The Recapitalization Phase

So far, here's what we know about the U.S. recapitalization plan (with my commentary sprinkled in):

Preferred Stock: The government will buy $250 billion of perpetual preferred stock in U.S. banks. $125 billion has already been committed to 8 large banks—$25 billion to BofA/Merrill, Citi, JPMorgan, and Wells Fargo, $10 billion to Goldman and MS, $3 billion to Bank of NY Mellon, and $2 billion to State Street. The other $125 billion "will be used to recapitalize other financial institutions around the country"—according to the WSJ, "potentially thousands of banks." The preferred stock "will carry a 5% annual dividend that rises to 9% after five years. ... [F]irms returning capital to the government by 2009 may get better terms for the government's stake."

• Most people expect the preferred stock to be nonvoting, but will the government give itself back-door voting rights by making the stock noncumulative with contingent voting rights? I doubt it, but it's something to watch out for.

Executive Comp "Limits": "All of the banks involved will have to submit to compensation restrictions as mandated by Congress."

• So basically, no meaningful executive comp limits.

Guarantee New Senior Unsecured Debt: The FDIC will "offer to temporarily guarantee, for a fee, certain types of new debt called senior unsecured debt issued by banks and thrifts. This would apply to debt issued by June 30 with maturities up to three years."


More FDIC Insurance: The FDIC "will offer an unlimited guarantee on bank deposits in accounts that do not bear interest — typically those of businesses."

• This is apparently "voluntary for banks," but without charging a fee for this guarantee (and no one is reporting that a fee will be required), every bank will presumably accept the FDIC's offer.

Goals of Recapitalization Plan: The Treasury is focused on "getting the participation of the firms most important to the financial system, according to people familiar with the matter. Treasury's main goal is to attract private capital."

• My sense is that the Treasury wants to inject capital into healthy, solvent banks as much as possible, in order to: (1) avoid rewarding the most reckless and irresponsible banks, and (2) allow the banking sector to triage itself by allowing the prudent banks (e.g., Goldman) to start taking over failing institutions.


• The word is that there's a lot of private capital sitting on the sidelines. I'm a bit skeptical that there's as much capital on the sidelines as some people claim, but I do think there's a lot. The Lehman CDS auction on Friday went well, so some of the cash that was being hoarded in preparation for the Lehman auction will undoubtedly go to work now. How much of Monday's surge was attributable to the Lehman CDS auction being behind us? We'll never know.

Favorable Terms for Everyone!

1. WSJ: Terms Will Be Favorable for Banks: "To make sure private investors aren't scared away, it is expected to structure its investment on terms favorable to the banks and will inject capital in exchange for preferred shares or warrants, these people said."


2. NYT: Terms Will Be Favorable for the Government: "The investments will be structured so that the government can benefit from a rebound in the banks' fortunes."

I'm guessing the Treasury won't be able to thread the needle on the preferred shares that well.