U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

1 

79–011 2009

110th Congress, 2d Session – – – – – – – – – – – – House Document 110–161 

OMB REPORT UNDER THE EMERGENCY ECONOMIC 

STABILIZATION ACT, SECTION 202 

COMMUNICATION 

FROM

THE DIRECTOR, THE OFFICE OF 

MANAGEMENT AND BUDGET 

TRANSMITTING

THE FIRST REPORT OF THE ESTIMATED COST OF ASSETS PURCHASED UNDER THE EMERGENCY ECONOMIC STABILIZATION 

ACT OF 2008, AS REQUIRED BY SECTION 202 

JANUARY 3, 2009.—Referred to the Committee on Financial Services and 

ordered to be printed 


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1The appointment of Assistant Secretary of Financial Stability, Neel Kashkari (interim) on 

October 6, 2008, by the Department of the Treasury (Treasury) was the first exercise of authority under the Emergency Economic Stabilization Act. 

EXECUTIVE OFFICE OF THE PRESIDENT, 

OFFICE OF MANAGEMENT AND BUDGET, 

Washington, DC, December 5, 2008. 

Hon. NANCY PELOSI, 

Speaker of the House of Representatives, 

Washington, DC. 

DEAR MADAM SPEAKER: Enclosed and as transmitted to the 

President of the United States is the Office of Management and 

Budget’s (OMB) first report of the estimated cost of assets purchased under the Emergency Economic Stabilization Act of 2008 

(EESA), as required by section 202. 

OMB is required to submit this report to the President and the 

Congress no later than sixty days after the first exercise of authorities granted under Section 101(aa) of EESA, and semiannually 

thereafter. Consistent with the requirement to analyze transactions 

up to thirty days before publication, this report analyzes the cost 

of transactions completed by November 6, 2008. 

OMB will continue to work closely with the Department of the 

Treasury to consider the budgetary impacts of this important program. 

Sincerely, 

STEPHEN S. MCMILLIN

(For Jim Nussle, Director). 

Enclosure. 

Identical letter sent to the President of the Senate. 

OMB REPORT UNDER THE EMERGENCY ECONOMIC STABILIZATION

ACT, SECTION 202 

The Emergency Economic Stabilization Act of 2008 (Pub. L. 110– 

343) authorizes the Department of the Treasury to purchase and 

insure certain types of troubled assets for the purposes of restoring 

liquidity and stability to the financial system of the United States. 

Section 202 of the Act requires the Office of Management and 

Budget (OMB) to report the estimated cost of assets purchased and 

guarantees issued pursuant to the Act. OMB is required to submit 

the report no later than sixty days after the first exercise of authorities granted under Section 101(a) of the Act, October 6, 2008.1

Consistent the requirement to analyze transactions up to thirty 

days before publication, this report analyzes transactions through 

November 6, 2008. 


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Purchases 

As of November 6, 2008, Treasury had purchased $115 billion in 

preferred stock and warrants for future purchases of common stock 

from eight financial institutions, as outlined in Treasury’s first 

transaction and tranche reports on the Capital Purchase Program. 

The preferred stock is senior to common stock and pays a dividend 

at an annual rate of 5 percent during the first five years and 9 percent after five years. The stock is an equity transaction and therefore has no stated maturity, but the institution issuing the preferred stock can redeem the shares under certain terms. As of November 6, Treasury also had made a commitment to purchase $10 

billion in preferred stock from a ninth institution. Treasury had not 

issued any guarantees of troubled assets. 

Cash Flows and Impact on the Deficit and Debt 

Section 123 of the Emergency Economic Stabilization Act (EESA) 

states that the cost of Treasury purchases under the Troubled 

Asset Relief Program (TARP) are to be estimated under the Federal Credit Reform Act (FCRA) of 1990 (2 USC 661 et seq.), with 

discount rates adjusted for market risks. FCRA requires accrual 

budgeting only for ‘‘direct loans’’ or ‘‘loan guarantees,’’ as defined 

in FCRA. As of the writing of this report, Treasury’s Capital Purchase Program has made equity—not loan—purchases, and has not 

issued guarantees, and thus the cash flows are reflected on a cash 

basis and not on an accrual basis. Table 1 displays the estimated 

impact of these purchases on the deficit and Federal debt as of the 

writing of this report: 

TABLE 1: CAPITAL PURCHASE PROGRAM 

[In billions*] 

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2009– 

2018 

Disbursements ...... 115.0 ............ ............ ............ ............ ............ ............ ............ ............ ............ 115.0 

Stock Dividends, 

Expected ........... ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ................

