Troubled Asset Relief Program
The U.S. Government Role as Shareholder in AIG, Citigroup, Chrysler, and General Motors and Preliminary Views on its Investment Management Activities Gao ID: GAO-10-325T December 16, 2009The recent financial crisis resulted in a wide-ranging federal response that included infusing capital into several major corporations. The Troubled Asset Relief Program (TARP) has been the primary vehicle for most of these actions. As a result of actions and others, the government is a shareholder in the American International Group (AIG), Citigroup Inc. (Citi), Chrysler Group LLC (Chrysler), and General Motors Company (GM), among others. As market conditions have become less volatile, the government has been considering how best to manage these investments and ultimately divest them. This testimony discusses (1) the government's approach to past crisis and challenges unique to the current crisis; (2) the principles guiding the Department of the Treasury's implementation of its authorities and mechanisms for managing its investments; and (3) preliminary views from GAO's ongoing work with the Special Inspector General for TARP on the federal government's monitoring and management of its investments. This statement builds on GAO's work since the 1970s on providing government assistance to large corporations and more recent work on oversight of the assistance and investments provided under TARP. In its November 2009 report, GAO recommended that Treasury ensure it has expertise needed to monitor its investment in Chrysler and GM and that it has a plan for evaluating the optimal method and timing for divesting this equity.
Looking at the government's role in providing assistance to large companies dating back to the 1970s, we have identified principles that serve as a framework for such assistance; including identifying and defining the problem, setting clear goals and objectives that reflect the national interests, and protecting the government's interests. These actions have been important in the past, but the current financial crisis has unique challenges, including the sheer size and scope of the crisis, that have affected the government's actions. As a result, the government's response has involved actions on the national and international levels and oversight and monitoring activities tailored to specific institutions and companies. We have also reported on considerations important for Treasury's approach to monitoring its investments in the companies that received assistance. The administration developed several guiding principles for managing its ownership interest in AIG, Citigroup, Chrysler, and GM. It does not intend to own equity stakes in companies on a long-term basis and plans to exit from them as soon as possible. It reserves the right to set up-front conditions to protect taxpayers, promote financial stability, and encourage growth. It intends to manage its ownership stake in institutions and companies in a hands-off, commercial manner and to vote only on core governance issues, such as the selection of a company's board of directors. Treasury has also required companies and institutions that receive assistance to report on their use of funds and has imposed restrictions on dividends and repurchases, lobbying expenses, and executive compensation, among other things. As part of its oversight efforts, it also monitors a number of performance benchmarks. Chrysler and GM will submit detailed financial and operational reports to Treasury, while an asset management firm will monitor the data on Citi, including credit spreads, liquidity and capital adequacy. To monitor its investment in AIG, Treasury coordinates with the Federal Reserve Bank of New York in tracking liquidity and cash reports, among other indicators. Treasury directly manages its investment in Citi, Chrysler, and GM, but the common equity investment in AIG, obtained with the assistance of the Federal Reserve, is managed through a trust arrangement. Each of these management strategies has advantages and disadvantages. Directly managing the investment affords the government the greatest amount of control but could create a conflict of interest if the government both regulates and has an ownership share in the institutions and could expose the government to external pressures. A trust structure, which places the government's interest with a third party, could mitigate any potential conflict-of-interest risk and reduce external pressures. But a trust structure would largely remove accountability from the government for managing the investment. GAO is reviewing Treasury's plans for managing and divesting itself of its investments, but the plans are still evolving, and, except for Citi, Treasury has yet to develop exit strategies for unwinding the investments.
GAO-10-325T, Troubled Asset Relief Program: The U.S. Government Role as Shareholder in AIG, Citigroup, Chrysler, and General Motors and Preliminary Views on its Investment Management Activities
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Testimony:
Before the Subcommittee on Domestic Policy, Committee on Oversight and
Government Reform, House of Representatives:
United States Government Accountability Office:
GAO:
For Release on Delivery:
Expected at 10:00 a.m. EST:
Wednesday, December 16, 2009:
Troubled Asset Relief Program:
The U.S. Government Role as Shareholder in AIG, Citigroup, Chrysler,
and General Motors and Preliminary Views on its Investment Management
Activities:
Statement of:
Orice Williams Brown, Director:
Financial Markets and Community Investment:
A. Nicole Clowers, Acting Director:
Physical Infrastructure:
GAO-10-325T:
GAO Highlights:
Highlights of GAO-10-325T, a report to The Subcommittee on Domestic
Policy, Oversight and Government Reform, House of Representatives.
Why GAO Did This Study:
The recent financial crisis resulted in a wide-ranging federal response
that included infusing capital into several major corporations. The
Troubled Asset Relief Program (TARP) has been the primary vehicle for
most of these actions. As a result of actions and others, the
government is a shareholder in the American International Group (AIG),
Citigroup Inc. (Citi), Chrysler Group LLC (Chrysler), and General
Motors Company (GM), among others. As market conditions have become
less volatile, the government has been considering how best to manage
these investments and ultimately divest them. This testimony discusses
(1) the government‘s approach to past crisis and challenges unique to
the current crisis; (2) the principles guiding the Department of the
Treasury‘s implementation of its authorities and mechanisms for
managing its investments; and (3) preliminary views from GAO‘s ongoing
work with the Special Inspector General for TARP on the federal
government‘s monitoring and management of its investments. This
statement builds on GAO‘s work since the 1970s on providing government
assistance to large corporations and more recent work on oversight of
the assistance and investments provided under TARP.
In its November 2009 report, GAO recommended that Treasury ensure it
has expertise needed to monitor its investment in Chrysler and GM and
that it has a plan for evaluating the optimal method and timing for
divesting this equity.
What GAO Found:
Looking at the government‘s role in providing assistance to large
companies dating back to the 1970s, we have identified principles that
serve as a framework for such assistance; including identifying and
defining the problem, setting clear goals and objectives that reflect
the national interests, and protecting the government‘s interests.
