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TARP OVERSIGHT: AN UPDATE ON WARRANT 

REPURCHASES AND BENEFITS TO TAXPAYERS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

OVERSIGHT AND INVESTIGATIONS 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

MAY 11, 2010 

Printed for the use of the Committee on Financial Services 

Serial No. 111–132 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

DAN MAFFEI, New York 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

DENNIS MOORE, Kansas, Chairman 

STEPHEN F. LYNCH, Massachusetts 

RON KLEIN, Florida 

JACKIE SPEIER, California 

GWEN MOORE, Wisconsin 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

ALAN GRAYSON, Florida 

JUDY BIGGERT, Illinois 

PATRICK T. MCHENRY, North Carolina 

RON PAUL, Texas 

MICHELE BACHMANN, Minnesota 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

May 11, 2010 ..................................................................................................... 1 

Appendix: 

May 11, 2010 ..................................................................................................... 27 

WITNESSES 

TUESDAY, MAY 11, 2010 

Atkins, Hon. Paul, Member, Congressional Oversight Panel, and former Securities and Exchange Commissioner .................................................................... 14 

Jarrow, Robert A., Ronald P. and Susan E. Lynch Professor of Investment 

Management and Professor of Finance and Economics, The Johnson School, 

Cornell University ................................................................................................ 16 

Miller, David N., Chief Investment Officer, Office of Financial Stability, U.S. 

Department of the Treasury ................................................................................ 4 

Puvalowski, Kevin R. Deputy Special Inspector General, Office of the Special 

Inspector General for TARP (SIGTARP) ............................................................ 12 

Wilson, Linus, Assistant Professor of Finance, B.I. Moody III College of Business, University of Louisiana at Lafayette ........................................................ 17 

APPENDIX 

Prepared statements: 

Moore, Hon. Dennis .......................................................................................... 28 

Atkins, Hon. Paul ............................................................................................. 32 

Jarrow, Robert A. ............................................................................................. 37 

Miller, David N. ................................................................................................ 52 

Puvalowski, Kevin R. ....................................................................................... 61 

Wilson, Linus .................................................................................................... 138 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Moore, Hon. Dennis: 

United States Department of the Treasury, Office of Financial Stability, 

‘‘Warrant Disposition Report’’ ...................................................................... 145 

Congressional Research Service report entitled, ‘‘Government Interventions in Response to Financial Turmoil,’’ dated February 1, 2010 ........... 201 

Atkins, Hon. Paul: 

List of field hearings held by the Congressional Oversight Panel ............... 245 

(1) 

TARP OVERSIGHT: AN UPDATE ON 

WARRANT REPURCHASES AND 

BENEFITS TO TAXPAYERS 

Tuesday, May 11, 2010 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON OVERSIGHT

AND INVESTIGATIONS, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 11 a.m., in room 

2128, Longworth House Office Building, Hon. Dennis Moore [chairman of the subcommittee] presiding. 

Members present: Representatives Moore of Kansas, Adler; and 

Biggert. 

Chairman MOORE OF KANSAS. This hearing of the Subcommittee 

on Oversight and Investigations of the House Financial Services 

Committee will come to order. Our hearing this morning is entitled, ‘‘TARP Oversight: An Update on Warrant Repurchases and 

Benefits to Taxpayers.’’ 

This is our 10th Oversight and Investigations hearing this Congress, and our 4th focused on our top priority, TARP oversight. Today’s hearing is a follow-up to our first TARP warrants hearing 

last July. We will begin this hearing with members’ opening statements, up to 10 minutes per side, and then we will hear testimony 

from our witnesses. 

For each witness panel, members will each have up to 5 minutes 

to question our witnesses. The Chair advises our witnesses to 

please keep their opening statements to 5 minutes to keep things 

moving so we can get to members’ questions. Also, any unanswered 

questions can always be followed up in writing for the record. 

Without objection, all members’ opening statements will be made 

part of the record. I now recognize myself for up to 5 minutes for 

an opening statement. 

Leading up to our first TARP oversight hearing focused on the 

issues of warrant repurchases last July, there were a number of 

concerns raised that taxpayers were not seeing maximum returns 

on their investment. I wrote a letter to Secretary Geithner last 

June expressing that, ‘‘I am concerned with recent reports that financial institutions that received TARP funds are lobbying to buy 

back warrants the U.S. Government received for providing taxpayer assistance at a reduced or minimal value. I strongly urge you 

to utilize your authority to maximize the best deal for taxpayers.’’ 

2 

I copied on that letter our TARP oversight entities, including the 

Congressional Oversight Panel (COP) and SIGTARP. Within a few 

days, I received a response from both that they would investigate 

further. 

Before our July hearing, COP reported that at that time, taxpayers were receiving only 66 percent of warrants’ value compared 

to their best estimate of their worth. With the mounting pressure 

from Members of Congress, the TARP oversight bodies, and the 

general public, I was pleased to learn the morning of our July hearing that Goldman Sachs announced they would buy back their warrants for $1.1 billion. That represents a 23 percent annualized return taxpayers received on the original $10 billion investment in 

the firm. 

At the hearing I said, ‘‘That sounds pretty good, but is it good 

enough?’’ Since that time, other large transactions include: Morgan 

Stanley agreeing to pay $950 million to repurchase their warrants; 

JPMorgan Chase auctioning their warrants for $950.3 million; and 

Bank of America auctioning their warrants for more than $1.5 billion. 

To answer my question from the July hearing, ‘‘Are these returns 

enough’’, I will read from the written testimony of our witnesses 

today. 

Professor Linus Wilson says, ‘‘Oversight works.’’ And that is a 

quote. 

Mr. Atkins, for the Congressional Oversight Panel says, ‘‘The 

Panel has been pleased to see that Treasury’s performance in this 

area has improved dramatically since we first analyzed its original 

warrant dispositions.’’ 

Professor Robert Jarrow remarks, ‘‘It is my belief that the Treasury’s warrant repurchase program has been a success.’’ 

In SIGTARP’s audit that we will discuss today, they write, ‘‘To 

its credit, Treasury has generally succeeded in negotiated prices 

from recipients for the warrants at or above its estimated composite value.’’ 

I will note that to the benefit of taxpayers, SIGTARP and COP 

rarely if ever hold back on being critical of various TARP programs 

and financial stability efforts, so those comments tell me that the 

program its really working pretty well. 

We should not lose sight of the forest for the trees, and before 

we focus on ways to improve this program, let me stress the TARP 

warrants program has worked and worked well, providing over $6 

billion of additional returns for taxpayers, with billions more expected. And that is beyond the $181 billion repayments of the initial TARP investment. If you add the $14 billion in total dividends, 

interest and distributions from TARP recipients today, taxpayers 

have received an additional $20 billion on top of the normal repayments. 

If Congress had enacted the Bush Administration’s original 3- 

page proposal for TARP, essentially a $7 billion blank check with 

no oversight and no strings attached, taxpayers would likely not 

have seen these additional returns today and would be left with the 

tab. But by authorizing the use of warrants, creating strong oversight entities like SIGTARP and COP, which have produced thousands of pages of oversight reports that are available online, and 

3 

adding the requirement that taxpayers must eventually be fully repaid, TARP will have done its job to both stabilize the economy and 

fully protect taxpayers. 

And don’t take my word for it. Consider what Professor David A. 

Walker from Georgetown University, a Republican witness at our 

Oversight and Investigations hearing last week, said, ‘‘I believe 

that the TARP commitment was essential. It’s my opinion that our 

economy would be rebounding much more slowly than it has if we 

had not implemented the TARP program.’’ 

While the TARP warrants have greatly benefited U.S. taxpayers, 

it is our duty to explore the program fully and ensure that it is as 

transparent and run as well as possible. For example, I hope we 

explore policy questions looking at the differences between the public auction and direct negotiations with Treasury. Is one option better than the other? How do we ensure there is consistency of outcomes over a subjective process in negotiating a fair value for the 

warrants? Also, how do TARP warrants work for smaller financial 

institutions compared to large ones? 

I look forward to hearing the testimony of all of our witnesses 

today as we continue working hard to provide tough oversight of 

TARP and to ensure taxpayers are fully protected. 

Chairman MOORE OF KANSAS. I now recognize for 5 minutes the 

ranking member of the subcommittee and my colleague from Illinois, Ranking Member Judy Biggert. 

