Bank of America's Gain Is Taxpayers' Loss 32 comments
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By James Kwak
I’m trying to figure out if I should be infuriated about the agreement allowing Bank of America (BAC) to walk away from the asset guarantees it got as part of its January bailout in exchange for a payment of $425 million. I can piece together part of the story from The New York Times, Bloomberg, and NPR, but the complete story is a bit hazy.
The initial deal was that Treasury, the FDIC, and the Fed would guarantee losses on a $118 billion portfolio of assets; B of A would absorb the first $10 billion and 10% of any further losses, so the government’s maximum exposure would be about $97 billion. Part of that guarantee was a non-recourse loan commitment from the Fed, basically meaning that the Fed would loan money to B of A, take the assets as collateral, and agree to keep the assets in lieu of being paid back at B of A’s option. In exchange, the government would get:
(a) An annual fee of 20 basis points on the Fed’s loan commitment, even when undrawn (if B of A drew down the loan, which it didn’t, it would pay a real interest rate). The loan commitment could be interpreted to be only $97 billion, so this comes to $194 million per year.
(b) $4 billion of preferred stock with an 8% dividend. That’s a dividend of $320 million per year; B of A can buy back the preferred stock by paying $4 billion.
(c) Warrants on $400 million of B of A stock. B of A was at $7.18 the day the bailout was announced and yesterday it closed at $17.61, so if Treasury had gotten an exercise price of $7.18, those warrants would be worth about $580 million now.
Now, at this point I was furious, but then I found this provision in the term sheet:
“Institution has the right to terminate the guarantee at any time (with the consent of USG), and the parties will negotiate in good faith as to an appropriate fee or rebate in connection with any permitted termination.”
The question is, what does this mean? As far as the Fed loan commitment, it’s clear: Bank of America can walk away from that. Since they had the loan commitment for about nine months, their fee should be about 9/12 of $194 million, or $145 million. I’m fine with that.
But what about the preferred stock and the warrants? Is B of A getting all that back as part of the $465 million payment? The news stories aren’t specific on this point, but I’m pretty sure B of A is getting it back. I say that because all three stories refer to the government holding $45 billion of preferred stock in B of A. That $45 billion is quite clearly the $25 billion cash investment from October and the $20 billion cash investment from January – which implies that the $4 billion in preferred stock that Treasury got in exchange for the asset guarantee is gone.
B of A’s position must have been – actually, I’m having a hard time making their position in a reasonable way, because it’s so untenable – something like this: “In January, we all thought we would need that guarantee for a long time, and that’s why we gave you $4 billion in stock for it, but now it turns out we don’t need it, so let’s pretend we never gave you that stock.”
But this is clearly ludicrous. The deal was very clear. The government did something for B of A. In exchange, B of A gave the government $4 billion in stock. If the idea had been for the government to get, say $400 million in stock for each year the guarantee was in force, then that’s what they would have written into the term sheet. The economics of the deal were also very simple. B of A was in trouble; only the government was willing to give them an asset guarantee; that guarantee was worth at least $4 billion to B of A, and probably a lot more; so the government got $4 billion worth of stock.
So I’m still left wondering what this could mean: “the parties will negotiate in good faith as to an appropriate fee or rebate in connection with any permitted termination.” If I’m the government, I’m thinking: “I gave you something that was worth $4 billion at the time; you gave me $4 billion. Now you don’t want the thing I gave you; fine, throw it away. But what’s to negotiate? You already got something worth $4 billion.”
So the government negotiators should have been asking for $4 billion, plus nine months’ worth of dividends ($240 million), plus the value of the warrants ($580 million), plus nine months’ worth of the loan commitment fee ($145 million), for a total of $4.965 billion. But what did they ask for? According to an earlier (no longer available except in Google search results) version of the Bloomberg story, regulators were asking for “$300 million to $500 million.” And they got $425 million – which is basically the loan commitment fee plus one year of dividends on the preferred stock, meaning they got nothing, nada, zilch for the preferred stock or the warrants.
