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Citi Rescue Talks Underway

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The market shrugged off the prospect of a Citigroup meltdown and focused instead on the leak that Timothy Geithner was Obama’s pick for Treasury Secretary. Citi fell another 20%, its shares dropping below $4. Have banking catastrophes become so routine that it is now assumed that the officialdom will clean up the broken china and put the bill in the post? I recall when Citi nearly failed in the early 1990s (the big culprit then was junior loans on a lot of commercial development in Texas that wound up being see-throughs) and it was white-knuckle time.

However, there is a big difference between this and other financial firm meltdown episodes. Despite the near vertical descent of the stock, there appears to be no run on the bank. And if there is no run on the bank, or flight of counterparties, there is no need for a rescue.

But as we have pointed out, the Fed is acutely sensitive to the needs of banks, so it would be highly unwise to bet against official intervention before the markets open on Sunday in Asia.

Forgive me for lifting a section from yesterday’s post, but it is germane:

John Hempton has suggested that the reason Shiela Bair pushed the deal with Citi, despite it being worse for the taxpayer that the one offered by the successful bidder, Wells Fargo, was that it would have provided a route for a back-door bailout:
Sheila Bair – as readers will remember – forced Wachovia to sell itself in three days whilst other parties had not had anything like enough time to complete due diligence. She – unilaterally and incorrectly – told the world that this deal could not be done without government assistance. She unilaterally decided to issue a guarantee that on a pool of $312 billion of Wachovia assets Citigroup could not lose more than $42 billion. She made that decision even though Wells Fargo was telling her that all they required was more time to do due diligence.

Given that Wells Fargo was willing to acquire Wachovia at no-cost to taxpayers that looks like a very bad decision indeed. But this is the post assuming that Sheila Bair is smarter than all of us.

And so we need to understand the significance of that guarantee. The significance is as follows: Once Citi owns $312 billion in assets on which they can only lose $42 billion the remaining pool must be worth $270 billion. That $270 billion is guaranteed by the US Government – as the FDIC is a full faith and credit organisation. Citigroup can put that $270 billion (plus the $42 billion in non-guaranteed assets) in a pool and repo it – and as Treasuries yield very little they will wind up paying well under a percent of interest. The Sheila Bair decision was equivalent to a cash injection into Citigroup of 270 billion because the repo-market will turn government guaranteed loans into cash.

That cash injection is almost 40 percent of the size of the whole bailout package and it was given to Citigroup by Sheila Bair without congressional oversight. We got all stroppy at giving Paulson that sort of unilateral powers – but – hey – we are prepared to forget that Sheila Bair already has them.

The size and nature of a rescue operation could indirectly confirm or dispute Hempton’s views. It suggests that Citi may never have gotten over the SIV mess of last year. Recall that Citi was far and away the biggest single exposed party and would clearly have been the biggest beneficiary had Paulson’s TARP version 1.0 (known as the MLEC, or Master Liquidity Enhancement Conduit) ever seen the light of day.

We don’t follow Citi systematically, but checking our posts, Citi as of end of second quarter 2008 had $1.1 trillion in off balance sheet assets, in addition to its $2.2 trillion of assets shown in its published financials. It was not clear at the time how Citi intended to deal with those exposures. Pandit had said then that he intended to reduce the balance sheet (as in the $2.2 trillion version) by $400 billion, which included $45 billion of former SIV assets.

From the New York Times;

With the sharp stock-market decline for Citigroup rapidly becoming a full-blown crisis of confidence, the company’s executives on Friday entered into talks with federal officials….the executives and officials weighed several options, including whether to replace Citigroup’s chief executive, Vikram S. Pandit, or sell all or part of the company.

Other options discussed included a public endorsement from the government or a new financial lifeline, people involved in the talks said….

As Citigroup’s stock sank during the day, falling 68 cents to close at $3.87, the Federal Reserve was carefully monitoring how much money corporations and other customers were withdrawing from the bank…

So far, these people said, most customers and clients remained committed to Citigroup….

But with Citigroup’s troubles opening a new chapter in the long-running financial crisis, government officials said that the Treasury Department was considering whether to ask for the second half of the $700 billion rescue fund approved by Congress in September.

It was unclear whether any of that money would be used to make a cash infusion into Citigroup, which received $25 billion from the government in October. A second financial rescue for banks might be difficult politically at a time that the struggling auto industry is being turned away in Washington…

“If there’s a flight from Citi’s stock, that’s unfortunate, but I don’t think that’s the government’s business,” said David M. Walker, the president of the Peter G. Peterson Foundation and a former United States comptroller general.

