An Unwarranted Sweet Deal for TARP Repayments

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 |  Includes: BAC, C, JPM, WFC
by: Zacks Investment Research

By Dirk van Dijk, CFA

Many of the banks want to repay the TARP funds. One of the things that the government got for its largess was warrants at each of the banks, in addition to the preferred stock (at a rate well below market -- a sweet deal that meant that we the taxpayers were immediately in the hole to the tune of $76 billion on the first $350 billion doled out, according to Elizabeth Warren, the head of the Congressional oversight panel for TARP). A warrant is like a long-dated option contract. Bloomberg has this little tidbit:

Banks negotiating to reclaim stock warrants they granted in return for Troubled Asset Relief Program (TARP) money may shortchange taxpayers by almost $10 billion if Treasury Secretary Timothy Geithner’s first sale sets the pace, data compiled by Bloomberg shows.

While 17 financial institutions have repaid TARP funds, only two have come to terms with the U.S. on the value of the rights to buy stock that taxpayers received for the risk of recapitalizing the industry. The first was Old National Bancorp in Evansville, Indiana, which gave the Treasury Department $1.2 million last week for warrants that may have been worth $5.81 million, according to the data.

If Geithner makes the same deal for all companies in the rescue program, lenders may walk away with 80 percent of profits taxpayers might have claimed.

For once we’d like to get a fair value when we come into contact with the banking system,' said Representative Brad Miller, a North Carolina Democrat and chairman of the Investigations and Oversight Subcommittee of House Science and Technology Committee. 'We don’t want a ruthless bargain.'

Under the Old National warrants formula, Bank of America Corp. (NYSE:BAC) would save $2.03 billion, followed by Wells Fargo & Co. (NYSE:WFC) at $1.48 billion and JPMorgan Chase & Co. (NYSE:JPM) at $1.46 billion. Morgan Stanley’s (NYSE:MS) benefit would be $983 million, (NYSE:C) would come in at $965 million and Citigroup Inc.’sGoldman Sachs Group Inc. (NYSE:GS) would have $693 million, according to the data compiled by Bloomberg.

This is simply incomprehensible to me. I agree with Rep. Miller, we can’t make a bad deal for the taxpayers get any worse. If the Treasury wants to get rid of the warrants, it should sell them off in the open market, not negotiate with the banks. That way the taxpayers would be far more likely to get the true value rather than just one more huge raid on the Treasury.

Also, if the warrants were sold on the open market, they would remain outstanding, which means when they were exercised, the bank would get more capital, while buying them back depletes their capital. Given the generally undercapitalized state of the banking system, more capital is better than less capital, even if it means potential dilution to the bank shareholders. We need a strong banking system -- the government has no interest one way or the other in the eventual level of any given bank's share price (especially if it does not have the warrants any more).

Memo to Geithner: You now work for the U.S. taxpayers, not the banks like you used to when you were heading up the N.Y. Fed (100% owned by the banks). You have a responsibility to get as much as possible for government assets when you sell them off. Given the massive size of the deficit, we could use that $10 billion. Either sell them on the open market or keep them and see if they will be worth substantially more in three or four years. If the banks don’t like it, so what? Screw 'em.