removing toxic assets from balance sheets: structures

stitutions, restructuring, non-performingloans, valuing assets, asset guarantees

INTRODUCTIONWith global financial markets in varyingstates of disarray, financial institutions andgovernment officials continue to seek tostabilise the banking industry and restorethe flow of credit. Financial institutionshave been plagued by continuing lossesfrom troubled assets on their balancesheets. The application of mark-to-marketaccounting has resulted in the announce-ment of new write-downs each quarter.These write-down announcements sapinvestor confidence in financial institu-tions and lead to stock price declines andincreased volatility. This chain of eventshas overshadowed efforts to refocus at-tention on business prospects. Overthe course of 2008, the scope oftroubled assets broadened, from subprimemortgage-related assets, to auction ratesecurities, to derivatives, to commercialreal estate-related assets. Now, in 2009,research analysts and economists warn thatwe should anticipate losses in connectionwith loan portfolios. Uncertainty regard-ing future losses and whether and whenmarket and asset values will hit ‘bottom’inhibit private investment in financialinstitutions.

On 3rd October, 2008, Congress

Anna T. Pinedo is a partner in Morrison &Foerster’s New York office. She concentrates onsecurities and derivatives, representing issuers,investment banks and financial intermediariesin financings, including public and private of-ferings of equity and debt securities, as wellas structured products and innovative financialproducts. In the derivatives area, Anna counselsfinancial institutions acting as dealers and par-ticipants in the derivatives markets. She adviseson structuring issues, as well as on regulatoryissues and hedging techniques.

ABSTRACT

Financial institutions and regulators in theUSA and abroad have taken many measuresto address the lingering effects of troubled assetson bank balance sheets. Several governmentsannounced asset guarantee programmes wherebygovernment entities share losses associated withpools of troubled assets ring-fenced from finan-cial institution balance sheets. Another ap-proach has been a series of initiatives to sell offtroubled assets. A third approach has been theformation of ‘good banks’ and ‘bad banks’wherein financial institutions cleave off troubledassets and discontinued business lines andoperations into a new entity. This paperdiscusses the merits of these differing ap-proaches.

Keywords: good bank-bad bank, toxicassets, troubled assets, financial in-

Removing toxic assets from balancesheets: Structures based on the goodbank-bad bank model

Anna T. PinedoReceived 15th April, 2009Morrison & Foerster LLP, 1290 Avenue of the Americas, New York, NY 10104-0050,USA. Tel: �1 212-468-8179; Fax: �1 212 468-7900; E-mail: [email protected]

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Journal of Securities Law,Regulation & ComplianceVol. 2 No. 4, pp. 289–309� Henry Stewart Publications,1758-0013

authorised the creation of the US$700bnTroubled Assets Relief Program, proposedby former Treasury Secretary Paulson topurchase troubled assets from financialinstitutions.1 However, for a variety ofreasons, including concerns regarding theappropriate valuation of those assets to bepurchased, by 12th November, 2008,Secretary Paulson abandoned the initialplan.2 Instead, the government proceededwith direct capital injections into financialinstitutions, through the Capital PurchaseProgram. In recent months, marketparticipants and regulators both in theUSA and in Europe have debatedalternative measures for restoring financialstability and investor confidence. Thereare two principal alternatives (and manypermutations of these) that have been putforth: an asset guarantee model and agood bank-bad bank model. Bothalternatives are intended to mitigate orring-fence troubled assets and limit thedetrimental effect on financial institutionsof subsequent losses from portfolios oftroubled assets.

Along these lines, after much anticipa-tion, on 10th February, 2009, TreasurySecretary Geithner announced a plan toestablish partnerships with private invest-ors to remove troubled assets fromfinancial institutions’ balance sheets.3 Ad-ditional information about the Public-Private Investment Program and its twosub-programs, the Legacy Loans Programand the Legacy Securities Program, wasannounced on 23rd March, 2009.4 Theprograms were intended to leveragegovernment investments to encourageprivate investors to purchase ‘bad’ ortroubled assets, now identified as ‘legacy’assets, from core financial institutions. Inrecent statements, regulators have indi-cated that these programs will be delayedor put on hold.

Financial institutions may wish toconsider independently implementing the

‘good bank-bad bank’ model, wherebythe core financial institution, or goodbank, separates off troubled assets into anewly formed bad bank. Below, wediscuss some of the structuring considera-tions for good bank-bad bank models andcompare and contrast these to assetguarantee models and the Public-PrivateInvestment Program.

OVERVIEW OF THE GOODBANK-BAD BANK STRUCTUREIn a good bank-bad bank structure, afinancial institution establishes a separateentity for its ‘bad’ assets. Free of troubledassets, the resulting ‘good’ bank can ex-pect restored investor and market con-fidence, allowing it to raise capital moreeasily and at more affordable rates, andresume normalised lending. In structur-ing a bad bank, consideration must begiven to the ultimate goal of the badbank: whether its purpose is solely toliquidate bad assets or whether it willalso house business operations. That deci-sion influences other decisions, includingownership of the bad bank, the legal andregulatory structure, capital and liquidityrequirements, management, compositionof the asset pool to be transferred andvaluation of those assets.

If the bad bank is left to focus en-tirely on loan recovery and self-liqui-dation, then funds recovered from thetroubled assets in the bad bank are paid toshareholders of the bad bank in the formof a dividend or interest payment after anyrepayment of debt raised by the bad bankto fund the purchase of the troubledassets.

StructureThe goal of the good bank-bad bankstructure is to ‘clean up’ the balance sheetof the good bank by transferring to thebad bank assets that are illiquid, non-

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Private investors specialising in work-outsituations or distressed assets will be moreinterested in a bad bank investment op-portunity over which they can exerciseasset management control, than in aninvestment in a global financial serv-ices enterprise. Depending on the needsof the financial institution and the sizeof the portfolio of bad assets, amongother factors, a bad bank may be estab-lished through a negotiated transactionwith a private investor or private investorgroup.5

The level of capital required by the badbank will be based on the anticipatedlosses on the pool of transferred assets.Independent analysis of potential losseswill be important for private investorsevaluating investments in bad bank struc-tures. As we note below, the requiredcapitalisation will depend on the assetmix, valuation of the assets, the an-ticipated loss levels on the assets and anumber of other related factors.

In a liquidation model, a bad bank’sfunding needs will be limited to in-clude, for example, ongoing managementcosts and debt service. A bad bank es-tablished with a model other than theliquidation model must consider addi-tional costs, including ongoing financingfor an unknown or perhaps indefiniteperiod and more variable management,legal and regulatory costs. Given the cur-rent widespread, sustained and unprece-dented dislocation in the markets, the badbank plan should include sources of ongo-ing funding and liquidity that do not relyexclusively on the capital market and newinvestors. Private investors will need toconsider carefully their ongoing fundingcommitment and the commitment of anyother partners in a bad bank enterprise.

