Look What We've Had All Along: The Paulson Plan to Purchase Bank Equities

Apparently the government has woken up and decided to move forward with a plan to take equity stakes in the nation's banks:

(From the Associated Press): WASHINGTON - Treasury Secretary Henry Paulson said Friday that the Bush administration will move ahead with a plan to buy stock in financial institutions.

Paulson said the program to purchase stock in financial institutions will be open to a broad array of institutions.

The administration received the authority to make direct purchases of stock in banks in the $700 billion measure Congress passed last week to rescue the nation's financial system.

It would mark the first time the government has taken equity ownership in banks in this manner since a similar program was employed during the Great Depression.

Paulson announced the administration was moving forward with the program during a news conference at the conclusion of discussions among finance officials of the Group of Seven major industrialized countries. That group endorsed the outlines of a sweeping program to combat the worst global credit crisis in decades.

"As we develop plans to purchase equity ... we are working to develop a standardized program that is open to a broad array of financial institutions," Paulson said in a statement.

Paulson said the government's program would be designed to complement the efforts of banks to raise fresh capital from private sources. He said that the government's stock purchases would be of nonvoting shares so that the government will not have power to run the companies.

The purchase of equity stakes in companies would be in addition to the main thrust of the $700 billion rescue effort, which involves purchasing distressed assets off the books of financial institutions as a way of unthawing frozen credit markets and getting banks to resume more normal lending operations.

Paulson told reporters the administration was moving "swiftly and thoughtfully" to implement the new rescue package.

The administration is expected to start making announcements next week of the private sector asset management firms that will be selected to help run the program.

Hey, better late than never; I'm quite pleased that Paulson is shifting gears a bit and deciding to allocate some funds towards equity investments into the banks, as it I think it's a vastly superior recapitalization strategy. Perhaps the performance of the Dow over the past week has been the resounding critique that the administration needed in order to encourage them to shift gears. My only concern (at this point) is the funds allocation between direct investments into the banks and TARP's purchase of mortgage securities, because (at this point) it appears that Paulson is still committed to purchasing mortgage securities as part of a banking bailout plan.

Finally, isn't it a bit odd that TARP quietly included a provision for the purchase of equity stakes in bank, yet the administration and the politicians in favor of the bill never mentioned it and focused entirely on the aspects of the bill focused on purchasing mortgage securities? Especially when many of the plan's most vocal critics favored equity investments in the banks, and mentioning the provision for equity investments would've made it easier to sell the plan to Wall St., the public and other politicians?

Better yet (especially in light of the market's recent performance) it would've been smarter to just sell the plan as a $700 billion appropriation of money, which could be used in a multitude of ways to stabilize the banking system: direct loans, equity investments, debt guarantees, asset purchases, etc, instead of just focusing on one strategy.

But that's just me being a professional critic; at this point I'm just glad the administration is moving forward with the equity investment plan. Let's hope that they eventually abandon the asset purchase plan all together.

You can read more here.

Source: The Associated Press (via Yahoo News):"Paulson endorses bank stock purchase plan" -- Martin Crutsinger, October 10, 2008.

Disclosure: At the time of publishing the author didn't own a position in any of the companies mentioned in this article.

Comments

[Serious Sue:]

I agree. The TARP program is flawed. The gov't could use incentives to help restart MBS market. They should also eliminate the captial gains tax on equities to spark buyers in the market.

2008 Oct 11 08:47 AM

[John Pseudonym:]

This is life support for the dead.

It's the end of the American Debt era. No longer will the world give us credit so we can go out and buy things we can't afford.

Not sure what this new world is going to look like, but I am sure that at the center will be the USA slaving away to pay back whatever it can to the nations that foolishly gave us way to much credit.

2008 Oct 11 10:13 AM

[icandoitdon:]

no, it isn't odd that paulson didn't promote the equity inverstment alternative and i can tell you why. it is anathama to the banking industry to do this. they want to offload their toxic crap on taxpayers at inflated prices to clean up their balance sheets and they're unwilling to give a damn thing for it, as if it's their birthright to be protected from further losses.

it was obvious to anyone except the brain dead that equity investments were the sensible alternative since it feeds needed capital to banks while allowing taxpayers to share in upside from assuming the risk of ownership and keeps the toxic crap on the books of the entities that originated it or invested in it, which is exactly where it belongs.

that paulson didn't want to do this speaks for itself....he's a shill for the industry. good riddance to paulson...he's a menace. as far as bernake is concerned, obama's first act should be to fire this incompetent idiot and i'll tell you why.

for years the fed has mismanaged risk in this economy. it has systematically underpriced debt capital by keeping the federal funds rate too low. tying the fed funds rate to inflation is inappropriate bercause any dummy understands that inflation has been understated for years. real interest rates have been negative for much of this decade.in order to prop up borrowing and spending...the root of this crisis. negative real rates is never an appropriate policy response to a business slowdown.

banks won't lend because they aren't being paid enough to assume the risk of default, which they know is high. would you accept 5 or 6% returns on loans to institutions if you fear getting paid back? of course not. neither will they. ever wonder why credit card companies typically charge 12-18% on revolving credit? because it covers the cost of all the deadbeats out there. look for banks to do the same with commercial lending.

capital is a precious resource in a financial crisis and it will remain that way because the jig is up. when normalcy returns to the financial markets debt capital will be available only at a price that properly discounts risk, fed funds rate be damned. thats how it should be.

2008 Oct 11 10:16 AM

[Realista:]

If U.S. Treasury purchases bank stocks and becomes member of Board of Directors...... will Government Control be far behind?

Will Federal Shares voted "Have Sovereign Immunity"?

