Finance – Page 7 – Donald Marron

Goldman Really Did Overpay for Its TARP Warrants

Yesterday, Treasury released a comprehensive report on the disposition of TARP warrants through 12/31/2009. It’s a font of fascinating information–at least for fellow TARP warrant aficionados.

Treasury apparently did quite well when it negotiated with banks that wanted to repurchase their TARP warrants. I am still a fan of auctions, but you have to give Treasury credit–they did defend taxpayer interests in the negotiations.

Treasury drove an especially hard bargain with Goldman Sachs. As shown in the following chart from the report, Goldman ended up paying much more than any of the estimates that Treasury considered:

The green line is what Goldman actually paid: $1.1 billion. The yellow lines are Goldman’s earlier bids ($600 million and $900 million). The black bars are the range of estimates from three different modeling efforts. Bottom line: Goldman overpaid.

The report has similar graphs for the other 33 firms that have repurchased their warrants; some of them paid at the upper end of the black bars, but none overshot like Goldman.

Disclosure: I have no investments in Goldman Sachs (or any TARP recipients).

Federal Reserve Earns $46 Billion for Taxpayers

The Federal Reserve system is doing its part to cut the budget deficit (at least for now). Treasury will receive $46.1 billion of profits from the Federal Reserve profits for fiscal 2009. That’s about a third higher than the amount remitted for 2008.

According to the Fed’s news release this morning, the following items drove profits:

$46.1 billion in earnings on securities acquired through open market operations (U.S. Treasury securities, government-sponsored enterprise (GSE) debt securities, and federal agency and GSE mortgage-backed securities) [Profits on traditional open market operations plus the new credit easing operations]

$5.5 billion in net earnings from consolidated limited liability companies (LLCs), which were created in response to the financial crisis [Profits on the Maiden Lane partnerships etc.]

$2.9 billion in earnings on loans extended to depository institutions, primary dealers, and others [Profits on the new loan facilities]

[$2.6 billion in] net earnings from currency swap arrangements, which have been established with 14 central banks, and investments denominated in foreign currencies

Additional net earnings of $1.5 billion were derived primarily from fees of $0.7 billion for the provision of priced services to depository institutions

Those $58.6 in gross earnings were slightly offset by the following expenses:

[$3.4 billion for] operating expenses of the twelve Reserve Banks, net of amounts reimbursed by the U.S. Treasury and other entities for services the Reserve Banks provided as fiscal agents

[$2.2 billion in] interest paid to depository institutions on reserve balances [As noted previously, the Fed’s still-new ability to pay interest on reserves is a big deal for monetary policy; this is the cost side]

[$0.9 billion in] Board expenditures, including the cost of new currency

The resulting $52.1 billion in new profits were then distributed as follows: $46.1 billion to the Treasury, $1.4 billion as dividends to member banks, and $4.6 billion retained to “equate surplus with paid-in capital.”

Treasury is Issuing More TIPS

As noted by the Wall Street Journal this morning (“U.S., in Nod to Creditors, Is Adding TIPS Issues“), Treasury is issuing more Treasury Inflation-Protected Securities (TIPS). Today’s auction involves $10 billion 10-year notes; one estimate suggest that total TIPS issuance this year will be $80-85 billion. Still small compared to our nation’s overall borrowing needs (somewhere in the $1 trillion range, not including rolling over existing debt), but a real boost to the TIPS world.

As I discussed in two earlier posts (here and here), many observers have recommended that Treasury increase TIPS issuance. The WSJ piece emphasizes one particular set of advocates: our creditors who are beginning to worry about inflation:

TIPS, which account for less than 10% of the $7 trillion Treasury market, offer investors a way to hedge against inflation as their value rises along with the increase in consumer prices. The fixed returns on nominal Treasurys, in contrast, can be eroded over time by inflation, which especially affects long-term bonds.

…

The small size of the market for inflation-protected securities means many large investors who want to be able to sell easily still prefer other ways to hedge against inflation risk, such as commodities.

But in the past year, China and other large foreign investors have become vocal about their concerns that the large U.S. fiscal deficits and the Federal Reserve’s ultra-loose monetary policy will lead to a spike in inflation. That would hurt the value of their large holdings of nominal Treasurys.

