Equity for Debt Swap

Hi!

I heard on NPR's Planet Money that the government is asking some companies to convert the preferred stock it was given as a result of the bailout to common stock. What's the different? Preferred stock is non-voting stock (meaning its owners don't get to vote during shareholder meetings) and is treated like debt. This means that preferred stockholders will get paid first if the company goes under. Common stockholders may lose it all.

If the government becomes a common stockholder, and exercises the voting rights that come with it, we'll effectively have government control over these institutions. I've already written about this NOT being true nationalization, so I won't get into that here. What I'd like to suggest in this post is that the government make the swap, then offer the shares to tax-paying individuals...at a discount.

The reason I'm clear about it being "tax-paying individuals" is to prevent other institutions and governments from using this to take control of U.S. companies. People (in this case, tax-paying individuals) who want to buy shares (say, of Citibank) could do so at a reasonable discount from the market price (say, 5%). The incentive in the short term would be the discount.

The incentive in the long term would be a tax benefit. If the shares are sold within a year, then capital gains are taxed at a VERY high rate. This is to prevent people from buying at 5% and immediately selling for a ~5% gain. Lots of volume would drive prices down and be bad for everyone. If the shares are kept for more than 10 years, then the gains are not taxed at all.

What's in it for the government? Well, the government can get some cash back that can then be put to other use...like paying down the debt. Sitting on hundreds of billions of dollars of stock won't help, so why not sell it off in a way that can create value for the tax payers who funded it in the first place?

Thanks,
Matt