Mrs. BIGGERT. Thank you, Mr. Chairman, and thank you for 

holding this hearing which is a follow-up to our hearing last July. 

It is important that we continue to have hearings like this to ensure that taxpayers are getting the best return on their TARP investment. I have concerns that taxpayers may not be getting the 

best possible return, and some witnesses have noted that the 

Treasury lacks the internal controls needed to measure whether a 

high enough price was set for warrant repurchases or sales. 

I am also concerned that in addition to the 18 warrants Treasury 

holds in financial institutions that have exited TARP, Treasury 

still holds warrants for 237 companies that have yet to exit TARP. 

SIGTARP’s April 20th quarterly report lists a number of companies 

that are late on their CPP dividend payments. EESA authorizes 

Treasury to appoint members to the boards of directors of such financial institutions. 

Does the Treasury plan to appoint government officials to these 

boards of directors of these delinquent financial institutions? I look 

forward to learning about Treasury’s plans regarding these issues. 

And finally, I am concerned about the Administration’s interpretation of the authority it thinks it has to use TARP funds. We have 

an auto bailout, a mortgage modification program, and potentially 

a small business program, all of which seem to stretch beyond the 

original intent of the use of TARP funds; and, coupled with AIG 

and the Fannie Mae and Freddie Mac bailouts, it caused a significant loss of TARP and taxpayers’ money. 

What is Treasury’s justification for these activities? 

In addition, what is the Administration’s plan to end this program, end bailouts, including that of Fannie Mae and Freddie Mac, 

and what is the exit strategy and what is the timeline? We need 

to put an end to the government picking winners and losers in the 

4 

marketplace, which has facilitated unfair competition—competitive 

advantages for some businesses and completely abandoned others. 

So I look forward to hearing from today’s witnesses and I yield 

back the balance of my time. 

Chairman MOORE OF KANSAS. Thank you to our ranking member. 

I am pleased to introduce our first witness this morning. Mr. 

David Miller is the Chief Investment Officer for the Office of Financial Stability in the Treasury Department. Without objection, 

sir, your written statement will be made a part of the record. 

Mr. Miller, you are recognized for 5 minutes. 

STATEMENT OF DAVID N. MILLER, CHIEF INVESTMENT OFFICER, OFFICE OF FINANCIAL STABILITY, U.S. DEPARTMENT 

OF THE TREASURY 

Mr. MILLER. Chairman Moore, Ranking Member Biggert, thank 

you for the opportunity to testify before you today regarding warrants received in connection with the Troubled Asset Relief Program. The Emergency Economic Stabilization Act of 2008 mandates that Treasury, with certain exceptions, receive warrants in 

connection with the purchase of troubled assets. These warrants 

provide taxpayers with an additional potential return on the Federal Government’s investment. 

I will focus my testimony today on TARP’s warrant disposition 

process, and I will highlight our consistency, commitment to transparency, and successful results on behalf of taxpayers. 

Of the $245 billion that was invested in financial institutions, 

$177 billion, or 72 percent, has been returned to pay down the deficit, and taxpayers have earned a modest profit on those investments, including more than $6 billion in warrant proceeds. These 

proceeds consist of approximately $3 billion from repurchases by 

issuers at agreed-upon fair market values and approximately $3 

billion through public auctions. For these 44 institutions, Treasury 

received an absolute return of 4 percent on its investment from 

dividends and an added 5 percent return from warrant sales, for 

a total absolute return of 9 percent. 

At this time, I will discuss our process for warrant valuation and 

disposition. Upon redemption of preferred stock issued to Treasury, 

a financial institution has a contractual right to repurchase its 

warrants held by Treasury at a mutually agreed upon price representing fair market value. Determining fair market value is challenging, especially given the limited comparable market data for 

long dated warrants. As a result, Treasury devised a comprehensive process to evaluate repurchase bids from financial institutions. 

Market quotations, comparables, independent third-party valuations and model valuations are the three primary valuation methods. 

Treasury aggregates the data from internal and external valuation sources to determine an estimated fair market valuation 

range. The Office of Financial Stability has maintained a consistent 

valuation process to treat each financial institution fairly and similarly. 

Treasury contracted Dr. Robert Jarrow, finance professor at Cornell University and noted options expert, to review Treasury’s warVerDate Nov 24 2008 18:12 Sep 28, 2010 Jkt 058042 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 K:\DOCS\58042.TXT TERRIE
5 

rant valuation process. Dr. Jarrow concluded that Treasury’s valuation methodology is fair to participating banks and taxpayers and 

consistent with industry best practice and the highest academic 

standards. 

Treasury has managed a transparent warrant disposition process. Treasury has published information on all CPP transactions, 

including investments, repayments, warrant repurchases, and auctions on financialstability.gov. 

This past January, Treasury released the Warrant Disposition 

Report. This report provides extensive analysis for each warrant repurchase and auction. We note that the SIGTARP audit release 

this week concluded that Treasury has successfully negotiated 

prices that were at or above Treasury’s estimated range of fair 

value. This report also described Treasury’s valuation methodology 

and it did not suggest any modifications. However, SIGTARP made 

recommendations regarding documentation of the negotiation process and ensuring that consistent information be provided to issuers 

seeking to repurchase their warrants. 

Treasury is carefully reviewing these recommendations and will 

make appropriate changes to its procedures. 

Throughout the warrant process, Treasury remains committed to 

providing the public with comprehensive detail and informative 

analysis. 

Following the repayment, a bank may notify Treasury that it 

does not intend to repurchase its warrants or it may not agree with 

Treasury on a price. As a result, Treasury has sold these warrants 

through public auctions. The warrant auctions have successfully attracted many bidders and have been oversubscribed multiple times. 

This has resulted in clearing prices in excess of the reserve price 

set by Treasury. 

These auctions have created a legitimate market, with abundant 

information and significant participation to determine a fair market value. Since auction warrants have achieved stable aftermarket 

prices, we believe the Treasury has received fair value. 

Implied volatility is one metric for measuring warrant disposition 

value. Generally, the higher the implied volatility, the greater the 

value Treasury receives. On average, Treasury has received better 

pricing, or higher implied volatility, for negotiated transactions 

than for auctions. In addition, the size of the warrant disposition 

has impacted the price Treasury has received. Treasury found that 

smaller warrant positions received, on average, a lower implied volatility. This differential is from a number of factors, including a 

larger liquidity discount and relatively higher transaction cost that 

would be incurred for smaller position auctions. 

Treasury intends to continue to execute a comprehensive and 

transparent process which achieves fair market values and protects 

taxpayer interests. This program has been extremely successful 

and Treasury will continue to strive for optimum results on behalf 

of taxpayers. 

I look forward to answering your questions. Thank you. 

[The prepared statement of Mr. Miller can be found on page 52 

of the appendix.] 

Chairman MOORE OF KANSAS. Thank you, sir, for your testimony. 

I now recognize myself for 5 minutes for questions. 

6 

First, Mr. Miller, let me commend you, Assistant Secretary Allison, Secretary Geithner, and the entire team at Treasury for the 

work that you do, especially as we review the success we have seen 

with the TARP warrants program. 

Before I focus on TARP warrants, I have a letter addressed to 

Secretary Geithner that I just signed today, discussing several 

items relating to TARP, but also my desire that Treasury redouble 

its effort and try to translate the success we have seen in the 

TARP warrants program to improvements in foreclosure mitigation. 

Will you be sure the Secretary receives this letter and responds 

in a timely manner, Mr. Miller? 

Mr. MILLER. I will. 

Chairman MOORE OF KANSAS. Thank you. 

Mr. Miller, I don’t think it is a surprise that the negotiations 

with Morgan Stanley, as reported by SIGTARP, were difficult and 

not clear-cut. Major negotiations are rarely straightforward, and I 

am glad Treasury was able to obtain an additional $50 million 

more than the Warrant Committee originally approved. 

Will you discuss generally how difficult these decisions and negotiations are and what factors does Treasury consider when seeking 

maximum return for taxpayers? 

Mr. MILLER. Thank you for the question. 

As I highlighted in my written testimony, there is a lot of uncertainty about the value of these warrants, particularly prior to 

launching the first auctions. Because there are no market prices, 

we employ a multipronged strategy which looks at market prices, 

looks at model valuation, and we also have a third-party independent contractor. 

