Offers You Can't Refuse: Henry Paulson Edition

From Tyler Cowen:

Marginal Revolution: The Deal:

Citigroup and JPMorgan Chase were told they would each get $25 billion; Bank of America and Wells Fargo, $20 billion; Goldman Sachs and Morgan Stanley, $10 billion each, with Bank of New York and State Street each receiving $2 to 3 billion. Wells Fargo will get an additional $5 billion, reflecting its acquisition of Wachovia, and Bank of America receives the same for amount for its purchase of Merrill Lynch.... The government will purchase perpetual preferred shares in all the largest U.S. banking companies. The shares will not be dilutive to current shareholders, a concern to banking...executives, because perpetual preferred stock holders are paid a dividend, not a portion of earnings. The capital injections are not voluntary, with Mr. Paulson making it clear this was a one-time offer that everyone at the meeting should accept.

Here is the story.  No matter what your point of view, you ought to be stunned by this development.

I am not stunned. I wqnt to sing!

Nunc dimittis servum tuum, Domine, secundum verbum tuum in pace:
Quia viderunt oculi mei salutare tuum
Quod parasti ante faciem omnium populorum:
Lumen ad revelationem gentium, et gloriam plebis tuae Israel.

If this doesn't revive the interbank market, nothing will. If this doesn't, I'm going to start training in flint-knapping to get ready to fight for cans of salmon in the aisles of Trader Joe's...

I am nervous about this "preferred stock" business...

As, say, Citi's net worth declines there comes a $25 billion tranche in which stockholders are effectively wiped out but the thing is still moving. Henry Paulson is performing a dread magic: creating zombie banks in the hope that they will do his will. Voting common stock seems to me to be a better idea. Otherwise, we may have need of the Ogoun Instructional Package:

Ogoun Feray, Ogoun Badagris, Ogoun Zye Wouj! St Jacques Majeur!!

Comments

[Sprizouse]

I'm not sure what Cowen's stunned about either. Nor the reaction of the commenters as to why Paulson forced it or that he went ahead with it. Isn't it obvious that it had to be done this way?

If the banks came voluntarily to ask for money it would signal weakness and any sign of weakness by a bank in the current climate has been severely punished. So the major banks had to be forced to collectively take it all at once. Why is any of this stunning? Wasn't what the markets just did last week MORE stunning?

Well, anyway thanks for being a constant source of intelligence Dr. DeLong. Where would we be without you and Krugman?

[albrt]

I suggest Flintknapping: Making and Understanding Stone Tools by John C. Whittaker. There are also a number of fairly good websites on teh Google.

[Roger Chittum]

This new capital is very cheap. Goldman is paying Buffett at least twice as much. Br'er Rabbit is in the briar patch. No mention of executive compensation. This tells overleveraged institutions not to return phone calls from potential private equity investors until they have milked Uncle Generous to the max.

[Matt]

With all that money directed at bank stocks at such generosity at the same time, we might just have our next bubble!

[low-tech cyclist]

I thought the philosophy behind both the original Paulson bailout plan, and the Dodd-Frank upgrades that Paulson's utilizing, was that Uncle Sam would inject cash in a manner that allowed the government to share in the wealth when the rebound came, and potentially come out ahead on the whole deal.

Since preferred shares' return is the same regardless of earnings, doesn't this eliminate that possibility?

Sure, this is great for the markets, and unless one or more of these banks goes under, Uncle Sam should get his money back in the end. But it seems to me that Paulson could have gotten us a better deal than this - could have gotten us common stock rather than preferred.

Sure, the banks' stockholders and execs didn't want to have their stakes diluted, but Paulson could have had a simple message: any bank that doesn't participate today, doesn't get bailed out later - if you go under, you go under, just like Lehman. And a larger percentage of zero is still zero.

[diesel mcfadden]

I'm assuming the rationale is that if it's the most obvious sweetest sweetest deal for the banks, the bank stocks will go rocket. Paulson bulletproofed 'em (we'll see in the long run). Right now, it looks like they got something more like debt (at 5%, behind current bondholders), virtually no restrictions, no equity dilution, no dividend suspension, no change in management, no board seat, and a perfect credit score for themselves going forward. I'd say that's something to smile about.

The 15% warrants are a way the papers can report that the government gets "upside", when relatively speaking, it's marginal.

The idea that this was "forced" on banks for the good of the country is 100% theater.

