,500 banks in five categories with the first being considered the most likely to be helped and the fifth as the least likely to be helped. Regulators are using a list based on secret gauging systems. A statement by the New York Times argued that the criteria used appeared to create a centre of consolidation by favoring the less affected in the industry. In fact, law makers argued that firms could be culled in their districts. A Journal by the Wall Street suggested that some TARP money could be channeled to aid weak banks in certain districts. Some aspects of capitalization program which are well known suggested that there was a loose definition of a healthy financial institution by the government. Banks whose profit has been consistent over the last year were likely to be preferred compared to banks with a questionable performance over the last one year. The so called weak banks must pass a further test. Banks are asked whether they have enough reserves or capital to withstand losses on its loan portfolio, troubled assets or non performing loans. Capital was given to some other banks on the basis that it will find a partner to merge up with. Also the firms are required to submit a business plan that is projected for the next two to three years and the mode of deploying the capital. The treasury was left to determine whether hedge funds will be regarded as virtually unregulated institutions though it was perceived as impossible. Hedge funds is a term used to refer to a group of experienced investors pooling together their resources in order to make complex yet risky investments using highly technical and advanced investment strategies. This technique has been dismissed by the United States government due to its belief that the process played a major role in contributing to the economic crisis. The treasury has therefore denied them participation in a bailout program funded by the tax payer. Eligible assets and asset valuation Treasury is mandated by TARP to buy troubled assets as well as any other asset considered necessary to enhance economic stability. Real estate and mortgage related assets are considered troubled assets plus their securities. These assets are only eligible if they were issued on a date not later than 14th march 2008. Pricing of troubled assets is one of the most challenging tasks facing the treasury, because balance between the use of public funds from the taxpayer and giving adequate assistance to financial firms must be arrived at. To solve this problem, an Act was put in place to encourage the treasury to come up with a mechanism that will allow the use of a reverse auction method to value assets. This means that bidders (those intending to sell troubled assets) will bid with the treasury to sell a specified asset. The lowest price bided is the sale price and it provides the required quantity of the asset. A method of pricing is needed to be published in two days by the treasury after the purchase of the first asset. An asset purchased under TARP can be valued at the Congressional Budget Office (CBO) using the Federal Credit Reform Act (FCRA). On 6th February 2009 a report by the Congressional Oversight Panel (COP) said that TARP paid a higher price on an asset than its then current cost. Actually, $254 billion was paid for assets worth $176 billion representing a loss of $78 billion. The assumption by COP was that securities like those under the TARP were trading fairly at capital markets hence employing various approaches to cross-check the results. Taxpayers’ investment protection Measures to protect tax payers include;1) issue of equity warrants by firms selling assets to TARP,2) limiting compensation on executives who are highly paid in firms participating significantly in TARP,3) ability to repay the tax payer(recoupment),4) transparency in participation,5)judicial review of treasury actions (Krugman P.2009). Commitments and expenditures By 9th February 2009, $388 billion had already been allotted with$296 billion already spent as per the committee of Responsible Federal Budget. The following money were committed;(1) $250 billion intended to buy bank equity shares via the capital purchase program and only $195 billion was spent, (2) $40 billion for preferred shares of American International Group(AIG) plus top 10 companies in U.S. of which all the amount was spent, (3) $20 billion to prevent any losses that the Federal Reserve Bank of New York might incur under Asset-backed security loan facility and so far nothing has been spent, (4) $40billion to purchase city group and bank of America each costing $20 billion as per the Targeted Investment Program, all the amount was spent ,(5) loan guarantees for City group and Bank of America costing $12.5 and none spent so far, (6)A loan of $25 billion for the automakers plus their financing firms as per the Automotive Industry Financing Program(only $21 billion spent). Participating firms These include firms like Gold man Sachs Group Inc., Morgan Stanley, J.P.Morgan Chase and Company, Bank of America Corp and Merrill Lynch., Citigroup Inc, Wells Fargo and Company, (Krugman.P.2009). References Landler, M & Eric, D. (2008). Paulson Says Banks Must Deploy New Capital: Drama Behind a $250 Billion Banking Deal.. New York Times. Krugman P. (2009). Geithner plan arithmetic. New York Times, 154(4), 324-334. Read More