US Capital Purchase Program (CPP)

The program was one of the first parts of a series of interventions aimed at stabilizing several sectors of the struggling American economy. TARP funds were disbursed to provide government investment in individual institutions, such as AIG, as well as entire sectors, such as housing and the auto industry. However, the CPP was considered to be the “centerpiece” of TARP (Treasury, n.d.d; FRBSTL 2009, 1).

Additional TARP bank investment programs included the Community Development Capital Initiative (CDCI), the Targeted Investment Program (TIP), the Asset Guarantee Program (AGP), and the Supervisory Capital Assessment Program (SCAP) (Treasury 2016). TARP’s credit market programs were the Public-Private Investment Program (PPIP), the Term Asset Backed Loan Facility (TALF), and the SBA 7(a) Securities Purchase Program (Credit Market Programs). TARP’s housing programs were the Making Home Affordable (MHA) and the Hardest Hit Fund (HHF), as well as support for FHA refinancing efforts (Housing Programs). TARP also funded individual restructuring agreements for Chrysler and GM through the Automotive Industry Financing Program (AIFP). Section 136 of TARP also temporarily increased the deposit insurance threshold from $100,000 to $250,000; Congress later made the change permanent (EESA 2008, 3799).

In total, Congress appropriated $700 billion of TARP funds in two tranches of $350 billion. Congress required Treasury to submit a report to Congress requesting that the second tranche of $350 billion be released should it be needed (EESA 2008, 3780–81). In total Treasury disbursed about $442 billion through TARP, with its capital injections through the CPP at almost $205 billion, and total assistance to banks at $245 billion (Treasury 2019a).

Legal Authority for the Capital Purchase Program came from Section 101 of the Emergency Economic Stabilization Act (EESA) of 2008, which was passed on October 3, 2008. Section 101 states that, “The [Secretary of the Treasury] is authorized to establish the Troubled Asset Relief Program (or ‘TARP’) to purchase, and to make and fund commitments to purchase, troubled assets from any financial institution…” (EESA 2008, 3767). Treasury and the Federal Reserve shortly decided to directly invest in the capital structure of banks rather than purchasing assets off their balance sheets (SIGTARP 2009b, 12). Treasury would allocate a total of $250 billion of the $700 billion.

The Bush administration faced considerable difficulty in getting Congress to pass TARP. Its original proposal, which was three pages long and released on September 20, 2008, was met with considerable resistance from Congress and the public (Calabresi 2008). In an attempt to persuade lawmakers and the public, Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke testified at the Senate Banking and Finance Committee on September 23 (Senate Banking Committee 2008).

Paulson testified that the proposal would be “the single most effective thing we [could] do to help homeowners, the American people and stimulate our economy” (Paulson 2008a). Bernanke backed the Treasury’s “proposal to buy illiquid assets from financial institutions” (B. S. Bernanke 2008, 4). He said the program would create liquidity, promote price discovery, and restore confidence in the broader system (B. S. Bernanke 2008, 4). Paulson and Bernanke worked in tandem, with Bernanke “provid[ing] the academic gravitas” and Paulson “argu[ing] passionately that [TARP] was the most effective way to recapitalize the banking system” (Jester, Nason, and Norton 2020). The two officials expressed an urgent need for intervention, with Paulson acknowledging the importance of post-crisis regulation (B. S. Bernanke 2008, 4; Paulson 2008a, 2). Paulson described TARP as an asset purchase program rather than a recapitalization program. In his testimony to the House Financial Services Committee the next day, he explicitly stated that the program “is not a spending program. It is an asset purchase program, and the assets which are bought and held will ultimately be resold with the proceeds coming back to the government” (Paulson 2008b).

The initial reaction from lawmakers was negative. Sen. Chris Dodd, who chaired the Senate committee, called the original proposal “stunning and unprecedented in its scope—and lack of detail...” Dodd said the program would not do anything to help homeowners. He articulated mistrust towards having the Treasury hold so much power. “[It] is not just our economy that is at risk but our Constitution as well” (Senate Banking Committee 2008, 3). Much of the criticism from lawmakers centered around the proposal’s lack of detail, its focus on rescuing financial institutions rather than homeowners, and the lack of punishment for the financial institutions that would be receiving TARP aid (Senate Banking Committee 2008).

The original proposal sparked some public outrage, such as over a thousand protestors rallying outside of the New York Stock Exchange (Bensinger 2008). Senators Sherrod Brown, Barbara Boxer, and Diane Feinstein reported that their offices alone received over 60,000 emails, calls, and letters about the proposal, most of which were decidedly against it (Stolberg 2008; Bensinger 2008). A poll by Pew found broad support for a government intervention; Gallup found that a majority of Americans supported Congressional action, but in a form different from Paulson’s proposal (Kohut and Parker 2008; Newport 2008).

The House of Representatives failed to pass EESA on September 29, 2008 (US House 2008b). In a public statement following the vote, Paulson expressed his disappointment, stating that the government’s toolkit was “substantial but inefficient” to address the continued stress (Paulson 2008c). Financial markets reacted extremely negatively after the vote, with the Dow Jones Industrial Average dropping 777 points and the S&P 500 falling 8.8 percent, with over $1 trillion in value being lost (Jester, Nason, and Norton 2020; Davis 2008).

In the aftermath of the failed vote, Paulson’s aides expressed privately that capital injections would likely be necessary to combat the crisis. Paulson agreed and told President Bush capital injections, not large-scale asset purchases, would be the best way forward (Jester, Nason, and Norton 2020, 213-214).

