Hi Glenn,
Here is an excerpt from the CBO Restructuring Paper:
Junior preferred shareholders are in line to receive the dividends associated with their shares before holders of new or existing common shares. Thus, they might refuse to allow the GSEs to retire their claims on the GSEs’ assets and income at less than the face value of their shares in the lead-up to a sale of new common stock. That refusal would reduce the value of the new common shares, making recapitalization more difficult. Even though the Treasury’s preferred shares have seniority over the preconservatorship preferred shares owned by investors, the Treasury would have an incentive to make an arrangement that took into account its ownership stake in the GSEs’ common stock.
Alternatives to the approach used in CBO’s model—such as having holders of junior preferred shares take reductions before the Treasury, or reducing both classes of preferred shares equally—would increase the proceeds received by the Treasury. However, those alternatives would not have a large effect on the results of this analysis, CBO estimates.
If FHFA put the GSEs in receivership, it might be able to transfer some of their assets and liabilities to a new corporation to which no existing shareholders had a claim. The new corporation could then sell common stock and use the proceeds to capitalize itself and to reimburse shareholders in the old GSEs according to the priority of their claims. That priority order would require senior preferred stock to be redeemed before any junior preferred or common stock.
If, however, the Treasury wanted to raise capital through the sale of new common shares without resorting to receivership for the GSEs, the claims of junior preferred shareholders would have to be addressed. In this analysis, those shareholders are paid the full $35 billion face value of their shares from the proceeds of the common-stock sale, if possible, thus retiring their claims on the assets and income of the recapitalized GSEs. In addition, if possible, the [i]Treasury liquidates its senior preferred shares and its warrants [/i]for common shares at the time of the common-stock sale. (Previously, when the Treasury provided financial commitments to private firms during the financial crisis, it exited from those commitments in multiple stages.31 A staged exit might work with the GSEs, but for simplicity, CBO’s recapitalization scenarios do not incorporate that approach.)
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