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 Wilson.

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?”

Wilson speculated that Goldman Sachs decided to pay fair price to avoid more of the bad press that’s been coming its way the last several months. The bank paid $1.1 billion for its warrants, which Wilson estimates have a fair market value of $1.12 billion based on Tuesday’s closing price on shares of Goldman Sachs.

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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Are we taxpayers winning?

A month ago, Treasury first cleared ten banks to repay their TARP funding, creating rules to sell its glass financial menagerie:

Submitted for your consideration, as discussed in this Wall Street Journal article, is a gargantuan Federal government that, for one good reason or another, now finds itself holding warrants in a series of financial institutions that it has forcibly recapitalized.

Ten big banks earlier this month paid back were cleared to pay back $68 billion in federal government aid. Those firms were: J.P. Morgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley, BB&T, U.S. Bancorp, American Express Co., Capital One Financial Corp., Bank of New York Mellon Corp., Northern Trust Corp. and State Street Corp.

At the time, I speculated:

Conclusion: negotiate, negotiate, then bid?

When the ten banks paid back their TARP money, they knew that it would trigger the buyback or resale of treasury warrants. Sight unseen, I can guarantee that every such bank would like to see those warrants extinguished, and will have already planned its entire tactics, up through and including a potential auction of the warrants.

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.

Knowing this, I expect Treasury’s advisors to be shrewd and to drive fairly tough bargains.

And not a groat more!

Did we?  It depends who you ask, and let’s start with some shrill Monday-morning warrant buyers over at the Huffington Post, whose title leaves no doubt where they stand: Ignoring Watchdog Report, Treasury Gives Three Major Banks Sweetheart Deals:

Less than two weeks after a congressional watchdog called attention to backroom deals in which the Treasury Department repurchased stock warrants from bailed-out banks at well below market value, three more such transactions have now been reported. The big loser: The U.S. taxpayer.

It was easier in the old days of smoke-filled rooms

Before we can call the taxpayers ‘losers,’ it’s as well to remember that any bank that has repaid its TARP has cost taxpayers nothing, and in fact we made money on the interim TARP dividends. 

[Also, don't forget that many banks, Goldman Sachs among them, took the TARP under extreme duress, and were not happy about having to do so. – Ed.]

The warrants are additional consideration, so here’s the equation:

            What we put in                                      What we got out

+ Capital advanced                                 + Capital repaid

+ Risk of losing capital                           + Dividends (at five percent annually)

                                                            + Value of the warrants

Although the risk of losing capital is significant, for the repaying banks, we haven’t lost any money.  Even the five percent dividends look decent in this interest rate environment, with sovereign rates close to zero.  So the warrants are ‘playing with house money,’ and what causes the Huffington posters to fulminate is that we sold them back to the issuing banks at a price the post, in its wisdom, believes to be below what we could have gotten had we auctioned them:

The Congressional Oversight Panel reported earlier last month that in 11 transactions with small banks, taxpayers walked away with about 66% of what they could have gotten.

That’s why Monday-morning quarterbacks are never wrong: they can never be disproved.  Who knows what the auction would have fetched?

Who knows what I would have done, if I’d done something different from what I did do?

Before we go completely ga-ga on this subject, we need to understand precisely what the warrants are, as outlined in a more balanced Washington Post view on the subject:

Many major banks that received federal aid are seeking to exit the Troubled Assets Relief Program. To completely sever ties with the program, the companies must also buy back these ownership stakes, known as stock warrants, which were given to the government in exchange for aid.

[Snip]

Stock warrants give their owner the right to buy a company’s stock after a set period of time at a predetermined price. The Goldman warrants allow the holder to buy 12.2 million shares at $122.90 apiece 10 years from now.

[Snip]

But the long-term nature of the warrants makes them difficult to value because no one knows what the stock price will be after a decade.

A lot can change in ten years

Between now and a decade from now lies inflation and uncertainty.  Future dollars will be worth less than present dollars – quite possibly, much less – and the alternate uses of capital in that interval could be quite high-yielding. 

At a hearing on the warrant repurchase program in the House on Wednesday, Herbert Allison Jr., a senior Treasury official, insisted that the sweet deals the banks got were needed to aid the liquidity of the smaller institutions.

I absolutely doubt that’s what Mr. Allison said, but leave that be.

But now, in three out of the four newly-reported transactions, all with much bigger institutions, the deals have only gotten worse. The transactions returned between 54% and 65% of what the taxpayers could have gotten on the open market, according to one estimate.

How many birds in the bush is a bird in the hand worth?

Do you think the answer’s two?  Bueller?  Anyone?