The Senate passed a revised bill on October 1, and on October 3, Congress passed the Senate version and President Bush signed it into law (US House 2008a). After the successful vote, Paulson reiterated the Treasury would provide “regular updates” in regular press releases and speeches (Paulson 2008d). From October 3 to October 14, the day the CPP was announced, the Treasury published updates chronicling the shift in its thinking on October 6, 8, 11, and 13. Paulson’s statements on October 8 are the first place where he mentions verbatim that the authority granted to Treasury under EESA allowed it to inject capital into financial institutions (Paulson 2008e). A day later, it was reported that capital injections “[had emerged] as one of the most favored new options being discussed in Washington and on Wall Street” (Andrews and Landler 2008). The language in the subsequent updates on October 11 and 13 indicate that capital injections were a serious option that Treasury was considering, despite initially campaigning for asset purchases (Paulson 2008f; Kashkari 2008a).^FPaulson’s remarks at the International Monetary and Financial Committee meeting on October 11, 2008, outlined five key areas of Treasury’s response, with one of them being strengthening the capital of financial institutions (Paulson 2008f). In his remarks before the Institute of International Bankers, Neel Kashkari specified that Treasury was “designing a standardized program to purchase equity in a broad array of financial institutions,” and that the program would be voluntary and attractive to healthy institutions (Kashkari 2008a).

In its first press release on October 14, Treasury specified that the program was “voluntary,” but that nine financial institutions had also already agreed to participate, which “signal[ed] the importance of the program for the system.” Treasury explicitly stated that these nine were healthy, and that they would participate “on the same terms that will be available to small and medium-sized banks and thrifts across the nation” (Treasury 2008c). (For more detail on these nine banks, see KDD No. 7.)

In an update made to the public on November 12, 2008, Paulson addressed the decision to avoid using TARP funds for asset purchases, stating that, “At the time, we believed that [asset purchases] would be the most effective means of getting credit flowing again” (Paulson 2008g). He described how the continuously deteriorating conditions leading up and subsequent to the passage of EESA made those at Treasury realize that an asset purchase program “would take time to implement and would not be sufficient given the severity of the problem” (Paulson 2008g). Ultimately, Paulson stated, capital injections were the “most timely, effective step to improve credit market conditions” (Paulson 2008g). 

Section 104 of EESA established the Financial Stability Oversight Board (FSOB) to review the policies implemented under section 101. Those policies included reviewing “the appointment of financial agents, the designation of asset classes to be purchased, and plans for the structure of vehicles used to purchase troubled assets…” (EESA 2008, 3770–71). The FSOB was also responsible for examining the effects that programs made under section 101 had on “assisting American families in preserving home ownership, stabilizing financial markets, and protecting taxpayers” (EESA 2008, 3771).

The Board had the following members:

• The Chairman of the Board of Governors of the Federal Reserve System
• The Secretary of the Treasury
• The Director of the Federal Housing Finance Agency (FHFA)
• The Chairman of the Securities Exchange Commission (SEC), and
• The Secretary of Housing and Urban Development (HUD).

Additionally, the Board was required to report to Congress, as well as the Congressional Oversight Panel at least quarterly to discuss the matters described above. Section 116(a)(2) of EESA also stipulated that GAO would be another oversight authority (EESA 2008, 3784).

The Special Inspector General for the Troubled Asset Relief Program, or SIGTARP, was established through section 121 of EESA. The Special Inspector General was to be appointed by the president and confirmed by the Senate, and was responsible for “coordinat[ing] audits and investigations of the purchase, management, and sale of assets by the Secretary of the Treasury…” (EESA 2008, 3788). SIGTARP did this by collecting the following information:

• Descriptions of categories of troubled assets purchased
• Listings of assets that fell into the aforementioned categories
• Explanations of the reasons for purchasing said assets from the Secretary of the Treasury
• Listings of the financial institutions that the troubled assets were purchased from
• Listings of, and “detailed biographical information” on the people hired to manage these troubled assets
• Estimates on the total number and value of troubled assets, how much remained with the Treasury, how much had been sold, and the profit or loss incurred from said sales (EESA 2008, 3788–89).

According to its mission statement, SIGTARP “is a federal law enforcement agency and is an independent watchdog protecting taxpayer dollars that fund TARP” (SIGTARP 2018, 3). SIGTARP reported to Congress about its supervisory activities twice a year, audited various TARP programs, and conducted and reported on investigations of misconduct for TARP recipients (SIGTARP, n.d.). SIGTARP’s quarterly reports generally consisted of assessments of various components of the program, such as the CPP, as well auto and housing industry support programs (SIGTARP 2010). SIGTARP reports included detailed recommendation sections, informed by the audits and investigations it conducted, and the reports also provided detailed tables of the implementation status of each of these recommendations (SIGTARP 2014, 313–36).

The Congressional Oversight Panel (COP) was another crucial component of TARP oversight. Created on the same day that TARP was passed, COP’s primary function was to “review the current state of the financial markets and the regulatory system” through the submission of regular and special reports to Congress (EESA 2008). The COP was responsible for drafting reports every 30 days to support its analysis on:

• the general use of authority provided in EESA by the Secretary of the Treasury, including with respect to contracting and administration;
• the impact of purchases made under the EESA on financial markets and financial institutions;
• the extent to which the information available on the transactions made by programs under EESA has contributed to market transparency;
• the effectiveness of foreclosure mitigation efforts, and the effectiveness of the program with respect to minimizing long-term costs to the taxpayer and maximizing taxpayer benefit (EESA 2008, 3791).

Additionally, EESA required that the COP submit a Special Report on Regulatory Reform by January 9, 2009. This report was expected to analyze the effectiveness of the current financial regulatory framework at overseeing its participants and protecting consumers, as well as make recommendations on how to fill any existing regulatory gaps. These gaps may include areas where consumer protection is lacking or those where financial market participants that may be outside of the current regulatory perimeter operate and should become subject to it. In its approximately two and a half years of operation, the COP held hearings and collected testimony from high-level officials, such as Treasury Secretary Tim Geithner, as well as published 29 reports on the impacts of key TARP initiatives. Much of COP’s analysis was informed by the functions listed above, with the Panel asking questions about the more immediate, stabilizing effects of TARP, as well as longer-form impacts, such as how TARP recipients were structuring their business and policies after receiving aid (COP 2008, 3). Other reports, such as those about specific firms like GMAC and AIG, as well as Treasury’s conduct with smaller CPP banks, were also published (COP, n.d.). In this way, Congress was able to provide another layer of feedback to Treasury in how they managed still-outstanding investments, while providing guidance on what to do for future initiatives.

