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.