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Report to Congress Pursuant to Section 102 of the 

Emergency Economic Stabilization Act 

12/31/2008 

This report fulfills the requirement under section 102 of the Emergency Economic 

Stabilization Act (EESA) for the Treasury Department to report to Congress within 90 

days of the passage of the bill on the insurance program established under Section 102(a). 

Asset Guarantee Program 

Treasury is exploring use of the Asset Guarantee Program to address the guarantee 

provisions of the agreement with Citigroup announced on November 23, 2008. Under 

the agreement, the Treasury Department will assume the second-loss position after 

Citigroup on a selected group of mortgage-related assets. 

As required by section 102(a), Treasury established the Asset Guarantee Program (AGP). 

This program provides guarantees for assets held by systemically significant financial 

institutions that face a high risk of losing market confidence due in large part to a 

portfolio of distressed or illiquid assets. This program will be applied with extreme 

discretion in order to improve market confidence in the systemically significant 

institution and in financial markets broadly. It is not anticipated that the program will be 

made widely available. 

Under the AGP, Treasury would assume a loss position with specified attachment and 

detachment points on certain assets held by the qualifying financial institution; the set of 

insured assets would be selected by the Treasury and its agents in consultation with the 

financial institution receiving the guarantee. In accordance with section 102(a), assets to 

be guaranteed must have been originated before March 14, 2008. 

Treasury would collect a premium, deliverable in a form deemed appropriate by the 

Treasury Secretary. As required by the statute, an actuarial analysis would be used to 

ensure that the expected value of the premium is no less than the expected value of the 

losses to TARP from the guarantee. The United States government would also provide a 

set of portfolio management guidelines to which the institution must adhere for the 

guaranteed portfolio. 

Treasury would determine the eligibility of participants and the allocation of resources on 

a case-by-case basis. The program would be used for systemically significant 

institutions, and could be used in coordination with other programs. Treasury may, on a 

case-by-case basis, use this program in coordination with a broader guarantee involving 

one or more other agencies of the United States government. 
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Justification 

The objective of this program is to foster financial market stability and thereby to 

strengthen the economy and protect American jobs, savings, and retirement security. In 

an environment of high volatility and severe financial market strains, the loss of 

confidence in a financial institution could result in significant market disruptions that 

threaten the financial strength of similarly situated financial institutions and thus impair 

broader financial markets and pose a threat to the overall economy. The resulting 

financial strains could threaten the viability of otherwise financially sound businesses, 

institutions, and municipalities, resulting in adverse spillovers on employment, output, 

and incomes. 

Determination of Eligible Institutions 

In determining whether to use the program for an institution, Treasury may consider, 

among other things: 

1. The extent to which destabilization of the institution could threaten the viability of 

creditors and counterparties exposed to the institution, whether directly or 

indirectly; 

2. The extent to which an institution is at risk of a loss of confidence and the degree 

to which that stress is caused by a distressed or illiquid portfolio of assets; 

3. The number and size of financial institutions that are similarly situated, or that 

would be likely to be affected by destabilization of the institution being 

considered for the program; 

4. Whether the institution is sufficiently important to the nation’s financial and 

economic system that a loss of confidence in the firm’s financial position could 

potentially cause major disruptions to credit markets or payments and settlement 

systems, destabilize asset prices, significantly increase uncertainty, or lead to 

similar losses of confidence or financial market stability that could materially 

weaken overall economic performance; 

5. The extent to which the institution has access to alternative sources of capital and 

liquidity, whether from the private sector or from other sources of government 

funds. 

In making these judgments, Treasury will obtain and consider information from a variety 

of sources, and will take into account recommendations received from the institution’s 

primary regulator, if applicable, or from other regulatory bodies and private parties that 

could provide insight into the potential consequences if confidence in a particular 

institution deteriorated. 
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TARP Accounting and Treasury’s Loss Position

Treasury generally achieves a greater impact per TARP dollar absorbed by taking an 

early loss position over a narrow interval of losses rather than a late loss position over a 

larger range of losses. 

Treasury’s purchasing authority under TARP is reduced by the total value of the 

guaranteed asset less the cash premium received, where the premium is equal to the 

expected loss on the guaranteed asset. If the Treasury collects a non-cash premium – for 

example, preferred shares – the TARP purchasing authority is reduced by the entire value 

of the guarantee until the preferred shares are sold and converted to cash. 