The COP was disbanded on April 3, 2011, after releasing its final report. In it, the Panel explained that, while TARP alone was not responsible for the economic recovery, “TARP quelled the immediate panic and helped to avert an even more severe crisis” (COP 2011, 152). However, COP did cite concerns about moral hazard, stigma, and a lack of transparency. TARP, and by extension the CPP, was “one of the most thoroughly scrutinized government programs in US history” (COP 2011, 160–61).

Despite the varied schedule in announcement dates and capital characteristics, all four classes of institutions had the same individual minimums and maximums for participation. If accepted into the program, all participating institutions were required to issue eligible securities at a minimum of one percent of their risk-weighted assets. However, no institution could issue qualifying capital up to the lesser of 1) $25 billion and 2) three percent of its risk-weighted assets (Treasury 2008b; Treasury 2008e; Treasury 2009b; Treasury 2009g).

Congress authorized a total of $700 billion of TARP funds. However, Treasury could freely disburse only $350 billion, and the president was required to return to Congress with a report asking to disburse the remaining $350 billion in funds, should they be necessary (EESA 2008, 3780).^FThe phrase “outstanding at any one time,” which implicitly allowed the government to re-use TARP funds, was removed with the passage of The Dodd-Frank Wall Street Reform and Consumer Protection Act in July of 2010. (See KDD No. 15 for more details.) Treasury allocated $250 billion to the CPP from these appropriations.

This authority lasted until October 3, 2010, or two years after the date of the passage of EESA. After this point, Treasury was not able to make new commitments under TARP (Treasury OFS 2010, 14). The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed on July 21, 2010, reduced this original commitment from $700 billion to $475 billion (Dodd-Frank 2010, 2133).

Prior to its official release of the details of the CPP, Paulson and a group of high-level government officials arranged a meeting on October 13, 2008, with the heads of nine of the largest US banks.^FThe nine banks were JP Morgan, Wells Fargo, Bank of America, Citigroup, Goldman Sachs, Merrill Lynch, Morgan Stanley, Bank of New York Mellon, and State Street. At the time, these institutions held about 55 percent of all US banking assets, and agreed in part to participate “to signal the program’s importance to the stability of the financial system” (GAO 2012, 7). They were selected because government officials viewed them as “systemically important” due to their size, scope of business, and interconnectedness in the broader economy (SIGTARP 2009b, 14–15). Although Treasury claimed in its initial announcement of the CPP that these institutions were healthy, other reports suggest that there were internal concerns about the health of the nine, and that protecting them would help protect a “system that was viewed as being vulnerable to collapse” (SIGTARP 2009b, 17). At the time, Chairman Bernanke even acknowledged that having one of these nine institutions fail “could rapidly cause the failure of others due to the high degree of interconnectedness of the systemically significant institutions” (SIGTARP 2009b, 17). The investments are shown in Figure 5.

Figure 5: Initial CPP Investment in Nine Large Financial Institutions ($ billions)

Source: Treasury, n.d.c

Institutions that wished to apply had to do so by applying through their primary federal banking regulator, and bank holding companies were required to apply to their supervisor as well as the regulator that monitored the largest depository institution it controlled. Public institutions had until 5 p.m. on November 14, 2008, to submit applications (Treasury 2008e). The details for privately held institutions (excluding S-corps and mutual banks) were released on November 17, and their application deadline was December 8, 2008 (Treasury 2008f). The names of approved publicly traded institutions would be released publicly unless they could “demonstrate the harm (for example, loss of competitive position, invasion of privacy) that would result from public release of information” (Treasury 2008a, 2–3).

Financial institutions applied to their primary federal regulator by submitting an application form, signed by the institution’s chief executive officer or an authorized designee. The form included the amount of preferred stock the institution requested; high-level financial data, such as the amount of authorized but unissued stock; a commitment that the management had reviewed and agreed with the terms of the investment agreement; a description of any conditions in the investment agreements that the bank could not meet; and a description of any mergers, acquisitions, or other capital raisings that were pending or under negotiation (FDIC/Fed/OCC/OTS, n.d.).

Treasury initially released the term sheet and documentation for publicly traded institutions and later published the details for private financial institutions, S-corporations, and mutual banks after expanding CPP eligibility. While non-public banks had their participation details released about a month after their public counterparts, S-corps and mutual banks did not get the necessary documents to participate until January and April of 2009, respectively (Treasury 2008f; Treasury 2009c; Treasury 2009h).^FMutual banks are different from commercial banks in that they do not have common shareholders. They are owned by their members, that is, their depositors, who share in the profits. As of the end of 2018, the largest mutual institution holds just over $14 billion in assets, and the average mutual institution holds approximately $593 million in assets (FDIC 2021a). Treasury also released sets of Frequently Asked Questions (FAQs) for each of the types of institutions eligible for the CPP, which primarily addressed concerns around institutional requirements, Tier-1 or Tier-2 eligibility of government capital (depending on whether it was preferred stock or subordinated debt), as well as the publicity of individual participants (Treasury 2008a; Treasury 2008d; Treasury 2009a; Treasury 2009f).

According to the term sheets disseminated by Treasury at the outset of the program, a Qualifying Financial Institution (QFI), could not be a foreign bank, foreign savings association, foreign Bank Holding Company (BHC), or foreign Savings and Loan Holding Company (SHLC). S-corporations and mutual banks were originally not included but would be made eligible in early 2009. Figure 6 describes the legal definitions of QFIs. 

