Bank Bailout 2008

In lieu of the recent provisioning of $250 billion of government funding, I felt it appropriate to discuss where this part of the US Citizens’ budget is going to.  Here is a break-down of where the money is going and what the money will be used for within the banking system:

The federal government intends to spend this $250 billion on purchasing SENIOR PREFERRED STOCK for nine (9) to ten (10) large banks.  Each bank is able to sell the government up to $25 billion of its preferred stock or up to 3% of the bank’s risk-weighted assets, whichever is the lesser.  The key in this bank bailout is the preferred stock purchase instead of an actual ‘infusion’ of taxpayer money into the banking system.  This is a government investment, and given the circumstances, a pretty risk-free way for the government to make some additional investment income off of the taxpayer money.

To clarify the importance of preferred stock – preferred stock returns mimic investment bonds.  Preferred stock is purchased with a specific percentage return, similar to a dividend or interest income.  Outside of the accounting aspect, preferred stock is not similar to common in regards to return, risk, and priority of credit upon dissolution of an organization.  For the bank bailout, the government has secured rates of 5% for the first two (2) years, and subsequently 9% each year until the stock is sold.  You are probably asking yourself, “why does this matter since stocks are failing and dividends are not being paid?”

This is why:

1.  Preferred dividends accrue if they are not paid annually, called dividends in arrears.  These dividends must be paid prior to any common stock dividends.  Essentially, if in 3 years a bank turns around and is able to distribute dividends, ALL DIVIDENDS IN ARREARS must be paid to preferred stockholders prior to any of those dividends being allocated to common stockholders.  The government returns will actually be paid prior to any US Citizen common stockholder, limiting any ability to stimulate that specific consumer’s spending.   

2.  Preferred stockholders receive priority upon dissolution of a company.  If a bank fails and discontinues operations, liquidation funds would be allocated to preferred stockholders before common.  If the bank fails and only has enough assets to pay debt to priority creditors and preferred dividends, common stockholders may actually be left with a share of stock that has no associated value. 

I must say, on the side of the federal government, this is a less-risky way to pump funding into banks, but does it really accomplish what the plan was intended for?  To me it appears that the government is looking to make some additional revenues from investment income, while appearing to support the banking system.  Knowing that the government selected preferred dividends would not give me a feeling of comfort if I was a common stockholder for the same bank, since I am taking a back seat to their returns.

However, if the plan intends to use taxpayer income to fund these purchases, the preferred stock will eventually be sold, and hopefully for a larger value.  Regardless, at some point the government will sell the stock and receive the bailout funding.  What is the plan for the money after the stock is sold and the economy is up?  Will taxpayers receive refunds for any additional taxes paid due to this bailout?  And if so, shouldn’t taxpayers have an associated interest rate attached to money ‘lend’ to the government for the bailout?  Of the $12.5 billion in interest income earned the FIRST YEAR from the bailout funds, how much of that will be dispersed to the people funding the bailout?

Year 1 @ 5% -> $12.5 billion = $40 for each citizen of the US

Year 3 @ 9% -> $22.5 billion = $73 for each citizen of the US

If the preferred stock was sold and all dividends in arrears were paid after 5 years, each US citizen could receive $300 in addition to receiving a refund of the additional taxes paid for the bank bailout.  This would give consumers greater leverage to stimulate the economy while still helping our current crisis.  Thoughts?