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Paulson Overpaid by $78 Billion for TARP Bank Equity

Even before its inception, we’ve been very skeptical of the TARP. Paulson managed to get the type of spending authorization that you only see in wartime, with almost no contraints on what he could do, and most troubling, put himself beyond the reach of law. From the original draft of the bill:

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

In addition, some of the Paulson’s actions were inexplicable, such as hauling the 9 prospective big bank bailout recipients before Paulson and having him engage in a thuggish “you’re not leaving until you agree to take the dough” when it turns out the dough was being offered on cheap terms. And even then, some of the CEOs reportedly left the meeting looking angry.

Why was the money spread more or less evenly over that group, when, for instance, JP Morgan protested that it didn’t need the funds, while Citi was clearly a black hole and could have taken most of the money on offer.

The illogic and wastefulness of these moves leave conspiracy theories, that Paulson was simply out to raid the Federal coffers and distribute as much as possible to his industry cronies, having more explanatory power other rationales. And the fact that Paulson from the get-go felt it crucial to be outside any review process signals bad intent.

The revelation that the Treasury misrepresented how it would price bank equity securities it received for TARP funds, to the tune of $78 billion, or 31% of the $254 billion disbursed, speaks either to gross incompetence or bad faith. And while I am generally of the “Never attribute to malice that which can be explained by incompetence” school, there are too many signposts in this case that point the other way.

From Reuters:

The U.S. Treasury looks to have overpaid financial institutions to the tune of $78 billion in carrying out capital injections last year, the head of a congressional oversight panel for the government’s $700 billion bailout program told lawmakers on Thursday.

Elizabeth Warren, a Harvard law professor, said her group estimated the Treasury paid $254 billion in 2008 in return for stocks and warrants worth about $176 billion under the Troubled Asset Relief Program, or TARP.

Warren said the Treasury, under then-Secretary Henry Paulson, misled the public about how it would price them.

“Treasury simply did not do what it said it was doing … They described the program one way, and they priced it another,”…

Warren said Treasury may have had a reason for paying more for investments than they appear to have been worth at the time of the transaction. “Once again, Treasury needs clear goals, methods, and measurement,” she said…

Barofsky, the inspector general for TARP within Treasury, told the Los Angeles Times in an interview Wednesday that misrepresentations in applications for TARP funds would be grounds for criminal prosecution…

Warren told the banking committee that after three months on the job, her panel is still not getting enough answers from Treasury.

Not surprisingly, the Wall Street Journal is trying to make this process sound partisan. Note how the story begins:

Lawmakers seized on a government watchdog’s assertion that the Treasury Department may have significantly overpaid for its investments in financial institutions, saying the government shouldn’t benefit the banking industry at the expense of taxpayers.

Given Elizabeth Warren’s reputation for fairness, and the high marks she has gotten so far, the “a government watchdog’s assertion” is an attempt to diminish her and shift attention away from the seriousness of her charges.

And in the Journal account, they merely speak of “overpaid” which conveniently obscures the mind-numbing amount at issue, until the end of the 10th paragraph of a 13 paragraph article. But before that, we get excuses made on behalf by the Treasury:

Treasury has frequently noted that its major investments, including the funds provided to American International Group Inc. and the targeted investments in Bank of America Corp. and Citigroup Inc., were done to maintain stability in the financial system and are different from the $250 billion plan to inject capital into the banking system, also under TARP.

However, the Journal does include a useful tidbit right before the close:

Neil Barofsky, the special inspector general overseeing TARP, said his office is opening an audit of Treasury’s multiple investments in Bank of America, as well as looking into how lobbyists may be influencing the application process for banks to receive capital infusions.

Corruption in high places is so rampant that I don’t see how we dig ourselves out. And that puts it on much the same footing as our debt hangover.

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45 comments

  1. ndk

    I think Paulson was operating under the theory that revealing who was sinking — as if that weren’t obvious enough already — was too dangerous. People still felt sufficiently empowered to do bank runs back in those heady days. If the funds were distributed only to the needy, then a weak bank might have a depositor exodus, only to collapse as soon as it was saved.