Ratings ImpactTransferring troubled assets to a bad bankis likely to improve the credit ratings of

performing or otherwise resulting inwrite-downs and depleting capital. Inorder to separate the problem assets, caremust be taken to ensure the newly formedbad bank is not under common controlwith the good bank such that foraccounting or regulatory purposes thebalance sheets are consolidated. Accord-ingly, although a bad bank may be initiallyestablished as a subsidiary of a good bank,sufficient external capital is required todeconsolidate the bad bank subsidiary. Atmost, the good bank may maintain anon-controlling minority interest in thebad bank.

In forming a bad bank, considerationmust be given to corporate, banking andsecurities laws. Assuming the bad bank’ssole purpose is to liquidate troubled assets,limited regulatory oversight is required.Although the new entity is referred toas a ‘bad bank’, whether the new en-tity needs to be chartered as a bankdepends on the assets transferred to it andthe business activities of the new entity.Transfer of ongoing business operations,in addition to troubled assets, is morelikely to require a banking charter orsatisfaction of relevant regulatory require-ments.

Funding the Bad BankThe bad bank must be capitalised. Itwill obtain a limited amount of capitalfrom reserves allocated to the acquiredassets. After that, a bad bank is typicallyfunded primarily by selling equity ordebt securities. In 2008, private invest-ors experienced significant losses as aresult of sizable investments in finan-cial institutions, inhibiting their willing-ness to step forward now and investin troubled institutions. However, invest-ment in discrete pools of assets mayattract private investors interested in tar-geted and concentrated ownership withsignificant control over the new entity.

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the good bank, reducing borrowing andfinancing costs for the good bank andultimately increasing earnings potential.Coordination with rating agencies is es-sential in order to ensure that the desiredbenefits of the good bank-bad bank struc-ture can be obtained. As a good bankevaluates the composition of the assets tobe transferred to the bad bank, considera-tion should be given to the impact oncredit ratings.

Valuing AssetsA challenge in establishing a bad bank isthe valuation of troubled assets. Financialinstitutions have reported significant con-cerns with the current interpretations ofmark-to-market accounting requirementsfor assets in illiquid markets.6 In illi-quid markets, such as the markets formost troubled assets, assets required tobe marked-to-market may be held at avaluation based on the institution’s in-ternal model. Internal models are based onmanagement’s assessments of various fac-tors that may include limited market priceinformation, credit expectations, whetherpayments are current or delinquent andanticipated losses. These models will varyby institution, resulting in different carry-ing values for similar assets and assetclasses.

Financial institutions and their financingpartners will need to determine the trans-fer prices of troubled assets, includingwhether to transfer at book value or atrecent trading prices, if different. Assetstransferred at less than carrying value willrequire an additional write-down by thegood, transferring bank. Current invest-ors and regulators can be expected toraise questions regarding any asset write-downs in connection with establishing abad bank. The financial institution’s bookvalue for an asset, however, may notreflect the price at which a private invest-or is interested in acquiring the asset.

Balancing these independent interests re-quires detailed negotiation with privateinvestors, and flexibility in determiningthe appropriate composition of the assetportfolio to be transferred.

The German Government recently an-nounced a plan under consideration toestablish a middle ground between valu-ing the transferred assets at carrying valueand at an illiquid market value. Germanbanks would value their troubled assets atcarrying value and above current illiquidmarket prices, preventing further write-downs by the transferring institution. If,in the future, the bad bank recovered lessthan the transfer value of the troubledasset, the good bank would be required tomake the bad bank whole. For such asolution to be implemented in the USA,new accounting guidance would be re-quired permitting such a transfer, not-withstanding the retained interest in theperformance of the asset by the goodbank, to be considered a ‘sale’ of the assetby the good bank.

Asset SelectionSelection of the asset portfolio is a criticalfactor in the ultimate success of a goodbank-bad bank transaction. Financial in-stitutions must transfer a significant por-tion of their bad assets in order to achievethe benefits of a bad bank model, withoutstripping their balance sheets of perform-ing assets. An institution also should con-sider the overall size of the resultinggood bank. There are regulatory, market,ratings and counterparty benefits to main-taining a large-size good bank.

Portfolio mix will be important to thebad bank’s ability to achieve its goals.Given the limited market for troubledassets, it is unlikely a bad bank willachieve a short-term goal of liquidation.An institution must structure the bad bankto align the goals of the private in-vestor with the capital structure of the


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established to liquidate or obtain the bestcurrent price for an asset will not face theconflicting goal of maintaining long-termlending and banking relationships withborrowers. As a result, decisions focusedon the goals of the bad bank — such asliquidation or obtaining current value foran asset — will take priority overborrower-focused goals or longer-termasset-performance goals. A bad bank withmore diverse or long-term operating goalsmay face ongoing conflicts in managingtroubled assets. If a bad bank is concernedwith its long-term business prospects, careshould be taken to align the entity’sinterests with those of its investors toensure management of troubled assets isconducted in a manner consistent with allparties’ objectives.

Benefits of the Good Bank-Bad BankStructureBenefits of the good bank-bad bankstructure include a renewed focus on thelong-term core operations of the goodbank without the ongoing distraction ofthe troubled assets. Management’s focuscan return to building or rebuilding thefinancial institution and reporting onresults of operations rather than perform-ance of the troubled assets. Removingtroubled assets from the balance sheetshould have a positive impact on theview of credit rating agencies, investors,potential investors, lenders, depositorsand borrowers. Additionally, removingtroubled assets will relieve pressure oncapital from the troubled assets, en-abling the institution to engage in moreprofitable and growth-oriented businessactivities, including lending.

As we note above, many factors needto work together to achieve the benefitsof a good bank-bad bank structure. Afinancial institution should develop itsviews on the optimal portfolio of badassets to structure a transaction that

new entity and the asset pool characteris-tics. For example, a bad bank fundedwith interest-bearing debt needs to holda portfolio of assets generating currentreturns sufficient to satisfy the debt obliga-tions.

As the recession continues, financialinstitutions are challenged to identify allof their bad assets. The benefit ofrelieving management from the burden ofmanaging troubled assets and focusing onwrite-downs rather than business oper-ations will not be achieved if the retainedassets continue to negatively impact thebalance sheet. Institutions will need to beconfident that they can transfer a sufficientamount of bad assets to prevent addi-tional announcements of significant write-downs following the creation of a badbank.

Care should also be taken to define theoptimal balance sheet for the resultinggood bank. Asset transfer decisions shouldbe consistent with business plans andstrategies for the retained businesses. Thebenefits of establishing a bad bank,including increased investor, rating agencyand counterparty confidence, could bediminished if the retained assets donot align sufficiently with the ongoingbusinesses and meaningful managementresources are still required to manage orliquidate a portfolio of troubled assets.

Asset ManagementThe good bank must consider theongoing management of the transferredassets. Options include having the goodbank transfer management resources tothe bad bank, providing managementservices on a contract basis, or having theprivate investors manage, or hire assetmanagers for, the portfolio.

Managing assets through the new badbank entity should simplify and targetdecision-making with respect to thetroubled assets. An independent bad bank

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reflects the institution’s long-term goals.At the same time, the institution mustretain the flexibility necessary to identifyand work with the best private partneravailable to finance and structure the badbank.

Models of good bank-bad banksThe good bank-bad bank model has beenused in the USA and internationally withsome success, as we describe brieflybelow.

