Geithner Announces Transparent Regime to Remove Toxic Securities from Bank Balance Sheets

US Treasury Secretary Tim Geithner unveiled a Financial Stability Plan based on transparency and accountability and risk management. With many financial institutions burdened with illiquid asset-backed securities, the Financial Stability Plan will respond to the uncertainty about the real value of these illiquid instruments through increased transparency and disclosure. Treasury will work with bank regulators and the SEC and accounting standard setters in their efforts to improve public disclosure by banks. This effort will include measures to improve the disclosure of the exposures on bank balance sheets. In conducting these exercises, the SEC and others recognize the need not to adopt an overly conservative posture or take steps that could inappropriately constrain lending.

Similarly, all relevant financial regulators will work together in a coordinated way to bring more consistent, realistic and forward looking assessment of exposures on the balance sheet of financial institutions.

A key component of the Capital Assistance Program is a requirement that major financial institutions undergo a comprehensive stress test assessing whether they have the capital necessary to continue lending and to absorb the potential losses that could result from a more severe decline in the economy than projected. All financial institutions with assets in excess of $100 billion will be required to participate in the coordinated supervisory review process and comprehensive stress test.

While banks will be encouraged to access private markets to raise any additional capital needed to establish a buffer, a financial institution that has undergone a comprehensive stress test will have access to a Treasury provided capital buffer to help absorb losses and serve as a bridge to receiving increased private capital. While most banks have strong capital positions, a Financial Stability Trust will provide a capital buffer that will operate as a form of contingent equity to ensure firms the capital strength to preserve or increase lending in a worse than expected economic downturn.

Firms will receive a preferred security investment from Treasury in convertible securities that they can convert into common equity if needed to preserve lending in a worse-than-expected economic environment. This convertible preferred security will carry a dividend to be specified later and a conversion price set at a modest discount from the prevailing level of the institution’s stock price as of February 9, 2009. Financial institutions with consolidated assets below $100 billion will also be eligible to obtain capital from the CAP after a supervisory review.


Any capital investments made by Treasury under the CAP will be placed in a separate entity, the Financial Stability Trust, set up to manage the government’s investments in US financial institutions.

In order to cleanse the balance sheets of financial institutions of toxic asset-backed securities, the Financial Stability Plan institutes a public-private investment fund and expands the Fed’s asset-backed securities loan facility. The public-private capital program is designed with a public-private financing component, which could involve putting public or private capital side-by-side and using public financing to leverage private capital on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion. Because the new program is designed to bring private sector equity contributions to make large-scale asset purchases, it not only minimizes public capital and maximizes private capital: it allows private sector buyers to determine the price for current troubled and previously illiquid securities.

The initiative will also expand the initial reach of the Term Asset-Backed Securities Loan Facility to include commercial mortgage-backed securities. In addition, Treasury will continue to consult with the Federal Reserve regarding possible further expansion of the TALF program to include other asset classes, such as non-Agency residential mortgage-backed securities and assets collateralized by corporate debt.

Going forward, the Financial Stability Plan will call for greater transparency, accountability and conditionality with tougher standards for firms receiving exceptional assistance. These will be the new standards going forward and are not retroactive.

All recipients of assistance must submit a plan for how they intend to use that capital to preserve and strengthen their lending capacity. This plan will be submitted during the application process, and Treasury will make these reports public upon completion of the capital investment in the firm.

Firms must detail in monthly reports submitted to the Treasury their lending broken out by category, showing how many new loans they provided to businesses and consumers and how many asset-backed and mortgage-backed securities they purchased, accompanied by a description of the lending environment in the communities and markets they serve. This report will also include a comparison to their most rigorous estimate of what their lending would have been in the absence of government support.

For public companies, similar reports will be filed with the SEC on Form 8-K simultaneous with the filing of the companies’ 10-Q or 10-K reports.

Additionally, Treasury will publish and regularly update key metrics showing the impact of the Financial Stability Plan on credit markets. These reports will be put on the Treasury FinancialStability.gov website so that they can be subject to scrutiny by outside and independent experts.

Firms will also be required to comply with the recently announced senior executive compensation restrictions, including those pertaining to a $500,000 in total annual compensation cap plus restricted stock payable when the government is getting paid back, shareholder advisory votes on executive compensation, and new disclosure and accountability requirements applicable to luxury purchases.