“If Paulson was still an employee of Goldman Sachs and he’d done this deal, he would have been fired,”

Back in October, I argued that it was incumbent that the taxpayers get a better deal than private investors. From Bloomberg:

"By Mark Pittman

Jan. 10 (Bloomberg) -- Henry Paulson’s bank bailouts, done under “great stress” during the worst financial crisis since the Great Depression, failed to win for U.S. taxpayers what Warren Buffett received for his shareholders by investing in Goldman Sachs Group Inc.( TRUE )

The Treasury secretary made 174 purchases of banks’ preferred shares that include warrants to buy stock at a later date. While he invested $10 billion in Goldman Sachs in October, twice as much as Buffett did the month before, Paulson gained certificates worth one-fourth as much as the billionaire, according to data compiled by Bloomberg. The Goldman Sachs terms were repeated in most of the other bank bailouts.( A DISGRACE )

Paulson’s decisions to prop up the financial system included purchasing shares in institutions from Goldman Sachs, the most profitable Wall Street firm last year, to Saigon National Bank, a Westminster, California, lender whose market value is $3.8 million.

“We were not looking to replicate one-off private deals” in the transactions, made under the $700 billion Troubled Asset Relief Program, Paulson said in a Bloomberg TV interview yesterday.( I ARGUE JUST THE OPPOSITE )

“The market was under great stress and the private sector was extracting very, very severe terms( IT WAS THE OTHER WAY AROUND! ). What we were attempting to do, which I think we did successfully, was design a program that would be accepted by a large group of healthy banks( ? ) with terms that would replicate what you would get in normal market conditions,” he said.

‘20-20 Hindsight’

“With 20/20 hindsight,” the bank-capital injections have achieved their objectives and the decisions on TARP will “prove to be the right ones,” the Treasury secretary said.( HUH? )

Paulson’s warrant deals may give taxpayers less profit from any recovery in financial stocks than shareholders such as Goldman Sachs Chief Executive Officer Lloyd Blankfein and Saudi Arabian Prince Alwaleed bin Talal, owner of 4 percent of Citigroup Inc., said Simon Johnson, former chief economist for the International Monetary Fund.

The transactions are “just egregious,” said Johnson, a fellow at the Peterson Institute for International Economics in Washington. “You want to do it the way Warren does it.”( OBVIOUSLY )

Paulson said “he had to make it attractive to banks, which is code for( COLLUSION ) ‘I’m going to give money away,’” said Joseph Stiglitz, who won a Nobel Prize in 2001 for his work on the economic value of information.

‘Giveaway’

“The worst aspect of this is that they were designed not to do what they were supposed to do,” he said in a telephone interview from Paris Jan. 7. “In many ways, it’s not only a giveaway, but a giveaway that was designed not to work.”( TRUE )

The Treasury would have held warrants for 116 million shares of Goldman Sachs under Buffett’s terms, which would be equivalent to a 21 percent stake when added to those currently outstanding. Instead, the dilution is 2.7 percent under the Treasury plan. Blankfein is the company’s biggest individual investor, with 2.08 million shares worth about $178 million today, according to Bloomberg data. His 0.47 percent interest would have declined to 0.36 percent under Buffett’s terms and would be 0.44 percent if the Treasury’s warrants were exercised.

Senator Judd Gregg, a New Hampshire Republican, estimated in a Jan. 4 Wall Street Journal opinion article that TARP investments have earned about $8 billion while recapitalizing the banking system.

Changes to TARP

Government agencies have committed more than $8.5 trillion to shoring up the financial system, including TARP, signed into law Oct. 3 by President George W. Bush. The program was sold to Congress as a way to buy securities that had fallen in market value. Paulson shifted his emphasis to direct capital injections to banks to prevent the financial sector from foundering.( NOT ACCEPTABLE. BAIT AND SWITCH. )

The House Financial Services Committee and TARP Congressional Oversight Panel plan hearings on how federal bailout money will be used during the administration of President-elect Barack Obama. The financial services panel scheduled its meeting for Jan. 13.

