Abstract
The extensive public support measures for the financial sector were key for the management of the financial crisis. This paper gives a detailed description of the measures taken by governments during the period 2008–2010 and attempts a preliminary assessment of the effectiveness of such measures. The geographical focus of the paper is on the European Union (EU) and the United States. The crisis response in both regions was largely similar in terms of both tools and scope. However, there are important differences, not only between the EU and the United States, but also within the EU (e.g. asset relief schemes).
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Notes
See Dewatripont and Freixas (2012) for a more formal review of bank resolution procedures.
BIS (2009) also addresses this issue, but the present paper focuses on a larger sample of countries and, in addition to government measures, also covers measures adopted by central banks for individual institutions which can be categorised either as capital injections, liability guarantees or asset support schemes. Stolz and Wedow (2010) provide a more complete description of central bank measures.
During an emergency summit in Paris on 12 October 2008, euro area heads of government agreed on a concerted European action plan. They decided to “complement the actions taken by the ECB in the interbank money market” and support fundamentally sound banks. The summit paved the way for a concerted and coordinated EU approach to (i) harmonising the provision of retail deposit insurance; (ii) issuing government guarantees for bank debt securities; (iii) making available funds for bank recapitalisations; and (iv) providing asset relief measures.
Declaration of the emergency summit of euro area heads of government in Paris on 12 October 2008. The declaration is available at http://www.eu2008.fr/PFUE/lang/en/accueil/PFUE-10_2008/PFUE-12.10.2008/sommet_pays_zone_euro_declaration_plan_action_concertee.html.
EU countries providing State aid to a financial institution are obliged to submit a viability plan, or a more fundamental restructuring plan, to confirm or re-establish the individual banks’ long-term viability without reliance on State support. The EC established criteria to delineate the conditions under which a bank may need to be subject to more substantial restructuring, and when measures are needed to cater for distortions of competition resulting from the aid. In addition to State aid control, the EC also has an important role in approving mergers that have an EU dimension.
The communication “The return to viability and the assessment under the State aid rules of restructuring measures in the financial sector in the current crisis” was published on 22 July 2009. The adoption of the Communication was finalised through its publication in the Official Journal.
As this paper focuses the order in which the different measures were generally adopted, it does not provide information on the dates at which specific schemes or individual measures were taken. Instead, the interested reader is referred to other papers that give details on the timing of support measures (e.g. Petrovic and Tutsch (2009). “National Rescue Measures in Response to the Current Financial Crisis”, ECB Legal Working Paper No. 8, July). Furthermore, the Fed provides a timeline on its website (http://www.newyorkfed.org/research/global_economy/IRCTimelinePublic.pdf).
Agreement on 7 October 2008 at the Ecofin meeting of EU ministers of finance: http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/103250.pdf
Liabilities covered include all retail and corporate deposits (to the extent not covered by existing deposit protection schemes in Ireland or any other jurisdiction); interbank deposits; senior unsecured debt; covered bonds; and dated subordinated debt (lower Tier 2).
Anecdotal evidence showed that depositors in the UK reacted to the increased coverage in Ireland by transferring money out of UK banks into the UK branches of Irish banks.
See http://www.fdic.gov/news/news/press/2010/pr10161.html for more information.
The participation fee for the Transaction Account Guarantee consisted of a 10 basis point annual rate surcharge on non-interest-bearing transaction deposit amounts over USD 250,000.
While banks seemed unconcerned about short-term roll-over risk, there is anecdotal evidence that some banks were concerned about the roll-over risks they would face in issuing government-guaranteed bonds at the time the guarantee expired (after 1 to 3 years in some countries and up to 5 years in others).
Some countries included an option to convert preferred shares into ordinary shares, for example the Netherlands in the case of ING.
In the words of the Royal Bank of Scotland CEO, “preference shares are just a disguised form of leverage”.
To strengthen its capital position, Citigroup converted USD 25 billion of preferred shares into common equity at the end of July 2009, thereby increasing the US government’s stake in the bank to 34 %. Before that transaction took place, almost all of the non-government holders of preferred shares had agreed to convert their holdings into common equity.
For example in Germany, the maximum limit for recapitalisations was set at EUR 10 billion for individual institutions. In the United States, the FDIC imposed a limit on debt guaranteed under the Debt Guarantee Program equal to 125 % of the institution’s senior unsecured debt.