When we create this range of valuation, there is still no single 

point estimate that one can nail down as the exact value. It is a 

range. There is uncertainty. We take this valuation after a lot of 

discussion and create a range. When we enter into the negotiation 

process, we have an idea of this range, and often some banks are 

way off, which requires a lot of conversations to explain how we arrive at the process and the inputs that go into it. 

The valuation ranges are highly sensitive to the inputs that go 

in. So it is quite important that we do have a discussion with the 

issuers if they want to repay. Some are more sophisticated. Larger 

banks tend to be more sophisticated than the smaller banks. 

Also, reasonable people can disagree about these inputs, which is 

why we use more than just our model. We like to go out to the 

marketplace and get a sense of where things trade. I also think the 

negotiation process is quite dynamic. It is going to be unique to 

each issuer, and one can’t follow exactly a checklist of exactly the 

same information, the same schedule of conversations, because we 

are trying to get the best value for taxpayers. 

And I think the point regarding how have we done in these negotiations, again, what we are always thinking about is can we get 

a price that is as good as or better than what we would be able 

to sell these in the marketplace, understanding that there is no 

quote that we can look at, but getting a sense of what we can sell 

it for. 

Chairman MOORE OF KANSAS. Thank you, Mr. Miller. 

7 

Mr. Atkins from COP, on our second panel, points out that in 

their estimate, auctions yield 110 cents on the dollar, while direct 

negotiations with Treasury yield 93 cents on the dollar. But Professor Jarrow points out the added cost by setting up an auction, 

so the advantages may not be as clear-cut. 

Does Treasury have a preference between auctions or direct negotiations? And what considerations are made by Treasury in this 

regard, sir? 

Mr. MILLER. Thanks for the question. 

We have looked at the comparison between our results from auctions and negotiations. And what we found—since we only do auctions for positions greater than $5 million, which is the threshold 

to list them on the New York Stock Exchange—is that on average, 

we have actually gotten 35 percent volatility for the negotiated 

warrants versus 33 percent at auction on the auction warrants, 

which suggests that we are doing slightly better in the negotiations, on average. 

We don’t have a preference, contractually, in the CPP preferred 

stock agreement. The banks have a right to repurchase the warrants under this program where we have to agree on fair market. 

We believe there are certainly cases where we can do better than 

what something would be sold for in the marketplace. I think as 

we released in our January report, putting all the detail out on the 

negotiated transactions as well as the first three warrant auctions, 

that we have done so. 

Chairman MOORE OF KANSAS. Thank you, sir. And I have a couple of additional questions, but my time is just about out. So we 

will submit those in writing and ask if you would respond to those, 

sir. 

Mr. MILLER. Thank you. 

Chairman MOORE OF KANSAS. At this time, I will recognize the 

ranking member for questions. 

Mrs. BIGGERT. Thank you, Mr. Chairman. 

Mr. Miller, does the Treasury Department have plans to place 

members on the boards of directors of the financial institutions 

that participated in the capital purchase programs but have missed 

the dividend payments? I think it was up by the time—the sixth 

quarter, you are supposed to put in two members of the board of 

directors? 

Mr. MILLER. Thanks for that question. 

Just to step back, I think you are referring correctly to the Capital Purchase Program. If an institution misses its dividend payment for six quarters, Treasury has the right to nominate someone 

for the board of directors. There have been a number of firms that 

have missed their dividend payments for several quarters. We have 

not yet had one miss it for six, although we are currently considering our options. 

This is a standard covenant in many financial agreements that 

if the bank does miss dividends, the owner of that security would 

have certain rights. But as far as putting government officials on 

the boards, we are not considering doing that. 

Mrs. BIGGERT. So it would be just—who would you put on the 

boards? 

8 

Mr. MILLER. We are precluded from actually having a government official, the legal interpretation is, but we would consider, as 

we have done in other cases with larger investments, looking for 

independent board members to provide an independent voice. 

Mrs. BIGGERT. In regard to the legality of the foreclosure mitigation program, HEMP, the Treasury Department has cited an internal legal memorandum that explains the authority for Treasury to 

fund HEMP with TARP funds. The most recent COP report, however, explains that the Treasury Department has asserted the attorney-client privilege over this memorandum. 

Why wouldn’t the Treasury Department simply disclose the 

memo describing its authority to fund HEMP through TARP? 

Shouldn’t this be made available to the members of this committee? 

I know that portions of it have been made available, and with at 

least $50 billion of money, taxpayer money on the line, I think that 

this committee and the Congress deserve at least a Treasury memo 

explaining the legality of funding this program. 

It seems to me that the thing originally about TARP was that 

the money that would come back was going to go into the fund to 

pay back the deficit, to pay back the debt, rather than to fund 

other programs. 

Mr. MILLER. The housing program—and you have raised some 

important questions—is not something that I have responsibility 

for, so I would be happy to take those questions back to Treasury. 

Mrs. BIGGERT. Would you take that back, so we can get an answer in writing? 

Mr. MILLER. Sure. 

Mrs. BIGGERT. Thank you. 

The SIGTARP has issued an audit that was critical of the method the Treasury used to document its warrant negotiations, and I 

think the chairman addressed this a little bit, but they cited the 

lack of any internal controls in the negotiation process. 

What are the internal controls? 

Mr. MILLER. I would be happy to discuss a little more about the 

report, because we have gotten a chance to review it. 

First, we feel we have quite robust controls, as far as we have 

something called the Warrant Committee where staff prepares 

memos to review the valuation, all the three methods. That committee will meet and discuss it and ultimately provide a recommendation to the Assistant Secretary for Financial Stability, 

Herb Allison. He may accept or reject that recommendation, but 

there is a lot of interaction along the way. 

As far as the negotiation process, we—again, each negotiation is 

dynamic. We are currently reviewing the recommendations made 

by the SIGTARP which really entail better documentation of the 

negotiation process, and it is something we are certainly— 

Mrs. BIGGERT. Would this include testing of whether Treasury 

was able to acquire a favorable warrant sale price or whether the 

taxpayer lost money on the negotiations? 

Mr. MILLER. I think we certainly look at it—it is very hard to 

make a comparison, as valuations done solely by model are going 

to be subjective. People will have different views, which is why we 

use multiple inputs. You can’t both do a negotiation, if successful, 

9 

and sell them into the market. And so you don’t have a perfect 

market price. 

But we do evaluate very closely what price we receive, and if we 

believe that will be better than what we get in the market price. 

So that is what guides our negotiating. And we have been very consistent in how we apply our valuations, although each negotiation 

is going to be different. 

Mrs. BIGGERT. But isn’t SIGTARP wanting to have testing to see 

the result? 

Mr. MILLER. I believe the focus of his report was really two 

areas. And again, I think we are always supportive of our oversight 

bodies helping us to improve the process. The first one is regarding 

our Warrant Committee and the minutes that are taken. And just 

to provide a little context, the committee minutes itself detail who 

is present, the recommendation made, the date, and the time. Attached to that committee minutes is a detailed memo that goes 

through how we arrive at our valuation ranges, and really is the 

basis for discussion of that committee meeting. So it is quite a lot 

of detail. 

However, the SIGTARP noted that it was a little bit difficult in 

the audit of that to find out exactly the key decision point, so we 

are certainly going to review that and look to add more information 

so it is easier to follow along. 

Mrs. BIGGERT. Thank you. 

Chairman MOORE OF KANSAS. We don’t have any other members 

present besides myself and the ranking member, so I think we 

have agreed that we would like to each have up to 5 additional 

minutes for additional questions, if you would, sir. And I thank the 

ranking member for her agreement. 

We learned a lot from the report Treasury released in January 

on the warrants program. Is that something Treasury could release 

semiannually? And before you respond, Mr. Miller, have the recommendations and oversight provided by SIGTARP, COP, GAO, 

and Congress been helpful over the past year-and-a-half in improving the administration of TARP and our mutual goal of stabilizing 

our economy while trying to fully protect taxpayers? 

Mr. MILLER. I will take the first one first. The report was certainly something that we had always wanted to do. Leading up 

until January, we certainly were concerned about releasing too 

much information too early because we were concerned that the 

banks that we negotiate with would take advantage of it and that 

could potentially hurt taxpayer returns. 

As we were able to successfully launch the auctions, we felt very 

comfortable that if we could not reach an agreement with the bank, 

we had an extremely viable alternative to sell them in the marketplace, so we did not have to in any way lower our standards or accept prices that we did not think were fair. So once we did that, 

we felt comfortable releasing a report. We certainly plan to release 

additional reports like that going forward. 

