I am puzzled why Wells Fargo (WFC) is allowed to repay the Troubled Asset Relief Program (TARP) preferred shares with such a low tier 1 common equity ratio of 6.2 percent relative to its peers, whose ratios exceed 8 percent.

Ticker	Q3 Assets in Trillions	Tier 1 Common Equity
BAC	$2.2	8.5%
JPM	$2.0	8.2%
C	$1.9	9.0%
WFC	$1.2	6.2%

Sources: 2009 Q3 10-Qs, WSJ, BofA Investor Relations

The only economic rationale that I can think of is that Wells Fargo with assets of $1.2 trillion is smaller than Bank of America (BAC), JP Morgan Chase (JPM), and Citigroup (C), Thus, it poses less systemic risk than these other institutions. Nevertheless, it is not that much smaller, and it seems to have lower ratios than many regional banks that have exited TARP.

88.4 million warrants to purchase JP Morgan Chase’s (JPM)’s stock for $42.42 per share will be auctioned off on Thursday, December 10, 2009. Those warrants will begin trading on the NYSE under the ticker JPM-WS if the auction is successful.

This is a huge event for the U.S. options markets, according to Risk Magazine. Never have so many warrants hit the public markets at any one time. If the results from the Capital One Financial’s (COF)’s auction are any guide, buyers of these long dated options probably can expect a bargain.

A new market was created on Thursday night: the long-dated warrant market in Capital One’s (COF) formerly Troubled Asset Relief Program (TARP) warrants. Warrants are call options issued by companies, which allow investors to buy stock at preset strike or exercise price.

I’m glad that prices are being discovered by markets instead of government officials, bankers, or academics. The taxpayers received fair market value, net proceeds of $146.5 million, as part of their risky investment in Capital One Financial. Prior to Friday, I am aware of no publicly traded warrants in the United States with expirations in excess of five years. Therefore, Thursdays’ auction and Friday’s trading resolves much uncertainty about the pricing of long-dated warrants.

Ken Lewis and company gave taxpayers and Bank of America’s (BAC)’s shareholders an early Christmas gift on Wednesday afternoon. BofA announced plans to raise common equity capital of $18.8 billion as early as Monday, December 7, 2009. This capital raise comes with regulatory approval to exit the Troubled Asset Relief Program (TARP). Exiting the bank bailout frees BofA from a lot of government micromanaging.

Bank of America is in a strong position to be a leader in retail and investment banking. Investors should be cheered by their deal to exit TARP. With the government assistance returned, BofA will be better able to retain key employees, find a new CEO, and develop and maintain important client relationships.

The U.S. Treasury has finally taken a small step toward trusting markets. It normally cuts deals with banks before investors can make an offer on the taxpayers’ warrants. Taxpayers obtained warrants as part of their banking sector bailout in the Troubled Asset Relief Program (TARP).

Yet, before Thanksgiving it announced that it would be auctioning off the warrants of JP Morgan Chase (JPM), Capital One Financial (COF), and TCF Financial (TCB). According to Dow Jones Newswires, this Thursday, December 3, 2009, it will auction off taxpayers' nearly 12.7 million warrants to buy Capital One Financial (COF) stock.

Another Friday and another bank that was deemed “healthy” by regulators and the U.S. Treasury sees its bailout shares wiped out. Taxpayers this time lost $4.1 million as the Federal Deposit Insurance Corporation (FDIC) seized the southern California Pacific Coast National Bank. Sunwest Bank of California will assume Pacific Coast’s deposits and assets.

FDIC head Sheila Bair, apparently anxious about the fact that her agency had wiped out a combined $303 million in taxpayer capital injections in two weeks, sat down with Paul Solomon of PBS’s Newshour. The FDIC is as much in the bailout business as the U.S. Treasury, but she used the interview to slam the U.S. Treasury’s efforts. She criticized the Troubled Asset Relief Program (TARP) capital injections into the big banks and, in the same breath, she said that the FDIC’s under-priced credit default swaps called the Temporary Liquidity Guarantee Program (TLGP) was the best way to run a bailout.