Mr. Walker said that the government should be concerned about Citigroup only if there were a run on the bank that threatened the financial system. The government should not, he said, be concerned about shareholders.

Some executives, however, argued that it was important to protect Citigroup’s shareholders because if they lose their investment, that will send other bank stocks diving.

Among the other ideas being bandied about Washington and the halls of Citigroup would be an assisted merger between Citigroup and another major bank. The merger might be structured with government assistance based on the blueprint that was developed for the Wachovia and Citigroup merger.

That deal ultimately did not go through because Wells Fargo stepped in with a higher offer, but it would have involved the Federal Deposit Insurance Corporation sharing the losses on $312 billion of Wachovia’s loans with Citigroup. Citigroup would have absorbed the first $42 billion in losses, and the government would have absorbed the rest. The F.D.I.C. would have been given $12 billion in warrants and preferred shares of Citigroup in exchange.

That structure could be used in a merger, but this time around, the government would be absorbing losses on Citigroup’s loans. But it remains unclear what other bank is in a strong enough position to merge with Citigroup.

Inside Citigroup on Friday, some angry senior executives said that the government had “allowed” Wells Fargo to take Wachovia from them, people at the firm said. They argued that had Citigroup and Wachovia been allowed to merge “we wouldn’t be in this position,” one executive said.

Yves here. This certainly seems to confirm Hempton’s theory. Back to the article:

Another option might be for the government to purchase a large chunk of Citigroup’s assets in one swoop. Such an action could be structured similarly to the proposed deal in Switzerland for UBS. A spokesman for UBS, Mark Arena, said on Friday that the arrangement would allow UBS to have “one of the cleanest balance sheets of our peers.”

At the time of the deal’s announcement in October, Jean-Pierre Roth, president of the Swiss National Bank, said the government had the time to wait for the values of the assets to improve. “UBS does not have time,” Mr. Roth said.

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28 comments

  1. Anonymous

    “Despite the near vertical descent of the stock, there appears to be no run on the bank. And if there is no run on the bank, or flight of counterparties, there is no need for a rescue.”

    Although this makes sense, it has me confused in terms of prior events. It was clear there was a run on the bank in the case of Bear Stearns, at least in the post mortem analysis. It wasn’t so clear in the case of Lehman. Or maybe I just missed it in the analysis. Could you comment?

  2. bg

    Very, very nice article.

    I am betting that all the banks are underwater, and this is not the last shoe to drop. But Citi sure went through their 25B quickly.

    If the GDP drops 4/5% (ElPimco) in Q4, its going to kick another leg out from the banks.

  3. Lune

    I can't believe the sense of entitlement of these jokers. They're upset that the govt didn't hand them Wachovia on a silver platter with a $250bil gift on top? What ever happened to selling to the highest bidder?

    And I love the argument that if you don't support Citi's stock price, you risk other banks' stocks declining too. To which the obvious retort is, so what? If stocks decline with no systemic risk being posed, exactly why should the government care about shareholders? But I guess the last capitalist left the building months ago.

    As for any bailout of Citi, there are several considerations:

    1) It is definitely peculiar that the stock is dropping so quickly despite no external evidence of a run. But that said, as a previous poster mentioned, with a financial empire as complex and interrelated as Citi, I'm not sure anyone without access to deep information could figure out if/when such a run occurs, and exactly what it would look like.

    I doubt we'll see lines of depositors at Citi branches waiting to pull out. But if large banks no longer trust Citi as a counterparty, its vital role as market makers in international currency trades and other globally important markets might be the equivalent of a "run", or at least would have similarly disastrous consequences. Does the market know something we Joe Blows don't? Or is it really just random suspicions and a jittery market?

    2) The usually preferred method of forcing weak banks to merge with strong ones can't really work with Citi, as no one (probably not even JPM) is large enough to absorb Citi whole.

    3) Given that so much of Citi's business is conducted outside of the U.S., how do you ensure that any money given to Citi only bails out domestic entities? A similar point could have been raised about AIG (which appears to have been bailed out when European banks pleaded with the Fed that they'd go under if nothing was done) and there was surprisingly little objection to spending >$100 bil bailing out European banks and Goldman. Will people remain similarly mum at bailout money bailing out Citi's foreign depositors, or have people finally gotten fed up with their tax money being wasted so profligately?

  4. Cary

    Excellent post, Yves!

    Everyone keeps looking for a “capitulation” to help mark a bottom in the market. Very few people in the world actually believe that Citi could declare bankruptcy.