These actions have been important in the past, but the current
financial crisis has unique challenges, including the sheer size and
scope of the crisis, that have affected the government‘s actions. As a
result, the government‘s response has involved actions on the national
and international levels and oversight and monitoring activities
tailored to specific institutions and companies. We have also reported
on considerations important for Treasury‘s approach to monitoring its
investments in the companies that received assistance.
The administration developed several guiding principles for managing
its ownership interest in AIG, Citigroup, Chrysler, and GM. It does not
intend to own equity stakes in companies on a long-term basis and plans
to exit from them as soon as possible. It reserves the right to set up-
front conditions to protect taxpayers, promote financial stability, and
encourage growth. It intends to manage its ownership stake in
institutions and companies in a hands-off, commercial manner and to
vote only on core governance issues, such as the selection of a company‘
s board of directors. Treasury has also required companies and
institutions that receive assistance to report on their use of funds
and has imposed restrictions on dividends and repurchases, lobbying
expenses, and executive compensation, among other things. As part of
its oversight efforts, it also monitors a number of performance
benchmarks. Chrysler and GM will submit detailed financial and
operational reports to Treasury, while an asset management firm will
monitor the data on Citi, including credit spreads, liquidity and
capital adequacy. To monitor its investment in AIG, Treasury
coordinates with the Federal Reserve Bank of New York in tracking
liquidity and cash reports, among other indicators.
Treasury directly manages its investment in Citi, Chrysler, and GM, but
the common equity investment in AIG, obtained with the assistance of
the Federal Reserve, is managed through a trust arrangement. Each of
these management strategies has advantages and disadvantages. Directly
managing the investment affords the government the greatest amount of
control but could create a conflict of interest if the government both
regulates and has an ownership share in the institutions and could
expose the government to external pressures. A trust structure, which
places the government‘s interest with a third party, could mitigate any
potential conflict-of-interest risk and reduce external pressures. But
a trust structure would largely remove accountability from the
government for managing the investment. GAO is reviewing Treasury‘s
plans for managing and divesting itself of its investments, but the
plans are still evolving, and, except for Citi, Treasury has yet to
develop exit strategies for unwinding the investments.
View [hyperlink, http://www.gao.gov/products/GAO-10-325T] or key
components. For more information, contact Orice Williams Brown at (202)
512-8678 or williamso@gao.gov A. Nicole Clowers at (202) 512-4010
clowersa@gao.gov.
[End of section]
Chairman Kucinich, Ranking Member Jordan, and Members of the
Subcommittee:
We are pleased to be here to discuss the federal government's role as
shareholder in American International Group (AIG), Citigroup Inc.
(Citi), Chrysler Group LLC (Chrysler), and General Motors Company (GM).
As you know, the recent financial crisis resulted in a wide-ranging
federal response that included providing large infusions of capital
into the financial system and automotive industry, sometimes in the
form of common equity investments. The Troubled Asset Relief Program
(TARP), which was created under the Emergency Economic Stabilization
Act of 2008 (the act), has been the primary vehicle for making these
equity investments.[Footnote 1] As market conditions have become less
volatile, Treasury is working to determine how best to manage these
investments and ultimately divest itself of them.
The government has purchased equities in hundreds of financial
institutions and other companies under TARP. As requested, our
statement today focuses on four of them: AIG, Citi, Chrysler, and GM.
Specifically, we will address three broad issues relating to the
government's ownership interest:
* the historical context of large-scale federal financial assistance
programs and the challenges specific to the current crisis;
* the U.S. Department of the Treasury's (Treasury) implementation of
its authorities under the act and management of its investments in each
company; and:
* preliminary observations on the federal government's role as
shareholder from our ongoing work with the Special Inspector General
for TARP (SIGTARP).
This statement builds primarily on our work since the 1970s on
providing government assistance to large corporations; our recent work
on the oversight of the assistance and investments provided under TARP,
including the government's investments in AIG, Citi, Chrysler, and GM;
and our ongoing work on the role of the federal government as
shareholder that we have undertaken with SIGTARP.[Footnote 2] As part
of our ongoing work, we have reviewed relevant laws, regulations,
guidance, and documents and interviewed relevant federal and company
officials. We conducted our ongoing work from August 2009 through
December 2009 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:
Using our previous work on federal financial assistance to large firms
and municipalities, we have identified three fundamental principles
that provide a framework for considering and evaluating such
assistance. First, the problems confronting the industry or institution
need to be clearly defined and those that require an immediate
financial response differentiated from those that are likely to require
more time to resolve. Second, the government needs to determine whether
the national interest will be best served through some type of
government intervention or whether market forces and established legal
procedures, such as bankruptcy reorganization, should be allowed to
take their course. If the federal government decides that federal
financial assistance is warranted, it must set clear objectives and
goals for this assistance. Third, given the significant financial risk
the federal government may assume on behalf of taxpayers, the structure
created to administer any assistance must have appropriate mechanisms
to protect them from excessive or unnecessary risk. These mechanisms
may include concessions by all parties, controls over management,
compensation for risk, and a strong independent board or other entity
managing or overseeing the assistance. We also have previously
identified considerations that are important for Treasury's approach to
monitoring its investments in some of the companies that have received
exceptional assistance. These considerations include retaining
necessary expertise; monitoring and communicating company, industry,
and economic indicators; determining the optimal time and method to
divest; and managing the investments in a commercial manner. While
Treasury adhered to certain aspects of these principles and
considerations, it has been challenged in meeting others due to the
widespread and evolving nature of the crisis.
Moreover, the government's role as a shareholder differed across the
institutions that received federal assistance, largely because of
differences in the types of institutions and the nature of the
assistance they received. For example, the Federal Reserve Bank of New
York (FRBNY) as a condition of secured loans it provided to AIG,
created a trust to hold the convertible preferred shares it purchased.
[Footnote 3] Conversely, Treasury later obtained common shares in Citi
after Citi requested that Treasury's initial investment in preferred
shares be converted to common shares to strengthen the bank's capital
structure. Treasury obtained an ownership interest in Chrysler and GM
during their bankruptcy and restructuring. To guide its oversight of
these investments going forward, the administration developed several
core principles. These include (1) acting as a reluctant shareholder or
not owning equity stakes in companies any longer than necessary; (2)
not interfering in the day-to-day management decisions of a company in
which it is an investor; (3) ensuring a strong board of directors; and
(4) exercising limited voting rights. Therefore, while Treasury has not
been involved in the day-to-day operations of these companies as a
result of its ownership stake, it has established conditions for
receiving assistance and routinely monitored the companies' operations--
for example, setting limits on executive compensation and voting on
certain limited matters.
