Wednesday, March 18, 2009

What price a warrant? The unaccountable TARP…

On the 20th October 2008, TARP warrant guidelines specified:

In all cases, the Treasury also must obtain warrants for common stock of the applicant. The terms of the warrants are explained in the Treasury agreements available on the Treasury web site. In general, the warrants must be convertible into an amount of common stock of the applicant equivalent in value to 15 percent of the amount of the capital purchased by the Treasury from the applicant under the CPP, calculated based on the average of closing prices of the common stock on the 20 trading days ending on and including the last trading day prior to the date of execution of the Purchase Agreement.

But 11 days later, on the 31st of October, the actual warrant documentation specified:

Initial exercise price to be calculated based on the average of closing prices of the Common Stock on the 20 trading days ending on the last trading day prior to the date the Company’s application for participation in the Capital Purchase Program was approved by the United States Department of the Treasury.

In both instances, the Treasury had committed to calculating the warrant strike price based on a 20-day trailing average: but whereas in the first case, this was taken to be the 20 days prior to the execution of the purchase agreement, in the second - enforced - instance, it was taken to be the 20 days prior to a participants’ application to the TARP scheme full stop.

This all sounds dreadfully dry. Stick with us, though.

The Sunlight Foundation - a US no profit congressional watchdog, explains:

We examined 228 CPP transactions and found that 185 (82%) received less favorable pricing as a result of the language change. On average the new language raised the strike price of the warrants by 8% (to Treasury’s detriment); the difference was worse for many of the larger transactions. For example, with Bank of America, which received $25 billion under CPP, the strike price found in the final contract was $30.79. It would have been $25.94 based on the language found in the term sheet, a 20% difference to Treasury’s detriment.

Here’s the Sunlight Foundation’s spreadsheet of the terms they analysed.

What appears to have happened then, is a change in the initial warrant terms conceived by the Treasury as a sop to the banks - as if the banks needed or deserved any more leniency. The change would also appear to jar with the assurances the Treasury was all the while busy giving Congress: that taxpayer’s interests would be protected in the strictest terms, and measures were being taken to ensure the TARP would not be a subsidy.

It quite clearly highlights the major failing of the TARP - one of utterly limited oversight.

All the measures and balances that Congressmen had written into the amended legislation after days of tense negotiation and still - as the above demonstrates - it’s very much the Treasury that remained in charge: unchecked and unaccountable.

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