Thursday, July 23, 2009

"Treasury Rip-off: New Sweetheart Deals for Banks"

"Treasury Rip-off: New Sweetheart Deals for Banks"
by Ryan Grim

"Ignoring Watchdog report, Treasury gives three major banks sweetheart deals. Four major banks have repurchased warrants from the Treasury Department since a congressional watchdog reported that the backroom deals where the prices were negotiated were ripping off the taxpayer. In three of the subsequent four transactions, the deals have only gotten worse.

The Congressional Oversight Panel report was based on 11 transactions with small banks and concluded that taxpayers walked away with about 66 percent of what they could have gotten. At a hearing on the warrant repurchase program in the House on Wednesday, Herbert Allison Jr., a senior Treasury official, insisted that the sweet deals the banks got were needed to aid the liquidity of the smaller institutions. The four transactions since then have all been with major institutions. Three of them returned between 54 and 65 percent of what the taxpayer could have gotten on the open market.

On June 17th, BB&T agreed to buy back its warrants for $67 million. The bank reported the transaction in a July 17th press release. On July 8th, the Treasury sold warrants back to State Street Corporation for $60 million. On July 15th, Treasury gave up warrants to U.S. Bancorp for $139 million. The latter two transactions are listed by the Treasury in its transactions report for the period ending July 17th. "We are very pleased to have completed the repurchase of the warrant, effectively concluding U.S. Bancorp's participation in the Capital Purchase Program," said Richard K. Davis, chairman, president and chief executive officer of U.S. Bancorp, when announcing the deal.

As well they should be. The warrants that USB bought from the taxpayer for $139 million had a fair market value of $260 million, says an academic who has closely tracked the bailout and the warrant repurchase program. Linus Wilson is an assistant professor of finance at the University of Louisiana at Lafayette's B. I. Moody III College of Business and he uses essentially the same methodology to calculate fair market value that the Congressional Oversight Panel used -- the Black-Scholes and Merton option pricing models. That methodology is signed off on in the report by Nobel-Prize-winning economist Robert Merton himself. According to Wilson's calculations, the State Street warrants, which paid the taxpayer $60 million, should have brought in $92 million at fair market value. And the value of BB&T's warrants was $114 million, meaning the Treasury left $47 million on the table.

Yet one bank did give the taxpayer a fair shake: Goldman Sachs. Yes, the Goldman Sachs that Rolling Stone reporter Matt Taibbi recently described as "a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money." Wilson speculated that Goldman Sachs decided to pay fair price to avoid more of the bad press that's been coming its way the last several months. The bank paid $1.1 billion for its warrants, which Wilson estimates have a fair market value of $1.12 billion based on Tuesday's closing price on shares of Goldman Sachs. Goldman could afford to pay it out, too, considering that it pulled down a $3.4 billion profit in the last quarter and the taxpayer gave it billions by funneling money through AIG to Goldman. But if the only way the public has of getting full price is to put the history of the bank on the cover of a magazine, then most banks are likely to get better deals.

A Treasury official said in a statement to the Huffington Post that the process it uses to determine the price of the warrants is fair: "The warrants for common stock held by Treasury do not trade on any market and therefore do not have observable market prices. Their values can only be estimated. Treasury follows a comprehensive approach to estimating these values, which involves using a variety of inputs including a set of well-known financial models. These models will include, but will not be limited to, binomial and Black-Scholes option-pricing models, and are widely used in financial markets to value options and warrants. Treasury also relies on indications from market participants as to what they would be willing to pay for the warrants. We obtain quotes from three separate market participants who regularly invest in or trade similar securities. We also retain outside managers to provide full, independent valuations. Together, these various methods constitute a robust process for estimating value and protecting the taxpayers' interests."The official went on to say that not making the valuation process completely public is ultimately in the taxpayers' interest, because it gives Treasury a bargaining advantage if the banks don't know the process in detail. There are plans to make the process public in the future, said the official, qualifying that it would be "counterproductive to put it out there now."

The Treasury Department refuses to comment on negotiations until two days after they are completed, giving the public and outside investors no say in the process. Recently, a group of House Democrats began an effort to end the practice and introduced legislation to require the Treasury to hold public auctions.The specific flaw in the Treasury methodology is that it doesn't give enough weight to the bank's stock price in its calculation. "Treasury starts out with a very low price that it offers in negotiations. Banks come back with an even lower price. Banks get a very good deal," said Wilson. "Taxpayers would be better served if the Treasury took an optimistic view of the warrants' value and moved most of them to auction." But the more general flaw with the Treasury process is a simple lack of transparency. A public auction would "avoid congressional scrutiny and immunize banks and Treasury from any accusations of there being some sort of sweetheart deal," said Wilson.

In several instances the banks have been more transparent about the transactions than the Treasury Department. The BB&T transaction has yet to appear on the Treasury report even though the deal was struck on July 17th, as the bank announced. The bank hasn't yet paid for the warrants, so Treasury won't comment on it. JPMorgan Chase & Co. has reportedly asked the Treasury to hold a public auction, unhappy with Treasury's offer. We know that because JPMorgan said so publicly, but a Treasury spokeswoman wouldn't confirm it, saying the department doesn't comment until two days after the transaction is complete.

The JPMorgan case is telling. Since Treasury has so far set the bar so low for the warrant repurchases, banks that are just now entering negotiations don't want to pay more than the nice deal the last guy got. Selling the warrants at auction would put an end to the game. There's still time, noted the oversight panel, chaired by Harvard Prof. Elizabeth Warren, stating that "the process is still at an early enough stage that the maximum benefit for the taxpayer could be realized if the open market process is enacted now." But the longer they wait, the more taxpayer money is left on the table. Treasury shows no signs of changing on its own. Rep. Mary Jo Kilroy (D-Ohio) hopes she can force it to with her House bill. "Other investors would want to get a return on their investment," she said. "There's no reason taxpayers shouldn't."
- Ryan Grim,

Wouldn't you and I love a deal like that? Don't hold your breath...

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