October 21, 2008 - TARP is the new program for buying mortgages and other assets from financial institutions like banks and thrifts. It stands for Troubled Asset Relief Program. It's also called the "bailout" program. Many people are confused about what this really does and fear that it's a boon for inept management, that will lead to more outrageous management pay and/or huge taxpayer losses. Far from it. Here are the details and why it's a well devised answer to current problems and how it can make good profits for taxpayers. Yes, good profits.

Second, the rate is relatively high after 5 years, especially in this low rate environment, as it should be since there is a risk that the borrower won't be able to pay the dividend due to losses. But that risk isn't very high. That's because not all banks are allowed to participate in TARP. In fact, only the healthiest banks or thrifts will be able to get this Tier 1 capital. In return, they have to pay a 5% dividend rate for the first 5 years, then the rate goes to 9% plus they give the government warrants to buy 15% of the value of the investment in the form of warrants. Those warrants will have a life of 10 years and will be exercised at a price that is calculated by the average price of the stock for the previous 20 days.

Here's an example of the math: If a bank uses $1,000,000 of the TARP money, it issues a senior preferred to the Treasury. It pays 5% a year for the first 5 years, then pays 9%. It also give warrants to the Treasury in the amount of $150,000 (15% of the value of the preferred). Those warrants are then able to buy the common stock of the borrower at the price that equals the price of the stock for the last 20 days before the warrants were issued. That means the Treasury can buy stock at pretty much the all time low for bank stocks. Many are selling well below book value. And there's more: the initial exercise price will be reduced by 15% of the original exercise price on each 6 month anniversary of the issue date fo the warrants if the consent of the issuing bank or thrift stockholders has not been received, subject to a maximum reduction of 45% of the original exercise price (this applies to insitutions that don't have enough shares available to grant the warrants...then it has to call a meeting of the shareholders for approval to issue more stock).

If the institution doesn't get shareholder approval or the stock is no longer traded or listed on a national securities exchange, the warrants will be exchanged for senior term debt or another economic instrument or security of the issuing institution.

One more provision to get the capital: senior executive officers shall modify or terminate all benefit plans, arrangements and agreements (including golden parachute agreements) to the extent necessary to be in compliance with, and following the closing and for so long as the Treasury holds any equity or debt of the bank or thrift, and the institution agrees to be bound by the executive compensation and corporate governance requirements of Section 111 of the EESA and any guidance or regulations issued by the Secretary of the Treasury on or prior to the date of this investment to carry out the provisions of such subsection. In other words, all the big money packages for senior executives aren't happening if a bank or thrift takes this money.

So here's the TARP deal: 5% money for 5 years, then it costs 9%. 15% of the value of the preferred granted in warrants for the common stock where the exercise price is equal to the average of the last 20 days. The right to add 2 directors to the board if 6 payments aren't made to the Treasury. No big bonuses and no golden parachutes for senior management.

As to the other part of TARP, when the Treasury actually buys the mortgages and/or other assets, there are rules established as to the tranparency of the purchases, how the price is to be determined, and other elements that ensure the Treasury will not be paying too much for any investment and that the public will be able to determine how each was made. There's a possibility of good profits in this program as many of the troubled assets will pay off and hopefully overwhelm the assets that don't. (See previous column for more detail on this part.)

TARP will make a difference to the financial institutions needing capital so they can lend to individuals and businesses, much needed in this economic crisis. But it won't be done without plenty of strings attached to the preferred stock sold to institutions. And the purchasing program for the troubled assets has the potential of making money. TARP could end up being a great investment by and for taxpayers.

- Ted Allrich