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Let's face it: The government has put a heck of a lot of taxpayer money at risk through its various bailouts. But we the taxpayers -- at least a good portion of us -- were willing to go along with it. On the one hand, we thought it would be good to avoid a complete Chernobyl of our financial system, and on the other, there was some talk about the potential for taxpayers to profit if the Treasury landed the triple Lutz and banks recovered.

A chunk of that profit potential came from the fact that with every loan made under TARP, the Treasury received warrants -- which are similar to stock options -- to purchase stock in the recipient bank worth 15% of the total loan amount.

We're talking real money here
To put some numbers to this, for the $10 billion TARP loan that Goldman Sachs (NYSE: GS  ) received, it issued 10-year warrants to purchase 12.2 million shares of its stock at a price of $122.90.

Now, the government could exercise those warrants today and score a profit upwards of $150 million. However, one of the big advantages of these warrants is their 10-year life, meaning that the Treasury can (potentially) watch Goldman's stock climb for the next decade before cashing in its warrants.

Fortunately, through the Nobel Prize winning work of Fischer Black and Myron Scholes, we can put a value on those warrants today. Taking that 10-year life, along with some other factors, we can calculate that today, those warrants could be worth (drum roll, please!) nearly $1 billion.

There's still a long way to go before taxpayers are made whole, but hey, that's not a bad start. Unfortunately, it's beginning to look as though taxpayers aren't going to see nearly the return on those warrants that is due to them.

Giving banks a break
The Treasury has set a hard line on making sure major banks such as JPMorgan Chase (NYSE: JPM  ) and Wells Fargo (NYSE: WFC  ) return their TARP funds, but there have already been a handful of smaller banks, such as TCF Financial and Old National Bancorp, that have paid back their TARP loans.

In fact, not only has Old National Bancorp returned the TARP funds, but it was also the first bank to also repurchase the warrants it issued to the government. Old National paid $1.2 million to reclaim the warrants, but calculations done by the folks at Bloomberg suggest that the warrants should have been valued at closer to $6 million. I can't help giving kudos to Old National's management team for working out such a plum deal, but as a taxpayer, I'd like to give Tim Geithner a wedgie for getting lowballed like that.

Now, sure, the $5 million or so that the Treasury failed to claim from Old National may be a drop in the bucket. However, when we start looking at all of the banks that may soon be lining up to pay back TARP funds -- not to mention Citigroup (NYSE: C  ) and Bank of America (NYSE: BAC  ) , which we hope will pay us back someday -- these shortfalls could become serious. For the top 20 TARP recipients, we could be talking about a $10 billion difference if they got deals similar to that of Old National.

Heads you win, tails you win
It's not the first time that the Treasury has taken a raw deal when it comes to TARP. As my fellow Fool Morgan Housel has noted, the Treasury's conversion of preferred stock to common stock at Citigroup left the Treasury with an investment that is a long, long way away from being whole.

So, apparently, the way the government "help" is going to work is that taxpayers need to be willing to see money poured into black holes such as AIG (NYSE: AIG  ) , Fannie Mae, and General Motors (NYSE: GM  ) , while accepting a haircut on the returns where the loans have actually helped get companies back on their feet. Seems like a set of rules that Bernie Madoff would be proud of.

But if you're on the right side ...
I hate to say it, but sometimes that old saw "If you can't beat 'em, join 'em" isn't just a tired cliche. Bank shares have had a crazy run over the past couple of months, and they could be in need of a cooling-off period. But with the all-too-obvious signs that the government is going to give the banks every break possible -- even if it's to the detriment of taxpayers -- it may be time to get more serious about some of the stronger banking names out there so we can actually benefit from Uncle Sam's largesse.

I think that group of stronger banks includes JPMorgan Chase, Wells Fargo, and US Bancorp, but you can chime in yourself and let the 130,000 members of the Motley Fool's CAPS community know which banks you think have an edge by heading over to CAPS.