BB&T agreed to buy back its warrants for $67 million, as reported in a July 17 press release. On July 8, the Treasury sold warrants back to State Street Corporation for $60 million. On July 15, Treasury gave up warrants to U.S. Bancorp for $139 million. The latter two transactions are listed by the Treasury in its transactions report for the period ending July 17.

“We are very pleased to have completed the repurchase of the warrant, effectively concluding U.S. Bancorp’s participation in the Capital Purchase Program,” said Richard K. Davis, chairman, president and chief executive officer of U.S. Bancorp, when announcing the deal.

As well they should be. The warrants that USB bought from the taxpayer for $139 million had a fair market value of $260 million, says an academic who has closely tracked the bailout and the warrant repurchase program.  Linus Wilson is an assistant professor of finance at the University of Louisiana at Lafayette’s B. I. Moody III College of Business and he uses essentially the same methodology to calculate fair market value that the Congressional Oversight Panel used — the Black-Scholes and Merton option pricing models.

A man who did his own math: Linus Wilson

At issue isn’t the method of valuation, but rather the assumptions used to make the calculations.

According to Wilson’s calculations, the State Street warrants, which paid the taxpayer $60 million, should have brought in $92 million at fair market value. And the value of BB&T’s warrants was $114 million, meaning the Treasury left $47 million on the table.

Judging from his home page, Professor Wilson is certainly qualified to do the calculations, and some interesting byplay about whether the pricing was right suggests he’s genuinely interested in the truth, not (unlike the Huffington Post) in scoring cheap rhetorical points.

A Treasury official said in a statement to the Huffington Post that the process it uses to determine the price of the warrants is fair: “The warrants for common stock held by Treasury do not trade on any market and therefore do not have observable market prices. Their values can only be estimated.”

Valuing financial assets that are not going to be traded always involves an element of uncertainty. 

Maybe I’m worth it, maybe I’m not

Conversely, the act of selling them changes reality permanently, so that if you go to the auction and are disappointed, you have no way of going back and taking the negotiated offer.

“Treasury follows a comprehensive approach to estimating these values, which involves using a variety of inputs including a set of well-known financial models. These models will include, but will not be limited to, binomial and Black-Scholes option-pricing models, and are widely used in financial markets to value options and warrants.”

This is what Professor Wilson did:

The specific flaw in the Treasury methodology, business professor Wilson told the Huffington Post, is that it doesn’t give enough weight to the bank’s stock price in its calculation. “Treasury starts out with a very low price [that it offers in negotiations].  Banks come back with an even lower price.”

While I have every confidence that Professor Wilson knows what he’s talking about, the quote attributed to him here doesn’t buttress the sentence that preceded it.  Obviously current price means something, but as we know, stock prices fluctuate, so without reading Professor Wilson’s analysis in depth, I can’t evaluate how much difference current stock price makes in a Black-Scholes forward projection. 

Meanwhile, Treasury brought into its estimations several other data sources unavailable to the good professor:

“Treasury also relies on indications from market participants as to what they would be willing to pay for the warrants.”

That’s sound.  In real life, my for-profit company provides independent valuations of complex real estate financial interests.  We build detailed financial models (discounted cash flow, which is to real estate interests what Black-Scholes is to options), populate them with the most defensible and evenhanded assumptions, and derive a value.  Then, when we have that value, whenever possible we go find people who might be buyers of whatever unique asset we are valuing, describe it (anonymously, of course) and ask, “how much would you pay for this asset?”

How much would you pay for all this?

But wait!

There’s more!

We do this because a sequence of reasonable assumptions can sometimes derive an unreasonable conclusion, whereas a market-maker in the money store will bring a holistic assessment of what the object is worth – and after all, that’s the real definition of value, what price will be paid by an independent party dealing at arm’s-length.

We’re dealing at arm’s-length

“We obtain quotes from three separate market participants who regularly invest in or trade similar securities.”

Not just one quote, but three.  Excellent confirmation if you can obtain it.

If we three agree, you gonna disagree?

“We also retain outside managers to provide full, independent valuations.”

These experts, one presumes, will have been drawn from the banking and valuation sectors.

“Together, these various methods constitute a robust process for estimating value and protecting the taxpayers’ interests.”

In point of fact, they do – when one needs to estimate, one gets a better answer by using multiple categorically distinctive approaches and then comparing the results.  So the Huffington Post, by not only relying on a single estimate (and if I were the author, I’d be cringing at the hyperventilated overclaims being made using my report as sole evidence) but also ignoring the ancillary procedural evidence, all of it relevant, whips itself into a lather.

Ignoring evidence? I’m not ignoring evidence!

“Banks get a very good deal,” said Wilson.  “Taxpayers would be better served if the Treasury took an optimistic view of the warrants’ value and moved most of them to auction.”

