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On my initial scan through the news the morning I read that the Treasury is planning to convert some of its preferred shares (purchased under the original TARP bailout for distressed banks) into common stock.  It’s supposed to be a way for the feds to stretch their bailout dollars because, according the New York Times, “The change to common stock would not require the government to contribute any additional cash, but it could increase the capital of big banks by more than $100 billion.”

That didn’t seem to make any sense, but hey, what do I know about high finance?  And then I got annoyed by California’s latest ballot initiative, and then intrigued by the Jane Harman wiretap, and forgot all about it.

But I guess I’m not crazy after all.  (Not totally crazy, anyway.)  James Kwak, who knows a thing or two about this, says the whole thing sounds ridiculous.  Here’s Kwak highly condensed:

If you don’t give a bank any more money, it doesn’t have any more money. By converting preferred into common, you haven’t changed the chances of the bank going bankrupt….If you accept the idea that converting preferred into common creates new capital, then you are implying that those preferred shares weren’t capital in the first place….Tangible common equity and Tier 1 capital are just two ways of measuring the health of a bank. Taking money that wasn’t TCE and calling it TCE doesn’t serve any economic purpose.

Right.  Back when the original TARP bailout money was handed out, the preferred shares were very deliberately and very conspicuously called Tier 1 capital.  That’s the bestest capital there is, and converting it into common stock doesn’t make it into super-duper Tier 1.  It does get the banks off the hook for paying dividends on the stock, but since most of these banks are (or claim to be) extremely cash flow positive, that shouldn’t be their biggest worry at the moment.

So….I dunno.  This is weird.  Might there be text hidden in the conversion contracts that releases banks from those horrible restraints on executive pay that they hate so much?  Or is there more to this than meets the eye?  Stay tuned.

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