Chairman MOORE OF KANSAS. Thank you, sir. 

And finally, Mr. Miller, Professor Wilson raises concerns with regard to the proposed small business lending fund and small firms 

being able to get rid of their warrant without any benefits to taxpayers. Would you discuss this issue generally of how TARP warVerDate Nov 24 2008 18:12 Sep 28, 2010 Jkt 058042 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\58042.TXT TERRIE
10 

rants relate to small and big firms? And I have said throughout financial regulatory reform that responsible community banks 

should not be subject to enhanced scrutiny. The new oversight system should focus on the Wall Street banks and nonbanks, like 

mortgage brokers, that did the most damage. 

Should we focus on the larger institutions to achieve the maximum gains for taxpayers? 

Mr. MILLER. First, with regards to what is known as the SBLF, 

the Small Business Lending Fund, that is in a proposal stage. The 

Administration put forth a proposal which is meant to allow banks 

to get attractive capital so that they could increase their small 

business lending. That is still in the design phase, and I understand it is still with Members of Congress. 

With regards to the warrants, it makes no indication—we certainly have not indicated that we would cancel any warrants, so I 

am not sure where that view is coming from. That was never an 

intention. 

Regarding small and large institutions, I think clearly the bulk 

of the dollars went to the largest institutions. Those are also the 

institutions that have repaid the lion’s shares of the $177 billion 

that has been repaid to date. 

The 650 or so remaining institutions in the Capital Purchase 

Program are small institutions. We still treat them equally. They 

are certainly more difficult to value the warrants. Many of them 

are private institutions which don’t have warrants that are the 

ones we are talking about today. But the smallest ones certainly 

trade differently if we were to sell them into the market, so that 

is a challenge we are certainly working through as we go forward 

in the best way to monetize those if we don’t reach agreement on 

repurchase as these banks continue to repay. 

Chairman MOORE OF KANSAS. Thank you, sir. 

And the Chair now recognizes again the ranking member for up 

to 5 minutes. 

Mrs. BIGGERT. Thank you, Mr. Chairman. 

Just going back a little bit to the previous question that I had, 

I think that SIGTARP found that unless there are sufficient internal controls and documentation—and I am glad to hear that they 

are going to do more of that because, really, fairly or unfairly, the 

criticism of the third parties, it is really subjecting themselves to 

the fact that they can be criticized for picking winners and losers 

unless there is that—that the price can be properly scrutinized, 

even though it is after the fact of the negotiation, and to ensure 

that taxpayers receive top value for their investments. Would you 

agree with that? 

Mr. MILLER. I think analysis of the value we are getting is absolutely important, and we welcome that. We do our own, and we 

welcome others to do so as well. But I would also add that these 

ultimate model valuations that people would use to test are highly 

sensitive to the volatility, which is one of the major inputs into determining that value, and so can be used, really, any result sum, 

if they were wanting to get to a number that was either very high 

or very low. What we are trying to do is find fair market value; 

what would the market pay for this? And so that is a slightly different process than some might go through. 

11 

We have seen a number of reports out in the press where people 

will make sort of outrageous claims that we could have gotten ‘‘X,’’ 

but they can’t substantiate it. 

Mrs. BIGGERT. So what is the Administration’s plan, including 

the time-lining for ending the TARP program? And when will this 

be revealed to us? 

Mr. MILLER. That is a very important question. And I think, as 

you know, the authority to make new investments expires on October 3rd of this year. We have also already wound down a number 

of programs, the Asset Guarantee Program, the Target Investment 

Program. The Capital Purchase Program ceased making new investments in December of last year, and we have already seen a 

huge amount of repayment which we are very encouraged by. 

I think the principle is clearly that we are reluctant holders of 

these securities and will look to monetize them as soon as is practicable, but taking into consideration, certainly, the prices we could 

get, financial stability overall. But again, we are working towards 

that, but we are doing it prudently and sensibly. 

Mrs. BIGGERT. One last question, Mr. Miller. If ever implemented, do you know where the funding for the Administration’s 

proposed small business lending fund will come from? I think that 

the first proposal was for $30 million—a $30 billion fund to come 

from TARP. I understand that a revised plan has been issued, but 

it is silent on how the program is to be funded. And some people 

say that this is nothing but TARP II without any potential benefit 

or payback to the taxpayer. 

Mr. MILLER. I don’t know the status, as well. I know initially it 

was proposed to come out of TARP. There were good reasons why 

it should not be part of TARP; namely, over time, the stigma associated with banks taking TARP money became quite difficult, and 

they were concerned about some of the issues, both stigma and 

some of the restrictions that came with it. And that was really 

hurting the system overall for small banks that may benefit from 

that capital and be able to lend more. But I don’t have a view on 

certainly which would be a better way to fund it, and I don’t know 

the status of it. 

Mrs. BIGGERT. Is there a projection of losses? I think some people have said $8.4 billion or 28 percent of the fund? 

Mr. MILLER. Depending on how it ends up getting structured, 

there have been a number of estimates that show varying degrees 

of subsidy or loss. 

Clearly, if you are giving capital that may be below market rate 

to encourage banks to take that capital, it is not going to be 100 

cents on the dollar, if you will; there will be a subsidy. But I don’t 

think there is a final estimate of that for the Small Business Lending Program. 

Mrs. BIGGERT. Thank you. I yield back. 

Chairman MOORE OF KANSAS. Thank you. 

And thank you, Mr. Miller, for your service and your testimony 

here today. You are now excused, and I will invite the second panel 

of witnesses to please take your seats. Thank you sir. 

I am pleased to introduce our second panel of witnesses. First, 

we have Mr. Kevin Puvalowski, Deputy Special Inspector General 

for TARP. 

12 

Second—while we normally have Professor Elizabeth Warren testify on behalf of the Congressional Oversight Panel on TARP—we 

are pleased to have a Republican appointee, the Honorable Paul 

Atkins, and a former Security and Exchange Commissioner represent COP today. 

Next, we will hear from Professor Robert Jarrow, the Ronald P. 

and Susan E. Lynch professor of investment management and professor of finance and economics at the Johnson School of Cornell 

University. 

And finally, we will hear from Professor Linus Wilson, assistant 

professor of finance, B.I. Moody III College of Business at the University of Louisiana at Lafayette. 

Without objection, the witnesses’ statements will be made a part 

of the record. 

Mr. Puvalowski, you are recognized, sir, for 5 minutes. 

STATEMENT OF KEVIN R. PUVALOWSKI, DEPUTY SPECIAL INSPECTOR GENERAL, OFFICE OF THE SPECIAL INSPECTOR 

GENERAL FOR TARP (SIGTARP) 

Mr. PUVALOWSKI. Chairman Moore, Ranking Member Biggert, 

and members of the committee, it is a privilege and an honor to 

testify today concerning SIGTARP’s audit of Treasury’s warrant 

disposition process which is being released today before this committee. 

The audit, which focuses on the process and procedure that 

Treasury uses to sell warrants that it obtained through TARP, was 

intended to complement the Congressional Oversight Panel’s July 

2009 report that examined the warrant valuation methodologies 

themselves. 

To its credit, Treasury has generally succeeded in negotiating 

prices for warrants at or above its internal estimated values. Our 

audit, however, identified two significant problems in Treasury’s 

warrant disposition process that have led to failures in transparency and consistency that, if left unaddressed, could result in 

significant harm to the program. 

The first deficiency is that Treasury does not sufficiently document important parts of the negotiation process. Treasury, for example, lacks detailed documentation supporting the decisions of the 

Warrant Committee, the committee that reviews TARP recipients’ 

offers. Significantly, committee minutes generally do not reflect the 

factors considered by the members when making determinations 

whether to accept a bank’s offer or their justifications or explanations for their decisions. Even more troubling, Treasury does not 

document the substance of its conversations with recipient institutions when it negotiates warrant repurchases, making it extremely 

difficult, if not impossible, to determine what actually happened. 

This lack of documentation significantly limits the ability to test 

the consistency of Treasury’s decision-making. Memories fade, 

Treasury officials leave office, and with the passage of time and the 

occurrence of intervening negotiations, different parties to a meeting or a conversation may have different recollections of what occurred. 

When a committee decision or a brief telephone conversation can 

mean the difference of tens of millions of dollars for taxpayers, it 

13 

is a basic and fundamental element of transparency and accountability that the substance of that meeting or call be recorded contemporaneously. 

