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Thursday, July 30, 2009

TARP Congressional Oversight Panel Chair, Elizabeth Warren Testimony

Elizabeth Warren Testimony
emphasis added

Testimony of Professor Elizabeth Warren
Chair, Congressional Oversight Panel
before the
House Committee on Financial Services
Subcommittee on Oversight and Investigations
July 22, 2009


The Oversight Panel is one of three organizations to which the TARP legislation gives oversight responsibilities. We work closely with GAO and the Special Inspector General to ensure that all our oversight efforts complement, not duplicate, one another. We all want to make the whole of our work greater than the sum of its parts.


In late 2008, our economy faced an exceptional crisis. The stock market had plummeted. Credit markets had frozen. Our most important financial institutions were teetering on the brink of collapse, threatening to bring the whole economy down. In this challenging moment Congress created the TARP. Under this program Treasury pumped billions of dollars into banks, an emergency action meant to stabilize the financial system.

These actions imposed an enormous risk on taxpayers. If the TARP failed to stabilize the financial system, the entire economy could collapse. Even if the system stabilized after huge infusions of taxpayer funds, if some institutions were unable to recover, taxpayers could be saddled with debt for generations. While these risks were looming, then-Treasury Secretary Henry Paulson argued that TARP assistance could be used to rescue the economy as well as generate a profit for taxpayers. When Congress authorized the commitment of $700 billion to rescue the financial system, it decided that taxpayers should have the opportunity to share in a potential upside if the banks returned to profitability.

The opportunity to profit from TARP investments comes through special securities called warrants, which represent the right to buy shares of a company at a set price at some point in the future. Banks that received financial assistance under the TARP were required to give the government warrants for the future purchase of some of their common shares. Now that the markets have begun to show signs of recovery and many banks want to repay their TARP money, repurchase their warrants, and free themselves from the stigma and stipulations that accompany government bailouts, it is timely to consider the issues involved in the repayment of TARP assistance and the repurchase of warrants.

The Panel’s mandate is to examine Treasury’s choices, and in our July report we consider whether it makes sense to allow repayment now, and determine if taxpayers are receiving the maximum benefit possible from the TARP. Treasury recently chose to allow 10 of the nation’s largest banks, holding a third of the nation’s banking assets, to exit the TARP. These banks have repaid their government capital infusions, but Treasury still has the warrants that accompanied the TARP assistance. Because these warrants represent the only opportunity for the taxpayer to participate directly in the increase in the share prices of these banks, made possible by public money, the price at which Treasury sells these warrants is critical. We do not know what value Treasury has placed on the warrants it still holds, but the Panel’s July report presents an independent valuation to generate a baseline for comparison for when Treasury does sell its warrants, to help determine whether Treasury is in fact maximizing the return on taxpayers’ investments in these financial institutions.

The Panel’s July report presents a detailed technical valuation of Treasury’s warrants using the most widely-accepted mathematical model for warrant valuation. The assumptions employed in the use of any model are crucial, and the report offers a range of estimates based on high, low and best estimate assumptions for certain key variables, particularly the volatility of the underlying stock of the bank in question The Panel’s estimates for the value of the warrants Treasury held on July 6, 2009 range from $4.7 billion to $12.3 billion, with its best estimate being $8.1 billion.


As of the date of our report (July 10th) eleven small banks had repurchased their warrants from Treasury for a total amount of only 66 percent of the Panel’s best estimate of their value. If the warrants had been sold for the Panel’s estimation of market value, taxpayers would have recovered $10 million more. In these sales, liquidity discounts – applied to reflect the difficulty in trading securities of small institutions – have been a major factor in a way not likely to apply to the warrants of large, publicly-traded institutions. However, if Treasury continues to accept only 66 percent of the Panel’s estimated market value for the rest of warrants it holds, the shortfall to taxpayers could be as much as $2.7 billion.