The oversight panel has contracted an independent analyst to examine the terms of TARP investments and is scheduled to deliver a report by Jan. 30, said Elizabeth Warren, chairwoman of the oversight panel, in an interview today. The question matters, Warren said, because shareholders are now being protected by taxpayer dollars.

“Supporting equity is such a profound shift in American economic policy that we must take a hard look at that decision( A GOOD IDEA ),” said Warren, a Harvard Law School professor who specializes in bankruptcy.

‘Something Worth Nothing’

Stiglitz said finance professionals at Treasury possessed expertise on warrant pricing that members of Congress didn’t. As a result, Paulson gave lip service to the lawmakers’ intent on TARP without gaining much value for taxpayers, said Stiglitz, a Columbia University professor who described the pricing mechanism as “a gimmick to make sure that they were giving away something worth nothing.”( I AGREE )

“If Paulson was still an employee of Goldman Sachs and he’d done this deal, he would have been fired,” he said.

A $5 billion U.S. loan last week to GMAC LLC, the Detroit- based finance affiliate of General Motors Corp., was made under the Treasury program and was part of $6 billion advanced to keep the automaker afloat.

In advancing the $5 billion, Paulson accepted warrants that reward taxpayers with an additional $250 million, or 5 percent of the stake. That compares with 15 percent on the 174 completed bank rescues as well as the 100 percent Berkshire Hathaway Inc. Chairman Buffett obtained on an investment in Goldman Sachs in September, Bloomberg data show. A warrant is a company-issued certificate that represents an option to buy a certain number of shares at a specific price by a predetermined date.

‘Stronger Terms’

“You’d certainly hope that the trend would be in the other direction, for stronger terms,” said Rep. Scott Garrett, a New Jersey Republican on the House Financial Services panel, in a telephone interview Dec. 26. “I don’t buy the methodology that they have to be circumspect to protect the parties involved. Ultimately their position has to be to protect the American taxpayer( CORRECT ).”

While the government has pledged to recover its investments, Congress provided little guidance on how to accomplish that. Legislation mandated that the Treasury receive warrants to acquire shares in companies tapping the program to potentially reward taxpayers. The law didn’t specify how many warrants or how they should be priced, factors that will determine how much money, if any, taxpayers get in exchange for their risk.

Buffett’s Warrants

The government has received warrants valued at $13.8 billion in the 25 biggest capital injections from TARP, according to Bloomberg data. Under the terms Buffett negotiated for his $5 billion stake in Goldman Sachs, the TARP certificates would have been worth $130.8 billion.( PLEASE DON'T TELL ME THAT. )

Buffett received 43.5 million Goldman Sachs warrants valued at $82.18 apiece on the date of the transaction, or $3.6 billion, Bloomberg analytics show. Paulson, who served as the New York- based bank’s chief executive officer until 2006, injected twice as much taxpayer money into Goldman Sachs a month later and got 12.2 million warrants worth $72.33 each, or $882 million.

If the Treasury had received the same terms as Buffett, taxpayers would have become the biggest investors in most of the bailed-out banks and existing stakes( COLLUSION ) would have been diluted, Bloomberg data show.

No Confidence

“I halfway believed that the taxpayers would make money in September, but I really don’t believe it now,” Rep. Brad Miller, a North Carolina Democrat on the House Financial Services committee, said in a telephone interview last month.

“We have to have confidence in Treasury to run the program in a way that protects taxpayers, and there’s very little in the way they’ve run it that inspires confidence( TRUE ),” he said.

Congress left it to Paulson and his staff to decide how warrants would be priced and how many the U.S. would receive under the TARP, according to Caleb Weaver, a spokesman for the program’s oversight board. Treasury imposed identical terms for 140 capital injections. Thirty-four closely held lenders issued certificates to the government for preferred stock instead of common shares and one community development institution wasn’t required to issue warrants, according to the Jan. 6 Treasury report on TARP.

Bailouts for American International Group Inc., GMAC, GM and the second of two infusions into Citigroup were reported separately in the Treasury statistics.

