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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," with Wendy Yan Wu, (2010), Financial Markets and Portfolio Analysis, Vol. 24, No. 1, 3-29. (lead article)

6. "A Model for Estimating the Cancellation Probabilities of TARP Warrants," (2010), Advances in Accounting, Finance, and Economics, Vol. 3., No. 1, 1-15.

7. "Slicing the Toxic Pizza: An Analysis of FDIC’s Legacy Loan Program for Receivership Assets," (2010), International Journal of Monetary Economics and Finance, Vol. 3, No.3, pp. 300-309.

8. "Troubling Research on Troubled Assets: Charles Zheng on the U.S. Toxic Asset Auction Plan," (2011), Economic Journal Watch, Vol. 8, No. 1., 33-38.

9. "Estimating JP Morgan Chase’s Profits from the Madoff Deposits," with Lou Davis, (2011), Risk Managment and Insurance Review, Vol. 14, No. 1, pp. 107-119.

10. "Selling Citigroup: A Simulation of the U.S. Treasury’s $37 Billion TARP Share Sale," (2011), Review of Business, Vol. 31, No. 2.

11. "Escaping TARP,"with Yan Wendy Wu, forthcoming Journal of Financial Stability

12. "Anchoring Bias in the TARP Warrant Negotiations" accepted by the Journal of Economics and Business

13. "The Demand for Stocks and TARP Returns," forthcoming in the Journal of Financial Economic Policy

14. "A Binomial Model of Geithner’s Toxic Asset Plan," forthcoming in the Journal of Economics and Business

15. "Debt Overhang and Bank Bailouts," forthcoming in the International Journal of Monetary Economics and Finance

Working Papers

"Lessons for the TARP Warrants from 1983 Chrysler Auction"

"Madoff's Dirty Money"

"Political Influence and TARP Investments in Credit Unions"

"TARP’s Deadbeat Banks"

"TARP’s Dividend Skippers"

"Toxic Asset Subsidies and the Early Redemption of TALF Loans"

"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," forthcoming in the Journal of Economics and Business (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, (2010), Financial Markets and Portfolio Analysis, Vol. 24, No. 1, 3-29. (lead article)

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), forthcoming International Journal of Monetary Economics and Finance

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

"Escaping TARP", with Yan Wendy Wu, forthcoming Journal of Financial Stability (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

"Madoff's Dirty Money,"

Abstract

The Madoff Ponzi scheme was sitting on a cash hoard in excess of a billion dollars by the 1990s. Yet, much of that money did not stay in the Ponzi account, account 703 at JPMorgan Chase, or make it into the hands of other Madoff investors. For many years, in excess of a billion dollars was missing from the 703 account as money drained out of the eleven other accounts, which received transfers from the Ponzi account. The author uses previously unanalyzed data from the Security Investor Protection Corporation (SIPC) to estimate that the balances in the JPMorgan Chase account were so large that JPMorgan Chase earned in $907 million pre-tax from the Madoff deposits at the bank from 1986 to 2008.

Keywords: banks, fraud, Madoff, Money Laundering, Ponzi schemes, pyramid schemes

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

"A Model for Estimating the Cancellation Probabilities of TARP Warrants," (2010), Advances in Accounting, Finance, and Economics, Vol. 3., No. 1, 1-15.

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

"Political Influence and TARP Investments in Credit Unions" (pdf file 91 KB)

Abstract

Forty-eight credit unions received capital injections as part of the financial sector bailout. The predicted probability of receiving bailout funds jumps from 23 percent to 76 percent for the typical credit union, if the institution’s headquarters was in the district of a member of the U.S. House Financial Services Committee (HFS). The credit unions receiving funds were significantly less likely to lend out their deposits, contrary to the goals of the program. These results indicate that political influence may be an important determinant of which institutions receive taxpayer funds.

Keywords: bailout, cooperatives, credit unions, CDCI, CDFI, Community Development, Capital Initiative. Community Development Financial Institution, EESA, Emergency Economic Stabilization Act, politics, subordinated debt, SBLF, Small Business Lending Fund, U.S. House Financial Services Committee, TARP

JEL Classifications: G21, G28, G38

"Selling Citigroup: A Simulation of the U.S. Treasury’s $37 Billion TARP Share Sale," (2011), Review of Business, Vol. 31, No. 2.

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," (2010), International Journal of Monetary Economics and Finance, Vol. 3, No.3, pp. 300-309.