SIGTARP was unable, for example, to determine with certainty 

what occurred during a key telephone conversation between Treasury and Morgan Stanley, a conversation that resulted in a $50 million swing for the taxpayer. Treasury failed to document the call, 

and the recollection of the participants as to what happened during 

that call differed very significantly. 

The second significant deficiency is that Treasury does not have 

established guidelines or internal controls over how the negotiations proceed, and, in particular, as to how much information is 

shared with recipient institutions about the price Treasury is likely 

to accept for the repurchase of its warrants. 

Descriptions provided to SIGTARP by several of the banks that 

engaged in negotiations with Treasury confirmed that Treasury 

was willing, for some banks, to provide clear indications as to what 

price it was prepared to sell the warrants. For other banks, Treasury was unwilling to share similar details. 

Indeed, as detailed in the audit, the amount of information provided, the circumstances of what information would be provided, 

and the results of the negotiations were all over the lot. 

While there may well be good reasons for treating different institutions differently in the context of the negotiation, because Treasury does not document the negotiations with financial institutions, 

and because there are no established guidelines or criteria for what 

information is shared or when it will be shared, it is impossible to 

determine with certainty, after the fact, whether the difference in 

the sharing information was justified or consistently applied, or if 

those different approaches were, in the final analysis, good or bad 

for taxpayers. 

Until Treasury addresses these deficiencies, it risks subjecting 

itself once again, fairly or unfairly, to criticism from third parties 

that through TARP, it is favoring some institutions over others, 

picking winners and losers, irrespective of whether, in fact, it had 

legitimate reasons to take the negotiating positions that it did. 

To address these deficiencies, SIGTARP’s audit recommends 

that: one, Treasury should ensure that more detail is captured by 

the Warrant Committee meeting minutes; two, Treasury should 

document in detail, contemporaneously, the substance of all communications with recipients concerning warrant repurchases; and 

three, Treasury should develop and follow guidelines and internal 

controls concerning how negotiations will be pursued, including the 

degree and nature of information to be shared with repurchasing 

institutions concerning Treasury’s valuation of the warrants. 

We await Treasury’s formal response to these recommendations. 

Chairman Moore, Ranking Member Biggert, I want to thank you 

again for this opportunity to appear before you today, and I am 

pleased to answer any questions that you may have. 

[The prepared statement of Mr. Puvalowski can be found on page 

61 of the appendix.] 

Chairman MOORE OF KANSAS. Thank you Mr. Puvalowski. I appreciate your testimony. 

14 

And the Chair will next recognize Mr. Atkins. You are recognized, sir, for up to 5 minutes. 

STATEMENT OF THE HONORABLE PAUL ATKINS, MEMBER, 

CONGRESSIONAL OVERSIGHT PANEL, AND FORMER SECURITIES AND EXCHANGE COMMISSIONER 

Mr. ATKINS. Thank you very much, Chairman Moore, Ranking 

Member Biggert, and distinguished members of this subcommittee. 

My name is Paul Atkins. I am a member of the Congressional 

Oversight Panel, and I appreciate very much this opportunity to 

testify about the Congressional Oversight Panel’s work assessing 

the performance of the Treasury Department in managing and disposing of stock warrants that it has acquired in conjunction with 

the Troubled Asset Relief Program. I should note that the views expressed today in this testimony are my own. I will do my best to 

try to convey the Panel’s views, but my statements cannot always 

reflect the opinions of our five very diverse thinkers. 

The Panel is charged by statute to review the current state of the 

financial markets and the financial regulatory system and provide 

monthly reports to Congress assessing the effectiveness of Treasury’s implementation of the TARP, including its disposition of stock 

warrants. 

When Congress authorized the commitment of $700 billion to 

rescue the financial system, it also required that taxpayers participate in the upside if assisted financial institutions returned to profitability. This is achieved through Treasury’s receipt of warrants to 

purchase common stock, or other securities, from the banks party 

to any transaction in which those banks received TARP capital, 

mainly through what is called the Capital Purchase Program or 

CPP. 

In May of 2009, CPP-assisted banks began to repay their TARP 

assistance. The Oversight Panel in July 2009 evaluated the prices 

that Treasury negotiated for; at that time, 11 banks had purchased 

their warrants. We used the industry standard Black Scholes option pricing model adjusted to reflect the particular characteristics 

of the warrants that Treasury received under the CPP, and specifically the dividend yield and the 10-year duration. The Panel’s analysis concluded that Treasury had received approximately 66 percent of our best estimate of the value of TARP warrants for these 

banks. 

However, we acknowledged as well that these repurchases represented less than one-quarter of 1 percent of our best estimate of 

the value of all the CPP warrants that Treasury had acquired as 

of that time. 

We also knew that Treasury’s own valuation of warrants of these 

smaller banks incorporated an adjustment for the likely relative 

illiquidity of a stock of these banks, a step that the Panel did not 

apply because of the subjectivity of that particular factor. 

The July report recommended that Treasury give serious consideration to employing auctions to dispose of warrants rather than 

relying heavily upon one-to-one negotiations with individual banks. 

Using a public auction for warrant repurchases would leave no 

room for speculation that Treasury either was too tough or too easy 

on a TARP recipient institution, while allowing banks to repurVerDate Nov 24 2008 18:12 Sep 28, 2010 Jkt 058042 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 K:\DOCS\58042.TXT TERRIE
15 

chase their warrants in competition with other market participants. The report noted the need for greater transparency in the 

Treasury warrant valuation and negotiation process and called for 

Treasury to publish periodic reports that provide details on the 

value determinations for the warrants that are being sold. 

I should note that committee member Jeb Hensarling, at that 

time a member of the Oversight Panel, emphasized in particular 

his unease with Treasury’s lack of disclosure. And I should also express my own concern with Treasury’s lack of openness in its dealings with the public and with the Oversight Panel, as Representative Biggert raised. 

The opinion that you mentioned, Representative Biggert, was addressed to me in my capacity as an Oversight Panel member, and 

as far as I am concerned, it is a public document. Treasury should 

not attempt to assert an inapplicable privilege to keep information 

submitted to a congressional oversight body out of the public domain. 

In addition to the warrants received under the Capital Purchase 

Program and the Targeted Investment Program, Treasury also receives stock warrants in conjunction with the Auto Industry Financing Program. Warrants received as part of the initial assistance to General Motors and Chrysler were extinguished as part of 

the credit bid process in bankruptcy. As in the case of other private 

institutions, the warrants that Treasury received in relation to 

GMAC for a variety of preferred securities were immediately exercised on the investment date. 

So in summary, the Oversight Panel is pleased to see that Treasury’s performance in this area has improved dramatically since we 

first analyzed its initial warrant dispositions. The use of public 

auctions have clearly allowed for taxpayers to receive a solid return 

on their investments in these institutions and the transparency 

provided by public auctions allows transactions to take place in full 

public view. The panelists urge the Department to continue publishing the details of its internal valuations for each warrant disposition transaction, as it did most recently in January this year. 

The Panel has also urged Treasury to provide more assurance 

that it is achieving consistency in the negotiated warrant sale price 

process. 

The issues of transparency and consistency of outcomes will each 

become more important as Treasury moves to dispose of the warrants for the many remaining TARP-assisted small banks whose 

stocks are thinly traded. Taxpayers expect and deserve no less for 

the integrity of the process. 

Thank you very much Mr. Chairman. 

[The prepared statement of Mr. Atkins can be found on page 32 

of the appendix.] 

Chairman MOORE OF KANSAS. Thank you, Mr. Atkins, for your 

testimony. 

The Chair next recognizes Professor Robert Jarrow. Sir, you are 

recognized for 5 minutes. 

16 

STATEMENT OF ROBERT A. JARROW, RONALD P. AND SUSAN 

E. LYNCH PROFESSOR OF INVESTMENT MANAGEMENT AND 

PROFESSOR OF FINANCE AND ECONOMICS, THE JOHNSON 

SCHOOL, CORNELL UNIVERSITY 

Mr. JARROW. Good morning. I would first like to thank the committee for my invitation to testify. 

Some relevant background on myself. I am an expert on risk 

management modeling and implementation. I wrote the first textbook on option valuation over 25 years ago. And since that time, 

I have continued to do research in this area. My models are currently used by the financial industry to value and to hedge both interest rate and credit derivatives. I have extensive consulting experience implementing derivative models, in practice. 

