Treasury officials are considering a new plan, the New York Times reports, to help banks recapitalize: they’d convert their current loans into common stock in the bank, which would translate to actual equity and, perhaps, the accompanying power that comes with being a shareholder. This would include some power to decide who stays on the board and, yes, would probably be a big step toward nationalization — all without having to ask Congress for any additional money.
The problem is that, for at least some of these banks, we’d be converting not just loans, as the Times leads with, but preferred stock into common stock. One stock for another? Paul Krugman was quick to call the plan baffling, and he came up with this analogy:
Here’s how I think about it: you started a business with a bunch of borrowed money, but of course had to put some of your own money in. Now, actually some of the money you put in was borrowed from your mother, but the original lenders don’t care about that, since they have prior claim.
Eventually you run into some business difficulties, and your creditworthiness is in doubt — which in turn is making it hard for you to do business. What you need is evidence of ability to repay the money you already owe.
So does it help if your mother converts her loan into a share of the business? Not really, because she won’t get repaid anyway unless all your other creditors get paid first. So the terms of her agreement with you don’t affect their prospects of payment.
And in this case, the TARP is your mother.
OK. But I think it actually would help me, as a business, survive — and would certainly increase the confidence lenders had in me — if my mother happened to have a GDP of $14 trillion when she became an official part-owner of my business.
No?
If that seems too cute by far, Felix Salmon likes the new plan, too, and says it in actual econo-speak. I’ll try and translate, but he’s speaking pretty plain English, too (this is me suggesting you scoot over and read him; he’s very good). Essentially, whether you like the new suggestion or not depends on how you looked at the original preferred stock plan. If, like Krugman, you considered preferred stock to come with equity, then this plan makes very little sense — it’s a swap of what we have for what we have, only with increased risk of losing everything. But Salmon makes the argument that preferred shares didn’t automatically confer ownership in the same way that common stock does, which seems to be generally true of preferred stock. Preferred stockholders are exactly that — preferred — in the case of bankruptcy. They (usually) get their money back just after bondholders, and certainly always before common stock holders. In exchange, preferred stock usually doesn’t come with voting rights, and isn’t usually as profitable in the long term as common stock.
The glass-half-empty way to look at this is that, if any of the nation’s 19 largest banks go under, we’re trading stock that would have guaranteed us at least some of our money back for stock where we could very well and easily lose everything.
Glass half full? We’re trading stock that gave us no say-so for stock that lets us start cleaning house, at least in a few places, and if we really get the house cleaned, we have a better chance of turning a profit.
I’ll just be over here drinking the rest of the glass. Now that TARP is my mother, I assume my inheritance is going to be huge.
SATURN SMITH 