The WSJ reports that the FDIC is planning to put a cap on the rates under capitalized banks are offering on deposits. This is a good idea. The only puzzle is, “Why have regulators not been doing this already?”

The FDIC proposes to limit zombie banks to offering no more than 0.75 percent over the national average for deposits. Banks on their last legs routinely use the FDIC guarantee and high interest rates to siphon CDs and deposits from healthy banks. Depositors don’t care because they won’t lose any money as long as the deposits are FDIC guaranteed. Then the zombie bank turn around and loan out those deposits on the most speculative ventures they can find. When the 100th strip mall in Boca Raton, Florida can’t find tenants, those loans go bad and the FDIC picks up the tab.

Dick Bove, the banking analyst from Rochdale Securities, gave Bank of America (BAC) shareholders a scare when he wrote in a research note that the government would require BAC to raise $45 billion more in common equity capital prior to allowing it to pay back the monies it received from the Troubled Asset Relief Program (TARP).

On the next trading day, BofA’s shares dropped by five percent. Mr. Bove’s note should be heeded as much as the advice that the government will never let Lehman Brothers fail. Bank of America is on the verge of exiting TARP, but only managerial ineptitude could blow the deal. The case is good to let Bank of America exit TARP. Ken Lewis needs to structure the exit in a way that both taxpayers and BAC shareholders will win. I have in the past said that both JP Morgan Chase’s and Goldman Sachs’s exit of TARP would benefit taxpayers. If all of TARP is paid back, BofA’s exit would also benefit taxpayers

CIT Group (CIT) filed for Chapter 11 bankruptcy on Sunday, November 1, 2009. With that filing, taxpayers absorbed their first loss of bank bailouts. Taxpayers will likely lose their $2.33 billion investment in CIT Group less than one year after it was made. The Chapter 11 bankruptcy filing and the success of the prepackaged bankruptcy exchange offer reported on in the New York Times means that taxpayers, other preferred shareholders, and common stockholders get wiped out according to page 6 of the exchange offer filing.

According to my analysis of the transaction reported in TheStreet.com, the CIT Group investment was a bad deal for taxpayers on the day it was made. Today it looks like what little value remained in the taxpayers' preferred stock investment has been wiped out. There was little evidence that Treasury officials performed basic due diligence when investing in CIT Group in December 2008. If they had, they would have been shocked by the high yields on its publicly traded preferred stock. Preferred stock is a very risky security. CIT Group is the first large lesson for taxpayers of its risks.

The President and the Assistant Secretary of the U.S. Treasury who heads the Troubled Asset Relief Program (TARP), Herb Allison, disclosed details of their “small business lending” initiative last week. It is nothing of the sort. It should be called the small bank subsidy initiative. It amounts to a $6.25 billion to $31.25 billion government subsidy to banks, which will lead to a less efficient banking sector for years to come. Contrary to its name, it will not extend credit to small businesses.

The so called “small business lending” initiative is a bad way to increase lending to small businesses, regardless of whether the decrease in lending is due to a decrease in the demand for loans from small businesses or capital problems in small banks. When businesses are afraid, they cut back borrowing. At my university, I conduct a survey of Chief Financial Officers (CFOs) in our region. The results are that they have found their cost of borrowing has been dropping though out 2009, and they have no trouble borrowing. The problem is that they are very pessimistic about the future. I suspect that these results can be found on a national scale. Thus, the decrease in loan volume is due in part to small businesses demand for credit. It is not due to an increase in the supply of credit to banks.

Tim Geithner and other U.S. Treasury officials told Reuters on October 21, 2009, that they will put an end to three bank bailouts by the end of the year. Those programs are the Capital Purchase Program (CPP), the Targeted Investment Program (TIP), and the Capital Assistance Program (CAP). The first program, the CPP, injected cash in exchange for primarily preferred stock and warrants in over 680 banks. While about $205 billion has been passed out in that program, over $70 billion has also been returned.