Figure 6: Qualified Financial Institution (QFI) definitions

In reviewing applications, primary federal regulators considered supervisory and other information. Treasury worked with the regulators to establish a common and streamlined applications process. Under this process, the primary federal regulator—or, in some cases, a council of representatives from each federal regulator—supervised an institution. If a bank had strong Capital adequacy, Assets, Management capability, Earnings, Liquidity and Sensitivity (CAMELS) ratings and its application was endorsed by the primary federal regulator then its application was sent directly to the TARP Investment Committee (Massad and Kashkari 2020, 399-400). For these banks, the Investment Committee would decide whether to recommend the bank to the Assistant Secretary of financial stability (Massad and Kashkari 2020, 400). Banks that did not receive this “presumptive yes” recommendation would have their applications sent to the CPP Council, which was comprised of representatives of all the bank regulators (Massad and Kashkari 2020, 400). The Council would then review these applications and make recommendations for the TARP Investment Committee, who would then make the final recommendations to the Assistant Secretary (Massad and Kashkari 2020, 400). Applications that were likely to be denied were given back to the primary regulator, who would encourage the bank to withdraw its application (Massad and Kashkari 2020, 400).

On receiving preliminary approval from the Assistant Secretary, applicants had 30 days to submit the investment agreements and related documentation (FSOB 2008, 7–8).

In its first term sheet, released on October 14, 2008, Treasury specified that the capital that it purchased had to have the following characteristics:

Figure 8: Capital Characteristics for types of QFIs

Dividends

All capital issued to Treasury was sold at $1,000 per instrument.^FPreferred stock had a liquidation preference of $1,000, and subordinated debt was sold with a par value of $1,000 (Treasury 2008b; Treasury 2008e; Treasury 2009b; Treasury 2009g). If necessary, Treasury could agree to purchase the senior preferred shares with higher liquidation preference per share to accommodate the QFI’s available authorized preferred shares; in this scenario, Treasury could make the QFI appoint a depositary to hold the senior preferred shares and issue depositary receipts (Treasury 2008b; Treasury 2008e). Dividends and interest payments were cumulative, paid quarterly, and at rates varying from 5 to 7.7 percent, depending on the type of institution and how long it had held the capital for. All rates were equal on a normalized tax basis. After five years, step-up clauses in the term sheets would kick in, increasing the dividend or interest rates as high as 13.8 percent, depending on what category the QFI was in.^FS-corporations and mutual banks paid 7.7 percent in quarterly interest for the first five years of holding Treasury capital, then 13.8 past five years. However, the after-tax effective rates of their interest payments were five and nine percent, respectively. Thus, they paid the same effective amount in interest as publicly traded and privately owned QFIs (Treasury 2009b, 2). For institutions that took preferred equity and were not controlled by a holding company, their dividends were non-cumulative (Treasury 2008b; Treasury 2008e).

Dividend Restrictions

 For all classes of QFIs, dividends on junior or equivalently ranked equities were prohibited from being paid out or declared while the QFI still had Treasury capital outstanding. QFIs were also subject to certain restrictions on repurchases and redemptions, as well (discussed in KDD No. 11). Additionally, any increases in common dividends were required to be approved by Treasury so long as the government’s investment remained outstanding, or until three years had passed. After the third anniversary of the capital injection, publicly traded QFIs could raise common-stock dividends by any amount without Treasury’s consent, while the other three types of QFIs could only do so to a maximum of three percent. If an institution still had Treasury capital outstanding after 10 years, it was allowed to raise common-stock dividends by any amount without approval (Treasury 2008b).

Warrants

 Treasury also received 10-year warrants to purchase common stock, additional preferred shares, or additional subordinated debt depending on the type of QFI it had an agreement with. The terms of these warrants are summarized in Figure 9. The warrants for both publicly traded QFIs and mutual banks included Reduction clauses, which stated that, if the QFI had not paid back Treasury’s investment by the end of 2009, then the number of securities underlying the warrants would be reduced to half of the total amount of Treasury’s initial investment (Treasury 2008b, 5; Treasury 2009g, 5).

For publicly traded institutions, the warrants could also be exchanged for “senior term debt or another economic instrument or security of the QFI such that [Treasury] is appropriately compensated for the value of the warrant…” (Treasury 2008b, 5). Treasury had the option to make this substitution if the QFI ceased to be publicly traded, or if a shareholder vote to issue enough common stock to cover the exercising of the warrant had not passed within 18 months (Treasury 2008b, 5).

In the fourth quarter of 2008, the Treasury immediately exercised all warrants for preferred shares in each privately-held QFI that received a CPP investment. Treasury did not require banks classified as community development financial institutions to issue warrants as a condition for a CPP investment (FSOB 2008, 9).

Figure 9: Characteristics of CPP Warrant by Type of QFI

Voting Rights

In both cases of preferred stock or subordinated debt, Treasury would have no voting rights other than those in instances where i) instruments more senior to their own were being issued, ii) the rights of their equity or debt were being amended, or iii) a merger, exchange, or similar transaction took place that would affect the rights of their investment (Treasury 2008b; Treasury 2008e; Treasury 2009b; Treasury 2009g).

As of October 2019, 34 institutions that received CPP investments were either undergoing or had gone into bankruptcy or were in receivership. Institutions in receivership would have their assets taken over and subsequently marketed and sold to make their creditors whole (FDIC 2014, 26). When referencing this category of institutions, the GAO reported that, “When [CPP] investments are restructured, Treasury receives cash or other securities, which generally can be sold more easily than preferred stock, but Treasury’s investments are sometimes sold at a discount” (GAO 2016, 6). For a small subset of CPP institutions, Treasury “would determine whether it would exchange or restructure the Government’s shares to facilitate a merger or acquisition of the TARP bank and whether or not it would take a discount,” though this was done on an ad-hoc basis (SIGTARP 2015, 12).

