Welcome To The Dodd-Frank Bailout Cafe! My Name's Hank, I'll Be Your Server

Krugman gets the Nobel, we all get some goodies without taking on any toxic mortgage debt, and the markets go up 11%. What sort of goodies, you ask? Nonconvertible preferred stock and equity warrants.

The preferred stock that each bank will have to issue will pay special dividends, at a 5 percent interest rate that will be increased to 9 percent after five years. The government will also receive warrants worth 15 percent of the face value of the preferred stock. For instance, if the government makes a $10 billion investment, then the government will receive $1.5 billion in warrants. If the stock goes up, taxpayers will share the benefits. If the stock goes down, the warrants will be worthless.

We're dealing with the most stable banks here, giving around $25B to Citigroup, JP Morgan Chase, and Wells Fargo. They're not in dire straits, so it's not like we can strong-arm them into giving us some freakishly good deal. We also end up guaranteeing three years of their future debt, which is a source of risk that I don't know how to evaluate very well, but which will probably do a lot to make people confident that system won't collapse.

As far as I can tell, the preferred stock is kind of like a bond with eternal life (please correct me if you know otherwise). I'd be happier to get ordinary stock, which probably has more upside as markets recover, but I guess Paulson doesn't want us wielding voting power. It's a concession I'm content to make. The warrants basically work as stock, so at least we get into a little of the action. I'm curious what the strike prices are. Given the possibilities, it looks like a solid moderate-risk moderate-return deal that will do a lot to stabilize things, and this is a moment where I feel pretty good about having been a post-Dodd-Frank bailout supporter.

My guess is that having shored up the solid banks, we'll move downmarket to banks in more trouble next. Since he started with the stable ones, there probably won't be too much stigma on weaker banks that decide to participate in the program. He's telling them, "Don't worry, investors aren't going to sneer at you for seeking help. They know it doesn't mean you're unstable -- look at all those perfectly fine people over there who did it too!" The big question is whether this'll get the solid banks back into the normal lending swing of things and reduce the self-perpetuating panic about a credit freeze. I feel fairly optimistic about that.

Amusing relevant personal news: I just got back from a lunchtime presentation to the Singapore Rotary Club on the financial crisis and the presidential election. Big laughs when I pantomimed Henry Paulson kneeling in front of Nancy Pelosi, begging her not to blow up the bailout deal, and Pelosi's "I didn't know you were Catholic." At the end, two different people told me that I looked like Barack Obama, which I found very flattering. I guess I kind of have his coloring and body shape, but it wouldn't have occurred to me before.

I'm feeling good about buying 200 Cisco at the open on Friday when everybody thought Acathla was going to devour the world. I spent most of my remaining cash on Apple Monday morning when the portal to hell closed. My general feeling is that Nasdaq 1844, where we are right now, is still a fine time to buy. The markets were crashing on worry of a global crisis of confidence in the financial system leading to a depression. Now they're just pricing in, I guess, a full-fledged recession. If we just get a mild recession, you still do fine.

Comments

[Joe]

So what do you think of the UK Gov't deal, where they now have 40% to 60% of each of the big UK banks (depending on how much help they wanted)?

UK taxpayers seem to have got more for their bucks.

Joe
(in London)

[Neil the Ethical Werewolf]

I'm very happy that the US is enjoying a diluted version of excellent UK policy, rather than the UK suffering under a diluted version of catastrophic US policy.

[Stephen]

Actually Joe, it looks like UK taxpayers are getting a much better deal, because Brown isn't constrained by the tenets of a failed religious belief.

Paulson is spending unprecedented amounts of money to prop up a failed industry, one that drove itself to the precipice, but is limiting the amounts of equity he's purchasing and making it non-voting shares because he's still worried that too much government interference might have negative effects.

The best analogy I can think of is parents who refuse lifesaving medical care for their child. Finally convinced that their child will die without the blood transfusion, they let their paternal bonds override their religious beliefs, but only enough to make sure their child is alive yet still extremely sick.