2008 Oct 11 10:30 AM

[fhall:]

what will happen to common shares if this happens

2008 Oct 11 10:34 AM

[Confederacy...:]

Another alternative would be for Beranke, Greenspan, Paulson, Dodd, Frank, Bush, Pelosi, Obama, McCain et al, the Fed, Congress, and Treasury Dept.to stay at home and play with Legos and drink Nestle's Quick since they can do way less harm that way. I'm not sure we can survive any more "help" from these clowns. The whole situation is beyond nauseating.

Most of the complicit bankers in this fiasco should be put in jail for violating their fiduciary responsibilities to their shareholders, rather
than bailed out by their prep school and Ivy League roommates working in Washington. Another nice touch would be a large brightly colored dunce cap, required for 10 years so nobody does business with them. Sheesh.

2008 Oct 11 10:34 AM

[whidbey:]

Come on! The bank share buy by Treasury is a "put" to the US taxpayer. Management goes out the door, as does pride, confidence and the whole damned future. There is no plan (TRAP), this is all public relations and it will morph into whatever the next crisis demands; it is the monster from Washington that just won't die.

2008 Oct 11 11:46 AM

[Getridofthe...:]

Agree. We have been through this before. We need to recapitalize the banks, as a vast amount (> 50%) are insolvent. The math is simple: on average 35% of banks total assets are in mortgages. Mortgages have declined in value by roughly -16% (note: take as an average the 2006 vintage as reported by Case-Schiller; take as average 2008 Case-Schiller; difference as % of 2006 average as proxy for decline). JPM and other estimate at least another 8% to go. This means that:

= .35*(.16+.08) = .084

That's 8.4%. Most banks are "well capitalized" at 10%. Thus, on average, 8.4% of banks capital is wiped out. This implies that there are a whole lot of "zombies" in the market right now. The only way to fix them is to recapitalize, as I have been saying since at least March-08 and the BSC bailout.

One need only read "Fifty Billion Dollars" (the book, read Chapter 2) to understand what "must" happen. Unfortunately, Paulson's plan doesn't accomplish what is needed. Moreover, as a politician and "power hungry POS" he wants to subsume the power into UST. This is stupid and inefficient. We already have the infrastructure to accommodate what's needed in terms of resolution teams in the FDIC, OCC, OTS, and FRB. Instead, he is appointing a 35 year old Neel Kashkari? Are you serious? Use the infrastructure that is ALREADY in place and be FAST.

One of the lessons of the Great Depression was that "slow" and ineffectual moves made the situation a lot worse. Sadly, Paulson's "power grab" is jeopardizing the success of the program. Rather than cooperating with Agencies ALREADY IN PLACE that can very aptly handle the problem, he is building his own "universe" in order to increase the power and clout of UST. Paulson, as has been said in NUMEROUS other forums, should be fired - YESTERDAY. UST should be solving fiscal, budget, and similar issues, not bank regulation, supervision, and market oversight. This should be vested with "others". Even the OCC should be pushed into a separately funded and "arms-length" (from gov't) entity, which I trust will be the nature of the reg reform law that is passed next year.

Immediate need:

1) FDIC handles "ABC" banks. "A" are basically sound but may need capital; "B" are in need of help, and should be immediate focus; "C" are dead and should be shut-down ASAP.

2) Asset sales of mortgage related product is coordinated, via the FDIC structure, with FNMA na dFHLMC. All "other" asset sales handled by FDIC (and their existing contract arrangements) with current loan and asset sales (i.e., workout) partners.

3) FRB handles, only as needed, systemic issues. FDIC and FRB coordinate much more closely.

4) We need to launch, as was done in 1930's, more infrastructure projects

5) We need to launch, as was done in the 1930's, direct corporate lending where it is a systemic issue (like the FRB's CPFF...good move)

6) Etc....(the list is long)

2008 Oct 11 11:52 AM

[thedozer:]

pdangelchik,

hilarious and true (1st paragraph)

getridofthem:

Well stated clean arguments! I don't agree with (4 as it implies more tax dollars to be spent... but I feel you could make a better case if pressed.

I'm of the school that less government intervention, the better.

It hasn't done much for us to this point.


Lastly, I too, hope the debt era DIES... I live well below my means and have cash instead of material things that are part of a balance sheet somewhere in California as an A/R statement.

time to grow slow and stable with capital... This country is broke as is most of it's constituents. Glad I'm not one of them

2008 Oct 11 12:53 PM

[fatcat:]

Inflation is the only way out of this mess,then an eventual revaluation of currency or creation of a new currency...it's sickening to think about,but it looks like we are running out of options..besides complete socialism that we are headed to at a rapid pace...hope I'm wrong.

2008 Oct 11 12:56 PM

[fhall:]

GETRIDOFTHEMNOW will you please answer my ? about what happens to common shares of banks if govt. injects capital Thanks

2008 Oct 11 01:02 PM

[thedozer:]

fatcat,

the same voting electorate that believes that healthcare is a right, government provided retirement (SS), Medicare, Medicade... Housing...
Government guaranteed loans (Fannie/Freddie) is good thing.

the American people as a whole are uneducated and lazy... I say this only because the majority is about to elect a socialist that is running on a platform that promises the moon!

I PROMISE YOU, if these bozo's send out another 'stimulus' check, I'm going to mail it back to them! I'm fed up!

People want handouts no matter the cost! But why should they... I'm paying for it!

2008 Oct 11 01:49 PM

[tragicomix:]

Pauslon and Bernanke take equity stakes in banks and insurance and make them potentially arms of the government. Under the new Obama administration, political groups then find it easier to require that mandates are passed to extend x% of loans to formerly excluded sections. Insurance rates re-engineered to cross-subsidise weaker sections and charge higher rates from those who can afford it.

What chance this happens? If it does, what will the economy look like?

2008 Oct 11 02:00 PM