What Was the Emergency Economic Stabilization Act?

In the fall of 2008, the United States faced a financial crisis not seen since the Great Depression. The crisis was rooted in a housing bubble fueled by subprime mortgages, which were bundled into complex financial instruments known as mortgage-backed securities. When the housing market collapsed, the value of these securities plummeted, leaving financial institutions holding trillions of dollars in toxic assets.

The crisis reached a tipping point in September 2008 with the bankruptcy of Lehman Brothers, an event that sent shockwaves through the global financial system and caused credit markets to freeze. In response, Treasury Secretary Henry Paulson and Federal Reserve Chair Ben Bernanke warned Congress that without immediate intervention, the country faced economic catastrophe. This spurred the creation of the Emergency Economic Stabilization Act of 2008 (EESA).

Signed into law on October 3, 2008, the EESA was designed to restore stability to the faltering financial system. Its goal was to halt the escalating panic and unfreeze credit markets. The legislation provided the U.S. Treasury with broad authority to implement programs aimed at strengthening financial institutions and averting a deeper economic downturn.

The Troubled Asset Relief Program

At the heart of the EESA was the creation of the Troubled Asset Relief Program (TARP). This program granted the U.S. Department of the Treasury the authority to purchase or insure up to $700 billion in troubled assets from financial institutions, an amount later reduced to $475 billion by the Dodd-Frank Act.

The initial concept was to buy the illiquid mortgage-backed securities at the center of the crisis. However, the Treasury quickly determined this process would be too slow. As a result, the focus of TARP shifted to making direct capital injections into financial institutions to stabilize the banking system more rapidly.

Capital Purchase Program

The largest of these initiatives was the Capital Purchase Program (CPP), announced on October 14, 2008. The CPP allowed the Treasury to inject capital directly into banks across the nation. Under this program, the Treasury purchased senior preferred shares from qualifying financial institutions, a form of equity that provided the government with a claim on the bank’s assets and entitled it to receive quarterly dividend payments.

In exchange for the capital injection, participating banks issued warrants to the Treasury, which gave the government the right to purchase the bank’s common stock at a predetermined price. This provision was included to ensure that taxpayers would share in any future profits of the rescued banks. The Treasury invested $205 billion in 707 institutions, and these investment programs ultimately generated a profit for the government.

Automotive Industry Financing Program

The financial crisis also severely impacted the American automotive industry. By late 2008, General Motors (GM) and Chrysler were on the brink of collapse due to tightening credit markets and a sharp decline in vehicle sales. The failure of these companies would have had a devastating impact on the U.S. economy.

To prevent this, the Treasury established the Automotive Industry Financing Program (AIFP) under TARP. Through the AIFP, the Treasury provided approximately $80 billion in loans to GM, Chrysler, and their financing arms. This funding was conditioned on the companies undertaking significant restructuring efforts, which allowed the automakers to go through managed bankruptcies and emerge as more competitive companies, at a net cost of about $12 billion to taxpayers.

American International Group Investment

Another intervention under TARP was the assistance provided to American International Group (AIG), a global insurance corporation. AIG’s near-collapse was a significant event in the crisis, driven by its Financial Products division, which had sold huge quantities of credit default swaps—a form of insurance on mortgage-backed securities.

As the value of these securities cratered, AIG faced collateral calls that it could not meet, threatening a cascade of losses throughout the global financial system. To prevent a systemic failure, the government provided an extensive assistance package. Under TARP, the Treasury provided AIG with a capital injection of approximately $68 billion, which was part of a larger federal assistance package that included a line of credit from the Federal Reserve. This intervention resulted in a net cost to taxpayers of about $15.2 billion.

Key Tax Provisions

The EESA was a multifaceted law that extended beyond TARP. Division C of the act contained a number of significant tax provisions aimed at providing relief to individuals and businesses during the economic downturn and stimulating the economy.

A central component of the tax package was a one-year patch for the Alternative Minimum Tax (AMT). The AMT is a parallel tax system that requires some taxpayers to calculate their liability twice and pay the higher amount. The EESA increased the AMT exemption amounts for the 2008 tax year, protecting many families from an unexpected tax increase.

The act also included a wide array of tax extenders, which renewed dozens of temporary tax breaks. These included:

• The research and development tax credit for businesses to incentivize innovation.
• The deduction for state and local sales taxes, benefiting taxpayers in states without an income tax.
• Targeted tax relief for individuals and businesses in federally declared disaster areas.
• Extended and expanded tax credits for renewable energy production and energy efficiency.

The EESA also granted the Securities and Exchange Commission (SEC) the authority to suspend the application of certain “mark-to-market” accounting rules. Financial institutions argued these rules forced them to write down the value of assets to fire-sale prices, and the change provided flexibility in how these assets were valued.

Executive Compensation and Corporate Governance

To address public concern over the use of taxpayer money, the EESA imposed strict limitations on executive compensation for institutions receiving TARP funds. These rules were designed to protect taxpayer interests and curb practices seen as excessive.

For institutions receiving assistance, the law prohibited new employment contracts with “golden parachute” severance payments. It also required that incentive-based compensation be tied to long-term performance to discourage excessive risk-taking, a response to bonus structures that had contributed to the crisis.

The act introduced a “clawback” provision, which required a company to recover any bonus or incentive compensation paid to its senior executives based on financial statements that were later found to be materially inaccurate. This aimed to hold executives accountable for the accuracy of their company’s reported earnings.

The law also established different tiers of restrictions based on the level of assistance a firm received. In the most extreme cases, the Treasury had the authority to approve compensation for the highest-paid employees, giving the government a direct say in pay packages at these firms.

Oversight and Accountability Mechanisms

To ensure the funds authorized by the EESA were properly managed, the legislation established a framework for oversight and accountability. This structure was created to provide transparency and prevent fraud, waste, and abuse in the Troubled Asset Relief Program.

The Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) was established to conduct audits and investigations. Its mission was to track funds and prosecute any criminal activity or civil fraud related to TARP money.

The EESA also created the Congressional Oversight Panel (COP), a bipartisan committee appointed by Congress. The COP’s role was to oversee the Treasury’s implementation of TARP and assess the program’s impact on the financial markets and the economy through its public reports.

A third body, the Financial Stability Oversight Board, was established to advise the Treasury. Composed of the heads of several federal financial agencies, its purpose was to ensure that policies implemented under EESA were coordinated across the government to promote financial stability.