These accounting rules imply that if guarantees for two assets of different values have the 

same expected loss, the larger asset will be more TARP-intensive to insure. For example, 

suppose Treasury has the choice between guaranteeing two different assets, one of which 

is worth $50 and has a 10 percent chance of losing all of its value and the other of which 

is worth $10 and has a 50 percent chance of losing all of its value. For the sake of 

simplicity, the premium in this example will be paid in cash. If the premium received 

equals the expected value of the losses to TARP from the guarantee (thereby meeting the 

statutory requirement), Treasury would collect a $5 premium for guaranteeing either 

asset. However, the TARP purchasing authority would be reduced by $45 for the 

guarantee on the first asset (the $50 covered minus the $5 premium) and just $5 for the 

guarantee on the second asset (the $10 covered minus the $5 premium). Although the net 

expected payouts of the two guarantees are equal, the second guarantee is more valuable 

per dollar of TARP absorbed: covering the first asset uses $9 of TARP per $1 of 

expected loss, whereas the second asset uses only $1 of TARP per $1 of expected loss. 

Because of this feature of TARP accounting under Section 102 of the EESA, Treasury in 

using the AGP will generally take a relatively early loss position over a narrow range of 

losses to provide the greatest protection per TARP dollar absorbed. 

Other Potential Asset Guarantee Programs 

Treasury is reviewing options for the development of other programs to insure troubled 

assets pursuant to the legislation. Two design considerations will be important factors for 

any potential program developed under Section 102: 

(1) Accounting under the TARP purchasing authority: The TARP purchasing authority 

is reduced dollar-for-dollar by the amount guaranteed less the premiums received; the 

expected net payout from the program is not considered for this purpose. This means 

that insuring an asset under section 102 has almost an equivalent impact on the TARP 

purchasing authority as purchasing the same asset (Section 102.c.4). 

(2) Adverse selection: Information on the credit risk underlying a particular asset, 

notably complex assets such as mortgage backed securities, can often be understood 

only through intensive research—and even then, the risk will ultimately depend on 

outcomes such as future home price appreciation that can be forecast only 
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imperfectly. If an insurance program were to offer a set premium for a specific asset 

class – even one that is narrowly defined – it could well be the case that only the 

holders of assets for whom the premium was either appropriate or underpriced would 

buy insurance. By construction, the credit risk associated with the securities that 

would actually be insured at any given premium would be higher than the premium 

would cover. Individually pricing the assets – a resource-intensive endeavor – is the 

only way of achieving an expected net payout of zero. In practice, this means that 

setting the pricing of the insurance premiums will inevitably require particular 

assumptions and judgments; the ex-post financial outcome involved with the 

guarantees could deviate substantially from the ex-ante actuarial analysis—for better 

or for worse. 

To assist in the consideration of programs under Section 102, the Treasury issued Federal 

Register Notice (Docket # TREAS-DO-2008-0018 posted 10/16/2008). Treasury asked 

for comment on programs consistent with Section 102 of the Emergency Economic 

Stabilization Act of 2008 (EESA). Treasury particularly invited comments on the 

appropriate structure for such a program, and whether the program should offer insurance 

against losses for both individual whole loans and individual mortgage backed securities 

(MBS), as well as the payout and triggering event, estimation of losses, and setting the 

appropriate premium. A summary of the comments received is attached next as an 

Appendix to this report. 
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Appendix: Summary of Responses to Request for Comments 

Treasury received 85 responses to the Request for Comments from a wide variety of 

respondents, including individuals, academics, financial institutions, municipalities, and 

trade groups. Many submissions chose to urge the eligibility of the represented group to 

EESA-related programs rather than to outline an insurance program structure. 

The responses to the Request for Comments largely envisioned a standard insurance 

program, in which the Treasury would offer a guarantee on some portion of the principal 

and payments from a security in return for a premium. The respondents recognized the 

difficulty associated with setting prices for these premiums, but argued that in order to 

avoid adverse selection, premiums for the securities must be priced either individually or 

on pools of homogeneous assets. Several respondents commented that a guarantee 

program could offer greater flexibility than asset purchase programs in structuring timelimited or partial support (by incorporating loss-sharing, for example). 

Respondents expressed differing view along two important dimensions of the program: 

the assets that should be eligible and the share of the assets that should be insured. 

Proposed structure of guarantee 

Most respondents focused on guarantees of existing individual loans or MBS. In 

guaranteeing whole loans, Treasury would receive insurance premiums and pay the insured 

(the owner of the mortgage loan) for a realized loss relative to principal and future interest 

payments due on the mortgage loan. Factors that would affect the premium include the 

degree of loss coverage (co-pay), the size of the deductible, and loan characteristics. 

In guarantees of pools of existing loans owned by financial institutions, Treasury could, in 

exchange for a premium, purchase any loan that reaches a certain level of delinquency at a 

predetermined price. Alternatively, Treasury could offer to share loss on a loan, once the 

institution carried the loan through appropriate workout adjustment including foreclosure. 

Other proposed structures included: 

• Limiting participation in the insurance program to institutions that successfully 

execute a private capital raise. 

