Treasury Coordination with Foreign Authorities and Central Banks
The Act requires that Treasury coordinate, as appropriate, with foreign financial authorities and central banks to work toward the establishment of similar programs by such authorities and central banks. This reflects the concern by many in Congress that U.S. taxpayers should not assume sole responsibility for the bailout of non-U.S. financial institutions. As discussed below, on October 10, 2008, the G-7 finance ministers and central bank governors issued a Plan of Action that outlines a commitment to work together to take action to address the current liquidity, banking and market environment. While establishment of a purchase or insurance program is not specifically identified, the goals outlined in the Plan align with the purposes of the Act. And in the following days, Treasury has clarified its commitment to purchasing equity of U.S. financial institutions to improve capital and encourage lending.
Additionally, as noted above, the Act's provision on coordination with foreign authorities provides that where a foreign financial authority or central bank holds troubled assets as a result of extending financing to financial institutions that have failed or defaulted on such financing, such troubled assets qualify for purchase under TARP.
Mark-to-Market (Fair Value) Accounting1
The Act requires that the SEC conduct a study on "mark-to-market" accounting and authorizes the SEC to suspend the application of the accounting rule for any issuer or category of transactions if the SEC finds it is necessary or appropriate, in the public interest and consistent with the protection of investors. "Mark-to-market" accounting, required by Statement 157 of the Financial Accounting Standards Board (FASB), mandates that financial assets be recorded based on their current fair value. When possible, fair value is determined based on the current market price of the asset. In recent months, when faced with increasing losses, write-downs, reduced capital and tightening liquidity, institutions sold mortgage-related securities at increasingly reduced prices. These stressed sales then established increasingly lower floors for the determination of the "market" value of the same and similar mortgage-related securities. It has been suggested that, in many cases, the resulting balance sheet value given to mortgage related assets is less than the present value of the expected cash flows from those assets, even after taking into consideration the current housing environment and increased expected losses on mortgage related securities.
On September 30, 2008, the SEC and the FASB Staff issued a statement providing clarifications on fair value reporting. On October 10, 2008, the FASB followed with FASB Staff Position 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. The statements provide clarification that where there is no active market for a security, the institution making a fair value determination may under the appropriate circumstances consider the future value of cash flows. At this time, it remains unclear whether the additional guidance will result in corporations modifying valuations with their accountants' blessing in future periods.
By January 2, 2009, the SEC must deliver to Congress a report undertaken in consultation with Treasury and the Federal Reserve. The study must consider, at a minimum:
- the effects of FAS 157 on a financial institution's balance sheet,
- the impact of such accounting on bank failures in 2008,
- the impact of such standards on the quality of financial information available to investors,
- the process used by the FASB in developing accounting standards,
- the advisability and feasibility of modifications to such standards, and
- alternative accounting standards to those provided in FAS 157.
The Act requires that the SEC assess the impact on financial institutions, including depositary institutions, and include any administrative and legislative recommendations in the report.
On October 7, 2008, the SEC announced initial steps to conduct the study, including the appointment of Deputy Chief Accountant for Accounting James Kroeker as staff director for the study. The SEC also published a request for public comment on October 8th and comments are due by November 13, 2008.
Treasury Analysis of Financial Disclosure Generally
Treasury is required to determine, for each type of financial institution that sells troubled assets, whether certain current public disclosure requirements are adequate to provide the public with sufficient information as to the true financial position of the institution. The specific areas of financial disclosure are: off-balance sheet transactions, derivatives instruments, contingent liabilities and "similar sources of potential exposure." If Treasury determines that the existing disclosure requirements are not adequate for the public to assess the true financial position of the institutions, it is required to make recommendations for additional disclosure requirements to the relevant regulators.
There are no deadlines or time requirements imposed upon Treasury with respect to this requirement.
To undertake an assessment of this nature Treasury will need information that is broader in scope than that which we would expect to see gathered to conduct an auction or reverse auction. In the case of direct purchases, the institution under stress may be more likely to share this level of information with Treasury. As with many of the reporting provisions of the Act, it remains to be seen what level of detail will be undertaken and, particularly absent a deadline, when a report may be submitted.
Regulatory Modernization Report2
By April 30, 2009, the Secretary of Treasury must deliver to Congress a regulatory modernization report. Treasury must conduct a review of the current state of the financial markets and the regulatory system, analyzing the effectiveness of the system in overseeing financial market participants. Both the over-the-counter derivatives market and the government-sponsored enterprises (GSEs) must be included in Treasury's analysis.
The report should identify whether any financial market participants currently outside the regulatory system should become subject to the regulatory system. It should also include any recommendations related to enhancement of the clearing and settlement of over-the-counter swaps.
We would expect many of the recommendations would mirror those found in The Department of Treasury Blueprint for a Modernized Financial Regulatory Structure, published in March 2008. The Blueprint includes short term, intermediate term and long term recommendations for a stronger regulatory structure. Changes proposed in the Blueprint include, among others, conversion of the federal thrift charter to a national bank charter over a two-year period accompanied by a merger of the Office of Thrift Supervision and the Office of the Comptroller of the Currency, merger of the SEC and the Commodities Futures Trading Commission, and establishment of an optional national insurance charter.
Report on Margin Authority
By June 1, 2009, the Comptroller General must submit the results of a study to determine to what extent leverage, and the sudden deleveraging of financial institutions, was a factor behind the current crisis. The study must include an analysis of (1) the roles of government parties to monitor leverage and their actions, if any, in curtailing leverage, (2) the authority, process and actions of the Federal Reserve regarding leverage and margin requirement setting and (3) recommendations on the authority of the Federal Reserve.
Report on Regulatory Reform
By January 20, 2009, the Congressional Oversight Panel must submit to Congress a special report on regulatory reform. The report should analyze the current state of the regulatory system and its effectiveness at overseeing the participants in the financial system and protecting consumers. The Panel should make specific recommendations for improvements in those areas, including whether and why any unregulated financial market participants should be regulated, and whether there are any gaps in existing consumer protections.
Federal Reserve Paying Interest on Reserves
The Act authorized the Federal Reserve Banks to begin paying interest on deposits held by or on behalf of depository institutions. The Financial Services Regulatory Relief Act of 2006 had authorized the interest payments commencing in October 2011, but the Act removed the waiting period. By paying interest on required reserve balances as well as excess deposits, the incentive for depository institutions to remove any excess on deposit at a Federal Reserve Bank has been removed. Additionally, the opportunity cost associated with maintaining the required balances has been reduced, which the Federal Reserve believes will enhance efficiency for banks. The necessary revisions to Regulation D to permit the payment of interest were made, effective October 9, 2008.
Temporary Increase in FDIC Insurance
From October 3, 2008 through December 31, 2009, the amount of deposits insured by the FDIC was increased from $100,000 to $250,000. The same limit increase applies to credit unions as well. As several commentators have noted, it will be challenging for Congress to permit the insurance to lapse back to the lower level.
Footnotes
1. See Morrison & Foerster LLP's News Bulletin "Fair Value and the Recent Market Turmoil" at http://www.mofo.com/news/updates/files/081013FairValue.pdf
2. See Morrison & Foerster LLP's News Bulletin "Credit Default Swaps as Insurance: One Regulator or Many?" at http://www.mofo.com/news/updates/files/081006CreditDefault.pdf
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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