New US treasury boss Tim Geithner needs a weekend in Nebraska. The Congressional Oversight Panel (COP), which is monitoring the US bank bailout, reckons former treasury boss Henry Paulson didn’t strike a hard enough bargain when he recapitalized banks. Omaha-based Warren Buffett and others, the watchdog says, did better. Geithner should take the message on board.
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Buffett bought $5 billion (Rs24,350 crore) of Goldman Sachs Group, Inc. perpetual preferred shares back in September. They carry a 10% dividend. He also collected warrants over another $5 billion worth of common stock. Although the COP’s valuers reckon the dividend yield was a little below the market rate at the time, the near-$2 billion market value of the warrants put the “Sage of Omaha” 10% or so in the money the day he did the deal.
Better yield: Warren Buffett, chairman of Berkshire Hathaway, got 10% dividend on Goldman Sachs shares; the US treasury got only 5%. Giuseppe Aresu / Bloomberg
The US government, on the other hand, demanded an initial yield of only 5% on its otherwise somewhat similar preferred stock—and collected a lot fewer warrants relative to its investments than Buffett did. As a result, the COP concluded that the $10 billion taxpayer investment in Goldman was only worth $7.5 billion at market prices—effectively handing the firm $2.5 billion, a 25% subsidy.
The COP also noted that Paulson’s treasury gave banks similar terms under the Troubled Asset Relief Programme, or TARP, despite their different circumstances. The effective subsidy for the first round of TARP investments went as high as roughly 40% for Morgan Stanley and Citigroup Inc., and as low as 5-7% for US Bancorp and Wells Fargo & Co.
Assuming Geithner continues to use TARP funds to recapitalize banks, there are a couple of lessons. First, he needs to be more transparent than Paulson—as he has promised to be—especially about the rationale and value of any subsidies. And second, he should set tougher financial terms in addition to attaching more strings governing bank behaviour.
He might not want to strain banks’ cash flows with yields as high, for example, as the 12% set in the UK’s bailout. But he could insist on the government receiving a lot more warrants. Their value crystallizes only when bank shares rise—so banks only face additional costs if their outlook brightens. That sounds fair. If the pricey bailouts succeed, the least taxpayers deserve is a Buffett-like payoff.