    I’m not saying this is a valid defense, but I think it’s one missed likely explanation of Treasury’s behavior aside from conspiracy theories.

    Neil Barofsky, the special inspector general overseeing TARP, said his office is opening an audit of Treasury’s multiple investments in Bank of America, as well as looking into how lobbyists may be influencing the application process for banks to receive capital infusions.

    Lobbyists? Financial industry lobbyists? Blasphemous. Next thing you know, FNM and FRE will be accused of making campaign contributions.

    Specifically targeting one bank out of the lot makes even this investigation reek of corruption. We’re getting Daddy to punish the weak brother.

  2. Anonymous

    I want to take this opportunity to speak out against economists that spill their swill behind the populist guise. I am speaking against the public ideas put about by academic economists like Mark Thoma and Brad Delong.

    I do not agree with their postulations, especially in regards to their trade proclamatons. Their concoctions are enethma to job creation in the US, yet appearing all the while like populists.

    They are not populists and they support, completly, the current trade imbalance.

  3. Yves Smith

    ndk,

    I discussed that the “we aren’t discriminating” idea As we noted at the time and found it wanting:

    To make the point more clearly: the public at large was taken not just once, but twice, It was hosed in the unduly generous terms given to nine banks (the lack of writedown of assets to realistic values, the failure to wipe out current equity holders and subject debt holders to a haircut, the merely symbolic limits on executive pay). But it also got a less obvious shellacking in the way legal and regulatory processes were trampled. Given the Treasury and Fed’s combined banking authority, and the dubious valuations of many types of assets on these firms’ books, the powers that be could easily have compelled any bank to accept a much less favorable deal, or frankly any deal they wanted them to take. And it would not have taken all that much additional effort (although it might have taken some planning, which is a persistent shortcoming of this Administration).

    But Paulson instead went through a bizarre, public exercise in sham corecion (and real sidestepping of even minimal normal forms) so as to avoid a candid discussion of how lousy the banks’ balance sheets really were. And the ruse, like the TARP itself, was another demonstration that the Treasury considers itself to be outside the law.

    Early in his career, Paulson was a staffer for John Erlichman. It appears that imprinting stuck.

  4. David Brown

    I expected this sort of behavior from a Bush White House. What disturbs me more is that it seems to be continuing unchecked under Obama.

    Now that is a lack of change we can’t believe in.

  5. Anonymous

    What, exactly, can be said about the condition of this great capitalism ? That it is really fascism ? Like a drunk awakening from an inebriated slumber we suddenly say that, surely, we have the most transparent, deep, and liquid markets ? The fallacy of the great moderation must have put that to rest.

    I really have nothing more to say than to call my countrymen to task. How is it that you vote as you do, for the Bush parasites. Suddenly you awake to vote for a populist when your family is at wits’ end.

    Well, there is an election looming. For the sweet love of Christ, put out the leftover fascists.

  6. cap vandal

    This argument makes no sense. TARP was a subsidy/bailout, it wasn’t an investment based on what the market would bear.

    Paulson had just finished with tough love and all it got was more problems. In fact, wiping out the GSE preferred was one of the reasons that banks needed more capital.

    They did an inverse triage and refused TARP funds to banks that were too weak. Except Barney Frank’s local minority bank.

    As long as the funds get repaid, then they didn’t overpay. If they decide to wipe out the preferred shareholders of C or BAC, then they messed up.

    This makes about as much sense as the assertion that TARP funds weren’t getting loaned out — as if money isn’t fungible.

    C just put out some huge document about how/where they loaned TARP funds. I don’t know why anyone would bother to read it.

  7. ndk

    I discussed that the “we aren’t discriminating” idea As we noted at the time and found it wanting:

    Wanting as a sufficient plan or good idea, certainly, Yves. I would have preferred the strong-arm you proposed at the time(and, isn’t it interesting how it seems tepid now, as strong as it was then), if propping up the Tacoma Narrows banks is taken as a given.

    But I still see nothing in the behavior of Treasury to suggest that the first TARP dispensation wasn’t at least half Potemkin bank recapitalization. That still strikes me as the most likely explanation.

