A Leaky TARP?

While plans for the financial bailout were inherently imperfect, criticism tends to ring hollow if one thinks back to the months of September and October. Many of the most seasoned financiers were gripped by raw fear as global markets imploded following the Lehman Brothers bankruptcy. Put yourself in Hank Paulson's shoes: it's September 16th, 9:45 AM, the market is open and the New York Fed is on the phone. Point blank: AIG stock is down 60%; they're facing a liquidity crisis and preparing to file for Chapter 11. This is uncharted territory for the financial markets and economy. Make a decision. What do you do?

With the benefit of hindsight, here is how it turned out, from Bloomberg News:

The Treasury secretary has made 174 purchases of banks’ preferred shares that include certificates to buy stock at a later date. He invested $10 billion in Goldman Sachs in October, twice as much as Buffett did the month before, yet gained warrants worth one-fourth as much as the billionaire, according to data compiled by Bloomberg. The Goldman Sachs terms were repeated in most of the other bank bailouts.

Paulson’s warrant deals may give U.S. taxpayers, who are funding the bailouts, less profit from any recovery in financial stocks than shareholders such as Goldman Sachs Chief Executive Officer Lloyd Blankfein and Saudi Arabian Prince Alwaleed bin Talal, owner of 4 percent of Citigroup Inc., said Simon Johnson, former chief economist for the International Monetary Fund.

Paulson said “he had to make it attractive to banks, which is code for ‘I’m going to give money away,’” said Joseph Stiglitz, who won a Nobel Prize in 2001 for his work on the economic value of information.

“The worst aspect of this is that they were designed not to do what they were supposed to do,” he said in a telephone interview from Paris Jan. 7. “In many ways, it’s not only a giveaway, but a giveaway that was designed not to work.”

The Treasury would have held warrants for 116 million shares of Goldman Sachs under Buffett’s terms, which would be equivalent to a 21 percent stake when added to those currently outstanding. Instead, the dilution is 2.7 percent under the Treasury plan. Blankfein is the company’s biggest individual investor, with 2.08 million shares worth about $178 million today, according to Bloomberg data. His 0.47 percent interest would have declined to 0.36 percent under Buffett’s terms and would be 0.44 percent if the Treasury’s warrants were exercised.

The government has received warrants valued at $13.8 billion in the 25 biggest capital injections from TARP, according to Bloomberg data. Under the terms Buffett negotiated for his $5 billion stake in Goldman Sachs, the TARP certificates would have been worth $130.8 billion.

[Ten times as much!]

If Goldman Sachs rises to its five-year average price of $147, Buffett will be able to profit by $1.4 billion from exercising his warrants. The government warrants will be in the money for $294 million, or about a fifth as much for twice the investment.

Stiglitz said finance professionals at the Treasury possessed expertise on warrant pricing that members of Congress didn’t. As a result, Paulson gave lip service to the lawmakers’ intent on TARP without gaining much value for taxpayers, said Stiglitz, a Columbia University professor who described the pricing mechanism as “a gimmick to make sure that they were giving away something worth nothing.”

“If Paulson was still an employee of Goldman Sachs and he’d done this deal, he would have been fired,” he said.