[John Emerson]

I think that in the post-prosperity economy the currency should be a standardized turnip. Fiat currency is what got us into this mess.

[prostratedragon]

I'm saving that url.

Isn't outright nationalization the only way to get control under circumstances such that seniority is not a big issue?

[dr2chase]

When I worked at a startup (or two) and the company needed more money, our asses got diluted. This sounds like special rules for fat cats.

[Joe S.]

Not to worry about zombies. The FDIC can put a bank to sleep pretty damn much whenever it pleases. Even with ostensibly positive equity.
This isn't straight corporate law, either. Supervisors are part of the governance equation. That is, if they develop some vertebrae.

[Neal]

So does this mean that the days of free and easy credit are back?

Is the clock reset to 2003 with another 5 years until the next bust?

Saves the bank, does nothing for the economy.

[skeptonomist]

Preferred stock at 5% interest and warrants for only 15% of investment? This is a giveaway, not a takeover.

[Neal]

From The Washington Independant

(quote)

The Fed’s weekly balance sheet has evolved into a fever-chart of Bernanke’s interventions. Start with the balance sheet of a year ago, in October, 2007. Total Fed assets were $890 billion, of which $780 billion comprised Treasuries, with the balance scattered among gold certificates, physical plant and other miscellany — or roughly the size it had been for several years.

Now jump ahead to the balance sheet from last week. The Fed’s assets have swelled to $1.6 trillion, an increase of 80 percent. But only $265 billion are Treasuries actually held at the Fed. The rest are a mélange of god-knows-what instruments vacuumed up from banks and investment banks.

There are $149 billion in dicey securities exchanged for Treasuries in bi-weekly auctions; “Other Loans,” to the tune of $420 billion (all we know is that it includes the credit extension to AIG, which has climbed to about $100 billion); a special $29-billion line for Bear Stearns, and $145 billion in direct lending to companies. There is also $325 billion in “Other Assets” — probably mostly dollars for foreign central banks to help local banks choking on dollar-based CDOs and other poison apples from America.

The total lending expansion, therefore, was about $700 billion, with about $650 billion in just three weeks since Paulson and Bernanke proposed what became TARP to purchase banks’ bad assets, or otherwise provide them with new equity.

In other words, even as academics and Congress agonized over TARP, Bernanke and Paulson had already pumped out roughly that amount of money — without so much as asking for a by-your-leave. Paulson even engineered a special $400-billion Treasury borrowing program -– i.e., increased the federal debt — to supply part of the extra cash needed to support Bernanke’s lending.

Fascinatingly, Bernanke’s fire-hose of liquidity has so far been accompanied by a steady tightening of lending conditions. Some market watchers worry that interbank liquidity is drying up because borrowing at the Fed is so much easier. Only time will tell.

If there’s one lesson from the past few years, it is the formidable nature of the law of unintended consequences. The vast new infusions of dollars will weigh on U.S. international balances for years. It is all in the name of staving off a “recession,” which now looks something like the 1960s specter of nuclear Armageddon.

We may have reached the point where the cure is scarier than the disease.

Charles R. Morris, a lawyer and former banker

(end quote)

[Anon.]

It does sound like Paulson is trying his best to screw up the Swedish/British/European plan, after being forced to admit that it's the right thing to do.

[anonymiss]

Sure, the banks' stockholders and execs didn't want to have their stakes diluted,

Seriously, fuck'em. They put their money on the roulette wheel.

This is a total giveaway. Paulson is being VERY generous to his friends with my money. If I'm ever in a superexpensive restaurant and I see him, I am going to spill my drink on him. And then steal his.

[Robert Lewis]

Henry Paulson and Goldman Sachs:

Scattered from California to New York: The judgments from the Department of Labor, tax liens against 401-K plans, state tax liens, mechanics lien, judgments from other companies

Henry Paulson, 5 weeks before he became Treasury Secretary, got a FANNIE MAE/FREDDIE MAC 30 year fix mortgage/loan for his 82 year old mother in May 2005 for 5.37%, (below rate)

webofdeception.com

[low-tech cyclist]

"Paulson is being VERY generous to his friends with my money."