Resolution Trust CorporationThe Federal Deposit Insurance Corpora-tion (‘FDIC’) in public statements hasindicated that it will consider a process forthe purchase of troubled assets that closelyresembles the Resolution Trust Corpora-tion (‘RTC’), established to manage anddispose of assets acquired by the govern-ment during the savings and loan crisis ofthe 1980s. The RTC both sold assetsand, when faced with illiquid marketsand depressed asset prices, partnered withprivate investors to manage and transferownership of assets.

Mellon Bank CorporationIn 1987, although not insolvent, MellonBank Corporation (a predecessor of TheBank of New York Mellon) facedsignificant liquidity and other issues asa result of a decline in real estatevalues and the price of oil. MellonBank Corporation (‘Mellon’) created anew institution, Grant Street NationalBank (‘GSNB’), which purchased Mel-lon’s bad loans, valued at US$1.4bn whenoriginated; they were written down 53per cent when sold to GSNB. GSNB wascapitalised with US$123m from Mellonand with US$513m in short-term bondssold by Drexel Burnham Lambert. GSNBhired a non-bank subsidiary of Mellon tomanage the troubled assets with a goal ofliquidation. Mellon’s earnings increased

following the sale of the bad loans toGSNB. GSNB liquidated all of the loansand wound down in 1995.

UBS AGIn October 2008, UBS AG (‘UBS’) soldUS$60bn of its troubled assets to aspecial-purpose vehicle acting as a badbank for UBS. To capitalise the bad bank,UBS raised US$6bn through share salesto the Swiss Government, giving thegovernment a 9 per cent ownership stakein UBS. In addition, the Swiss NationalBank loaned the bad bank US$54bn tohelp pay for the troubled assets. In thetransaction, UBS diluted its shareholders’interests by 9 per cent (as a result of thegovernment ownership stake), investedUS$6bn in a bad bank, and removedUS$60bn of troubled assets from itsbalance sheet.

CitigroupIn January 2009, Citigroup issued a pressrelease announcing its decision to divideitself into two banks: Citicorp andCiti Holdings.7 The bank’s ‘core’ assetswill be held in Citicorp and Citicorpwill focus on its future growth oppor-tunities. Citigroup’s non-core assets willbe transferred to Citi Holdings, includingCitigroup’s brokerage and retail assetmanagement, local consumer finance andspecial asset pool. The management ofCiti Holdings will focus on obtainingvalue from the non-core assets andmanaging risks and losses. Citigroupnoted in the press release that it is stilllooking for managers for Citi Hold-ings. At the time of the announce-ment, Citigroup was seeking necessaryregulatory approvals, resolving tax issuesand working to address the interests of allstakeholders. The Citigroup proposal in-cludes a transfer of substantive operationsinto the ‘bad’ bank, Citi Holdings, a morecomplex model than the liquidation bad


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eliminated in the guarantee approach, butwill not result in additional write-downs.The guarantor provides the guarantee fordefined losses, which may be all losses upto book value or another agreed-uponvalue, or may be losses after a first loss isabsorbed by the financial institution.Under Treasury’s Asset GuaranteeProgram, the financial institutions retainlosses up to a threshold and Treasury andthe FDIC share 90 per cent of losses upto a second threshold. Thereafter, theFederal Reserve will loan the institutionfunds for any further losses on the assetpool. Determining the point at which theguarantee coverage attaches andterminates, and the premium for thecoverage, can be as complex asdetermining the valuation for transferringassets to a bad bank, but the impact to thebalance sheet is less transparent. Anadditional benefit of the governmentguarantee may be a lower risk-weightingassigned to the asset pool. In theCitigroup programme, the risk-weightingfor the troubled assets in the pool is 20per cent.

There are some disadvantages to thegovernment guarantee approach, mostnotably the executive compensationand corporate governance requirementsimposed on participating institutions.Participation in the Targeted In-vestment Program and the AssetGuarantee Program requires compliancewith the executive compensation andgovernance requirements of the Emer-gency Economic Stabilization Act of2008 (‘Stabilization Act’), as interpretedthrough Treasury’s evolving rulemakingand as amended by the AmericanRecovery and Reinvestment Act of 2009.In addition, each of the participatinginstitutions must comply with corporategovernance agreements limiting corporatedividends and certain corporate spending.Notwithstanding the unique benefits of a

bank. As discussed, impact on creditratings, funding and liquidity needs andregulatory requirements will be importantconsiderations as Citigroup structures itstwo entities.

THE ASSET GUARANTEE MODELIn November 2008, Citigroup announcedan agreement whereby Treasury, theFederal Reserve Board (‘Federal Reserve’)and the FDIC will guarantee and providefunding for a pool of troubled assets. Bankof America entered into a similar agree-ment several weeks later. Each of theCitigroup and Bank of America transac-tions fall under Treasury’s Asset GuaranteeProgram, used in coordination withsignificant capital investments by Treasuryunder its companion Targeted InvestmentProgram.8 The key difference betweenasset guarantees and a good bank-badbank model is the retention, in the assetguarantee model, of the troubled assets onthe institution’s balance sheet.

The financial institution identifies apool of troubled assets using a processsimilar to that used in the good bank-badbank model, but without the samelimitations. Because the assets are retained,the institution will not need to align thecharacteristics of the asset pool with thefunding requirements for the bad bank. Apool of assets that might not be ap-propriate to transfer to a bad bank, forexample, because they are not generatingreliable cash flow, would be appropriate toretain in the asset guarantee pool. Theseassets are then segregated or ring fencedfrom other assets. The most straightfor-ward method of segregating assets is toannotate in the institution’s records thatthe assets are subject to the guarantee.Alternative approaches are possible, in-cluding transferring the assets to a newlyformed, wholly owned subsidiary.

Valuation considerations are not

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government guarantee, serious consider-ation must be given to the longer-termimpact of the accompanying restrictions.

Asset guarantee models are also beingconsidered outside the US. The approachrequires limited initial government ex-penditure, providing policymakers with amore politically acceptable solution inlight of the extensive spending and rescueprogrammes already announced. Addi-tionally, independently negotiating attach-ment points for the guarantee with eachinstitution provides more flexibility thanpurchasing whole assets under an ag-gregator bank model.

Treasury’s Asset Guarantee ProgramAs originally presented to Congress,former Treasury Secretary Paulson’sbailout proposal did not include aguarantee programme. Members ofCongress, concerned that the proposalwould result in significant US Govern-ment ownership of troubled assets, pushedfor inclusion of an alternative insurance,or guarantee, programme. Although aprogramme to guarantee assets reduces theinitial expenditure of taxpayer money andretains private ownership of troubledassets, Treasury has found it challenging toimplement the programme. In addition, aguarantee, while protecting a financialinstitution against future losses, does notprovide the institution with new capitalor liquidity.

Under the Stabilization Act, eachguarantee reduces the amount availableunder the Act on a dollar-for-dollar basis,offset only by the amount of anycash premium collected. For example, aguarantee on an asset valued at US$10mwould reduce the amount available toTreasury under the Stabilization Act byUS$10m, offset only by the amount ofany cash premium collected. As a result,the benefits of the guarantees, balanced bythe burden of determining a premium,

must be weighed against the benefits ofthe Stabilization Act’s alternative pro-grammes.