I was engaged as an independent contractor by the U.S. Treasury 

during the summer of 2009 to audit their warrant valuation procedure. A summary of my valuation is available on the Treasury’s 

Web site. 

It is my belief that the Treasury’s warrant repurchase program 

has been a success. It has generated sales fair to both U.S. citizens 

and to the banks and the TARP program. The Treasury warrants 

repurchase process is well constructed, containing two components, 

a negotiated repurchase and/or an auction sale to third parties. 

In the negotiation process, the Treasury determines a warrant’s 

fair price using the judgment of Treasury’s internal experts in conjunction with three different price estimates, quotes from market 

participants, third-party valuations, and an internal model. 

The Treasury’s internal valuation model is based on best industry practice and the highest academic standards. 

Early in the warrant repurchase program, in the summer of 

2009, criticism of the Treasury’s fair valuations appeared in the financial press and in the July 2009 Congressional Oversight Panel 

report. This criticism was unjustified because it was based on price 

estimates obtained from poor model implementations. 

Since that time, the Treasury’s valuations have converged to 

those of their critics. This convergence was due to changing market 

conditions. It was not due to a modification of the Treasury’s methodology, except perhaps for the reduced use of a liquidity discount. 

Let me explain these statements in slightly more detail. As it is 

well known, the top warrants are American-type call options on a 

bank’s common stock with a 10-year maturity date. Valuing these 

warrants is a complex exercise involving the modeling of stock 

prices, stock price volatilities, dividends, and interest rates over the 

next 10 years. 

Industry best practice is to use a modified Black Scholes model 

which assumes very simple evolutions for these quantities. 

The crucial input is a stock price volatility used. The correct volatility input should be a forecast of the average stock price volatility over the next 10 years, and this is a very difficult quantity 

to estimate. 

The early criticism of the Treasury’s valuation estimates was 

mostly based on disagreements concerning this input. The correct 

approach is the one used by the Treasury and not that of the critics. 

17 

Since the early warrant repurchases in the summer of 2009, the 

stock market’s volatility has declined. This decline in volatilities 

has caused the differences between the stock price volatility inputs 

of the critics and the Treasury to narrow, resulting in more similar 

warrant valuations. 

As is typical of most option pricing techniques, the Black Scholes 

model also assumes that markets are frictionless, with no transactions cost and with infinite market liquidity. 

Obviously, these assumptions are not satisfied for large sales of 

nontraded warrants. In this case, a liquidity discount is appropriate. 

In the early repurchase of TARP warrants, the Treasury applied 

such a liquidity discount. As market conditions stabilized, liquidity 

discounts were less necessary in subsequent warrant sales. The 

critics’ valuation estimates never included such a liquidity discount. This was the second important difference. 

I am running out of time. I am used to lecturing. 

I will conclude my testimony here, and I welcome questions from 

the committee. 

[The prepared statement of Professor Jarrow can be found on 

page 37 of the appendix.] 

Chairman MOORE OF KANSAS. Thank you, sir, very much, for 

your testimony. 

The Chair next recognizes Professor Linus Wilson. 

And I will remind each of the witnesses that your testimony will 

be received into the record. Thank you. 

Mr. Wilson. 

STATEMENT OF LINUS WILSON, ASSISTANT PROFESSOR OF FINANCE, B.I. MOODY III COLLEGE OF BUSINESS, UNIVERSITY 

OF LOUISIANA AT LAFAYETTE 

Mr. WILSON. I am honored to be invited to appear before the subcommittee today. Thank you, Chairman Moore and Ranking Member Biggert. 

While I teach and conduct research and finance at the University 

of Louisiana at Lafayette, the views that are expressed today are 

my own and not necessarily the views of my university or the State 

of Louisiana. 

I received my doctorate of philosophy in economics at Oxford 

University in England in 2007. In addition to my other academic 

research in finance economics, I have written 14 academic papers 

on the TARP warrants government plans to buy so-called toxic assets from banks, the effectiveness of various types of capital in encouraging bailed-out banks to make good loans, and the ‘‘too-big-tofail’’ problem. 

Half of those papers on the bank bailouts have, to date, been accepted or appeared in peer-reviewed academic journals. We meet 

today on almost the 1-year anniversary of the first warrant transaction with Old National Bank Corp. 

Much to my surprise, my research into the Goldman Sachs warrants and the first warrant repurchase with Old National Bank 

garnered considerable interest. 

I argued that only through third-party sales and auctions could 

taxpayers hope to get the best prices. With pressure from this comVerDate Nov 24 2008 18:12 Sep 28, 2010 Jkt 058042 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 K:\DOCS\58042.TXT TERRIE
18 

mittee, the Congressional Oversight Panel, and me, Goldman Sachs 

announced its $1.1 billion repurchase of the taxpayers’ warrants. 

That price was the closest price to my estimated fair market value 

of any bank up to that time. Several other very good negotiations 

for taxpayers followed. 

Yet one outlier among the big investment banks was Morgan 

Stanley, which repurchased the taxpayers’ warrants for $950 million, or $450 million less than the amount that I estimated for the 

Financial Times and Reuters. 

It is alleged in the SIGTARP report released today that the top 

Treasury official for the TARP, Herb Allison, a Wall Street veteran, 

told the chief financial officer of the Wall Street investment bank 

Morgan Stanley the minimum price which the Treasury would accept for the taxpayers’ warrants. 

Homeowners don’t want their real estate agents telling potential 

buyers what the minimum price is that they would accept for their 

house. Yet Mr. Allison, the taxpayers’ agent, did just that, telling 

Morgan Stanley that he would accept $950 million to prevent private investors from pricing these very valuable securities at auction. 

We need leadership in the U.S. Treasury that looks after taxpayers, not Wall Street investment bankers. Mr. Allison should be 

here to answer for these allegations made in the SIGTARP report. 

The first auctions were in December 2009. Before December 

2009, there were no traded options or warrants with expiration 

dates later than 2014. In December, taxpayers got higher prices 

than they were offered in negotiations. Since then, the auction and 

secondary market prices have increased in March, April, and May 

of 2010. 

In addition, we have seen that in-the-money warrants, like those 

of Morgan Stanley and Goldman Sachs, have traded at premiums 

to short-term options with higher implied volatilities than shortterm options. 

We need to let markets, not backroom deals, price the big bank 

warrants. The Administration is asking Congress to give away taxpayers’ warrants. The U.S. Treasury and the Administration today 

plan to squander a fair market value of warrants and preferred 

stock of approximately $3 billion by allowing almost 600 existing 

Capital Purchase Program recipients to cancel their warrants and 

convert their preferred stock in subordinated debt into the proposed small business lending fund. 

If we add in the subsidies to new banks entering the fund which 

are not in the CPP, the subsidy to small banks and their shareholders would increase by $5.5 billion. That is, for a $30 billion 

fund, taxpayers should expect to lose $8.4 billion, or 28 percent of 

their investment, on the day the typical investment is made into 

the fund. 

TARP was an emergency legislation enacted to stop a banking 

panic. I think policymakers can design better ways to stimulate 

growth through tax cuts, government spending or deficit reduction. 

Giving handouts to banks does not make any economic sense. 

I think taxpayers should be rewarded for the investments they 

have made. 

19 

With the recovery in bank shares, the U.S. Treasury has collected $6.1 billion for the repurchases and auctions. I estimate that 

the fair market value that over 200 publicly traded banks and insurance company warrants, excluding AIG, which have not been 

sold prior to this hearing, were worth $4.1 billion on March 31, 

2010. 

Thank you for having me today. I look forward to your questions 

and perspectives. 

[The prepared statement of Professor Wilson can be found on 

page 138 of the appendix.] 

Chairman MOORE OF KANSAS. Thank you, Professor Wilson, for 

your testimony. I will now recognize myself for up to 5 minutes for 

questions. 

Mr. Puvalowski and Mr. Atkins, since you represent SIGTARP 

and COP, would you discuss your views as to whether the Treasury 

Department has been receptive to criticisms and recommendations 

to improve the Tarp Warrants Program? And has their performance improved over time? Mr. Puvalowski or Mr. Atkins? 

Mr. ATKINS. I think they have worked to try to increase their accountability and transparency and, as the SIGTARP’s report and as 

the Congressional Oversight Panel’s report from last year indicate, 

they have been making strides to that goal. Is it perfect yet? Probably not, but I think the transparency obviously is a thing that we 

want to try to achieve. Also, an equivalence of outcomes is ultimately the goal. 

