No wonder Heebner is short WM while Nygren stubbornly holds on.

http://www.beearly.com/pdfFiles/SprottJune2008.pdf

The list is growing shorter. But there were at least some smart investors who noted the downward trend and successfully negotiated for downside protection. We know of at least two cases (though there are doubtless others); namely, Merrill Lynch’s $12.8 billion investment from Temasek (the Singapore sovereign wealth fund) and Washington Mutual’s $7 billion raise from TPG (a private equity firm). Quite unbeknownst to the general public at the time, downside protection was built into these equity raises to protect these investors. They are called “look back” provisions or “full ratchet” compensation. We believe it is more accurate to call them “death spiral” securities. They work as follows. The investors in the equity raise would have their investment “protected” by a provision which states that should the bank afterwards raise money at a lower price than what they paid, these investors would be compensated retroactively by having their initial investment priced at this lower price, thereby being issued new shares for free. It doesn’t take a mathematician to see how these provisions can result in massive dilution should the bank subsequently raise even a paltry amount of capital. A new offering will trigger a lower price because of the dilution it would cause, which would trigger even more dilution because of the lower price, which would then trigger an even lower price because of the even higher dilution, etc. This is why we call such securities a death spiral. They hurt the price of any and all future equity offerings and open the door for potentially limitless dilution of existing shareholders if and when the bank goes to the markets for more capital at ever-lower prices. However, unless the bank goes bankrupt, these investors can’t lose. And we already know to what lengths the Fed will go to prevent a banking bankruptcy. It’s heads I win, tails I win. They can even short the stock in the expectation that it will go down and still not lose. At the next financing, which is sure to come, they will be made whole... even making money on the short! It’s a perverse situation. Even if they don’t short (or aren’t allowed to short) they still can’t lose. It’s like being given a free put option written by existing shareholders. They get all the upside and existing shareholders (insult to injury) pay them on the downside! It’s the worst way to raise equity. We wouldn’t even call it equity. It comes at a tremendous cost to the already beaten up shareholders of these financial institutions. How did this happen? Because these are “private” transactions, and thus no prospectus was required at the time of the offering. The banks disclosed only what they wanted to disclose. It is only after the fact, in the footnotes of subsequent 10-Q’s, that shareholders (if they dig deep enough) will realize that they got nailed/ratcheted/screwed. How many other financings were done on this basis? Only time will tell. In the meantime, it is little wonder that banking indices are in freefall and the demand for new bank equity is becoming increasingly muted. Investors are finally beginning to say: no mas! When regulators have to get involved in order to push financings through (for instance, Bradford and Bingley in the UK), it is a signal for ordinary investors to steer clear of the financial sector. It’s a misallocation of capital… good money chasing bad… that can ultimately only be resolved by a massive central bank bailout. You don’t want to be a shareholder when this happens… and in the interim be subjected to an unacceptable lack of transparency. Financial shares, if they weren’t already, are now toxic. They will become only more so with each equity offering.