‘Not Day Traders’

Paulson and former Goldman Sachs banker Neel Kashkari, who runs TARP as the interim assistant secretary of the Treasury for financial stability, have said the bank bailout will pay off.

“We’re not day traders, and we’re not looking for a return tomorrow( YOU SHOULD BE LOOKING FOR THE BEST DEAL GENIUS. ),” Kashkari told a Mortgage Bankers Association conference on Dec. 5 in Washington. “We are looking to try to stabilize the financial system, get credit flowing again, and over time, we believe that the taxpayers will be protected and have a return on their investment.”

Jackie Wilson, a spokeswoman for Omaha, Nebraska-based Berkshire Hathaway, didn’t respond to e-mail and telephone messages seeking comment. Goldman Sachs spokesman Michael DuVally declined to comment, as did Citigroup spokesman Michael Hanretta.

Paulson left money on the table in three ways, according to economist Johnson:( 1 ) accepting fewer warrants than Buffett did;( 2 ) setting the certificates’ price trigger, or strike, above market values; and( 3 ) receiving an annual yield on the preferred shares that is half of what Buffett will get for the first five years.

Dividend Payments

The government will forgo almost $48 billion over the next five years in preferred stock dividend payments from the 25 biggest TARP infusions, as compared with Buffett, according to the terms of the deals.

Buffett’s five-year warrants for 43.5 million shares of Goldman Sachs were valued at $82.18 each using the Black-Scholes option pricing model developed by Fischer Black and Myron Scholes to estimate the fair market value of such contracts. The model uses, among other data, the implied price volatility of the underlying security. The Treasury received 10-year warrants for 12.2 million Goldman shares priced at $72.33 on Oct. 28 using the same method.

The taxpayers’ certificates were set at the 20-day trailing average of the share price, which for Goldman Sachs was $122.90 on Oct. 28, when the company closed almost $30 cheaper at $93.57. The trailing average ensured a higher strike price, and lower value for the warrants, because bank stocks were plummeting.

8 Percent

By contrast, Buffett received an 8 percent discount to the market price at $115 a share on Sept. 23, when the stock closed at $125.05.

Taxpayers also acquired preferred shares as part of the bailout. These securities, which can’t vote unless the issue at hand is the creation of a more senior preferred stake, carry an interest payment of 5 percent that increases to 9 percent in five years. Buffett’s preferred shares in Goldman Sachs pay a 10 percent yield.

If Goldman Sachs rises to its five-year average price of $147, Buffett will be able to profit by $1.4 billion from exercising his warrants. The government warrants will be in the money for $294 million, or about a fifth as much for twice the investment.( COME ON )

TARP was set up to recapitalize banks and other financial institutions that lost money on subprime mortgages and commercial lending. It allocated $125 billion to nine of the largest banks and securities firms, and then invited all banks or savings and loans to apply for part of another $125 billion.

Saigon National

Recipients range from JPMorgan Chase & Co. in New York, which got $25 billion, to Saigon National, which received $1.2 million.

The government plans billions more in cash injections to companies including credit-card networks Discover Financial Services and American Express Co.

Under Buffett’s terms, the Treasury’s investment in Citigroup would also have brought greater potential for profit to taxpayers. The two cash infusions totaling $45 billion would have resulted in warrants for about 5.6 billion shares, which would more than double the 5.4 billion of existing shares. The Treasury’s warrants call for 464 million shares, or 8 percent of the number under Buffett’s terms.

None of the bank warrants for the biggest 25 capital injections from TARP funds can be exercised profitably now. Goldman Sachs closed in New York Stock Exchange composite trading at $83.92 yesterday, 32 percent less than its $122.90 strike price. Citigroup closed at $6.75, or 62 percent less than its highest exercise price of $17.85.

Exercising Warrants

Four of the 25 bank warrants could be exercised in the next year, based on Bloomberg surveys of analysts’ 12-month share- price forecasts. The average projection for Morgan Stanley at $26.46 is more than $3 higher than its strike price.

Analysts also expect American Express Co., Bank of New York- Mellon Corp. and the second capital injection for SunTrust Banks Inc. to rise above their strike prices, according to the surveys.