Perhaps; perhaps not.  I have direct personal experience suggesting that a tortuous internal negotiation can be a good result for the government, much better than allowing the market to work.

The best road isn’t always a straight line

[Continued tomorrow in Part 2.]

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Someone who’ll treat them delicately

Submitted for your consideration, as discussed in this Wall Street Journal article, is a gargantuan Federal government that, for one good reason or another, now finds itself holding warrants in a series of financial institutions that it has forcibly recapitalized.

They made us an offer we couldn’t refuse

Ten big banks earlier this month paid back were cleared to pay back $68 billion in federal government aid. Those firms were: J.P. Morgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley, BB&T, U.S. Bancorp, American Express Co., Capital One Financial Corp., Bank of New York Mellon Corp., Northern Trust Corp. and State Street Corp.

Because warrants are options to purchase common stock for a preset price at any time during a stated interval, they have a positive value even if the exercise price today is above the stock’s trading value today. Further, because the warrant holder has all the optionality – choosing when to exercise – plus minimal carrying costs, the value is greater when the exercise window is long, such as ten years.

A lot could happen on that future road

Yet this very large governmental body probably ought not to be in the business of holding warrants, even from a fully transparent Bank of Glass, because aside from the sticky-finger conflicts of interest rampant in such a situation, government is a slow-moving behemoth that is seldom a good holder of complex real estate assets, nor adept at defusing unexploded financial ordnance, and still having trouble enough finding the right CEO(s) for its schizophrenic GSEs.

Under a key TARP program, the government injected capital into hundreds of banks around the country in exchange for warrants to purchase common shares.

When a publicly-traded bank repays the government, the bank can repurchase the warrants. But that process is expected to be complicated given that the warrants have an unspecified value.

One approach to valuing anything odd is to auction your headaches, but as in divorce, when the current holder(s) both know the asset well, a pre-auction negotiation is effective – and that, has been structured in to the TARP repayments that will be forthcoming shortly:

WASHINGTON — Now that large banks have started paying back government aid, the U.S. Treasury Department is shedding light on its process for negotiating warrant repurchases with banks, saying Friday that it has developed “a robust set of procedures” to protect taxpayers.

Strong enough to protect taxpayers

Treasury Friday released a packet of documents that explain the warrant repurchase process.

As an exercise in procedural negotiation, the TARP warrant repayment is an illuminating case study:

Government grows best in the sunshine, so let’s illuminate

Step 1. I hold warrants in you, so you tell me what you think it’s worth

In negotiations, who makes the first offer is a significant issue; sometimes one is best served by going first and proposing; sometimes one is better served by letting the other side go first.

Here, Treasury concluded – and I think rightly, for reasons I’ll give in a moment – that it wants to see what the financial institutions propose.

The gist is this: Within 15 days of repaying funds to the Treasury, a bank seeking to repurchase the warrants should submit a determination of fair market value to Treasury.

When one party knows much more than the other about the issue at hand, but the two parties need to reach agreement, as a general principle the side that knows less should go second, especially if

Treasury has several reasons for letting the banks lead, one of them particularly subtle.

a. Anchor the bidding. The banks want the warrants to go away; they want to buy them. Whatever the banks offer in their initial determination is immediately Treasury’s floor price. That’s significant value given that Treasury right now has no idea what the warrants are worth. Planting that first flag and knowing the discussions will only move up from there is psychologically useful.

b. You’ll educate my experts. Even as there is negotiation between principles, buyouts like this also involve examination of evidence. When Treasury asks the bank to provide a valuation, the methodology used and the data collected represent a starting point for the education of Treasury’s appraisers.

c. Now I can tweak your numbers. If your analysis is generally sound except for a few knobs, I can tweak them to my benefit, even if I don’t understand everything you’re doing.

You give me the assumptions, I’ll tweak them

Long ago, in a district court far away (Utica, New York, which from the airlines’ perspective might as well have been the far side of the moon), I was scheduled to be an expert witness in a bankruptcy matter where our client (the owner) needed to show it had value in its position. It wasn’t clear that I would be able so to opine, but fortunately for our side the other expert went first, and offered an opinion based on a set of assumptions and calculations that were much more favorable than anything I could have presented with a straight face. There then ensued a funny contra dance where I’d whisper a question to our counsel, he’d ask the witness, and the witness – who had no stake in the outcome – would answer, looking straight at me. After a few such cycles, the other side suddenly scuttled to a corner of the courtroom, agitatedly poring over the cash flow schedule they had just entered into evidence.

d. You’re under pressure to show good faith. The government has infinite patience, infinite money, and infinite time. The repurchasing bank wants out, and while there’s a procedure for a unilateral exit, no bank wants to offend its sovereign regulator.

