This article was last updated on May 31
In my previous post I wrote about the long term fall out and adverse impacts from all these government bailouts. Tony Parker, a regular contributor to this site and an experienced investor, offers a different view as to why the bailouts could end up being a success and even realize a decent profit for the American taxpayer.
In light of the recent bailout of the finance services firms, the mainstream media is making it sound like the taxpayers will be left “holding the bag”. In my opinion, the government has structured this bailout in a favorable and profitable way. Below, I discuss the three major bailouts and the likely outcome for the markets and the taxpayers.
Freddie/ Fannie (At risk: $200 billion)
– The government has provided a line of credit for $100 billion for each company
– The government has warrants (the right to purchase shares) for almost 80% of the companies. In other words, the government has the right to take ownership of 80% of the companies and
thereby be eligible for 80% of the profits in the future.
– The government’s money will purchase senior preferred shares. This means the government will be first in line before anyone else when profits begin to flow.
– The senior preferred shares pay a dividend (interest payment) of 10%.
– The housing market will bottom out within the next one to two years.
– Housing prices will stabilize – not appreciate significantly, just stabilize. But this will be enough to stop Freddie and Fannie from losing money.
– Now that the government has “explicitly” backed Freddie and Fannie, their borrowing rates are very similar to the government’s…very low. Therefore, the spread (profit) between borrowing (say 3%) and lending (say 6%) will allow Freddie and Fannie to start making lots of money in a short amount of time.
– Freddie and Fannie will be very profitable within about 3 years and taxpayers will get all their money back plus a nice bonus. The government could walk away with upwards of $25 to 50
billion on this deal, especially if they decide to re-privatize the companies and “cash-out” in an IPO.
AIG (At risk: $85 billion)
– The government is lending $85 billion to AIG at an interest rate of about 11%.
– The government has warrants to purchase almost 80% of AIG, similar to the deal with Freddie and Fannie.
– The loan is due to be paid back within two years.
– Once AIG gets the bad loans off its books (see next part), it will be making lots of money.
– Other than the bad mortgages AIG is currently holding, there other insurance businesses are doing well. So, unlike Freddie and Fannie, they are much more diversified and much less dependent on the housing market.
– The loan will likely be paid back – on time – and the government (taxpayers) will receive a nice return on their investment (11%).
Government buys bad debt (At risk: $700 billion)
– Government will purchase bad loans from all US financial firms.
– Government will pay 20 to 40 cents on the dollar for these loans.
– Government has no time limit on when they need to sell them.
– Unlike a bank or you and me, the government can hold on to these loans as long as is needed and not subject to credit rating agency downgrades. Because of that fact, they are not forced to liquidate in “distressed” times.
– A lot of these bad loans will be paid in full when the housing market stabilizes. As long as the government gets them “on the cheap” (20-40 cents on dollar), the chance that more than 80% will become non-performing is highly unlikely.
– Once the housing market stabilizes, the government will be able to slowing sell these securities – at a profit – to banks and the taxpayers will make out. It will probably take 3 to 5 years, but our economy is resilient and as stated above, the government has all the time it needs.
Conclusion: I believe that over the next 3 to 5 years, taxpayers will be handsomely rewarded for saving the financial system. My guess is – all in – the taxpayers will have gained $100 to $200 billion from this bailout; which is clearly against the conventional wisdom prevailing in the media. But a bet against the short to medium-term viability of the US economy is a sucker’s bet. At least until China takes over the world in 30 to 50 years.