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J.P. Morgan to Send Warrants to Market

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By: Debbi Solomon and Robin Sidel | July 09, 2009

WASHINGTON -- Several Wall Street firms seeking to buy back warrants held by the government as part of the $700 billion financial bailout are complaining that the Treasury Department is demanding too high a price, according to people familiar with the matter.

The Treasury has rejected the vast majority of valuation proposals from banks, saying the firms are undervaluing what the warrants are worth, these people said. That has prompted complaints from some top executives. J.P. Morgan Chase & Co. Chief Executive James Dimon raised the issue directly with Treasury Secretary Timothy Geithner, disagreeing with some of the valuation methods that the government was using to value the warrants.

The inability to agree on a price has already prompted J.P. Morgan to take the next step in a complex process to remove the warrants from the hands of the government. The bank has waived its right to buy the warrants and will allow the Treasury to auction them in the public market, which bank executives say will result in an actual market price.

"We're very supportive of the Treasury's process regarding the warrants," a J.P. Morgan spokesman said. The bank said it took the action after the Treasury rejected its bid that was based on an independent appraisal.

The disagreement between banks and the Treasury indicates that the banking sector, despite being pilloried for its role in the financial crisis, is becoming increasingly confident in its dealings with Washington. Some banks have begun pushing back against some government initiatives, a move fraught with political risk.

It also is an indication of how tricky it is going to be for the government to extricate itself from its unprecedented investment in the financial sector. The U.S. has flooded the financial sector with hundreds of billions of dollars, most of which is expected to eventually be repaid and, possibly, create a profit for taxpayers.

Many banks have repaid their Troubled Asset Relief Program funds. But the government still holds warrants giving the U.S. the right to buy common equity in those firms for a set price. The warrants are difficult to value because they don't trade and depend on an estimate of a bank's future stock price.

Some banks argue they shouldn't have to pay much, saying the government's investment was essentially a short-term loan they accepted under duress to help stabilize the financial sector.

Others argue that the government shouldn't be draining bank capital at such a fragile time. At least one bank has argued it shouldn't have to pay the government anything at all.

But the Treasury is under pressure to extract as much money as possible for the warrants and avoid seeming to favor Wall Street over taxpayers. Lawmakers and the bailout's independent overseers have warned the Treasury against settling for too low a price and robbing taxpayers of a richer return.

A Treasury spokesman said the government "has laid out a consistent and clear process for valuing warrants which is the same for all institutions, large and small. We believe our process goes a long way in protecting taxpayers."

Dozens of banks are seeking to repay TARP and either buy back their warrants or have the government dispose of them through an auction. The government received warrants in more than 600 financial institutions when it bought preferred shares. Congress required the government to receive warrants, believing that would help taxpayers potentially profit from the investment.

Eleven small banks have repurchased their warrants. It is unclear exactly how much money is at stake, given the debate over valuation, but some independent valuations have placed the warrants at anywhere between $4 billion and $15 billion.

Treasury officials are cognizant that their actions will be highly scrutinized, with likely congressional hearings and reports, and are taking a firm line.
"Treasury would be well advised to push hard because the Congress and the public really care about whether it's perceived that there's a fair price being received for the warrants," said Douglas Elliott, a fellow at the Brookings Institution in Washington. Given the support offered banks in recent months, "it's reasonable to at least get a fair market price for the warrants," he said.

The Treasury already has taken heat for the price at which it sold its warrants to Old National Bancorp, which returned its TARP money earlier this year. Many observers say the Treasury left money on the table. Pluris Valuation, a financial advisory firm, contends that the Treasury undervalued the warrants by 53%.

To smooth the transition out of TARP, the Treasury outlined a process last month for disposing of the warrants. Banks can purchase the warrants if the Treasury agrees with the price the firms are willing to pay. If the Treasury rejects the valuation, the two sides can enter into a potentially lengthy arbitration process involving multiple third-party valuations.

Banks also can waive their right to purchase the warrants and have the Treasury sell them through a public auction. That's the step taken by J.P. Morgan Chase.

While banks could bid on their own warrants through a public auction, some are reluctant to go that route since it could drive up the price for the warrants and let them out of their control.

Many banks want to buy back the warrants so that the government no longer has its tentacles into the firms. Many banks are repaying TARP because of concerns about executive compensation and other restrictions imposed on firms accepting government aid. While the law currently exempts the warrants from any type of restrictions, many banks are wary that the rules could be changed.

To determine what the warrants are worth, the Treasury said it will use market prices, financial models and consult outside asset managers.
That banks are pushing back against the Treasury speaks to a newfound confidence in an industry that, not too long ago, was capitulating to the government. Today, many banks have raised fresh capital and were given a seal of approval by the government's "stress tests."

The industry has also started to criticize aspects of the Obama administration's regulatory revamp, including its plan to launch a consumer financial protection agency to create new rules for credit cards, mortgages and other financial products.