The administration had been overstating the returns of banks repaying the CPP preferred stock and warrants by about 3 percent, according to my calculations. These early profits may be fleeting because taxpayers stand to lose all of their $2.33 billion, bad investment in CIT group. That would almost wipe out most of their profits from warrant repurchases thus far. The Targeted Investment Program (TIP) injected $20 billion each into Citibank (C) and Bank of America (BAC). The Capital Assistance Program (CAP) program was never used. Banks were more eager to turn to private investors to raise common equity capital by the time the CAP was introduced by Tim Geithner in February.

The U.S. government does few thing better than create debt. After a year of talking about it, the government is going to have the chance to throw their good debt, Treasury bills notes and bonds, after bad, non-performing toxic loans and securities. The Federal Deposit Insurance Corporation (FDIC) and the U.S. Treasury are going their separate ways on their cash for trash schemes at this point. Accountants and investors should be wary of the big prices they see coming from the FDIC’s auctions, but taxpayers should be afraid of the U.S. Treasury’s efforts to re-inflate the securitization bubble.

Reuters reports that Bank of America (BAC) agreed to pay $425 million to end an $118 billion asset guarantee. This agreement is another example of a “too-big-to-fail” bank underpaying taxpayers for the insurance that helped keep it afloat during the market troughs.

This is less than one-tenth of the price Bank of America promised taxpayers on January 15, 2009. For all the talk by BofA CEO Ken Lewis and others that they did not reach a final agreement, it took Bank of America until May 6, 2009, to notify the Federal Reserve that the loss-sharing agreement was to be cancelled per the asset guarantee term sheet. During that period, BofA’s stock hit a low of $2.53 in March. It could have gone lower without the explicit federal support. According to my calculations, BofA owed taxpayers $96 million in dividends, the fair market value of the warrants would have been about $331 million, and the preferred stock was worth $4 billion. Thus, taxpayers were owed $4,427 billion for the guarantee. They got $425 million. That is less than 10 cents on the dollar.

The WSJ reports that Citigroup (C) wants to issue up to $5 billion of equity to repurchase a corresponding number of shares from the U.S. Treasury. This is a great idea that benefits both taxpayers and Citigroup’s shareholders. Citi does not have enough common equity capital to repurchase the government’s shares outright. Yet, if it issues new common equity to reduce the government’s stake, no capital is lost.

Citi’s shareholders should be cheered that managers are taking steps to exit the government ownership. Taxpayers should be eager to lock in some of their paper profits on the Citigroup stake. On the $25 billion investment that was converted into common shares, taxpayers are looking at paper profits of over $11 billion on the 7.7 billion shares of stock and the 210 million warrants that they received for that cash infusion. It would be hard to quickly reduce this stake through open market sales alone without pushing down the share price. Yet, a larger underwritten sale of the government shares may be possible without a large negative impact on the share price. Typically, seasoned equity is issued at a two to three percent discount from the previous day's closing price.

A trial balloon was floated by the WSJ on Tuesday. It was just another attempt to give a to-big-to-fail (TBTF) bank special treatment at taxpayer expense. The WSJ said that there is a proposed deal in the works that would have Bank of America (BAC) pay back its $20 billion of preferred shares that pay taxpayers 8 percent dividends. Plus the deal plans to let Bank of America out of a Troubled Asset Relief Program (TARP) insurance contract for pennies on the dollar. This would be a bad deal for taxpayers, which would make it less likely that Bank of America will pay back the other $25 billion of TARP.

It is at the U.S. Treasury's, Tim Geithner’s, discretion as to whether Bank of America can pay back the 8 percent or the 5 percent preferred stock first. Clearly, taxpayers get more dividends if Bank of America pays back its 5 percent preferred stock first. To make the comparison apples for apples, I assumed that BAC returns either $20 billion of the 8 percent preferred or $20 billion of the 5 percent preferred. Taxpayers would lose out on $600 million in dividends per year if BAC pays back the $20 billion of the 8 percent TARP shares before returning the first $20 billion of the 5 percent TARP shares.

The WSJ reports that JP Morgan Chase (JPM) has received assurances from the US Treasury that it will be allowed to bid in the largest warrant auction in U.S. history. That warrant auction will feature the 88 million warrants that JPM issued to taxpayers as part of the Troubled Asset Relief Program (TARP). Yet, there is a danger that JP Morgan will scare away other bidders unless it fights for those options with one hand tied behind its back.