As part of our ongoing work with SIGTARP, we are reviewing the extent
of government involvement in the corporate governance and operations of
companies that have received exceptional assistance, the mechanisms
used to ensure that companies are complying with key covenants, and its
management of the investments and divestiture strategies. According to
Treasury officials, direct investments are managed at three levels:
individually at the institution and program levels and collectively at
the portfolio level. While Treasury does not manage the day-to-day
activities of the companies by virtue of its ownership interest, it
does monitor their financial condition, with the goal of achieving
financial viability. While the AIG convertible preferred shares
acquired by FRBNY is held in trust, the Office of Financial Stability
(OFS) manages common equity investments in Citi, Chrysler, and GM. Each
of these strategies has advantages and disadvantages that must be
weighed in deciding which to adopt. GAO is currently reviewing
Treasury's plans for divesting itself of the investments in the four
companies, but the plans are still evolving, and, except for Citi,
Treasury has yet to develop exit strategies for unwinding the
investments. Given the complexity and importance of this decision, we
recommended in November that Treasury develop criteria for evaluating
the optimal method and timing for divesting its equity stake. In
response to this recommendation, Treasury said that it will continue to
monitor and evaluate the performance of Chrysler and GM with a view
toward determining the appropriate method and timing for divesting
Treasury's interest in the auto companies.[Footnote 4]
Background:
The act's purposes are to provide Treasury with the authorities and
facilities to restore liquidity and stability to the U.S. financial
system while protecting taxpayers, including the value of their homes,
college funds, retirement accounts, and life savings. The act also
mandated that Treasury's efforts help preserve homeownership and
promote jobs and economic growth, maximize overall returns to
taxpayers, and provide public accountability for the exercise of its
authority. The act created OFS within Treasury to administer TARP,
which in turn created a number of programs designed to address various
aspects of the unfolding financial crisis. Some of those programs
resulted in the government having an ownership interest in several
companies.
* The Capital Purchase Program (CPP) is the largest program, with
several hundred participants, including Citi. Created in October 2008,
it aimed to stabilize the financial system by providing capital to
viable banks through the purchase of preferred shares and subordinated
debentures. In addition to the value of the assets purchased, these
transactions require that the fixed dividends be paid on the preferred
shares, that the debentures accrue interest, and that all purchases are
accompanied by a warrant to purchase either common stock or additional
senior debt instruments. Citi is one of several hundred participants in
this program.
* The Targeted Investment Program (TIP) was created in November 2008 to
foster market stability and thus strengthen the economy by investing in
institutions that Treasury deemed critical to the functioning of the
financial system. In addition to the value of the assets purchased,
transactions under this program also required that the fixed dividends
be paid on the preferred shares, and that all purchases be accompanied
by a warrant to purchase common stock or additional senior debt
instruments. TIP provided assistance to two institutions, which
Treasury selected on a case-by-case basis.[Footnote 5] Citi is the only
remaining participant but has recently announced plans to repay the
Treasury.
* The Asset Guarantee Program (AGP) was created in November 2008 to
provide federal government assurances for assets held by financial
institutions that were deemed critical to the functioning of the U.S.
financial system. Citigroup is the only institution participating in
AGP. As a condition of participation, Citigroup issued preferred shares
to the Treasury and the Federal Deposit Insurance Corporation (FDIC)
and warrants to Treasury in exchange for their participation, along
with the Federal Reserve Bank of New York (FRBNY) $301 billion of loss
protection on a specified pool of Citigroup assets.
* The Systemically Significant Failing Institutions Program was created
in November 2008 to help avoid disruptions to financial markets from an
institutional failure that Treasury determined would have broad
ramifications for other institutions and market activities. AIG has
been the only participant in this program and was targeted because of
its close ties to other institutions. Assistance provided under this
program is in addition to the assistance provided by FRBNY. Under this
program, Treasury owns preferred shares and warrants. Treasury now
refers to this program as the AIG, Inc. Investment Program.
* The Automotive Industry Financing Program (AIFP) was created in
December 2008 to prevent a significant disruption of the U.S.
automotive industry. Treasury has determined that such a disruption
would pose a systemic risk to financial market stability and have a
negative effect on the U.S. economy. The program requires participating
institutions to implement plans to show how they intend to achieve long-
term viability. Chrysler and GM participate in AIFP.
The Federal Response to the Current Financial Crisis Builds on
Responses to Past Crises but Faces Unique Challenges:
The government has a long history of intervening in markets during
times of crisis. From the Great Depression to the Savings and Loan
crisis of the 1980s, the government has shown a willingness to
intervene in private markets when national interests are at stake. It
has undertaken financial assistance efforts on a large scale, including
to private companies and municipalities--for example, Congress created
separate financial assistance programs totaling over $12 billion to
stabilize Conrail, Lockheed, Chrysler, and the New York City government
during the 1970s. Most recently, in response to the most severe
financial crisis since the Great Depression, Congress authorized
Treasury to buy or guarantee up to $700 billion of the "troubled
assets" that were deemed to be at the heart of the crisis. The past and
current administrations have used this funding to help stabilize the
financial system and domestic automotive industry. While TARP was
created to help address the crisis, the Treasury, Federal Reserve
Board, FRBNY, and FDIC have also taken a number of steps to address the
unfolding crisis.
Looking at the government's role in providing assistance to large
companies dating back to the 1970s, we have identified three
fundamental principles that can serve as a framework for large-scale
federal financial assistance efforts and that still apply today. These
principles are identifying and defining the problem, determining the
national interests and setting clear goals and objectives that reflect
them, and protecting the government's interests. The federal response
to the current financial crisis generally builds on these principles.
