It’s Complicated to Get Out of TARP

The banks that are trying to escape TARP are fighting to reduce the early exit fees. The government bought stock in the banks to provide them money to survive through the Troubled Asset Relief Program. Attached to that stock was “warrants’, which is an option to purchase more stock later at a fixed price. To get out from under the thumb the banks need to buy back the stock from the government, essentially returning the money with interest–but there is controversy over the warrants.

Some in Treasury want to keep the warrant, either to be in a position to save the company banks if necessary later or to earn a return. The Wall Street Journal reports that as of now, “most of the warrants are essentially worthless, because their exercise price”–the fixed price the bank stock can be purchased at–“is higher than where most banks’ stocks are trading. But the government believes the warrants still have value, since they give the Treasury the right to buy common stock at a set price for 10 years.” The assumption is that in 10 years most of the banks will have recovered, making the warrants potentially very lucrative.

For example, if a bank is trading at $10 today, and the government holds a warrant that allows it to buy stock at $15 a share, then there is little point in using those warrants. But if that same bank five years from now is trading at $150, then the warrant would allow the government to buy stock for full value, but at only 10 percent of the price.

Thus, the banks want to take back the warrants with the stock. But they would rather not pay for them, since they didn’t get any money for them in the first place. According the WSJ, “Bank representatives say the cost of buying back the warrants could be equivalent to paying 60% annual interest on short-term loans. That, they argue, would exacerbate banks’ existing problems.”

This issue is complicated in two ways. First, the banks did issue the warrants, and it is arrogant and elitist of the financial industry to believe they can just alter term agreements because of their importance. I have argued that the AIG bonuses should have been paid because that was what the contract said, whether or not it was right. My logic would have to extend here.

But on the other hand, the government should not be in the business of trying to make a profit. The government shouldn’t be investing taxpayer dollars. That’s not what taxes are for. Treasury probably could have made a killing by using tax money to buy Google stock at their IPO, but didn’t because that is not the role of government–nor the purpose of our taxes. So in this case, for the government to hold on just to use the warrants for investment value seems wrong. Not to mention that the whole point of the bailout is to help the banks recover, and charging them more wouldn’t help that.

I believe that there is a very real belief in the Treasury that they have the best knowledge for how to intensely regulate these firms and want to have the legal authority to dictate terms to them like compensation… or to tell them they should accept 15 cents on the dollar for their loans to GM because the government helped out the banks, and now it needs bank help to save GM. Its a political nightmare.

Anthony Randazzo

Anthony Randazzo is a senior fellow at Reason Foundation, a nonprofit think tank advancing free minds and free markets.