Was Goldman politically pressured to overpay when it purchased TARP warrants?
In connection with the repayment of it $10 billion TARP funds, Goldman bought back 12 million warrants issued to taxpayers. There was a lot of fear that Goldman might try to underpay, mostly because they are wily financial types who could no doubt bamboozle the Treasury folks on the other side of the table if they wanted to.
But Goldman promised not to cheat taxpayers and, shockingly, they didn’t.
After a day of rejoicing that taxpayers actually made out pretty well, attention is now turning to the question of whether or not Goldman overpaid. Steven Davidoff, who does the “Deal Professor” column for the New York Times, points out that Goldman could have cancelled half the warrants if it wanted to. He warns that Goldman might have decided not to cancel the warrants in hopes of winning public favour and escaping more stringent regulations.
To put it slightly differently, Goldman’s been getting so much bad publicity–led, of course, by that Matt Taibbi fellow and his vampire squid–that it might have decided to take a hit on the warrants just to garner some good publicity and avoid political scrutiny.
We asked our favourite TARP warrants expert, Linus Wilson, what he makes of this argument. Here’s what he told us:
I think Goldman Sachs (GS) paid fair market value for the Troubled Asset Relief Program (TARP) warrants. Nevertheless, they could have probably struck a harder bargain, but that course of action would have been fraught with risks.
So far there have been three other big banks that repurchased their TARP warrants, BB&T, State Street, and US Bancorp. All three got sweetheart deals paying between 54 and 65 cents on the dollar. Goldman paid 98 cents on the dollar, according to my estimates. Yet, because of the media and political storm surrounding Goldman Sachs, I think it was in GS’s shareholder’s best interest to defuse any hint of favoritism or taking advantage of taxpayers in the negotiations. Moreover, based on yesterday’s testimony in the House Financial Services Committee, there is no evidence that the U.S. Treasury is moving quickly to auction the warrants of JP Morgan or any other bank. By paying fair price now versus later, Goldman Sachs does not have to be stuck in TARP limbo for several more months.
Professor Davidoff is correct that Goldman Sachs could have got half price on the TARP warrants within the bounds of the TARP securities purchase agreement that its management signed. There is an obscure provision in the Capital Purchas Program warrants that allow the banks to cancel half those options if they issue enough equity before 2010. My paper entitled “A Model for Estimating the Cancellation Probabilities of TARP Warrants” estimated in June that there was a 80 per cent chance that Goldman Sachs would issue $4.25 billion in common stock by year end to cancel half the taxpayer’s warrants. Yet, as I understand the warrant negotiations, banks must actually issue enough new equity to cancel half the TARP warrants before the U.S. Treasury gives them a discount.
GS was under a lot of pressure on its second quarter earnings call to bring down its equity capital ratios (which should be somewhat scary to taxpayers). Moreover, there was a high likelihood that Goldman would be criticised heavily if it cancelled half the taxpayers’ warrants. My paper “Should Goldman Sachs and Morgan Stanley Try to Get Half Price on the TARP Warrants?” argues that Goldman could have raised shareholder value by about $150 million last week, net of the costs of issuing equity, by issuing $4.25 million in common stock to cancel half the TARP warrants. Yet, giving up $150 million of gains would come with the myriad of news stories about how Goldman took advantage of taxpayers yet again. There is no way to know precisely what the impact of such recriminations would be on GS’s bottom line. I think, in the end, political concerns trumped purely financial calculations.
Yet, I believe that Blankfein and Co. served their shareholders (and this time taxpayers) well by paying full price for the TARP warrants. I believe that taxpayers will not get full price on their risky warrant investments with other banks unless the most valuable TARP warrants are moved to third party auctions due to Congressional action or due to tougher negotiation stances at the U.S. Treasury.
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