EESA Warrant Coverage was Key to Early Bailout Costs: Liquid Scenarios -- Using the Merrill Lynch Bank of America Transaction as an Example, Liquid Scenarios Estimates That Immediately Setting Exercise Prices on Shares of CDO / Mortgage Sellers Could've Easily Covered 1+ Years of Interest Costs on the Federal Reserve's Plan

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The dollar amount of stock warrant coverage granted, as a percentage of mortgage securities sold under the proposed Emergency Economic Stabilization Act of 2008 (EESA), could have been one of the most important factors impacting the net cost of the bailout plan within the first 6 months of the program, according to Liquid Scenarios estimates. Depending on how exercise prices were set, stock warrant coverage of just 10% of Collateralized Debt Obligations (CDOs) sold could have funded 163% of the first year of interest expenses on US Treasuries used to finance the purchases.

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20% warrant coverage is not at all extreme

Terms and Stock Warrant Issuer Accounting Rules Would Have Had to be Set Quickly – Key Factors Would Be

LOCK IN APPRECIATION: The exercise price of warrants on shares of institutions participating should be based on very recent pre-bailout averages DON'T USE CASH: The stock warrants should allow for cashless, or "net", exercise by the holder DON'T HURT THE BALANCE SHEET: The issuer should be allowed to apply special accounting rules to how they treat the stock warrants on their balance sheet Mortgage Securities Sold

  $10 Billion

  Stock Warrant Coverage @ 10% of Securities Sold

$1 Billion

  Divided By Exercise Price of $17.05, based on grant price of options to Bank of America

58.65 Million Sh.

  X ($29.50 Merrill Lynch (MER) Close 9/19/08 minus $17.05 warrant exercise price)

$12.45 / Sh.

  Potential Gain (24.75 million Merrill Lynch shares net)

$730 Million

As an example, Liquid Scenarios created a model that assumed Merrill Lynch (NYSE: MER) had participated in the government proposed bailout, as opposed to agreeing to merge with Bank of America (NYSE:BAC). Under that hypothetical scenario, Merrill Lynch takes $10 billion of CDOs and other mortgage assets and sells them under the rejected EESA plan. If the stock warrant coverage was just 10% of the transaction amount and the exercise price was, for instance, the same price stock options were granted to Bank of America ($17.05 strike price) by Merrill on September 15, EESA could have exercised its stocks warrants and received around 24.75 million shares of Merrill Lynch, or $730 million of value, without investing any more cash four days later. That would have more than cover one year of interest on the debt incurred to finance the purchase. It would also decrease the speed with which the CDOs or other mortgage securities acquired had to perform, allowing the patience to resell them when the market recovers.

"20% warrant coverage is not at all extreme," according Lorenzo Carver, CEO and inventor of the Carver Import Algorithm. "To put that figure into perspective, Warren Buffet's recent investment in Goldman Sachs essentially proposed 100% warrant coverage. Also, in venture capital transactions involving bridge debt, 20% to 25% initial warrant coverage is typical, with that coverage growing over time if certain triggers occur. Applying this same logic to the prospective EESA transactions could have afforded the same benefits and protections the government, even if the industry standard stock warrant coverage was cut in half."


Liquid Scenarios (bpCentral, Inc.) allows venture capitalists, investors, founders and ventures to conquer uncertainty through application and software that reduces complex financial and business relationships to a single screen anyone can interactive with, challenge and understand. To see Liquid Scenarios perform complex modeling in seconds, watch the Liquid Scenarios Minute on For more about information, please visit

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