TARP - Troubled Assets Relief Program

TARP allows the United States Department of the Treasury to purchase or insure up to $700 billion of "troubled" assets. "Troubled assets" are defined as "(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and(B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress."

In short, this allows the Treasury to purchase nonliquid, difficult-to-value assets from banks and other financial institutions. The targeted assets can be collateralized debt obligations, which were sold in a booming market until 2007 when they were hit by widespread foreclosures on the underlying loans. TARP is intended to improve the liquidity of these assets by purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses.

TARP does not allow banks to recoup losses already incurred on troubled assets, but officials hope that once trading of these assets resumes, their prices will stabilize and ultimately increase in value, resulting in gains to both participating banks and the Treasury itself. The concept of future gains from troubled assets comes from opinion in the financial industry that these assets are oversold, as only a small percentage of all mortgages are in default, while the relative fall in prices represents losses from a much higher default rate.

Another important goal of TARP is to encourage banks to resume lending again at levels seen before the crisis, both to each other and to consumers and businesses. If TARP can stabilize bank capital ratios, it should theoretically allow them to increase lending instead of hoarding cash to cushion against future, unforeseen losses from troubled assets. Increased lending equates to 'loosening' of credit, which the government hopes will restore order to the financial markets and improve investor confidence in financial institutions and the markets. As banks gain increased lending confidence, the interbank lending interest rates (the rates at which the banks lend to each other on a short term basis) should decrease, further facilitating lending.

The TARP will operate as a “revolving purchase facility.” The Treasury will have a set spending limit, $250 billion at the start of the program, with which it will purchase the assets and then either sell them or hold the assets and collect the 'coupons'. The money received from sales and coupons will go back into the pool, facilitating the purchase of more assets. The initial $250 billion can be increased to $350 billion upon the President’s certification to Congress that such an increase is necessary. The remaining $350 billion may be released to the Treasury upon a written report to Congress from the Treasury with details of its plan for the money. Congress then has 15 days to vote to disapprove the increase before the money will be automatically released.

The authority of the United States Department of the Treasury to establish and manage TARP under a newly created Office of Financial Stability became law October 3, 2008, the result of an initial proposal that ultimately was passed by Congress as H.R. 1424, enacting the Emergency Economic Stabilization Act of 2008 and several other acts.

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A TARP In The Trillions?

How much to bail out the banks now? $3.5 trillion by one estimate.

A federal program to guarantee or buy bad assets from the ailing U.S. bank sector could come with a $3.5 trillion price tag.

That would push the accumulated costs of rescuing the financial markets over the last year through various federal loan, stock purchase, debt guarantee and other programs close to $9 trillion and counting, with practically no end in sight for the bad news battering the banking industry.

That figure doesn't count the $825 billion economic stimulus plan also under consideration.

"We expect massive federal intervention into the financial sector from the new administration in the coming months," says Keefe Bruyette & Woods (nyse: KBW - news - people ) analyst Frederick Cannon, who calculated the $3.5 trillion figure, which is one-quarter of the banking sector's $14 trillion in combined assets.

So far, more than 200 banks have gotten $191 billion in relief from the $700 billion Troubled Asset Relief Program, according to Keefe Bruyette. About $90 billion of it went to just two banks, Citigroup (nyse: C - news - people ) and Bank of America (nyse: BAC - news - people ).

Just before leaving office, the Bush administration asked Congress to release the remaining $350 billion authorized under the TARP plan, which passed in October.

The new Obama administration will certainly use that money--and ask for more. "The ultimate costs of this crisis will be greater if we do not act with sufficient strength now," said Treasury nominee Timothy Geithner in his Senate confirmation hearing Wednesday. "In a crisis of this magnitude, the most prudent course is the most forceful course."

Geithner, the president of the Federal Reserve Bank of New York who has been in the crucible as the financial crisis erupted over the last year, told the Senators that the TARP needed "serious reform."

The new idea: A federal plan to buy up bank assets, relieving bank balance sheets of the need to constantly adjust deteriorating market values, could come in the form of an "aggregator" bank or other type of bad bank structure--a throwback to the 1980s real estate lending crisis--that would buy assets from banks.

This was former Treasury Secretary Henry Paulson's original vision for the TARP fund, but he switched course and decided to devote $250 billion to direct equity stake investments in banks before waffling again and heading back in the direction of asset purchases.

In November, and again last week, the Treasury agreed to guarantee more than $400 billion of assets at Citigroup and Bank of America.

The availability of federal bank bailout funds attracted other industries, including the automakers, who managed to get $17 billion under the program, and American International Group (nyse: AIG - news - people ), an insurer, which got $40 billion.

Regulators have been trying to calm panicked markets by emphasizing that most banks (98% of the industry according to Federal Deposit Insurance Corp. Chairman Sheila Bair) are well-capitalized.

That doesn't mean they don't need to raise more capital, however, a fact that just about every bank stock analyst has dwelled on in the last few months.

"There is a fear factor," Bair acknowledged in a television interview Wednesday. People don't know how bad the economy is going to get, what the outer limit on these losses could be."

A federal "bad bank" could warehouse billions in deteriorating assets and relieve banks of the need to continually shore up capital. It would come at a steep price to shareholders, however, potentially wiping them out.

But free from the burden on their balance sheets, banks could revive lending, regulators say, and get the economy humming again.