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Confusion reigns

Scott Jagow May 6, 2009

I’ve been on the hunt on this morning for an explanation about Bank of America. I’m at a loss to explain why word leaks out that B of A needs $34 billion in capital and then its stock goes up. Not only that, but to raise the money, B of A will likely convert $45 billion of government-owned preferred shares to common shares, thereby diluting current shareholders. Here’s what I found:

I talked to MIT’s Simon Johnson about it. He believes the government is selectively leaking information, so as to not paint a picture of the financial system that is too negative or too sunny. The result is confusion:

The best way to handle this is by jamming your own signal – which they are starting to do in brilliant fashion. To the WSJ you leak that BoA needs to raise a great deal of capital ($35bn); they run this story on the front page, next to a great frown on the face of Ken Lewis. But you tell the FT that Citi will need “to raise less than $10bn” …

Of course, deliberately or inadvertently confusing people is made much easier by the fact that the experts are in sharp disagreement (about the economy’s condition).

Johnson says shareholders might have been expecting worse, and at least $34 billion is an actual number instead of uncertainty.

Over at Yahoo’s Tech Ticker, you can watch analyst Henry Blodget express his view that the taxpayers are the likely losers here because converting to common stock means taxpayers would lose the dividend and seniority rights granted by the preferred shares.

Plus:

Since the capital BofA needs is less than the government’s pledge, the bank would be left with an $11 billion “surplus” that it would seek to use to pay back its TARP loans…

So in sum, in all makes perfect sense: the government will use the TARP to help the bank repay its TARP loans. Peter, meet Paul. Paul, meet Peter.

And finally, Steve Liesman at CNBC reports, based on his sources, that the reason this doesn’t look so bad to shareholders is that the conversion to common stock will be on an “as needed” basis (emphasis mine):

“…sources tell CNBC that regulators will be satisfied that the cushion against tougher times will be sufficient by the holding of mandatory convertible preferred (MCP). The bank does not need to convert the MCP to common immediately, only as needed to maintain a certain common equity percentage of its capital. So that makes the $35 billion a source of potential dilution, but not an absolute dilution.

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