A guarantee programme requiresdetailed negotiation by the parties to eachtransaction. Treasury and a participantmust agree on the valuation of the assets,including whether Treasury will guaranteethe full face value, the currentmarked-down value, or losses withinnegotiated thresholds. In addition, bothparties must agree on the asset poolsize and composition, the term andcoverage of the guarantee, and associatedpremiums. As a result of illiquid marketsfor troubled assets, the assets have beenmarked down to different values onfinancial institutions’ balance sheets. Eachfinancial institution holds a uniquequantity and composition of troubledassets and each institution is willing, orable, to absorb different losses and pricingpremiums. The terms of a guarantee mustbe negotiated separately with eachinstitution; standardised objective termscannot be established for an auctionprocess or other broad-based guaranteeprogramme.9

The calculation of the premium affectsthe desirability of the guarantee. Sections102(c)(2) and 102(c)(3) of the Stabiliza-tion Act provide that premiums must beset based on the risk of the troubled assetand to ‘create reserves sufficient to meetanticipated claims, based on an actuarialanalysis, and to ensure that taxpayers arefully protected’. A detailed underwrit-ing function is necessary to evaluate therisks and determine the amount of thepremium. Given that a high percentage oftroubled assets are illiquid, distressed, highrisk and in many cases, non-performing,premiums should be high in order forthe guarantee programme to meet thestatutory guidelines.

Faced with these challenges, on 10thOctober, 2008, Treasury requested public


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to credit markets or paymentsand settlement systems, destabiliseasset prices, significantly increaseuncertainty, or lead to similar losses ofconfidence or financial market stabilitythat could materially weaken overalleconomic performance.

5. The extent to which the institution hasaccess to alternative sources of capitaland liquidity, whether from the privatesector or from other sources of govern-ment funds.

To be eligible for the Asset GuaranteeProgram, a troubled asset must have beenoriginated prior to 14th March, 2008.Treasury will provide protection againstspecified losses on each guaranteed asset,determined on a case-by-case basis. Suchprotection may be structurally similar tothat provided in the Citigroup or Bank ofAmerica transactions, with one party (theentity holding the asset) assuming the firstloss position, and Treasury assuming asecondary loss position. Additionally, theinstitution will be subject to portfoliomanagement guidelines for the coveredassets, to be established by Treasury.

The 31st December, 2008 report onthe Asset Guarantee Program notes theunique guarantee accounting mandatedby the Stabilization Act and outlinesTreasury’s considerations when evaluatinga guarantee structure. The guaranteedportion of the troubled asset reduces, ona dollar-for-dollar basis, the funds avail-able for use under the Act, offset by thevalue of any cash premium received byTreasury. Non-cash premiums, such aspreferred stock, will not offset thereduction of available resources under theStabilization Act. As a result, Treasury willevaluate on a case-by-case basis thetroubled assets to be covered by theProgram to minimise the impact onavailable funds.

Treasury also notes ongoing efforts to

input on the guarantee programme,‘seeking the best ideas on structuringoptions for the insurance programme’.10

Responses were due by 28th October,200811 and 10 weeks later, on 31stDecember, 2008, Treasury issued itsreport to Congress, establishing the AssetGuarantee Program under section 102 ofthe Stabilization Act.12

Asset Guarantee Program TermsAs announced on 31st December, 2008,the Asset Guarantee Program providesguarantees on troubled assets held by‘systemically significant financial institu-tions that face a high risk of losing marketconfidence due in large part to a portfolioof distressed or illiquid assets’. Treasuryhas reported that the Program will not bemade widely available, and potential par-ticipants will be evaluated using the samefive factors established for the TargetedInvestment Program.

The five factors for the Targeted Invest-ment Program are:

1. The extent to which destabilisationof the institution could threaten theviability of creditors and counterpartiesexposed to the institution, whetherdirectly or indirectly.

2. The extent to which an institution isat risk of a loss of confidence and thedegree to which that stress is caused bya distressed or illiquid portfolio ofassets.

3. The number and size of financial in-stitutions that are similarly situated, orthat would be likely to be affected bydestabilisation of the institution beingconsidered for the programme.

4. Whether the institution is suf-ficiently important to the na-tion’s financial and economic systemthat a loss of confidence inthe firm’s financial position couldpotentially cause major disruptions

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continue evaluating the development ofother insurance programmes. In doing so,Treasury will be guided by two factors.The first is the Stabilization Act’s account-ing for guarantees: that the impact toavailable Stabilization Act funds is thesame for insuring an asset as for purchas-ing an asset. The second is the risk ofadverse selection arising from the com-plexity of the troubled assets and thechallenges of pricing premiums. Anystandardised premium established for aclass of troubled assets is likely tobe attractive to parties for whom thepremium was appropriately priced orunder priced. As a result, the credit riskwould result in greater losses than thepremium could cover. As a result,premiums should be priced based on anasset-by-asset review of credit risk.

Citigroup TransactionTreasury completed its first transactionunder the Guarantee Program on 16thJanuary, 2009, when it finalised the termsof a guarantee agreement with Citigroup,which was announced on 23rd Novem-ber, 2008. The agreement with Citigroupprovides a package of guarantees, liq-uidity access and capital, and includestwo distinct programmes: a guaranteefrom Treasury and the FDIC of up toUS$301bn and a US$20bn investment byTreasury under the Stabilization Act’sTargeted Investment Program.13

Impact of the ProgramDespite its challenges, the Asset GuaranteeProgram can be beneficial to the par-ticipating institution, as well as to thetaxpayer. In exchange for a premium pay-ment, a financial institution that purchasesthe guarantee will receive the benefits ofthe original payment stream on a finan-cial instrument that is a troubled asset.A guarantee makes it easier for a finan-cial institution to hold troubled assets to

maturity. The mark-to-market effects ofdeclines in market values will be mitigatedonce the guarantee level is hit, easingpressure to sell as a means of avoiding therisk of future markdowns. If, as has beenwidely reported, market values currentlysignificantly understate the true economicvalue of certain assets, a guarantee thatfacilitates holding those assets to maturityprovides significant benefit.

Additionally, the balance sheet benefitsmay be significant. Troubled assets underthe Asset Guarantee Program are assigneda 20 per cent risk-weighting, reducing theassociated capital burden. Longer term,if a guaranteed troubled asset becomesa performing asset, the financial institu-tion will benefit from holding a healthierasset.

Finally, the financial institution retainsmanagement of the troubled assets in theAsset Guarantee Program, enhancing thelikelihood of efficient decision-making.If held by Treasury, a new portfoliomanager would be responsible for manag-ing a diverse and new pool of troubledassets. The financial institution maintainingownership retains direct economic incen-tive to maximise the value of the troubledassets given its ongoing exposure.

A key disadvantage to be care-fully considered is the requirement thatparticipating institutions comply withTreasury’s executive compensation restric-tions, which continue to evolve. Participa-tion requires compliance with executivecompensation rules, corporate governancerestrictions, mortgage modification plansand asset management guidelines.

