Taxpayers' TARP Warrants Are Worth Billions: Don't Give Them Away

The Wall Street Journal reported on April 22, 2009, that the banks are lobbying Congress to have the U.S. Treasury give away the warrants that taxpayers paid for as part of the Capital Purchase Program.

The two largest banks which have wanted to quickly retire the TARP investments, JP Morgan (JPM) and Goldman Sachs (GS), stand to gain $2.7 billion if the Treasury gives away the warrants. My estimates indicate that despite the fact that these warrants are or have recently been out of the money they are very valuable because they have about 9.5 years before they are exercised. (Options are out of the money if they would be worthless today if exercised.) Over nine years or so, Goldman Sachs’ and JP Morgan’s stock prices could rise substantially to the benefit of U.S. Taxpayers or whoever owns the warrants. It would be a massive loss to taxpayers if the U.S. Treasury retired these warrants for free.

The U.S. Treasury holds 88.4 million of JP Morgan’s TARP warrants. These warrants on JPM are worth $20.20 each or about $1.79 billion according to my estimates. According to my estimates, taxpayers’ 12.2 million warrants on Goldman Sachs are currently worth $74.87 each or about $914 million dollars. I used option pricing models to calculate these figures based on intraday prices on April 22, 2009. I adjusted for dividends and the dilution associated with warrant exercise

Instead of JP Morgan and Goldman Sachs buying (or worse being given) the warrants from the Treasury, it is a better idea for the U.S. Treasury to sell those warrants to 3^rd party investors. Section 4.9 of the Securities Purchase Agreement for the Capital Purchase Program requires the U.S. Treasury to sell the warrants to 3^rd party investors if the issuing bank is not willing to buy them for “fair market value.” Fair market value for the GS and JPM warrants is a lot closer to $2.7 billion than $0.

My research on bank bailouts (such as “Debt Overhang and Bank Bailouts”) indicates that it would be a bad idea for bank regulators to encourage the mega banks to buy the warrants themselves. Buying back warrants or shares reduces banks’ cash cushion and makes them less likely to withstand tough market environments. We don’t want GS and JPM returning to the taxpayer money in the future.

Disclaimer: No one should construe this article as investment advice. The estimates are believed to be reasonably accurate at the time of writing, but they are not guaranteed. Option values can vary substantially from models, and there are many assumptions in option pricing models that may not be borne out. I do not have any long or short positions in any banks' securities except long positions in broad-based index funds.

Comments

[apppro]

Give away 'out of money' warrants? Sounds like reverse M2M to me!

Banks want out of TARP and I don't blame them. I am still convinced that until we resolve the entire "Shorting of America" Crisis, nothing anyone does will help fix a problem that was self inflicted spurred on by narsarssistic short sellers.

BUT UNTIL THEN, all the banks really are in this mess together. What's good for one is good for another, SOOOOOO>>>

Banks want out: then they should be required to BUY the Treasuries stock shares of ANOTHER bank!

Keeps the money in the system.
Banks are now connected.
Government gets their money back, AND

WE ALL CAN MOVE ON WITH RESOLVING THE REAL ISSUE: 'THE SHORTING OF AMERICA'.

2009 Apr 23 07:16 AM

[Old Rick]

One of the problems with the TARP and the warrants is that (according to some bank insiders) a few of the banks (e.g. JPM, WF) did not want TARP in the first place but were arm-twisted by Paulsen to take some to avoid the solvent bank-insolvent bank appearance.

As far as apppro's comment on the "Shorting of America", I think this will continue for at least 2 years and as long as the socialist/marxist anti-business crowd is in charge here at the White House.

2009 Apr 23 09:50 AM

[Allan Frain]

The linked WSJ article reveals that several smaller banks have already paid for to retire their warrants. The Big Banks, through their lobbyists--would like to have theirs returned for free. More of the same. The select group of Big Banks recognize that the only thing that stands between them and the Sovereign Wealth of the US is a paid-for Congress and the most bank-friendly Administration to date.

2009 Apr 24 07:47 AM

[Linus Wilson]

As an update, Clusterstock reports that GS is not one of the banks that thinks the warrants are worthless. See www.businessinsider.co... . A representative from GS says it is committed to pay fair market value for the warrants and they unlike some other banks have never lobbied congress to get out of paying for the warrants. This is response to an earlier story on Clusterstock www.businessinsider.co... .

2009 Apr 24 10:48 AM

[Linus Wilson]

I have updated my valuation of the GS warrants. if the value of Goldman Sachs’ warrants are representative of the value of all the warrants issued in the Capital Purchase Program (CPP), then expunging the CPP warrants would amount to a $5-to-$24 billion dollar additional subsidy to the banking industry at taxpayers’ expense

See my paper at papers.ssrn.com/abstra...

2009 May 07 06:45 PM