Profiting From TARP: The Treasury Department Nets $1.5 Billion In Bank Of America Warrant Sale

On Wednesday, the Treasury Department completed an auction of warrants it received from Bank of America in exchange for emergency TARP loans. The government indicated that it netted $1.54 billion from the Bank of America warrant auction. By all indications, this is the most lucrative and profitable warrant auction for the Treasury Department since it began the warrant auction process in December. A warrant is a derivative security that gives the holder the right to purchase securities from an issuer at a specific price within a certain time frame. The Bank of America TARP warrants expire in 2018 and 2019 and have a strike price that is close to double Bank of America’s recent trading price ($16.42 as of the close of the NYSE on Wednesday).

Recall, Bank of America repaid $45 billion in TARP funds to the federal government late last year, in December. As reported earlier on this Blog, things are looking up for American banks. Last year, the Congressional Budget Office (“CBO”) estimated that the TARP program would cost taxpayers $356 billion. Recently, indeed in January, the CBO estimated that the TARP program would only cost taxpayers $99 billion over its lifetime. The Obama administration’s Office of Management and Budget produced a similar estimate. The stock market rally in recent months, and the fact that relatively few banks retain TARP funds has narrowed the original gap somewhat. Again, the estimates regarding the TARP program are just that—estimates—it may take a number of years to fully understand the impact of the program and see fully just how much it might end up costing taxpayers.

TARP recipients have two options: 1. to repurchase their own warrants; or 2. to allow the government to auction the warrants to others. Goldman Sachs spent $1.1 billion to repurchase its warrants in July, after repaying $10 billion in TARP loans. Morgan Stanley spent $950 million to purchase its warrants associated with a $10 billion TARP loan. The Treasury Department began its first warrant auctions in December of 2009. In these first auctions, the Treasury Department raised $950 million auctioning JPMorgan Chase warrants. JPMorgan had received and repaid $25 billion in TARP funds. Citigroup and Wells Fargo, the last two megabanks to receive and repay TARP funds, have not yet decided whether they want to repurchase their own warrants or have the Treasury Department auction off those warrants.

At the end of the day, for all the criticism of the TARP program, the Treasury Department has recouped some profit for taxpayers. From the taxpayer’s perspective, however, when it comes to TARP bailouts in the auto and housing industries we might not end up being so lucky. The jury is still out!

The Bank Tax Revisited: A Closer Look At President Obama's Proposed Bank Tax To Recoup TARP Losses

In my post today, as a follow-up to Professor cumming's excellent post yesterday, I want to take a moment to revisit President Obama's bank tax proposal. I've uncovered some interesting data that explores the direct impact of the bank tax on a handful of big financial institutions like Citigroup, Bank of America, JP Morgan, Goldman Sachs, and Morgan Stanley.

On Thursday, President Obama announced a bank tax plan designed to tax roughly 50 of the largest banks and financial institutions over the course of the next decade to recoup losses associated with the bailout of Wall Street. Smaller community banks won't be affected by the bank tax. President Obama stated that his goal over the next decade is to “recover every single dime” from the TARP bailout of Wall Street. President Obama hopes to officially include the so-called “bank tax” provisions in February when he proposes his budget plans to Congress.

Who will be covered by the bank tax? The tax, if adopted, will be levied on banks, insurance companies and brokerages with more than $50 billion in assets, and would start after June 30, 2010. The bank tax would not apply to bank customer’s insured accounts, but rather it would apply to assets used as part of the institution’s risk-taking operations and activities. The goal that President Obama seeks to reach is to recoup roughly $90 billion over a ten (10) year period. The bank tax could remain in effect for over ten (10) years if losses from TARP are not recovered after a decade. At the moment, Obama Administration officials suggest that TARP will likely be about $117 billion, which is roughly 1/3 of the losses that officials projected last summer. The lion’s share of the TARP losses are associated with the bailouts of Chrysler, General Motors, and AIG.

In delivering his remarks on Thursday, President Obama noted: “We’re already hearing a hue and cry from Wall Street suggesting that this proposed fee is not only unwelcome but unfair…That by some twisted logic it is more appropriate for the American people to bear the cost of the bailout rather than the industry that benefited from it, even though these executives are out there giving themselves huge bonuses.” President Obama continued: “What I say to these executives is this: Instead of sending a phalanx of lobbyists to fight this proposal or employing an army of lawyers and accountants to help evade the fee, I suggest you might want to consider simply meeting your responsibilities”

Naturally, big banks have bulked at the bank tax. Their argument is that they have paid back their TARP allocations with interest. In anticipation of this argument, the Obama Administration noted that the bank tax is in a sense a “financial crisis responsibility fee” aimed at policing those institutions whose risky behavior started the financial crisis in the first place.