You’re right, officer, that joke was in poor taste

In addition, the submitting bank is also certainly required to certify the valuation’s accuracy and completeness under pains and penalties of perjury. The submitting bank therefore needs to create a record that makes the bank look forthcoming and fair, even examined later in the worst possible light – especially since, even after this transaction is done, Treasury or the government will still be regulating the bank’s future.

In short, lead with something very professional or risk incurring the regulator’s wrath.

(Treasury Friday [June 27 – Ed.] would not comment on whether banks have already submitted such value determinations.)

But of course they have! The repaying banks can read the same rules Treasury can, and paying back the preferred stock is being done to rid themselves of government intrusion, so they’ll naturally want to rid themselves of the warrants (which are simply future stock shares) as well.

Step 2. I’ll tell you what I think it’s worth.

Treasury will then respond within 10 days.

Given the short time frames, we can see the value of educating the government’s appraisers, and of tweaking the bank’s numbers. Treasury has capable advisors under contract, but even so.

Step 3. We bargain … quietly.

If Treasury objects to the bank’s plan and an agreement cannot be reached –

Catch that casual passive-voice phrase? ‘Agreement cannot be reached’ means that the principals have a chance to negotiate – and if the bank’s originally submitted value is reasonably close, there will be many reasons why treasury will suggest gently, why don’t you guys raise your bid by five percent, and we’ll call it quits?

Can we reach a gentlemen’s agreement here?

Step 4. We invite two guys driving through the rear-view mirror, to value it.

Any two-person closed system requires unanimity for agreement, and as such can often reach an impasse.

When that happens, one needs a third party, preferably an independent expert

– the bank and Treasury Department will have independent appraisers step in to help determine a final price.

If you’re scoring at home, that’s the bank’s advisors, Treasury’s advisors, the bank’s third-party appraiser, and Treasury’s third-party appraiser. Lots of professionals.

Because you could hurt yourself valuing these things

Step 5. The two guys pick a Delphic oracle.

I’m presuming that the third appraiser is picked by consensus of the other two. That’s normally how it’s done.

If those appraisers can’t agree, a third appraiser is hired –

It’s always dangerous to consult the oracle … because you never know what she’ll decide.

Even a pre-Raphaelite one

Step 6. We puree the results

Not wishing to trust the oracle, somehow the parties will puree together all the information.

Yummy data, dad!

– and a composite valuation of the three appraisals is used to establish the fair market value.

This is odd, and questionable. I doubt it will be used much … but before we consider it, let’s look at the alternative approach.

Step 7: Plan B, let the market price it

Additionally, a bank can decide against repurchasing warrants.

After all, the bank might not want to cash them out right now, or it might engage in the extended negotiations with Treasury, only to be unable to reach an amicable valuation. If that happens, then Treasury gains its unilateral alternative.

In that case, Treasury said it would sell the warrants through an auction process over the next few months.

I am happy to know I shall hit something!

Auctions are at least definitive. They work well in thick markets – many buyers – or in commoditized markets – many similar products – and they’re the disposition of last resort when it’s essential to realize a cash price now.

Treasury added that it has no plans to hold onto warrants until their expiration.

From Treasury’s perspective, this is both the exit and the hammer.

An exit because the government wants to be out of the business of holding the glass menagerie.

“The president has clearly stated that his objective is to dispose of the government’s investments in individual companies as quickly as is practicable,” said the Treasury documents. It noted that it considered options that would involve the government holding warrants for a longer term or until they expire. But under those scenarios, “there was no certainty that we would realize higher values, and it was not appropriate for the government to be exercising discretionary judgment on timing market sales,” the documents said.

A hammer because Treasury can tell the bank, if you don’t like having me own you, how would you like to be owned by Larry the Liquidator?

I’m not from the government and I’m not here to help you

The department is currently establishing guidelines for the auctions.

“A fully transparent auction … provides the best method for the Treasury to realize the market value of the warrants in the near-term on behalf of taxpayers,” the documents said.

Step 8 … at which the bank itself can bid

Nothing in the rules I read prohibits the bank from bidding on its own warrants. Which makes the game almost self-referential] – negotiate, negotiate, negotiate, and then bid at the auction.

Conclusion: negotiate, negotiate, then bid?

When the ten banks paid back their TARP money, they knew that it would trigger the buyback or resale of treasury warrants. Sight unseen, I can guarantee that every such bank would like to see those warrants extinguished, and will have already planned its entire tactics,. Up through and including a potential auction of the warrants.

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.

Knowing this, I expect Treasury’s advisors to be shrewd and to drive fairly tough bargains.

And not a groat more!

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