TARP Warrants: Spreading the Value Game Beyond The Government

The Treasury said that it plans to dispose of the warrants that it got from banks as part of bail out financing given to, and, in some cases, forced upon major US financial firms at the end of last year. Bloomberg reports that the government wants out of its role as a holder of interests in banks as quickly as possible. That means that it is stepping away from the opportunity to make substantial sums if bank stocks rebound further over the next two or three years. It could also mean that it may avoid having the value of the warrants drop precipitously if bank losses begin to rise again, but that may not matter. Another collapse of the banking industry will almost certainly mean that taxpayers will own a terribly large part of the industry. The warrants will be an appendix.

Most estimates put the value of the warrants which are primarily in very large banks including JPMorgan (JPM), Goldman Sachs (GS) and Morgan Stanley (MS) to be above $5 billion. The Treasury says that it does not want to act as a de facto mutual fund which tries to time the market to get the best exit price for the securities.

The government may not want to be a mutual fund, but there are a number of private money management firms that would take on that task for a relatively modest sum. The value of the nation’s largest banks may not appreciate over the next year or two because banks are likely to post large losses as consumer credit card and commercial loan portfolio write-offs mount.

The value of large banks three or four years from now is a different matter. The economy should be on the mend sometime in 2010 and should hit a reasonable stride late next year or in 2011. Core bank services in the consumer and corporate lending sectors and investment banking operations may be as profitable as they were in the 2005 and 2006 period before earnings were jacked up by returns on derivative securities. Bank stocks traded fairly flat from early 2005 to late 2007. JP Morgan’s stock changed hands about 40% higher than it does now compared to that three year period. There is certainly a reasonable chance that shares could recover to that point before the end of this decade.

The federal government may be right about not having the expertise to handle warrant valuation and sales timing. But if the function was outsourced it could improve the taxpayer return on investment by several billion dollars. It could also place the blame on a private organization if the bank system fails again and the federal government ends up with warrants that are worthless.

Douglas A. McIntyre