Yesterday the Wall Street Journal reported that the banking industry is aggressively lobbying the Treasury Department to “expunge” the warrants granted to the government when banks took TARP funds. Just counting the warrants issued by Goldman Sachs and JP Morgan Chase, the two biggest banks that have said they would like to pay back the TARP immediately, the cost of this giveaway could be as high as $2.7 billion.
The warrants were issued when the government bought preferred stock in banks. They give the government the right to purchase common stock in the banks for the next 10 years, and were an essential part of the promise to taxpayers that the TARP would be an investment rather than a straight out giveaway.
Most of those warrants are currently underwater because the actual stock prices of the banks are less than the exercise price. This means they would be worth nothing if they had to be exercised today. But because the warrants have a 10-year lifespan, with 9 and half years left to run, they have the potential to be worth far more.
The banking sector lobbyists have been arguing that they should be allowed to purchase the warrants back at deeply discounted values, or perhpas even have them cancelled outright on the grounds that they are currently worthless. Of course, even the most junior banker knows that out of the money options are not actually worthless if there is potential for them to come into the money in the future. This is just a scam.
“Over nine years or so, Goldman Sachs’ and JP Morgan’s stock prices could rise substantially to the benefit of U.S. Taxpayers or whoever owns the warrants. It would be a massive loss to taxpayers if the U.S. Treasury retired these warrants for free,” <>University of Louisiana at Lafayette economist Linus Wilson tells Clusterstock.
The U.S. Treasury holds 88.4 million of JP Morgan’s TARP warrants. These warrants on JPM are worth $20.20 each or about $1.79 billion according to Wilson’s estimates based on options pricing models. Wilson estimates that the government’s 12.2 million warrants on Goldman Sachs are currently worth $74.87 each or about $914 million dollars.
Wilson says that it is a bad idea to encourage the banks to buy the warrants at market prices, given their well-known capital weaknesses. Instead, the Treasury should sell the warrants to 3rd party investors.
“My research on bank bailouts< indicates that it would be a bad idea for bank regulators to encourage the mega banks to buy the warrants themselves,” Wilson explains. “Buying back warrants or shares reduces banks’ cash cushion and makes them less likely to withstand tough market environments.”
Section 4.9 of the Securities Purchase Agreement for the Capital Purchase Program requires the U.S. Treasury to sell the warrants to 3rd party investors if the issuing bank is not willing to buy them for “fair market value.” For Goldman and JP Morgan that value is a lot closer to $3 billion than zero. Hopefully the Treasury Department is smart enough not to get bamboozled by the lobbyists into going along with another huge giveaway to the banking secotr.
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