U.S. officials reassured China in late July that the Treasury remained committed to its TIPS program and would take investors’ views into account when drawing up its issuance plans. That pledge was seen as a commitment to increasing TIPS sales.

What’s the United States Worth? $1.4 Quadrillion

Happy 2010, everyone. To kick off the new year, I am in Atlanta at the annual meeting of the American Economic Association. As Paul Kedrosky notes, there are lots of sessions on the financial crisis and its aftermath. Perhaps not surprisingly, many presentations have a pessimistic tone. But there are pockets of optimism, including Robert Shiller’s luncheon speech about the potential benefits of continued financial innovation.

One of Shiller’s ideas is that the federal government should issue a new kind of security that would pay quarterly dividends based on the nation’s gross domestic product (GDP). More specifically, each security would entitle its owner to one-trillionth of America’s gross domestic product (GDP). These “Trills” would be perpetual, like common stock in a private company, and would be backed by the government’s full faith and credit.

I will leave to others to argue the pros and cons of Trills. What caught my attention was Shiller’s estimate of how much they would be worth. With GDP around $14 trillion, each Trill would pay about $14 in annual dividends this year. That dividend would then increase (or, of course, decrease) as the economy grows (or contracts) in the future.

How much you would be willing to pay for a Trill? In principle, that should depend on your expectations of future GDP growth and your choice of what discount rate to apply to cash flows that track GDP. Oh, and if you worry about the U.S. government defaulting (still a very low risk), you might include a discount for that as well.

Shiller’s own answer is $1,400. In other words, he thinks Trills would be priced with a yield of about 1%. Trill owners would be willing to accept that low yield because they would expect future economic growth to boost dividends–and, therefore, Trill values–in the future.

That figure feels a bit high to me, but not unreasonable. For example, you could justify a $1,400 per Trill valuation if you believe that nominal GDP growth will be 4 percent and that an appropriate discount rate would be 5 percent.

If you take Shiller’s estimate seriously, it is just a short step to placing a value on the U.S. economy as a whole. If one trillionth of the economy is worth $1,400, then the entire economy would be worth $1.4 quadrillion.

TARP Repayments Reach $164 Billion

An upbeat news release from the Treasury Department as we approach the holiday break: Wells Fargo and Citigroup have repaid $45 billion in TARP money, bringing total repayments to $164 billion. In addition, Treasury now expects that the portion of TARP that stabilized the banking system will actually generate a profit for taxpayers. (Of course, some of the other parts of TARP look like serious money losers, but we can discuss that in the new year.)

I couldn’t find the Treasury news release on its website (either I’m dense or the person in charge of that took the day off), so here’s the full text with my emphasis added:

Today, the U.S. Department of the Treasury received repayments on its Troubled Asset Relief Program (TARP) investments in Wells Fargo and Citigroup in the sum of $45 billion, bringing the total amount of repaid TARP funds to $164 billion. Wells Fargo repaid $25 billion under the Capital Purchase Program (CPP) and Citigroup repaid $20 billion under the Targeted Investment Program (TIP), both of which will wind down at the end of this year. Treasury now estimates that total bank repayments should exceed $175 billion by the end of 2010, cutting total taxpayer exposure to the banks by three-quarters.

In addition, effective today, Treasury, the Federal Reserve, the Federal Deposit Insurance Corporation and Citigroup terminated the agreement under which the U.S. government agreed to share losses on a pool of originally $300 billion of Citigroup assets. This arrangement was entered into in January of this year under Treasury’s Asset Guarantee Program (AGP) and was originally expected to last for 10 years. The U.S. government parties did not pay any losses under the agreement and will keep $5.2 billion of $7 billion in trust preferred securities as well as warrants for common shares that were issued by Citigroup as consideration for such guarantee. With this termination, the AGP is being terminated at a profit to the taxpayer.

Treasury currently estimates that TARP programs aimed at stabilizing the banking system will earn a profit thanks to dividends, interest, early repayments, and the sale of warrants. Total bank investments of $245 billion in FY2009 that were initially projected to cost $76 billion are now projected to bring a profit. Taxpayers have already received over $16 billion in profits from all TARP programs and that profit could be considerably higher as Treasury sells additional warrants in the weeks ahead.

The Worst Decade for Stock Investors

According to this morning’s Wall Street Journal, the 2000s are on track for a dismal record: the worst performance of U.S. stocks in any decade on record.

