Goldman Sachs reached agreement with the Treasury to buy back Treasury’s TARP warrants. As the press release makes clear:
In June, Goldman Sachs repaid the U.S. Treasury’s investment of $10 billion, and during the eight months of the investment, the firm paid $318 million in preferred dividends. We are pleased that the payment of the dividends and the redemption of the warrants, which total $1.418 billion, represent an annualized return of 23 percent for US taxpayers.
As Goldman’s PR agency well knew, all sorts of commentators have taken to calling the 23% return a good investment. It is not. It is and was an awful investment, and the reaction to its liquidation is showing how few people in DC who are in charge of taxpayer money have even the most basic understanding of investing.
First, to deal with the most obvious item: doesn’t the 23% headline number prove a good investment? It is way above the government’s cost of capital and better than the overall market…
Nope. If you went to a casino and the winning blackjack payout was 1.23x, I hope you would stay well away from the table. The entire outcome distribution – including the 0x payout of a losing hand and an assessment of the probability of winning and losing – is necessary to understanding whether a 23% payout is appropriate for a winning hand. In essence, what is your risk, and what should you earn in a successful outcome to compensate for absorbing the risk?
When the Treasury made its TARP investment in Goldman Sachs on October 28, 2008, the common share price (dividend adjusted) was $92.82/share. The Treasury had already supervised the transfer of billions of dollars to Goldman through AIG. The government was insuring Goldman’s debt. The government should have understood quite clearly that the only thing keeping Goldman solvent was the government’s own intervention; had the government pulled its loan guarantees and/or pressured Goldman to mark its assets to market, Goldman would have been finished. Indeed, Goldman’s stock would lose half its value in the coming month on just these concerns.
There was one precedent transaction in the market – Berkshire Hathaway’s investment in a $5bn convertible preferred yielding 10%, made the day after the government graciously allowed Goldman to become a bank. Was the US Treasury taking any less risk than Berkshire? Of course not. If Goldman had been liquidated, either both positions would have been wiped or neither position would have been wiped. The probability that the liquidation value would exactly cover GS’ third-party debt plus the TARP but not anything else (the only case in which the structural seniority would matter) was vanishingly small. To any approximation, both the US and Berkshire were taking common equity risk.
$10bn /$92.82 would imply an as-converted position of 107.7mm shares. Throw in a 10% PIK over 267 days and that’s 115.5mm shares, recognizing there is some dividend double-counting in there. Goldman’s share price on Treasury final exit (7/22) was $160.46, for a total position value of $17.3bn. This would be a 111% IRR, and this rate of return should be the baseline for any discussion of the government’s performance.
I would argue that the government should have gotten a much better deal than Berkshire. The government was (a) doing Berkshire’s deal; (b) putting in twice the capital; (c) insuring the rest of the balance sheet. I think the government should have required Goldman to file for bankruptcy and come in a minute after the filing if it felt it so important. But even granting the government’s perspective at the time, it got a terrible deal. It left $6.8bn on the table; indeed, the government gave the $6.8bn to the rest of its fellow shareholders.
All of these numbers are confusing; we jump back and forth between deficits and individual bailouts and overall bailout packages, between the money supply and contingent liabilities and direct investments, between market values and personal bonuses. What is a few billion dollars when we are getting back more than our basis?
Well, here is my answer: the 2009 budget request for the National Cancer Institute was $6.0bn (we allocated $4.8bn). So, in very round terms, Hank Paulson and Tim Geithner gave the good shareholders of Goldman Sachs one year of the National Cancer Institute. The shareholders of Goldman are nice people. If you have an S&P 500 index fund, you are a shareholder, and I am sure you are a wonderful person. But a government that countenances gifts on this level is not a good custodian of the people’s money. It’s one thing to have it leak out through waste; quite a different thing to refuse to pick it up. Treasury owes each of us an apology.
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