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Media Mentions

Accepted and Published Papers

1. "Should Goldman Sachs and Morgan Stanley Try to Get Half Price on the TARP Warrants?" (2009), The Journal of Finance and Accountancy Vol. 2, pp. 1-8.

2. "The Goldman Sachs Warrants," (2009), Review of Business, Vol. 30, No. 1, Fall, pp. 4-32. (lead article)

3. "The Biggest Warrant Auction in U.S. History," (2010), Research in Business and Economics Journal, Vol. 2, 1-12.

4. "The Put Problem with Buying Toxic Assets," (2010), Applied Financial Economics, Vol. 20, No. 1, pp. 31-35.

5. "Common (Stock) Sense about Risk-Shifting and Bank Bailouts," (2010), Financial Markets and Portfolio Analysis, Vol. 24, No. 1, 3-29. (lead article)

6. "Estimating JP Morgan Chase’s Profits from the Madoff Deposits," with Lou Davis, forthcoming Risk Managment and Insurance Review

7. "Slicing the Toxic Pizza: An Analysis of FDIC’s Legacy Loan Program for Receivership Assets," accepted by International Journal of Monetary Economics and Finance

8. "A Model for Estimating the Cancellation Probabilities of TARP Warrants," accepted by Advances in Accounting, Finance, and Economics

Working Papers

"Anchoring Bias in the TARP Warrant Negotiations"

"A Binomial Model of Geithner’s Toxic Asset Plan"

"Debt Overhang and Bank Bailouts"

"Did the TARP Share Sale Drive Down Citigroup’s Stock Price?"

"Escaping TARP"

"Lessons for the TARP Warrants from 1983 Chrysler Auction"

"Selling Citigroup: A Simulation of the U.S. Treasury’s $37 Billion TARP Share Sale"

"TARP’s Deadbeat Banks"

"Valuing the First Negotiated Repurchase of the TARP Warrants"

"Anchoring Bias in TARP Warrant Negotiations"

Abstract

Fifty-two publically traded banks exited the Troubled Asset Relief Program (TARP) in 2009, and most of them successfully repurchased the warrants that they issued to U.S. taxpayers. This paper finds that banks that offered lower opening bids were rewarded with significantly lower warrant repurchase prices in transactions that raised $2.856 billion. These results were scaled by third-party consultants’ and the Congressional Oversight Panel’s estimates of the warrants’ value. In contrast to the experimental psychology studies on anchoring bias in negotiations, these are real transactions involving large sums of money. This paper finds that larger banks paid significantly higher prices, and the U.S. Treasury obtained better prices over time.

Keywords: anchoring bias, behavioral economics, behavioral finance, alternating offers, bailout, banks, banking, bargaining, bids, Capital Purchase Program (CPP), Emergency Economic Stabilization Act (EESA), heuristics, negotiations, offers, options, Troubled Asset Relief Program (TARP), valuation, warrants

JEL Classifications: D03, C78, G01, G13, G21, G28, G32, G38

"The Biggest Warrant Auction in U.S. History," Research in Business and Economics Journal, Vol. 2, 1-12.

Abstract

On December 10, 2009, the auction of JP Morgan Chase’s warrants raised gross proceeds of $950 million, topping the previous warrant auction record of the 1983 Chrysler warrants in real and nominal terms. This paper analyzed the results from the secondary market trading on December 9, 2009, of the Troubled Asset Relief Program (TARP) warrants issued by Capital One Financial (COF) to estimate the likely auction price of the JP Morgan Chase (JPM) TARP warrants. The Capital One Financial warrants have displayed an implied volatility discount relative to other historic and implied volatility metrics. The paper translates the percent volatility discounts from traded TARP warrants to estimate the likely implied volatility of long-dated TARP warrants that have not yet gone to auction.

Keywords: bailout, banks, banking, Capital Purchase Program, Emergency Economic Stabilization Act, options, TARP, valuation, warrants, Capital One Financial, J.P. Morgan Chase, TCF Financial

JEL Classifications: G01, G13, G21, G28, G32, G38

"A Binomial Model of Geithner’s Toxic Asset Plan" (pdf file 127 KB)

Abstract

This paper formally models the Public Private Investment Partnership (PPIP), a plan for U.S. government sponsored purchases of distressed assets. This paper solves both the problem of the asset manager buying toxic assets and the banks selling toxic assets. It solves for the fair market value of toxic assets implied by subsidized toxic asset auctions, and it estimates the size of the government’s subsidy. Moreover, this paper finds under what circumstances banks and asset managers will meet at a mutually acceptable prices. In general, healthier banks will be more willing sellers of toxic assets than zombies.

