09.30.10

First Citi, Now AIG

Posted in Economics, Financial Markets, Politics and Policy at 8:38 pm

The Treasury seems to be in an awful rush to convert the preferred shares it acquired in these companies as part of the bailouts into common shares.  This entails giving up a sizable dividend, giving up their place in the hierarchy of creditors should there be future financial problems at the firms, and exposing themselves to additional market risk as the value of the common shares fluctuate.

There are a number of scenarios under which this could make sense.

If the Treasury intended to sell the shares all at once, the dividends and creditor standing would largely be irrelevant.  They also wouldn’t be exposed to market risk over time, although the selling of such a large block at once would certainly depress the price enough to significantly reduce the amount of money they’d receive.  In any case, the Treasury has signaled that they do not intend to take this route and will slowly dispose of their common shares over an extended period.

Another scenario where this approach would be desirable would be if the Treasury expected a period of strong economic growth leading to strong profit growth for these companies followed by a significant appreciation in share price.  It’s hard to see how that could realistically be their near to mid term forecast, however.

That leaves largely political motivations.  The administration wants to end the noise about “government takeovers” coming from the Right.  The American people in general find the idea of bailouts distasteful.  The firms in question want to improve their PR images.  So on and so forth.  There are risks here though.  Prematurely paying back the government and having the government prematurely extricate themselves will leave the firms more exposed should the financial storm reappear.  It would also make it politically difficult for the government to engineer additional policy measures should that happen.

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