Congress may have another chance to get money back. The TARP legislation includes a requirement that lawmakers find a way in five years for taxpayer losses to be recouped from the financial industry.

To contact the reporter on this story: Mark Pittman in New York at mpittman@bloomberg.net."

I said at the time that it was a disgrace.

Now, in graphic form, from The Big Picture:

"Earlier this morning, we discussed how badly the Treasury department, along with Congress, had bungled the bailout monies.

These two graphics show exactly what an awful deal the taxpayer got for our monies.

Buffett’s Better Deal

click for much larger graphs

>

Source:
Paulson Bank Bailout in ‘Great Stress’ Misses Terms Buffett Won
Mark Pittman
Bloomberg, Jan. 10 2009
http://www.bloomberg.com/apps/news?pid=20601087&sid=aAvhtiFdLyaQ&"

. “That hang-up is not compatible with the depth of this crisis"

From Bloomberg:

"Banks’ ‘Catatonic Fear’ Means Consumers Don’t Get TARP Relief

By James Sterngold

Jan. 5 (Bloomberg) -- As the new owner of $172.5 billion of preferred shares and warrants in 208 U.S. financial institutions( WHAT WE GOT FOR THE MONEY ), the Treasury Department hasn’t succeeded in thawing frozen credit markets, leaving taxpayers propping up an industry that won’t lend to them.( THE CREDIT STIMULUS WITHOUT THE STIMULUS )

While inter-bank lending rates have fallen since Congress approved the $700 billion Troubled Asset Relief Program on Oct. 3, most bank lending to consumers remains tight and interest rates high. The average credit-card rate was 14.33 percent on Dec. 16, according to IndexCreditCards.com in Cleveland, almost unchanged from 14.41 percent in October 2007.

That’s prompted criticism from Alan S. Blinder, a professor of economics at Princeton University in New Jersey and a former Federal Reserve vice chairman, who says the government should take a more active role as a stakeholder in the nation’s banks.

“With the banks in a state of catatonic fear now( THAT'S IT. SHELL-SHOCKED. THE FEAR AND AVERSION TO RISK. ), they’re just sitting on the capital,” Blinder said in an interview. “I don’t fault the banks one bit( THEY'RE DOING WHAT'S IN THEIR BEST INTEREST. ), since this shows Wall Street they’re safer, but then this doesn’t get you much improvement. If you’re taking money from the public purse( ON THE OTHER HAND, AS AN INVESTOR NOW, WE WANT THEM TO DO WELL AND PLAY IT SAFE. ), we should get something in return, and we’re really not.”( AS I'VE SAID, TARP IS A HYBRID, WITH THE BANKS AND GOVERNMENT HAVING DIFFERENT GOALS. )

Jeffrey Garten, a professor of international trade and finance at the Yale School of Management in New Haven, Connecticut, and a Commerce Department undersecretary during the Clinton administration, says banks should be forced to increase their lending or risk having taxpayer money taken away( I AGREE ).

“The government isn’t acting aggressively enough to demand a quid pro quo,” Garten said. “The public good is the key to the private good in this case. It’s not the other way around( I AGREE ).”

$8.5 Trillion

Although the government has committed more than $8.5 trillion to energizing the economy, and the Fed cut a key lending rate almost to zero, banks haven’t made it easier to borrow. The Fed said consumer credit fell by $6.4 billion in August, the largest drop in 65 years, and then by $3.5 billion in October, the first time since 1992 that there were two months of declines in a year.