What possible explanation is there for this? Here are a few:
(1) B of A somehow convinced the government negotiators that the deal was really for $4 billion over some period of time, and hence the government didn’t have a right to it, no matter what the term sheet said.
(2) That “negotiate in good faith” clause was meant all along as a way for B of A to get out of the deal. That is, in January the government wanted to claim for PR purposes it was getting $4 billion in exchange for the guarantee, but nudged B of A and said that if things worked out, it wouldn’t actually be $4 billion.
(3) B of A threatened to go even more public with the claim that it only closed the Merrill Lynch acquisition under government pressure (remember, this asset guarantee was widely believed to be a quid pro quo for closing Merrill – see the Bloomberg headline, for example), and the government didn’t want that episode in the news again.
(4) As Bloomberg reports, “while the guarantee was announced in January, an agreement was never signed.” Wait a second. The deal was never signed? What? Why isn’t this a front-page scandal? Remember, the announcement of the guarantee bolstered confidence in B of A’s survival. (It may not have been good for the stock price because of the dilution, but it was a signal that the company would not be allowed to go bankrupt.) Even if nothing was ever signed, there is no way the government would have been able to back out after going public with the guarantee. So the taxpayer was committed. And somebody forgot to get B of A to sign the piece of paper? Or was this a conscious oversight to make it easier for B of A to get out of the deal later?
OK, now I’m infuriated. Shouldn’t you be?
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This article has 32 comments:
Unfortunately, there are some missing details, but this is a very nice analysis of the information that is available.
Big Jack58,
With the exception of the comment about B of A being strong-armed into buying Merrill, you are in a fantasy world. B of A was provided with a $100B liquidity facility backed by toxic and extremely illiquid assets. Without the governental backstop, B of A was beyond history whether or not they went through with the Merrill purchase.
Your reliance on the BAC announcement that they would never use the guarantee is amazingly gullible. BAC admitting a need for the facility would have been about as likely as Bear truthfully declaring that they were experiencing a run on the bank as it was happening.
If Congress could pass out up to $700B in TARP funds without even a stipulation that the money had to be loaned out, I will believe any ineptness regarding paperwork and contract terms.
With perfect hindsight, when things calm down, it's easy to ask for a change in the terms asked for when all hell was breaking loose.
If you try this in Vegas at the blackjack table, you get a broken arm.
Big Jack,
The ones being milked are the tax payers, the ones being advantaged are the ones who made the mistakes originally.
Rewarding failure, is a recipe for more & greater failure!
As an aside, Ritholtz' book and James Stewart's piece in last week's The New Yorker are the two best things I've read on the meltdown, FWIW.
And, Mr Chang, you're right. Much of the harshest criticism of President Obama is more than likely racially motivated and can be discounted. However, unlike most of Asia which is experiencing a very sweet economic boom, the only sweetness in America is happening on Wall Street. Main Street, however, is in the throws of a bonifide depression with tent cities and joblessness springing up all over. You might consider that Americans, rather than complaining too much, are simply complaining about the wrong things. It is my understanding that over in China for example, white collar criminals who cheat the citizenry are arrested and perhaps even executed. Over here they are given multi-million dollar bonuses. See anything wrong with this picture?
And Main Street America is also aware of the mockery in the world toward us. But we suspect that it changed to 'aghast' when our leaders paid Americans to buy new cars while not giving even one penny to single payer health care.
As for preventing a world-wide financial melt-down, stay tuned. Zimbabwe printed money to pay down their debt and ended up having to abandon their currency. You'll notice that all of our ivy league educated economic wizards in Washington are using this same 'banana republic' monetary policy to paper over this financial crisis in order to simply postpone it. You see, the rules in any Ponzi Scheme is that the last one holding the bag of trash has to reconcile it. And the target bag holder was China until the Central Committee gave permission to the affected State-Owned-Enterprises to chose to default on their now worthless derivative contracts. Now GS and UBS and Morgan Stanley are frantically trying to find new investors (Read 'suckers') to take their bag of trash before they're caught with it before the end of the year. Despite the ad campaign stating the they're doing an honorable thing divesting themselves of all derivatives by the end of the year, it was China that forced them into to it. And for that I want to say thank you. They're going to take a much deserved bath.
