Who says the price is unfair? Part 2, there’s what we did
[Continued from yesterday's Part 1.]
Some weeks back, the first banks not only repaid their TARP advances (some of which they took under intense pressure to accede) but also bought back their warrants, for cash. You’d think that seeing banks get out of hock and giving our deficit-ballooning government free cash would be a good thing, but some folks at the Huffington Post found in this a source of outrage that the banks were getting away too cheap. They want either that the banks pay the computed Black-Scholes valuation, without adjustment, or that the warrants be put up for public auction. As I mentioned yesterday, I have personal experience with mandatory government negotiations regarding asset values, and my experience suggests the government did well then and is doing well now.
Yes, I’ll negotiate
Fifteen years ago, in the face of what it called a national housing emergency, the Federal government breached its contractual agreements with owners of affordable housing properties. Instead of allowing them to go market when contractually agreed, the government abrogated that right, taking it in an eminent-domain-style expropriation (which so personally offended me I sued the Federal government), and offering eminent-domain-style compensation via a statute known as LIHPRHA. Our company represented dozens of owners going through the negotiated valuation-and-compensation. After a few years, the government suspended the program, restoring owners’ right to go market, because incessant criticisms from some policy advocates about owner overcompensation had convinced Congress owners were bluffing. In fact, with the benefit of hindsight, the government got a great bargain in the lion’s share of the cases.
We did? Good for us!
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.
For goodness’ sakes, it’s a negotiation. Do the fans get to listen in on the quarterback’s huddle?
Okay, Black-Scholes on two, break!
Recently, a group of House Democrats began an effort to end the practice and introduced legislation to require the Treasury to hold public auctions.
That is a choice. One I would not recommend, because as I said before:
My guess is that at least eight of the ten banks buy back their own warrants via appraiser-aided negotiations with Treasury. Letting them go to the auction would be too hairy when compared with a known strike price that could be closed at the table there and then.
An auction is a crapshoot. Either party could do better than the baseline; either party could do worse. A negotiated settlement will have a much lower band of error.
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
Do I have to be immunized against criticism?
Here again, I believe the Huffington Post has stapled the professor’s comments onto an editorial conclusion it had pre-baked. Sure, the public auction reduces suspicion of sweetheart deals, but it wouldn’t silence the Monday-morning warrant buyers, since if it went badly for Treasury, they could howl that any fool should have taken what was offered.
In fact, we’re likely to find out:
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 17, as the bank announced. The bank hasn’t yet paid for the warrants, so Treasury won’t comment on it.
Treasury’s doing the right thing. Transparency’s a good thing when either (a) those observing can offer valuable advice to those who are acting, or (b) those observing are a necessary check to keep honest those who are acting. Here there’s no suggestion of impropriety – which is the usual justification for transparency. Rather, the critics (or at least, the singular critic of the Huffington Post) simply doubts that Treasury’s competent, and wants to watch the brain surgery so see for itself. But the observer’s not especially competent to comment, so what’s the point of real-time transparency?
Does transparency really help here?
In fact, there’s good evidence the process is working well, only the Huffington Post is too blind to see it:
JPMorgan Chase & Co. has reportedly asked the Treasury to hold a public auction, unhappy with Treasury’s offer.
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.
That is utterly ridiculous. If the bar is low, JPMorgan would jump at it. That JPMorgan wants to go to an auction suggests the price isn’t too low.
In fact, the poster’s statement is completely nonsensical. To get the other party to raise its offer, you don’t announce publicly that you want an auction, you use the multiple internal steps already set forth in the process, which (from my previous post) include:
Step 2. I’ll tell you what I think it’s worth.
Step 3. We bargain … quietly.
Step 4. We invite two guys driving through the rear-view mirror, to value it.
Step 5. The two guys pick a Delphic oracle.
Step 6. We puree the results
If JPMorgan (and its advisor) and Treasury (and its advisors) have reached an impasse despite these multiple resolution steps, that’s very, very powerful evidence Treasury isn’t being a lapdog on pricing.
Let’s discuss this
In fact, the situation’s asymmetric in several other ways, all of which imply that Treasury has grounds to get premium values, not discounts:
1. Fractional interests are always worth more to the controlling party than to an outsider. Without getting lost into the valuation theory of appropriate discounts for illiquidity, large-bloc size, fractionality, and lack of control, we can certainly apply common sense. If I already own most of something, and you own a small part of the something, it’s worth a bit more to me to consolidate your minority interest into my majority piece, resulting in an indivisible whole. I don’t have to worry about reporting and tracking the fractional position; I don’t have to concern myself with possible fiduciary-duty or prudent-man documentary standards (not that I’m unethical, just that I don’t have to write down all the whys and wherefores). I’m free and both my optionality and my internal efficiency increase.
2. Treasury will play the game more times than any individual bank. If these bargains are a game, the game is one each bank plays only once. Treasury will play it ten times or more. The multi-player party has a grater willingness to play hardball in some cases, as an experiment, because the knowledge gained in any single experiment can be applied multiple times. Each individual bank gains nothing from the experiment and has no particular loyalty to the overall cause of banking.
3. Banks will pay a premium to escape. The banks never wanted to be here, remember? They gain substantial non-economic value from escaping. No more regulators crawling through every administrative orifice. No more dividend and compensation limitations that are acting as competitive disadvantages relative to other non-TARP banks. No more ongoing hostile press. No more having to consume valuable executive time dealing with the government. No more worrying about how any given business decision may look in the press.
Banks will pay a premium to flee. In fact, one bank fairly clearly did:
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.”
“Yes, Goldman Sachs, may I entangle you?”
Have you ever bought a house? Did you ever offer the Ask? If you did, I can tell you why you did it – you felt that if you didn’t, the opportunity would run away. In fact, Goldman originally offered much less than the Ask:
The investment giant initially offered to pay $650 million, sources familiar with the negotiations said.
Goldman Sachs said Wednesday that it had paid $1.1 billion to buy back the ownership stakes it had handed over to the government when it received a federal bailout package last year, acceding to Treasury Department demands for a higher price on the securities.
If my mental arithmetic is on target, the price Goldman initially offered is probably in line with the discounts from calculated valuation agreed in the other bank buyouts. But then Goldman caved, and fairly rapidly, suggesting (at least to my way of thinking) that Goldman paid a big premium for exiting swiftly.
I’m in a hurry to escape
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.
[That 'funneling money through AIG to Goldman' crack has been floating around the internet for some time. I think it's a calumny but it's not worth trying to explode. – Ed.]
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.
Isn’t that another way of saying that the price includes a ’shakedown premium’ for not being unfairly vilified?
Don’t go there
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.”
Maybe it could. Maybe not.
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.
Looking out for the tapayer: Kilroy was here
“Other investors would want to get a return on their investment,” she said. “There’s no reason taxpayers shouldn’t.”
Actually, I think they did.
We won?
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