Repurchases and Redemptions

In effect, the government’s investment subordinated all other holders of equity, though holders of senior and subordinated debt still ranked senior to the senior preferred equity that the government held. Redemption of Treasury’s investment in all types of QFIs except for mutual banks required a qualified equity offering (or qualified securities offering in the case of subordinated debt) in which the institution raises additional Tier-1 or Tier-2 capital in private markets of at least 25% of the original issue price of Treasury’s investment. For mutual banks, redemptions could be done at any time, provided they obtained approval from their federal banking regulator (Treasury 2008b; Treasury 2008e; Treasury 2009b; Treasury 2009g).

The term sheets also required QFIs that issued preferred equity to obtain Treasury approval for any repurchasing of shares that were either senior or non-government. QFIs that issued subordinated debt had to seek Treasury’s approval for any repurchases of equity. However, if a QFI still had CPP investments outstanding after ten years, then they were no longer required to obtain Treasury approval for repurchases or undergo a qualified equity offering for redemptions (in the cases of publicly traded and nonpublic QFIs). Publicly traded institutions were only required to wait three years before these restrictions were lifted (Treasury 2008b; Treasury 2008e; Treasury 2009b; Treasury 2009g).

CDCI and SBLF Conversion

 The Community Development Capital Initiative (CDCI), which was created on February 3, 2010, allowed certain CPP institutions to convert their CPP capital into lower-cost CDCI capital (Treasury 2010; Webel 2013, 15–16). In order to be eligible for this conversion, CPP institutions needed Community Development Financial Institution (CDFI) certification. CDFIs are financial institutions that seek to generally expand economic opportunities in underserviced and low-income areas (Treasury 2012b; CDFI Fund, n.d.). If a QFI was accepted, their current CPP capital would be exchanged, and they would be expected to issue additional shares up to a maximum of five percent of their risk-weighted assets (Treasury 2012b). 28 institutions had $362 million in CPP investments refinanced through the CDCI.

The Small Business Lending Fund (SBLF), established on September 27, 2010, as part of the Small Business Jobs Act, was a program that “encourage[d] lending to small businesses by providing Tier-1 capital to qualifying community banks with assets of less than $10 billion (Treasury 2011; Treasury, n.d.b). CPP institutions that met that requirement could apply to the SBLF to have their Treasury capital refinanced provided that they were 1) not on the FDIC’s problem-bank list and had not been on that list for the last 90 days, and 2) had missed a maximum of one dividend payment for CPP or CDCI preferred shares (Treasury, n.d.b, 8).

While the terms of the SBLF in many ways mirrored the CPP and CDCI, the dividend structure was tied to the amount of small business lending a given SBLF participant did. The more a participant’s small business lending increased after receiving SBLF capital, the lower its dividends would be (Treasury, n.d.b, 4).^FThere were still step-up clauses present in the CPP/CDCI to SBLF term sheet, however. After the first nine quarters, dividend rates would increase to a maximum of seven percent (from five percent for the first nine quarters). After four-and-a-half years, all dividends, irrespective of lenders’ performance, would increase to nine percent (Treasury, n.d.b, 4). This incentive structure was amplified by an annual “lending incentive fee” of two percent of the total amount of preferred stock outstanding that would trigger if the institution did not increase its small business lending relative to its baseline amount after two and a half years in the program. The fee would apply starting on the fifth anniversary of the original CPP investment and each subsequent quarter (Treasury, n.d.b, 4–5). Because the SBLF was not a TARP program, many TARP restrictions, such as those on executive compensation, did not apply (Massad and Kashkari 2020, 392-393). This was particularly appealing to institutions eligible for the SBLF, as these restrictions did not vary based on the size of the bank and thus disproportionately impacted smaller banks with senior executives and officers who were not as generously paid (Massad and Kashkari 2020, 392-393). For these firms, the expanded restrictions “reached well down the organizational chart” and may have contributed to a lack of participation in the program or quicker repayment of the funds by smaller institutions (Massad and Kashkari 2020, 392-393). The SBLF was an alternative with less onerous restrictions, provided that a bank could continue to increase its lending (Massad and Kashkari 2020, 393). SBLF conversions were quite popular, with a total of 137 QFIs refinancing approximately $2.2 billion in Treasury capital through the SBLF through November 1, 2019 (Treasury 2019b, 1). 

Section 111 of EESA outlines executive compensation restrictions and corporate governance standards. Specifically, Section 111(b) describes these standards as they apply to direct purchases or investments in financial institutions. Section 111(b)(2) specified that there would be:

• “limits on compensation that exclude incentives for senior executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity or debt position in the financial institution;
• a provision for the recovery by the financial institution of any bonus or incentive compensation paid to a senior executive officer based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate; and
• a prohibition on the financial institution making any golden parachute payment to its senior executive officer during the period that the Secretary holds an equity or debt position in the financial institution” (EESA 2008, 3777).

Senior executive officers (SEOs) were defined by EESA as the top-five highest paid executives of companies that took TARP money (EESA 2008, 3777). Treasury passed several interim final rules that provided additional guidance on executive compensation post-EESA, as well (Treasury, n.d.a). Treasury passed one of these rules on October 20, 2008, which gave additional clarification to the three rules outlined in Section 111 of EESA with respect to CPP investments.

The rule required that a financial institution accepting CPP funds had to identify features that may “lead SEOs to take unnecessary and excessive risks that threaten the value of the financial institution” and ensure that they are not encouraged to take these risks. Compensation committees had a maximum of 90 days to make these reviews, and were required to meet at least once a year with senior risk officers to discuss these policies (Kashkari 2008b, 7–8). The regulation also required that any bonuses and incentive compensation paid to SEOs were subject to a clawback if they were earned through inaccurate financial statements or “any other materially inaccurate performance metric criteria” (Kashkari 2008b, 9). For the third and final provision under Section 111(b)(2), golden parachutes were defined as “any payment in the nature of compensation to (or for the benefit of) a SEO made on account of an applicable severance from employment to the extent that the aggregate present value…equals or exceeds an amount equal to three times the SEO’s base amount” (Kashkari 2008b, 9). The restrictions were narrow, as the Bush-era Treasury team believed that additional restrictions might have discouraged participation, and they were not the purpose of the program (Massad and Kashkari 2020, 392). Treasury officials Neel Kashkari and Tim Massad later recounted, “We viewed our highest priority as preventing a financial collapse, even if that meant we would take substantial criticism for our actions” (Massad and Kashkari 2020, 392-393).