The management at JP Morgan should have better information than other bidders. If somebody bids higher than JPM they might find themselves saying "Does Jamie Dimon, the CEO of JP Morgan, know something I don't?" This "winner's curse" problem could lose taxpayers hundreds of millions of dollars.

I disagree with the Congressional Oversight Panel’s (COP) conclusions about the wisdom of using Geithner's toxic asset plan to help small undercapitalized banks outside of receivership. The Congressional Oversight Panel writes monthly reports about the Troubled Asset Relief Program (TARP) program also known as the $700 billion bailout.

The August 2009, COP report makes the false assumption that when a bank is insolvent that it ceases operations. This is not true. Receivership is the way that a bank’s liabilities are restructured when that institution is insolvent. A restructured bank's debts are reduced and depositors are always able to access 100 percent of their insured deposits right away.

American Express (AXP) agreed to repurchase the $340 million kicker from taxpayers on Wednesday, July 29, 2009. A kicker is a warrant “sweetener” that makes a bond or preferred stock deal have a little upside to compensate for its big downside risk. This price is in line with $1.1 billion price tag for Goldman Sachs' (GS) TARP warrants. Both prices are very close to my middle estimates of those warrants’ fair market value, assuming a zero chance of cancelling half the taxpayer’s warrants. The Amex deal makes it seems less likely that the Goldman price was an anomaly. Morgan Stanley (MS) is faced with the choice of paying full price or being stuck in TARP limbo until Treasury rolls out its auctions at some unspecified date in the future.

The other branch of the long separated house of Morgan, JP Morgan Chase (JPM), said it didn’t like the U.S. Treasury’s price and it hopes third party investors come up on low valuation the way the Tim Geithner and Co. used to. My study of the Chrysler warrant auction in 1983 makes me think that the third party investors are going to pay a lot more than the U.S. Treasury sold the U.S. Bancorp (USB) warrants for. Yet, it could be 2010 before those auctions are rolled out. The first banks exited TARP at the end of March, but there have been no auctions. Most banks that exited TARP prior to Morgan Stanley passed on repurchasing the TARP warrants. Further, if it postpones a deal too long, the PROFIT act could be snuck into some bill sailing towards passage. If that happens all the big banks’ TARP warrants would have to be auctioned by law. Then Morgan Stanley could no longer exit TARP on its own. Can Morgan Stanley afford to be subject to the whims of the compensation czar during bonus time?

Morgan Stanley (MS) reports earnings today, Wednesday, July 22, 2009. Its rival Goldman Sachs (GS) busted through earnings estimates a week earlier, raking in $2.7 billion in quarter two. Both banks have a decision to make about the TARP warrants.

They, of course, could opt for an auction of the TARP warrants as both Jim Cramer and I advise. A public auction, as opposed to a closed door negotiation, is a win-win for taxpayers and the investment banks. Taxpayers get higher prices for the warrants, and the investment banks inoculate themselves from criticism by the media and Congress. My research shows that the auction of taxpayers’ Chrysler warrants in 1983 generated prices much closer to the theoretical Black-Scholes value than the U.S. Treasury is currently obtaining through negotiations.

The conventional wisdom was that Wells Fargo (WFC) would exit TARP before the likes of Morgan Stanley (MS) and certainly Bank of America (BAC). Yet, Morgan Stanley is out and Bank of America is increasingly looking to be the most likely of the big six TARP recipients to exit. This is an unlikely turn of events for the bank that was told by the Federal Reserve to raise the most common equity, $33.9 billion, after the stress tests. How did it do this? Bank of America did its homework. It finished raising $38 billion a few weeks back mostly through a combination of swaps and seasoned equity offerings.

This number likely puts it close to getting Fed permission to leave TARP. The “A” student in the stress test, JP Morgan (JPM), was forced by the Fed to raise $5.75 billion to exit TARP. I speculated that this was because the Fed did not want JPM to shed any of its common equity capital when it returned the subsidy on the TARP preferred.