What the “Treasury Talk” is Saying

A reluctant Henry Paulson announced this morning what the Department of the Treasury is prepared to do, if smaller banks request the help. There’s nothing in this plan for direct help to homeowners – no capping home loan interest rates, no moratorium on foreclosures – it’s directed at the smaller banks, who have no real options right now. And what’s worse, in a market with tight credit, Paulson’s preferred stock purchase (buying preferred stock, bearing interest, that gets paid back ahead of the shareholders’ common equity) plan is making the little banks pay a 5% return (rising to 9% in five years) on the government’s investment. That rate is a significant multiple of the rate that the Federal Reserve has set for its highest-rated bank-borrowers.

So this “interest generating” string pretty much assures that the small business and individual customers of those local banks who get federal aid will get socked with a higher rates and tighter requirements than the big boys and their customers (read: jobs and payrolls are still at risk if companies cannot reasonably bank their receivables). These higher rates make any qualified lender who accepts these terms much less competitive than any bank or savings & loan that does not.

Unlike the European governments, who simply guaranteed that on a temporary basis, they will support their banks from failure, the U.S. plan places an expensive layer, a financial burden on the cash-strapped, already-fearful local lenders. For those who want specifics, George White at thedeal.com summarized the government’s Capital Purchase Program (my notes are in brackets):

• The senior preferred shares will pay a cumulative dividend rate of 5% annually for the first five years that will reset to a rate of 9% annually after that.
• The government's shares will be non-voting.
• The maximum amount the government will invest is $25 billion or 3% of risk-weighted assets.
• The minimum amount the government will take is 1% of risk-weighted assets.
• Treasury will buy the senior preferred shares by year-end 2008.
• The government's senior preferred shares will qualify as Tier 1 capital and will rank equally with existing preferred shares and be senior to common stock. [Read: the government is a better position than the bank shareholders]
• The program is available to qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies. The Treasury will determine eligibility and allocations for interested parties after consultation with the appropriate federal banking agency.
• Treasury may transfer the shares to a third party at any time.
• Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of its investment.
• Participating banks must adopt Treasury's standards for executive compensation. [A retroactive clawback and a ban of any golden parachutes – a good idea – but the big parachutes are not likely going to be in these little banks in desperate need of federal assistance. It looks better on paper than what it really means to taxpayers.]

The markets rose mildly on the news – this was hardly the U.S. government reassurance they were looking for – but since the burden is on the smaller banks to “ask,” no one really knows if this structure has a chance of working. And think of the legal and advisory fees this exceptionally complex structure will generate – money to those who helped create this problem, a transaction tax that siphons off a chunk of the value of the $700 billion rescue package.

With nothing in direct aid to consumers, still looking at institutions before people, this plan lacks the transparency and simplicity of the European action. Don't expect the stock market to stay up. Don't expect the worries to vaporize. And don't expect this to help consumers or homeowners with any significant relief anytime soon.

I'm Peter Dekom, and I approve this message.