Rip Off!!!!!!!!!!!!!!
Since his inauguration last November Obama has been doing a lot of talking but, when his comments are analyzed, it becomes clear that his comments sound good but don't hold up to scrutiny. Like many politicians, he speaks in half truths and feel good slogans. What he says may sound good to other countries but they don't have to pay our debts or taxes. They don't have to live with Obama's mistakes. They don't fully understand that since becoming President Obama has given many Americans the impression that he was trained by a "snake oil salesman" and the medicine he is selling us seems to be expensive, useless in the short term, and in the long run harmful because the problems have not been attended to.
This is total BS and ya'll know it. All of this BS is turning us into a 4th world nation. Wake Up, America !!
The real rip-off is that the banks are all sticking it to the public by charging high rates and fees while paying almost zero and keeping obscene bonuses. I would create a special heavy tax on Financial service companies profits and bonuses.
The other problem we have in general is lack of shareholder control of companies. Shareholders, especially non-preferred, have been totally ripped by USG and company managements.
Create true resolution authority for the BF's. If one of them is failing, FDIC or something similar takes them over and liquidates them, making sure the innocent get their deposits back.
But we should all be just as furious about AIG, and I see very little coverage on that. Goldman Sachs gets paid 100 cents on the dollar from AIG, then turns around a has huge profits and the bonuses that go with it. What if GS had gotten 10 cents on the dollar? What would their profit be? Yes, they had an AIG failure hedged, but, (and here is the 185 billion dollar question) if AIG had failed, would those counterparties have been able to pay GS 100 cents on the dollar. I very strongly suspect that GS would have gotten a much smaller payoff. The writer who can prove that gets a Pullitzer, because it looks to me like Goldmans profits, and most of the profits of the big Financials this year, came from the US Treasury.
You wrote:
"...has been well reported for several months..."
I have to disagree with your criticism. Outrageous events deserve to be reported again and again. If fact, they need to be reported frequently and not to be forgotten after a few months.
James - - -
I'm with you. I'm still trying to figure out the subtleties of this situation. The obvious features are not credible. I fear that the more sinister possibilities (such as collusion, cover up, etc.) are very possible.
On Sep 23 02:33 PM Big Jack58 wrote:
> No, I'm not infuriated.This was another mechanism the governement
> was using to try to milk money out of one of our largest financial
> institutions. And we can count on the inept government lackies to
> fail to get the documents signed (which has been well reported for
> several months, but it took this author until now to figure this
> out). Additionally, in it's quarterly meeting for Q1 in April, BAC
> announced they would never leverage this backstop because the terms
> would cause the price to be paid by BAC to be greater than any backstopping
> they would receive (but the author failed to call into that analyst
> meeting and hear any of this). Being a shareholder, I'm furious at
> our sleezy government because BAC received nothing in return for
> their $425 million payment for backstopping ... again, nothing was
> backstopped. So let's see: Sept 2008 the gov't highly encourages
> BAC to buy a failing ML in an attempt to save the economy the gov't
> couldn't save themselves; Dec 2008 the gov't threatens BAC to not
> back out of the deal nor leverage the MAC for a cheaper price on
> the merger; Jan 2009 the gov't, as consolation to BAC for a forced
> merger, decides to throw $20 billion in loans at 5.5% interest along
> with a scheme to backstop several billion that would never materialize
> (given they had $45 billion in TARP); Summer 2009 the gov't blames
> the recession on BAC, changes it's board and management teams and
> forces lending practices that provide handouts to irresponsible consumers
> (at the expense of the bank's profits and the shareholders' gains).
> It's obvious our gov't is no longer the leach we thought it was ...
> its a full sized vampire.
