How the Economic Stabilization Act Worked

In 2008, the United States faced a financial crisis of a magnitude not seen since the Great Depression. The collapse of Lehman Brothers, a global financial services firm, sent shockwaves through the banking system, and credit markets froze. In response, the U.S. Congress passed the Economic Stabilization Act of 2008 (EESA), which was signed into law on October 3, 2008. The act’s most prominent feature was the authorization of the Troubled Asset Relief Program (TARP), which granted the government authority to intervene in the financial sector to restore stability.

Creation of the Troubled Asset Relief Program

The EESA established the Office of Financial Stability within the Treasury Department to implement and oversee TARP. Initially, the Treasury was authorized to purchase or insure “troubled assets” from financial institutions, primarily residential and commercial mortgage-backed securities (MBS). The goal was to remove these assets from the balance sheets of financial firms to restore confidence and unfreeze credit markets. The authority to make new financial commitments under TARP was set to expire on December 31, 2009, though it could be extended by one year.

Major TARP Initiatives

While initially conceived to purchase troubled assets directly, the Treasury quickly shifted its strategy to more direct forms of support. The various programs implemented under TARP reflected this evolution, targeting specific sectors of the economy deemed at risk.

Capital Purchase Program

The Capital Purchase Program (CPP) became the main channel for stabilizing the banking system. Instead of buying troubled assets, the Treasury injected capital directly into financial institutions by purchasing preferred stock. This approach was considered more efficient for bolstering bank balance sheets, allowing them to absorb losses and resume lending. In exchange for the capital, the Treasury received senior preferred shares that paid a dividend, and it also received warrants to purchase common stock in the participating banks.

Automotive Industry Financing Program

The financial crisis also severely impacted the U.S. auto industry. In December 2008, the Automotive Industry Financing Program (AIFP) was created to prevent the collapse of General Motors (GM) and Chrysler. The government determined that an uncontrolled liquidation of these companies would have catastrophic effects on the economy. The assistance was conditioned on the companies undergoing significant restructuring to achieve long-term viability, allowing them to navigate managed bankruptcies and re-emerge as more streamlined operations.

Systemically Significant Failing Institutions Program

Some non-bank financial institutions were deemed so interconnected with the financial system that their failure could trigger a domino effect. The most prominent case was American International Group (AIG), an insurance corporation whose near-collapse stemmed from its sale of credit default swaps. To prevent a disorderly failure, the Treasury established a program for AIG, committing TARP funds through capital injections. This intervention gave AIG time to unwind its complex financial positions in an orderly manner.

Homeownership Preservation Programs

A core cause of the crisis was the collapse of the housing market and the subsequent wave of foreclosures. In response, TARP funded several programs aimed at helping homeowners, the most significant being the Home Affordable Modification Program (HAMP). HAMP’s goal was to prevent avoidable foreclosures by providing incentives to mortgage servicers to modify loans for struggling homeowners. The program worked by reducing a homeowner’s monthly mortgage payment to a sustainable level through steps like lowering the interest rate or extending the loan term.

Executive Compensation Provisions

The Economic Stabilization Act placed restrictions on executive compensation for companies receiving TARP funds to ensure taxpayer money was not used for unjust enrichment. The rules established different tiers of restrictions based on the amount of assistance a firm received. For all recipients, there were limits on tax deductions for executive pay and provisions to “claw back” bonuses paid based on inaccurate financial statements.

More stringent rules applied to firms receiving exceptional assistance, such as AIG. For these companies, the Treasury appointed a special overseer to review and approve compensation structures for the most highly paid employees. Specific prohibitions were put in place to curb practices seen as encouraging excessive risk-taking, including banning or limiting bonuses and retention awards. The act also prohibited “golden parachute” payments for top executives at any institution with outstanding TARP funds.

Oversight and Accountability Structures

To ensure accountability, the Economic Stabilization Act created a multi-layered oversight framework for TARP. This structure was designed to provide transparency through independent audits, investigations, and public reporting, with two key bodies serving as the primary watchdogs.

Special Inspector General for the Troubled Asset Relief Program

The act created the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) as an independent law enforcement and audit agency. SIGTARP’s mission was to conduct audits and investigations into the purchase, management, and sale of assets under TARP to prevent fraud, waste, and abuse. The agency was required to report its findings to Congress quarterly and has been responsible for numerous criminal charges and civil enforcement actions related to TARP fraud.

Congressional Oversight Panel

In addition to SIGTARP, the EESA established the Congressional Oversight Panel (COP) to provide a legislative branch review of the Treasury’s actions. The COP was a bipartisan body tasked with reviewing the state of financial markets and the regulatory system. Its duties included assessing the impact of TARP on the economy and ensuring that foreclosure mitigation efforts were effective. The panel was empowered to hold public hearings and submitted regular reports to Congress before its mandate expired.

Financial Summary of TARP Funds

While initially authorized at $700 billion, the total authority for the Troubled Asset Relief Program was later reduced to $475 billion by the Dodd-Frank Wall Street Reform and Consumer Protection Act. All TARP programs were closed as of September 30, 2023.

Across all its initiatives, TARP disbursed a total of $443.5 billion. These funds were spread across programs for banking stability, the auto industry, AIG, credit markets, and housing preservation. The largest portion, over $204 billion, went to the Capital Purchase Program to stabilize banks. The auto industry programs disbursed nearly $80 billion, while assistance to AIG totaled approximately $68 billion.

The government recovered funds through loan repayments, interest, dividends, and the sale of assets like stock warrants. In total, the government recovered $429.9 billion. After accounting for all disbursements and recoveries, the lifetime cost of all TARP-funded programs was $31.1 billion. This net cost is largely attributable to the homeownership preservation programs, which were designed as grants and not expected to be repaid, while the bank support programs resulted in a net gain.