Troubled Asset Relief Program
Additional Actions Needed to Better Ensure Integrity, Accountability, and Transparency Gao ID: GAO-09-266T December 10, 2008This testimony discusses our first report on the newly created Troubled Asset Relief Program (TARP), which gave the Department of Treasury the authority to purchase and insure up to $700 billion in troubled assets held by financial institutions through the Office of Financial Stability (OFS). Treasury was granted this authority in response to the recent financial crisis that has threatened the stability of the U.S. banking system and the solvency of numerous financial institutions. Among other things, the Emergency Economic Stabilization Act (the act) that authorized TARP on October 3, 2008, requires GAO to report at least every 60 days on findings resulting from our oversight of the status of actions taken under the program. This testimony is based on our December 2, 2008, report. This report is the first under the act's mandate and covers the actions taken as part of TARP through November 25, 2008.3 Our oversight work under the act is ongoing, and our next report will be issued by January 31, 2009.
Treasury has taken a number of steps to try to stabilize the U.S. financial markets and banking system, including injecting billions of dollars into financial institutions. Although Treasury initially planned to buy mortgages and mortgage-related assets through TARP, Treasury shifted its focus to a preferred stock and warrant purchase program, known as the Capital Purchase Program (CPP). Treasury has provided more than $155 billion in capital to 87 institutions through CPP as of December 5, 2008. It has also established a Systemically Significant Failing Institution (SSFI) program, through which Treasury may invest in any financial instrument, including debt, equity, or warrants determined to be a troubled asset, and continues to explore other programs, including those focused on insurance, foreclosure mitigation, and consumer lending. As of December 5, 2008, Treasury had allocated a total of $335 billion of TARP funds and disbursed $195 billion to institutions under the various programs. While we recognize that TARP has existed for a short time and that a new program of such magnitude faces many challenges, especially in this current uncertain economic climate, we found that Treasury has yet to address a number of critical issues. These include determining how it will ensure that CPP is achieving its intended goals and monitoring compliance with limitations on executive compensation, dividend payments, and stock repurchases. Moreover, it has yet to formalize transition planning efforts given the upcoming shift to a new administration or to establish an effective management structure and an essential system of internal controls.
GAO-09-266T, Troubled Asset Relief Program: Additional Actions Needed to Better Ensure Integrity, Accountability, and Transparency
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Testimony:
Before the Committee on Financial Services, House of Representatives:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 10:00 a.m. EST:
Wednesday, December 10, 2008:
Troubled Asset Relief Program:
Additional Actions Needed to Better Ensure Integrity, Accountability,
and Transparency:
Statement of Gene L. Dodaro:
Acting Comptroller General of the United States:
TARP:
GAO-09-266T:
Mr. Chairman, Ranking Member Bachus, and members of the committee:
I am pleased to be here today to discuss our first report on the newly
created Troubled Asset Relief Program (TARP), which gave the Department
of Treasury the authority to purchase and insure up to $700 billion in
troubled assets held by financial institutions through the Office of
Financial Stability (OFS).[Footnote 1] Treasury was granted this
authority in response to the recent financial crisis that has
threatened the stability of the U.S. banking system and the solvency of
numerous financial institutions. Among other things, the Emergency
Economic Stabilization Act (the act) that authorized TARP on October 3,
2008, requires GAO to report at least every 60 days on findings
resulting from our oversight of the status of actions taken under the
program.[Footnote 2] My statement today is based on our December 2,
2008, report. This report is the first under the act's mandate and
covers the actions taken as part of TARP through November 25,
2008.[Footnote 3] Our oversight work under the act is ongoing, and our
next report will be issued by January 31, 2009.
Like the report, this statement focuses on (1) the nature and purpose
of activities that were initiated under TARP as of November 25, 2008;
(2) the structure of OFS, its use of contractors, and its system of
internal controls; and (3) preliminary indicators of TARP performance.
