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Retiring TARP Warrants: Obama's Treasury Makes a Significant Mistake

Whether or not you think that it is good for the system for banks to buyback the preferred-stock investments that the Treasury has made through the TARP program, there is no argument at all that it is good for the system to buy back the equity warrants: we want banks to have more equity capital right now, not less. If you don't want the U.S. government holding them, sell them on the open market. But don't retire them until the financial crisis is two years past.

There's at least one chance in ten that the banks will hit the wall again sometime in the next couple of years if the recession turns out to be worse than forecast, and we may once again be desperate to have the banks have as much equity as possible.

And I haven't even reached the issue of what price the warrants should be valued at: just don't do it.

David Mildenberg:

U.S. TARP Warrant Plan Favors Banks, Professor Says: Policy makers want to speed the withdrawal of the government from the banking industry, rather than attempt to maximize returns for the taxpayers by waiting for share prices to rise, Washington banking lawyer William Sweet of Skadden, Arps, Slate, Meagher & Flom said last week. “The president has clearly stated that his objective is to dispose of the government’s investments in individual companies as quickly as is practicable,” the Treasury statement said. The Obama administration gave approval in June for 10 of the biggest U.S. banks, including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Morgan Stanley, to repay $68 billion of TARP funds. When the money was first obtained, banks had to give the Treasury preferred stock plus warrants to buy stock at a future date at a specific price, called the strike price.

Wilson values JPMorgan’s warrants at $1.55 billion using the traditional method of determining how much the stock may gain in the next decade, compared with $1.33 billion set by Treasury, he said. The strike price for JPMorgan is $42.42, about 25 percent higher than yesterday’s closing price of $34.11 in New York Stock Exchange composite trading. Banks will have 15 days after retiring government stakes to propose a “fair-market value” for the warrants, the Treasury said last week. Should officials object to the estimate, up to three “independent advisers” will help set a price. If lenders don’t make an offer, the warrants will auctioned.

Negotiations as planned by Treasury open the door to political favoritism and corruption, Simon Johnson, an economist at Massachusetts Institute of Technology, said in an interview. Johnson favors public auctions. “The question is why wouldn’t you sell these on the open market and the answer is that the banks would probably lose,” he said. Treasury is bound by contracts with the banks that set out a specific negotiating process, spokesman Andrew Williams said.

Valuing the warrants may rile Congress because lawmakers including Sen. Jack Reed, a Rhode Island Democrat, have warned Treasury Secretary Timothy Geithner not to let banks buy back government stakes at discount prices. “I will be watching closely to ensure Treasury’s pricing system works both fairly and efficiently for the benefit of taxpayers,” Reed said in a June 26 statement. At least 10 smaller banks have negotiated warrant buybacks with Treasury, including First Niagara Financial Group Inc., which paid $2.7 million, according to a statement this week. It’s among the best prices Treasury has received so far, equal to 65 percent of what the warrants were actually worth, compared with an average of 48 percent for the 10 previous repurchases, Wilson said.