Chairman MOORE OF KANSAS. Thank you. Mr. Puvalowski? 

Mr. PUVALOWSKI. One way in which Treasury has done a much 

better job over time is in terms of transparency. The Government 

Accountability Office, the Congressional Oversight Panel, and 

SIGTARP were all quite critical of Treasury in the early days of 

the warrant disposition process as to almost a complete lack of 

transparency. Treasury has done a pretty good job in responding to 

that criticism and the warrant report that was published in January was a significant step forward in terms of transparency in the 

program. 

With respect to SIGTARP’s recommendations in the audit that 

was released today, they are, in our view, very straightforward, 

very commonsense recommendations—that the process be documented better, that communications between Treasury and the recipient institutions be documented better. Right now, they are not 

documented at all. And that Treasury have some guidelines as to 

how the negotiations take place. Treasury has not yet responded to 

those specific recommendations, so we look forward to getting the 

response, and we will report an update on that in our next quarterly report. 

Chairman MOORE OF KANSAS. Thank you, sir. 

Professor Jarrow, I appreciate your perspective as an authority 

on model evaluations. Will you go into more detail as to how difficult it is to value warrants and address issues that these warrants values decay over time. While models are valuable, we know 

they don’t always work as we saw in the recent financial crisis. 

Should Treasury be careful not to rely on mathematical formulas 

too much to ensure maximum returns for taxpayers, sir? 

20 

Mr. JARROW. Thank you for that question. So let’s start first with 

the models, the models are approximations to a complex reality. 

And as an approximation, they contain errors. You need judgment 

to adjust the model for these errors. 

Relying on a model alone to make judgments with respect to repurchase and sales would be a big mistake, especially for these financial instruments. They are what we call loan dated, they are 

what we call American type options. American type options are options that have a decision embedded within them to value them. 

You have to decide when over the 10 years you want to exercise 

the options. Those are very, very complex financial instruments 

and modeling them is correspondingly complex. 

Chairman MOORE OF KANSAS. Thank you, sir. I would like to 

hear from each of you as to which provides the most value for taxpayers through the TARP Warrants Program, direct negotiations or 

options? And what public policy issue should Treasury and the 

Congress keep in mind as lessons from the use of these warrants 

and the TARP program. Professor Jarrow, we will start with you, 

sir. 

Mr. JARROW. Thank you. One of the big issues in valuation is deciding what is called the amount of the liquidity discount. When 

you sell a large quantity of shares in the market, you don’t get the 

price that you would get, you get a lower price than if you sold only 

a few shares and this liquidity discount is a key factor. When you 

do negotiation, you can avoid this market impact potentially. And 

secondly, when you do an auction, you have a third party cost you 

have to pay to the investment bank. So as a rule of thumb, you 

should always do negotiation first, and if negotiations fail, then I 

think having as an alternative an auction process is a very good 

idea. 

Chairman MOORE OF KANSAS. Mr. Puvalowski, do you have any 

comments, sir? 

Mr. PUVALOWSKI. The options that have taken place thus far did 

return a slightly better return just in terms of calculation investment return, but there haven’t been enough options thus far to 

compare against the negotiated results, we haven’t drawn a firm 

conclusion on that one way or the other. 

Mr. ATKINS. And by definition, an auction obviously is a market 

price, it is better than any modeling price so that is ideally I think 

what we should strive for. It has been relatively easy with the big 

banks, as we get into the smaller banks it may get more problematic. 

Chairman MOORE OF KANSAS. My time has expired, and I will 

have to yield now to the ranking member, please. 

Mrs. BIGGERT. Thank you, Mr. Chairman. 

Commissioner Atkins, a number of the Capital Purchase Program recipients have missed the dividend payments, it might not 

have reached six yet, but there is a whole list of those that have 

missed some of the payments. And after missing a sixth quarterly 

dividend payment, Treasury will have to place members on the 

board of directors of the financial institutions that participated, 

does this concern you? 

Mr. ATKINS. Well, it does, obviously having the government even 

more involved in these sorts of private entities, we see it already 

21 

with respect to GM, Chrysler, GMAC, and AIG. And I think the 

importance will be the process of choosing those particular directors by Treasury, how open and transparent a process it is, and 

what sort of direction those directors will have. 

Mrs. BIGGERT. And do you have any concerns regarding the 

Treasury’s small business lending fund? You know what the original proposal was for TARP, but the latest iteration doesn’t specify 

how it will be funded. 

Mr. ATKINS. Yes, I think you brought up a very good point. I 

think the reason why it is probably not clear how it will be funded 

is that I don’t believe that it can be funded from TARP under the 

statute, which is one of the issues for HAMP and HARP as well, 

and I think one of the reasons I asked for Treasury for that opinion. 

Mrs. BIGGERT. I am glad you did bring that up. And that is why 

we want to probe further, and hopefully we will get a written response on that authority, thank you. 

Has the Congressional Oversight Panel adopted a budget? 

Mr. ATKINS. Well, apparently, we have one, I haven’t actually 

seen it. I understand it has $5 million or so, but the specifics I am 

not— 

Mrs. BIGGERT. How is it funded? 

Mr. ATKINS. Apparently, the money comes through the Senate 

Rules Committee, from the Senate side. 

Mrs. BIGGERT. I am glad they are paying for it. I am sure it is 

the taxpayers, but wouldn’t it make sense to adopt a budget where 

the taxpayers know how much is being spent, and not just the Senate? 

Mr. ATKINS. I agree; I think transparency is good. Obviously, 

that is, I think in your bailiwick as Members of Congress. 

Mrs. BIGGERT. If possible, can you or the COP staff provide this 

panel with a full list of congressional field hearings at which a 

member of the COP has testified since the Panel’s creation? Are 

there a lot of field hearings? 

Mr. ATKINS. There have probably been about half a dozen or so 

field hearings. There is one, in fact, up in New York today. I am 

sure we can get that to you. 

Mrs. BIGGERT. We would appreciate that. Then, given that large banks comprise a significant higher share of loans under $1 million, do you worry that the Administration’s small business lending 

fund proposal to inject capital into the community banks will not 

have the desired effect of significantly increasing credit for small 

businesses? 

Mr. ATKINS. Well, I think there is a big debate, in fact we are 

coming out with a report this week with respect to commercial 

lending. But I think there is a big debate as to whether it is demand or supply that is really affecting small business lending. 

Mrs. BIGGERT. Thank you. 

Professor Wilson, you compared the Treasury’s first version of 

the small business lending fund to TARP 2, I think that is where 

it came from without any of the benefits to the taxpayers that 

TARP 1 had. Have you had an opportunity to examine the revised 

version of this program and how it would affect the Capital Purchase Program? 

22 

Mr. WILSON. I was looking at the fact sheet that was put on 

whitehouse.gov, which I think was dated February 2nd—if there is 

a more recent version I haven’t seen it, and I would love to look 

at it. 

Mrs. BIGGERT. Thank you. 

Mr. WILSON. I would also say my thoughts about the small business lending program, my research has shown that if you give 

banks preferred stock that is senior to common, and managers try 

to maximize the value of common stock, not preferred stock. So, in 

essence, preferred stock adds leverage to their incentives and 

doesn’t have desired incentives for banks that are undercapitalized. 

Mrs. BIGGERT. It certainly didn’t when they purchased Fannie 

and Freddie preferred stock, did it, as they were asked to do. 

Mr. WILSON. Yes. I don’t think that the government programs 

have necessarily been as successful as people had hoped. 

Mrs. BIGGERT. Thank you, I yield back. 

Chairman MOORE OF KANSAS. Thank you, Mr. Puvalowski, for 

showing your office’s audit. What was the most troubling finding 

in your report? And if Treasury made only one change to improve 

the TARP warrants program what would that be, sir? 

Mr. PUVALOWSKI. It would be the development of guidelines or 

criteria to put some framework around how the negotiation process 

is conducted. SIGTARP’s audit identified very significant differences in how different banks were dealt with during the negotiation process, particularly with respect to how much information 

was provided to the institutions about Treasury’s estimated value. 

Obviously, the negotiation process is a dynamic thing that requires 

some flexibility, but without some form of guideline or criteria, 

there is a real danger of arbitrariness of different banks being 

treated differently, of frankly just having one person, whether it is 

the analyst or assistant secretary or someone else at Treasury having a very significant discretion in terms of decisions that make the 

difference of tens of billions of dollars of taxpayer return. 

