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TARP Repayment Sells Taxpayers Short


And Americans could really use the money that belongs to them.

When the financial world collapsed last fall, I held out a strange sense of hope. I thought the government would come in as the only buyer in a landscape of forced sellers. It would buy a lot of assets at a deep discount to their longer-term value, walk away, and sell them when something closer to true value could be realized. I'd seen this movie again and again in various hedge-fund theaters. This time, I hoped, the taxpayer would play the role of the deep-pocketed investor taking advantage of a bunch of overextended peers.

While this proved to be a naive view of the situation, it was far from completely wrong. And some of this scenario is playing out in the process of the government selling warrants back to banks like Citigroup (C), JPMorgan (JPM), and Bank of America (BAC) redeeming their TARP loans.

First, let's talk irony. The warrants get their value from the perception of volatility (meaning more upside potential with known downside of the warrants' full cost), and the reality of hedging. Almost without exception, the highest prices for warrants get paid by hedgers who buy the warrants and short the underlying stock.

It's a good thing, then, that we no longer have the absurd ban on short-selling financials - although only those most ignorant of history's wisdom would say it couldn't happen again. The government would be shooting itself in the foot (not for the first time, either) if it imposed such a ban, since warrants are worth a lot less when you can't hedge them.

When it comes to selling the warrants -- which the Treasury apparently has to do when it receives TARP repayments -- it's an absolute travesty if the Treasury gets less than market value. That's because hedge funds like few things better than attractively priced warrants: They enable relatively low-risk leverage and create ongoing trading opportunities in volatile markets.

I'd like to learn a lot more about the process the government is using to make sure taxpayers receive proper value for their warrants from the market. Trying to embarrass a bunch of highly paid bankers in front of Congress may make for a few cheap quasi-populist thrills, but it really doesn't do anyone any good. Maximizing the value of the warrants for taxpayers, on the other hand, is potentially a multi-billion-dollar deal, and taxpayers could use the money. Especially because it belongs to them.
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