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The Deal
Citigroup and JPMorgan Chase were told they would each get $25 billion; Bank of America and Wells Fargo, $20 billion; Goldman Sachs and Morgan Stanley, $10 billion each, with Bank of New York and State Street each receiving $2 to 3 billion. Wells Fargo will get an additional $5 billion, reflecting its acquisition of Wachovia, and Bank of America receives the same for amount for its purchase of Merrill Lynch.
...The government will purchase perpetual preferred shares in all the largest U.S. banking companies. The shares will not be dilutive to current shareholders, a concern to banking...executives, because perpetual preferred stock holders are paid a dividend, not a portion of earnings. The capital injections are not voluntary, with Mr. Paulson making it clear this was a one-time offer that everyone at the meeting should accept.
Here is the story. No matter what your point of view, you ought to be stunned by this development.
Addendum: Brad DeLong adds musical commentary.
Posted by Tyler Cowen on October 13, 2008 at 08:52 PM in Current Affairs | Permalink
Comments
"Not voluntary."
Wow.
Posted by: Mercutio.Mont at Oct 13, 2008 9:05:51 PM
I am, generally, a free-marketeer and was/am hugely against the TARP/reverse auction thing, but I have, for a long time, felt that the US Government should invest funds (preferably part of the Social Security fund, but this works) in the equity markets. This is mainly because our government's "investment portfolio" (treasury securities) has always seemed overly conservative given a stable government's time horizon. At least here they are doing so on what seems at least somewhat likely to be decent terms, and in nonvoting shares that are less likely to distort the markets. The fact that this might help the economy broadly is a bonus.
Posted by: Andrew at Oct 13, 2008 9:10:06 PM
Sounds like the kind of deal you'd get from a mobster. The ones without scruples, not the TV kind.
Posted by: scim at Oct 13, 2008 9:15:41 PM
>>nonvoting shares that are less likely to distort the markets>>
Given that financial institutions' risky behavior got us into the current mess, distorting the market would not be the worst thing.
Posted by: fusion at Oct 13, 2008 9:15:43 PM
Forced "injections" of money is hardly an investment.
The government can't resist new toys. Despite any promises of non-interference, any body which took time in a one of the largest financial crises of the last century to put in a clause for wooden arrows, will certainly want to influence banks for political ends at some point in the future. They've done it without ownership, there is no reason to believe this will dissipate with ownership.
Posted by: Gary at Oct 13, 2008 9:16:57 PM
Treasury securities aren't the investment of our government, they are the borrowings. Wrong side of the balance sheet. Unless you are thinking of the Fed, but that's a different issue.
Back to the main topic - we need to wait for more details, but perpetual preferred stock sounds a lot like very junior perpetual debt with weak cash flow rights and no control rights at all. On the other hand, the apparent fact that some banks did not want to take it is a mildly encouraging signal about the terms of the deal.
Posted by: Commenterlein at Oct 13, 2008 9:18:48 PM
I'm citing the Social Security trust fund being invested in Treasuries. Obviously they are a net liability, but we do have investment funds in gov't.
Posted by: Andrew at Oct 13, 2008 9:19:47 PM
Perpetual preferred shares that will have no secondary market? As the military would say: What is the exit strategy?
Posted by: KipEsquire at Oct 13, 2008 9:20:22 PM
Of course they are dillutive -- dividend payments reduce net earnings.
Posted by: ANON at Oct 13, 2008 9:47:42 PM
The exit strategy is a future secretary saying "Give us a bunch of money, or else" at a future date.
Posted by: srp at Oct 13, 2008 9:51:59 PM
Why should I be stunned by this? I don't really understand. Explanation?
Posted by: Matt at Oct 13, 2008 9:54:16 PM
You're right. Stunning. When I took macro over 30 years ago I didn't appreciate the meaning of the phrases "lender of last resort" and "license to print money."
Kip, I didn't see details about resale of the preferred stock. Clearly, the government is paying a premium today vs. the risk (if the instruments were convertible, it would be another story). At some point in the future the stability of the (high?) coupon may allow the government to get out for a gain. Heck, the company may even be able to buy it back either from the shareholder or the market. We'll probably know tomorrow.
