An equity stake equal to the purchase price

[koganbot]

Today's column from Paul Krugman: Cash For Trash

Krugman's ongoing blog

I'd summarize Krugman's argument as follows: (1) If we the gov't buy the bad assets at market value we're not going to get the financial firms out from under, (2) if we buy the assets at way more than market value we will be helping the firms by giving a windfall to the firms (and their stockholders and executives) at taxpayer expense, so (3) what we should be doing instead is give capital straightup to the firms - without buying bad assets and without having to guess the value of what we're getting - in return for part ownership of the firms, so that we can demand that some benefit of the bailout goes to the public.

In any event, Senator Chris Dodd, who chairs the Senate Banking Committee, is floating a counterproposal that I haven't looked at but at first glance seems to Krugman to be a step in the right direction. Here's a Bloomberg.com article on the Dodd proposal and here's a text of the proposal.

Says the article:

The legislation requires Treasury to take an equity stake equal to the purchase price of the assets being bought. If the company isn't publicly traded, the government would take senior debt instead, placing it in the front of the line of debt holders for repayment in the event of a bankruptcy.

Dodd's proposal also would create a five-member oversight board to supervise the Treasury secretary's purchase and sale of distressed mortgage debt.

Comments

[koganbot]

Sebastian Mallaby in the Washington Post saying pretty much what Krugman's been saying: A Bad Bank Rescue

In practice this means the government would make subjective choices about which bad loans to buy, and it would pay more than fair value. Billions in taxpayer money would be transferred to the shareholders and creditors of banks, and the banks from which the government bought most loans would be subsidized more than their rivals.

...

Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks' bad loans but by buying equity stakes in the banks themselves. Whereas it's horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.

[koganbot]

Henry Blodget also saying close to what Krugman says: Paulson's Bailout Plan Will Screw Taxpayers: Here's a Better One

If the government pays as little for the banks' troubled assets as it should to protect taxpayers (i.e., the market rate), the banks will still be screwed. Why? Because they'll have to raise humongous amounts of new capital to offset the losses. Where is this capital going to come from? Paulson doesn't say.

Under the Paulson plan, the way this problem will likely be resolved is that the government will overpay for the assets--to "save the financial system." In the process, the government will also save two constituencies who deserve no protection whatsoever: bank shareholders and bondholders.

...

If/when a bank needs capital, the government should provide it--in exchange for a fair equity stake. Knowing there is an investor-of-last-resort should persuade bank clients to stick around. The taxpayers will then own significant chunks of the banks and will therefore benefit from their recovery. Meanwhile, the folks who are directly responsible for all the crap on the banks' balance sheets--the banks--will still be responsible for sorting it all out. And their shareholders--not taxpayers--would take it on the chin

Good ole internet

[koganbot]

Note the first comment in response to Blodget:

Yeah ok henry, so you as a Merryl analyst at your peak are smarter than the former Goldman CEO and current Treasurer. Sure.

Not to mention he is Jewish, who are infinitely smarter than everyone else in matters of finance.

I think you need to take a step back bro and know your place.

Cripes!

[edgeofwhatever.livejournal.com]

That reminds me, you are the only person I know who might know this: What is an equity stake?

Treasury agrees to take equity stake. Wait! It doesn't agree.

[koganbot]

Wall Street Bailout Talks May Drag Into Next Week

After Monday's bailout talks, Rep. Barney Frank, a top Democrat, told CNBC that the Bush administration had agreed to Democratic demands that the government take an equity stake in the companies seeking a bailout. But the Treasury later denied there was any such agreement.

Frank said the Treasury also agreed to an oversight board to monitor the bailout and that the plan should minimize the number of Americans who will lose their homes to foreclosure.

But he said lawmakers and Treasury officials disagreed on the emotional issue of whether the executives at the companies in need of rescue should be required to agree to limits to their compensation.

With details still in dispute, Frank said the legislation could take until next week to complete.

[koganbot]

You see, if you push a stake into my heart, I get to push a stake into your heart! That way we have equity. Notice that I don't get to drive two stakes into your heart.

Funny thing, an hour ago, as if I were anticipating your question, while actually having little idea what "equity" means, I visited Wikipedia, which says, "In accounting terms, after all liabilities are paid, ownership equity is the remaining interest in assets."

And when I look up "stake" I find it is "a share of ownership of a company."

So, anyway, putting those two concepts together, clearly we have...

Er, so I went to Google and typed "equity stake" and "definition" into the search box and got this quick hit:

No results found for "equity stake". Multiple Words. The words "equity stake" do not appear together, but you can try a search on the individual words.

So, there you have it.

[koganbot]

It was MSN Encarta that didn't find the words together, that is. Google gave me plenty of hits, e.g., "Microsoft acquires equity stake in Facebook, expands ad partnership."

[koganbot]

But the Dodd plan would require that Treasury receive:

contingent shares in the financial institution from which such assets are to be purchased equal in value to the purchase price of the assets to be purchased.

I'm not sure I get this. Treasury pays for the questionable assets (in dollars, I presume) and not only gets the assets but "contingent shares" in the financial institution equal to the (apparent?) value of the risky assets. So huh? For the price of the assets we also get shares in the firm as well, in a two for one deal? I guess a lot depends on the meaning of the word "contingent."