Will the bank tax be passed on to consumers? The answer is to a certain extent yes. However, by exempting smaller community banks if large banks increase their fees too drastically savvy smaller banks will likely draw a line on their fees to attract customers of higher fee large banks. In many ways President Obama’s proposal drives a wedge between small and large banks. Due to their exemption from the bank tax, small community banks will likely support the Obama proposal at the cost of their larger brethren.

Practically speaking, how would the tax impact financial institutions like Citigroup, JPMorgan Chase, Bank of America, Goldman Sachs, and Morgan Stanley? Analysis shows that Citigroup would a roughly $2.2 billion per year assessment. Both JPMorgan Chase and Bank of America would face an annual assessment of $2 billion. Similarly, Goldman Sachs and Morgan Stanley would pay assessments in the same ballpark. The bank tax would amount to a roughly $1.5 million tax on every $1 billion in institutional assets subject to the tax or levy. Again, Tier 1 capital, including common stock, and insured customer deposit accounts, for which banks already pay fees to the Federal Deposit Insurance Corporation (“FDIC”), would not be subjected or exposed to the bank tax.

In a mid-term election year President Obama’s bank tax proposal taps into popular angst and distrust of large financial institutions on both sides of the political aisle. Philosophically, most fiscal conservatives are opposed to taxes in almost any form during a recession. Interestingly, Republicans have not been so quick to criticize the bank tax fearing that they may draw the ire of their own political base and remaining mindful of the fact that small community banks, which may benefit, exist in virtually every Congress member’s district. President Obama is tapping into populist angst that cuts across party lines—Citizens are angry about the role that large banks played in nearly pushing our economy over the abyss through uncontrolled risk-taking.

Remembering Lehman on the Eve of the First Anniversary of Its Collapse: Part I

As we approach the first anniversary of Lehman Brothers’ collapse, a failure that many believe triggered the current global economic crisis, we should perhaps pause and reflect on the topsy-turvy financial year that Americans have survived. This is not an anniversary that Richard S. Fuld, Lehman’s former chairman and chief executive officer is looking forward to celebrating. Fuld has been vilified and humiliated before a congressional panel last October and named in nearly 40 different legal actions. “I’ve been pummeled, I’ve been dumped on, and it’s all going to happen again. I can handle it. You know what, let them line up,” Fuld stated recently. To be fair to Fuld, he took control of Lehman in 1994 at one of Lehman’s darkest hours and rebuilt it into the fourth-largest U.S. investment bank, a Wall Street powerhouse whose massively profitable mortgage banking machine inspired rivals’ envy. The question remains, however, how did it all go wrong? Is Fuld really to blame for Lehman’s demise or was Lehman the first victim of a massive systemic failure in the American financial services industry? Perhaps, more importantly, why didn’t the federal government save Lehman like it saved, Long-Term Capital Management, a hedge fund in the late 1990s, Bear Stearns a mere six months before Lehman’s collapse, Merrill Lynch at the same time that it allowed Lehman to collapse, Bank of America, Goldman Sachs, AIG and countless other financial institutions after it allowed Lehman to collapse, that were deemed too big to fail?

On Friday, September 12, 2008, U.S. Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke assembled thirty of the most powerful figures in the American banking industry to the headquarters of the U.S. Federal Reserve in New York. The group of thirty was told Merrill Lynch and Lehman Brothers were on the brink of collapse. The U.S. government would not bail them out because it was only a week since the U.S. government had agreed to rescue Fannie Mae and Freddie Mac. It was up to the thirty banking executives in the room to save Merrill and Lehman. The future of the entire global banking system was now under threat because the collapse of these two Wall Street giants would deal a huge blow to the world’s confidence in the U.S. financial industry. In particular it would raise questions as to whether American financial service companies could make good on their debts, if Lehman and Merrill were to collapse.