Treasury announced significantly harsher restrictions on executive compensation on February 4, 2009, by distinguishing between institutions that required “exceptional assistance,” such as AIG, and Bank of America and Citigroup, and institutions participating in “generally available capital access program[s],” such as the CPP (Treasury 2009d). Institutions that received exceptional assistance faced even greater restrictions, such as a significant increase in golden parachute prohibitions (top 10 SEOs) and restrictions (one-year salary for next 25 highest-paid employees), as well as more restrictive limits to SEO compensation.

For generally available capital access programs, SEO compensation was further limited to $500,000 in total yearly compensation, though this could be waived with “full public disclosure and [a] shareholder vote” (Treasury 2009d). The clawback provisions also applied to the next twenty highest paid employees, in addition to the top five. Golden parachutes were further restricted to one year’s compensation, instead of three. The “exceptional assistance” distinction was the only one that Treasury made, which meant that the restrictions applied to all banks participating in the CPP regardless of size (Treasury 2009d). ARRA further expanded the restrictions and required the Secretary of the Treasury to retroactively analyze the bonuses and retention awards paid to each TARP recipient’s top-25 most highly compensated employees to determine whether the payments were inconsistent with the purpose of EESA and TARP or were contrary to the public interest (ARRA 2009). If a TARP recipient was found to be in violation of this standard, then the Secretary would negotiate with them “for appropriate reimbursements to the federal government” (ARRA 2009). The Treasury Secretary delegated the responsibility for this “Look Back” review to the Special Master for TARP executive compensation (Feinberg 2010, 2). The decision to significantly increase these restrictions across the board may have contributed to both a lack of participation at smaller banks and quicker repayment of TARP investments—regardless of whether the institution had replacement investments lined up (Massad and Kashkari 2020, 392-393).

Treasury published their last Interim Final Rule on June 10, 2009. The final rule limited bonuses paid to SEOs to one-third of total compensation, with the number of SEOs affected by this limit increasing based on the amount of CPP aid given.^FInstitutions that received over $500 million in assistance had their top-five highest paid executives, as well as the 20 next highest paid, affected by the one-third of total compensation limit. The $500,000 limit specified in the February guidance would be amended to “link compensation to long-term firm value” by allowing additional compensation over $500,000, providing that this was in the form of long-form, restricted stock (Treasury 2009i). The final rule also included the creation of a Special Master for TARP Executive Compensation, and further accountability for the Board of Directors of TARP recipients (Treasury 2009i).^FA number of the provisions laid out in the June 10 Interim Final Rule, such as the one-third limit on total compensation, as well as the number of SEOs and employees affected by executive compensation restrictions based on total TARP aid received, were originally passed via Section 111 of the American Recovery and Reinvestment Act of 2009 (ARRA). The June 10 Interim Final Rule implemented and clarified these restrictions.

Kenneth Feinberg, who was appointed as the Special Master, was responsible for reviewing compensation plans at firms receiving “exceptional” assistance in such a way that “maximize(s) long-term shareholder value and protect(s) taxpayer interests” (Treasury 2009i).^FIn addition to approving compensation agreements, the Special Master was also responsible for reviewing compensation that was paid prior to the passage of ARRA, as well as negotiating reimbursements for these where relevant (Treasury 2009i). This review was done with six factors in mind:

• Risk. Compensation plans generally should not encourage SEOs to take unnecessary risks. This includes incentives that reward employees for short-term or temporary increases in value or performance.
• Taxpayer return. Compensation structures should reflect the need for the entity to remain competitive and repay TARP obligations.
• Appropriate allocation. The composition of the compensation should be appropriately allocated with respect to the amount that is provided in salary, equity, executive pensions, et cetera.
• Performance-based compensation. An “appropriate portion” of compensation should be performance-based. This should be determined through specific metrics that encompass individual performance as well as company-wide or specific business unit performance.
• Comparable structures and payments. Compensation structures should generally be consistent with structures for persons in similar roles at similar entities, including those that are similarly financially distressed.
• Employee contribution to TARP recipient value. The compensation plan should reflect the value that the current or prospective contributions of the employee is providing to the TARP recipient (Feinberg 2010, 4-5).

To the extent that two or more of these principles may be inconsistent with one another when evaluating a specific compensation plan, the Special Master was afforded discretion in determining the relevant weight of these conflicting principles (Feinberg 2010, 5).

Treasury specified that institutions that received exceptional assistance included AIG, Citigroup, Bank of America, as well as automakers such as GM and Chrysler (Treasury 2009i). Institutions that participated in the CPP did not fall under this category (Treasury 2009i).

If dividends were not paid for six quarters (consecutive or not) then Treasury would have the option to elect two directors, with this right expiring after dividends had been paid for four consecutive quarters (Treasury 2008b, 3).^FFor non-publicly traded applicants, the right to elect directors ended when dividends had been paid for four consecutive periods (for non-cumulative preferred) or when all prior dividends had been paid (for cumulative preferred) (Treasury 2008e, 4). For S-corps and mutual banks, the right to elect directors ended when interest was paid for all prior missed quarters (Treasury 2009b, 4; Treasury 2009g, 3). After Treasury had received these backlogged payments, institutions were under no obligation to keep the government-appointed directors, but could choose to do so (Treasury 2012a). If five dividend payments were missed, however, Treasury would request permission from the institution to send observers “to help determine how to best exercise its contractual rights to nominate up to two directors” (Treasury 2012a). If multiple institutions required directors to be nominated, Treasury prioritized them based on the size of its investment, with large institutions receiving attention first. Specifically, they stated that, “Treasury [would] focus first on institutions where [its] investment exceeds $25 million” (Treasury 2012a).