  8. Anonymous

    My dear Yves;

    There is so much malfeasance afoot, I cannot express my anguish. My father holds some of his hard earned money in C and GMAC, positions that I assured him 7 years gone were good.

    My father is a simple man, always concerned with how the neighbor is doing. Maybe that is the way of Montanans. He was a smelterman and the only son of a widowed mother, exempt from WWII. None-the-less, he enlisted and ended up in Patton’s 7th Cavalry. He was shot in the face, six weeks into his personal journey to rid the world of evil. The great America put him back together, thanked him for his bravery with two silvers, a bronze, and a purple heart, and a society built on middle class wealth.

    He knows nothing about the elite new york and california cultures that have taken hold and strangulated all that is good about the trials and tribulations we have been through.

    And they hold a man like him, a true hero, in contempt. I can scarcely hold my anger at Chuck Schumer, Barney Frank, Lieberman, and all the rest of the NY scum that have promoted their financial scams onto the people that saved their asses.

  9. Andrew Bissell

    Jim Rogers and the Daily Reckoning guys were right: we should have just let ’em all go bankrupt. Rip the band-aid off and start over.

  10. Yves Smith

    cap,

    With all due respect, your comment shows how badly brainwashed you are. “Oh, this was just supposed to be a handout, this caviling about how the numbers work misses the point.”

    Sorry, we live in a country of rule of law, or at least in theory do, and with that goes certain procedures.

    The money that Warren was discussion was the equity injections. Equity by definition does not get paid back, it is not a loan.

    Her document has not been released yet, so we will need to see the particulars of her complaint. However, I imagine that it is there was a pricing mechanism for the equity (remember, 5% perpetual preferred, as I dimly recall with conversion rights, and I believe warrants also) and as the articles suggest, it was not adhered to.

    There were many complaints at the times that the pricing was well below market level, at established by the Warren Buffet investment in Goldman, which was the best of the sorry bunch. So there was already a subsidy.

    It appears at a minimum that per Warren, the public was told one thing, the actual deal was another. And remember, when the 9 banksters in that famous strongarm meeting with Paulson were finally given the terms, they weren’t unhappy, They knew it was a good, maybe even great deal for them.

    So there is either a discrepancy between the published terms and the actual deals, or perhaps the infusions were more generous than the actual deals, that somehow cash in excess of what was papered up was put into some (many?) banks.

    You can’t give gifts to companies, except at a token level. It either has to go in as a liability and is accounted for (debt, equity, whatever) or if it is a gift, it is income and is taxable.

    Of course, given the scale of losses, most banks have plenty of ways to shield any “gifts”. But it would need to be accounted for and disclosed.

  11. doc holiday

    Re: “”Treasury simply did not do what it said it was doing … They described the program one way, and they priced it another,”…”

    I’ve burned up most of my notes from The Salvador Dali TARP Surrealist Period, but I did save this bit on how things were to be valued, which was in the original TARP footnotes on 9.28.08:

    See: § 502(5)(E)(E) In estimating net present values, the discount rate shall be the average interest rate on marketable Treasury securities of similar maturity to the cash flows of the direct loan or loan guarantee for which the estimate is being made.



    That stuff also was linked to this stuff, below, but it was a bad experience and I still remain in denial and hope the fine folks at The White House can sort out all the chicanery!

    See Stuff: In estimating net present values, the discount rate shall be the average interest rate on marketable Treasury securities of similar maturity to the cash flows of the direct loan or loan guarantee for which the estimate is being made.


    >> Noetheless, have a very nice evening and Yves, what about a mask for either you or TARP?

    And another thing, it’s been too long, but I’ve meant to say thank you for your hard work and continued coverage on this mess; most people burned out 4 months ago and you’ve hung in there as a great an amazing resource! Buena!!!!!! ♥ ♥ ♥ ♥ ♥

    A Five Heart Salute! You deserve a massive box of TARP Chocolate for Valentines day!

  12. Markel

    It appears at a minimum that per Warren, the public was told one thing, the actual deal was another

    Yes, she says we were told the deals were at par, but we in fact paid $1 for about 66 cents.