Keywords: bailout, banking, CMBS, CDOs, EESA, Emergency Economic Stabilization Act, lending, mortgages, Public-Private Investment Partnership, PPIP, TARP, RMBS, too big to fail, toxic assets, zombies

JEL Classifications: G12, G13, G18, G21, G28, G38

"Common (Stock) Sense about Risk-Shifting and Bank Bailouts" (pdf file 161 KB) with Yan Wendy Wu; forthcoming Financial Markets and Portfolio Managment

Abstract

If a bank faces potential insolvency, it will be tempted to reject good loans and accept bad loans to shift risk onto its creditors. We analyze effectiveness of buying up toxic mortgages in troubled banks, buying preferred stock, and buying common stock. If bailouts for banks that are deemed “too-big-too-fail” involve buying assets at above market values, then these banks are encouraged ex ante to gamble on bad assets. Buying up common (preferred) stock is always the most (least) ex ante- and ex post-efficient type of capital infusion whether or not the bank volunteers for the recapitalization.

Keywords: banks, bailout, lending, risk-shifting, TARP, too-big-to-fail

JEL Classifications: G21, G28, G38

"Debt Overhang and Bank Bailouts" (pdf file 117 KB)

Abstract

When a bank is deemed “too-big-to-fail” by regulators, it may be tempted to buy risky assets. This paper analyzes bank bailouts involving the purchases of toxic assets, preferred stock, and common stock when the government wants to encourage efficient lending. It finds that preferred stock recapitalizations are the least efficient in correcting debt overhang problems from both an ex post and ex ante perspective. In contrast, efficient lending and voluntary participation can be best achieved without subsidy by purchasing either toxic assets or common stock. Nevertheless, troubled banks must be subsidized if they will voluntarily participate in any recapitalization.

Keywords: bailout, banking, debt overhang, common stock, Capital Purchase Program, lending, preferred stock, TARP, too-big-to-fail, toxic assets

JEL Classifications: G21, G28, G38

"Did the TARP Share Sale Drive Down Citigroup’s Stock Price?" (pdf file 117 KB)

Abstract

This study uses a unique natural experiment to contribute to the long-running debate as to whether the demand curves for stocks slope downward. The U.S. Treasury’s large share sales of Citigroup’s common stock during trading hours in April, May, and June of 2010 coincided with significantly higher volumes of shares traded. Yet, there is little evidence that the demand curve for Citigroup’s stock has a negative slope. The share price declines over that selling period are not abnormal given the implied volatility of the shares and the broader market decline that occurred at the time. This indicates that “dribble-out” privatizations of Citigroup, General Motors, Chrysler, and GMAC may not hurt those firm’s stock prices.

Keywords: Bailout, Banks, Bank of America, Block Trades, Brownian Motion, Chrysler, Citigroup, Demand Curves, General Motors, GMAC, Privatization, Troubled Asset Relief Program, TARP, Secondary Offerings, SEOs, U.S. Treasury

JEL Classifications: G01, G13, G21, G28, G32

"Escaping TARP", with Yan Wendy Wu (pdf file 79 KB)

Abstract

This paper studies the factors that were associated with a bank’s early exit from TARP in 2009. We find that larger publicly traded banks with better accounting performance, stronger capital ratios, and fewer troubled loans exited early. Banks that raised private capital in 2009 were significantly more likely to return the taxpayers’ money early. We find that the original eight TARP recipients, which received $165 billion of the $245 billion passed out, had weak tangible common equity ratios at the end of 2008, relative to other TARP recipients. Those eight banks raised common equity capital in 2009, and all at least partially exited the government’s embrace. While executive pay restrictions were often a rationale cited for early TARP exit, we can only find that CEO pay was significantly higher in banks exiting TARP in univariate tests. These CEO pay metrics were insignificant in multivariate regressions.

