In the game of government bailout whack-a-mole, round one was won by the mole. The amendment to name the $30 billion Small Business Lending Fund (SBLF) "TARP Jr." lost on a party line vote with Democrats voting against it and Republicans voting for it. Whether or not that is the name on the legislation, the mole smells like TARP Jr. to me. The SBLF lets Tim Geithner buy preferred stock from small banks with dividend rates as low as 1 percent. Now TARP Jr. passed its committee and will be considered by the full house. No major news service or newspaper made note of the committee passage of this unpopular legislation.
My estimate is that the subsidy is about $6.9 to $8.4 billion or about 23 to 28 percent of every dollar invested in the $30 billion fund. Thus, taxpayers should expect to retain just 72 to 77 cents of every dollar invested in these banks on the day the investment is made. Yet, the Obama administration’s spokesman Gene Sperling testified in the questions and answer part of the May 18, 2010, hearing that the SBLF would “not cost taxpayers any money.” Mr. Sperling’s legal background allows him to blissfully ignore basic concepts such as discounted cash flow analysis. (Note that Mr. Sperling has no graduate degrees in economics despite his long career as a government “economist.”)
The administration worries that the stigma of TARP has reduced the effectiveness of the bailout program. I think they are wrong. The stigma of TARP has allowed the administration to show a modest profit as banks forgo a subsidy to exit the unpopular program early. Taxpayers never lose money from an investment that is paid back in full with dividends and proceeds from warrants.
It is the banks that never pay back like Midwest Bank Holdings, which failed this last Friday and would have been eligible for the Small Business Lending Fund, that cause taxpayers to lose money. At last count, over 11 percent of TARP banks skipped their dividend or interest payments to taxpayers. The TARP has achieved its objective of stopping a banking panic. It is time for the Treasury to stop buying up stakes in the nation’s banks.
The Small Business Lending Fund (SBLF) is the sequel to TARP without the upside benefits for taxpayers that the original had. (It lacks the warrants and it does not pay as high dividends as the TARP’s Capital Purchase Program, which it is modeled after.) Yet, unlike a movie sequel, which can be cancelled after a poor week at the box office, these programs never end because most of the recipients have little incentive to pay back the taxpayers’ capital. The U.S. taxpayers will hold large illiquid ownership stakes in hundreds if not thousands of banks at below market rates. The expansion of government ownership allows the government to pick winners and makes it harder for regulators to close down insolvent institutions with taxpayer investments.
The administration is wrong to think that these small banks have costs of preferred stock below 9 percent. These banks have costs of preferred stock that are on average 9.5 percent, according to my estimates, if they have any preferred stock at all. (I suspect that most of the eligible institutions would struggle to raise preferred stock at a yield of 9.5 percent.) That means paying back the preferred stock when the dividend rate rises to 9 percent would entail bank managers hurting their shareholders by giving up a subsidy. Thus, without a stigma to the government funds, the government ownership of the banking industry will have no end date because the capital injections are perpetual securities, paying dividends below most of these institutions’ cost of preferred stock.
The folks in Washington DC have never been concerned by niceties such as the cost of capital. Yet, prior to Hank Paulson’s $700 billion bailout, the political class was not interested in long-term socialization of the banking industry. Now they seem to love it. We’ll see if the TARP Jr. can fly under the radar until it is the law of the land before taxpayers realize what happened.
Disclosure: I have no long or short positions in individual securities issued by the companies mentioned. I have long positions in broad-based index funds.