At a conference on Monday, November 10, Treasury Assistant Secretary Neel Kashkari, head of the Troubled Asset Relief Program ("TARP"), was asked when purchases of assets under TARP would begin. "I can't give you a date," he said, pointing out that Treasury Secretary Henry Paulson would make the decision on when to roll out a program. On Wednesday, Mr. Paulson provided the date: probably never. 

Speaking at the summit of leaders of the Group of 20 in Washington on November 12, Secretary Paulson announced that the Treasury has concluded that purchasing illiquid mortgage-related assets "is not the most effective way to use TARP funds." (Click here to read the Treasury press release.) Instead, the Treasury will concentrate on (i) continuing to build capital through direct infusions of TARP investments in financial institutions, with possibly an increased focus on matching private investments; (ii) finding strategies to mitigate mortgage foreclosures; and (iii) examining strategies to support the securitization sector by providing liquidity facilities and credit enhancement for asset-backed securities, with a view to jump-starting the stalled ABS markets for automobile, student, and credit card loans and increasing the amount of financing available for consumer purchases.

This represents a near-complete reversal of the original expectations for TARP, as it was described to Congress in connection with passage of the Emergency Economic Stabilization Act. At that time, purchasing distressed mortgage assets was the focus, although the Act also included, at the urging of Congressional Democrats and a number of economists, provisions authorizing the purchase of "any other financial instrument that the Secretary, after consultation with the Chairman of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability" (EESA Sec. 3(9)(B)). Since the Act went into effect, the Treasury has committed approximately $250 billion of the $700 billion total authorized under the Act to its Capital Purchase Plan, with initial commitments in place for direct capital infusions to nine major financial institutions and applications from other institutions and industries coming in fast.

The prospect of distressed asset purchases is a matter of keen interest to many financial institutions, including community and regional banks anxious to offload defunct commercial real estate loans to developers and investors. Although Treasury has now turned away, asset deals may get an indirect boost from the new liquidity facilities for ABS transactions now under consideration. In addition, asset purchases appear to have been taken up in an unexpected move by the Federal Reserve System. 

This represents another turn-around. In September, with short-term lending markets approaching a state of paralysis, Treasury officials reportedly urged on the Fed the view that the Fed had legal authority to take on distressed assets directly from banks, without Congressional approval. Fed officials reportedly argued that the central bank's emergency powers did not extend so far. In the event, Mr. Paulson and Mr. Bernanke went to Congress and got express authority for the Treasury to purchase troubled assets, authority which Mr. Paulson has now put on the shelf. 

On Monday, November 10, however, the New York Fed announced that as part of its new and extended restructuring plan for AIG, it will (i) lend money to a newly-formed LLC which will buy residential mortgage-backed securities directly from AIG and (ii), more surprisingly, lend up to $30 billion to a newly formed LLC, a special purpose vehicle which will use the money "to fund the LLC's purchase of multi-sector collateralized debt obligations ("CDOs") on which AIG Financial Products has written credit default swap ("CDS") contracts." (Click here to read the FRB press release.) Details are to come, but it appears that the idea is for the SPV, operating under the NY Fed's guidance, to go out into the market and buy up CDOs on which AIG has outstanding credit default swaps, and in connection with those purchases the CDS counterparties will agree to "concurrently unwind the related CDS transactions."

This appears to be the first time that either the Fed or Treasury has undertaken to go into the market to buy assets not already owned by a troubled or failed institution—in this case CDOs held by third parties where AIG is exposed through outstanding CDS contracts. AIG will make a $5 billion subordinated loan to the LLC and will bear the risk for the first $5 billion of any losses on the portfolio. The Fed loans will be secured by the LLC's assets and will be repaid from cash flows produced by those assets and from the proceeds of any sales. The NY Fed and AIG will share any residual cash flows after the loans are repaid. Edward Liddy, CEO of AIG, was quoted on Monday to say that, "The taxpayer is going to do very well out of this deal."

The outcome of the New York Fed's earlier experiment with an SPV for distressed assets is yet to be seen. In March, to facilitate the acquisition of Bear Stearns by J.P. Morgan Chase, the New York Fed spun off around $30 billion of Bear's assets to Maiden Lane LLC, extending credit for $28.8 billion to enable the SPV to acquire the portfolio, with J.P. Morgan covering the first $1 billion in losses. (Click here for the Federal Reserve Statistical Release H. 4. 1 for Maiden Lane LLC.) As of November 5, the fair value of those assets was $26.8 billion.