Bloomberg is out with an article that suggests the government is being overly generous with the prices it’s accepting for the warrants attached to the TARP money that was advanced to the banks. Only two banks of the seventeen that have repaid TARP money have settled up on the warrants but Bloomberg contends that the price accepted might be far short of what the government should receive.
They use the example of Old National Bancorp which repaid its TARP loan and also purchased the outstanding warrants for $1.2 million when they may have been worth as much as $5.81 million. According to Bloomberg if the Old National formula is applied to the 20 largest recipients of TARP money the U.S. would forgo $9.985 billion in revenue.
The numbers are derived from modeling using the Black-Scholes options pricing model and other models. Linus Wilson, an assistant professor at the University of Louisiana was the first out with a criticism of the warrant purchase prices and his study has been bubbling up through the blogosphere and into the MSM all week.
It’s important to keep in mind that pricing these options is a much an exercise in art as it is in science. Bloomberg readily admits that there is a range of prices at which they could be valued depending upon the assumptions you make for the inputs to whichever model you choose.
While I’m not a fan of the banks, I do think that they might be getting a bit or some undeserved bad publicity on this particular issue.
It’s worth recalling how these loans and warrants came into existence. It wasn’t in a low key, sober negotiation among parties in which the pros and cons were considered by all, forecasts run and cost/benefit analyses applied to the proposed transactions. No, it occurred in a highly charged atmosphere in which the government dictated on a Sunday afternoon the terms of loans that a group of banks were to accept regardless of whether they wanted them. It was many things and may have even been necessary overreach by the government given the circumstances but one thing it was not was a good faith business negotiation.
Given that, it seems disingenuous to now cooly calculate how much money the banks owe the government for warrants that they were forced to hand over. The mere fact that there was no agreement as to how to value the warrants initially speaks forcefully to the nature of the transaction. Viewed in the abstract, it is quite easy to arrive at mathematical conclusion as to the value of the warrants. Context, however, does matter and in context there are arguments to suggest that the government is truly entitled to the upper range of the indicated value.
I think that there is a larger principle here as well. The loans to the banks were extended not necessarily to save any particular bank, rather they represented an attempt to salvage what appeared to be an incipient meltdown of the financial system. The government was doing what it justifiably does in the event of a national emergency, using the resources of the country to protect the citizens from the advers effects of the crisis.
When an hurricane devastates New Orleans, or an earthquake levels portions of the San Francisco Bay area, aid flows swiftly and without expectation of repayment. That occurs partly for humanitarian reasons but also for purely economic reasons. Abandoning the devastated area to fend for itself implies an overly long recovery period and a severe impact on the economy of the country. It’s in society’s best interest to spend part of its treasure to repair the damage.
Had the financial system been allowed to collapse the damage would have been many orders of magnitude greater than we have ever experienced from a natural disaster. There was no alternative other than to save the system. To expect to profit from that mission seems as wrong as it would be to seek extra taxes from the citizens of New Orleans as a repayment for helping them recover from Katrina.
I know the argument is that New Orleans did not bring Katrina on itself nor did the Bay Area ask for an earthquake while the bankers created their own problems. True enough, but in an ideal world a rational person would not choose to live in such disaster prone areas. In choosing to do so the residents of those areas compounded the cost to society. The bankers made mistakes but then so did the government in its role as a regulator and one might argue that irresponsible behavior by borrowers also contributed to the problem. It was truly the near failure of a system that was caused by forces that can’t be fairly put on the shoulders of a single group and as such an argument can be made that a part of the cost must be born by society at large.
The demonization of the banking sector is much in vogue and the proverbial pound of flesh is being sought. Perhaps a more balanced view would be appropriate.