Bailout a Potentially Lucrative Investment for Taxpayers

The $700 billion financial bailout plan gives the U.S. Treasury an option to buy, on behalf of taxpayers, an equity stake in troubled financial firms. If the plan facilitates the recovery of these firms, that equity provision could create big profits down the road for American taxpayers.

Elvis Presley generated public outcry when he showed up on the entertainment scene in the 1950s. Many believed his suggestive dancing would usher in a new era of immorality. Today, Americans aren't worried about gyrating hips; they're worried about future tax increases related to the bailout. But lawmakers worked an upside into the bill that, hopefully, will offset the expense: stock warrants.

Give and take

The meat of the financial bailout bill allows the federal government to purchase heaps of worthless mortgage-related securities from struggling firms. The program is voluntary, but firms that want the help have to award stock warrants to the Secretary of the Treasury.

A warrant is a financial instrument that gives the holder the right to purchase stock at a specific price and within a certain timeframe. An example is the deal that Goldman Sachs made with Warren Buffet's Berkshire Hathaway in late-September. Berkshire Hathaway pumped $5 billion dollars into Goldman Sachs. In return, they received warrants allowing for the purchase of up to $5 billion worth of Goldman stock at $115 per share. The warrants can be exercised at any time during the next five years. On October 14, Goldman Sachs stock was trading at around $120 per share, $5 higher than the warrant exercise price.

Been there, done that

The purpose of the rescue plan's warrant provision is to allow taxpayers to benefit from the recovery of the bailed-out firms. The federal government has done this before. Back in the 1970s, the feds guaranteed a private loan to Chrysler Corporation.  The automaker had to agree to certain conditions, one of which was to give the feds stock warrants. Things went as planned, and Chrysler quickly turned itself around. The warrants subsequently became valuable and the government sold them at a huge profit.

An all-powerful Secretary

The warrant provision language in the bill authorizes the Secretary of the Treasury to manage the program, top to bottom. Specifically, he will collect the warrants, specify the exercise price, and have the authority to sell, exercise, or surrender them "for the benefit of taxpayers." The Secretary's shareholder rights, however, are limited; the bill states that the Secretary/Treasury will not be a voting shareholder, should the warrants be exercised.

Also, companies cannot head off the Treasury's right to exercise warrants by delisting from the stock exchange; in the event that a company delists, the warrants automatically convert into senior debt.   

The public expected the worst from Elvis Presley, but they received an ever-popular genre of music called rock-and-roll. Maybe this situation will end in a similar fashion; instead of sticking taxpayers with a huge bill, lawmakers can surprise them by making this bailout pay for itself.