The Baseline Scenario

Warrant Sales Could Cost Government $10 Billion

Mark Pittman at Bloomberg estimates the total potential cost to taxpayers of selling warrants back to banks at low prices: $10 billion. These are the warrants that banks had to issue to Treasury in exchange for preferred stock investments under TARP. Pittman uses the Old National example as a benchmark: Old National paid $1.2 million to buy back warrants that he estimates at $5.8 million. (Linus Wilson, the first person I know of to do the calculations, estimated a range of values from $1.5 million to $6.9 million.) Extrapolating that “discount” to all the other warrants that Treasury currently holds, Pittman finds:

Under the Old National warrants formula, Bank of America Corp. would save $2.03 billion, followed by Wells Fargo & Co. at $1.48 billion and JPMorgan Chase & Co. at $1.46 billion. Morgan Stanley’s benefit would be $983 million, Citigroup Inc.’s would come in at $965 million and Goldman Sachs Group Inc. would have $693 million, according to the data compiled by Bloomberg.

If you are concerned about banks’ capital levels, that’s one way to help them out. The alternative, suggested by Wilson and others, would be for Treasury to auction off the warrants; if the bids were too low, it could create a trust, transfer them from Treasury to the trust, and release the banks of any TARP obligations triggered by those warrants.

It also contrasts sharply with the treatment of private (not publicly-traded) banks such as Centra, as documented by David Kestenbaum of Planet Money.

I’ll have more on option pricing later.

By James Kwak