(I'm not actually going to read the Dodd plan. It's 44 pages, and I won't understand it. I won't, I tell you. I won't!)

[koganbot]

In any event, I actually wrote two of my three congressmen: Diana DeGette, my representative, who's the Chief Deputy Whip of the House Of Representatives as well as the Vice Chair of the powerful Committee on Energy and Commerce; and Ken Salazar, U.S. Senator, who serves on the powerful Finance Committee, which oversees the nation's tax, trade, social security, and health care systems. He also serves on the Agriculture, Energy and Natural Resources, Ethics, and Aging Committees, which presumably are not as powerful.

[koganbot]

But I did search the Dodd plan for the word "contingent":

3) VESTING OF SHARES.—If, after the purchase of troubled assets from a financial institution, the amount the Secretary receives in disposing of such assets is less than the amount that the Secretary paid for such assets, the contingent shares received by the Secretary under paragraph (1) shall automatically vest to the Secretary on behalf of the United States Treasury in an amount equal to—
(A) 125 percent of the dollar amount of the difference between the amount that the Secretary paid for the troubled assets and the disposition price of such assets; divided by (B) the amount of the average share price of the financial institution from which such assets were purchased during the 14 business days prior to the date of such purchase.

Still doesn't tell me what "equity stake" is, which isn't a word used in that particular paragraph, but does explain that we only get the contingent shares if we don't get full value on the troubled assets.

"Troubled" assets. I like that term.

[justfanoe.livejournal.com]

Equity is the accumulated assets minus the accumulated liabilities of a company. Therefore equity stake means you "own" a certain percentage of that? I dunno, I've never heard the term equity stake before.

[edgeofwhatever.livejournal.com]

This is exactly what happened to me last week.

Perhaps it is just a stake in the company's value after all liabilities are paid? Sort of like the difference between net income and gross income.

OH LOOK!

(sometimes called net assets) is the total assets minus total outside liabilities of an individual or a company. For a company, this is called shareholders' equity/fund...

And if we look up "liabilities," we get:

The accounting equation relates assets, liabilities, and owner's equity:

Assets = Liabilities + Owner's Equity

Hmm.

[dubdobdee.livejournal.com]

the purpose of the equity proposal is to give the taxpayer an upside in this deal, an upside which puts the company being bailed on notice not just to offload a toxic asset (for whatever they can get for it) then scamper off untouched when it proves worthless

so yes, the money that the taxpayer is handing over purchases two things -- the asset itself (true value to be revealed) and a stake in the future of the company being bailed (a share of its future profits etc; a measure of control also, since ultimately -- some caveats -- the shareholders are the group owners of a company)

"stakeholder" is a recent formulation to bring in a language of community values to the world of shareholder democracy -- tho it's wildly abused and buzzwordy, esp. in the uk -- the idea is that, as part owners of such-and-such an operation (let's say the national health service) the shareholder and/or taxpayer cares for its well-being in capitalist tersm AS WELL AS in social terms -- they are not just thinking "is it there when i'm ill?" but also "how is my money being spent?" -- and this combo is (allegedly) an improvement on just the one or the other

essentially offering "equity stakes" to hold, as opposed to just selling off assets, the company being bailed is allowing itself to be partially nationalised

"equity: a beneficial interesdt in an asset. For example, a person having a house worth £100,000 with a mortage of £20,000 can be said to have an equity of £80,000 in the house" (there's other defns which seem less relevant)

"stakeholder theory: an approach to business that incorporates all the interests of stakeholders in a business. It widens the view that a firm is responsible only to its owners; instead it includes other interested groups, such as its employees, customers, suppliers, and the wider community, which could be influenced by environmental issues. it thus attempts to adopt an inclusive rather than a narrow approach to business responsibility."

(i sense a degree of scepticism in this dictionary definition -- viz the oxf.dict. of finance and banking, early 90s edn -- and a lot of foax* don't believe that the non-owner element of the stakehold community ever get a fair shake in tough times... or that a decent market system can be built to take them into account)

*(ie on the left -- who say capitalism is heartless and thoughtless and ultimately lays waste to all -- or the right, who say that its heartlessness and thoughtlessness, in a well-designed market system, make it objective, rather than the subjective tool of the few, and the best deliverer of value to all) (it's the centre that likes the stakeholder idea, bcz it believes that a mixed economy can deliver prosperity and justice for all)

ps "yves" is a boy's name but i've seen some speculation (eg on an unfogged comments thread) that "yves smith" is actually the pseud of a girl!

[dubdobdee.livejournal.com]

in fact there's already two versions of the meaning of stakeholder in the above post, which reflect the degree of vagueness and disagrrement there is about the theory, i think

1: is that the general public ought to be brought in as shareholders if and when they have a stake in the future of the company in question (that's the defn i think applies in this current proposal) <-- this is the minimal version, i guess, which is that the shareholder community should be manipulated (eg by the govt) to reflect wider social needs
2: is that the stakeholder community is much larger than the shareholder community, and that others BESIDES shareholders have their needs taken into acount when the company makes decisions (the mechanism for this latter being particularly controversial) <-- this is the maximal version, which says that company and shareholders should be made to bend (eg by the govt) to wider social needs