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Goldman Sachs still ripping off taxpayers

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Update 1st Aug: A friend pointed out to me via a New York Times blog article that the warrants issued by Goldman came with a cancellation feature which automatically voids half of them should Goldman Sachs undertake a successful equity public offering of US$10bn before 31st Dec 2009.  So far, they have raised $6bn to date.  The warrants are dated to last 10 years and have a strike price of US$122.90 Goldman’s stock is currently trading at $163.30

The article goes on to conclude that in light of this revelation, it’s not unreasonable to suppose that Goldman Sachs may have paid Treasury the full worth of its warrants.  I have since relooked the original news sources, HuffPo and FT, and unfortunately neither of them pointed this out.

I haven’t been posting much in the past few days due to work commitments.  I finally had time to sit down and write some stuff during this weekend.  Anyway…

A few days ago, Financial Times reported that Goldman Sachs bought back warrants it issued to the US Treasury in a bid raise capital, shedding the last remains of its bailout legacy:

Goldman Sachs became the first major bank to buy back warrants held by the US Treasury on Wednesday, allowing the group to shake off the last vestige of its participation in the government bail-out programme after just nine months.

Goldman paid $1,1bn to the US Treasury to buy back the warrants. which were granted as part of the government’s $10bn investment of troubled asset relief programme funds in the bank last year.

Goldman Sachs wasn’t just the first bank to buy back its warrants.  It was also the first bank to raise funds to repay its TARP loan of US$10 bn, and the first major bailed-out bank to report a profit of US$3.4 bn.  As said earlier, Goldman’s excellent performance of the past few months says nothing about the general state of the American economy, which is slowly but surely starting to be dragged out of its moribund state towards a jobless recovery.

It looks more and more likely by each day that the investment banking crisis is finally drawing to an end.  What’s not doing half as well as the investment banks would be bad credit which dragged down commercially-oriented banks such as Citi and Bank of America.  One has to wonder if American taxpayers ever got anything good out of all those bailouts they financed.  Recent reporting by Huffington Post suggested that they are still getting ripped off:

Less than two weeks after a congressional watchdog called attention to backroom deals in which the Treasury Department repurchased stock warrants from bailed-out banks at well below market value, three more such transactions have now been reported. The big loser: The U.S. taxpayer.

The Congressional Oversight Panel reported earlier last month that in 11 transactions with small banks, taxpayers walked away with about 66 percent of what they could have gotten.

The article goes on to note that surprisingly (at least to me), Goldman Sachs actually gave the American public a better deal compared to the rest of the banks:

One bank did give the taxpayer a fair shake: Goldman Sachs.

Wilson [an assistant professor of finance at U of Louisiana] speculated that Goldman Sachs decided to pay fair price to avoid more of the bad press that’s been coming its way the last several months. The bank paid $1.1 billion for its warrants, which Wilson estimates have a fair market value of $1.12 billion based on Tuesday’s closing price on shares of Goldman Sachs.

Even so, the Financial Times notes in the earlier report that Goldman was essentially forced to agree to the Treasury’s asking price of US$1.1bn since it appears likely that auction participants would bid for a (much) higher price than US$1.1 bn:

Goldman began negotiating to buy back the warrants several weeks ago, said a source familiar with the matter, and agreed to a deal on Wednesday after trying unsuccessfully to talk the Treasury down from its asking price of $1.1bn.

Where exactly did they pull out the number 1.1bn from?  It turns out that the $1.1bn was valued by the Treasury’s less than transparent methods which was criticised on the grounds of ignoring investors’ sentiments of share prices:

A Treasury official said in a statement to the Huffington Post that the process it uses to determine the price of the warrants is fair: “The warrants for common stock held by Treasury do not trade on any market and therefore do not have observable market prices. Their values can only be estimated. Treasury follows a comprehensive approach to estimating these values, which involves using a variety of inputs including a set of well-known financial models. These models will include, but will not be limited to, binomial and Black-Scholes option-pricing models, and are widely used in financial markets to value options and warrants. Treasury also relies on indications from market participants as to what they would be willing to pay for the warrants. We obtain quotes from three separate market participants who regularly invest in or trade similar securities. We also retain outside managers to provide full, independent valuations. Together, these various methods constitute a robust process for estimating value and protecting the taxpayers’ interests.”

The specific flaw in the Treasury methodology, business professor Wilson told the Huffington Post, is that it doesn’t give enough weight to the bank’s stock price in its calculation. “Treasury starts out with a very low price [that it offers in negotiations]. Banks come back with an even lower price. Banks get a very good deal,” said Wilson. “Taxpayers would be better served if the Treasury took an optimistic view of the warrants’ value and moved most of them to auction.”

The best way of ensuring greater transparency which also takes into account investor sentiment would be for the Treasury to hold a public auction for these warrants.  Such a move would allow investment funds and other financial entities, which the average taxpayer might have funds in, to own a stake in the banks they financed. Instead, Treasury Secretary Geithner opted for a backroom deal in which Government Goldman Sachs got away with paying only US$1.1 bn.

JP Morgan, on the other hand reportedly disagreed with the Treasury’s valuation of its warrants and is seeking a public auction to price them:

Assigning a value to the warrants has been a source of contention for the financial institutions seeking to buy them back. JP Morgan Chase has said the Treasury would sell its warrants at a public auction after the two sides disagreed over how to price them.

However, to do a fair comparison between whether a public auction would yield greater dividends for the taxpayers as compared to one-to-one deals cut out in smoky backrooms, one would first have to know the Treasury’s valuation of those warrants.  So far, we’ve only been witnessing ironic occurrences of the banks themselves being more transparent than the public-backed Treasury:

In several instances the banks have been more transparent about the transactions than the Treasury Department. The BB&T transaction has yet to appear on the Treasury report even though the deal was struck on July 17, as the bank announced. The bank hasn’t yet paid for the warrants, so Treasury won’t comment on it.

So who does Geithner work for?  The American public or Wall Street?


Written by defennder

July 25, 2009 at 4:37 PM

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