Identifying and defining the problem includes separating out those
issues that require an immediate response from structural challenges
that will take more time to resolve. For example, in the case of AIFP,
Treasury identified as a problem of national interest the financial
condition of the domestic automakers and its potential to affect
financial market stability and the economy at large. In determining
what actions to take to address this problem, Treasury concluded that
Chrysler's and GM's lack of liquidity needed immediate attention and
provided short-term bridge loans in December 2008. Treasury also
required Chrysler and GM to prepare restructuring plans that outlined
how the automakers intended to achieve long-term financial viability
and provided financial assistance to help them through the
restructuring process.
Determining national interests and setting clear goals and objectives
that reflect them requires deciding whether a legislative solution or
other government intervention best serves the national interest. For
example, during the recent crisis Congress determined that government
action was needed and Treasury determined that the benefits of
intervening to support what were termed "systemically significant"
institutions far exceeded the costs of letting these firms fail. As we
have also seen during the current crisis, companies receiving
assistance should not remain under federal protection indefinitely, and
as we discuss later, Treasury has been clear that it wants to divest as
soon as practicable.
Because large-scale financial assistance programs pose significant
financial risk to the federal government, they necessarily must include
mechanisms to protect taxpayers.[Footnote 6] Four actions have been
used to alleviate these risks in financial assistance programs:
[Footnote 7]
* Concessions from others with a stake in the outcome--for example,
from management, labor, and creditors--in order to ensure cooperation
and flexibility in securing a successful outcome. For example, as a
condition of receiving federal financial assistance, TARP recipients
had to agree to limits on executive compensation and GM and Chrysler
had to use their "best efforts" to reduce their workers' compensation
to what workers at foreign automakers receive.
* Controls over management, including the authority to approve
financial and operating plans and new major contracts, so that any
restructuring plans have realistic objectives and hold management
accountable for achieving results. Under AIFP, Chrysler and GM were
required to develop restructuring plans that outlined their path to
financial viability. In February 2009, the administration rejected both
companies' restructuring plans, and required them to develop more
aggressive ones. The administration subsequently approved Chrysler's
and GM's revised plans, which included restructuring the companies
through the bankruptcy code.
* Adequate collateral that, to the extent feasible, places the
government in a first-lien position in order to recoup maximum amounts
of taxpayer funds. While Treasury was not able to fully achieve this
goal given the highly leveraged nature of Chrysler and GM, FRBNY was
able to secure collateral on its loans to AIG.[Footnote 8]
* Compensation for risk through fees and/or equity participation, a
mechanism that is particularly important when programs succeed in
restoring recipients' financial and operational health. In return for
the $62 billion in restructuring loans to Chrysler and GM, Treasury
received 9.85 percent equity in Chrysler, 60.8 percent equity and $2.1
billion in preferred stock in GM, and $13.8 billion in debt obligations
between the two companies.
These actions have been important in previous financial crises, but the
shear size and scope of the current crisis has presented some unique
challenges that affected the government's actions. For example, as
discussed later, as Treasury attempted to identify program goals and
determine, which ones would be in the national interest, its goals were
broad and often conflicted. Likewise, while steps were taken to protect
taxpayer interests, some actions resulted in increased taxpayer
exposure. For example, preferred shares initially held in Citi offered
more protection to taxpayers than the common shares into which they
were converted. However, the conversion strengthened Citi's capital
structure. In the next section, we discuss the federal government's
actions in the current crisis that resulted in it having an ownership
interest and provide information on how the government is managing its
interests.
In addition to these principles, we have also reported on important
considerations for Treasury in monitoring and selling its ownership
interest in Chrysler and GM, which may also serve as useful guidelines
for its investments in AIG and Citi as well. The considerations that we
identified, based on interviews with financial experts and others,
include the following:
* Retain necessary expertise. Experts stressed that it is critical for
Treasury to employ or contract with individuals with experience
managing and selling equity in private companies. Individuals with
investment, equity, and capital market backgrounds should be available
to provide advice and expertise on the oversight and sale of Treasury's
equity.
* Monitor and communicate company, industry, and economic indicators.
All of the experts we spoke with emphasized the importance of
monitoring company-specific indicators and broader economic indicators
such as interest rates and consumer spending. Monitoring these
indicators allows investors, including Treasury, to determine how well
the companies, and in turn the investment, are performing in relation
to the rest of the industry. It also allows an investor to determine
how receptive the market would be to an equity sale, something that
contributes to the price at which the investor can sell.
* To the extent possible, determine the optimal time and method to
divest. One of the key components of an exit strategy is determining
how and when to sell the investment. Given the many different ways to
dispose of equity--through public sales, private negotiated sales, all
at once, or in batches--experts noted that the seller's needs should
inform decisions on which approach is most appropriate. Experts noted
that a convergence of factors related both to financial markets and to
the company itself create an ideal window for an IPO; this window can
quickly open and close and cannot easily be predicted. This requires
constant monitoring of up-to-date company, industry, and economic
indicators when an investor is considering when and how to sell.
* Manage investments in a commercial manner. Experts emphasized the
importance of Treasury resisting external pressures to focus on public
policy goals over focusing on its role as a commercial investor. For
example, some experts said that Treasury should not let public policy
goals such as job retention interfere with its goals of maximizing its
return on investment. Nevertheless, one expert suggested that Treasury
should consider public policy goals and include the value of jobs saved
and other economic benefits from its investment when calculating its
return, since these goals, though not important to a private investor,
are critical to the economy.
Treasury Has Developed Core Principles to Guide the Management of Its
Varied Ownership Interests:
Treasury ownership interests differ across the institutions that have
received federal assistance, largely because of differences in the
types of institutions and the nature of the assistance they received.
Initially, Treasury had proposed purchasing assets from financial
institutions as a way of providing liquidity to the financial system.
Ultimately, however, Treasury determined that providing capital
infusions would be the fastest and most effective way to address the
initial phase of the crisis. As the downturn deepened, Treasury
provided exceptional assistance to a number of institutions including
AIG, Citi, Chrysler, and GM.[Footnote 9] In each case, it had to decide
on the type of assistance to provide and the conditions that would be
attached. In several cases, the assistance resulted in the government
obtaining an ownership interest that must be effectively managed.