The preferred stock issued to Treasury by banks (both public and non-public) was perpetual life, whereas the subordinated debt issued to them from S-corps and mutual banks had a 30-year term (Treasury 2008b, 2; Treasury 2008e, 2; Treasury 2009b, 2; Treasury 2009g, 1). However, the initial terms for CPP preferred stock only allowed repayment for the first three years if CPP capital was replaced by private capital, as the Bush-era Treasury wanted the financial system to fully recover before banks began repaying the loans (Massad and Kashkari 2020, 408).

Ultimately, these restrictions were removed with the passage of ARRA. The Obama-era Treasury team, led by Tim Geithner, believed that making institutions “investable” again by convincing private investors that it was safe to return to the market, was the correct approach (Clark, Kabaker, and Sachs 2020, 257). Simply put, the Geithner-era Treasury focused on restoring confidence (Clark, Kabaker, and Sachs 2020, 257). To do this, the Treasury released a Financial Stability Plan on February 10, 2009, designed to “address the uncertainty, troubled assets and capital constraints of our financial institutions as well as the frozen secondary markets that have been the source of around half of our lending for everything from small business loans to auto loans” (Geithner 2009a). The most significant component was a comprehensive, public stress test for banking institutions (including holding companies) with over $100 billion in assets. The Plan also outlined a comprehensive government capital backstop—called the Capital Assistance Program (CAP)—to increase confidence and act as a bridge to private capital (Geithner 2009a; Treasury 2009l). (Further details on the SCAP and CAP programs can be found in Lawson [2021].^FSee “The U.S. Supervisory Capital Assessment Program (SCAP) and Capital Assistance Program (CAP)” in The Journal of Financial Crises, Volume 3, Issue 3.)

Though Treasury did not specify a timeline for CPP, the American Reinvestment and Recovery Act (ARRA), passed on February 17, 2009, enabled TARP recipients to repay their CPP funds earlier than what was permitted by the CPP’s original terms. Initially, recipients could not repay Treasury without first completing a qualified equity offering within a specified minimum period (Treasury 2012a). In contrast, ARRA section 7001 required Treasury^FThis portion of the ARRA amended section 111 of EESA. Subsection (g), titled “No Impediment to Withdrawal by TARP Recipients,” read thereafter:           

“Subject to consultation with the appropriate Federal banking agency… the Secretary shall permit a TARP recipient to repay any assistance previously provided under the TARP to such financial institution, without regard to whether the financial institution has replaced such funds from any other source or to any waiting period, and when such assistance is repaid, the Secretary shall liquidate warrants associated with such assistance at the current market price.” to permit a recipient to repay the CPP funds: (1) upon the participant’s request and (2) subject to primary regulator’s consultation and approval—irrespective of a completed qualified equity offering or the waiting period. Otherwise, all the previous terms and conditions for redemption still applied, as described in KDD No. 11.

In a letter written to Congress in December 2009, Treasury Secretary Geithner stated that the CPP “is effectively closed,” and that the only commitments for capital injections would be “to provide capital to small and community banks, which are important sources of credit for small business” (Geithner 2009b). At the same time, Geithner reiterated that, despite limiting its new commitments, the government should maintain an “adequate financial stability reserve” in case conditions further worsened (Geithner 2009b). In terms of CPP investments, Geithner stated that they would be managing them, “in a commercial manner and [would] dispose of them as soon as practicable” (Geithner 2009b).

Section 120 of EESA stated that the authority to purchase troubled assets (and by extension, inject capital), would expire on December 31, 2009 (EESA 2008, 3788). However, the Secretary of the Treasury could extend this authority up through two years from the enactment of EESA (EESA 2008, 3788). On December 9, 2009, Treasury Secretary Tim Geithner made this extension to “enable us to continue to implement programs that address housing markets and the needs of small businesses, and to maintain the capacity to respond to unforeseen threats…” (Geithner 2009b). This authority expired on October 3, 2010, at which point Treasury began the wind-down of its TARP investment programs (Treasury OFS 2013, 4).

From this point on, CPP was largely in a wind-down phase, with 649 of 707 institutions remaining in the program at the end of 2009, and the vast majority of these were institutions with less than $100 million in assets (SIGTARP 2015, 11). At the beginning of 2010, 74 CPP institutions had already missed dividend or interest payments. This number would continue to grow as the program went on, despite the program approaching profitability (SIGTARP 2015, 11).

Generally, the Treasury wished to exit its TARP investments as quickly as possible, subject to the following principles:

• “Promote taxpayer investments and maximize overall investment returns within competing constraints;
• Promote financial stability and prevent disruption of financial markets and the economy;
• Bolster market confidence to increase private capital investments; and
• Dispose of the investments as soon as practicable, in a timely and orderly manner that minimizes the impact on the market and economy” (Massad and Kashkari 2020, 409-410).

On May 3, 2012, Treasury announced a strategy to more quickly exit its investment from the 343 remaining banks (Massad 2012). Despite nearly half of the total number of institutions still involved in the program, Assistant Secretary for Financial Stability Tim Massad stated that, of the $245 billion that they had invested in the capital structure of the banking system, Treasury had recovered $264 billion.^FThe $245 billion figure includes $40 billion invested into both Citigroup ($20 billion) and Bank of America ($20 billion) as part of the Targeted Investment Program (TIP). Most of the remaining institutions were “smaller, community lenders” that were having a more difficult time attracting private capital. Massad discussed three options that Treasury was planning to exit its involvement:

• Repayments. This was the most common method in which institutions exited the CPP (Treasury 2013, 7). According to Treasury, the majority of the remaining CPP institutions were unlikely to exit the program in this way. Treasury even stated, “In order for the investment to be considered high-quality capital for regulatory purposes, we could not require a bank to repay Treasury on a specific timeline” (Massad 2012).
• Restructurings. As discussed above, a “handful” of participants had already approached Treasury about restructuring their investment, usually within the context of a merger or plan to raise private capital. Treasury only agreed to these if “the terms represent[ed] the best deal for taxpayers under the circumstances.”
• Auctions and sales. Treasury had already auctioned off some of the warrants associated with its investments for a profit and had conducted a test auction of preferred stock in March of 2012. The auction, which received “eight times as many bids as the number of securities offered,” suggested that this was a beneficial way for the government to exit as it would attract private capital to replace their investment (Massad 2012).

