More Un-Preferred

A while back, Adam Levitin threw the spotlight on the essential phoniness of the government's "subordinated debt" stake in the bank bailout (link). Now we have James Kwak to explain a new round of the old absurdity, this time in the new Capital Assistance Program (link). We're talking about "convertible preferred stock" at the moment, and Kwak offers a crisp and comprehensible account of why convertible preferred is a good way to pump money into a risky project. Okay, you are behind debt, but if things go well you get a chance to share in the equity.

But this new Treasury plan says you get to convert at the option of the debtor. Kwak is 100 percent right when he says that this is from backwardsville: it is heads-I-win, tails-you-lose. The company will never exercise the option unless the preferred is worthless and so the investor (us) never gets a chance to share the upside.

Look, in Business 01 (hell, sometimes in sixth grade) you learn that shareholder equity is the bottom of the food chain. It is the "net" in "net worth;" it is the residual claim. Evidently somebody (Geithner? Summers? Bernanke?) went fishin' that day. On the issue of bailout, the consistent policy from the last administration to this is that being equity means never having to say you're sorry.

Footnote: Actually, Levitin has been doing some of the most interesting bailout/debt coverage months now. See especially here, and generally here.

Heads I Win, Tails You Lose ...

It's touching to listen to Henry Paulson explain why those bankers don't really want this new capital injection, but how as a civic duty they will graciously set aside their morals and agree to take our money. But Adam Levitin explains how (surprise!) the bankers have pretty well bought themselves the best of both worlds: we (taxpayers) are coming in below debt, but we don't really have the protections of equity (link). Adam calls the new scheme "subordinated debt," which is true in a way but beside the point. The real kicker is that equity can continue to get dividends. I wonder if this trumps the usual rule under which you can't pay a dividend while insolvent? Adam thinks he sees a regulatory motive here, but I suspect he's being too generous: I infer it just proves that bankers are willing to take all the money in the world as long as it doesn't destroy the comfort and convenience of the bankers' life. Well, who among us can blame them for that?