BY MATT HUTCHINS
When the Troubled Asset Relief Program was first implemented by Treasury Secretary Henry Paulson, the primary rationale put forward for departing from an asset protection model to a recapitalization model was the need to provide confidence to the markets without wasting taxpayer dollars. As the financial crisis continues to evolve and the economy enters a virulent recession, it is unsurprising that the Federal Government has needed to follow its first “recapitalization” with a second and in some cases third round of multibillion dollar investments. It is by now clear that many of the nation’s most critical financial institutions will be unable to weather the current economic turmoil without ongoing support from the Treasury. Indeed, President Obama’s budget sets aside a further $250 billion for ongoing intervention to support the financial sector. Despite the repeated statement by Federal Reserve Chairman Ben Bernanke that the nationalization of banks is not being seriously considered, it remains uncertain to both investors and taxpayers how the Federal Government will support the financial sector and at the same time protect its investments without acquiring an equity stake large enough to effectively take control of troubled institutions.
The spectre of nationalization which is hanging over financial institutions has caused turmoil in the markets and driven away investors. Each time a major institution announces huge losses, the government is forced to step in and reassure markets that there will not be another “Lehman” to avoid further blockage of credit markets. Yet with each step it takes to protect financial institutions, the Treasury weakens the prospects for private sector assistance to those same institutions and increases the burden of repaying the massive capital injections or making regular payments of interest. The restructuring of the Citi bailout as an equity interest demonstrates what investors intuitively know, that the government expects to be repaid, but will not accept the outside role of a contract creditor. The market is thus left to wonder just how long the 800 pound gorilla will sit quietly in the corner while other investors carry on with the business of the company. Further iterations of the bailout downward spiral only make it more difficult for the “silent partner” model to continue. With the price of financial stocks depressed by the threat of nationalization, further investments have to be arbitrarily re-priced to higher stock values to prevent them from establishing a majority stake in the company. Afterwords, the price of publicly traded stock becomes further depressed by the impending threat that the step-by-step acquisition will be completed or remain inadequate to prevent seizure by regulators.
From a taxpayer perspective, the government is irrationally feeding zombie corporations like AIG that are already dead, poisoned by their toxic assets and now dragging down the whole economy. The opaque structures used to designate investments as preferred shares that are convertible to stock leave citizens frustrated, not knowing if their government is the next unwitting victim of Wall Street’s great ponzi pyramid. Whether it is a private jet, a resort vacation, a renovated executive suite, or a fat bonus check, taxpayers suspect that their billions are being funneled straight to the men who designed the economic catastrophe which they are now paying for and suffering through.It is time for the government to recognize that in forming a $700 billion dollar pool of capital through the TARP program it has effectively created a sovereign wealth fund big enough to rival the Abu Dhabi Investment Authority. Each investment is a deployment of capital resources that can rebuild the financial sector with the expectation of a return on investment. The conflicts of interest created by being both an investor and the regulating body are complex and not easily resolved. Nonetheless, when the Treasury functions in the same manner as foreign governments that invest in our economy, it should at least deploy its TARP funds according to the same rules applied to other investors. If the government wants to make a capital injection in a company and at the same time take substantial control over corporate governance and lending practices, the proper method is through a tender offer for shares on the open market, not a dilutive transaction which reduces the proportional ownership of other investors.
By making a tender offer at a modest premium (25%-50%) above the market price for a majority stake in the company, the Treasury could provide investors with the traditionally recognized means of escaping from a failing company while at the same time securing the power to protect its investments without exercising its regulatory authority. Once the Treasury becomes Chairman of the Board, regulation of executive pay and efforts to restructure the firm’s debt could all be handled in the board room rather than the halls of Congress, and if a complete reorganization was necessary, a traditional “going private” transaction could be used to bring the company under the 100% ownership of the government. Furthermore, it would send a message to markets that the Treasury respects the rules of the road and will avoid mixing its regulatory authority with its clout as a mega-investor.
This private actor approach to nationalization would certainly require further outlays of taxpayer dollars, but if the Treasury genuinely believes that these institutions will be viable in the long-term, then there is no reason to believe that the full amount invested cannot be recovered in later public offerings. There would also be a substantial risk of excessive government involvement in management of the firm, but this could easily be avoided by appointment of a board of outside directors with fixed terms of office, composed of experienced executives, economists, attorneys, and management gurus, similar to that of any other Fortune 500 corporation. Delegation of authority in this manner would create a new private form of public ownership, with the resulting corporation resuming its normal activities in a manner consistent with the regular practices of widely held entities. The primary difference from a normal public company would be that, while independently empowered to run the company, the board of directors would be overseen by and indirectly accountable to Treasury Secretary Timothy Geithner and President Obama, allowing taxpayers to feel secure in the ability of the government to protect their investment.