Keywords: bailout, banks, banking, Basel capital standards, callable bonds, capital ratios, Capital Purchase Program (CPP), dividends, Emergency Economic Stabilization Act (EESA), hybrid securities, investment, preferred stock, Targeted Investment Program (TIP), Troubled Asset Relief Program (TARP), U.S. Treasury, warrants

JEL Classifications: G01, G13, G21, G28, G32

"Estimating JP Morgan Chase’s Profits from the Madoff Deposits" (pdf file 68 KB); forthcoming Risk Management and Insurance Review

Abstract

JP Morgan Chase allegedly had deposits from Bernard L. Madoff totaling $5.5 billion at one point in 2008. The Chase account was supposedly where most of the funds in his Ponzi scheme were deposited. Any large deposit can be a considerable source of profit to a bank. Assuming that the deposits returned the bank’s net interest margin and grew at a random geometric rate, this paper estimates that JP Morgan Chase generated $483 million in after-tax profits from this very large account over the course of sixteen years. With JP Morgan Chase the target of pending lawsuits relating to the Madoff fraud, this paper’s methodology and results may be of interest to litigants, prosecutors, journalists, and academics.

Keywords: deposits, fraud, JP Morgan Chase, litigation, Madoff, Monte Carlo simulation, net interest margin

JEL Classifications: G01, G21, G24, K13, K14, K23, K41, K42

"The Goldman Sachs Warrants," Review of Business, Vol. 30, No. 1, Fall 2009, pp. 4-32. (lead article)

Abstract

This paper values the Capital Purchase Program (CPP) and Berkshire Hathaway warrants issued by Goldman Sachs in 2008. The paper’s methodology could be of interest to policy makers, non-profits, journalists, and advisors for the government and the over 500 banks with CPP warrants outstanding.

Keywords: bailout, banks, banking, Capital Purchase Program, Emergency Economic Stabilization Act, Goldman Sachs, options, TARP, too big to fail, valuation, warrants

JEL Classifications: G01, G13, G21, G28, G32, G38

"Lessons for the TARP Warrants from 1983 Chrysler Auction" (pdf file 35 KB)

Abstract

The U.S. Treasury began auctioning its warrant holdings in December 2009. Nevertheless, this was not the first large auction of warrants. The U.S. Treasury auctioned its holdings of warrants from the bailout of Chrysler Motors in 1983. That warrant auction resulted in an implied volatility of less than zero, but it generated higher price than the management of Chrysler was willing to pay in negotiations. The similarities and differences between this auction and the more recent auction of the JP Morgan Chase warrants, which were issued as part of the Troubled Asset Relief Program (TARP), are discussed.

Keywords: auctions, bailout, banks, banking, Capital Purchase Program, Chrysler, EESA, Emergency Economic Stabilization Act, JP Morgan, options, TARP, Troubled Asset Relief Program, valuation, warrants

JEL Classifications: A44, G01, G13, G21, G28, G32, G38

"A Model for Estimating the Cancellation Probabilities of TARP Warrants" (pdf file 70 KB); accepted by Advances in Accounting, Finance, and Economics

Abstract

Under the Capital Purchase Program (CPP), U.S. taxpayers hold warrants issued by over 270 publicly traded banks. The provisions of the CPP allow for half of the warrants to be cancelled if the recipient bank issues enough preferred or common stock by the end of 2009. This paper develops a model to estimate the probability of a qualified equity issuance that is consistent with standard option pricing techniques. The model is based on the transaction costs of issuing new equity and can be solved numerically.

Keywords: bailout, banks, banking, Capital Purchase Program, Emergency Economic Stabilization Act, options, TARP, valuation, warrants

JEL Classifications: G01, G13, G21, G28, G32, G38

"The Put Problem with Buying Toxic Assets," Applied Financial Economics, Vol. 20, No. 1-2, pp. 31-35.

Abstract

This paper uses the option pricing arguments of Merton (1974) to demonstrate that even solvent banks will be reluctant to sell volatile, toxic assets at market prices. Banks’ shareholders have insolvency puts that give them limited liability in the event of default. The insolvency puts are more valuable when the banks’ assets are more volatile. Shareholders in banks will require any buyer to pay for the lost volatility as well as the market price of the toxic assets. Thus, taxpayers must be ready to richly overpay if they want banks to voluntarily part with their toxic assets.