In its most recent quarterly Senior Loan Officer Opinion Survey in October, the Fed reported that about 85 percent of U.S. banks said they had tightened standards on commercial and industrial loans to companies with more than $50 million in annual sales, up from 60 percent in July. Ninety-five percent said they increased the cost of those loans. About 70 percent said they made it more difficult to obtain prime mortgages, and almost 65 percent said they did the same for consumer loans.( THEY'RE SHELL-SHOCKED )

Mortgage Rates

While mortgage rates have declined, they haven’t fallen as fast as bank borrowing rates, meaning financial institutions are demanding more profit for every dollar they lend( THEY NEED THE MONEY, AND MUST PAY MORE FOR DEPOSITS SINCE DEPOSITORS ARE AFRAID AS WELL. ). Average rates on 30-year residential mortgages fell to 5.14 percent last month, according to data compiled by McLean, Virginia-based Freddie Mac. That’s down from 6.67 percent in June 2007, before the worst turmoil in the housing market. At the same time, the spread of mortgage rates over the 10-year Treasury bond yield rose to 2.958 percentage points from 1.567.( IMPLICIT VERSUS EXPLICIT GUARANTEES )

The spread of rates on so-called jumbo mortgages( DUE TO GUARANTEES ), those of more than $729,750, is close to a record at 1.6 percentage points above the rate for smaller mortgages that conform to terms of ones Freddie Mac and Fannie Mae will purchase, according to financial data firm BanxQuote in White Plains, New York. A year ago the difference was 0.23 percentage points.

High interest rates have angered consumers. The Fed has offered relief in the form of rule changes that allow banks to raise rates only on new credit cards and future purchases, not on existing balances. Banks will also have to give cardholders 45 days notice of changes in terms, up from 15 days. Those changes aren’t scheduled to take effect until July 2010.( THEY WERE GOOD CHANGES )

‘We Own Them’

“We own them now( WE SHOULD HAVE. THE SWEDISH PLAN WOULD HAVE BEEN PREFERABLE. ), and we should use that to make sure they stop ripping us off,” said Gail Hillebrand, head of the financial-services campaign at Consumers Union, an advocacy group based in Yonkers, New York. “We shouldn’t allow banks to use the money to support things that hurt consumers and taxpayers. What we’re looking for is responsible behavior, not social benefits.”( KEEP LOOKING. )

Bank profits or returns on the government investments are secondary concerns( TRUE. BUT A VALID ENOUGH CONCERN FOR THE BANKS TO IGNORE LENDING. ), Hillebrand said.

That view is opposed by free-market advocates such as Gary Becker, a professor of economics and sociology at the University of Chicago and a Nobel Prize winner, who says the primary aim of the government bailout should be a hasty withdrawal from investments that shouldn’t have been made in the first place.

“If you believe in a private-enterprise system( WE DON'T HAVE ONE. WE HAVE A WELFARE STATE. ), you use competition to control the banks, not a stakeholding,” Becker said. “It would be a grave mistake to use these private institutions for social goals.”( NOT IN A CALLING RUN. )

Paulson Changes Course

Diane Casey-Landry, chief operating officer of the American Bankers Association, a trade group in Washington, said that bank profitability had to come ahead of any demand to ease lending.

“Taxpayers should get a return on their investment,” Casey-Landry said. “We have to go back to a time when we realize not everyone is entitled to get a loan. What is going to get us out of this recession is sound lending to people who are going to pay it back( THAT'S TRUE ), not throwing money at people who can’t.”

When Congress passed the Emergency Economic Stabilization Act in October authorizing TARP, the funds were supposed to be used to acquire troubled mortgage-related assets from banks in order to ease credit.

“The underlying weakness in our financial system today is the illiquid mortgage assets( CAN'T BE SOLD ) that have lost value as the housing correction has proceeded,” Treasury Secretary Henry Paulson said on Sept. 19. “These illiquid assets are choking off the flow of credit that is so vitally important to our economy( THROUGH A CALLING RUN. THE NEED TO RAISE MONEY WHEN YOUR ASSETS AREN'T AVAILABLE TO SELL OR BORROW AGAINST. ). When the financial system works as it should, money and capital flow to and from households and businesses to pay for home loans, school loans and investments that create jobs.”

TARP Allocations

Two weeks after the legislation was passed, Paulson changed course and said it was more important to recapitalize the banks, allowing them( HYBRID ) to determine how best to deploy their capital.

Since then, Treasury has allocated $250 billion to buy non- voting preferred shares of banks paying a 5 percent annual dividend, as well as warrants convertible into equity. The investments range from $25 billion each in JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co. in San Francisco to $1.6 million in Westminster, California-based Saigon National Bank.

