Treasury's Standardized Terms

The details of Treasury's recapitalization plan are out, and it's more or less what I expected, but with a lower coupon. In fact it looks very much like Warren Buffett's investment in Goldman Sachs, or MUFG's investment in Morgan Stanley, only without the profit motive:

Under the program, Treasury will purchase up to $250 billion of senior preferred shares on standardized terms...
The senior preferred shares will pay a cumulative dividend rate of 5 percent per annum for the first five years and will reset to a rate of 9 percent per annum after year five. The senior preferred shares will be non-voting, other than class voting rights on matters that could adversely affect the shares. The senior preferred shares will be callable at par after three years... In conjunction with the purchase of senior preferred shares, Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15 percent of the senior preferred investment. The exercise price on the warrants will be the market price of the participating institution's common stock at the time of issuance, calculated on a 20-trading day trailing average.

A 5% cost of tier-1 capital is incredibly low, especially when there's an embedded call option. And the common-equity kicker, at 15%, is small: that makes it a maximum of $3.75 billion, for firms getting the full $25 billion. (Citi, JPM, BofA, Wells Fargo.) There's not much dilution for equityholders here, and their companies are getting lots of cheap money: no wonder shares in Citi and Bank of America are up again today, even as the broader market is down.

But here's the thing: JP Morgan and Wells Fargo, who don't need the money, have seen their stocks fall. The government has given them $50 billion to play with, and presumably there's some hope that they'll leverage that $50 billion and lend it out in the real economy -- as opposed to simply using it to shore up their capital ratios. But in this market, shareholders don't want to see lending nearly as much as they want to see as much cash as possible on the balance sheet. So don't hold your breath waiting for large new loan commitments from any of these banks -- especially since Treasury has no voting rights, and hasn't told the banks that they need to start lending again.

There's no doubt that TARP II, in its present incarnation, is a vast improvement on TARP I. But it's still not nearly as good as the UK scheme, which was put together to inject money exactly where it would do the most good, rather than trying to set up "standardized terms" which treat each bank equally. That seems like a waste of government money to me.

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