By Dan Wilchins and David Lawder

NEW YORK/WASHINGTON, March 3 (Reuters) – A small Midwestern bank has negotiated with the U.S. Treasury for taxpayers to essentially buy the bank’s shares at an above-market-value price, in an unusual transaction reflecting how the government’s bank investments are entering a new phase.

Midwest Banc Holdings Inc agreed to swap $84.8 million of preferred shares it sold to the U.S. government in 2008 for securities that will convert into about $15.5 million of common shares — roughly an 80 percent loss to taxpayers.

To some analysts, the transaction is an outrageous giveaway to an ailing bank, and its investors.

“There’s a lot of funny stuff going on here,” said James Ellman, president at hedge fund Seacliff Capital in San Francisco.

Others say it is a sign of the tough choices the Treasury faces dealing with banks that remain weak despite receiving government capital. In some cases, taxpayers must choose whether to lose 80 percent of their money, or all of it.