US Treasury: Proud New Owner of America’s Banks

by Stubborn Mule on 14 October 2008 · 5 comments

The latest moves by the US Treasury in the GFC have been hitting news headlines on the screens today:

  • US TO INVEST $250 BILLION DIRECTLY INTO BANKS
  • US TO GET PREFERRED SHARES IN BANKS
  • US TO INVEST IN MORGAN STANLEY, GOLDMAN, JPMORGAN, BANK OF NEW YORK, STATE STREET, CITIGROUP, BANK OF AMERICA, WELLS
  • US TO INVEST $10 BILLION IN GOLDMAN SACHS
  • US TO INVEST $25BLN EACH IN CITI, BANK OF AMERICA, JPM

This is a big shift in strategy from the original intention of the TARP bailout plan which aimed to help banks by buying up distressed assets from troubled banks rather than investing directly in them. As I discussed in an earlier post, the original  draft of the bailout bill was a mere three pages. However, this ballooned to 451 pages before it was finally passed by Congress. It looks as though, in the process, enough wiggle room emerged to allow the direct equity investment we are now seeing. While I am certainly not an expert on US law, it looks to me as though this wiggle room appears in Section 113 of the bill, “MInimization of Long-Term Costs and Maximization of Benefits for Taxpayers”. This sections allows for either on market purchases of securities or direct purchase. However, there is the following caveat on direct purchases.

(d) Conditions on Purchase Authority For Warrants and Debt Instruments

IN GENERAL.—The Secretary may not purchase, or make any commitment to purchase, any troubled asset under the authority of this Act, unless the Secretary receives from the financial institution from which such assets are to be purchased—
(A) in the case of a financial institution, the securities of which are traded on a national securities exchange, a warrant giving the right to the Secretary to receive nonvoting common stock or preferred stock in such financial institution, or voting stock with respect to which, the Secretary agrees not to exercise voting power, as the Secretary determines appropriate;
or
(B) in the case of any financial institution other than one described in subparagraph (A), a warrant for common or preferred stock, or a senior debt instrument from such financial institution, as described in paragraph (2)(C).

Direct investment in banks is likely to prove far more effective in stabilising banks and bringing about an orderly deleveraging than attempts to buy securities that no-one wants to own and no-one knows how to value. While free market fundamentalists would doubtless prefer to see troubled banks fail than to have even a partial shift in ownership to the Government, for anyone who accepts that Governments should attempt to at least ameliorate the damage that the GFC will do, this is almost certainly the right step for the US to take. The markets certainly seem to think so.

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{ 4 comments… read them below or add one }

1 Duncan October 14, 2008 at 2:29 pm

Interesting commentary from Nobel Prize winner Paul Krugman giving Gordon Brown credit for this :

http://www.nytimes.com/2008/10/13/opinion/13krugman.html

2 stubbornmule October 14, 2008 at 3:48 pm

@Duncan: thanks, hadn’t seen that one (despite being a regular reader of Krugman’s blog). After dithering in the face of the failure of Northern Rock, Brown certainly seems to have developed some intestinal fortitude of late. I imagine that the equity injection approach would have seemed obvious to many in the US a while back, but the banks would not have liked it (dilution of returns for equity holders, loss of control, etc), so the banking lobbyists would have been working very hard. Britain’s actions would certainly have helped provide a counterbalance, so Krugman is probably right that their actions helped to get the US over the line.

3 stubbornmule October 14, 2008 at 3:51 pm

I should add that if you have a lazy hour free, this episode of This American Life (TAL) is worth a listen (talks about freezing of money markets, the role of credit default swaps in the crisis and even touches on this equity injection issue at the end).

Thanks to Michael Michael for the pointer to TAL.

4 Michael Michael October 15, 2008 at 1:25 pm

I think you just identified the title of your autobiography with the phrase “An orderly deleveraging”, sunshine. Follow it up with a colon and the words “My journey from eyeliner to fatherhood”, and you’ve got yourself a bestselling badboy.

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