On 17 April, the US Treasury exchanged its Series D Fixed Rate Cumulative Preferred Shares for Series E Fixed Rate Non-Cumulative Preferred Shares, with no change to the Treasury’s initial investment amount. In addition, in order for AIG to fully redeem the Series E Preferred Shares, it had an additional obligation to the Treasury of USD 1.6 billion, to reflect the cumulative unpaid dividends due to the Treasury on the Series D Preferred Shares as of the exchange date.
It was agreed on 16 January 2009 that BofA would assume the first USD 10 billion of losses on a pool of USD 118 billion of toxic assets and that the United States government would assume the next USD 10 billion, as well as 90 % of all further losses, with Bank of America being responsible for the remaining 10 % of such further losses.
Under this loss-sharing arrangement, Citigroup assumed the first USD 39.5 billion of losses on an asset pool of USD 301 billion, while the US Treasury assumed 90 % of a second loss tranche of USD 5 billion and the FDIC 90 % of the third loss tranche of USD 10 billion. In the emergence of even higher losses, the Federal Reserve System would have extended a non-recourse loan to cover the rest of the asset pool, with Citigroup being required to repay 10 % of such losses to the Federal Reserve immediately. A summary of the terms of the loss sharing arrangement is available at http://www.citigroup.com/citi/press/2009/090116b.pdf?ieNocache=345. The fee for the loss coverage consisted of USD 7.059 billion of 8 % cumulative perpetual preferred stock (USD 4.034 billion corresponding to the Treasury and USD 3.025 billion to the FDIC) and a warrant to the Treasury to purchase 66,531,728 million shares of common stock at a strike price of USD 10.61 per share.
Using USD 75 to 100 billion of TARP capital and capital from private investors, the PPIP intended to generate USD 500 billion in purchasing power to buy toxic assets, with the potential to be expanded to USD 1 trillion over time. The eligible assets of each bank that wished to participate in the PPIP would have been moved into a bank-specific fund.
The US Treasury and private capital provided equity financing, and the FDIC provided a guarantee for debt issued by the Public-Private Investment Funds to fund the asset purchases. The Treasury provided 50 % of the equity capital for each fund, but private managers retained control of asset management subject to rigorous oversight by the FDIC. To reduce the likelihood of the government overpaying for the assets, the price of the loans and securities purchased under the PPIP was established by private sector investors competing with one another.
One concern was that the banks selling assets were also able to bid for them. Hence, critics charged that the government’s public-private partnership—which provided generous loans to investors—was intended to help banks acquire, rather than sell, troubled securities and loans, using the leverage provided by the PPIP. The fear was that instead of helping price discovery, the PPIP could let banks use taxpayers’ money to make bids at above the current market prices for the assets. If those bids eventually turned out to have been too high and the cash flows never materialised, then the taxpayer would ultimately pay the bill.
The equity and debt investments may be incrementally funded. Hence, the number given represented the Treasury’s maximum obligation.
Under the original agreement of February 2009, RBS and Lloyds agreed to put GBP 325 and 260 billion of assets into the schemes, respectively. The arrangements specified a first loss tranche of GBP 42 and 25 billion, respectively, which the banks themselves were to bear, the government agreeing to cover 90 % of any further losses. In November 2009 Lloyds terminated the agreement before it could be implemented, while the terms of the agreement with RBS were adjusted (the first loss tranche was increased from GBP 42 to 60 billion and the asset pool was reduced from GBP 325 to 282 billion).
NAMA paid €13 billion for the loans, representing an average discount of 52.3 %.
For more details on the scheme, see Stolz and Wedow (2010).
As part of the economic stabilisation programme in Greece, a Financial Stability Fund was established with the task to provide capital support to banks. In addition, the Greek government introduced a facility which guaranteed up to EUR 15 billion of new loans with up to 3 years and up to EUR 8 billion of lending to banks of special zero coupon bonds of the Greek state (see IMF 2009d).
The extended guarantee scheme (the so called Eligible Liabilities Guarantee (ELG) Scheme) covered deposits that were not covered by deposit insurance, senior unsecured CDs and CPs and other senior unsecured bonds and notes. The key point was that the blanked guarantee covered all liabilities including subordinated bonds, while the modified ELG did not guarantee subordinated bonds or asset covered securities. The ELG, however, was still broader than other European guarantee schemes since it covered short-term deposits including interbank deposits.