Redemptions, and 

Exercised Warrants ................. ¥3.9 ¥7.0 ¥6.5 ¥20.2 ¥19.3 ¥16.4 ¥10.4 ¥9.5 ¥8.3 ¥8.8 ¥110.4 

Net Outlays .. 111.1 ¥7.0 ¥6.5 ¥20.2 ¥19.3 ¥16.4 ¥10.4 ¥9.5 ¥8.3 ¥8.8 4.6 

*Components may not sum to totals due to rounding. 

The table shows an initial disbursement of $115 billion in 2009 

to purchase preferred stock. As stated above, this amount corresponds to purchases made prior to November 6, 2008. The table 

also includes the sum of estimated dividend payments that Treasury will receive, estimated redemptions that will occur each year, 

and estimated net proceeds from the exercise or sale of warrants, 

based on the initial disbursement of $115 billion dollars. The table 

shows that redemptions are predicated to increase in 2012 through 

2015, when the incentives are greater for financial institutions to 

redeem shares, including the fact that the dividend rate on the 

shares will increase from 5 percent to 9 percent after five years. It 

also shows that Treasury is expected to recover nearly all of the 


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2For banks that are subsidiaries of bank holding companies (BHCs), dividends on the preferred stock are cumulative, meaning that a bank would need to pay the accumulated amount 

of all unpaid dividends on preferred stock before recommencing payment of dividends to common 

stock holders. For banks that are not subsidiaries of BHCs, dividends are non-cumulative, 

meaning that the bank would not need to make up past unpaid dividends before recommencing 

payment of dividends to common stock holders. The risk of dividend curtailment is substantially 

mitigated for cumulative preferred stock, although it still leads to a reduction in net present 

value due to the time value of money, and a higher exposure in the case of bank closure. 3Short-term risk-free interest rates are based on current Treasury yields. A firm’s financial 

strength and ability to make dividend payments is estimated using a ratio of market value of 

the firm’s total assets (current market capitalization plus total liabilities) divided by total liabilities (as recorded in the most recently available financial statement). The estimate of the 

strength of a firm’s financial position factors in stock price volatility in its calculation. 

$115 billion in disbursed funds in the first ten years of the program. 

See the Alternative Valuation section of this report for an analysis of the cost of the Capital Purchase Program using the net 

present value of the expected cash flows. 

Method for Estimating the Cash Flows of Preferred Stock 

Cash flows to and from the government occur when the preferred 

stock is purchased, when the government receives dividend payments, and when the preferred stock is redeemed (‘‘called’’) by the 

financial institution or sold by Treasury. OMB developed an analytical model to project these cash flows on an annual basis, incorporating the following risks underlying the cash flows: • Credit risk—the risk that closure or failure of the institution 

will forestall the payment of principal (or value of stock sales or redemptions) and dividends to the Treasury. OMB takes this risk 

into consideration by factoring in the strength of the issuing firm, 

as evidenced by its market value. • Call risk—the risk that the financial institution will buy back 

the preferred stock in scenarios where it is relatively cheaper for 

the institution to get financing in the open market, when market 

interest rates are low and therefore the returns on these securities 

are more valuable to the Treasury, and not buy it back in scenarios 

where it is not. Call risk derives primarily from uncertainty about 

Treasury rates and about future levels of credit risk. • Dividend Curtailment Risk—the risk that the institution will 

stop paying dividends. The terms of the preferred shares prohibit 

the institution from paying dividends to common stock holders unless they pay dividends on the preferred stock, but companies can 

forgo dividends on all types of equity including the preferred 

stock.2 OMB takes this risk into consideration by factoring the 

strength of the issuing firm in its cash flow projections. 

The model is probabilistic, meaning that it projects cash flows 

under a number of different scenarios and then weights the likelihood of the different scenarios to obtain the annual expected cash 

flow of the investment. 

