Banks: TARP Imperils Ability to Overpay Executives

Via Kevin Drum, we get some context Goldman Sachs’ “noble” desire to pay back $5 billion in TARP funds.

Back in September, Goldman Sachs received a $5 billion capital investment from Warren Buffett that requires interest payments of 10%.  A month later they received a $10 billion capital injection from the Treasury that requires interest payments of only 5%.

So this should mean that if Goldman is animated by shareholder best interest, it would pay off the Buffet loan first, right? After all, the interest will cost the company — and shareholders — much more the longer it sits on the books, so this should be a no-brainer. Analyst Richard Bove sheds some light.

“If you were thinking of shareholders first, you would get rid of the most onerous amount first, and that would benefit shareholders. … However, if you pay off TARP you are eliminating all of the restrictions on paying management,” Bove told TheStreet.com. “You shouldn’t be diluting existing shareholders to pay off TARP so you can pay management more money.”

I suppose you could make the argument that the best interest of shareholders would be best met by the PR boon associated with unshackling the company from more rigorous government oversight, but I think given the financial industry’s history over the past couple years,  it’s pretty safe to assume this isn’t the true motivating factor. Further, this logic would be rendered even more incredulous when you consider that TARP money aside, financial firms are still the benefactors of significant government aid.

Even as they clamor to exit the most prominent part of the bailout program by repaying government investments, firms continue to rely on other federal programs to raise even larger amounts of money….The Federal Deposit Insurance Corp. has helped companies [] borrow more than $336 billion through the end of March, by guaranteeing to repay investors if the firms defaulted. And financial firms hold more than $1 trillion in emergency loans from the Federal Reserve.

Goldman Sachs declared a “duty” to repay the Treasury after posting a first-quarter profit. The chief executives of several large banks at a meeting last month urged President Obama to accept repayments. But no company has similarly pledged to leave the government’s other aid programs.

The explanation appears to be simple: Only the capital investments by the Treasury require the companies to make significant sacrifices, such as restricting executive pay.

I’m aware that the strict government oversight is legislatively codified in the TARP bill, but Congress ought to pass a law extending the jurisdiction of these powers to cover banks currently relying on government loan guarantees. The legislation should be written loosely enough to allow leeway in determining who is subject, but the recent spate of news suggesting banks are all of a sudden “profitable” is insulting to one’s intelligence. After all, if Goldman was doing well enough to pay off the TARP funds, why did they need to raise $5 billion in stock to do it?

Finally, these measures represent a significant gamble by the part of the banks that the populist rage engendered by the AIG bonus mess has finally subsided. They might be right to assume that the more complicated nature of the situation won’t result in the same level of outrage, but it’s not a lock. It’s hard to speak for “the public”, but I can tell you that I’m not yet comfortable enough with the idea that finance should return to its status quo to let this slide — and Barney Frank is no fool.

How to Show A Profit While Failing

Wells Fargo should consider auctioning this.

I was at dinner with my family this past weekend, and my brother, whose roommate works at Wells Fargo, was remarking on the good news that Wells Fargo had posted a record profit. Likewise, we’re seeing today reports that Goldman Sachs had turned an impressive profit in the first “quarter” of 2009. I didn’t make too much noise at the table, but I did casually mention a substantial amount of banking “profits” this quarter — especially at Goldman — were the result of government AIG payouts. What’s more, despite rumblings that some banks intend to pay back TARP funds, most of these banks are really only in business because of government guarantees that they aren’t permitted to fail. In other words, don’t pop the champagne yet.

Along these lines, we learn today that Wells Fargo will probably have to raise another $50 billion in capital. According to a report by KBW:

“Details were scarce and we believe that much of the positive news in the preliminary results had to do with merger accounting, revised accounting standards and mortgage default moratoriums, rather than underlying trends,” wrote Cannon, who downgraded the shares to “underperform” from “market perform.” “We expect earnings and capital to be under pressure due to continued economic weakness.”

Similarly, while Goldman still managed to post a profit in first quarter, it’s significantly lessened by the fact that Goldman employed some accounting sophistry to exclude massive write downs in December.

I say all of this without a particular recommendation in mind, but at least to offer a reminder that a) we’re not close to being out of this yet and b) comabat this emerging meme that bailouts are somehow impeding recovery.

Bankruptcy or Bonuses, Which Would You Rather Have?

Megan McArdle has a post up on the tax system, but says this in the post:

I’m not angry and bitter; I’m about as mad as I am at the prospect of people who bought homes they can’t really afford getting a bailout while I continue renting–which is to say, not very.  Life is rather too short to spend it getting angry at remote strangers.