[Footnote 10]
First, Treasury has committed almost $70 billion of TARP funds for the
purchase of AIG preferred stock, $43.2 billion of which had been
invested as of September 30, 2009. The remainder may be invested at
AIG's request. As noted earlier, FRBNY has also provided secured loans
to AIG. In consideration of the loans, AIG deposited into a trust
convertible preferred shares representing approximately 77.9 percent of
the current voting power of the AIG common shares after receiving a
nominal fee ($500,000) paid by FRBNY. The trust is managed by three
independent trustees. The U.S. Treasury (i.e., the general fund), not
the Department of the Treasury, is the sole beneficiary of the trust
proceeds.[Footnote 11]
Second, Treasury purchased $25 billion in preferred stock from Citi
under CPP and an additional $20 billion under TIP. Each of these
preferred stock acquisitions was also accompanied by a warrant to
purchase Citi common stock. Treasury has also received $4.03 billion in
Citi preferred stock through AGP as a premium for Treasury's
participation in a guarantee against losses on a defined pool of $301
billion of assets owned by Citi and its affiliates.[Footnote 12] As
part of a series of transactions designed to strengthen Citi's capital,
Treasury exchanged all its preferred shares in Citi for a combination
of common shares and trust-preferred securities.[Footnote 13] This
exchange, which was completed in July 2009, gave Treasury an almost 34
percent common equity interest in the bank holding company.
Finally, under AIFP Treasury owns 9.85 percent of the common equity in
the restructured Chrysler and 60.8 percent of the common equity, plus
$2.1 billion in preferred stock in the restructured GM. Treasury's
ownership interest in the automakers was provided in exchange for the
assistance Treasury provided before and during their restructurings.
The restructured Chrysler is to repay Treasury $7.1 billion of the
assistance as a term loan, and the restructured GM is to repay $7.1
billion of the assistance as a term loan.
Four Core Principles Guide Treasury's Management of Its Ownership
Interest:
Recognizing the challenges associated with the federal government
having an ownership interest in the private market, the administration
developed several guiding principles for managing its TARP investments.
According to Treasury, it has developed core principles that will guide
its equity investments going forward, which are discussed in detail in
OFS's financial report.[Footnote 14]
* Acting as a reluctant shareholder. The government has no desire to
own equity stakes in companies any longer than necessary and will seek
to dispose of its ownership interests as soon as it is practical to do
so--that is, when the companies are viable and profitable and can
contribute to the economy without government involvement.
* Not interfering in the day-to-day management decisions of a company
in which it is an investor. In exceptional cases, the government may
determine that ongoing assistance is necessary but will reserve the
right to set upfront conditions to protect taxpayers, promote financial
stability, and encourage growth. When necessary, these conditions may
include restructurings similar to that now under way at GM and changes
to help ensure a strong board of directors.
* Ensuring a strong board of directors. After any up-front conditions
are in place, the government will protect the taxpayers' investment by
managing its ownership stake in a hands-off, commercial manner. Any
changes to boards of directors will be designed to help ensure that
they select management with a sound long-term vision for restoring
their companies to profitability and ending the need for government
support as quickly as possible. The government will not interfere with
or exert control over day-to-day company operations, and no government
employees will serve on the boards or be employed by these companies.
* Exercising limited voting rights. As a common shareholder, the
government will vote on only core governance issues, including the
selection of a company's board of directors and major corporate events
or transactions. While protecting taxpayer resources, the government
has said that it intends to be extremely disciplined as to how it uses
even these limited rights.
Treasury's investments have generally been in the form of nonvoting
securities. For example, the preferred shares that Treasury holds in
financial institutions under CPP do not have voting rights except in
certain limited circumstances, such as amendments to the charter of the
company or in the event that dividends are not paid for several
quarters (in which case Treasury has the right to elect two directors
to the board). However, the agreements that govern Treasury's common
ownership interest expressly state that Treasury does not have the
right to take part in the management or operation of the company other
than voting on certain issues, which are summarized in the following
table (table 1).
Table 1: Treasury's Governance Principles for Exercising Its Voting
Power:
Potential Voting Matter: Election or removal of directors;
Citi: [Check];
Chrysler: [Check];
GM[A]: [Check][B].
Potential Voting Matter: Certain major corporate transactions such as
mergers, sales of substantially all assets, and dissolution;
Citi: [Check];
Chrysler: [Check];
GM[A]: [Check].
Potential Voting Matter: Issuances of equity securities that entitle
shareholders to vote;
Citi: [Check];
Chrysler: [Check];
GM[A]: [Check].
Potential Voting Matter: Amendments to the charter or bylaws;
Citi: [Check];
Chrysler: [Check];
GM[A]: [Check].
Potential Voting Matter: Matters in which Treasury's vote is necessary
for the stockholders to take action, in which case the shares will be
voted in the same proportion (for, against, or abstain) as all other
shares of the company's stock are voted;
Citi: [Check];
Chrysler: [Check];
GM[A]: [Check].
Potential Voting Matter: All other matters requiring a vote;
Citi: [Check][C];
Chrysler: [Empty];
GM[A]: [Empty].
Source: GAO summary of Monthly Section 105(a) Report, OFS, Treasury.
December 2009.
[A] Before GM's expected initial public offering (IPO), Treasury will
vote its shares as it determines, provided that it votes in favor of
directors nominated by the GM Voluntary Employee Benefit Association
(VEBA) or the government of Canada, the other shareholders.
[B] The election of directors, provided that Treasury votes in favor of
individuals nominated through a certain predesignated process, and
individuals nominated by the Voluntary Employee Benefit Association
(VEBA).
[C] On all other matters, Treasury will vote its shares in the same
proportion (for, against or abstain) as all other shareholders.
[End of table]
The AIG trust created by FRBNY owns shares that carry 77.9 percent of
the voting rights of the common stock. FRBNY has appointed three
independent trustees who have the power to vote and dispose of the
stock with prior FRBNY approval and after consultation with Treasury.