ALTERNATIVE AND HYBRIDPROPOSALS

Government ‘Good’ BankPrior to the announcement of thePublic-Private Investment Program, dis-


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out by the government, the resultingimplied safety net will continuouslyimpede an appropriate level of riskmanagement. This will result in anationalised banking system in practice, ifnot in name. In contrast, Mr Sorosnotes, if financial institutions and theirshareholders are made to pay the price ofpast decisions, they will be more prudentin future corporate and capital allocationdecision-making.

Hybrid ProposalThe proposal of Max Holmes15 offersa hybrid approach, including bothgovernment intervention and privaterestructuring16 The plan requires thatfinancial institutions establish separate,government-owned bad banks, ratherthan using a government-sponsoredaggregator bank. Government supportwould come in the form of long-termfunding for the separately formed badbanks. Each financial institution wouldtransfer its selection of troubled assets toits new bad bank at most recentquarter-end or year-end valuations,eliminating many of the valuationconcerns discussed above with a singleaggregator bank. The government wouldfinance the bad banks by assumingoutstanding debt of the financialinstitutions, rather than issuing newTreasury debt. The specific debt instru-ments would be selected by thegovernment, in an aggregate amountequal to the troubled assets transferred tothe good bank. Cash flow from thetroubled assets would be used by thegovernment to repay the outstandingdebt, with the government absorbing anylosses. The portfolio of assumed debtcould be structured to match, as closely aspossible, the expected cash flows from thebad bank.

Mr Holmes’s proposal focuses on thelargest financial institutions ‘and perhaps

cussed below, the federal governmentevaluated the merits of establishing an‘aggregator’ bad bank. Under an ag-gregator bank model, the federal govern-ment would form a bad bank to acquiretroubled assets from numerous financialinstitutions. This aggregator bank couldbe funded with government capital, or acombination of private and public capital.

An alternative government good bank-bad bank model has been proposed byGeorge Soros.14 Under the proposal,financial institutions would establish a badbank into which they would transfer theirtroubled assets, funded with a transfer ofexisting capital and debt. Rather thanfinance the bad bank, Mr Soros proposesthat government capital would be bet-ter spent re-capitalising the remaining,and capital-depleted, good bank. Existingshareholders would be given interests inthe new bad bank, as well as rights tosubscribe for new shares of the goodbank. Government resources would beused to capitalise the good bank — amore appealing investment for US tax-payers and their policymakers. It wouldbe easier to attract private capital to thegood bank than to the bad bank, limitingthe cost to the government, a keyconsideration given the scope of thecurrent crisis.

Losses on the bad bank assets would beborne first by pre-existing shareholders,rather than by new investors. Mr Sorosnotes that any risk of loss to bad bankdebtholders may reduce the ability offinancial institutions to borrow in thefuture, an outcome he finds acceptablegiven his belief that financial institutionsshould not be as highly leveraged in thefuture.

The proposal supports a public policygoal of preventing moral hazard aris-ing from government intervention.Widespread concerns are being discussedthat once financial institutions are bailed

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some others’. The proposal requires man-datory participation by four major finan-cial institutions, but does not providedetails on the criteria for including others.If such a proposal were to be adopted,the financial institution stress tests to beperformed under Treasury’s Plan couldpotentially be used to identify additionalfinancial institutions.

The structure of the Program providessome funding advantages. First, fund-ing with long-term debt would permitmanagement of the assets absent pressureto attempt immediate liquidation at cur-rent fire-sale prices. Additionally, assump-tion of debt, rather than printing newmoney, resolves a frequent criticism andconcern expressed over the growing sizeof the government’s stimulus and stabilisa-tion programmes. Mr Holmes recom-mends that participating institutions granttransferable warrants to the government,so that the expected upside potential fromclean, strong balance sheets could beshared by the US taxpayer.

PUBLIC-PRIVATE INVESTMENTPROGRAM

BackgroundAs noted, prior to the announcement on23rd March, 2009 of the Public-PrivateInvestment Program (‘Program’), mostof the government’s effort to addresstroubled assets focused on development ofan ‘aggregator bank’. Although the ag-gregator bank model has the advantage ofproviding a single entity in which tomanage acquired assets, the model mustcontend with the challenges of funding adiverse collection of assets from multiplesellers and developing an efficient andeffective pricing methodology. To ad-dress the complexity of one aggregatorbank managing purchases from mul-tiple institutions, the Program will es-

tablish numerous bad banks, each aPublic-Private Investment Fund (PPIF),to purchase legacy assets. The pricingmethodology for the Program will in-volve private investors establishing priceson pools of assets or securities, sig-nificantly minimising the government’srole in the valuation process.

Program OverviewThe Program is a joint effort by Treasury,the FDIC and the Federal Reserve. Inaddition to the goal of clearing up thebalance sheets of financial institutions, theProgram seeks to encourage the extensionof credit and to restart the markets forlegacy loans and securities. Additionally,enhanced confidence in financial institu-tions’ balance sheets should reduce uncer-tainty, restore investor confidence andencourage private capital investment infinancial institutions. Treasury will con-tribute US$100bn of funds available underthe Stabilization Act. Including capi-tal investments from private investorsand loans supported by the FederalReserve and the FDIC, the Program mayultimately purchase US$1trn of legacyassets. Treasury will invest alongsideprivate investors, contributing half of thecapital for each purchase of a legacy loanor legacy security.

The Program leverages the success oftwo other crisis-related federal pro-grammes, the Temporary LiquidityGuarantee Program, launched by theFDIC and the Term Asset-backedsecurities Loan Facility (TALF), an-nounced by the Federal Reserve. Treasuryand the FDIC will operate the LegacyLoans Program, for the purchase of loansand similar assets, while Treasury and theFederal Reserve will operate the LegacySecurities Program, for the purchase ofsecurities. Each of the Legacy LoansProgram and the Legacy SecuritiesProgram will be structured based on the


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vestors and banking institutions have beenunable to reach mutually agreeable pricingterms, the Legacy Loans Program termsmay encourage higher bidding by privateinvestors.

Legacy Loans Program Participants andAssetsOnly insured US banks or US savingsassociations17 are eligible to sell loansunder the Legacy Loans Program. For-eign-owned or controlled entities are noteligible to participate.18 Interested eligiblesellers must consult with their respectiveprimary federal banking regulator to iden-tify loans and assets for the Loans Pro-gram. The Program initially targets realestate-related assets, including residentialand commercial real estate loans and anycollateral supporting the loans must be‘situated predominantly in the UnitedStates’.

The Program is designed to encourageparticipation by private investors. Thenon-exclusive list of potential investortypes includes financial institutions, in-dividuals, insurance companies, mutualfunds, publicly managed investment fundsand pension funds.19 Investors and groupsof private investors must pre-qualify withthe FDIC for participation in auctions.

Legacy Loans Program Structure andFinancingAs noted, the specific legal form for a badbank will depend on the assets transferredand the expected activities of the badbank. The specific legal form for thePPIFs has not been identified, but theywill need to be structured to permitmultiple equity owners to issue warrantsto Treasury as required under the Stabil-ization Act20 and to issue debt guaranteedby the FDIC. Potential investors will beinterested in ensuring the PPIFs are notsubject to securities reporting or registra-tion requirements to minimise the costs

assets to be acquired and the respectiveauthority and experience of each of theFDIC and Federal Reserve.

