October 08, 2008
Can the Treasury Take Equity?
Posted by David Zaring

Today Paulson announced that although he would purchase some of the so-called toxic assets on bank balance sheets, he may also, like Britain, take equity in banks.  Can he do that?  Paulson said:

the EESA adds broad, flexible authorities for Treasury to buy or insure troubled assets, provide guarantees, and inject capital. We will use all of the tools we've been given to maximum effectiveness, including strengthening the capitalization of financial institutions of every size. We will design programs that encourage healthy institutions to participate.

The "strengthening ... capital[]" phrase - or partly nationalizing banks, if you want to be statist about it - is the key move in the speech.  That's not what the TARP was all about - it is a "Troubled Assets Relief Program," and, based on the debate that happened when the statute was passed, we may have thought that the assets at issue were the mortgage backed securities that no one can sell.  But it was a program passed in a hurry, with plenty of flexibility given to Treasury.  Here's the relevant general grant of authority:

The Secretary is authorized to ... make and fund commitments to purchase, troubled assets from any financial institution, on such terms and conditions as are determined by the Secretary, and in accordance with this Act and the policies and procedures developed and published by the Secretary....
[including] establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase, hold, and sell troubled assets and issue obligations.

So the plain language move that Treasury must make to change its toxic assets program into a nationalization program is to interpret the stock of ailing banks as "troubled assets."  Or, put another way, the question would be whether taking equity in an ailing bank could reasonably be interpreted as taking a troubled asset (that is this case).  And I don't see why that interpretation wouldn't fly.

But moreover, the statute has some explicit guidance for the Secretary if he does decide to take equity (or warrants, anyway), viz encouraging him in some cases to take for the troubled assets:

a warrant giving the right to the Secretary to receive nonvoting common stock or preferred stock in such financial institution, or voting stock with respect to which, the Secretary agrees not to exercise voting power, as the Secretary determines appropriate

So Congress contemplated that the Secretary could end up with some equity under the program (and I don't think this means only non-voting equity, I think the Secretary has discretion to take voting or non-voting as he likes). 

UPDATE: It's even easier than I thought, because "troubled assets" are defined as, in part (Eric Posner has analysis here):

(B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.

A comment: this is why congressmen give up their jobs to run the DEA or the Department of Transportation.  The executive branch has flexibility in how it interprets congressional directives, and though Congress probably wouldn't mind, changing the TARP from a toxic asset program to a bank nationalization program is a pretty big change.  But the statute doesn't preclude it, so that appears to be what the Secretary may do.

Finally: how do we know, based on that speech, where injecting capital is just one of a number of options Treasury is entertaining, that it will probably go the equity route?  We don't, but the journalists think they know.  It's Washington inside baseball, but if the Times headlined its story about the speech "US May Take Ownership Stake in Banks," the odds aren't bad that Treasury is telling it off the record that that's precisely what it is planning on doing.

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