The trust agreement provides that the trustees cannot be employees of
Treasury or FRBNY, and Treasury does not control the trust or direct
the actions of the trustees. Treasury also owns AIG preferred stock,
which does not have voting rights except in certain limited
circumstances (such as amendments to the charter) or in the event
dividends are not paid for four quarters, in which case Treasury has
the right to elect additional directors to the board.[Footnote 15]
Treasury Imposed a Number of Conditions That These Companies Must Meet:
As a condition of receiving exceptional assistance, Treasury placed
certain conditions on these companies. Specifically, the agreements
with the companies impose certain reporting requirements and include
provisions such as restrictions on dividends and repurchases, lobbying
expenses, and executive compensation. The companies were also required
to establish internal controls with respect to compliance with
applicable restrictions and provide reports certifying their
compliance.
While all four institutions were subject to internal control
requirements, as set forth in the credit and other agreements that
outline Treasury's and the companies' roles and responsibilities,
Chrysler and GM have agreed to (1) produce a portion of their vehicles
in the United States; (2) report to Treasury on events related to their
pension plans; and (3) report to Treasury monthly and quarterly
financial, managerial, and operating information. More specifically,
Chrysler must either manufacture 40 percent of its U.S. sales volume in
the United States, or its U.S. production volume must be at least 90
percent of its 2008 U.S. production volume. In addition, Chrysler's
shareholders, including Treasury, have agreed that Fiat's equity stake
in Chrysler will increase if Chrysler meets benchmarks such as
producing a vehicle that achieves a fuel economy of 40 miles per gallon
or producing a new engine in the United States.[Footnote 16] GM must
use its commercially reasonable best efforts to ensure that the volume
of manufacturing conducted in the U.S. is consistent with at least 90
percent of the level envisioned in GM's business plan. Treasury has
stated that it plans to manage its equity interests in Chrysler and GM
in a hands-off manner and does not plan to manage its interests to
achieve social policy goals. But Treasury officials also noted that
some requirements reflect the administration's views on responsibly
utilizing taxpayer resources for these companies as well as efforts to
protect Treasury's financial interests as a creditor and equity owner.
As a condition of receiving exceptional assistance, all four
institutions must also adhere to the executive compensation and
corporate governance rules established under the act, as amended by the
American Recovery and Reinvestment Act of 2009 (ARRA), which limited
compensation to the highest paid executives.[Footnote 17] Treasury also
created the Office of the Special Master (Special Master) to carry out
this requirement.
The Special Master generally rejected the companies' initial proposals
for compensating the top 25 executives and approved a modified set of
compensation structures with the following features:
* generally limited salaries to no greater than $500,000, with the
remainder of compensation in equity;
* most compensation paid as vested "stock salary," which executives
must hold until 2011, after which it can be transferred by executives
in three equal annual installments (subject to acceleration of the
company's repayment of TARP funds);
* annual incentive compensation payable in "long-term restricted
stock," which requires three years of service, in amounts determined
based on objective performance criteria;
* actual payment of the restricted stock is subject to the company's
repayment of TARP funds (in 25 percent installments);
* $25,000 limit on perquisites and "other" compensation, absent special
justification; and:
* no further accruals or company contributions to executive pension
plans.
The Special Master also made determinations about the compensation
structures (but not individual salaries) of these companies' next 75
most highly compensated employees. He rejected the proposed
compensation structures for the companies subject to review, so the
companies must make additional changes to their compensation structures
and resubmit them for approval.[Footnote 18]
Treasury Monitors a Number of Performance Benchmarks as Part of Its
Oversight Effort:
One of the principles guiding the government's management of its
investments in the companies includes monitoring and communicating
information from company, industry, and economic indicators. According
to OFS, the asset management approach is designed to implement these
guiding principles. It attempts to protect taxpayer investments and
promote stability by evaluating systemic and individual risk through
standardized reporting and proactive monitoring and ensuring adherence
to the act and compliance with contractual agreements.
Treasury has developed a number of performance benchmarks that it
routinely monitors. For example, as we reported in November, Treasury
will monitor financial and operational data such as cash flow, market
share, and market conditions and use this information to determine the
optimal time and method of sale.[Footnote 19] Similarly, for AIG and
Citi, Treasury has been monitoring liquidity, capital, profits/losses,
loss reserves, and credit ratings. Treasury has hired an outside asset
management firm to monitor its investment in Citigroup. The valuation
process includes tracking market conditions on a daily basis and
collecting data on indicators such as credit spreads, bond and equity
prices, liquidity, and capital adequacy. To monitor its investment in
AIG, Treasury also coordinates with FRBNY in tracking liquidity, weekly
cash forecasts and daily cash reports, among other indicators.
Our Ongoing Work Suggests That Different Management Strategies for
Investments Have Advantages and Disadvantages and That Divestment
Strategies Are Evolving:
As part of our ongoing work with SIGTARP, we are reviewing the extent
of government involvement in the corporate governance and operations of
companies that have received exceptional assistance, Treasury's
mechanisms for ensuring that companies are complying with key
covenants, and the government's management of the investment and its
divestiture strategies.[Footnote 20] Today, we will highlight some of
our preliminary observations from this review including observations
about the advantages and disadvantages of managing these investments
directly or though a trust arrangement.
According to OFS, investments are managed on the individual
(institutional and program) and portfolio levels. As previously
discussed, the government generally does not manage the day-to-day
activities of the companies. Rather, Treasury monitors the financial
condition of the companies with the goal of achieving financial
viability. In conducting the portfolio management activities, OFS
employs a mix of professional staff and external asset managers.
According to OFS, these external asset managers provide periodic market-
specific information such as market prices and valuations, as well as
detailed credit analysis using public information. A portfolio
management leadership team oversees the work of asset management
employees organized by program basis, so that investment and asset
managers may follow individual investments. OFS uses this strategy to
manage its investment in Citi, Chrysler, and GM, and the independent
trustees of the AIG trust manage the government's common equity
interest in AIG.[Footnote 21] According to officials we interviewed,
each structure--managing the investment directly or through a trust--
has advantages and disadvantages.
Directly managing the investments offers two significant advantages.