Ken Lewis, chief executive officer of Bank of America, was interested in buying Merrill, but Lehman was out of the question, primarily because no one was really sure of the Lehman’s true financial condition, that is--the true state of the Lehman’s finances, the true worth of thousands of “esoteric contracts” to which Lehman was a counterparty. There could be billions of dollars in liability for the company that eventually purchased Lehman. Lehman’s potential liability for its outstanding loans was not clear and no one wanted to take on such a tremendous risk. Except perhaps Barclays, a 300 year-old British bank, who wanted flagship operations in the United States. The Financial Services Authority and Bank of England were adamant in their belief that the U.S. Federal Reserve would not allow Lehman to fail. They had grave reservations about the idea of a Barclays-Lehman deal. They wanted reassurances from the U.S. government, in particular they wanted guarantees as a condition precedent to the deal. If Barclays were to purchase Lehman blind, unsure of the liabilities Barclays would inherit from the “esoteric contracts,” the U.S. government would have to provide some insurance for Lehman’s and eventually Barclays’ potential losses. The U.S. government refused not because it did not want to save Lehman but because the U.S. government itself did not know what the ceiling of the potential Lehman losses would be. Lehman was too big for the U.S. government to rescue. The Barclays deal was dead and so was Lehman.


On Monday, September 15, 2008, 158 years after it was founded, Lehman filed for bankruptcy. It was a catastrophic event. Shockwaves were felt throughout the global banking industry. Within days, Halifax Bank of Scotland had been rescued by Lloyds of London. Within two weeks, Bradford & Bingley was nationalized. Within a month, the British government had given financial bailouts to Lloyds of London and Royal Bank of Scotland with an unprecedented £37bn. Banks were in crisis everywhere. Not to be outdone, the United States developed a $700bn Troubled Asset Relief Program (TARP) to bailout American banks. On September 21, 2008, Goldman Sachs and Morgan Stanley were given permission from the U.S. government to convert their status from investment banks to regulated commercial banks, marking the end of the last two major independent Wall Street investment banks. It was the end of an era.

A year later, as we remember Lehman, the American banking system is still fragile, recovery is slow, and many questions and lessons exist regarding the near-death experience of the American banking system. "You had an old 19th century-style panic," said Cary Leahey, senior economist at Decision Economics. "There was no single catalyst" for the upheaval. Economists believe that big investment banks and other influential financial market players had taken on massive risks, borrowing heavily to bet on securities tied to subprime real estate loans which were outside the scope of regulators’ authority. As a result, when the U.S. housing market collapsed, this sent the walls crashing down, freezing credit markets and economic activity in the worst crisis since the Great Depression. Hugh Johnson, chairman and chief investment officer at Johnson Illington Advisors stated that "there was a belief that the financial crisis could not be solved and would lead to a second Great Depression.” The U.S. government took aggressive action. The new regulatory focus may curb the excesses that led to the boom and bust of Lehman. However, the current focus on regulation and risk mitigation "have enormous implications for the availability of risk capital in the U.S. and the primacy of the U.S. financial system," said Joel Naroff of Naroff Economic Advisors.

What shall be remembered about the Lehman collapse?

First, although some historic names have vanished forever and others are mere shadows of their former selves, Wall Street hasn't changed all that much. It still operates on the principle of an insider club where disclosure is minimal even to regulators. The best interest of the public is not the primary concern. Business is good and likely to get better. Simply look at the second quarter earnings report for the major financial service firms. Previously on July 22, 2009, I commented on the amazing second quarter earnings of the large banks that had received TARP funds and queried whether they really needed the TARP funds, in the first place? Currently, the burgeoning need for Wall Street’s capital raising services will be a welcomed relief in a world that's suffered trillions of dollars in losses over the past two years.

Second, regulators and central bankers could not save Lehman because Lehman was too big to save. The huge uncertainty of Lehman’s potential losses illustrated that the world's capital markets have become too powerful relative to the central banks. "The U.S. government didn't let Lehman fail; it didn't have the authority to save it," Treasury Secretary Tim Geithner said in an interview with Fortune.
"The fundamental constraint was that the Treasury at that point had no authority" to put capital into Lehman, and "the central bank did not have the ability to fill a capital hole." There was no buyer willing to assume most of Lehman's obligations, as Morgan Stanley did for Bear Stearns. The U.S. government would have been risking unlimited losses because Lehman didn't have enough collateral to back hundreds of billions or trillions of dollars of outstanding loans.

Third, the American financial markets can overwhelm the U.S. government’s resources. Lehman shall remain an unfortunate footnote in U.S. financial history. However, Lehman's collapse underscores for all of us that financial regulation is not only fashionable, it is instrumental for the survival of the American financial system and global economic stability. Despite everything that has transpired, hope is not lost. In the words of Mr. Fuld, “I’m not a defeatist. I do believe at the end of the day that good guys do win.”

Lydie Nadia Cabrera Pierre-Louis
Assistant Professor of Law
St. Thomas University