Wednesday, October 15, 2008

Mr. Hanky’s reverse Midas touch

I have, in recent days, taken to calling Treasury Secretary Henry “Hank” Paulson Mr. Hanky, not because of any complex metaphor, but more because I just knew he was full of shit. Well, thanks to his most recent actions, Hank has given my allusion a new, improved accuracy.

As discussed in recent days, Paulson changed his position on stock injection, and decided to use $250 billion of bailout money to pump equity into troubled banks. He made his announcement after Still President Bush broke the ice for him on Tuesday morning. . . which was a day after Hank made the directors of America’s nine largest banks an offer they couldn’t refuse. . . .

Or so the story goes.

The thing is, it was an offer that the bankers couldn’t refuse, but not in that Godfather way. It was an offer they couldn’t refuse because the deal was so sweet!

As Dean Baker noticed:

[T]here is a big issue about the terms under which they were given capital. Secretary Paulson decided that a 5 percent rate of return on preferred share was good enough for the taxpayers. Warren Buffet got a 10 percent return for his investment.

No one would confuse Henry Paulson for Warren Buffet, but come on -- he could get a 4.0 percent return buying treasury bonds. I can't believe that he had such bad business sense when he was CEO of Goldman Sachs.

And a commenter on Baker’s post noticed even more:

[I]t's not just the 5% "coupon" (dividend, technically), that marks this as bad relative to the Buffet deal. Buffet received an equivalent amount ($5 billion) of favorably-priced common stock warrants that he can exercise anytime during the next five years. The rough plan for Paulson, as I understand it, is for the Treasury to get warrants equal to just 15% of the preferred stock injection.

Also striking is how different this is than the Treasury-AIG deal. I understand that the AIG bailout was for different purposes -- AIG was going immediately bankrupt whereas the solvency of the banking system over the next, say, 24 hours, is relatively assured (with diminishing levels of confidence the farther one goes out) -- but the Treasury charged AIG for its loan facility a rate of LIBOR + 8.5%. While I understand that there is a difference between a loan and a preferred stock purchase, they are not all that different: preferred stock is like a bond, but with fewer recovery protections, and like a stock for capitalization purposes, but it doesn't share in the broader common stock market gains. The important point with the present Paulson action is, to my eye, that the Treasury picked a very low fixed rate for a LONG time (five years!) without reference to LIBOR.

OK, kind of technical there, but the point is clear: Paulson took what was a fairly good idea as structured by Gordon Brown (or even by Warren Buffet), and turned it into shit. Don’t believe me, check out what investors thought (again from Baker):

The markets gave Paulson's investment strategy a big thumbs down from the taxpayer perspective. Goldman Sachs shares jump 10.7 percent after the details were made public. Shares of Bank of America rose 16.4 percent and Citigroup's stock rose 18.2 percent. Obviously the market thinks that Paulson gave the banks a really good deal.

Conversely, the United Kingdom’s big three all saw their stock prices fall after Brown exchanged equity for preferred and common shares and exercised their voting rights to make changes in bank leadership.

(This might sound a little counterintuitive, but if you are not a board member of a bank, you actually want to see this result, at least in the short term. It actually means that screwing up has repercussions—which means less of that “moral hazard” that so many of the serious set warn us about when plans to help those facing home foreclosure are mentioned.)

The former King of Goldman has turned what was his Midas touch when it came to private capital, and turned it into the reverse for his public service. Even when shown a golden blueprint by the UK, Paulson’s fingerprints changed the result into a shitpile.

So, congratulations, Mr. Hanky, the Treasury Poo, you’ve now wholly embraced your nickname. Alas, it is the rest of us that are left holding the bag. . . .

(cross-posted on The Seminal)

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