Faced with swooning losses in the stock value of Citi, the U.S. government on Sunday agreed to another major bailout for a financial institution that the deregulatory actions of the past four decades had allowed to grow too big to fail. See Joint Statement from the Treasury, Federal Reserve and the FDIC on Citigroup, Nov. 23, 2008.
The bailout goes well beyond what the government has already done for ailing financial giants such as AIG. It involves an upfront commitment of about $20 billion in new capital, with a guaranteed 8% return (better than the return the US government is getting on other TARP funds, but not as good as some private investors have gotten in similar deals, such as Buffet's fabled 10% return on his investment in Goldman), as well as a tiered loss agreement whereby Citi will absorb $29 billion in first losses, with any remaining losses being borne 10% by Citi and 90% by the U.S. government. Treasury's TARP funding is in line for the next $5 billion in losses, the FDIC for the next $10 billion, and the Fed for the rest that the government bears through a nonrecourse loan arrangement, up to a total loss on $306 billion of assets (valuation to be agreed between the government and Citi). The guarantee is long-term: it will be in place for 10 years for residential properties, 5 years for commercial properties. In return, the Treasury and FDIC will receive only $7 billion of preferred shares (at the same 8% rate). Citi retains the income stream from the guaranteed assets. Eric Dash, U.S. Approves Plan to Help Citigroup Cope with Losses, NY Times, Nov. 23, 2008; Joint Statement appendix: summary of terms for the agreement.
Note that the $270 million in losses that the government would absorb is about the same as the cash infusion Citi would have gotten if it had been able to carry out its purchase of Wachovia. Of course, Wells Fargo got that plum instead, right after the Treasury had announced it would not enforce the law (ie., Notice 2008-83 regarding the nonenforcement of the section 382 limitation on use of built-in losses) for banks that acquired losers. That notice amounted to a Treasury giveaway to Wells Fargo making the takeover of Wachovia a goody too good to pass up. And now Citi gets its bailout as well.
What's the impetus for another huge bailout of a huge, badly managed, risk-taking, taxpayer-flipping-the-finger-at financial institution, with very little taxpayer return possible ($7 billion of preferred shares for a potential $270 billion of taxpayer aid; only a guaranteed 8% return on another $20 billion of capital used to purchase additional preferred shares!) at the same time that the Bush Administration refuses to provide even minimal assistance ($25 billion) to the country's three major auto manufacturers that are beleaguered, in part, by the economic crisis engendered by the big banks? According to the New York Times, "In tense, round-the-clock negotiations that stretched until almost midnight on Sunday, it became clear that the crisis of confidence had to be defused now or the financial markets could plunge further." Eric Dash, U.S. Approves Plan to Help Citigroup Cope with Losses, NY Times, Nov. 23, 2008. Isn't the plunge of the entire economy--and a possible staggering job loss of 3 million or more--upon a failure of Detroit's Big Three an equivalent (or worse) crisis? One has to think that a union-busting ideology is behind the differentiation in the Bush administration's handling of these two scenarios.
Citigroup is not giving up much (other than the somewhat higher rates on the preferred shares it issues, and the very slight dilution of shareholder equity). According to the release, "Citigroup will comply with enhanced executive compensation restrictions and implement the FDIC's mortgage modification program." Joint Statement from the Treasury, Federal Reserve and the FDIC on Citigroup But look at the term sheet. There is only a limited three-year restriction on the bank paying dividends to its shareholders while the U.S. government absorbs up to $270 billion in the bank's losses: the agreement merely provides that the bank will not pay more than $.01/share/quarter without the consent of the Treasury, FDIC and Fed. (The decision about consent will take into account the bank's ability to make a common stock offering.) After all that has gone by, it is clear that this government doesn't really intend to prevent dividend payments. There is no explicit commitment to repay the government for the losses absorbed over time if the bank successfully survives the recession and returns to profit-making status, nor any explicit commitment to lending any of the capital infusion to ordinary Americans, and no real restrictions on management beyond the de minimis restrictions enacted as part of the TARP legislation (any executive pay plan must reward "long term performance and profitability" and have "appropriate limitations"). How can there be no provision for clawback and no government control, including kicking out top management and limiting executive compensation to some reasonable amount (say, $300,000 a year)? Why should any of these institutions being saved by the TARP taxpayer funding not be required to pay back whatever amount the US government puts into them once the crisis is over and they return to profit-making status? In a situation where shareholders have reaped enormous rewards from the speculative frenzy of the banks in mortgage and other securitizations leading up to this crisis, this is again more socialization of losses after privatization of huge gains.
As the New York Times points out, this new version of the Bush Administration's bailout strategy "may set the precedent for other multibillion-dollar financial rescues" while "draw[ing] a firestorm of criticism from smaller institutions that were not big enough to be saved." Eric Dash, U.S. Approves Plan to Help Citigroup Cope with Losses, NY Times, Nov. 23, 2008.
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