The new TARP programs hurts investors and taxpayers
After Henry Paulson outlined the new goal of the TARP program to buy shares of stock in banking corporations rather than purchase bank debt, investors went into panic mode. There are many reasons as to why investors should be unhappy with the new plan but the main reason is a complete theft of shareholder equity.
Throughout the last few months many banks have been diluting their shares, that is creating new shares out of thin air that can then be sold to the public to raise cash for the corporation. Unlike stock splits which create more shares worth proportionally less money (A 2:1 stock split on a $20 share would make two $10 shares) stock dilution is the creation of new shares that inevitably steals shareholder equity.
For example lets use a figurative company with 100 shares for a total market cap of $100. This XYZ company could then dilute, or create 10 new shares, for a total share count of 110. Each share would now be worth 10% less in that the 110 shares are still worth what the 100 were previously. If you owned 10 shares of stock you would own just 9% of the company when you owned 10% the day before. One share of stock would have a value of roughly $.90, opposed to $1 prior to the dilution.
Under the old plan, bankers had to borrow money from taxpayers to cover their old debts. $100 worth of debt could be mortgaged for a $100 loan to recapitalize the bank. Taxpayers would stand to make money on the transaction in the form of interest charges and shareholders would own the same amount of the company as they did before the bailout. With the current plan, shareholders own less of a company while the Federal government takes control of freshly created shares of stock.
Many of the Federal government’s purchases will likely be preferred stock which does not hurt shareholder equity but instead opens more doors for taxpayer money to be lost. When a company declares bankruptcy the lineage for repayment starts first with debt owners, then preferred shareholders and then common stock holders. Before the change in the TARP program, taxpayers would be the first to be paid as they were debt holders. As of the new change, they’ll be either second or third in line rather than first, and judging from history it is unlikely that preferred shareholders will get their full value if they get anything and common stock holders will likely get nothing.
The long and the short is simple, the new TARP plan completely rips off the investor through dilution and the taxpayer through additional risk of default. US citizens and investors should be outraged!
