Progress on Auctioning TARP Warrants

Ten major banks repaid almost $70 billion to TARP in recent weeks. But they aren’t free from TARP just yet: Treasury still owns warrants to purchase their common stock.

I’ve previously argued that Treasury ought to auction these warrants to the highest bidder. Auctions would (a) be transparent, (b) provide full, fair value to taxpayers, (c) free banks from the TARP, and (d) give banks the opportunity, but not the requirement, to repurchase the warrants. As close to a win-win-win policy as one can hope for in Washington.

Unfortunately, as I noted in a follow-up post, the original TARP investment contracts include a specific process by which banks can negotiate to repurchase the warrants. As much as I like auctions, I believe even more strongly that the government should live up to its agreements. Which is why you haven’t seen me blogging about warrant auctions lately.

Until now.

Earlier today, Treasury announced the process by which it will divest itself of the warrants of banks that have repaid their original TARP investments. This announcement includes lots of good news: Continue reading “Progress on Auctioning TARP Warrants”

The TARP Peace Sign

Wednesday was a rare day in Washington: the Federal government was actually cash-flow positive.

The reason, of course, is that ten major banks repaid $68 billion in TARP money. Smaller banks had previously repaid about $2 billion, so Wednesday’s action lifted total repayments to $70 billion, almost 30% of TARP support to individual banks.

TARP Peace Sign(For those who don’t get the title, this pie chart reminds me of a peace sign.)

As noted in my previous post on TARP, that means that two firms — Citigroup and Bank of America — now account for the majority of outstanding TARP support to banks.  Citigroup has received $50 billion in three transactions, and B of A has received $45 billion in two transactions. Investments in all other banks now total “only” $79 billion.

Continue reading “The TARP Peace Sign”

Tracking the TARP

The TARP continues to grab headlines, so I thought it would be useful to summarize how the TARP money has been used to date.

As you may recall, the Troubled Asset Relief Program (TARP) created a pool of $700 billion that the Treasury Secretary could use to stabilize the financial sector.  The following chart summarizes the TARP transactions that have already occurred (dark blue) and any additional funds that Treasury has announced for each program (grayish):

Tracking the TARP

As the chart illustrates, Treasury has announced plans for about $645 billion of the TARP money, of which $435 billion has been committed to specific transactions.  But the most interesting facts involve the specific programs:

Continue reading “Tracking the TARP”

The Citigroup Anomaly Lives

Summary: Citigroup securities are still violating the law of one price.

Later this week, Citigroup will finally launch its offer to convert some preferred stock into common stock.  That exchange has big implications for the government, which purchased preferred shares through the TARP program; after the exchange, the government will become Citi’s largest shareholder.

The exchange also has big implications for investors.

As I noted two weeks ago, there have been some anomalies in the pricing of Citigroup securities. Those anomalies have gotten smaller, but they are still with us. Citigroup is still violating the law of one price.

The crux of the pricing anomaly is that there are three different ways to invest in Citigroup’s common stock:

Continue reading “The Citigroup Anomaly Lives”

Auction the Warrants: Follow-Up

Summary: Readers had some excellent comments on last week’s post about auctioning the TARP warrants.  Here are some updated thoughts. 

Last week I argued that the Treasury should auction off the warrants it received when it made TARP investments in banks.  Specifically, when banks are ready to repay the TARP investment, Treasury should auction the associated warrants to the highest bidder, which might turn out to be a private investor or the bank itself. Among other things, I argued that this approach would enhance the transparency of the process, ensure that taxpayers get a fair return on their investment, and allow banks to preserve needed capital.  A potential win all-around.

In response, readers sent me several very helpful comments that deserve highlighting.

Continue reading “Auction the Warrants: Follow-Up”

Auction the TARP Warrants

Treasury should give up on negotiated sales and simply auction the bank warrants it received through its TARP investments. Auctioning the warrants will enhance the transparency of the process, ensure that taxpayers get a fair return on their investment, free banks from the nuisance of government involvement, and allow banks, if they choose, to preserve needed capital.

Summary: Treasury should give up on negotiated sales and simply auction the bank warrants it received through its TARP investments.  Auctioning the warrants will enhance the transparency of the process, ensure that taxpayers get a fair return on their investment, free banks from the nuisance of government involvement, and allow banks, if they choose, to preserve needed capital.

Healthy banks are anxious to escape from the government’s Troubled Asset Relief Program.  TARP capital seemed cheap at first since the government offered more generous financial terms than were available from private investors.  But now the hidden costs of government investments – compensation limits, tighter regulatory scrutiny, and a public backlash against financial bailouts – have become apparent.  As a result, many banks want to pay off Uncle Sam and free themselves from the TARP.

Repayment sounds simple.  Subject to regulatory approval, banks can simply write a check to Treasury that covers the amount of money they received (by selling preferred stock) plus any outstanding dividends.  But there’s a complication.  When Treasury purchased the preferred shares, it also received warrants to purchase common stock in the future.  To fully escape the burden and stigma of TARP, the banks thus need a way to get Treasury to relinquish those warrants.

Continue reading “Auction the TARP Warrants”

The Citigroup Anomaly

Something is amiss in the market for Citigroup securities: prices are out-of-whack with standard arbitrage relationships. This suggests that (a) recent financial turmoil — or, perhaps, the policy responses to it — have undermined market efficiency and (b) some investors are over-paying.

Summary: Something is amiss in the market for Citigroup securities: prices are out-of-whack with standard arbitrage relationships.  This suggests that (a) recent financial turmoil — or, perhaps, the policy responses to it — have undermined market efficiency and (b) some investors are over-paying.   

Recent weeks have witnessed yet another case of law-breaking in the financial sector: Citigroup is violating the law of one price.

When the market closed last Friday, there were at least three different ways you could invest in Citigroup’s common stock:

Simple: You could buy common shares of Citigroup, just as you would with any publicly-traded company.

Preferred: You could buy shares of preferred stock that will convert into common shares. Citi has announced, for example, that it intends to convert each share of Series F preferred into about 7.3 shares of common stock.

Synthetic: You could buy and sell options in a way that replicates the financial returns from owning Citi stock.  For example, you could buy a call option with a strike price of $4, sell a put option with the same strike price, and set aside $4 in a bank account.  Taken together, those investments will give you the same financial returns as owning a share of Citigroup common stock. (I am gliding over some small details here.)

In normal times, the law of one price would imply that you should pay nearly identical prices under any of these approaches.  Transaction costs might allow prices to stray a bit from one another, and the preferred might trade at a small discount if the conversion isn’t completely certain.  But any price differences should be small as arbitrageurs buy stock the inexpensive way and sell it the expensive way.

That isn’t the case today. Continue reading “The Citigroup Anomaly”