To do this work, we reviewed documents related to TARP, including
contracts, agreements, guidance, and rules. We also met with OFS,
contractors, federal agencies, and officials from the eight large
institutions that had received disbursements. Going forward, we plan to
continue to monitor the issues highlighted in the report, as well as
future and ongoing capital purchases, other more recent transactions
undertaken as part of:
TARP (e.g., capital purchases in Citigroup and American International
Group), and the status of other aspects of TARP. We conducted this
performance audit in October 2008 and November 2008 in accordance with
generally accepted government auditing standards. Those standards
require that we plan and perform the audit to obtain sufficient,
appropriate evidence to provide a reasonable basis for our findings and
conclusions based on our audit objectives. We believe that the evidence
obtained provides a reasonable basis for our findings and conclusions
based on our audit objectives.
Summary:
Treasury has taken a number of steps to try to stabilize the U.S.
financial markets and banking system, including injecting billions of
dollars into financial institutions. Although Treasury initially
planned to buy mortgages and mortgage-related assets through TARP,
Treasury shifted its focus to a preferred stock and warrant purchase
program, known as the Capital Purchase Program (CPP). Treasury has
provided more than $155 billion in capital to 87 institutions through
CPP as of December 5, 2008. It has also established a Systemically
Significant Failing Institution (SSFI) program, through which Treasury
may invest in any financial instrument, including debt, equity, or
warrants determined to be a troubled asset, and continues to explore
other programs, including those focused on insurance, foreclosure
mitigation, and consumer lending.[Footnote 4] As of December 5, 2008,
Treasury had allocated a total of $335 billion of TARP funds and
disbursed $195 billion to institutions under the various
programs.[Footnote 5] While we recognize that TARP has existed for a
short time and that a new program of such magnitude faces many
challenges, especially in this current uncertain economic climate, we
found that Treasury has yet to address a number of critical issues.
These include determining how it will ensure that CPP is achieving its
intended goals and monitoring compliance with limitations on executive
compensation, dividend payments, and stock repurchases. Moreover, it
has yet to formalize transition planning efforts given the upcoming
shift to a new administration or to establish an effective management
structure and an essential system of internal controls. In our report,
we recommended that Treasury take nine actions to help ensure the
program's integrity, accountability, and transparency. These would
require that Treasury:
* work with the bank regulators to establish a systematic means of
determining and reporting in a timely manner whether financial
institutions' activities are generally consistent with the purposes of
CPP and help ensure an appropriate level of accountability and
transparency;
* develop a means to ensure that institutions participating in CPP
comply with key program requirements (for example, executive
compensation, dividend payments, and the repurchase of stock);
* formalize the existing communication strategy to ensure that external
stakeholders, including Congress, are informed about the program's
current strategy and activities and understand the rationale for
changes in this strategy to avoid information gaps and surprises;
* facilitate a smooth transition to the new administration by building
on and formalizing ongoing activities, including ensuring that key OFS
leadership positions are filled during and after the transition;
* expedite OFS's hiring efforts to ensure that Treasury has the
personnel needed to carry out and oversee TARP;
* ensure that sufficient personnel are assigned and properly trained to
oversee the performance of all contractors, especially for contracts
priced on a time-and-materials basis, and move toward fixed-price
arrangements whenever possible;
* continue to develop a comprehensive system of internal control over
TARP, including policies, procedures, and guidance that are robust
enough to protect taxpayers' interests and ensure that the program
objectives are being met;
* issue final regulations on conflicts of interest quickly and review
and renegotiate mitigation plans to enhance specificity and compliance;
and:
* institute a system to effectively manage and monitor the mitigation
of conflicts of interest.
In the short period covered by our report, Treasury has taken a number
of important steps to set up TARP and to address the unfolding
financial crisis. While immediate action is important, this urgency
must be balanced against the need for strong management and oversight.
Because Treasury is establishing oversight policies and procedures at
the same time that it is setting up the program, we found some lag in
its administrative efforts, which we have highlighted in this statement
and discussed in detail in our report. Until these issues are resolved,
there is heightened risk that the interests of the government and
taxpayers may not be adequately protected and that OFS may not achieve
its mission in an effective and efficient manner. We are continuing to
follow up on these issues and to oversee new developments in the
program, such as the foreclosure mitigation and insurance programs,
SSFI, and minority contracting issues, as we prepare for our next
report.