The Swiss government converted a note that gave it a 9.3 % UBS stake and immediately sold the 332.2 million shares at 16.50 Swiss francs each, a 1.4 % discount on the stock’s closing price on the day before the transaction. However, the deal generated a net return of more than 30 % over a period of around 8 months.
Political pressure on UK banks to step up lending, in particular to small enterprises, was mounting during the financial crisis. The Chancellor of the Exchequer, Alistair Darling, met with the CEOs of Royal Bank of Scotland and Barclays to discuss their lending practices at the end of July 2009. The Chancellor said that he was “extremely concerned about what the banks are doing for small companies”.
In this vein, the IMF (2009a) recommended in its April 2009 GFSR that supervisors who were in the process of evaluating the viability of banks looked into a whole range of aspects, such as write-downs and available capital, funding structures, business plans and risk management processes, the appropriateness of compensation policies and the strength of management.
In the US, the so called Volcker rule that forbids commercial banks to engage in proprietary trading is being implemented through the Dodd Frank Act. In the UK, the Vickers Report endorsed by the government recommends that retail banks be ring-fenced from investment banking activities. Finally, in the EU, the Liikanen Report combines elements of both proposals by requesting mandatory separation of proprietary trading and other high-risk non-client-related activities from the deposit taking institutions (subject to certain thresholds) whilst prohibiting certain trading activities.
The Treasury lost its full USD 2.3 billion investment in CIT when CIT defaulted. This was the first loss to arise from TARP.
These estimates are taken from the Federal Reserve System Monthly Report on Credit and Liquidity Programs and the Balance Sheet published in June 2010. Profit and losses refer to the period from the inception of the facilities until the end of the first quarter of 2010.
Recapitalisations of banks and other financial institutions through purchases of new equity at market prices are recorded as financial transactions without any (immediate) impact on the government deficit/surplus. Recapitalisations, loans and asset purchases increase government debt if the government has to borrow to finance these operations. Government securities lent or swapped without cash collateral in temporary liquidity schemes are not counted as government debt; neither are government guarantees, which are contingent liabilities in national accounts. Interest and dividend payments, as well as fees received for securities lent and guarantees provided, improve the government budget balance. More details of the statistical recording of public interventions to support the financial sector are provided in Box 1 in A. van Riet (editor), “Euro area fiscal policies and the crisis”, ECB Occasional Paper No. 109, April 2010.
The support measures had adverse impacts on the public debt positions of a number of euro area countries. Another important factor for the severe deterioration of public finances was the activation of automatic stabilisers—that is the loss of tax revenue and higher government expenditure outlays that ordinarily results from weaker economic activity—as a consequence of the marked contraction of economic activity that followed the collapse of Lehman Brothers. Because the structural fiscal imbalances of a number of euro area countries were sizeable before the financial crisis erupted, fiscal deficits in those countries expanded to very high levels. Added to this were the discretionary fiscal measures taken by many countries to stimulate their economies following the agreement in December 2008 of the European Economic Recovery Plan. This fiscal stimulus came close to matching the impact on deficits of automatic stabilisers. More information on the impact of the financial crisis on fiscal positions is provided in A. van Riet (editor), “Euro area fiscal policies and the crisis”, ECB Occasional Paper No. 109, April 2010.
These numbers exclude measures targeted at non-financial institutions and measures taken by the Federal Reserve System, the ECB, the BoE and other national central banks within their monetary policy framework. See Stolz and Wedow (2010) for a more detailed discussion of central bank measures.
In Europe, several international fora have started to look into these issues (including the EC, the Committee of European Banking Supervisors and the European Banking Committee).
See http://www.fdic.gov/regulations/resources/tlgp/index.html for more details.
Fees were determined by the amount of FDIC-guaranteed debt, the maturity of the debt (expressed in years) and the annualized assessment rate, which increased with the maturity of the debt.
See Monthly Treasury Statement of Receipts and Outlays of the United States Government.
The two Maiden Lane transactions involving AIG differed as regards the asset pools acquired. Maiden Lane II involved the purchase of residential mortgage-backed securities and Maiden Lane III multi-sector collateralised debt obligations.
The interest rate for the senior loan to Maiden Lane I (ML-I) was based on the Primary Credit Rate while, in the other two cases, the interest rate was the 1-month LIBOR plus 100 basis points.