According to data from the Yale International Center for Finance, stocks have fallen about 0.5% per year, on average, during the current decade. Unless stocks stage a healthy rally in the next two weeks, the 00s will thus come in behind each of the past 17 decades, including the -0.2% average annual return of the 1930s.

As the article notes, this comparison is partly driven by a “quirk of the calendar, based on when the 10-year period starts and finishes.” For example, stocks fell more in the ten-year period ending in 1938 than they did in the 00s. For a nice year-by-year display, see the WSJ’s graphics (which include the chart to the right).

Let’s hope the 2010s do better.

Talking about TARP and Chairman Bernanke

The Business News Network of Canada interviewed me yesterday about TARP and Fed Chairman Bernanke’s “Person of the Year” award from Time Magazine.

Here’s a link to the video of the interview. Going in, I was focused on the following talking points:

Within current budget rules, the Congress can indeed use unspent TARP money to “pay for” new spending initiatives. However, it needs to cut TARP authority by $2 for every $1 it wants to spend.

Those “savings” are mythical, however. Treasury Secretary Geithner recently predicted that TARP would use at most $550 billion of its $699 billion in authority. Trimming TARP’s authority by a moderate amount (e.g., $50 billion) will thus generate no actual budget savings. Only deep cuts would begin to generate some savings.

The financial system is not fully healed, and the United States still lacks a coherent system for dealing with large, failing financial institutions. For that reason, I support Geithner’s extension of TARP as an insurance policy. However, I do not support the TARP extension if its main effect it to allow Congress to use TARP “cuts” to generate mythical budget “savings” or to encourage creative uses of TARP money.

Usain Bolt had a remarkable year, but Chairman Bernanke is still the right choice as Person of the Year. And he’s the right choice for Fed Chairman.

But his work is only half done. If he can figure out an exit strategy that keeps the economy growing, avoids new asset bubbles, and sidesteps inflation, then maybe he will be Person of the Year again next year.

Fed Chairman Bernanke Submits 70 Answers to His Take-Home Exam

A few weeks ago, Fed Chairman Ben Bernanke appeared before the Senate Banking Committee for his confirmation hearing. Following the normal ritual, Committee members made their statements and peppered Bernanke with questions about every economic topic under the sun. That much is well-known (and was closely followed on CNBC).

What’s less well-known is that Bernanke went back to his office to discover an enormous stack of homework, including a 70-question take-home exam from Senator Jim Bunning.

Senator Bunning’s questions cover a lot of territory: Fed policy, fiscal policy, AIG, the dollar, etc. Chairman Bernanke’s answers are worth a read, when you have time for a 34-page, single-spaced document.

Here’s one important excerpt, reiterating the Fed’s view that Lehman could not have been saved with then-existing authorities:

54. What was your rationale for letting Lehman fail?

Concerted government attempts to find a buyer for Lehman Brothers or to develop an industry solution proved unsuccessful. Moreover, providers of both secured and unsecured credit to the company were rapidly pulling away from the company and the company needed funding well above the amount that could be provided on a secured basis. As you know, the Federal Reserve cannot make an unsecured loan. Because the ability to provide capital to the institution had not yet been authorized under the Emergency Economic Stabilization Act, the firm’s failure was, unfortunately, unavoidable. The Lehman situation is a clear example of why the government needs the ability to wind down a large, interconnected firm in an orderly way that both mitigates the costs on society as whole and imposes losses on the shareholders and creditors of the failing firm.

P.S. Calculated Risk also posts some good excerpts.

Another Issue With Redirecting TARP Money

Last week I noted two challenges that Congress will face if it wants to use unused TARP money to “pay for” new spending efforts. The first is that each dollar of redirected TARP money generates only 50 cents in budget “savings” (because TARP budgeting uses credit principles that immediately recognize the potential for some money to be repaid in the future). The second is that the alleged budget “savings” are likely mythical (because the existing TARP program is on track to use much less than its full $699 billion authority).