Further financial Foolishness:

Fool contributor Matt Koppenheffer owns shares of Bank of America, but he owns no shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool. The Fool's disclosure policy has never once been caught with its pants down. Of course, it doesn't actually wear pants …

Read/Post Comments (8) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 26, 2009, at 11:45 AM, arthurmnev wrote:

    The title is wrong: "Banks Are Getting a Great Deal at Our Expense!" should be titled "Banks Are Getting a Great Deal from our Foolishness"

    The fact that the meat of the article can be sum up by:

    "I'd like to give Tim Geithner a wedgie for getting low-balled like that." Tells me that it is not our expense that provides great deal for the banks but our inability to play in the field. By us, I mean the US Taxpayer that ELECTED people like Mr. Geithner... Ok, not exactly him, but he got where he is via the man we elected. What right do we have to complain now?

    What is scary, however, is this: if the US government (or cumulative us) cannot understand that 1.2mln is 20% of what it should have been (and consequently voluntarily give up 80% of the profit) , how in the world can we (the government on the behalf of the electorate) be trusted to run things like Healthcare or Social Security?

  • Report this Comment On May 26, 2009, at 11:47 AM, catoismymotor wrote:

    Vote with your wallet by joining a credit union, end your relationship with your bank and manage your own portfolio.

  • Report this Comment On May 26, 2009, at 12:10 PM, MKArch wrote:

    Matt I think you have it backwards particularly in the case of Bank of America. BAC sold the government $45B in preferred shares specifically to boost their regulatory capital ratios. So BAC under U.S. and international regulatory standards is very well capitalized but Timmy is the new sheriff in town and needs to build up some street creds with the shorts and financial terrorist so he decides to change the rules in the middle of the game and not count the $45B BAC raised selling preferred shares to the government.

    Now BAC has the choice to change the name of the equity it raised from the government to common instead of preferred raising $0.00 however in the process diluting existing shareholders into oblivion. Not to mention giving the government the excuse to micromanage whats left into the ground. Or they can raise a fresh $34B with a depressed stock price just to humor Timmy and his new buddies. So BAC is well on their way to raising $34B that they will then use to buy back the preferred shares that they sold to the government for no apparent reason to begin with.

    Thanks for nothing Timmy!

  • Report this Comment On May 26, 2009, at 12:18 PM, benbot wrote:

    I"v seen arguments that at least some of the banks were forced into TARP terms that weren't fair to them, either. Perhaps the discounted repurchase of the warrants is a recognition of the improper valuation of the worth of the TARP program to the banks. It's not so much what the warrants could be worth as what banks should be charged for use of funds forced upon them.

  • Report this Comment On May 26, 2009, at 3:57 PM, anon104 wrote:

    Is the purpose of the government bailout to help financial firms in the private sector weather this storm so that the "American Taxpayer" (aka., us) is not affected by a meltdown in this sector, or is it to generate a nice return for us? While I believe the government should charge an appropriate risk premium for the potential losses we as taxpayers may suffer, I don't believe the government should be maximizing returns off the backs of firms in the private sector.

  • Report this Comment On May 26, 2009, at 7:03 PM, rd80 wrote:


    Good article, but there's a critical omission. Based on your piece and some similar entries over at Seeking Alpha, I'm researching a blog entry with a recommended approach for Treasury to liquidate these warrants and discovered an interesting clause in the Capital Purchase Program term sheet.

    The critical piece you're missing is that the number of warrants gets cut in half if the bank completes an equity offering for at least the amount of the TARP investment by the end of 2009. In your GS example, Treasury only has 6.1 million warrants if GS issues $10 billion of equity before the end of the year.


  • Report this Comment On May 27, 2009, at 7:35 AM, CommonSenseFoo wrote:

    Ordinary investors have made upwards of 300% on BAC this year alone. Why is the MFool's so disdained over ordinary taxpaying citizens getting a return on our investments? Why do you guys write such garbage stories geared towards cheating ordinary investors using fear? Economic terrorists?

  • Report this Comment On May 28, 2009, at 5:18 PM, MKArch wrote:

    TARP the gift that keeps on giving.

    Thanks Timmy!

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