The loss-sharing arrangement was complex: Citigroup would have covered the first USD 39.5 billion losses on an asset pool of USD 301 billion, while the US Treasury would have assumed 90 % of the second loss tranche up to USD 5 billion, the FDIC would have assumed 90 % of the third loss tranche up to USD 10 billion. Should even higher losses have materialised, the Federal Reserve would have extended a non-recourse loan to cover the rest of the asset pool, with Citigroup having been required to immediately repay 10 % of such losses to the Federal Reserve.
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We are particularly indebted to Perttu Korhonen who started to collect information on bank rescue measures and from whom we took over the database.
Appendices
Appendix 1. The support measures in the United States
This appendix describes the measures taken by the Treasury, the FDIC, and the Federal Reserve System in response to the current financial crisis. With respect to the Fed, it describes the non-standard measures in support of specific institutions.
Description of measures
The crisis response of the US Administration consists of four large building blocks: (i) The Treasury’s Troubled Asset Relief Program (TARP); (ii) The FDIC’s Temporary Liquidity Guarantee Program; (iii) measures targeted at the Government Sponsored Entities, which are administered by the Treasury and the Fed; and (iv) the Fed’s unconventional measures. Table 4 gives an overview of the various programs (including the committed and disbursed amounts), which are described in more detail below.
2.1 TARP/financial stability program
The Troubled Assets Relief Program (TARP) was established under the Emergency Economic Stabilization Act of 3 October 2008 (EESA) with the specific goal of stabilizing the US financial system and preventing a systemic collapse. TARP has a volume of USD 700 billion and is run by the Treasury’s new Office of Financial Stability. The measures taken under TARP encompass capital injections, loans and asset guarantees and target both the financial and non-financial sector. Originally, the mandate of TARP was to purchase or insure “troubled” assets of financial institutions. This mandate, however, has been flexibly adjusted and extended as needs have arisen. The scope was first extended in mid-October 2008 to allow for capital injections and in November 2008 to allow for the support of the automobile industry. These amendments are reflected in the establishment of several programs under TARP. Table 5 gives an overview of the objectives of the programs. Some of these programs have stringent rules for participation, a narrow choice of instruments and strict conditions (e.g. CPP and the Consumer and Business Lending Initiative Investment Program implemented under TALF). Others have been designed to provide the Treasury with a high degree of flexibility (e.g. AGP, TIP and SSFI), which has been used to tailor their application to specific institutions. Under the umbrella of the Financial Stability Plan, the Treasury’s new extended crisis management strategy, some of the programs set up under TARP have been extended (e.g. the Consumer and Business Lending Initiative Investment Program implemented under TALF) and new programs have been set up (e.g. CAP and PPIP). Out of a total of USD 700 billion, the Office of Financial Stability (OFS) expects to use up to USD 475 billion. So far USD 388 billion has been disbursed under the specific programs and USD 204 billion have already been recovered.Footnote 43 On basis of committed amounts under the different measures of USD 475 billion this amounts to a take up ratio of about 82 %.
