Why Shouldn’t Private Bailout Money Deserve A Decent Return, Too?

What the heck’s the matter with Floyd Norris? On the one hand, he thinks it’s just great that Old Second National Bank of Aurora,Ill., a non-SIFI if there ever was one, was able to avail itself of a government bailout. On the other, he’s disturbed that private investors who made a speculative investment in Old Second at a crucial moment in its fight for survival now stands to earn a windfall. That’s exactly backwards. First, no, the government had no business selling TARP preferred to small banks. Second, yes, investors ought to be rewarded when they take risks and are right.Background: Having written too many loans to local developers in the run-up to the bust, Old Second took $73 million in TARP money in 2009. But the bank’s problems worsened; it stopped paying dividends on the preferred in 2010. When Treasury auctioned off its TARP odd lots last year, the Old Second paper went for 35 cents on the dollar. But lately, to help clear the way for a secondary of common stock that will supposedly restore the bank’s balance sheet, the company has agreed with holders of some of the preferred to buy back at near face value, with dividends waived.Got all that? Anyway, Norris sees the Old Second saga some sort of re-run of It’s a Wonderful Life:By bailing out [smaller] banks – and in some cases by stepping up regulatory oversight – the government kept those banks in business. Now those that have recovered are able to make loans again in the communities they know. Had there been no bailouts, many of those banks would have failed or been snapped up by larger competitors with greater resources. Bank concentration would be greater than it is. Whether the new bank would have been as willing to make local loans is, of course, not knowable. Even when the government lost money on the bailout, the net result was sometimes positive for the bank and its customers.If he says so. To me,there’s nothing the matter with letting failing banks be “snapped up by larger competitors with greater resources,” and leaving taxpayers out of it. That’show capitalism works. More objectionable, though, is his reaction to how the TARP holders-the ones who bought their shares at 35 cents from the government and will possibly sell them back to the bank at near par-will fare:[T]he bank could besetting up for an interesting game involving the current holders of the preferred shares issued for the bailout. . . . The bank directors who own some of the stock plan to take a similar deal. That will allow them to almost triple their money in a year, which is a little galling . . . [Emph. added.]

Wait. What’s so “galling” about private investors making a lot of money on what was clearly a high-risk investment? The preferred holders bought their stock at 35 cents on the dollar, remember. There was a very real chance they’d end up with nothing. Anyone was free to buy alongside them, even Floyd Norris!So in Norris World, it’s perfectly okay for the government to lose money in its effort to needlessly prop up a failing non-systemically-important bank, but there’s something not right about investors putting capital at extreme risk in the very same bank and ending up making a lot of money. There’s a word for a view like that: insane. What do you think? Let me know!