We also have started to evaluate indicators that, when reviewed
collectively, should provide information about the state of financial
markets and credit flow. However, it is too soon to determine whether
the program is having the intended effect on credit and financial
markets. Further, isolating TARP's impact will be difficult because of
the number of actions that have been taken by U.S. regulators and
foreign governments to stabilize the markets and because we cannot say
what would have happened in the absence of TARP and these other
efforts. We will continue to monitor and report on these preliminary
indicators, including trends in interest rate spreads, mortgage rates,
mortgage originations, and foreclosures, and to identify additional
indicators as the program evolves.
Treasury Has Moved Quickly to Establish CPP, but Plans for Other
Approaches to Strengthening Financial Markets Are Ongoing:
Treasury allocated $250 billion to CPP and purchased $115 billion in
senior preferred shares of eight national financial institutions on
October 28, 2008, and about $40 billion in senior preferred shares of
79 additional financial institutions on November 14, 21 and December 5,
2008.[Footnote 6] Treasury and the regulators have publicly stated that
they expect these institutions to use the funds in a manner consistent
with the goals of the program, which include both the expansion of the
flow of credit and the modification of the terms of residential
mortgages. But it is unclear how OFS and the banking regulators will
monitor how participating institutions are using the capital
investments and whether these goals are being met. The standard
agreement between Treasury and the participating institutions does not
require that these institutions track or report how they use or plan to
use their capital investments. Although Treasury has said that it
expects the institutions to increase the flow of credit, Treasury has
not yet determined whether it will impose reporting requirements on the
participating financial institutions or whether it will leverage
existing reporting requirements to the banking regulators to reduce the
regulatory burden. While we understand that money is fungible, such
monitoring and reporting requirements are critical to ensuring the
transparency and accountability of CPP and would help Treasury to
monitor how the infusions were being used in the aggregate across the
participating institutions. We recommended that Treasury work with the
bank regulators to establish a systematic means of determining and
reporting in a timely manner whether financial institutions' activities
are generally consistent with the purposes of CPP. Treasury had a
different perspective on what should be done to evaluate how
institutions were using funds received under CPP, and is opting for
development of general metrics for evaluating the overall success of
CPP rather than working with bank regulators to establish a systematic
means for determining whether financial institutions' uses of CPP funds
were consistent with the purposes of the program, as we recommended.
While we agree that it will be important to develop a range of metrics
to evaluate the overall success of CPP and we welcome continued
discussions with Treasury and the bank regulators on general metrics to
achieve this purpose, given the magnitude of funds provided to this
program, these types of metrics alone will not provide the necessary
transparency and accountability needed to ensure that participating
institutions are using the funds in a manner that is consistent with
the purposes of the act. Moreover, institution-level information
aggregated across the participants would also provide an alternative
basis to assess the effect of TARP in restoring liquidity and stability
to the financial system.
The standard terms of the securities purchase agreements also include
certain requirements regarding executive compensation--for example,
certain senior executives must repay any incentive or bonus
compensation that was based on materially inaccurate financial
statements. [Footnote 7] However, Treasury has not yet determined how
it will monitor compliance with this or other requirements, such as
limitations on dividend payments and stock repurchases. Without a
strong oversight and monitoring function, Treasury's ability to ensure
an appropriate level of accountability and transparency will be
limited. Our related recommendation in this area is intended to bolster
the program's accountability and transparency.
The creation of CPP was a shift in the direction of TARP. Treasury's
rationale for the shift was that purchasing troubled assets would not
provide the immediate results that were needed, given the deepening
crisis in financial markets. Treasury believed that purchasing
preferred stocks and warrants from financial institutions would be the
fastest way to stabilize the markets, encourage interbank lending, and
increase confidence of lenders and investors.[Footnote 8] While
Treasury has provided information on its Web page about its activities,
this shift in the direction of the program heightened the need for
Treasury to provide sufficient information to external stakeholders,
such as Congress and the public, about not only the change in strategy
but also the rationale for the new focus. Consequently, we urged
Treasury to strengthen its communication strategy about plans for the
program in order to avoid information gaps as market conditions and
TARP evolve.