Folks , The whole damned economy , financial system IS going to implode by year end or sooner . No doubt about this . ALL the capital has been vaporized , as it was Hugely leveaged . The federal government , FDIC , Banks are insolvent . Please Prepare or be Toast !
Treason: 1. A crime that undermines the offender's government.
Of course if the government is not an actual entity separate from the bankers...well then, nevermind....
The demand for $245k for a note that is seven years old, paid to date with NO late payments and never a missed or partial payment. My employees got unemployment and my retirement got gutted.
The demand for the building mortgage because I couldn't come up with $245k in ten days in March (when my retirement assets were at all time lows).
Increased interest rates and lowered credit limits and a couple paid off accounts closed. Which lowered my FICO score and caused them to "reassess" my credit AGAIN.
Oh yeah, I forgot, NO bank on god's green earth that is willing to lend a 25 year old manufacturing company one red cent.
That, is what I, and thousands of other customers received.
Seems fair considering that BoA got multimillion dollar bonuses and increased stock value on a bankrupt company.
On Sep 24 08:40 AM violinist wrote:
> I am not surprised at this turn of events, and anyone that is doesn't
> have any clue about what is going on between wall street, the banking
> industry and the good old usgovt. The banking industry and wall street
> caused this massive mess and the gvt stepped in to bail them out.
> Wall street and banks control the gvt and congress. Hasn't anyone
> figured this out yet!! Duh!! Former and present treasury sec wall
> street exec, and half of the executive branch wall street exec. Come
> one. BofA needed the cash, now that the're away from the fault line
> they just back out. So what else is new in this mess??/ The writer
> is infuriated, but shouldn't be. Its almost predictable. What should
> be infuriating people, and doesn't seem to be is that the common
> people, don't get a thing from this. We're paying the bill and get
> nothing from this except feeble excuses and promises, that will be
> broken guararnteed, that this will never happen again. Yes and the
> sun will rise in the west and set in the east!!! This is all a joke
> on us , and most haven't figured this out. Wake up , people, your
> being used to make some rich and it wont stop. Your gvt doesn't care
> about you at all. Why should they??? They're make a mint off you
> and you don't stop it. You walking around with blinders on and that
> is pathetic. Wake up. Your being used . This wont stop until you
> stop it.!!! There is more crap going down , this is just the beginning.
No business tax is "neutral" it all gets passed down to the customer. Every single penny PLUS the profit margin needed to make the extra profit.
The reason the country is run by the major corporations is precisely because of our obscene corporate taxes and regulations.
If we the people paid our fair share then Congress would listen to us.
Instead they listen to the true taxpayers and the campaign contributors. Not we the people.
On Sep 24 01:12 PM User 321716 wrote:
> Too many back-door deals done in a panic is going to lead to some
> questionable back pedaling later. Maybe this is B of A's payoff
> for being pressured into buying Merill Lynch.
>
> The real rip-off is that the banks are all sticking it to the public
> by charging high rates and fees while paying almost zero and keeping
> obscene bonuses. I would create a special heavy tax on Financial
> service companies profits and bonuses.
>
> The other problem we have in general is lack of shareholder control
> of companies. Shareholders, especially non-preferred, have been
> totally ripped by USG and company managements.
On Sep 24 09:30 AM HChang wrote:
> Seems that some americans like to complain, no matter what. They
> complained about Obama helping the banks (while missing the big
> picture that if that was not done, it will lead to a global disaster),
> now they complained about BAC. I see the whole issue differently:
> Obama has done a great job by avoiding a global crisis while making
> some nice money along the way for americans. They need to learn to
> be grateful and thankful to this great president. I'm not an american
> and Obama's reputation overseas had soared because of his wisdom.
> If it was Bush, good luck to America. He will spend all the money
> on starting a war, somewhere, with zero returns and many american
> killed. I'm also not politician, I just want to speak what many overseas
> countries think about your current president. He's under a lot of
> stress trying to rescue your country but had been criticised endlessly.
> What a mockery.