First, it affords the government the greatest amount of control over
the investment. Second, having direct control over investments better
enables the government to manage them as a single portfolio. However,
such a structure also has disadvantages. For example, having the
government both regulate and hold an ownership interest in an
institution or company could create a conflict of interest and
potentially expose the government to external pressures. Treasury
officials have noted that they have been contacted by members of
Congress expressing concern about dealership closings, and as long as
Treasury maintains ownership interests in Chrysler and GM, it will
likely be pressured to influence the companies' business decisions.
[Footnote 22] Further, a direct investment requires that the government
have staff with the requisite skills. For instance, as long as Treasury
maintains direct control of its ownership interest in Citi, Chrysler,
and GM, among others, it must have staff or hire contractors with the
necessary expertise in these specific types of companies. In our
previous work, we questioned whether Treasury would be able to retain
the needed expertise to assess the financial condition of the auto
companies and develop strategies to divest the government's interests
given the substantial decline in the number of staff and lack of
dedicated staff providing oversight of its investments in the
automakers. We recommended that Treasury take action to address this
concern.[Footnote 23]
In contrast, a trust structure puts the government's interest in the
hands of an independent third party. While the Treasury has interpreted
the act as currently prohibiting placing TARP assets in a trust
structure, FRBNY was able to create a trust to manage the government's
ownership interest in AIG.[Footnote 24] One potential advantage of a
trust structure is that it helps to avoid any potential conflicts of
interest that could stem from the government's having both regulatory
functions and its ownership interests in a company. It also mitigates
any perception that actions taken with respect to TARP recipients were
politically motivated or that any actions taken by Treasury were based
on any "inside information" received from the regulators. Conversely, a
trust structure largely removes control of the investment from the
government. Finally, the trustees would also require specialized staff
or contractors, would need to develop their own mechanisms to monitor
the investments and analyze the data needed to assess the financial
condition of the institutions or companies and decide when to divest.
We are reviewing Treasury's plans for divesting its investments and so
far, have found that the strategy is evolving. Although Treasury has
stated that it intends to sell the federal government's ownership
interest as soon as doing so is practical, it has yet to develop exit
strategies for unwinding most of these investments. For Citi, Chrysler,
and GM, Treasury will decide when and how to divest its common
shares.[Footnote 25] With the exception of the TARP investments, the
AIG trustees, with FRBNY approval, generally are responsible for
developing a divestiture plan for the shares in the trust.
For Chrysler and GM, Treasury officials said that they planned to
consider all options for selling the government's ownership stakes in
each company. However, they noted that the most likely scenario for GM
would be to dispose of Treasury's equity in the company through a
series of public offerings. While Treasury has publicly discussed the
possibility of selling part of its equity in the company through an
initial public offering (IPO) that would occur sometime in 2010, some
experts we spoke with had doubts about this strategy. Two said that GM
might not be ready for a successful IPO by 2010, because the company
might not have demonstrated sufficient progress to attract investor
interest, and two other experts noted that 2010 would be the earliest
possible time for an IPO. Treasury officials noted that a private sale
for Chrysler would be more likely because the equity stake is smaller.
Several of the experts we interviewed agreed that non-IPO options could
be possible for Chrysler, given the relatively smaller stake Treasury
has in the company (9.85 percent, versus its 60.8 percent stake in GM)
and the relative affordability of the company. Determining when and how
to divest the government's equity stake will be one of the most
important decisions Treasury will have to make regarding the federal
assistance provided to the domestic automakers, as this decision will
affect the overall return on investment that taxpayers will realize
from aiding these companies. Given the complexity and importance of
this decision, we recently recommended that Treasury develop criteria
for evaluating the optimal method and timing for divesting its equity
stake.[Footnote 26]
In closing, we would like to highlight three issues. First, as we have
noted, having clear, nonconflicting goals is a critical part of
providing federal financial assistance. Treasury, however, faces a
number of competing and at times conflicting goals. For example, the
goal of protecting the taxpayers' interests must be balanced against
its goal of divesting ownership interests as soon as it is feasible.
Consequently, Treasury must temper any desire to exit as quickly as
possible with the need to maintain its equity interest long enough for
the companies to demonstrate sufficient financial progress. Second, an
important part of Treasury's management of these investments is
establishing and monitoring benchmarks that will inform the ultimate
decision on when and how to sell each investment. To ensure that
taxpayer interests are maximized, it will be important for Treasury to
monitor these benchmarks regularly. And finally, while many agree that
TARP funding has contributed to the stabilization of the economy, the
significant sums of taxpayer dollars that are invested in a range of
private companies warrant continued oversight and development of a
prudent divestiture plan.
Mr. Chairman, Ranking Member Jordan, and Members of the Subcommittee,
we appreciate the opportunity to discuss these critically important
issues and would be happy to answer any questions that you may have.
Thank you.
Contacts:
For further information on this testimony, please contact Orice
Williams Brown on (202) 512-8678 or williamso@gao.gov or A. Nicole
Clowers on (202) 512-4010 or clowersa@gao.gov. Contact points for our
Congressional Relations and Public Affairs offices may be found on the
last page of this statement. Individuals making key contributions to
this testimony were Emily Chalmers, Rachel DeMarcus, Francis A. Dymond,
Nancy M. Eibeck, Sarah A. Farkas, Heather J. Halliwell, Cheryl M.
Harris, Debra R. Johnson, Christopher Ross, and Raymond Sendajas.
[End of section]
Footnotes:
[1] Pub. L. No. 110-343, Div. A, 122 Stat. 3765 (Oct. 3, 2008),
codified in part, as amended, at 12 U.S.C. §§ 5201-5261.