    But what would happen if they did?

    From a technical (stock chartist) standpoint, the timing now would be almost perfect. Two weeks ago we made new lows, then rocketed 900 points on the Dow by the end of the day. A BOAT-LOAD of dumb money was sucked into the market (which is, imo, a prerequisite for a crash). The very next day, we began rolling over. Most everyone who entered is still riding the longs and are now in the red, hoping for a rally to get out of their longs.

    Right now… RIGHT NOW would be the perfect time to inflict maximum pain on the market. Hardly anyone is expecting a huge crash. The Citi problem has crept up quietly. The Geithner news offset the Citi woes, giving a false sense of stability on Friday. This coming week will see low liquidity with Japan on holidays and everyone trading on lower volume for Thanksgiving.

    RIGHT NOW would be the moment to inflict maximum pain on the market.

    The Treasury has shot most of it’s bullets. They may not have the funds to dig Citi out of their mess. The Fed is also up to their eyeballs in filth. The last thing they need is more. Sheila Bair tried to sneak help through to Citi, but failed. Their bullets have been shot. There may be nothing left that is substantive enough to fix Citi’s problems.

    I hope to heaven I’m wrong, but it would sure make sense to me if Monday was blacker than the blackest midnight.

    If I’m right (and I hope I’m not), Monday and the days that follow could redefine the meaning of the word “Black Monday.”

  5. ndk

    Given that so much of Citi’s business is conducted outside of the U.S., how do you ensure that any money given to Citi only bails out domestic entities?

    I don’t think that’s the right question to be asking. Can we bail out foreign entities who put their trust in Citi, as depositors or counterparties? Think about Iceland or South Korea, and how much citizens suffered for the foreign adventures of their banks and corporations.

    I’m deeply concerned we may be unable to support international obligations that Citigroup (and other U.S.-domiciled corporations) have already made.

  6. Don

    I think that this was part of Bair’s thinking:

    On the Wachovia sale:

    http://www.nytimes.com/2008/10/05/business/05bank.html

    “Lawyers not involved in the battle said that Wachovia could defend the Wells Fargo deal by arguing that it is better for its shareholders. Wachovia is likely to claim that its fiduciary obligations — its responsibility to protect the interests of its investors — required it to consider the Wells Fargo bid and, given its higher price, to accept that bid.

    The litigation could put regulators in a difficult spot. The Wells Fargo deal may be better for taxpayers, but if it succeeds, in the future other financial institutions may not be willing to help the government, as Citigroup did, because of the risk that they might not reap the anticipated benefit.”

    You think?

    Don the libertarian Democrat

  7. K Ackermann

    And to the man on the street who who has just watched the automakers leave empty-handed, and who has read about the steady stream of Citi corruption and abuse year after year…

    That man on the street, who cannot fathom what good a bank is if it does not lend money…

    That man on the street might very well be inclined to burn down the most crime-ridden neighborhood to infest this country – Wall Street.

  8. Blissex

    The stock price of a bank is relevant ion two ways, even if there is no run:

    * Because of 401ks and so on, there are many votes in keeping stock prices high. Thus the Greenspan Put and the Plunge Protection Team.

    * If a bank stock price goes down, so does the ability to raise capital by selling shares in case that capital is needed to refinance the bank, and that means the bank is perceived as a much bigger risk.

    Also, perhaps some important actors own Citi shares, and writing them down would have consequences for others too.

  9. ruetheday

    If Paulson has to go back to Congress in the next couple of weeks to ask for the second half of the $700 billion after he just said it wouldn’t be requested until after the new administration is sworn in, the excrement is going to hit the spinning blades – both on Wall Street and in DC.

  10. Anonymous

    Thank you for excellent posts everyday, Yves!

    I am not an expert on this field, but agree with comments by Steve and nkd, after looking at some numbers in:

    http://econompicdata.blogspot.com/2008/11/who-will-save-citi.html

    Citi’s total deposits: USD 820 billion
    Foreign deposits out of it: USD 554 billion (about two-thirds)

    FYI, JPY and foreign currency deposits at Citi’s bank subsidiary in Japan, where I live, had long been uninsured, but the JPY portion got insured (by GOJ), if I remember it correctly, just a few years ago.

  11. Anonymous

    Didn’t Paulson defend the $25 billion cash injection to Citi as necessary to keep it from collapsing in his testimony to Congress just 4 days ago? IIRC, he testified the financial system was stabilized by the purchase of preferred shares in the nation’s major banking firms.