It is unclear what other approaches Treasury will pursue to meet the
purposes of the act, including purchasing and insuring mortgage-related
assets. Treasury has established the SSFI program under TARP. According
to Treasury, institutions will be considered for participation in SSFI
on a case-by-case basis, and there is no deadline for participation in
this program. For example, in early November, Treasury announced that
it would purchase $40 billion in senior preferred stock from AIG as
part of a comprehensive plan to restructure federal assistance to this
company, which Treasury views as systemically significant. In addition,
Treasury has taken initial steps to gather comments on ways of using
its authority to insure troubled assets and is exploring approaches to
supporting loan modification efforts. For example, Treasury solicited
comments on how to structure the program, identify institutions and
assets for inclusion, and calculate premiums in the Federal
Register.[Footnote 9] Moreover, having decided against large purchases
of troubled mortgage-related assets under TARP, Treasury stated that
the agency was considering other ways to meet Congress's expectation
that Treasury would work with lenders "to achieve aggressive loan
modification standards" to mitigate foreclosures but has not yet
developed a program to maintain homeownership, an area we continue to
closely monitor.[Footnote 10]
Efforts to Establish the Office of Financial Stability Are Ongoing:
Treasury quickly established an overall organizational structure for
OFS, filled key leadership roles on an interim basis, and contracted
for support services. Currently, it is working to hire the full
complement of staff (perhaps as many as 200 full-time-equivalent
positions depending on the ultimate design of the program), and OFS
officials said that about 48 employees were assigned to TARP as of
November 21, 2008, including those from other Treasury offices, federal
agencies, and organizations who were providing assistance on a
temporary basis and 5 permanent hires. Identifying and hiring the
numbers and types of staff needed to successfully operate TARP will be
challenging because of the evolving nature of the program and the
upcoming transition to a new administration. While Treasury has filled
key positions on an interim basis, these same issues may limit its
ability to ensure that key leadership positions at OFS remain filled
both during and after the transition, potentially creating uncertainty
about the direction of the program and impeding efforts to effectively
implement and oversee TARP. Therefore, we made several recommendations
aimed at facilitating a smooth transition to the new administration and
ensuring effective oversight of the program.
In addition to using permanent staff, OFS plans to rely on contractors
and financial agents in several key areas. Treasury used expedited
solicitation procedures and structured the agreements and contracts to
allow for flexibility in obtaining the required services. Most of the
contracts awarded thus far have been priced on a time-and-materials
basis, which provides for payments based on a set hourly rate plus the
cost of any materials. As we have noted in past work, this type of
pricing arrangement requires enhanced oversight.[Footnote 11] Treasury
has also taken steps to help promote the use of small businesses in
carrying out TARP. In addition, Treasury has issued interim guidelines
to address potential and actual conflicts of interest. As required by
Treasury, the financial agent and contractors selected have identified
a variety of potential and actual conflicts of interest and proposed a
variety of solutions to mitigate identified conflicts. However, the
agent and contractors have provided few written details on how they
intend to implement mitigation plans or communicate related issues to
OFS, and OFS has not yet developed a process for monitoring conflicts
of interest. As a result, Treasury must continue to take steps to
formalize its oversight of conflicts of interest and monitoring time-
and-materials contracts.
Recognizing the importance of internal controls, Treasury awarded one
of the first contracts to PricewaterhouseCoopers to assist OFS in
developing and implementing a comprehensive system of internal control
over TARP activities, including a risk-assessment framework. However,
the rapid pace of implementation and the evolving nature of the program
have hampered efforts to put a comprehensive system of internal control
in place. Instead, OFS has focused on specific transaction controls as
programs such as CPP are implemented. While OFS and
PricewaterhouseCoopers are working to implement a comprehensive system
of internal controls, until such a system is fully developed and
implemented there is heightened risk that the interests of the
government and taxpayers may not be adequately protected and that the
program objectives may not be achieved in an efficient and effective
manner.
Measuring the Impact of TARP on Credit Markets and the Economy Will Be
Challenging:
TARP's activities could improve market confidence in institutions that
choose to participate and have beneficial effects on credit markets,
but several factors will complicate efforts to measure any impact. If
TARP is having its intended effect, a number of developments might be
observed in credit and other markets over time, such as reduced risk
spreads, declining borrowing costs, and increased lending. However,
several factors will make isolating and measuring the impact of TARP
challenging, including simultaneous changes in economic conditions,
changes in monetary and fiscal policy, and other programs introduced by
Treasury, the Federal Reserve, Federal Deposit Insurance Corporation,
and Federal Housing Finance Agency to support banks, credit markets,
and other struggling institutions. As a result, any improvement in
capital markets cannot be attributed solely to TARP, nor will a slow
recovery necessarily reflect its failure, because of the effects of
market forces and economic conditions outside of the control of TARP.