It should be noted that Treasury is just beginning its warrant repurchase program. It is possible that policymakers may conclude that other objectives should override the goal of maximizing taxpayer returns. For example, Treasury has said that it wants to allow banks to operate again without TARP assistance as soon as they are strong enough to do so. The determination of whether they are in fact financially sound and able to repay their assistance remains critical, especially in light of ongoing concerns about the macroeconomic environment and the possibility of further credit losses down the road. As discussed in the Panel’s June report, the stress tests provide some comfort in this regard but the fact that the key economic assumptions used in those tests continue to deteriorate remains a cause for concern.

Banks have bought back only a fraction of one percent of all warrants issued, and the prices paid thus far may not be representative of what is to come. In fact, in the weeks since our report was published, Treasury seems to have begun conducting its warrant negotiations more aggressively. U.S. Bancorp, which recently paid back its $6.9 billion in TARP assistance, repurchased its warrants from Treasury for $139 million dollars. This figure was actually higher than that given by the Panel’s best estimate model – which would be good news for taxpayers if it is indicative of how future warrant negotiations with large institutions will play out. Additionally, as has been widely reported, banks like JPMorgan Chase and Goldman Sachs have thus far been unable to reach agreement with Treasury on a price for their warrants. Reports in the media also indicate that these two banks believe Treasury is asking too much for their warrants and that JPM Chase is urging Treasury to conduct an auction for them.

Treasury is obligated under the terms of the contracts it initially signed as part of the Capital Purchase Program to enter into negotiations with the banks to repurchase warrants once they have repaid their CPP investments. Only if the price ultimately negotiated is rejected by the bank in question can Treasury then move to an auction procedure to dispose of its warrants.

Nevertheless, because warrant valuation is a difficult task, the Panel explores the possibility that Treasury should leave it to the markets by selling the warrants in an open, public auction. This has the benefit of stopping any speculation about whether Treasury has been too tough or too easy on the banks that want to repurchase their own warrants. It also permits the banks to bid for their own warrants – in direct competition with outsiders.

As always, it is critical that Treasury make the process – the reason for its decisions, the way it arrives at its figures, and the exit strategy from or future use of the TARP – absolutely transparent. If it fails to do so, the credibility of the decisions it makes and its stewardship of the TARP will be in jeopardy.


Just yesterday, the Panel released a special report on farm credit and farm loan restructuring, as mandated by the Helping Families Save Their Homes Act of 2009. Farmers entered the recession in a historically strong position, and for many, balance sheets are in fairly good shape. But prosperity is not evenly spread across America. Today, more farmers are struggling. Net farm income is expected to fall 20 percent this year, and some sectors – especially dairy – are doing worse. Congress asked the Panel to consider whether three existing loan restructuring models – the USDA’s Farm Service Agency, the Farm Credit System, and the Making Home Affordable program for residential mortgages – could be used as a model for a farm loan restructuring mandate for TARP recipient banks.

The Panel found that a foreclosure plan that only works through a mandate on TARP recipient banks, no matter which model it followed, would have limited effect. Right now TARP recipient banks only hold about ten percent of farm real estate debt.
Treasury and Congress could consider other alternatives, such as setting aside a portion of remaining TARP funding for a farm mortgage foreclosure mitigation program, patterned on the incentive based program developed to protect homes, but focusing on bank participation beyond current TARP recipients. Another option would be to create within TARP a loan guarantee program for restructured farm loans. Both commercial banks and other lenders, like the Farm Credit System, report using government guaranteed loans to restructure trouble loans, but the availability of such loan guarantees is insufficient to meet the need. Finally, Congress has options outside of TARP to assist struggling farmers, such as commodity and price support programs. Such programs could allow assistance to be targeted to the specific sectors in need, like the dairy industry.

For August the Panel will turn to the topic of toxic assets. The precipitous drop in value of classes of assets linked (primarily) to residential real estate loans, produced the most serious financial crisis of the last 75 years. But government policy has not focused on those assets. Instead it has aimed to stabilize the financial institutions that hold them. What are the consequences, and more important, the risks of this approach to putting the financial sector into a position where the crisis cannot reignite?


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