  13. Anonymous

    “Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”

    Was anyone watching when Paulson proposed this arrangement to Congress on TV and got it with just one whimper of protest, the only one, from Dodd?

    Why aren’t we screaming about that? After that how can anything the banks have done be shocking? They were given the authority to do any f88888king thing they wanted to do with the entire treasury, $700,000,000 of it. What’shappening with the final $350,000,000?

    I’ve lost track.

    This is lousy theatre.

  14. cap vandal

    Yves:

    The equity injections were preferred stock. That is junior debt, although it counts for capital ratios. The government got some warrants also. This is all from memory, but the terms were obviously below the market price at the time.

    Maybe there is some substance to this, but as you noted, there are no details.

  15. Anonymous

    For the next two years any lobbyist who attempts to speak with a politician will be thrown in federal prison. Two attempts warrants a death sentence.

    Problem solved.

    I’m so sick an tired of everyone skirting the real source of all our problems. Jesus this is NOT putting a person on Mars or curing pancreatic cancer. It’s not even on par with preventing ice cream headache.

  16. Anonymous

    Anyone who questions Liz Warren’s integrity is a cheat, a liar, and/or a scoundrel.

    She is one of a handful of patriots left. I love how she took the credit card industry to task. LEave it to a woman. Men are too easily bought or ‘assasinated’ – see Elliot Spitzer.

    Her problem is she is not beholden to bankers, and that is why she is derided. God Bless her.

  17. Anonymous

    Hold on, hold on.

    What is being suggested here?

    That Hank Paulson, a 100 percent Grade-A Wall Street type, was less than completely honest and wholly above board?

    Are you insane? Have you taken complete leave of your senses???

    Next thing, you’ll be suggesting that Bernie Madoff has been running some kind of a Ponzi scheme, for crying out loud!

  18. Yves Smith

    cap,

    Thanks for the link. That will prove very useful when the report is published (I think it comes out tomorrow).

  19. Anonymous

    Don’t forget Paulson ensured that there was an imunity clause incorporated into the TARP.

    You all are barking up the wrong tree. The TARP stopped the panic and allowed the investment banks to conduct an orderly retreat within their franchise business units, PCS, and “de-risk” those portfolios.

    If you cannot understand that you are clueless. As for all you liberal Dems out there, you need to look a bit closer at your fearless leaders and the financial sponsors behind them. The rest of the country is getting a good look… Rubin, Geithner, Daschle, the Clintons, Richardson, Blogo, etc…

    Washington is corrupt. Whoa! I know amazing. The GOP wins an election or two every once in awhile, but the Dems run Washington.

  20. retread

    2:19, How many counterfactuals can we manage in one short post? You may have set a record.

    “The TARP averted panic.” The TARP was passed October 3. Take a look at what happened to the VIX, the stock market, bond yields, and the TED spread in the next few weeks. Paulson announced that his initial concept was unworkable, and flailed around. You call that success? I’d like to know what failure looks like.

    “It’s really all the Dems fault.” Who were the architects of deregulation? Reagan and his appointee Greenspan. Clinton was dragged to the middle by the 1994 seizure of the Congress by Republicans, and hard-nosed ones at that. We’ve had Republican presidents for 20 of the last 28 years, but no, we’ll pin the blame entirely on the Democrats.

    I hate the Rubin followers as much as the next guy, but don’t use them as the basis for sweeping, wrongheaded accusations.

  21. Richard Kline

    Hank Paulson didn’t just cut the corners off the TARP, he drove a killdozer over a building full of women and children. For the sake of the historical record, I might find it interesting to have his motives reconstructed, but for the sake of immediate need what was required was that he be stopped by any means necessary. Instead, Congress waived and waved him onward, Godspeed. We are governed by idiots, that is our best hope, because if not they are criminals.

    More of the same coming.

