Financial Markets Rescue Package Q&A: Impact of Legislation (9 of 10)

The federal government's Troubled Asset Relief Program (TARP)—created by the Emergency Economic Stabilization Act of 2008 (EESA) signed into law by President Bush on October 3, 2008—gives the U.S. Department of the Treasury authority to purchase "troubled assets" from financial institutions. The Faegre & Benson TARP Task Force has developed answers to some frequently asked questions about which institutions qualify to participate in the program and how the program is expected to work.

What will be the legislation's impact?

Q: Does the Act address the treatment of failed or failing banks?

A. The EESA makes certain agreements limiting the ability to acquire banks or their assets unenforceable. Specifically, the EESA provides that "any standstill, confidentiality, or other agreement that, directly or indirectly, (a) affects, restricts, or limits the ability of any person to offer to acquire or acquire, (b) prohibits any person from offering to acquire or acquiring, or (c) prohibits any person from using any previously disclosed information in connection with any such offer to acquire or acquisition of, all or part of any insured depository institution" or any liabilities, assets or interest in any such institution shall be unenforceable. (§ 126(c).) These provisions will generally only apply to transactions in which the FDIC was acting as conservator or receiver.

This provision is at issue in the dispute over the Wachovia purchase. As widely reported, Wachovia reached an agreement with Citibank for Citibank to acquire a number of Wachovia's assets. Later, Wells Fargo made what Wachovia believed to be a better offer, and Wachovia sought to terminate the Citibank transaction and take Wells Fargo's offer. Citibank sued to force Wachovia to honor its transaction, and Wachovia and Wells Fargo argued that Section 126(c) of the EESA voided any exclusivity provisions in the Citibank deal. As of today, no court has ruled on that issue.

Q: Will the bailout plan work? Is it enough?

A: For financial and credit markets, even more important than the type of assets purchased is the price that the government will pay for them. As noted above, the Act does not explain how the prices will be established. It is only clear that the government will have complete discretion to set the offering price, and very broad discretion about the institutions from which it will buy the assets.

Using low "fire sale" prices, while perhaps seeming attractive at first blush, may do more harm than good, since an artificially low price will not accurately reflect the value of the securities and will fail to revive the market for such securities. Many experts agree that reviving the market is crucial, as there are likely far more troubled assets than the Treasury Department can purchase within its $700 billion limit.

If the TARP succeeds in reviving the credit markets, then the economy would improve, and mortgage and other credit defaults could be minimized. If the plan works well and the government could sell the formerly troubled assets, the government would be repaid, at least in part. It is even possible that the government could recognize a substantial return on some of the assets that it purchases under the TARP.