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?" (2009), 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

"Stock Demand Curves and TARP Returns," forthcoming in the Journal of Financial Economic Policy (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

"TARP’s Deadbeat Banks"

Abstract

This paper studies the factors that predict that privately held banks will miss their bailout dividends. Banks with weaker core capital ratios, more charged off loans, more allowances for loan losses, more non-performing loans, and lower returns on assets are more likely to miss their Troubles Asset Relief Program (TARP) dividends. Banks which are subject to regulatory orders and banks that issue non-cumulative preferred stock are also more likely to be TARP deadbeats. This study finds a high degree of dividend persistence. Thus, models taking into account past preferred dividend payment behavior correctly predict over 95 percent of the missed and made dividends. This paper finds that the high one-year dividend skipping rates for TARP banks suggests that the average rating of these issues would have been well below investment grade. At the end of the paper all the public and private banks missing bailout dividends and interest payments are listed. There were 101 TARP deadbeat banks in May 2010.

Keywords: bailout, banking, Capital Purchase Program, dividends, Emergency Economic Stabilization Act, hybrid securities, preferred stock, SBLF, Small Business Lending Fund, trust preferred, TRUPS, TARP

JEL Classifications: G21, G28, G38

"TARP’s Dividend Skippers" with Dobrina Georgieva

Abstract

Most of the banks receiving capital injections from the Troubled Asset Relief Program (TARP) issued preferred stock to taxpayers. This paper looks at the factors that affect publically traded banks’ ability to pay the scheduled TARP preferred stock dividends. Smaller banks with weaker capital ratios and more problem loans are significantly more likely to suspend payments of their bailout dividends.

Keywords: bailout, banking, Capital Purchase Program, dividends, Emergency Economic Stabilization Act, hybrid securities, preferred stock, SBLF, Small Business Lending Fund, trust preferred, TRUPS, TARP

JEL Classifications: G21, G28, G38

"Toxic Asset Subsidies and the Early Redemption of TALF Loans"

Abstract

This paper develops a formula to numerically estimate the unsubsidized, fair-market value of the toxic assets purchased with Federal Reserve loans. It finds that subsidy rates on these loans were on average 33.9 percent at origination. Yet, by the 3rd quarter of the 2010, there was on average no subsidy in TALF loans. The theoretical model is used to predict the early redemption of Term Asset-Backed Securities Loan Facility (TALF) loans used to purchase commercial mortgage backed securities (CMBS). The predictions of the model are strongly supported by the data. In addition, this paper looks at the determinants of early redemption. CMBS originated inside the peak bubble years of 2005-2007 were much less likely to be redeemed early. The giant investment managers, Blackrock and PIMCO, were much more likely to redeem their TALF loans early than smaller investment managers

Keywords: Alternative Investments, Bailout, Banking, Blackrock, Call Options, Commercial Mortgage Backed Securities, CMBS, CDOs, Dodd-Frank, EESA, Emergency Economic Stabilization Act, Lending, Legacy Securities Program, Mortgages, PIMCO, PPIP, TARP, Troubled Asset Relief Program

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

"Troubling Research on Troubled Assets: Charles Zheng on the U.S. Toxic Asset Auction Plan" (2011), Economic Journal Watch, Vol. 8, No. 1., 33-38.

Abstract

Charles Zhoucheng Zheng’s “The Default-Prone U.S. Toxic Asset Auction Plan” (Zheng 2009) seems to be a simple case of getting reality wrong when claiming relevance for a model. The paper claims to model the policy announced by the U.S. Treasury on March 23, 2009, to buy up to $500 billion to $1 trillion of toxic assets through a Public Private Investment Partnership (PPIP). In the model, “moderately poor bidders outbid rich bidders in such auctions,” because Zheng assumes that all of a borrower’s assets are at risk if they default on the government loan. Thus, says Zheng: “After defeating their rich rivals and acquiring the toxic assets, such bidders will default on government-provided loans whenever the toxic assets turn out to be unsalvageable” (abstract). The chief trouble with the paper is that the assumptions do not fit reality. In reality, the government-provided loans used to buy toxic assets are nonrecourse, allowing the borrower to walk away from the loan with no penalties besides ceding the asset that the loan purchased. Thus, there is nothing to make rich bidders less ready to win the auction, and Zheng’s equilibrium in which less well endowed borrowers win toxic asset auctions is irrelevant.

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

"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