Keywords: TARP, too-big-to-fail, toxic assets, mortgage securities, FDICIA

JEL Classifications: G01, G13, G21, G28, G32

"Selling Citigroup: A Simulation of the U.S. Treasury’s $37 Billion TARP Share Sale" (pdf file 50 KB)

Abstract

On April 26, 2010, the U.S. Treasury had 163 trading days to sell a $37 billion dollar stake of 7.7 billion shares in Citigroup. Citigroup’s stock price on April 23, 2010, was well above the U.S. Treasury’s “break even” price of $3.25. The U.S. Treasury announced that it planned an at-the-market sale over about six months. This paper uses Monte Carlo simulations to argue that the U.S. Treasury bore a 17 percent chance of not completing the sale if it refused to sell its shares at a loss and sold no more than 50 million shares per day. The author argues the government could have had less downside and idiosyncratic risk by selling a significant fraction of its holdings in an underwritten offering early in the selling period.

Keywords: Bailout, Banks, Block Trades, Brownian Motion, Citigroup, Dark Pools, Electronic Trading, Exchange Offers, Monte Carlo, Privatization, Simulation, Troubled Asset Relief Program, TARP, Secondary Offerings, SEOs, U.S. Treasury, Underwriting

JEL Classifications: G01, G13, G21, G28, G32

"Slicing the Toxic Pizza: An Analysis of FDIC’s Legacy Loan Program for Receivership Assets" (pdf file 73 KB); accepted by International Journal of Monetary Economics and Finance

Abstract

The Legacy Loans Program is an elaborate way of slicing the FDIC’s receivership assets. At best, the financial structure is irrelevant to the FDIC’s expected long-run recovery rates. Yet, it may boost short-term prices by creating bond insurance liabilities that will come due several years down the road. If the private investor can increase the value of the toxic loans through non-contractible investments, then the public equity stake and subsidized leverage may hinder the FDIC from obtaining the best recovery rates from these troubled loan portfolios.

Keywords: Banks, FDIC, LLP, Legacy Loans Program, loans, mortgage securities, PPIP, Public Private Investment Partnership, real estate, receivership, TARP, toxic assets

JEL Classifications: G01, G13, G21, G28, G32

"Should Goldman Sachs and Morgan Stanley Try to Get Half Price on the TARP Warrants?" The Journal of Finance and Accountancy, Vol. 2, pp. 1-8.

Abstract

The cancellation provisions in the Troubled Asset Relief Program (TARP) warrant agreements loom large for the investment banks Goldman Sachs and Morgan Stanley. These banks could gain hundreds of millions of dollars by issuing equity to satisfy the cancellation provisions of the TARP warrant agreements. Nevertheless, they could maximize the value of these provisions by postponing an equity issuance if they could afford to wait to unwind the TARP investments.

Keywords: bailout, banks, banking, Capital Purchase Program, EESA, Emergency Economic Stabilization Act, options, TARP, Troubled Asset Relief Program, valuation, warrants

JEL Classifications: G01, G13, G21, G28, G32, G38

"TARP’s Deadbeat Banks"

Abstract

Eighty-two banks that received funds from the Troubled Asset Relief Program’s (TARP)’s Capital Purchase Program (CPP) failed to pay scheduled preferred stock dividends or interest on their subordinated debt in February 2010. This is an increase from the fifty-six banks that failed to pay dividends or interest at the last quarterly dividend payment in November 2009. In February 2010, 11.6 percent of the 707 banks that received CPP investments failed to make their payments. Since sixty banks had exited TARP by the end of February 2010, one-eighth of the banks remaining in TARP were behind in their payments to taxpayers.

Keywords: bailout, banking, debt overhang, Capital Purchase Program, Emergency Economic Stabilization Act, lending, preferred stock, subordinated debt, TARP

JEL Classifications: G21, G28, G38

"Valuing the First Negotiated Repurchaseof the TARP Warrants" (pdf file 50 KB) revisions submitted to the Journal of Applied Finance

Abstract

Old National Bancorp was the first publicly traded bank to buy back its Capital Purchase Program (CPP) warrants. It paid $1.2 million, which is below the low-end of this paper’s estimates of the fair market value of the warrants. This paper estimates the warrants are worth between $1.9 and $6.9 million. This low negotiated price from the perspective of taxpayers indicates that the U.S. Treasury would have probably gotten a better price marketing those warrants to third party investors.

Keywords: bailout, banks, banking, Capital Purchase Program, Emergency Economic Stabilization Act, financial crisis, options, TARP, Troubled Asset Relief Program, valuation, warrants

JEL Classifications: G01, G13, G21, G28, G32, G38