Back on October 1 (http://delong.typepad.com/sdj/2008/10/dean-baker-on-t.html), Brad spoke thusly:

"My belief is that if Paulson were to stay on he would treat undercapitalized banks like a Goldman-Sachs honcho treats counterparties in trouble: strip them of everything and send them naked into the blizzard to live or die on their own--that's what he and Bernanke have done to the preferred and common shareholders of Freddie, Fannie, AIG, WaMu, Wachovia, Bear-Stearns, Lehman, and to the bondholders and counterparties of Lehman..."

Brad, I think you were being just a tad optimistic.

[Neal]

Meanwhile, in the "real" economy (St. Paul Pioneer Press)...

(quote)

Minnesota's food stamp demand is up 5 percent for the year. The increases have been greater in states such as Florida, which has seen a 22 percent spike in one year.

Officials say the surge is just beginning. That's because rules have been loosened at the same time the nation endures a brutal economic downturn.

As of Oct. 1, child care expenses and retirement savings are not counted against families seeking help. The maximum income limits have been raised slightly, and the benefits now are indexed for inflation.

The rolls are bound to soar because it usually takes three years for an economic downturn to result in increased food stamp use, said Deb Schlick, director of the poverty-fighting Affirmative Options Coalition.

That's how long it typically takes a family without a breadwinner to become impoverished, having depleted personal savings and loans from banks or family members.

(end quote)

[horsec]

Partial nationalization was not part of the original bailout plan but this is why it's going to happen:

Inside Treasury, the Office of the Comptroller of the Currency (OCC) charters, regulates, and supervises all national banks. The OCC's task is, ''To ensure the safety and soundness of the national banking system.'' ''The OCC does not receive any appropriations from Congress. Instead, its operations are funded primarily by assessments on national banks. National banks pay for their examinations, and they pay for the OCC's processing of their corporate applications.'' - http://www.occ.treas.gov/aboutocc.htm

The new plan covers up OCC's failure ''To ensure the safety and soundness of the national banking system.'' This failure is the fault of a Congress that didn't pay for regulation, didn't get regulation, that opted instead for a 'free lunch.'

[R.M.Flanagan]

Glad to see the my aversion to preferred shares is echoed here. I've blogged fruitlessly to that effect for a couple of days.

Gordon Brown took voting common but I fear that this is yet one more
last ditch nod by Paulson to the mythical(or at least uncritically praised)benefits of the market. At the expense of the tax payers who've been deprived of their chance to benefit from the resurgence when it comes.

[pgl]

I hope you can walk to the nearest Trading Joe's. In LA, there is never enough parking. Maybe I should bring along something to barter for a nearby parking spot!

[Lawrence Krubner]

Delong writes:

"Henry Paulson is performing a dread magic: creating zombie banks"

In this context, I think the phrase "zombie banks" has a strong historical association with Japan in the 90s. I had to read this sentence 3 times before I was certain you were making an unrelated joke. My first reading of the sentence left me wondering "Why would Paulson want to recreate the Japan crisis of the 90s? But then I realized (I think) that you are not actually accussing Paulson of that.

[PghMike]

The warrants can be exchanged for stock if the stock rises, providing a return to taxpayers if things go well.

What it looks to me is that Paulson is still trying to buy time for the banks to find some way to unload their bad securities. By guaranteeing interbank loans for 9 months, he can keep money flowing (or it *should* flow, I'd guess, if the Treasury is promising to back any short term paper).

But nowhere do I see any reference to the triage that Roubini thinks is necessary. And (FWIW) I agree with him -- the banks participating in this plan may still be *insolvent* -- no one will know unless the government pretty much takes over the banks in question and looks at their books in detail. And if the banks may still be insolvent, then no one's going to buy their equity, or any bonds except for those guaranteed by the US Treasury, in which case, the banks may as well borrow directly from the Treasury instead of from each other.

Still, he's bought time by preventing anything that could kill off a bank; I like the zombie terminology.

The whole plan reminds me of that story (from Heinlein?) about a thief who, when about to be executed for his crimes, offered to teach the Sultan's horse to sing before a year is out. In the tale, the Sultan accepts, and someone asks the thief how he was going teach a horse to sing. His reply -- "A lot can happen in a year -- I may die. Or the Sultan may die. Or, perhaps, the horse will learn to sing."

Its a cute story, but the smart money's not taking the bet.

[BaxterJ]

Do you think the average American has a clue what this all means?
http://www.entertonement.com/collections/4696/Henry-Paulson-On-Purchasing-Bank-Shares