Moreover, little time has passed since the initial infusion of capital
into the institutions, and a variety of other programs and efforts
directed at bolstering the economy and helping homeowners are still
being considered. Nevertheless, we have preliminarily identified some
indicators to facilitate our assessment of TARP's activities. We
believe that these preliminary indicators, when viewed collectively,
should signal whether TARP and other programs are functioning as
intended. Among these preliminary indicators are interest rate spreads,
mortgage rates, and mortgage originations. We also have identified
other indicators that may prove useful as TARP evolves. Together, these
indicators should provide additional information to policymakers and
others on the overall stability of our financial markets.[Footnote 12]
Mr. Chairman and Ranking Member Bachus, I appreciate the opportunity to
discuss this critically important issue and would be happy to answer
any questions that you may have. Thank you.
Contact:
For further information on this testimony, please contact Thomas J.
McCool on (202) 512-2642 or mccoolt@gao.gov.
[End of section]
Footnotes:
[1] GAO, Troubled Asset Relief Program: Additional Actions Needed to
Better Ensure Integrity, Accountability, and Transparency, GAO-09-161
(Washington D.C.: Dec. 2, 2008).
[2] The Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-
343(Oct. 3, 2008). The act requires the U.S. Comptroller General to
report at least every 60 days, as appropriate, on findings resulting
from oversight of TARP's performance in meeting the act's purposes; the
financial condition and internal controls of TARP, its representatives,
and agents; the characteristics of asset purchases and the disposition
of acquired assets, including any related commitments entered into;
TARP's efficiency in using the funds appropriated for its operations;
its compliance with applicable laws and regulations; and its efforts to
prevent, identify, and minimize conflicts of interest among those
involved in its operations.
[3] Selected transaction information in this statement has been updated
through December 5, 2008.
[4] The Secretary of the Treasury is to make the determination that the
asset is a troubled asset, after consultation with the Chairman of the
Board of Governors of the Federal Reserve System and notice to
Congress.
[5] As of December 5, 2008, Treasury had allocated $335 billion to
various programs, including $250 billion to CPP, $40 billion to
American International Group (AIG) under SSFI, $20 billion to
Citigroup, and $20 billion to a Federal Reserve lending facility. To
date, it had disbursed a total of $195 million of the $335 billion
including $155 billion under CPP (excludes $10 billion committed to
Merrill Lynch & Co., which has yet to be disbursed) and $40 billion to
AIG.
[6] One additional purchase of $10 billion is pending until a merger is
complete.
[7] Under CPP, a qualified financial institution can receive a minimum
investment of 1 percent of its risk-weighted assets, up to the lesser
of $25 billion or 3 percent of those risk-weighted assets. In exchange,
Treasury receives shares of nonvoting senior preferred stock that pay
dividends of 5 percent annually for 5 years and then 9 percent
annually, redeemable after 3 years and earlier under certain
conditions. Treasury will also receive warrants to purchase a number of
shares of common stock at market-based prices. Among other things, the
number of shares of common stock underlying a warrant can be reduced by
half if a financial institution receives proceeds from one or more
"qualified equity offerings" that equal the amount of the preferred
shares by December 31, 2009.
[8] See Section 3(9)(B) of the act. Treasury transmitted its
determination to the appropriate committees of Congress on October 13,
2008.
[9] 73 Fed. Reg. 61452 (Oct. 16, 2008), Department of the Treasury:
Development of a Guarantee Program for Troubled Assets (Notice and
Request for Comments).
[10] GAO, Troubled Asset Relief Program: Status of Efforts to Address
Defaults and Foreclosures on Home Mortgages, GAO-09-231T (Washington,
D.C.: Dec. 4, 2008).
[11] GAO, Defense Contracting: Improved Insight and Controls Needed
over DOD's Time-and-Materials Contracts, GAO-07-273 (Washington, D.C.:
June 29, 2007).
[12] GAO-09-161, see pp. 49-57.
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