10/6/08

Client Alert: Financial Crisis Update 4

Related Practices

H.R. 1424, commonly referred to as the Financial Bailout Bill, was passed by Congress and signed into law by President Bush on October 3, 2008.  A selective summary of the pertinent provisions in each of the Bill’s three divisions is provided below.  A longer Executive Summary also appears on www.vorys.com/f-40.html, as does a PDF of the entire Bill.

Division A, Titles I-III: Emergency Economic Stabilization Act of 2008 (“EESA”)

Troubled Asset Relief Program

EESA creates the Troubled Asset Relief Program, or TARP, which authorizes the Treasury to purchase “troubled assets” from “financial institutions,” and then manage and sell them.  TARP mandates the Treasury to also encourage private sector purchases of troubled assets.  In addition, TARP authorizes the Treasury to offer insurance for troubled assets, as an alternative to outright purchases.

Oversight.  TARP will be overseen by numerous entities, including Congressional committees, the U.S. Comptroller General, a TARP Inspector General, a Financial Stability Oversight Board comprised of agency heads, the executive and legislative budget offices, and the public, through an online database of purchases of troubled assets.  Judicial review of the Treasury Secretary’s actions under TARP is only available for arbitrary, capricious, or illegal acts, and courts can only enjoin those of the Secretary’s actions which are constitutional violations.

Key definitions. 

Policies.  EESA requires TARP to be implemented in harmony with EESA’s stated policy considerations, which include minimizing impact on taxpayers, stabilizing financial markets to protect American jobs and savings, preserving home ownership, protecting multifamily rental properties, stabilizing governmental entities, protecting retirement, and assisting banks that (1) are likely to be viable in the long term, (2) are of diverse sizes, geography, and portfolio composition, and (3) have less than $1 billion in assets, were adequately capitalized on June 30, 2008, and dropped at least one capital level due to losses in Fannie Mae and Freddie Mac stock.

Details.  The Treasury has begun, and will continue for at least the next six weeks, to promulgate regulations implementing EESA, which include criteria for identifying troubled assets for purchase, mechanisms for purchasing troubled assets, methodology for valuing troubled assets, procedures for selecting asset managers, and conflict of interest policies.  §§ 101(c), 108 

To date, EESA and the Treasury have provided the following guidance on these details:

Stake in Sellers.  The Treasury must receive an equity or debt stake in participating financial institutions, on terms designed to provide a reasonable participation in equity appreciation or a reasonable interest rate, and to protect taxpayers against losses and administrative expenses. 

Limits on Executive Compensation.  New limits on deducting executive compensation apply to all participating financial institutions.  Also:

Foreclosure Mitigation.  The Treasury, as well as certain other federal agencies that hold troubled assets, must use its role as buyer and holder of troubled assets to reduce foreclosures, including as follows:

Accounting and Insurance Provisions

TARP Guarantee Program.  The Treasury will establish a guarantee program for principal and interest payments on troubled assets, in exchange for risk-based premiums.  The Treasury must also encourage private sector purchases of troubled assets and investments in financial institutions. 

Mark-to-Market Accounting.  EESA gives the SEC authority to suspend and replace mark-to-market accounting if the SEC determines that doing so will protect investors.  § 132

Federal Deposit Insurance Increases. 

Money Market Mutual Fund Guarantees.  The Exchange Stabilization Fund (ESF), which has recently been used to guarantee programs relating to money market mutual funds, will no longer be used for future guarantees of these programs, and Treasury must use TARP to reimburse ESF for any expenses it incurs in fulfilling guarantees under the existing guarantee program.  § 131

Tax Provisions
Sale or Exchange of Preferred Stock.  Gain or loss from the sale or exchange of preferred stock in Fannie Mae and Freddie Mac by qualifying financial institutions or financial institution holding companies is to be treated as ordinary income or loss, if the stock was held by the financial institution on September 6, 2008, or was sold or exchanged by the financial institution on or after January 1, 2008, and before September 7, 2008.  § 301

Executive Compensation. 

Exclusion of Income from Discharge of Indebtedness.  The Act provides a 3-year extension, through 2012, of the current exclusion of income from discharge of qualified principal residence indebtedness (i.e., forgiveness of mortgage debt).  § 303

Division B, Titles I-IV: Energy Improvement and Extension Act of 2008

The following credits have been extended, expanded, and/or modified:

Bonds were created for clean renewable energy (Section 107) and qualified energy conservation (Section 301).

Additional Noteworthy Provisions:

Division C, Titles I-VII: Tax Extenders and Alternative Minimum Tax Relief

Title I – Alternative Minimum Tax Relief: 

Titles II-VII:  Extends and expands a number of individual and business tax provisions and extends Katrina Emergency Tax Relief Act provisions to include taxpayers in presidentially-declared major disaster areas.

Click here for Financial Crisis Update 1

Click here for Financial Crisis Update 2

Click here for Financial Crisis Update 3

This communication is for general information purposes only and does not constitute a full legal analysis of the subject matter discussed herein. The information in this email should not be relied upon as specific legal advice.