• Conditioning participation on foreclosure mitigation efforts. 

• Guaranteeing securitizations of whole loans or MBS 

o In return for a fee, Treasury would purchase existing loans or MBS pools, issue 

securities backed by these assets, and guarantee principal and interest on 

securities if an institution that issued the loans in the pool defaults. 
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o This could be made operational through an SPV set up to purchase and hold the 

assets and issue short- and medium-term obligations against them, with Treasury 

guaranteeing the performance of the SPV securities.

o This securitization and pool guarantee could be applied to shorter-term securities 

that are also troubled due to market seizure, for example asset backed commercial 

paper (ABCP). 

o There is a question of whether this satisfies the statute, which states that the 

guarantee must apply to assets originated before March 14th, 2008. The 

guaranteed assets, in this case, would be payments from a securitized pool issued 

through the SPV, not the assets underlying these pools.

• Guaranteeing severe loss for insurance entities holding portfolio credit risk. For 

example, rather than guaranteeing individual assets, the program could compensate 

holders of MBS or mortgage loans for losses in excess of a threshold in exchange for 

a fee. 

• Issuing derivatives correlated with the performance of an existing index of mortgagerelated credit. For example, the Treasury could sell put options on the ABX index, or 

link payout to an existing house appreciation index such as the Case-Shiller index. 

This structure allows institutions to hedge their exposure to aggregate risk associated 

with the assets in their portfolios but not asset-specific risk. 

o For the institutions’ capital position to be improved by this program the 

derivatives must qualify as “highly effective” hedges – their performance 

must be highly correlated with the performance of the hedged assets. 

Eligible assets 

Respondents generally commented that the guarantee should be offered where it may be 

more efficient than asset purchase under Sec. 101. Respondents suggested that 

performing but illiquid assets – such as senior tranches of non-agency residential and 

commercial MBS, performing whole mortgage loans, ABS (credit card, auto loans, and 

student loans), auction rate securities (ARS), and municipal bonds – would be most 

suitable for such a program. 

The assets that received the most attention were whole residential loans and residential 

MBS. 

Determining risk and pricing premiums 

Respondents uniformly agreed that – no matter which assets are insured in this program – 

pricing is a monumental task that will almost certainly have to be contracted out. 

Respondents suggested that Treasury use the methods and models standard in the 

industry to determine risk. No feasible alternative to individually pricing the assets was 

offered. 
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Payout 

Most respondents suggested paying out 100 percent of principal and expected interest, or 

some portion thereof. Arguments in favor of each were as follows: 

100 percent of principal and expected interest: The higher the guarantee the government 

provides, the more liquidity and confidence will be restored to the market. Most 

respondents favoring this structure argued that the 100 percent guarantee should be 

applied to the current value of the asset, on an expected cash-flow basis, rather than the 

original value of the asset. 

A portion of the principal and expected interest: Guaranteeing less than 100 percent 

ensures that the participating institutions share in the loss, thus incentivizing them to 

pursue all their loss-mitigation options. Institutions holding whole loans and MBS with 

deductibles or other loss-sharing mechanisms would be far more likely to attempt to 

restructure those loans. 

Respondents suggested either guaranteeing a fixed percentage of the original value of the 

asset, regardless of the current expected cash-flows, or guaranteeing a fixed percentage of 

the current value of the asset, as measured on an expected cash-flow basis. 

Several respondents suggested that the level of guarantee should reflect the broad risk 

characteristics of the asset class. For example, a higher level of coverage should be 

available for senior tranches of MBS than for junior tranches, and residential mortgages 

should be insured at a higher level than incomplete residential development projects. 

Setting premiums 

Premiums should reflect the risk of default and total losses for the insured assets. 

Respondents agreed that premiums will vary for different classes of assets to reflect the 

risk and total credit loss associated with that asset class. The majority of respondents 

recommend pricing the premiums either on an asset-by-asset basis or on a homogeneous 

pool of assets and periodically re-evaluating the assets and premiums as the program 

continues. 

The premiums can either be paid up front as a lump sum or periodically. Respondents 

cited the flexibility of periodic payments as a desirable feature; the premium can be 

adjusted based on long term performance, actual loss, and improvements. 

Market value of the guarantee 

Respondents argued that making the guarantee transferable is essential to establishing 

liquidity to the market this guarantee program is targeting. The guarantee should be 

attached to the asset and transferred to the asset’s new owner when the asset is sold. 
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Administrative issues 

Management of the program, including premium setting, determination of institution and 

asset eligibility, and extensive monitoring of guaranteed institutions and assets will be 

complex and resource-intensive. Most proposals recommend Treasury seek outside 

expertise in accounting, insurance, pricing, and administration.