Verret in Forbes: Why the Bailout is Self-Defeating
"Frozen options," subject to a multiyear binding sales plan to prevent insider trading, are the best way to limit some of the most significant challenges to the bailout, says Professor J.W. Verret in a Forbes commentary.
Verret points out that under the Financial Stability Plan formerly known as TARP, the Treasury Department operates with immunity from insider trading laws and a political interest in using shareholder power for special interests. Verret maintains that government ownership will weaken the banks, and he proposes that to help counter that effect, a new financial instrument he calls a "frozen option" could be issued to the Treasury as a long-term option to purchase common equity that could only be exercised at a point in the future after purchase by a non-governmental investor.
Why the Bailout is Self-Defeating, Forbes, March 5, 2009. By J.W. Verret.
"A healthy share price makes for a healthy bank. But healthy share prices require healthy profits. When governments become powerful shareholders in companies, the profit motive is inevitably watered down.
"After European governments privatized government-run industries in the 1980s they maintained powerful equity positions in the privatized firms. Those companies were twice as likely to need to subsequently obtain subsidies and bailouts at the public trough.
"The Treasury's preferred shares are a first, stealthy step toward bank nationalization. Treasury gave up ordinary voting rights in its shares, but not in all cases, and it kept the right to vote to block tender offers.
"Even worse, the Obama administration is discussing taking preferred shares convertible into voting common equity as part of the second round of the bailout. U.S. Treasury Secretary Tim Geithner has now converted Treasury's Citigroup shares into enough voting common equity to gain complete control over the bank.
"Outright bank nationalization is the only nail left to drive into the coffin. In some ways, that would be preferable to the effective nationalization of holding a control stake. At least then the bank would be on the federal budget. If you think the government stuffs pork into its budget, wait until Treasury gets its hands into the budgets of private banks unencumbered by the federal budget process and those pesky separation-of-powers restraints.
"This is not the first time the U.S. government has been given influence to choose directors in publicly traded companies. We have two recent examples to learn from: Fannie Mae and Freddie Mac. For better or worse (and as former Freddie Mac Director Rahm Emmanuel knows), the federal government encouraged Fannie and Freddie not to let silly notions like revenue and profits get in the way of backing unaffordable mortgages for home buyers. Why? Because home buyers vote."