Well, we finally have details on how the government’s latest bailout will work. As expected, it will shaft taxpayers. On a positive note, the reaming isn’t quite as bad as it could have been.
The key element here has always been price. Specifically, at what price will the new preferred stock the government buys convert into common stock?
The fair price would be the common stock price at the time of conversion. This way, the more worthless the bank became, the more of it the preferred shareholders would own. And the more valuable the bank became (assuming such a thing is possible), the less of it preferred shareholders would own–thus incenting bank managers to get their act together.
Of course, the new TARP won’t work that way. Instead:
Capital provided under the CAP will be in the form of a preferred security that is convertible into common equity at a 10 per cent discount to the price prevailing prior to February 9th.
A 10% discount to the price prevailing prior to February 9th.
According to the term sheet, this specifically means the average of the closing prices for the 20 days prior to February 9th. Which means, in the case of many banks, we can be sure of one thing: This price is considerably higher than the one prevailing today.
Take Citigroup, for example. For the 20 days prior to February 9th, Citi traded between $3-$4 a share, which means that our conversion price is, say, $3.50. But Citi’s stock is trading at $2.50. So if we converted today, we’d get hosed.
As Citi gets more and more worthless, moreover, we’ll get more and more hosed. What if Citi stock pulls an AIG and drops to say, $0.40? We’ll still be converting at about $3.50.
So, enjoy our money, Citi!
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