A $125 Billion (Taxpayer) Gamble
The rules of economics, and the court of public opinion, dictate that Wall Street must act responsibly with its new government money. Whether the banks will actually quell their greed remains to be seen.
The question rattling through the canyons of Wall Street these days is this: What will the nine firms that Treasury Secretary Hank Paulson decided unilaterally to give $125 billion of our money—on terms that continue to boggle the mind in their generosity—do with their windfalls? To date, Paulson has attached no strings to the money’s use and so far none of the CEOs who got the money are ’fessing up to what they are going to do with it.
That seems to be the party line. “There is no express statutory requirement that says you must make this amount of loans,” John C. Dugan, the comptroller of the currency told The New York Times. “But the economics work so that it is in their interest to do so.” But, David Walker, the president of the Peter G. Peterson Foundation—named for the co-founder of the Blackstone Group—faulted the Treasury for leaving the terms so vague at such a treacherous moment. “It is the government’s responsibility to set the terms and the conditions on this money,” he said. “This is the people’s money. They’re giving it out with no rules.”
The fear, of course, is that the banks will use the $125 billion to pay bonuses to the army of bankers and traders who have done virtually nothing this year to deserve them.
The banks are happy to take it, especially at a cost of a mere five percent dividend per year, far below what it would cost these firms to get that kind of capital in the market today, assuming they could get it on any terms. For instance, the Treasury invested $10 billion in Morgan Stanley, at 5% annually, less than a week after a $9 billion investment from Mitsubishi UFJ Financial Group, was priced at a 10% dividend plus a 21% ownership stake. No wonder John Mack, Morgan Stanley’s CEO, jumped on the Treasury’s gift. The $25 billion Paulson bestowed on Citigroup was “incremental to our thinking,” Citigroup CFO Gary Crittenden said. “We now have more capital than we anticipated, [which will] allow us to opportunistically build what we have not been able to do.” Delightfully vague, Mr. Crittenden.
The new King of Wall Street, Jamie Dimon, acknowledged that the government would like JPMorgan Chase to “use the [$25 billion of] capital” but that, unlike JPMorgan, “if you are a bank that is filling a hole, you obviously can’t do that.” Bank of America, which will soon acquire Merrill Lynch, said its $25 billion “will add to our capital, which will increase our capacity to expand our balance sheet and make more loans.”
At the moment, of course, none of that is happening. The corporate-loan and high-yield-bond markets remain frozen solid and many of the existing loans and high-yield bonds are trading at or near default levels. There does seem to be a slight thawing in the inter-bank markets, as some tentative lending has resumed and LIBOR, the interest rate banks charge each other, has fallen to 4.18%, fifty basis points lower than a week ago (but still well above the 2.75% of a month ago.)
The hope is that the banks will resume making loans of all kinds, or use the cash to reduce their leverage, or to facilitate the ongoing process of industry consolidation. The fear, of course, is that the banks will use the $125 billion to pay bonuses to the army of bankers and traders who have done virtually nothing this year to deserve them. Since there are no strings attached to all that money, the only thing keeping that from happening, according to Dugan, the Comptroller of the Currency, will be the “court of public opinion.” The court is in session.