The bailout bill requires the Treasury to obtain warrants or stock from all financial institutions from which Treasury buys troubled assets. This is, I think, what some here are referring to as the stock injection program. And for those who don’t already know this, a warrant is a right to purchase stock at a fixed price. In this case, the warrant must also be convertible to senior debt if the financial institution fails, which should mean we come ahead of a lot of other creditors even in the event of bankruptcy.

Here is the applicable language from section 113:

(1) IN GENERAL.—The Secretary may not purchase, or make any commitment to purchase, any troubled asset under the authority of this Act, unless the Secretary receives from the financial institution from which such assets are to be purchased— (A) in the case of a financial institution, the securities of which are traded on a national securities exchange, a warrant giving the right to the Secretary to receive nonvoting common stock or preferred stock in such financial institution, or voting stock with respect to which, the Secretary agrees not to exercise voting power, as the Secretary determines appropriate; or (B) in the case of any financial institution other than one described in subparagraph (A), a warrant for common or preferred stock, or a senior debt instrument from such financial institution, as described in paragraph (2)(C).

The Treasury must get an equity position. The only real question is how much. I know Paulson opposed this provision, and may try to eviscerate it in operation. However, there are several oversight boards to hold his feet to the fire, the purchases are required to be disclosed, apparently on the internet, and Paulson may view this as an opportunity to squeeze the juice out of Goldman Sachs’ competitors.

One of the goals of the TARP, as the bailout bill calls the troubled asset relief program, is to recapitalize financial institutions, by paying more for troubled assets than their book value, which should have been marked to market at very low prices. Those low prices have badly impaired the capital structures of many lenders, making them unwilling to lend. By overpaying, we increase their capital. The hope is that this will encourage more lending.

The Treasury is required to set up rules for acquisitions, and this warrant requirement should be covered. One rule should be that the exercise price is the price of the stock of the financial institution on the date the troubled assets are purchased. Another should be that the more we overpay, the more equity we get. And one more: the more worthless the troubled assets are, the more equity we get. This last rule would mean that for mortgage based securities we get one level of equity, for credit default swaps and other trash we get a whole heck of a lot more.

Even if Paulson is in the tank for his competition, I don’t think he can use up all, or even a large part of, the money in the few weeks between the time the program is up and running, which is supposed to take as much as six weeks, and January 20, 2009, when the Obama administration takes over operation of the program. I do not doubt that the new people will insist on punitive warrants, designed to insure that taxpayers profit.



I read a lot of books.