Bank of America Gets Quite a Deal
We have a deal. You, US taxpayer, have generously provided to Bank of America the following: one Treasury-FDIC guarantee "against the possibility of unusually large losses" on a pool of assets taken over from Merrill Lynch to the tune of $118bn, and a further Fed back stop if the Treasury-FDIC piece is not enough. In return we receive $4bn of preferred shares and a small amount of warrants "as a fee". There is a $10bn "deductible," i.e., BoA pays the first $10bn in losses, then remaining losses are paid 90% by the government and 10% by BoA.
We are also investing $20bn in preferred equity, with a 8 percent dividend. There will be constraints on executive compensation and BoA will implement a mortgage loan modification program. Essentially, this is the same deal that Citigroup received just before Thanksgiving, known as Citigroup II, which was generous to bank shareholders but not good value for the taxpayer.
This is more of the same incoherent Policy By Deal that has failed to stabilize the financial system, while also greatly annoying pretty much everyone on Capitol Hill. Hopefully, it is the last gasp of the Paulson strategy and the Obama team will shortly unveil a more systematic approach to bank recapitalization; it would be a major mistake to continue in the Citi II/BoA II vein.
In addition, you might ponder the following issues raised by the term sheet.
1. The $118bn contains assets with a current book value of up to $37bn plus derivatives with a maximum future loss of up to $81bn. This is more detail than we got in the Citi deal, so there is evidently greater sensitivity to calls for transparency. But the maximum future loss is based on "valuations agreed between institution and USG." What is the exact basis for these valuations? From the term sheet, it sounds like we are talking mostly about derivatives that reference underlying residential mortgages. Absent any other information, my guess is that they can easily lose more than $81bn - depending on how the macroeconomy and housing market turn out.
2. What is the strike price of the warrants? This was controversial in the Citigroup II deal (because it was unreasonably high), but at least it was quite explicit up front. The announcement is suspiciously quiet on this point, perhaps due to the recent spotlight on warrant pricing terms.
3. What kind of reporting will there be by BoA to Treasury, and what will be disclosed to Congress, in terms of the exact securities covered by this guarantee and how they perform? The lack of information is a big reason why TARP became discredited and Capitol Hill is so concerned to see more transparency going forward. There is nothing in the term sheet that reveals the true governance mechanisms that will be put in place, or how information will be shared with the people whose money is at stake (you and me, or our elected representatives). I understand there is market-sensitive information present, but there are obviously well-established ways to share confidential information with members of Congress.
Overall, it feels like the latest (and hopefully the last) in a long line of ad hoc deals, which have done very little to help the economy turn the corner. The new fiscal stimulus needs to be supported by a proper bank recapitalization program, as well as by a large scale initiative on housing.
This is just wrong. Not the article, but the deal.
TARP was sold as a means to unfreeze credit markets. The first round did that. Now it is being abused to socialize gambling losses.
This is just wrong.
January 16, 2009 3:54 AM | Reply | Permalink
TARP was sold as a means of recapitalizing the banks.
And after Citigroup no financial institution is more in need of recaptitalization than is BoA after it ingested Countrywide* and Merrill Lynch.
* Hey, but think of all the money everyone's hero, Sheila Bair, is saving.
January 16, 2009 4:40 AM | Reply | Permalink
By the way "everyone's hero" is now plumping for using TARP II monies to establish a "bad bank" to be used to buy up all those toxic assets.
“We think by leveraging TARP funds in this way, you could have a significant capacity to acquire troubled assets,” Bair, who is set to stay on under Obama, said today. Bloomberg 1/16/2008
January 16, 2009 1:18 PM | Reply | Permalink
Bair's devil is in the details.
Which assets are how toxic?
Again, non-performing home loans are one thing, side bets placed on the performance of those loans or their securitizations are another thing.
Don't cover gambling losses with TARP funds, period.
January 16, 2009 4:15 PM | Reply | Permalink
I answered this already in another thread. TARP was sold (publicly) as lubricant to unfreeze credit markets. Recapitalization is only one of the means available. How Paulson sold it to the banks last fall, I don't know exactly. Some were reluctant to take the bailout funds, which means some snapped them up (I'd guess Citi is in the latter category, and JPM in the former).
January 16, 2009 4:08 PM | Reply | Permalink
Further, to be clear: ML's losses are someone else's gains. It's not like farmland blew into the Gulf of Mexico, or California fell into the Pacific Ocean. It's not like actual currency was burned to light cigars... or is it?
This is true of Citi et al, too.
Taxpayer money must not be allocated to cover private party gambling debts. If an entity cannot separate out their various interests, they should get zero public support (in any form).
January 16, 2009 4:00 AM | Reply | Permalink
The other thing that Bank of America is getting is a narrative that blames the Merrill assets for BAC needing tax payer funds.
See the coverage in the Financial Times:
http://www.ft.com/cms/s/0/7ebeb6b0-e35c-11dd-a5cf-0000779fd2ac.html
http://www.ft.com/cms/s/0/453b82ca-e338-11dd-a5cf-0000779fd2ac.html
And Bloomberg:
http://www.bloomberg.com/apps/news?pid=20601087&sid=aeZm19V4gAxY&refer=home
This is a lot of spin and hooey.
If anyone recalls that weekend in early September when Lehman went pop and Bank of America bought Merrill, there was major presser with Ken Lewis and John Thain - explaining what they could about their shot-gun marriage.