  22. Anonymous

    And they hold a man like him, a true hero, in contempt. Shows just how strong the ground roots feelings are running in the US about political and business interests which run counter to the interest of the general populace. As an foreigner I am always amazed at how you can listen to your politicians when they declare what they believe in. Everywhere else in the world a politician will talk about what their electorate want and need.
    Personally I doubt whether Paulson was deliberately doing things underhand, just that the situation was so far outside the boundaries of what he was used to, that he made bad decisions. To me it is obvious that he knew from the start that some of his decisions would be wrong. The world is lurching to a new reality and there are far too many dinosaur decision makers who seem unable to adapt. Recent decisions on bank executive pay will filter out to other company’s executives and to Sports super stars and even lawyers. A paradigm change is happening and everybody needs to start thinking a little differently especially about economics and politics.

  23. Glen

    Only Paulson can explain his actions and why he’s an idiot with NFI. Will that explanation ever be forth coming? Not in any of our lifetimes.

  24. ndk

    Hank Paulson didn’t just cut the corners off the TARP, he drove a killdozer over a building full of women and children. For the sake of the historical record…

    Also for the sake of the historical record, and in defense of my home state, nobody was killed by the original killdozer. Just sayin’. These things are important when you live at a high enough elevation.

  25. Erich Riesenberg

    I have seen dozens of SEC filings for banks receiving TARP funds, and my recollection is they have all had the same basic structure.

    The purchase of preferred stock, equal to 1 – 3% of assets (3% being the standard), paying 5% for five years, 9% thereafter, with the option for the company to redeem. Treasury also receives warrants for 15% of the value of the preferred, at a trailing average price, of I think 30 days.

    I think this was still better than the original plan to buy assets at whatever price Paulson determined, but it would have been so much easier to make it fair. Require private sector co-investment, for instance.

    Requiring private sector co-investment would have also hopefully let some of these banks fail, due to lack of privat sector interest. We all have banks in our communities that are doing fine, I belong to two, and they should not have to compete against Treasury supported banks.

  26. ruetheday

    I’m getting the feeling that yeasterday’s “CNBC leak” may actually prove accurate this time – a plan that consists of suspending mark to market accounting for banks, insuring most assets against further losses, and then purchasing the most toxic of the assets (those expected to decline further) at market prices (and hiding the resulting insolvency as a result of the suspension of M2M).

    Like the hacked road sign said, “Zombies Ahead”.

  27. fresn dan

    Yves said “…The illogic and wastefulness of these moves leave conspiracy theories, that Paulson was simply out to raid the Federal coffers and distribute as much as possible to his industry cronies, having more explanatory power other rationales….”
    According to Occam’s razor, never use a complex elaborate explanation when a simple one will suffice.
    Paulson did not, does not, and never will, know what he is doing…with regard to economics (I concede he works the old boy deal network well). It is more frightening that these people really don’t know than that they are venal. A robber leaves you alone after getting your money. A clueless “helper” keeps giving you coca cola when you are having a dibetic reaction.

  28. fresno dan

    Ok, read the comments. Yves and NDK, I love you both. Can’t you see each other’s point and agree that Paulson is a fool and a knave???

  29. DoctoRx

    Re 2:19 and Retread: Perhaps it’s time to stop thinking of the two major parties as different. I now think of them as the nominally left and right sides of the Establishment.

    Re Erich Risenberg: Right on! I also “belong” to a local bank that is facing competition from Federally subsidized mismanaged giants.

  30. Anonymous

    Just wanted a post a link to TARP as passed (the original bill that is cited was two pages, the final bill was 120): http://banking.senate.gov/public/_files/AYO08C04_xml2.pdf

    Pages that might be of interest to readers:
    Preventing unjust enrichment – page 9, lines 11-22

    Oversight and audits – starting page 49, line 3.
    Corrective response to an audit – page 54, line 18

    Thanks for the post!

  31. VangelV

    It is because there is a great deal of corruption in the system that we need to take away the power to meddle in markets from politicians. Let people and companies succeed or fail based on their judgements and let them be rewarded or punished accordingly. We don’t need more regulations or programs because there are already laws against the use of force or fraud on the books and because the use of power to transfer income or wealth from some people to others cannot be justified morally or ethically.

