More big news from the Obama administration: The Treasury is considering converting taxpayer bank bailout stakes into common equity, the same way it is doing with Citigroup (NYT).
Doing this would allow the Treasury to strengthen the banks without going hat in hand to Congress for more bailout money. It might also, however, screw taxpayers yet again–by converting the preferred, dividend-paying securities they now own into common stock. Common stock no longer pays a dividend at most TARP banks, and if the bank fails or needs more capital, the common stock gets hit first.
One positive aspect of this plan is that it won’t require the US government to borrow any more money to fix the banking system. If the banks can actually be turned around, moreover, it might eventually lead to–gasp–profit for the taxpayer, when the stakes are eventually sold. But the government should be converting bondholders’ stakes to equity, not taxpayers’ stakes.
As we’ve said before, the idea of converting debt to equity as a way of strengthening banks is a good one: The folks who voluntarily lent money to banks should cover some of the cost of the fixing them. It is typical of our approach to this crisis, however, that what is being proposed here is not the conversion of debt to equity but the conversion of taxpayers’ preferred stock to equity. In other words, in the interests of protecting private-market bondholders to the tune of 100 cents on the dollar, taxpayers may, yet again, likely take it on the chin.
The key metric in such transactions is the conversion ratio: The number of common shares the taxpayer gets for each preferred share. If Tim Geithner’s goal here is to give the banks another gift at taxpayer expense, he’ll do it through the conversion ratio (see Geithner’s Gift To Citigroup).
Converting preferred stakes to common stock will dilute common shareholders, perhaps severely. Since dilution is preferable to bankruptcy, however, the stocks may not get hammered on this news.
Such a conversion would also radically increase government ownership of the banks. Since the government already controls the banks through de facto nationalization, however, this would be more an acknowledgement of the existing reality rather than a major change.
Converting the bailouts to common stock will also eliminate the concept of banks “paying the taxpayer back.” Not that that was going to happen at most of the TARP banks anytime soon (if ever).