When a Wall Street bank goes out and decides to do a bareknuckled negotiation with a counterparty with one kind of party 

and a more accommodating approach with another counterparty 

that is business, that is what business is all about. Treasury is not 

a Wall Street bank. And when Treasury is administering a government program, it is fundamental to accountability, to transparency 

that there be some ground rules to make sure that banks are being 

treated the same. 

Chairman MOORE OF KANSAS. Thank you, sir. Mr. Atkins, or 

other witnesses, what key change should Treasury focus on with 

respect to TARP warrants? 

Mr. ATKINS. I would have to echo what Mr. Puvalowski has said. 

I think the potential allegations of favoritism or other things that 

might come up by disparate treatment of institutions need to be 

headed off before they happen. Obviously, there is a lot of cynicism 

in the public, and more openness and more documentation to be 

able to replicate the determinations as necessary. 

Chairman MOORE OF KANSAS. Mr. Jarrow and Mr. Wilson, do either of you have any comments? 

Mr. JARROW. I would just echo that transparency is a good. And 

I think the Treasury, at least from my perspective, has been very 

23 

accommodating in regard to that, so I expect that they will continue to do so in the future. 

Chairman MOORE OF KANSAS. Mr. Wilson? 

Mr. WILSON. I think the SIGTARP report reveals very interesting details about how different banks were treated in different 

ways. And the way that Treasury communicated its minimum 

prices to different banks, and not all banks were treated the same. 

So American Express was not told anything and we got the highest 

price that I have estimated as a percent of fair market value. 

Treasury thought that was a very high price too. 

In contrast with Morgan Stanley, there was supposedly, according to the Morgan Stanley executive, there was a lot of communication about the minimum price they were willing to accept, and taxpayers lost between $375 million and $450,0000, whether you take 

my estimate at the time or my estimate after looking at the auction 

warrants. One of the things that we found from the auction warrants is that in-the-money warrants trade for a lot more than outof-the-money warrants. And this is well-known in option markets; 

it is called the volatility smile. The volatility smile is working in 

the favor of the Treasury with American Express, Goldman Sachs, 

Morgan Stanley, but Morgan Stanley paid less than the implied 

volatility short-term options or at-the-money option, but Goldman 

Sachs and Morgan Stanley paid significantly higher implied 

volatilities. 

Chairman MOORE OF KANSAS. The Chair would next recognize 

Mrs. Biggert if you have questions for up to 5 minutes. 

Mrs. BIGGERT. Yes, thank you, Mr. Chairman. 

Mr. Puvalowski, when we were talking about how there is the 

auction and the negotiation, is there a third way to do this and 

with the third party valuations, or is that folded into the other 

two? 

Mr. PUVALOWSKI. Part of Treasury’s process is a series of steps, 

and the first is the negotiation process. The bank essentially gives 

its first offer, Treasury will assess that offer, and reject or accept 

it. If it is rejected, the bank has an opportunity to provide additional offers, sometimes there are multiple offers that are provided. 

If a price cannot be determined through that process, the parties 

do have the option of entering into an appraisal process where essentially each side would pick an appraiser, they would try to 

agree, if they couldn’t agree a third appraiser would be selected. So 

there is a kind of intermediate step. The appraisal process has not 

been invoked in any case thus far. The banks would have to incur 

the cost of the appraisal, which is one of the reasons that has been 

identified, that the appraisal process hasn’t happened thus far. So 

there is an intermediate step that is built into the process, but it 

has not yet been used. 

Mrs. BIGGERT. Thank you. You know the regulatory reform bill 

said in the Senate right now and soon to be the House again, I suppose the bills allow for a permanent government intervention into 

‘‘too-big-to-fail’’ for any financial institution or business deemed a 

problem to the Federal regulators. Is there a moral hazard in making these programs permanent if the financial institutions, or any 

business thinks that if they make poor decisions, then the government will simply take over and taxpayers will pick up the tab, does 

24 

this give businesses more or less the green light to engage in risky 

activities? This is a question for anybody who wants to answer. 

Mr. ATKINS. Well, I can take a stab at that. I think there are certain aspects to that Senate bill as it is moving on the Floor that 

raise a lot of the concerns that you have mentioned, particularly 

the flexibility that is still within the government to determine who 

is systemically significant and make those determinations sort of a 

star chamber type of group that would make that determination, 

there is an appeal process and things like that. But I am not sure 

how that is going to work in practice and it is quite concerning, I 

think. 

Mrs. BIGGERT. Anybody else? Okay. 

Then Mr. Jarrow, in your testimony, you state that you believe 

that Treasury warrant repurchase program has been a success. In 

the interest of full disclosure, were you compensated for your warrant valuation consulting services to the Treasury? 

Mr. JARROW. Yes, I was. 

Mrs. BIGGERT. Then having served as a consultant to the Treasury last year regarding the valuation of the TARP warrants, can 

you comment on SIGTARP’s recent audit finding regarding the lack 

of documentation or internal controls? For example, how did we 

know that the Goldman warrant repurchases were the best deal for 

the taxpayer? 

Mr. JARROW. I can’t really comment on the transparency of the 

negotiation because that isn’t what I was really looking at. I was 

looking at the process for the valuation and whether or not the internal models were good. And I found, and I concluded that the 

process itself was fair and the internal models were good. 

One way you could check to see whether or not the resulting sale 

was fair is to get market quotes before the fact and compare them 

to the ultimate sale, to have an internal model and to see whether 

or not the estimates that come out of the model are close to the 

sale. And on those latter criteria, I judge that to be quite good and 

therefore a success. 

Mrs. BIGGERT. Thank you. Let’s see, I have a minute here. 

Professor Wilson, you said in your testimony that we should be 

contracting State ownership of the banking sector, not expanding 

it, and I couldn’t agree more. Recently revised small business lending fund leaves open the possibility that Congress could still fund 

the program through TARP. What harm to the taxpayers could 

come from implementing this program? 

Mr. WILSON. Right now, we have made investments in over 700 

banks and other institutions. Most of those are preferred stock or 

subordinated debt. The subordinated debt lasts 30 years, preferred 

stock you never have to pay that back. So that the taxpayers to 

exit the TARP will eventually have to sell that or convince those 

institutions to pay that back. I believe that the institutions that 

have paid back early were most likely the ones to paid back early, 

they are also the most healthy institutions. 

There are many institutions that have received preferred stock or 

subordinated debt that are not paying dividends or interest if it is 

subordinated debt. And last count, it was 82. Three of those have 

been restructured in bankruptcy and there may be more in the future. But it would be very hard to exit these preferred stock injecVerDate Nov 24 2008 18:12 Sep 28, 2010 Jkt 058042 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 K:\DOCS\58042.TXT TERRIE
25 

tions if we don’t convince the banks to do that. And I think the adverse selection problem will be even worse if we are offering a 1 

percent dividend to banks that have not participated in the Capital 

Purchase Program because we have really exhausted all the banks 

that are really willing to participate and only really desperate institutions would want to enter into government ownership. 

Mrs. BIGGERT. Thank you. Thank you, Mr. Chairman. I yield 

back. 

Chairman MOORE OF KANSAS. Thanks again to the ranking member. And again, I want to thank all of our witnesses for your testimony here today. Today’s hearing was helpful in getting an update 

on where things stand for the United States taxpayers with respect 

for TARP and warrant repurchases. While it is good to celebrate 

the success of the TARP Warrants Program, this subcommittee will 

not and should not rest easy. We must keep pushing for greater 

transparency and accountability while maximizing return for taxpayers. 

I ask unanimous consent that the following reports be entered 

into the record: Exhibit 1, the Treasury Department’s January 

TARP Warrant Disposition Report; and Exhibit 2, a CRS report, 

‘‘Government Interventions in Response to Financial Turmoil.’’ 

Without objection, those 2 reports will be made a part of the 

record. 

The Chair notes that some members, whether they are here or 

not, may have additional questions for our witnesses which they 

may wish to submit in writing. Without objection, the hearing 

record will remain open for 30 days for members to submit written 

questions to these witnesses and to place their responses in the 

record. This hearing is adjourned, and again, I thank very much 

the witnesses who attended today to give their testimony. 

[Whereupon, at 12:21 p.m., the hearing was adjourned.] 

(27) 

A P P E N D I X 

May 11, 2010 

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