Legacy Loans ProgramUnder the Legacy Loans Program,Treasury and the FDIC will establish aseries of PPIFs with private investors forthe purchase of troubled loans and otherassets. An eligible financial institutionseller will offer a pool of loans for salethrough an auction process to bedeveloped by the FDIC. Private investorswill bid on the portfolio through anauction process and, after the FDICselects a winning bid, the financialinstitution seller can accept or reject thepurchase offer. If a bid is accepted,Treasury and the successful bidder willeach provide 50 per cent of the equityrequired for the purchase. The remainingfinancing will be in the form ofFDIC-guaranteed debt issued by the PPIF.Based on the FDIC’s assessment of thecredit quality of the pool of assets, thePPIF’s debt-to-equity ratio may be as highas 6-to-1. The FDIC-guaranteed debt isexpected to be initially placed with theselling banking entity as partial satisfactionof the purchase price. In summary, thebanking entity will be selling its legacyloans for cash and a debt instrumentguaranteed by the FDIC. The auctionprocess, the availability of a matchingequity investment from Treasury and thelow-cost financing supported by an FDICguarantee are inducements to encourageboth financial institutions to offer loans forsale and private investors to place bidsacceptable to the selling institutions.

Inclusion of the funding incentives andpricing by the private investors throughan auction process addresses many of theaggregator bank valuation concerns. TheFDIC-guaranteed debt is non-recourse tothe private investors, secured only by thePPIF’s assets. Although many private in-

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associated with a Legacy Loans Programinvestment.

Considerations for ParticipantsUnlike a private good bank-bad bank, theTreasury and FDIC will have an on-going relationship with the PPIF, includ-ing some supervisory authority. Privateinvestors will need to consider the ex-penses and time commitment required tomanage both the assets being acquiredas well as the relationship with eachof Treasury and the FDIC. Addition-ally, government participation necessitatesa certain degree of transparency, whichwould not be required in a private trans-action; the selling financial institutions andprivate investors in the PPIF will need toconsider what elements of the transactionswill be publicly disclosed or available. TheFDIC has also indicated that it will bepre-qualifying potential private investors,including their selection for asset managerof the asset pools. As noted above, on-going asset management is a critical com-ponent of designing a good bank-badbank. Treasury and the FDIC will eachhave a vested interest in protecting theirinvestment and risk profile, respectively,which may influence asset managementdecisions.

Another impact of the partnership withthe federal government is compliancewith other federal programmes, includingthe Making Home Affordable mortgagemodification programme recently an-nounced by Treasury.21 Private investorsevaluating the long-term value of a poolof mortgage-related assets will need toconsider the impact of Making HomeAffordable on their valuation.

Market participants, accountants andregulators are evaluating the accountingimpact of the Legacy Loans Program.Given the advantageous financing avail-able to private investors bidding on poolsof legacy loans, prices established through

auctions may not be determinative forestablishing new values or loan lossexpectations for similar assets at the sellingfinancial institution or other financialinstitutions holding similar assets. How-ever, the longer-term impact of the PPIFtransactions cannot be predicted at thistime.

Legacy Securities ProgramUnder the Legacy Securities Program,Treasury will hire a limited number oflarge asset managers22 to each establisha PPIF for the purchase of troubledsecurities, with an initial focus on residen-tial and commercial real estate-backedsecurities. Each asset manager will beresponsible for attracting private investorsto acquire an interest in their respectivePPIF. Treasury will make capital invest-ments alongside the private investors,similar to the 50/50 investment in theLegacy Loans Program. Additionally, eachfund can apply for a non-recourse loanfrom Treasury and, under terms to beannounced, a TALF loan from the FederalReserve Bank of New York.

Legacy Securities Program EligibilityEligible sellers include those institu-tions from whom Treasury can purchasetroubled assets under the Stabilization Act.These ‘financial institutions’ must beestablished and regulated under the lawsof the US23 and have significant opera-tions in the USA. The definition includesa non-exclusive list of institution types:banks, savings associations, credit unions,security brokers or dealers, or insurancecompanies. Expressly excluded are centralbanks of, or any institution owned by, aforeign government. This group of sellersis significantly broader than the sellerseligible to participate in the Legacy LoansProgram and includes many non-bankinginstitutions that have reported losses as aresult of real estate-related securities,


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TALF program. Private investors will needto consider any potential additional fund-ing requirements as Treasury and FederalReserve investments become unavailable.

Considerations for ParticipantsAs is the case for participants in theLegacy Loans Program, the potentialparticipants in the Legacy SecuritiesProgram will need to consider therelationship with Treasury and, in thiscase, the Federal Reserve, when evaluat-ing the costs of participating in theProgram. Similarly, the accounting impactof transactions in distressed securities isnot clear at this time. Unlike the LegacyLoans Program, the Legacy SecuritiesProgram requires that private investorswork through an asset manager; theywill need to be comfortable with thePPIF’s investment and asset managementguidelines and the level of discretionmaintained by the asset manager.

Evaluation of the ProgramLegacy assets continue to impedeeconomic recovery, as realised losses andthe perceived risk of future losses preventprivate investment in financial institutions.Development of a federally sponsoredProgram to develop a series of bad banksmay enhance market perception offinancial institutions’ balance sheets.Significant additional operational andstructural information is required forpotential participants to more fully assesstheir interest in the Program. TheProgram addresses many of the concernsraised about an aggregator bank model,including how the federal governmentwould price troubled assets. The outlineof the Program raises new questions,including the imposition of an assetmanager between the private investor andthe pool of assets to be acquired in thetransaction.

As discussed above under ‘Asset Selec-

including insurance companies.To be eligible for purchase by a PPIF,

a security must be:

1. either a residential or commercialmortgage-backed security;

2. originally issued prior to 1st January,2009;

3. originally rated in the highest ratingcategory by at least two NRSROs,without ratings enhancement;24

4. secured by loans or other eligible assetssituated predominantly in the US;

5. backed by loans and not othersecurities or derivatives (subject tolimited exceptions); and

6. eligible under other criteria to be es-tablished by Treasury.

Legacy Securities Program Structureand FinancingThe proposed structure requires privateinvestors to work through an asset managerto invest in legacy securities. Unlike theprivate good bank-bad bank structures des-cribed above, the Program’s investors willnot directly negotiate and select the assetsin which they are investing. While assetmanagers are expected to provide investorswith detailed investment and managementguidelines, the Legacy Securities Programwill attract investors that are comfortabledelegating significant responsibility to theasset managers.

Detailed information is not currentlyavailable on the Federal Reserve’s rolein providing financing to the LegacySecurities Program. As in other goodbank-bad bank structures, potential invest-ors will need to consider the fundingavailable from Treasury in the form ofcapital and debt, as well as Treasury’s exitstrategy for its investment. Similarly, theterms of loans available from the FederalReserve may require repayment prior tothe maturity of the securities purchased bythe PPIF, as is the case currently under the

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tion’, financial institutions will need toconsider carefully the pools of loans andsecurities offered for sale to the Pro-gram. The selling financial institution willbenefit from being able to announce asale of all or a significant portion ofits portfolio of troubled assets. Bankingregulators will also have an interest in theportfolio of assets and loans. However, thepool of assets or securities must be attract-ive to potential bidders.