    With a market cap less than the cash injection and likely to fall further, looks like the Treasury made a shrewd investment of taxpayer money.

  12. Anonymous

    FYI, THERE IS A SILENT RUN ON CITI. I AM A BANKER IN NYC, AND JUST AS WITH WAMU BEFORE IT GOT BOUGHT OUT I TOOK IN MILLIONS IN DEPOSITS FROM THEIR CUSTOMERS. MSM MADE NO MENTION OF IT.

    YESTERDAY I TOOK IN A COUPLE MILLION IN DEPOSITS FROM CITI CUSTOMERS. MY COLLEAUGES HAVE DONE SO AS WELL.

    THIS ALSO HAPPENED WELL WITH LEHMAN, AND MORGAN STANLEY DAYS BEFORE THEY WENT OUT.

    ONE CUSTOMER HAD BEEN A CITI CLIENT FOR DECADES AND WAS TOLD BY HIS BANKER TO DIVERSIFY HIS DEPOSITS.

  13. FairEconomist

    You’d think a private banker in NYC would know about the Caps Lock key.

    That said, as everybody pointed out above, a run on Citi is not detectable without access to internal financials. “Emergency board meeting” and “rescue talks with the government” sure sound like “run is on!” to me.

  14. tompain

    I would bet that C would rally significantly if Treasury would simply clarify its intentions and make it clear that whatever it does will not be driven by the stock price. Investors need confidence that the government is not going to pre-emptively wipe out the equity. The crisis of confidence is being caused more by the government than by C’s financial condition.

    This is also why banks are not lending to the degree the government would like. With a sagging stock price, C has to be able to point to its capital ratios to keep the government at bay. NCC got wiped out with higher capital ratios than C, for reasons that are still secret. Why should C do anything at all to increase its risk of being sold to JPM or WFC or PNC for $1?

    Meanwhile Treasury is talking about doling out more TARP money on a “matching funds” basis for institutions that raise private capital? You can’t realistically expect that to work while you are also leaving on the table the ongoing threat of arbitrary government wipeouts. Private capital went into FNM at the government’s encouragement, only for that capital to be stolen by the government a few months later. Later when the gov was urging FNM and FRE to raise even more capital, private equity groups were very explicit that they would not move as long as they were uncertain what the government might do. They were right to worry that way. TPG’s capital was wiped out at WM not long after the FNM/FRE debacle.

    The government is the one causing a run on bank stocks.

  15. doc holiday

    I wonder if this will be a textbook example of a no win deal, because there is not enough money to save Citi and whatever money is given to them, will be lost and the Treasury is in a position to just burn money on bad deals. This death spiral is in need of some other innovative shock therapy and with deflation kicking in, I think they may need to hook up a few dozen super computers and then find someone to plug in some new directions and see what pops out (someday). Then again, garbage in, garbage out and you can't fix a problem on the same level it was created, so maybe we need to have some smart people with slide rules, like an Einstein managing a handful of engineers in some effort like when America went to The Moon (and back). They did with the computer power of a toaster and bunch of smart people that had friggn slide rules!

    Also see and touch: http://pr-canada.net/index.php?option=com_content&task=view&id=65751&Itemid=65

    IBM SEEKS TO BUILD THE COMPUTER OF THE FUTURE BASED ON INSIGHTS FROM THE BRAIN

    … the amount of digital data is growing at a mind-boggling 60 percent each year …

    IBM and its collaborators have been awarded $4.9 million in funding from the Defense Advanced Research Projects Agency (DARPA) for the first phase of DARPA's Systems of Neuromorphic Adaptive Plastic Scalable Electronics (SyNAPSE) initiative. IBM's proposal, "Cognitive Computing via Synaptronics and Supercomputing (C2S2)," outlines groundbreaking research over the next nine months in areas including synaptronics, material science, neuromorphic circuitry, supercomputing simulations and virtual environments.

    >> I imagine these guys will hook that retarded computer effort up to The HLC fantasy and look for shit that is really important — using some of the greatest minds of our time to continue looking beyond current reality, to a time that has no meaning or connection to the black hole we are in. I think our society will make progress when many of these boobs are going hungry, when they are unemployed and forced at some point to contribute to society, versus suck off the teats of excess bullshit!

    I've said it before, i.e, if the engineers of today had to build bridges or Hoover Dams or giant public works projects, anything these new generation fools touch will fall apart, because they lack the focus and ethics to produce work that is useful! The engineers of this age are as corrupt as the financial engineers that delivered financial chaos and the current deflation problem. I assure you, they have no clue as to how to fix it, because they had no clue as to what they were doing in the first place, besides trying to get rick as fast as possible.

