Did the TARP Chief Tell Morgan Stanley What to Bid on the Warrants?

Includes: AXP, KBE, MS, XLF
by: Linus Wilson

A Special Inspector for the Troubled Asset Relief Program (SIGTARP) report released on Tuesday, May 11, 2010, said that the head of the Troubled Asset Relief Program (TARP), Herb Allison, may have told the investment bank Morgan Stanley (NYSE:MS) the minimum price he was willing to accept for the taxpayer’s warrants. By my calculations, this was a $375 to $450 million mistake if true.

It is alleged in the SIGTARP report on the warrant sales that the top Treasury official for the TARP, Herb Allison told the Chief Financial Officer of the Wall Street investment bank Morgan Stanley---the minimum price which the Treasury would accept for the taxpayers’ warrants. The report says the following on footnote 18 on page 21:

"…according to a senior official of Morgan Stanley, the Assistant Secretary called him to communicate that Treasury was not going to accept Morgan Stanley’s offer of $900 million. The official told SIGTARP that a $950 million figure was discussed during that call; although the official could not recall who suggested that figure, contemporaneous documentation indicates that the official understood from that call that Treasury was prepared to accept $950 million."

The assistant secretary is Herb Allison. It also quotes from an e-mail by the CFO of Morgan Stanley (MS) in footnote 20 on page 23:

"In an e-mail from the day of the call, the chief financial officer wrote ‘Allison rang me 950 or go to auction. JJM,s [sic] decision, but frankly I would go to auction.’"

I believe JJM is Morgan Stanley CEO John Mack. I’m assuming 950 means $950 million since that was the repurchase price for the taxpayers’ warrants issued by Morgan Stanley.

Homeowners don’t want their real estate agents telling potential buyers the minimum price that they would accept for their house. Imagine if a real estate agent listed your house for $220,000 but told the potential buyer, “The homeowner will accept a price as low as $180,000.” If you found out about that, you certainly would not let that agent list any other properties you had for sale. Yet, Mr. Allison, the taxpayers’ agent, allegedly did just that, telling Morgan Stanley that he would accept $950 million to prevent private investors from pricing these very valuable securities at auction. It is too bad because based on stock, bond, and option prices at the deal date I think the auction route would have generated hundreds of millions more for taxpayers.

We need leadership in the U.S. Treasury that looks after taxpayers, not Wall Street investment bankers. Unfortunately, these accounts make you wonder if the ex-president and chief operating officer of Merrill Lynch, Herb Allison, may have more loyalties to his friends on Wall Street than to the taxpayers he is supposed to represent. When the million dollar jobs are passed out at Morgan Stanley, perhaps they will remember their friends at the U.S. Treasury’s warrant committee!

Other banks such as American Express (NYSE:AXP) did not get this special treatment, and it paid a higher price than I believed they needed to at the time. Unfortunately, SIGTARP does not do its own valuations of the warrants, because it lacks the infrastructure to do that and takes the U.S. Treasury’s estimates as the truth without question.

What is especially galling about the story of Allison’s dialog is that by the accounts in Too Big to Fail, Morgan Stanley was the next big institution to fail. It only received a capital infusion from a Japanese bank on the eve of the U.S. Treasury’s capital program where the warrants were obtained. Unfortunately, taxpayers’ annualized returns on the Morgan Stanley (MS) $10 billion investment were only 16.8 percent. (I assume all dividends are reinvested at the T-bill rate.) The U.S. Treasury got one-fifth the annualized returns of private investors, who were taking the same risks as taxpayers but bought the publically traded preferred stock in Morgan Stanley. That is a negative alpha of 75 percent! I cannot help but think that the realized returns would have been higher if that conversation between Allison and the Morgan Stanley official had never taken place.

Disclosure: I only own broad-based index funds, and I do not own securities in the companies mentioned. I liked the book Too Big to Fail, but I get no compensation for mentioning it.

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