Editor: Describe, in broad terms, the Emergency Economic Stabilization Act of 2008 and the Troubled Asset Relief Program.
De Simone: The Emergency Economic Stabilization Act of 2008 (EESA), among other things, authorized the Secretary of the Treasury to create a program pursuant to which the Treasury Department would acquire from financial institutions "troubled assets." Troubled assets are mortgage-related financial instruments originated or issued before March 14, 2008, or any other financial instrument the Secretary of the Treasury determines the purchase of which is necessary to promote financial market stability. This program is called the Troubled Asset Relief Program, or TARP. Congress allocated up to $700 billion for the program, with the Secretary being initially authorized to use only $250 billion. The Treasury's use of the balance of the funds was made subject to the President submitting a written certification of need to Congress. In addition, Congress reserved the right to restrict the use of the final $350 billion by a joint resolution of Congress.
Receiving less attention is the guaranty program that the Treasury is required by the EESA to establish in connection with its establishment of the TARP. Under this guaranty program, the Treasury would guarantee the payment of principal and interest on troubled assets with a premium collected from financial institutions participating in this program sufficient to meet anticipated claims.
Editor: How is the EESA currently being implemented?
Hauser: At the time of the EESA's enactment, the expectation was that the TARP would be used to purchase troubled assets from various financial institutions in order to improve their balance sheets. The assets would then be held for some period of time by the Treasury Department. This approach was intended to address the fact that these assets had become impaired and highly illiquid for a variety of reasons, including the underlying weakness in the housing market. However, shortly after the enactment of the EESA, the Treasury announced that the initial $250 billion to be used under the TARP would be used to make direct investments in financial institutions. This direct investment approach within the TARP is called the Capital Purchase Program (CPP). After an initial focus on publicly traded banks, the Treasury announced the expansion of the CPP to privately held banks and is expected to further expand the CPP to non-bank financial companies, such as insurance and consumer finance companies, this latter group reflecting the Treasury's stated concern for the quality and availability of credit card, car loan, and student loan financing. Interestingly, the Treasury ultimately announced that it was moving away from its initial plan and would not be utilizing the TARP for the purchase of troubled assets, though it said that it might consider targeted forms of asset purchases. Secretary Henry M. Paulson also stated that the use of the balance of the TARP funds beyond the CPP would likely be limited in order to preserve the Treasury's and the next administration's flexibility in dealing with future problems.
Editor: What effect are the Treasury's efforts having?
Barksdale: Generally, the Treasury's efforts have helped to stabilize the short-term lending and borrowing markets, including the bank deposit, money market, and commercial paper markets, which are critical to not only our financial system but also our overall economic system. No longer are people talking about the seizing-up of these markets or the possibility of a "run" on the banks or the mutual funds. Beyond this stabilization, which was critical, the effects of the Treasury's efforts really depend on your perspective. If you are in, or deal with, the financial industry, the landscape has changed considerably - government ownership of financial institutions with its resulting requirements and restrictions; consolidation, which has started in the banking industry and is expected to increase and to spread to other industries, including insurance and mutual fund companies; and expected increased regulation will all have a significant effect on the financial industry.For most other businesses, the fact that commercial and consumer credit is constrained and will likely remain constrained for some time is clearly having an adverse effect on revenue, as well as on hiring and capital investment plans. It remains to be seen if and when the Treasury's efforts will help improve these credit markets. As mentioned, the Treasury has stated that it is considering other ways to help improve the consumer credit side of things with the hope that strengthening the consumer will lead to increased economic activity and a better business climate.
Editor: What is your firm seeing in terms of activity?
De Simone: The short answer is a lot. We have a very diverse practice across our 12 offices, touching on almost all types and sizes of companies and business activity, so we have been able to develop a very good sense of how all of this is playing out in the real world. A great deal of our activity of late has been based in our Distressed Real Estate Initiative, which we formed at the beginning of this year, and our Economic Stabilization and Recovery Initiative, which we formed as the Emergency Economic Stabilization Act was being developed. Through both of these initiatives, which involve a significant number of our lawyers in multiple practice areas, we have been spending a tremendous amount of time advising clients who are dealing with problems resulting from current market conditions, as well as advising clients who are looking to pursue opportunities created by the same market conditions. We are also spending a good deal of time with clients who are simply trying to understand things in terms of their businesses.
Barksdale: With respect to our Distressed Real Estate Initiative, loan restructuring and workout activity has increased considerably across all of our markets, especially our Nevada, Arizona, and California offices, as the real estate downturn continues and spreads to commercial real estate. It has been quite some time since lenders and borrowers have had to deal with these types of issues on this scale and though, in some respects, the issues are the same, in other respects, things are very different when you consider the fact that many deals today involve securitized loans and loan servicers, mezzanine, other junior debt and preferred equity positions, and residential and commercial condominium structures that give rise to complex issues, such as successor liability risks. Time spent on real estate investment activity is increasing in terms of advising clients who are interested in stepping into a distressed situation by purchasing the property, investing on a preferred equity basis in the entity that owns the property, or acquiring some or all of the debt.
Hauser: With respect to our Economic Stabilization and Recovery Initiative, we are spending a significant amount of time advising clients who have participated, or are considering participating, in the CPP, as well as clients interested in providing services, either directly or as a subcontractor, to the government in connection with the administration of the TARP and related programs. We also are spending a considerable amount of time talking with market participants, government officials, and other professionals so as to remain abreast of what is an ever-changing situation. Through frequent client e-alerts and teleconferences, we have been able to keep clients current on important developments.
Editor: What do you anticipate for the next 6 to 12 months?
Hauser: As much as we would like to say things will be getting better, that will likely not be the case. In terms of the real estate industry, we are most likely in the early stages of a protracted downturn that will see a significant number of failed deals and troubled loans. Due to the constrained credit environment, this downturn will affect otherwise good projects that will not be able to replace maturing loans. The overall effect will be to depress prices further and limit new development for some time.
Barksdale: That being said, a tremendous amount of wealth traded hands during the last major real estate downturn, which began in the late 1980s, and there appears to be a considerable amount of investment dollars standing ready to take advantage of what is expected to be a tremendous buying opportunity.
De Simone: On the corporate side, one area worth watching will be sale-leaseback transactions, which often pick up when corporate credit is constrained. We are already talking to clients about sale-leaseback and other strategies for using corporate real estate as a capital source. We also expect that the lending that does occur will be on a much tighter basis with increased financial and other covenants and limitations on borrowers. Finally, watch for significant consolidation in the financial services industry and increased government regulations.