Taxpayers Will Benefit from JPMorgan's Exit from TARP

The Federal Reserve has asked JP Morgan (JPM) to raise common stock prior to paying back its TARP preferred stock. This was a good move by the Fed which reduces systemic risk.

Joint work by Wendy Yan Wu and myself, “Common (Stock) Sense about Risk-Shifting and Bank Bailouts,” and solo work, “Debt Overhang and Bank Bailouts,” found that $1 of subsidy on a preferred stock recapitalization is equivalent in terms of incentives to $1 of new common stock issued. A greater common stock cushion means that the bank is more likely to make good lending decisions, and is less likely to make bad decisions that lead to bailouts in the future.

I looked at the yields of JP Morgan’s non-TARP preferred stock on June 1, 2009. It yielded about 7.5 percent. The TARP preferred stock pays a 5 percent dividend for the next four and a half years. This means that JPM is giving up a subsidy with a present value of about $2.4 billion by paying back TARP before the TARP preferred stock dividend rises to 10 percent. Buying back warrants is roughly equivalent to repurchasing shares. It reduces the common equity cushion. By my estimates, the JP Morgan warrants were worth about $1.6 billion by the close of trading on Monday, June 1. Suppose that JP Morgan pays $1.6 billion to repurchase the TARP warrants. On net, that means that its common equity cushion has increased by $5.0 - $2.4 - $1.6 = $1.0 billion.

Taxpayers win on two counts. First, the $2.4 billion subsidy is returned by repaying the preferred early. Second, JP Morgan has more, but not much more, common equity and is less likely to make bad decisions that lead to future bailouts.

I don’t agree with Jamie Dimon that JP Morgan should get a half price sale on the TARP warrants. The purchase agreement that he signed says half the warrants will be forgiven if he raised $25 billion of stock. (I already took into account the chance, 14 percent according to my model, that JP Morgan would want to raise the full $25 billion, reducing my valuation of those warrants by about 7 percent.) If he wants half price on the TARP warrants, he should raise $25 billion not just $5 billion of common stock. I’m sure Mr. Dimon won’t agree to give back half his stock options. Nor should taxpayers give away half their warrants. There is no economic justification for such subsidies when JP Morgan can easily tap equity markets. If Mr. Dimon wants to get the government out of his business, he should stop asking for subsidies.

Disclosure: I do not have any long or short positions in any banks' securities except long positions in broad-based index funds.

Comments

[LJKJ3:]

You are misinformed if you think JPM asked for the TARP money, the bank did not ask for subsidies, they were given, and the TARP money was forced on them. In the end the government diluted the common shareholders of JPM so that all the banks were in the same position. Dimon went along as he felt it was the right thing to do, but he never had his hand out asking for money.

Jun 03 07:22 AM

[DONE_SONZ:]

"A greater common stock cushion means that the bank is more likely to make good lending decisions, and is less likely to make bad decisions that lead to bailouts in the future".I don't know about that statement.Shaking the government's watchful eyes by paying back tarp could lead to bad lending or lack of lending decisions too.Who is the lesser of the two evils?The million dollar question?

Jun 03 08:03 AM

[BlueOkie:]

You are smart not to have any long or short positions in banks.

Jun 03 08:43 AM

[John Olagues:]

In March and April , 2008 J.P. Morgan bought Bear Stearns with $55 Billion in Bail Outs to J.P. Morgan. The $55 Billion consisted of two loan facilities from the New York FED. One was a $25 Billion loan to Bear Stearns and another was a $30 Billion loan to JPMorgan. Both were collateralized solely by Bear Stearns assets of dubious quality. $29 Billion of the $30 Billion was a non recourse loan to JPM from the New York Federal Reserve Bank.

During the entire time, Jamie Dimon was on the Board of Directors of the NY FED and is still there today. He is of course the CEO of JPM.

His actions are subject to Title 18 section 208 USC which makes his decisions vis-a-vis the NY FEDs granting those bail out funds to JPM a felony. Just because he hasn't been charged with the crime doesn't lessen the fact that he did it.

Now we find that Dimon is negotiating with the FED and Treasury for a bargain on the warrant re-purchase, while he sits as Director of the NY FED, again a felony under Title 18 section 208.

Where is the FBI and why won't they enforce the law against Dimon.

On Jan 20, 2009 executives of JPM received enormous equity compensation far greater than the amounts alleged to be paid the executives at AIG or Merrill. The value of the equity to the top 15 at the day of grant was over $80 million, which now has a street value of over twice that much as of June 2, 2009.

Dimon himself "bought" over 4 million shares when the stock was in the neighborhood of 20 (now 36). He did not want to show it as an equity grant so the equity position shows as a "purchase". My speculation is that the "purchase" was with a low interest, non-recourse loan from JPM, which essentially is a grant of options.

Can't everyone see that these are merely hogs feeding at the trough, unrestricted by "law enforcement".

John Olagues

Jun 03 10:39 AM

[zaq:]

Congress changed the rules for repaying TARP. Raising $25 billion in equity has not been a reqirement since the change.

Jun 06 08:40 PM

[rjp:]

88.4MM warrants with a strike price of $42.42 that someone estimated were worth $20.20 in late April versus $35 stock - at a 54 vol they were worth that, but today with vol at 39 versus $42, they are worth $21.25 – and 39 vol is still historically too high. JP Morgan Chase can posture all it wants but it knows its stock volatility will normalize over time and that this will work in its favor (and a return to it’s former 38¢ quarterly dividend knocks another $6 off off the warrant’s value). Because of the length of the term left to the options, over 9 years, JP Morgan Chase knows the warrants won’t be exercised for years and will just be traded as an individual issue.

Aug 10 04:44 PM