Next Up: Bank Bailout Equity Investments?

If anything, the nation’s financial crisis has clearly led to some creative ideas around how to prop up ailing financial markets and the institutions that make up much of it: from TALF, to TGLP, to TARP. But as the Troubled Asset Relief Program has gone from savior to what JP Morgan Chase & Co. (JPM) chief Jamie Dimon last week labeled a “scarlet letter,” officials in the Obama administration have been vexed by how to best continue to aid a financial sector that is still reeling from punches to the collective gut. The latest idea? Convert preferred shares representing loans from the government into common equity at any of the 19 banks receiving TARP funding thus far that need additional capital; the move would wipe out existing shareholders, of course, but also would recapitalize banks without actually costing the government any more of its precious taxpayer money. Which is good in some regards, since Congressional Democrats have made it amply clear that further funding for a Wall Street bailout is going to be tough to come by. Not that the plan is without problems of its own; such a move would ostensibly place troubled banks more directly into the lap of taxpayers, and potentially bring about a type of faux nationalization like we’ve already seen at AIG — and perhaps at Citigroup Inc. (C) as well, which recently completed negotiations over a similar swap agreement. White House chief of staff, Rahm Emanuel, made waves this weekend by confirming that a preferred-into-common strategy was in the works for some banks. “We believe we have those resources available in the government as the final backstop to make sure that the 19 are financially viable and effective,” Emanuel said in an ABC interview on Sunday. “If they need capital, we have that capacity.” Those banks that need capital will largely be determined via much-criticized “stress tests” being conducted by the Treasury, to determine what level of losses banks can withstand should the economy continue to deteriorate. It’s unclear just how the government will choose to release the results, scheduled for early May, however. Both the criteria for the stress tests as well as what some see as a lack of transparency involved in the process have been the subject of intense criticism from those within and outside of the mortgage banking industry. Critics suggest the criteria have not been stringent enough, while others are pushing for a complete release of results; Obama officials have allegedly told banking officials not to release results of the tests, out of concern that banks receiving lower marks would be targeted for a bank run. “Not surprisingly, different banks are in different situations; they are going to need different levels of assistance of taxpayers,” Obama told a press conference at a summit in Trinidad on Sunday, according to a report in the Financial Times. National Economic Council director Lawrence Summers told various press last week that banks needing capital would need to go to private markets first in an attempt to raise any needed funds before any further government funds would be committed; of course, such a move would suggest that banks needing capital are signaling weakness, raising fears among some that doing so might actually cause a run on deposits. The stigma now attached to government funding via TARP has led more than a few banks to decide to wriggle out of the restrictions now being placed on firms that have received funding via the $700bn program. Both Goldman Sachs (GS) and JP Morgan are pressing to repay the funds they’ve received. Such repayments could help the government channel funds to more problematic banks, but also are a signaling tool that allow banks to suggest to the market that they are healthier than their government-funded counterparts. As a result, Obama officials say they are likely to put conditions on any repayment of TARP funds, according to published reports. Write to Paul Jackson at [email protected]. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.