Posted by: Steve Y. at Oct 13, 2008 10:01:57 PM
How does this force liquidity? [in the sense of "Main Street" being able to get loans?]
(Oh, and how much dividend does it pay? Isn't that an important detail missing from the story?)
Posted by: zbicyclist at Oct 13, 2008 10:03:31 PM
Given that financial institutions' risky behavior got us into the current mess, distorting the market would not be the worst thing.
Low interest rates for to long
and Fredie Mac and Fannie Mae
Give back to community act
It was the government who distorted the market
Incentives matter
Posted by: k at Oct 13, 2008 10:17:25 PM
So, this was an offer they couldn't refuse.
And we're ragging on what Putin's crowd is doing in Russia?
Posted by: MHodak at Oct 13, 2008 10:18:39 PM
So taxpayers paid a lot of money to big banks. Nobel Prize winner says we need a bigger new deal. The rescue package is merely an attempt to paper over a pyramid of debt and then issue even more new debt at the base of the pyramid and Tyler Cowen is optimistic. Anything else new today?
Did Thomas Friedman win a peace prize for telling iraqis to "suck on this"?
Posted by: Gabe at Oct 13, 2008 10:20:16 PM
(Oh, and how much dividend does it pay? Isn't that an important detail missing from the story?)
No it is not important. Your not getting anything so don't even ask.
Posted by: gabe at Oct 13, 2008 10:22:07 PM
The capital injections are not voluntary, with Mr. Paulson making it clear this was a one-time offer that everyone at the meeting should accept.
What does that even mean? Is it like the IRS telling me I should accept my tax liability?
Tyler, what does this signal? :)
Posted by: Bob Murphy at Oct 13, 2008 10:23:10 PM
It is most unfortunate that we do not have a strong President who understands economics and has the confidence of the people. In a sense Mr. Bush is to blame for the current bad situation and the worse remedy now being put into place -in the way a weak and ineffectual police force is to blame for crime. It seems likely, barring a miracle, that we are about to get something worse -a President whose understanding is wrong, being nothing more than a bunch of left-wing ideas which make no sense: "Spread around the wealth," etc.
Posted by: at Oct 13, 2008 10:30:48 PM
This was not a surprise...the Carlyle group/CFR director told us this was going to happen last week.
http://www.cfr.org/publication/17508/grasping_radical_economic_change.html?breadcrumb=%2F
Posted by: gabe at Oct 13, 2008 10:38:50 PM
It is highly unfortunate that we lack a President at this time. ("Forgotten but not gone.") We desperately need someone who understands economics, is articulate, and has the confidence of the people. In a way Mr Bush is responsible for the current situation and the coming "solution." -in the same way that a weak ineffective police force can be said to be responsible for crime. The transfer of wealth resulting from this "solution" will be highly regressive and if it helps produce an Obama victory will probably result in all sorts of enduring damage to the economy
Posted by: at Oct 13, 2008 10:44:06 PM
Please excuse the repetition. I thought my first post has been lost.
Posted by: at Oct 13, 2008 10:45:09 PM
Nothing surprises me anymore
Posted by: Robert Olson at Oct 13, 2008 11:09:46 PM
And the rich get richer and can legally get rid of their competitors. Next, we'll have a new financial crisis over the $700 billion, and those at the top will get rid of the others who received some of that bail out money. The question is, who will be left standing? And there you have it world...the winner of the beast that will make it so you can't buy or sell without their permission.
And Americans go back to their credit hungry lifestyles, with their false security in the stock market going back up....and while they sleep, the bankers and their Congressman plan the next stage.
And nations like Iceland declare bankruptcy and join the EU. Who's union will America join when we officially declare bankruptcy?
Makes you wonder who the spider is, doesn't it?
Posted by: SharkGirl at Oct 13, 2008 11:14:02 PM
What sort of voodoo economic theory does this deal originate from?
So why wasn't the money used to establish new clean banks with this money under new rules that insured that, once again, prudence is adhered to. Why are the folks that caused the problem being handed all this more money and the rules are not being changed?
Where is my share? I want an amoral federal tit to suck on.
Posted by: psychohistorian at Oct 13, 2008 11:16:38 PM