I guess a lot of this was discussed following the famous Santelli rant, but it’s worth noting that as yet (Senate vote is pending — who knows what they’ll do to it), there are no people who bought homes they can’t really afford getting a bailout. In fairness, Megan seems to acknowledge as much (“the prospect of”), but were this prospect to become a reality, it wouldn’t change the fact that the two are pretty wildly different. On the one hand, you have financial service firms who were instrumental in magnifying the damage of the housing bubble wistfully dolling out bonuses financed by $300 billion from taxpayers, that in many cases will be larger than whatever “bailout” homeowners receive. Of course, this $300 doesn’t include the other ways that people in the financial services have been bailed out, like today’s announcement from the Treasury Fed committing $750 billion buying mortgage backed securities (this was in addition to $500 billion already spent).

On the other hand, the so-called “bailout” for homeowners allows bankruptcy judges to alter the terms of a mortgage once the lender and the bank have already tried to adjust the mortgage voluntarily. In other words, the “bailout” results in the decrease of a home’s mortgage (and asset value, I’ll add) after you go to bankruptcy court. The way people have been describing this, you’d think Barack Obama was going to come strolling down your street with a t-shirt gun loaded with wads of cash to make it rain on your irresponsible neighbors. In reality though, nobody wants to go to bankruptcy court, but I bet there are a lot of people who wouldn’t mind receiving “retention” bonuses when they’re quite lucky to even have a job. The two aren’t even remotely close. (I know people are arguing that there’s demand for these AIG workers elsewhere, and that if their departure could bring to bear disaster. To which I would ask, $173 billion isn’t disaster?)

I say all this fully understand that there are sound policy reasons to be bailout banks and homeowners, and I think these issues of fairness are secondary, but to suggest the level of unfairness is symmetrical is ludicrous.

UPDATE: Also want to point out the obvious that whatever you might say about owners buying homes they couldn’t afford, it’s not as if these people bought their homes on a credit card. That is, someone else looked at their finances and decided to give them a loan. Now, whether they were given a loan under the assumption the house could be sold several years later at a higher value, whether the loan officer just didn’t care as long as they qualified, or whether the bank legitimately thought their new debtors could afford the home is basically immaterial insofar as the powers that be gave the loan a green light. Of course, this doesn’t absolve the homeowner of total responsibility, but it’s a bit of a stretch to suggest that this whole operation was the result of homebuyers run amock.

Fool Me Twice

For what it’s worth, I never thought limiting executive pay was tremendously important component of the TARP (ultimately, it seemed mostly symbolic, and the need for a bailout was certainly not), but that doesn’t mean the Bush Administration didn’t completely snooker Congressional Democrats:

But at the last minute, the Bush administration insisted on a one-sentence change to the [limits to executive pay] provision, congressional aides said. The change stipulated that the penalty would apply only to firms that received bailout funds by selling troubled assets to the government in an auction, which was the way the Treasury Department had said it planned to use the money.

Now, however, the small change looks more like a giant loophole, according to lawmakers and legal experts. In a reversal, the Bush administration has not used auctions for any of the $335 billion committed so far from the rescue package, nor does it plan to use them in the future. Lawmakers and legal experts say the change has effectively repealed the only enforcement mechanism in the law dealing with lavish pay for top executives.

Say it ain’t so? Verily, as the Washington Post describes, “the modification reflects how the rapidly shifting nature of the crisis and the government’s response led to unexpected results.” Oh wait, as the Washington Post later reports in the same exact article:

Meanwhile, [Treasury Secretary] Paulson repeatedly told lawmakers that he did not plan to use bailout funds to inject capital directly into financial institutions. Privately, however, his staff was developing plans to do just that, Paulson acknowledged in an interview.

I’m not sure which is more stunning, the Washington Post’s willingness to just chalk it up to the “rapidly shifting nature of the crisis” while simultaneously reporting Paulson had no intention of using auctions, or the fact that the Bush Administration so capably hoodwinked Congress yet again.

As Steve Benen quips, “The relationship between Lucy and Charlie Brown keeps coming to mind.”

Christmas Comes Early

Well, there’s been a deal reached on the CitiGroup bailout, and people are pissed. The basic terms:

In short: (a) Citi gets another $27 billion on the same terms as the first $25 billion, except that the interest rate is now 8% instead of 5%, and there is a cap on dividends of $0.01 per share per quarter; and (b) the government (Treasury, FDIC, Fed) agrees to absorb 90% of losses above $29 billion on a $306 billion slice of Citi’s assets, made up of residential and commercial mortgage-backed securities. (If triggered, some of that guarantee will be provided as a loan from the Fed.) There is also a warrant to buy up to $2.7 billion worth of common stock (I presume) at a staggeringly silly price of $10.61 per share (Citi closed at $3.77 on Friday).

In addition, there will be no management changes and according to the NYT, “the preferred shares will pay an 8 percent dividend and will slightly erode the value of shares held by investors.” Seems like a pretty sweet deal for Citi and Citi’s shareholders to me. Meanwhile, the government has done absolutely nothing to restructure mortgages our bailout homeowners, whose instability is what’s causing the government to guarantee $270 billion in Citi’s “troubled” assets in the first place. If you really want to get upset, read yesterday’s article in the Times about how Citi got here in the first place.