[2] See GAO, Guidelines for Rescuing Large Failing Firms and
Municipalities, [hyperlink, http://www.gao.gov/products/GAO/GGD-84-34]
(Washington, D.C.: Mar. 29, 1984); Auto Industry: A Framework for
Considering Federal Financial Assistance, [hyperlink,
http://www.gao.gov/products/GAO-09-242T] (Washington, D.C.: Dec. 4,
2008); Auto Industry: A Framework for Considering Federal Financial
Assistance, [hyperlink, http://www.gao.gov/products/GAO-09-247T]
(Washington, D.C.: Dec. 5, 2008); Auto Industry: Summary of Government
Efforts and Automakers' Restructuring to Date, [hyperlink,
http://www.gao.gov/products/GAO-09-553] (Washington, D.C.: Apr. 23,
2009); Troubled Asset Relief Program: Status of Government Assistance
Provided to AIG, [hyperlink, http://www.gao.gov/products/GAO-09-975]
(Washington, D.C.: Sept. 21, 2009); Troubled Asset Relief Program: One
Year Later, Actions Are Needed to Address Remaining Transparency and
Accountability Challenges, [hyperlink,
http://www.gao.gov/products/GAO-10-16] (Washington, D.C.: Oct. 8,
2009); and Troubled Asset Relief Program: Continued Stewardship Needed
as Treasury Develops Strategies for Monitoring and Divesting Financial
Interests in Chrysler and GM, [hyperlink,
http://www.gao.gov/products/GAO-10-151] (Washington, D.C.: Nov. 2,
2009).
[3] Under TARP, Treasury also purchased preferred shares and acquired
warrants as part of its investment in AIG.
[4] [hyperlink, http://www.gao.gov/products/GAO-10-151].
[5] On December 9, 2009, Bank of America, the other participant in this
program, repurchased its preferred shares held by Treasury. As of this
date, Bank of America has not exercised its right to buy back the
warrants held by Treasury.
[6] [hyperlink, http://www.gao.gov/products/GAO-01-1163T] and
[hyperlink, http://www.gao.gov/products/GAO-09-975].
[7] [hyperlink, http://www.gao.gov/products/GAO/GGD-84-34].
[8] FRBNY provided secured loans to AIG as part of its revolving credit
facility.
[9] The Targeted Investment Program, the Systemically Significant
Failing Institutions Program, and the Automotive Industry Financing
Program are considered exceptional assistance programs. Companies that
have received exceptional assistance included AIG, Bank of America,
Citi, Chrysler, GM, and GMAC.
[10] While the Office of Financial Stability's (OFS) financial
statements reflect activities involved in implementing TARP, including
providing resources to various entities to help stabilize the financial
markets, the statements do not include the assets, liabilities, or
results of operations of commercial entities in which OFS has a
significant equity interest. According to OFS officials, OFS's
investments were not made to engage in the business activities of the
respective entities.
[11] Under TARP, Treasury also holds AIG preferred shares and warrants.
For the purposes of this statement, we will focus on the shares held in
trust.
[12] Treasury's exposure under the guarantee is limited to $5 billion.
The Federal Deposit Insurance Corporation (FDIC) and the Federal
Reserve Bank of New York are also participating in this guarantee. FDIC
also received preferred shares. As part of an exchange offering, both
Treasury's and FDIC's shares were converted to trust preferred shares.
[13] Initially, Citigroup requested that Treasury exchange its
preferred shares for common shares to strength its capital structure
and increase its tangible common equity. Following the Federal Reserve
Board stress test conducted as part of OFS's Financial Stability Plan,
Citi expanded its planned exchange of preferred securities and trust
preferred securities for common stock from $27.5 billon to $33 billion.
The stress test found that Citigroup would need an additional $5.5
billion in tier 1 common capital, for a total of $58.1 billion, to
ensure adequate capital for the more adverse economic scenario.
[14] Office of Financial Stability: Agency Financial Report Fiscal Year
2009, Department of the Treasury.
[15] AIG has not made any dividend payments since receiving assistance.
After four missed dividend payments OFS may appoint to the AIG board of
directors the greater of two members or 20 percent of the total number
of directors of the company.
[16] Current equity ownership in New Chrysler is as follows: the
Chrysler Voluntary Employee Benefit Association (67.7 percent), Fiat
(20 percent), Treasury (9.85 percent) and the Government of Canada (2.5
percent).
[17] Section 111 of EESA, as amended by the American Recovery and
Reinvestment Act of 2009, Pub. L. No. 111-5, Div. B, Title VII, 123
Stat. 115, 516-520 (2009), codified at 12 U.S.C § 5221, prescribes
certain standards for executive compensation and corporate governance
for recipients of financial assistance under TARP. Treasury published
an interim final rule setting forth the applicable compensation and
corporate governance standards (74 Fed. Reg. 28,394, June 15, 2009,
codified at 31 C.F.R. Part 30).
[18] The determinations cover four companies: AIG, Citigroup, GM, and
GMAC. Chrysler and Chrysler Financial were exempt from the Special
Master's review during this round because total pay for their
executives did not exceed the $500,000 "safe harbor" limitation in
Treasury's compensation regulations. Because Bank of America repaid its
TARP obligations on December 9, 2009, its 26 - 100 most highly
compensated employees plus additional executive officers are not
subject to the Special Master's review.
[19] [hyperlink, http://www.gao.gov/products/GAO-10-151].
[20] Companies that have received exceptional assistance include AIG,
Bank of America, Citi, Chrysler, GM, and GMAC. We also include Fannie
Mae and Freddie Mac in our review.
[21] OFS also manages its preferred investments and warrants in AIG but
for purposes of this statement, we focus on the government's interest
in AIG common shares.
[22] [hyperlink, http://www.gao.gov/products/GAO-10-151].
[23] [hyperlink, http://www.gao.gov/products/GAO-10-151].
[24] EESA § 101(c) (4) authorizes the secretary to take all necessary
actions to carry out its authorities under ESSA, including, without
limitation, "establishing vehicles that are authorized , subject to the
supervision of the Secretary, to purchase, hold and sell troubled
assets and issue obligations." Under a traditional trust structure,
however, the assets of the trust would be under the supervision of
trustees, not Treasury.
[25] Citi announced its intention to repay the government's assistance
and Treasury announced that it intends to sell up to $5 billion of its
common equity position in Citigroup. Treasury said it expects to sell
the remainder of its shares in an orderly fashion within six-12 months.
[26] [hyperlink, http://www.gao.gov/products/GAO-10-151].
[End of section]
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