  32. Anonymous

    16:19 There was a certain rich man, which was clothed in purple and fine
    linen, and fared sumptuously every day:
    16:20 And there was a certain beggar named Lazarus, which was laid at
    his gate, full of sores,
    16:21 And desiring to be fed with the crumbs which fell from the rich
    man’s table: moreover the dogs came and licked his sores.
    16:22 And it came to pass, that the beggar died, and was carried by the
    angels into Abraham’s bosom: the rich man also died, and was
    buried;
    16:23 And in hell he lift up his eyes, being in torments, and seeth
    Abraham afar off, and Lazarus in his bosom.
    16:24 And he cried and said, Father Abraham, have mercy on me, and
    send Lazarus, that he may dip the tip of his finger in water, and
    cool my tongue; for I am tormented in this flame.
    16:25 But Abraham said, Son, remember that thou in thy lifetime
    receivedst thy good things, and likewise Lazarus evil things: but
    now he is comforted, and thou art tormented.
    16:26 And beside all this, between us and you there is a great gulf fixed:
    so that they which would pass from hence to you cannot; neither
    can they pass to us, that would come from thence.
    16:27 Then he said, I pray thee therefore, father, that thou wouldest send
    him to my father’s house:
    16:28 For I have five brethren; that he may testify unto them, lest they
    also come into this place of torment.
    16:29 Abraham saith unto him, They have Moses and the prophets; let
    them hear them.
    16:30 And he said, Nay, father Abraham: but if one went unto them from
    the dead, they will repent.
    16:31 And he said unto him, If they hear not Moses and the prophets,
    neither will they be persuaded, though one rose from the dead.

  33. ndk

    Ok, read the comments. Yves and NDK, I love you both. Can’t you see each other’s point and agree that Paulson is a fool and a knave???

    I love you both too, and while we disagree on precisely which kind of foolish knave he may be, that is indeed the bottom line.

  34. BondsOfSteel

    IMHO, the biggest mistake was in buying preferred shares with the TARP.

    Why should taxpayers take losses before bondholders? Was it the fear of CDS being triggered?

    If these banks do go into recivership, we’ll now see bondholders fighting to be made whole before any of the TARP funds since TARP is equity.

    It’s looking increasingly likely that we’ll lose all the BAC and C TARP funds.

    A much better use of the money would have been a fund like the FDIC or Resolution Trust Corp to allow these bad bets to be unwound as the bank themselves are unwound.

  35. doc holiday

    Pardon me for being rusty, but I wanted to make another point related to the original valuation method:

    § 502(5)(E)(E) In estimating net present values, the discount rate shall be the average interest rate on marketable Treasury securities of similar maturity to the cash flows of the direct loan or loan guarantee for which the estimate is being made.



    >> The point being, these clever Treasury people speak to the theory of " marketable Treasury securities", which is the place to focus in this mess, i.e, because, most marketable Treasury securities are not marketable. I guess you would have to think about that and then re-read in context that Treasury interest rates near zero and securities with non-performing cash flows will result in a return close to zero! This is all about cash flow baby and if Treasury is holding garbage loans and then suggesting those can be connected to zero-coupon bonds, then if nothing else, Treasury will have a vault full of crap for decades!

    Then again, orange juice lacks the powerful force of coffee and maybe I'm not awake yet? HELP!

  36. AP

    David Brown, not to sound disrespectful, but you really didn’t think Obama was going to CHANGE anything… did you? I stopped falling for those cheap tricks three (s)election cycles ago.

  37. eh

    I thought that was the whole idea — to give money to the banks.

    The bailout of AIG — recall GS has huge exposure to AIG — should tell you all you need to know about TARP.

  38. VangelV

    “I thought that was the whole idea — to give money to the banks.”

    That is the way it has been for a number of administrations. America has not had any of its governments have a true respect the free market for quite some time. Had Clinton not saved LTCM the current mess would not have happened. Before Clinton we saw Bush I, Reagan, Carter, Ford, Nixon, and so on and so on.

  39. Yves Smith

    cap,

    Preferred stock is NOT debt. While the terms vary and re set in the offering documents, there is no obligation to repay. Moreover, in the vast majority of cases, dividends are paid only to the extent earned. Preferred dividends may have a stipulated liquidation preference, but that is not the same as an obligation to repay principal (which applies in the case of debt).

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