Sunday, April 26, 2009

The Debts of the Spenders: The US Govt's Plan to Convert Preferred to Common Equity

Excellent article detailing the inevitable.

Equity dilution - whether it is in commercial real estate REITs, banks, credit card companies, auto companies, or any number of overleveraged entities - is inevitable.

Ironically, while dilution is normally a negative for the shareholders, some sectors (most notably CRE) have rallied the hardest in the face of extremely poor fundamentals. This could be b/c the alternative - bankruptcy is considered worse off.

The administration knows that the banking system will need more capital to survive in its present form. The big banks are sitting on billions more losses than can possibly be absorbed by their dwindling equity.* This implies that those further up the capital structure (i.e. preferred shareholders, subordinated and senior creditors) will eventually be forced to eat losses themselves. Unless taxpayers continue to run interference.



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