    Barf!

  16. Anonymous

    Felix Salmon also mentioned Citi’s vulnerability to a run on the bank by its foreign depositors, who aren’t covered by FDIC. It’s hard to imagine who’s big enough to comforably take over $554 billion of foreign deposits — perhaps HSBC or a Chinese bank assisted by the Chinese government?

    There is already a great deal of anger in Asia among retail investors and private banking clients who invested a lot of money in structured notes linked to Lehman that became worthless. If foreign depositors get burned again in an even bigger way by Citigroup, US financial products and companies might get the same reputation overseas as Chinese dairy products and toys did: toxic and contaminated.

  17. m donner

    Citi got 25B from the TARP program. I wondered if the execs have a private jet, if they were grilled and had to come up with a detailed plan of going forward…to make sure they did not need more gov’t/tax payer money later…if they were forced/encouraged to re-negotiate salaries and bennie with all their workers BEFORE they got the money (show us the plan and we will show you the money)
    i just cannot help but see a double standard here and worse…a wall st vs main street mentality at work.

  18. luther

    if hempton's theory holds water (and i have long suspected that it does) some other things to consider on the citidramarama:

    –> the under-the-table tax law change that give WF the ability to pull the rug out from under the citi-wachovia deal

    –> "Moreover, departing Wachovia Corp. executives will receive up to $225 million in "golden parachutes" from the Wells Fargo deal. They would have received none from the Citigroup Inc. merger. "

    http://www.tradingmarkets.com/.site/news/Stock%20News/1941447/

    –> wachovia's CEO Bob Steel was undersec for domestic finance until june 2008 and is an old GS guy under Paulson.

    –> Sir Hank 'magnimously' said last week he was not going to request release of the remaining $350B of TARP, even though he is most well aware of the problems at Citi.

    –> this thurs, the USG asked 4 Arab nations for about $300B to help assist in curbing 'the global financial meltdown'. what for pray tell at this late date?

    –> of course, the well-known theory that Citi is the 'Saudi bank'.

    could this whole play be a final 'quid pro quo' between the bushies & the sheiks?

    stay tuned…same rat time…same rat channel…

  19. Anonymous

    Citi has 2 trillion in assets and a 25B mkt cap. The mkt says their leverage is 98 to 1. Robert Rubin, Sandy Weill et al. should be in prison. SIV’s are Enron type vehicles. Sorbanes Oxly was passed as a result of Enron, making executives liable for untruthful financial statements. Let’s see some charges.

  20. Anonymous

    @doc holiday, Engineers? what engineers? Physics is no longer a required subject in that field and has not been so for years, computers have taking over that role. Engineers are no more than data input lackeys now days. All because the market needed more engineers than the system could pump out, only thing left to do was lower the standard. People with real expertise are expensive too.

    I find this example the rule in all of business now. One person that has real expertise running an army of juvenile look at me types.

    On another point, the education system has been running at over capacity for years now and like the useless durables now stock piling around the world, we now have a over supply of people coming the education system with debt to pay back and not even a job at star bucks to get along, till things get better.

    Skippy

  21. Anonymous

    Decided to double post this, as it puts a human face on the problem.
    Its from a friend in San Fran, who works as a tax consultant in his fathers firm and his dealing with Citibank inc, in regards to buying a house.

    If Citibank goes under, I will laugh my ass off forever.

    We just bought our house in September. The previous owner had two loans on the house and by the time we finished agreeing on the price, they were like 200K in the negative, so both of the note holders had to approve of the sale, because they were getting shorted. Their first loan was held by Citifinancial bank and the second loan was held by Citiresidential bank. The day AFTER we signed our FINAL documents, Citibank came up with a bogus charge of $6000 that they said was billed to them by an insurance company for the liability insurance during a time that the house was vacant for 9 months. They said they would void the entire contract and foreclose the house if we didn’t pay for this. The insurance company that the bill came from was of course Citibank Insurance. My Realtor ended up eating this and is trying to sue them right now to get it back. The lamest part of the entire f***over was after they dropped this on us, they stopped answering the phone and faxes, or like 200 e-mails that they all sent them and went and hid under a rock. Citibank and all their companies are a complete bunch of douche bags.

    I’ll bet you anything that if they do go under, soon afterwords, we’ll hear a story about how their top execs earned 20 million apiece for their wonderful work putting so many people out of work.

    Skippy

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