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Our Stake in the Bailouts

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By Michael Brownrigg
Tuesday, January 6, 2009; Page A13

Washington is wrestling with the financial and ideological challenges of owning a growing chunk of the American economy -- banks and insurers today, automakers tomorrow, who-knows-what next. Rather than leaving management of this $700 billion-plus "venture capitol" fund to the federal bureaucracy, Congress and the Obama administration should establish a bipartisan cadre of private-equity directors to oversee it. Not only would such a group of skilled investors do better for shareholders -- the U.S. taxpayers -- but it would also help to mitigate the uncomfortable ideological aspects of social ownership.

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During the 1980s savings-and-loan crisis, the Resolution Trust Corp. generated its best returns when it partnered with private investors to dispose of assets. With today's crisis, however, there are also front-end negotiations with the relevant chief executives to consider. For example, what is the government's justified ownership stake in companies such as AIG or General Motors if it injects taxpayer money into them? And who will sit on the boards to ensure that the companies do what they promise?

At present, the decisions on structuring these investments are being handled by Treasury officials. But it is obvious that Treasury feels an uncomfortable tension between, on one hand, helping U.S. banks and therefore the U.S. banking system and, on the other, making money for U.S. taxpayers by taking advantage of the banks' (or others') bad situations.

Treasury Secretary Henry Paulson has said several times that this investment is not meant to be "punitive." But that's the wrong way to look at it. In fact, investing in a failing organization is one of the more charitable steps one can take, and there's nothing wrong with asking for something meaningful in return. Treasury is being too genteel here. A group of government private equity directors would certainly seek better upfront terms.

If there is any doubt about this, we have an empirical example. Late last year, Warren Buffett took a stake in Goldman Sachs. His terms, simplified, were a $5 billion loan with 10 percent interest (dividend), a 10 percent bonus payment whenever the loan is repaid, and options to purchase $5 billion worth of stock at that day's price at any time in the future -- called 100 percent warrants since they match the loan amount. Buffett would certainly not say he is being punitive (though I am sure he would be pleased with "hard-nosed").

And what did Treasury, our fund manager, propose? It offered to lend up to $25 billion to the biggest banks, at a 5 percent interest rate (rising to 9 percent after five years), no bonus when the loan is paid off, and only 15 percent warrants. It is no wonder that J.P. Morgan Chase chief executive Jamie Dimon reportedly called it relatively cheap capital. When Treasury claims -- with apparent satisfaction -- that banks are "lining up" to get their government money, it is further indication that we have priced it too cheaply.

Government private equity directors could also help at the back end by making sure that the fund's stakes are disposed of at a point when doing so makes commercial sense for taxpayers. Treasury or Congress may be lobbied by future auto or bank executives to hold on to our public stakes so as not to depress stock prices or for other reasons; buffered from such pressures, private equity directors would better safeguard the fiduciary interests of shareholders -- namely, taxpayers.

All that said, the administration and Congress still ought to make a majority recommendation as to the rate of return they expect on any capital being deployed. What return should the investors -- again, taxpayers -- expect? The answer will drive the negotiators to take more or less risk and to drive harder or easier bargains with the targets.

It is okay if our "venture fund" rate of return is less than Buffett's. That's because there are certain social objectives whose accomplishment can compensate for a lower financial return -- a stable financial system is a public good; a vibrant auto industry and employment may be public goods. Those are intangible returns for Congress that Buffett would not value in the same way. We call this coupling of financial and social returns maximizing total tangible and intangible returns. But we would be making a blunder if we did not also demand a strong positive financial return for all this capital.

The Government Accountability Office has forcefully criticized the Troubled Asset Relief Program as lacking oversight and follow-through. What this process needs are savvy private investors to help make the investments and then to sit on the boards and manage them. It is not that private equity directors will always make money -- Chrysler's owners are PE guys, after all. But let's manage our "venture capitol" the way the best institutional investors do, with hard-nosed experts who are the people's fiduciaries.

The writer worked at the State Department and then the U.S. trade representative's office from 1984 to 1997. He worked in private equity for 10 years, including from 1997 to 2007 as a managing partner at ChinaVest.

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