Boy, I really didn't explain this very well.
>
>> 1. Each financial company is required to sell the government an
>> amount of stock equal to 60% of its market cap as of some past date.
>
> Okay, let's say the market cap of Citi is $100bn. The company can't
> sell the government $60bn worth, because it doesn't own it (KIA does,
> among others.) Do you mean it should issue a new $60bn? Is this
> ordinary stock or preferred stock?
No, this would be newly issued stock. Otherwise, it's not a
recapitalization. Probably it would be preferred stock - preference
dividends and no voting rights. (Though maybe voting rights.)
>
>
> And what are you thinking about when you say "some past date." You
> mean before the troubles, when banks might be worth 3 or 4 times what
> they are now?
No, "some past date" is just to prevent the announcement of the plan from itself affecting stock prices and thus market caps. It could be yesterday's date. Or average daily market caps for July 2008. Or whatever.
>
>> 2. However, the government also distributes to each financial
>> company "waivers" equal to 30% of its market cap as of that date.
>
> I'm not sure how you're using the word waiver. Normally a stock
> waiver is something I use to sign my stock over to you. What do these
> waivers do, what do they claim, what does their price refer to or
> measure?
Oy, I shouldn't have dashed this off at 4am..... No, by "waiver" I mean an exemption from the stock-selling requirement. So to use your example: If I'm Citibank with a market cap of $100bn, the law requires me to sell the govt $60bn in newly issued stock. But the government gives me "waivers" - credits - exempting me from $30 bn of that stock-selling requirement. So right now, in total I have a net obligation to sell the govt $30 bn in stock ($60bn minus $30bn).
To continue with this example: If Citi feels well-capitalized and doesn't want to dilute its existing equity by $30bn , then it must go onto the market for waivers and buy up an additional $30bn worth of waivers from companies in the opposite situation (under-capitalized and needing money). Let's say Morgan Stanley, needing capital and also carrying a $100bn market cap, sells Citibank its $30bn in waivers. At the end of the transaction, MS will be left with zero waivers and thus the full $60bn stock-selling requirement and Citi will have $60bn in waivers and thus zero stock-selling requirement.
MS thus is forced to sell $60bn in stock to the Treasury, which puts the
shares in an equity fund. Let's say the equilibrium price in the waiver
market was such that companies were willing to pay, say, for 20¢ for
every $1 exemption from issuing dilutionary stock. Then the sale of
$30bn in waivers from MS to Citibank cost $6bn. That $6bn Citibank paid
will then be converted into a $6bn stake in the govt-managed equity fund
composed of (inter alia) the $60bn of new Morgan Stanley stock. (Morgan
Stanley would only receive $54 million from the Treasury for the $60
million in stock purchased - the other $6m was already provided by
Citibank.)
>
>> 3. A market for waivers is established. Companies with extra cash
>> buy wavers from cash-strapped companies.
>
> Why would they do this as opposed to buying some other security? A
> speculative investment is what they need right now? Is there a
> requirement somewhere as in cap and trade?
I think this question is based on the assumption that I meant something else by "waivers."....But yes, the idea here is that strong banks invest in weak banks and the size of their investment is determined by how much they are willing to pay for the right not to be required to sell dilutionary stock themselves.....Keep in mind, it's a market. No one pays more than they think it's worth. If you don't want to pay, fine - but then the govt buys your stock and your existing equity-holders get diluted.....However, in the end the vast bulk of the recapitalization funds will come not from the strong banks through their waiver purchases but from the Treasury.
One more thing: This plan could easily be extended to address Zingales' point about making creditors take a haircut. So, the bankruptcy law could be written to forgive companies' debt in proportion to the size of their (market-determined) capital injection from the Treasury.
Seth