A third issue, recently pointed out to me by a friend, is that the original TARP legislation includes language that’s intended to prevent TARP money from being redeployed to other uses. As I say in a new piece at e21:

When Congress created TARP, it specified that future TARP rescissions should not be used to pay for new spending. Section 204 of the Emergency Economic Stabilization Act indicates that the costs of TARP were being incurred because of an emergency (and therefore were exempt from certain congressional budget requirements) and that “rescissions of any amounts provided in this Act shall not be counted for purposes of budget enforcement.” In other words, Congress wanted to make sure that the emergency spending in TARP wouldn’t subsequently be rescinded to pay for new, non-emergency spending.

That limitation has not been a factor thus far when Congress has used TARP rescissions to pay for new legislation. In the spring, Congress used a $1.26 billion TARP rescission to help pay for legislation to help struggling homeowners. A few weeks ago, the House used a $34 million TARP rescission to pay for a new TARP database. In both cases, the resulting budget savings were relatively small ($630 million and $17 million, respectively) and were used to pay for programs related to TARP’s goals (housing and transparency). Looking ahead, a key question is whether Section 204 will play a bigger role now that Congress is considering larger TARP rescissions that would be used to fund programs well outside TARP’s scope.

I am not sure whether section 204 will have any practical relevance to today’s TARP debate (insights from folks close to the process would be appreciated). At a minimum, however, it is interesting that someone in Congress saw the potential for today’s TARP debate and tried to prevent it.

P.S. In case you’d like to check my interpretation, here’s the complete language of Section 204 of the Emergency Economic Stabilization Act:

SEC. 204. EMERGENCY TREATMENT.

All provisions of this Act are designated as an emergency requirement and necessary to meet emergency needs pursuant to section 204(a) of S. Con. Res 21 (110th Congress), the concurrent resolution on the budget for fiscal year 2008 and rescissions of any amounts provided in this Act shall not be counted for purposes of budget enforcement.

Mythical Budget Savings from Cutting TARP

The TARP news continues fast and furious. This afternoon’s installment involves the House’s financial regulation bill, officially known as H.R. 4173, the Wall Street Reform and Consumer Protection Act of 2009. That bill would make many changes to financial regulation, one of which – enhanced dissolution authority for financial firms that run into severe trouble – would cost about $10 billion over the next five years, according to the Congressional Budget Office.

In order to pay for those costs, the bill would reduce TARP authority by $20.8 billion. Consistent with previous scoring decisions, CBO estimates that this provision would result in budget savings of $10.4 billion (because CBO assumes, for scoring purposes, that each dollar of reduced TARP authority translates into 50 cents of reduced outlays; for more explanation, see this earlier post.)

Why is this important? Because the alleged savings are mythical.

Earlier today, Secretary Geithner predicted that the maximum draw on TARP would be $550 billion out of the $699 billion currently authorized. Reducing TARP authority from $699 billion to $678 billion, as the bill would do, would thus have no effect on spending or the deficit.

Under congressional budget rules, CBO is required to score the House bill relative to the budget baseline developed back in March. That was during the depths of the financial crisis so CBO assumed that all TARP authority would eventually be used. Happily, conditions have since improved, and that assumption is no longer realistic. But it is still used in congressional scoring.

The “savings” attributed to the House bill thus exist because the financial world has improved, not because the House bill is actually doing anything new to pay for its costs.

I hasten to add that this isn’t just my opinion. CBO itself highlights this issue in its cost estimate for the House bill, saying (in its more measured tones):

That reduction in spending relative to the March baseline might occur even in the absence of this legislation because financial conditions have improved considerably since March. Indeed, the Secretary of the Treasury noted in his December 9, 2009, letter to the Congress that “beyond these limited new commitments, we will not use remaining [TARP] funds unless necessary to respond to an immediate and substantial threat to the economy stemming from financial instability.” Thus, if CBO were to estimate the impact of the TARP provision in this legislation taking into account current financial conditions, the agency would not expect that the TARP’s ceiling on outstanding investment would be fully utilized. Therefore, the savings estimated relative to the budget resolution baseline may be attributable to the improvement in financial conditions rather than enactment of H.R. 4173. (emphasis added)

P.S. I should emphasize that there are good reasons for the current congressional budget rules. Developing legislation takes time, and it would be disruptive if CBO were constantly updating cost estimates to reflect changes in the economy. Fixing a baseline in March, however, does open up the possibility of budget game playing, particularly in budget categories that are volatile (TARP spending is one; royalties on oil and gas leases are another). The hard question is when Congress should decide to deviate from the March baseline to reflect new realities.