In addition, $40 billion has gone to New York-based American International Group Inc.; another $20 billion to Citigroup in New York, along with a $5 billion guarantee against possible losses; $20 billion to purchase consumer and small-business loans; and $13.4 billion to Detroit-based automakers General Motors Corp. and Chrysler LLC.

‘No New Lending’

Last week the government announced that $5 billion of TARP funds would be used to purchase preferred shares and warrants in GMAC LLC, the automaker’s financing arm, with Treasury separately lending another $1 billion to GM to support GMAC’s transition into a bank holding company.

With the exception of GMAC, which immediately began offering loans to GM customers with lower credit scores in order to halt the decline in auto sales, most financial institutions that received TARP funds have been reluctant to lend.

“Right now there is no new lending, and without new lending it’s going to be difficult for the economy to recover( TRUE ),” Roger Altman, founder and chief executive officer of boutique investment bank Evercore Partners Inc. and an assistant Treasury secretary in the Carter administration, said in a Dec. 29 interview with Bloomberg TV.

Stifling Innovation

A report released Dec. 2 by the Government Accountability Office in Washington questioned whether Treasury is policing the cascade of federal money closely enough.

“Although Treasury has said that it expects the institutions to increase the flow of credit,” the report said the department “has not yet determined whether it will impose reporting requirements on the participating financial institutions( AS I SAID, TARP WILL BE HARD TO ASSESS. ).”

David John, a senior fellow with the Heritage Foundation, a public policy and research group in Washington, said it was inappropriate for the government to demand policy changes from the banks and that doing so would be counterproductive because it would stifle innovation( WE'RE IN A CALLING RUN. ). Instead, he said banks should use the capital to recover stability and then be forced to return the taxpayer funds.( I UNDERSTAND, BUT THAT WASN'T THE DEAL. )

“Bureaucrats take no risks, they have no ideas( SILLY ),” John said. “If this recoups a profit for the taxpayer, great, but a slight loss would be acceptable. I don’t see it as a long-term value to be an activist shareholder( I AGREE ).”

‘No Road Map’

There are no partisan lines separating those who favor a passive investment strategy and those who want the government to play a more active role.

“I do not see the Treasury or the Fed as active investors in the banks, and it would be a mistake if they were,” said Martin N. Baily, a chairman of the Council of Economic Advisers in the Clinton administration and now a senior fellow at the Washington-based Brookings Institution. “The goal is to stabilize the financial sector and to be mindful of the costs to taxpayers. Perhaps there will be positive returns on these investments, but not necessarily( I UNDERSTAND, BUT DON'T AGREE. WE COULD HAVE SPENT THE MONEY IN BETTER WAYS THEN. ).”

Bruce Josten, executive vice president for governmental affairs at the U.S. Chamber of Commerce, a pro-business group, said taxpayers had a right to expect a loosening of credit by the banks, though the government “shouldn’t micromanage them.”( FINE. LEND. )

“I don’t think there’s one good answer here,” Josten said. “There’s no paint-by-the-numbers road map. It’s all improvised.”( THE SWEDISH PLAN IS A ROAD MAP. )

For Garten, the unprecedented nature and scale of the problems means that policy makers and taxpayers will have to get used to a new way of thinking as long as the crisis lasts.

“There’s a philosophical conflict in the American mind( SOME PEOPLE ARE BOTHERED. MOST AREN'T ) because we’re just not used to this level of( OBVIOUS ) intervention,” Garten said. “That hang-up is not compatible with the depth of this crisis( I AGREE ).”

This was all predictable from the fact that TARP was a HYBRID PLAN with the government and the banks having different objectives. The free market worries are hilarious. If anything, a Hybrid Plan will be far harder and costlier to exit in the long run. Also, if you believe in the efficacy of FDIC Insurance, then some government intervention to stop a Calling Run is no more intrusive than that. The free market as propounded by some is a theory or goal, not a reality. The inability to grasp how our system works is amusing but sad.