There was one nugget from that presser, where Ken Lewis said that the advice provided by JC Flowers, who had looked at both Merrill and Lehman's toxic assets, was critical in swaying Lewis toward the Merrill deal. In other words, because Merrill had marked their inventory more conservatively than Lehman, Lewis saw the Merrill deal as more easy to value. (there's another theory that Lewis has simply always coveted Merrill's wealth management business, but this does not negate the importance of the Flowers opinion)
The chickens have now however come home to roost. In the integration of the BAC and MER businesses, amongst the many things that are happening is that trading books are being consolidated and marks are being reconciled.
I have seen some of the data points, but there is trend emerging - BAC have their toxic assets marked, fairly consistently, 20 points more aggressively than MER. And those are the tradebable MBS and ABS.
The Treasury statement says the relief package is directed at:
"an asset pool of approximately $118 billion of loans, securities backed by residential and commercial real estate loans, and other such assets, all of which have been marked to current market value. The large majority of these assets were assumed by Bank of America as a result of its acquisition of Merrill Lynch."
Here's the deal - these 118 yards of legacy Merrill trash might lose further value. Absolutely true. But what of Bank of America's "pool of loans, securities backed by residential and commercial real estate loans, and other such assets"? This is the stuff that no-one has shone a light on yet - and I repeat, the data points I have seen put BAC marking their real estate-backed assets 20 points richer than Merrill.
The 20 billion of equity and 118 billion of guarantees is, as implicit in the Treasury announcement, basically fungible across the new consolidated group.
So don't let Ken Lewis hoodwink you into believing this bail-out is all because those dastardly Merrill bankers dropped a giant turd in his empire. This bail-out was not needed because BAC aquired a crappy company, it was because BAC has seen the same writing on the wall as that seen by Citigroup.
There has been - and probably will continue to - plenty of innuendo that Lewis will be looking for people to sue. JC Flowers, maybe? If he does so, Lewis will have a microscope trained on his running of BAC - something which he surely will not want.
January 16, 2009 6:53 AM | Reply | Permalink
Yes, BAC was weak and maybe about to die itself.
January 16, 2009 4:24 PM | Reply | Permalink
At the WSJ link one finds
To disguise my economic ignorance I shall not go into details, but Daddy Warbucks ought to be able to work out that that sentence might sound to the ignorant lay sheep as if the second mugger is superior to the first only by not pretending to be interested in benefitting the patient.
Baaaaaah!
Happy days.
January 16, 2009 6:53 AM | Reply | Permalink
So now we have a house of cards *and* scotch tape.
Methinks we have another leg down yet. When these Banks Too Large to Fail actually do fail, We the People will now take a large hit, too. A double-whammy, in fact, as our "preferred shares" become equally worthless along with the lowly common, and the economy (whatever that really is) tanks again. (Or should I say "tanks a lot!"?)
And at some point, I genuinely fear, the insolvency of the ultimate Bank Too Large to Fail -- that is, the Federal Government -- will be found out. And then all hell breaks loose.
Dow 6000 in 2009. After that, who knows?
-- ARG
January 16, 2009 10:30 AM | Reply | Permalink
Perhaps institutions should somehow not be allowed to become "Too big to fail.
I'm a supporter of Single Payer Medical Insurance to solve our medical coverage problems. I don't know why a for profit insurance company should siphon billions out of the system to support exhorbitant compensation packages while layering mountains of bureaucracy which only helps to drive costs up.
So, if the major problem is housing and mortgages in arrears wouldn't it be better to bypass the people that caused this problem, the banks and investment people where $Billions will go to die, and try to find a way to go directly to the people who are trying to pay their mortgages while helping qualified others to purchase the houses already in foreclosure?
Could we offer to pay the mortgage holders a pre payment penalty in order to get a more favorable mortgage for the homeowner who is on the way to default on a mortgage that shouldn't have been issued in the first place?
January 16, 2009 11:21 AM | Reply | Permalink
I believe Bair floated something like that late last year, providing funds for refinance. Trouble is, if the mortgage is 20% underwater, someone has to make up at least that much capital.
Basically, owners who sold at inflated bubble prices made out like bandits, as did brokers and others who took commissions along the way.
What should happen is that all parties should take losses and some banks should go under. This idea/meme that a bank going bankrupt will kill the economy has got to be fought off.
January 16, 2009 4:23 PM | Reply | Permalink
Frankly, I'm surprised and pleased we taxpayers received anything at all in consideration of this latest "investment" in BoA. Were I running BoA I'd tell the USG to take a hike were it to ask for any consideration at all.
Under current financial theory BoA has been determined to be too-big-to-fail. There are two ways two "save" the company, either find another company to take it over or invest capital in it. In the case of BoA the first solution is a non-starter; there's no financial institution big enough to take over BoA. That leaves it up to the USG to step up to the plate.
It's a case of that old joke -- if you owe the bank a million dollars . . . but if you owe the bank one hundred million dollars . . . .
January 16, 2009 12:42 PM | Reply | Permalink
take it over
This is where People's Capital Fund comes in.
Instead of taking 350 B.(US) and pretending to buy preferred stock warrents, The PCF will take said money straight to the market and buy the motherfuckers outright.
Especially considering they hired that *rude chief executive with the one eye
*take a hike
January 16, 2009 2:20 PM | Reply | Permalink