The model estimates how cash flows vary depending on 1) current interest rates that affect the call decision; and 2) the strength 

of a financial institution’s assets and net equity position that affect 

dividend curtailment or possible failure (credit risk).3 The component of the model used to determine the effect of interest rates 

builds on models used for other government programs with interest 

rate risk exposure such as Federally guaranteed student loan programs. The component of the model used to determine the effect of 


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4While the term of the preferred stock is perpetual life, the projected cash flows are truncated 

at thirty years for the NPV calculations. 5 A single effective discount rate is a weighted average of the rates used to discount the cash 

flows over multiple periods. Under FCRA, for example, cash flows are discounted using a ‘‘basket of zeros’’ approach where each period’s cash flow is discounted using the yield of a Treasury 

zero-coupon bond of a similar maturity. The single effective discount rate is the one discount 

rate that generates the same subsidy cost as the basket of zeros. 6 It should be noted that these discount rates are based on a snapshot of current Treasury 

rates as of the time of preparing this report, and are not the rates that would be used to value 

preferred stock purchases if they were evaluated under FCRA. Under FCRA, the discount rates 

for credit transactions executed in fiscal year 2009 are based on the economic assumptions used 

to prepare the 2009 Budget, released in February 2008. 

the financial institutions’ strength is based on the model used to 

project bank failures in the context of Federal bank deposit insurance. 

In each of multiple scenarios, the model calculates the optimal 

call decision for each bank, the estimated dividends received by the 

Government, and the probability of each scenario. The result is the 

expected likely cash flows to the government from the preferred 

stock purchases. 

Method for Estimating the Cash Flows of Warrants 

While the call option of the preferred stock benefits the institution, the warrants for common stock that Treasury received as part 

of the transaction benefit Treasury. OMB values and projects the 

cash flows of the warrants using a commonly applied option-pricing 

approach based on the current stock price and its volatility. By 

using the same volatility parameters as used for the preferred 

stock model, the model maximizes consistency between the estimates of the downside risks associated with the preferred stock 

and the upside potential associated with the warrants. 

Alternative Valuation 

Although OMB is reflecting the equity purchases on a cash-basis, 

this report also shows the cost of the preferred stock purchases 

under the Capital Purchase Program using the net present value 

(NPV) of the expected cash flows.4

NPV is calculated under two alternative discount rates. The first 

alternative discounts the expected cash flows using current Treasury yields as of the time of preparing this report, which reflect the 

government’s cost of borrowing. The single effective discount rate 

for these purchases is 3.84 percent.5 The second alternative view 

of the cost of TARP purchases uses a market-risk adjusted rate, as 

outlined in Section 123 of EESA. It reflects the higher rate of return that private investors would demand to compensate for the 

risk that future cash flows may be lower than expected due to 

higher than expected default rates. The single effective discount 

rate with the market risk adjustments is estimated to be 8.79 percent.6

Table 2 shows the estimated cost of the preferred stock and warrants: 


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TABLE 2: ESTIMATED COST OF EQUITY PURCHASES 

[In billions*] 

NPV at the USG’s 

cost of borrowing 

NPV with risk ad- justments 

Expenditure .......................................................................................................................... 115 .0 115 .0 

Present Value of Preferred Stock ........................................................................................ (115 .7) (81 .9) 

Present Value of Warrants .................................................................................................. (11 .8) (7 .6) 

Net Cost (Gain) ................................................................................................. (12 .6) 25 .5 

*Components may not total due to rounding. 

This table shows that under the first alternative (calculating 

NPV at the Government’s cost of borrowing), the estimated value 

of the preferred stock and warrants represents a net gain of $12.6 

billion or 11 percent of the initial disbursement. This means that 

Treasury is estimated to receive on average a rate of return on its 

investment that exceeds the Government’s cost of borrowing, reflecting an estimated overall net gain to the Government in an average scenario. Under the second alternative (calculating NPV with 

adjustments for market risk), the estimated value of the preferred 

stock represents a net loss of $25.5 billion or 22 percent of the initial disbursement. This means that the estimated average return 

on Treasury’s investment will not equal what a typical private investor would demand for an investment facing similar risks given 

the private investor has a higher cost of borrowing. Thus, the return on the investments would represent a net loss compared with 

what would typically be demanded by a private investor. 

Future OMB Reports 

Section 202 of the Emergency Economic Stabilization Act requires OMB to submit a recurring report at least semi-annually. 

OMB may satisfy this requirement in 2009 and future years 

through reporting in the Budget and Mid-Session Review. 

Æ 


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