SUMMARYEach of the structures we discussed,and their numerous variations, haveadvantages and disadvantages. No struc-ture is ideal for all institutions, which is acontinuing challenge for the governmentas it tries to balance the unique situationand nature of each institution with thegoal of creating a programme that can beimplemented consistently across the in-dustry.

Below we summarise the points for andagainst of some of the basic structuringalternatives.

CONCLUSIONAs the financial crisis continues, the needto remove troubled assets from financialinstitutions’ balance sheets has becomecritical. Confidence in our banking andfinancial system requires confidence inour financial institutions and the ongoingreporting of losses and write-downscontinuously hampers progress. The SEChas rejected suspending mark-to-marketaccounting, which would have helped.Recent guidance from the FinancialAccounting Standards Board addressingsome of the concerns about mark-to-market and fair value accounting mayprovide incremental improvements, but isunlikely to dramatically restore balancesheets. Segregation of troubled assetswould alleviate the pressures they create


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Structure For Against

Private GoodBank-Bad Bank

• Removal of bad assets from balance sheet• Institution can structure an ideal solution

tailored to a specific portfolio of troubledassets

• Bad bank can be established to manage orliquidate a discrete pool of assets or caninclude operations, either business lines to bephased out or to continue

• Bad bank will not face conflicts of interestwith troubled asset counterparties and willhave time to manage assets

• Depending on structure, shareholders mayreceive interest in bad bank, retaining somepotential upside

• Permits management to focus on good bankbusinesses and assets

• Separate good bank improves rating agency,shareholder, investor and market perception ofinstitution

• Private structure will not subject institution toexecutive compensation and corporategovernance requirements

• Limited current availability of private investors• Must be highly structured to meet the needs

of private investors• Valuation of assets challenging and highly

negotiated; likely to result in either short-termadditional write-downs or longer-termopportunity costs

• May require ongoing management of assets,for example on a contract basis, depending oninvestors

• Requires management of shareholderexpectations, which may be ongoing,particularly if private investor profits fromtransaction

• Establishment of new legal entity may raiseregulatory compliance and charter issues

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Repackage TroubledAssets for Private Sale

• Flexibility in selecting portfolio• No further involvement with assets

• No current market

Asset GuaranteeProgram

• Retention of upside• Out-of-pocket costs limited to price of

premium; potential to issue securities to satisfypremium obligation

• Ease of transaction execution — no need toestablish separate legal entity; valuationquestions simpler

• Asset risk-weighting adjusted to reflect benefitof government guarantee

• Ability to prepay Federal Reserve loans andterminate guarantee

• Does not eliminate future option of bad bank• No upfront funding requirement for any

guarantor• Guarantee can be restructured and assets can

be restructured

• Institution will be subject to governmentexecutive compensation and corporategovernance requirements

• Long-term nature of guarantee results inlonger-term imposition of government rules

• Asset management decisions subject togovernment rules

• Assets retained on balance sheet: additionallosses to be absorbed; management costs;ongoing management distraction

• Does not achieve public separation from badassets, no good bank boost

• Does not provide funding, bank mustcontinue to finance the assets

GovernmentAggregator Bank(Bad Bank)

• See ‘Private Good Bank-Bad Bank’ above• No further involvement with assets, which are

removed from balance sheet and managed bygovernment asset managers

• Unlike Private Good Bank-Bad Bank,government will establish legal entity andstructure transaction

• Unlike Private Good Bank-Bad Bank,government more likely to accept broaderscope of troubled asset classes


• Unable to participate in upside• Unlike Private Good Bank-Bad Bank

alternative, bad bank must be limited totroubled assets to be liquidated, no operatingbusinesses

• Unlike Private Good Bank-Bad Bank,negotiations on price will be more transparentand public

• Valuation of assets challenging and becausethey will need to be consistent across allinstitutions, likely to result in either short-termadditional write-downs or longer-termopportunity costs

• Requires management of shareholderexpectations, which may be ongoing,particularly if the government profits from thetransaction

Government SponsoredGood Bank(Soros Proposal)

• Removal of bad assets from balance sheet• Institution can structure an ideal solution

tailored to specific portfolio of troubled assetsand funding needs for bad bank

• No further involvement with assets, which areremoved from balance sheet and managed bygovernment asset managers



• Good bank will be well capitalised• Assets will be transferred at book value with

no additional write-downs



• Establishment of new legal entity will be morecomplex than using a government aggregatorbank (but less complex than Private GoodBank-Bad Bank as structure would havegovernment approval)

• Current shareholders will be diluted• Depending on the size of the portfolio

transferred to the bad bank, may createeffective nationalisation of good bank


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• Achieves public policy objectives of chargingcurrent shareholders for the impact ofacquiring troubled assets

• Will increase cost of debt financing (risk oftransfer of debt to new entity, risk of lossfrom bad assets)

• Unlike Private Good Bank-Bad Bankalternative, bad bank must be limited totroubled assets to be liquidated, no operatingbusinesses

• Unlike Private Good Bank-Bad Bank,valuation of assets will be more transparentand public

Hybrid: MultipleGovernment FundedBad Banks

• Removal of bad assets from balance sheet• No further involvement with assets, which are

removed from balance sheet and managed bygovernment asset managers

• Assets will be transferred at book value withno additional write-downs



• Achieves public policy goal of fundingstructure through assumption of existing debt,rather than ‘printing money’



• Establishment of new legal entity will be morecomplex than using a government aggregatorbank (but less complex than Private GoodBank-Bad Bank as structure would havegovernment approval)

• Unlike Private Good Bank-Bad Bankalternative, bad bank must be limited totroubled assets to be liquidated, no operatingbusinesses

• Ability to raise future debt may be impededby risk that government can assume debt atany time

• Unlike Private Good Bank-Bad Bank,valuation of assets will be more transparentand public

Public-PrivateInvestment Program

• Removal of bad assets from balance sheet• Bad bank (PPIF) will not face conflicts of

interest with troubled asset counterparties andwill have time to manage assets

• Permits management focus on good bankbusinesses and assets


• No further involvement with assets• Unlike aggregator bank, valuation not

complicated by the need to be consistentacross institutions

• Preferential financing terms may encouragehigher bids

• Valuation of assets continues to be a challenge,although auctions and purchase programs maydevelop efficiencies as the program terms arefinalized

• Some participants likely to be subject toexecutive compensation and corporategovernance requirements although whichparticipants remains unclear

• Ongoing supervision and coordination withtwo governmental entities

• Impact of Treasury’s requirement to hold awarrant issued by the PPIF is unclear at thistime

• Federal government’s exit strategy notcurrently clear

Morrison & Foerster LLP, FederalReserve Board Liberalizes Rules forInvestments in Banks, September, 2008,available at: http://www.mofo.com/news/updates/files/14497.html.