2.2 FDIC measures
Starting on 14 October 2008, the Temporary Liquidity Guarantee Program (TLGP) has tried to strengthen confidence and encourage liquidity in the banking system by (i) guaranteeing newly issued senior unsecured debt of banks, thrifts, and certain holding companies (the Debt Guarantee Program), and by providing full coverage of non-interest bearing deposit transaction accounts, regardless of the dollar amount (the Transaction Account Guarantee Program (TAGP)). Table 6 provides some details of these two programs. The FDIC has estimated that about USD 700 billion of deposits in non-interest bearing transaction accounts have been guaranteed which otherwise would not have been insured.Footnote 44 Banks could choose to opt out of one or both of the programmes. With regard to the Debt Guarantee Program, the basis for the pricing of newly issued debt is linked to the maturity of the debt.Footnote 45 The amount of debt guaranteed by the FDIC is limited to 125 % of the par or face value of senior unsecured debt outstanding as of 30 September 2008 per bank. For banks with no senior unsecured debt outstanding, a limit of 2 % of total liabilities applies. Based on these limits, the FDIC estimated that the total amount of guaranteed debt that can be issued is about USD 609 billion. The debt guarantee program was extended by 6 months for senior unsecured debt issued after 1 April 2009 and before 31 October 2009 and maturing before the end of 2012. However, a phasing out process has been initiated by raising the assessment fee in accordance with the time at which the debt was issued and the maturity date. In addition, non-insured depository institutions were charged a higher fee. On 20 October 2009 the FDIC established a limited, 6-month emergency guarantee facility upon expiration of the Debt Guarantee Program. Under this emergency guarantee facility, financial entities can apply to the FDIC for permission to issue FDIC-guaranteed debt during the period from 31 October 2009 to 30 April 2010. The fee for issuing debt under the emergency facility will be at least 300 basis points, which the FDIC reserves the right to increase on a case-by-case basis, depending upon the risks presented by the issuing entity. Overall, about USD 305 billion of FDIC insured debt was outstanding as of 30 April 2010. With regard to the TAGP, the participation fee consists of a 10 basis point annual rate surcharge on non-interest-bearing transaction deposit amounts over USD 250,000. The TAGP was extended by a 12 month period until 31 December 2010 with participation costs rising after the end of 2009. Riskier institutions will be subject to a higher fee for participating in the TAGP. Overall, the FDIC earned about USD 11.4 billion in fees and surcharges on both programmes with the debt guarantee programme contributing USD 10.4 billion.Footnote 46
2.3 Measures targeted at government sponsored entities
Specific measures in support of the government sponsored entities (i.e. Fannie Mae, Freddie Mac, Ginnie Mae and the Federal Home Loan Bank) have been established by the Treasury and the Fed. As of June 2010, the overall amount used has been sizeable (USD 1,548 billion). The Treasury organised the support of the GSEs outside TARP, and thus the support needs to be added to the overall measures taken. The Treasury injected about USD 148 billion of capital in the GSEs and bought USD 167 billion of mortgage-backed securities (MBSs) issued by these entities.Footnote 47 The Fed also bought USD 1,079 billion of GSEs’ MBSs and a further USD 154 billion of agency debt as of end September 2010.
2.4 Fed measures
The Federal Reserve System has adopted a range of non-standard measures in response to the current financial crisis. These measures are reflected in the establishment of several separate facilities that target specific financial institutions or market segments. Table 7 provides the details of these measures.
The Fed has also supported some financial institutions directly. The so-called Maiden Lane transactions comprise three separate limited liability companies (LLCs) which acquired assets from Bear Stearns and AIG.Footnote 48 The Fed provided funding of USD 81.7 billion in the form of senior loans to the LLCs. The duration of the loans is 10 years for the Bear Stearns’ facility and 6 years for the two AIG facilities.Footnote 49 After the repayment of the loans, any remaining proceeds from ML-I are paid to the Fed and, in the cases of ML-II and ML-III, shared between the Fed and AIG. The transactions thus resemble a bad bank in which assets are transferred out of the institutions’ balance sheets. In addition, the Fed made a lending facility available to AIG in September 2008. The initial commitment under this facility was USD 85 billion secured by a pledge of AIG’s assets. The commitment under this facility was reduced to USD 60 billion in November as a result of a capital injection under TARP of USD 40 billion. In June 2009, AIG agreed with the Fed to swap USD 25 billion of debt for equity which cut the amount of AIG’s debt from USD 40 billion to USD 15 billion. More specifically, the transaction led to a reduction in the maximum amount available under the lending facility from USD 60 billion to USD 35 billion in December 2009. Subsequent sales of business units by AIG further reduced the ceiling of the credit facility to USD 29 billion as of October 2010. Finally, the Fed contributes to a ring-fencing agreement between Citigroup, the US Treasury, the FDIC and the Fed by committing to extend a non-recourse loan should the losses exceed a certain threshold.Footnote 50
Another set of actions has the aim of supporting the mortgage market by the outright purchase of securities issued by government-sponsored enterprises (GSEs) and mortgage-backed securities guaranteed by GSEs with a total volume of USD 154 billion and USD 1,079 billion, respectively, as of 29 September 2010, acquired via open market operations. These securities are held in the System Open Market Account (SOMA), which is managed by the Federal Reserve Bank of New York.
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Stolz, S.M., Wedow, M. Keeping banks afloat: public lifelines during the financial crisis. Int Econ Econ Policy 10, 81–126 (2013). https://doi.org/10.1007/s10368-013-0231-1
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DOI: https://doi.org/10.1007/s10368-013-0231-1