The auctions ultimately had mixed results, with the vast majority (70%) of auctioned CPP investments being bought by large, private fund investors that were “unknown to the banks and not from the banks’ communities” (SIGTARP 2015, 14–15). SIGTARP raised some concerns about how some buyers may have bought these shares at steep discounts ranking from 1% to 90%, accusing others of flipping shares back to the banks at a premium to what Treasury received and citing a few cases where smaller institutions were apparently unable to, or unsuccessful at, repurchasing their own shares at auction (SIGTARP 2015, 17). However, one former Treasury official highlighted that the fact there was flipping does not necessarily undermine the results of the auction. The same commentator emphasized that Treasury recovered $3 billion from auctions—a small portion of the total $227 billion recovered from all CPP investments. Treasury officials at the time kept non-public information tightly concealed, worked to not prematurely disclose a sale or auction to avoid market participants “front running,” or trading against them, and worked with bank regulators to ensure that regulatory ownership restrictions were observed (Massad and Kashkari 2020, 410-414).

As of October 2019, only two institutions have about $17.4 million in CPP investments outstanding (Treasury 2019b, 1). Of the $204.9 billion that Treasury invested, they obtained approximately $226.4 billion in repayments, dividend payments, and interest income for a profit of about $27.1 billion (Treasury 2019a). See Figure 4 for a complete breakdown of this calculation.

Figure 10: CPP Funds Outstanding ($ billions)

Source: Treasury, n.d.c.

For privately-held QFIs, Treasury received warrants to purchase preferred shares or debt and had exercised all of them upon closing the initial investment by the fourth quarter of 2008 (Treasury 2009j). For publicly traded QFIs, Treasury received warrants to purchase their common stock; when publicly traded QFIs exited the CPP by repurchasing their shares, they also had the contractual right^FIf the publicly traded QFI did not request to repurchase its warrants after repurchasing the CPP securities, Treasury sold the warrants via auctions over the course of several months (Treasury 2009k). to repurchase the warrants at fair market value. According to a former Treasury official, Treasury’s sale of CPP warrants was important for returning profits to taxpayers because the derivative securities offered long-term equity upside exposure on the public’s CPP investments. Balancing taxpayers’ interests with the need to exit its CPP positions “as quickly as practicable,” Treasury followed specific protocol for the valuation, negotiation, and sale of its CPP warrants (Treasury 2009j).

Broadly, the disposition process went as follows: (1) within 15 days of full repayment, the bank communicated its estimate of fair market value to Treasury; (2) within 10 days of receipt, Treasury separately estimated fair market value and accepted or objected to the bank’s estimation; (3) if Treasury objected and could not agree with the bank’s estimation, each party hired an independent appraiser to conduct separate valuations of fair market value, and the appraisers attempted to agree on fair market value; (4) if the appraisers did not agree, a third appraiser would be hired, and fair market value would be a “composite valuation” of the three independent appraisals (Treasury 2009j).

To determine the fair market value of the options contracts, Treasury officials relied on three valuation approaches: market prices, internal financial modeling, and independent assessments from external financial agents (Treasury 2009j; Jarrow 2009). A former Treasury official described the valuation process as occasionally difficult because some of the warrant markets were opaque and illiquid, given their unusually long term (10 years) and lack of comparable securities. Additionally, options-pricing models rely on inputs (ex: interest rates and volatility) that are challenging to forecast one decade into the future. (See Jarrow [2009] for more discussion of Treasury’s models, inputs, modifications, and justification.) 

The American Reinvestment and Recovery Act (ARRA) passed on February 17, 2009, amended EESA in several key ways, though it primarily broadened EESA’s executive compensation and corporate governance restrictions. Title VII of ARRA further restricted bonus payments made to SEOs based on information that was “materially inaccurate” from the five highest paid executives to 20, as well as increasing the number of employees that golden parachute payment prohibitions applied to (ARRA 2009, 517–18).

ARRA also restricted, “any bonus[es], retention award[s], or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding” (ARRA 2009, 518). SEOs were prohibited from receiving these bonuses based on the size of Treasury’s investment. Despite these substantial restrictions on any bonuses and awards, they did not apply retroactively. Specifically, ARRA said that these prohibitions “shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009” (ARRA 2009, 404). This portion of the legislation was highly controversial and was what allowed the controversial decision by AIG to pay out $165 million in bonuses to its executives (Thatcher 2009, 25).

Figure 11: Summary of ARRA CPP Thresholds for Executive Compensation Restrictions

Source: ARRA 2009, 517-518.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed on July 21, 2010, included the “Pay It Back Act.” This act had three key features that affected TARP:

• A decrease in the amount authorized under TARP from $700 billion to $475 billion (Dodd-Frank 2010, 2133).
• A removal of the phrase, “outstanding at any one time” from all subsections of Section 115(a), which removed the implicit authority that the Secretary of the Treasury to reuse TARP funds after assets were sold (EESA 2008, 3780; Dodd-Frank 2010, 2133; Webel 2013, 10).
• A limitation on the usage of TARP funds for programs that were initiated subsequent to June 25, 2010 (Dodd-Frank 2010, 2133).

The temporary increase in the maximum deposit insurance amount to $250,000 was made permanent in Section 355 of Dodd-Frank, as well (Dodd-Frank 2010, 1540). The decrease in the maximum TARP authorization in the act was only relevant for a couple of months, as Treasury’s authority to make new investments under TARP expired on October 3, 2010.