(6) See Morrison & Foerster LLP,Mark-to-Market Update: AfterCongressional Hearing, FASB ProposesNew Fair Value Accounting Guidance(19th March, 2009), available at:http://www.mofo.com/news/updates/files/090319FASB.pdf; Morrison &Foerster LLP, SEC Study RecommendsKeeping Mark-to-Market Accounting (7thJanuary, 2009), available at:http://www.mofo.com/news/updates/files/090107SECStudy.pdf; andMorrison & Foerster LLP, Fair Value andthe Recent Market Turmoil (13th October,2009), available at:http://www.mofo.com/news/updates/files/081013FairValue.pdf.

(7) Press Release, Citigroup Inc., Citi toReorganize into Two Operating Unitsto Maximize Value of Core Franchise,16th January, 2009, available at:http://www.citigroup.com/citi/press/2009/090116b.htm.

(8) A description of the TargetedInvestment Program is available at:http://www.financialstability.gov/roadtostability/targetedinvestmentprogram.html.

(9) Treasury faced similar challenges withan asset purchase programme. Assigningvalues to illiquid and distressed assetsrequires one-on-one negotiation withcounterparties. Additionally, negotiatingprices or premiums based on diversepools of assets is time intensive.

(10) Treasury’s request for comment isavailable at: http://www.treas.gov/press/releases/reports/federalregisternotice1.pdf.

(11) Responses to Treasury’s request areavailable at: http://www.regulations.gov/search/search_results.jsp?sid=11F5D6AB1377&Ntt=asset+guarantee&Ntk=All&Ntx=mode+matchall&N=8060&css=0&Ne=2+8+11+8053+8054

on the individual institutions, and on thefinancial system. Private investors workingwith individual institutions have theopportunity to structure bad banks thatmeet individualised investment needs.Whether a good bank–bad bank structureduplicates past precedent or brings some-thing novel to the table, regulatorsare highly motivated to approve plansthat transfer troubled assets and restorestability.

The Public-Private Investment Pro-gram’s ultimate design will be shaped bypolicy and practical considerations. Thecreation of the government’s programmesand the PPIFs may serve as a modeland springboard from which creativeprivate investors may partner with finan-cial institutions interested in structuresthat can be tailored to individual cir-cumstances.

References(1) The Troubled Assets Relief Program

was authorised under the EmergencyEconomic Stabilization Act of 2008.Public law 110-343.

(2) Press Release, US Dept of the Treasury,Remarks by Secretary Henry M.Paulson, Jr. on Financial RescuePackage and Economic Update (12thNovember, 2008),http://www.financialstability.gov/latest/hp1265.html.

(3) Press Release, US Dept of the Treasury,Secretary Geithner Introduces FinancialStability Plan (10th February, 2009),http://www.treasury.gov/press/releases/tg18.htm.

(4) Press Release, US Dept of the Treasury,Treasury Department Releases Detailson Public Private PartnershipInvestment Program (23rd March,2009), http://www.financialstability.gov/latest/tg65.html.

(5) For general information on privateinvestment in financial institutions, see

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+8098+8074+8066+8084+8055+11.(12) 31st December, 2008 Treasury report is

available at http://www.treas.gov/press/releases/reports/0010208%20sect%20102.pdf.

(13) A summary of the Citigroup agreementterms can be found in Citigroup’s form8-K, available at: http://idea.sec.gov/Archives/edgar/data/831001/000095012308016585/0000950123-08-016585-index.idea.htm.

(14) The 4th February, 2009 Wall StreetJournal opinion article ‘We Can DoBetter than a ‘‘Bad Bank’’’ by GeorgeSoros is available at:http://online.wsj.com/article/SB123371182830346215.html.

(15) Max Holmes is an adjunct professor offinance at the Stern Graduate School ofBusiness at New York University andthe chief investment officer of an assetmanagement firm.

(16) The 31st January, 2009 New York Timesopinion article ‘Good Bank, Bad Bank;Good Plan, Better Plan’ by MaxHolmes is available at:http://www.nytimes.com/2009/02/01/opinion/01holmes.html.

(17) According to the Legacy LoansProgram Summary of Terms, ‘US bank’and ‘US savings association’ mean abank or savings association organisedunder the laws of the United States orany State of the United States, theDistrict of Columbia, any territory orpossession of the United States, PuertoRico, Northern Mariana Islands, Guam,American Samoa, or the Virgin Islands.

(18) The Loans Program is unique amongfederal crisis programs in limitingparticipants to FDIC-insured banks andsavings associations. Another FDICprogram, the Temporary LiquidityGuarantee Program (TLGP), limitsparticipants to insured depositoryinstitutions and many of their holdingcompanies. The TLGP program isfunded through a special assessment.Any shortfall in the TLGP will result inan emergency assessment of all insured

depository institutions but not theirholding companies. The FDIC hasbeen criticised for the inequity betweenthe beneficiaries of the Program andthose with responsibility for its funding.In response to these concerns the FDIChas taken a number of actions,including requesting legislative changesto permit fee assessments on holdingcompanies, imposing TLGP Programsurcharges on many participatingholding companies and most recentlycreating a new surcharge that will notfund the TLGP but will be depositedin the Deposit Insurance Fund (DIF).Limiting Loans Program eligible entitiesto insured banks and savingsassociations, rather than a broadergroup of financial institutions, may havebeen a response to, and an effort toavoid a repeat of, the perceivedinequities of the TLGP.

(19) Program documentation is available at:http://www.financialstability.gov/roadtostability/publicprivatefund.html.

(20) Section 113(d) of the Stabilization Actrequires that when Treasury purchasesany troubled asset, in this case aninvestment in the PPIF, it must receivea warrant with terms that ‘provide forreasonable participation . . . in equityparticipation or a reasonable interestrate premium’ and protect againsttaxpayer losses from sale of assets.

(21) See the Making Home Affordablewebsite at: http://www.makinghomeaffordable.gov/. See also, Morrison &Foerster LLP, The Rear View Mirror:Mortgage Finance and MortgageModification Efforts (6th March, 2009),available at: http://www.mofo.com/news/updates/files/090306RearView.pdf.

(22) Asset managers will be evaluated basedon:1. demonstrated capacity to raise at

least US$500m of private capital,2. demonstrated experience investing in

eligible securities, including throughperformance track records,


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possession of the United States, theDistrict of Columbia, Commonwealthof Puerto Rico, Commonwealth ofNorthern Mariana Islands, Guam,American Samoa, or the United StatesVirgin Islands’.

(24) We expect that the limit on ratingsenhancement will mirror the similarcurrent requirement in the TALF thatthe rating cannot be obtained as aresult of a guarantee or insurancepolicy; it will not limit enhancementsuch as overcollateralisation.

3. a minimum of US$10bn marketvalue of eligible securities undermanagement,

4. demonstrated operational capacityto manage legacy securities inPPIFs in a manner consistent withTreasury’s stated objectives for theProgram while also protectingtaxpayers and

5. being headquartered in the US.(23) The entity must be established and

regulated under ‘the laws of the UnitedStates or any State, territory, or

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removing toxic assets from balance sheets: structures

Documents