Progress on Auctioning TARP Warrants

by Donald Marron

Saturday, June 27, 2009 at 02:24 AM EDT

Ten major banks repaid almost $70 billion to TARP in recent weeks. But they aren’t free from TARP just yet: Treasury still owns warrants to purchase their common stock.

I’ve previously argued that Treasury ought to auction these warrants to the highest bidder. Auctions would (a) be transparent, (b) provide full, fair value to taxpayers, (c) free banks from the TARP, and (d) give banks the opportunity, but not the requirement, to repurchase the warrants. As close to a win-win-win policy as one can hope for in Washington.

Unfortunately, as I noted in a follow-up post, the original TARP investment contracts include a specific process by which banks can negotiate to repurchase the warrants. As much as I like auctions, I believe even more strongly that the government should live up to its agreements. Which is why you haven’t seen me blogging about warrant auctions lately.

Until now.

Earlier today, Treasury announced the process by which it will divest itself of the warrants of banks that have repaid their original TARP investments. This announcement includes lots of good news:

• It reiterates that President Obama’s “objective is to dispose of the government’s investments in individual companies as quickly as practicable.” That’s the right goal, for a host of reasons.

• It rejects the idea that the government should hold the warrants in hopes that they might have higher future value. Treasury notes, quite rightly, that in making its decision to sell promptly “there was no certainty that we would realize higher values [by holding longer], and it was not appropriate for the government to be exercising discretionary judgment on timing market sales.” Here, here.

• Consistent with the contractual language, it sets out a process by which banks could negotiate to repurchase the warrants. Given the existing contracts, that’s the right thing to do.

• It endorses auctions as the preferred approach if such negotiations do not result in a sale. That’s the right decision; auctions are far superior to any other method of selling the warrants. And it’s encouraging that, according to news reports, Treasury is already looking for outside experts to help run the auctions.

• It recognizes the transparency benefits of auctions: “a fully transparent auction … provides the best method for the Treasury to realize the market value of the warrants in the near term on behalf of taxpayers.” Absolutely right.

In short, kudos to Treasury for striking a reasonable balance between the myriad benefits of auctions and the reality of the existing contracts. There will undoubtedly continue to be concerns about negotiated sales — that’s inherent in the process — and Treasury should do its best to drive a hard bargain. Let’s hope that some banks decide to go the auction route instead.

P.S. This is just the first inning of a very long game to come: how will the government divest itself of all the equity stakes it has acquired? Today the issue is warrants in banks. But somewhere down the road — one hopes not too far down the road — we will have to decide how to divest ownership positions in AIG, Citigroup, GM, Chrysler, Fannie Mae, Freddie Mac, and other firms.

Disclosure: I have no investments in any TARP recipients except Citigroup. As research for my continuing series on the Citigroup anomaly (latest installment here), I am currently long a small amount of Citigroup preferred and short some call options on the common.