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Busch: Patient "Saved" But Growth Lost?

Today, the US Treasury, the Federal Reserve, and the FDIC announced measures to stabilize the financial markets, to build capital to increase the flow of financing to U.S. businesses and consumers, and to support the U.S. economy. Under the Treasury's voluntary Capital Purchase Program, they will purchase up to $250 billion of senior preferred shares.

The program will be available to qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies engaged only in financial activities that elect to participate before 5:00 pm (EDT) on November 14, 2008.

Nine major US banks have apparently agreed to this program that will utilized $250 billion of the $700 billion available under the authority granted by Congress. Bloomberg reports that with the plan, nine companies will get $125 billion: Citigroup Inc., Goldman Sachs Group Inc., Wells Fargo & Co., JPMorgan Chase & Co., Bank of America Corp., Merrill Lynch & Co., Morgan Stanley, State Street Corp. and Bank of New York Mellon Corp.

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"The senior preferred shares will qualify as Tier 1 capital and will rank senior to common stock and pari passu, which is at an equal level in the capital structure, with existing preferred shares, other than preferred shares which by their terms rank junior to any other existing preferred shares.

The senior preferred shares will pay a cumulative dividend rate of 5 percent per annum for the first five years and will reset to a rate of 9 percent per annum after year five. The senior preferred shares will be nonvoting, other than class voting rights on matters that could adversely affect the shares. The senior preferred shares will be callable at par after three years." Notice, this is very different from the structure of the AIG loan and the deal Buffet got for his investment into Goldman with the dividend payout only 5% vs 10%.

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Also, the Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15 percent of the senior preferred investment. The exercise price on the warrants will be the market price of the participating institution’s common stock at the time of issuance, calculated on a 20-trading day trailing average.

Here's the part that Barney Frank wanted: "Companies participating in the program must adopt the Treasury Department’s standards for executive compensation and corporate governance, for the period during which Treasury holds equity issued under this program. These standards generally apply to the chief executive officer, chief financial officer, plus the next three most highly compensated executive officers."

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I haven't gotten through all of it, but I'm wondering where is the section for auditing all banks that participate to understand the structure of their debts? It seems logical that the US government is making investments into banks to recapitalize them and to generate liquidity for lending. It seems logical that there will be a bad asset removal program and a commercial paper guarantee program. It seems logical that the FDIC would boost deposit guarantees and to insure bank lending. These steps will help to unfreeze the credit markets and we'll need to see how fast the credit spreads will move. The key question is when banks/lenders feel comfortable enough to provide capital beyond only overnight for the term and only US Treasuries for collateral.

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We're seeing some of this today, but I would caution that the world is not going back to where it was before September. The freeze has meant that the outlook for the economy has soured and we're still not sure by how much. Call it the Z factor. This means that no one can be sure the impact on companies sales or earnings. The market was assessing a very negative outcome by selling equities down as far as they did prior to the US/global actions. Now, we have had a massive rally as the market anticipates brighter times ahead. Don't get too excited by the upmove. The Z factor will cap this rally as will the terrible economic numbers that will come out over the next 6 weeks.

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Andrew Busch

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