Monday, November 24, 2008

The Citi That Should be Put to Sleep

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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A constant refrain that has been heard from the New York Investing meetup since the Credit Crisis began is "there is no such thing as one bailout for an insolvent financial institution". If there was a poster for credit crisis relief, Citibank's picture would be on it with words underneath, "Can you bail me out? We accept funds from Arab sheiks, sovereign wealth funds, foreign banks, the Federal Reserve, the U.S. Treasury, the FDIC, and any welfare program for banks the government can invent - and we take food stamps". As with the daily crashes in the stock market,the bailouts for Citibank have become so common it's easy to lose track of them. From the end of 2007 into the spring of 2008 there were five different bailouts five months in a row. The Fed has pumped substantial amounts into the bank through its various lending facilities. Citi got the biggest chunk of funds from the TARP bill just recently. The 'success' of these efforts came to fruition last week when Citi (C) stock went into a death spiral losing 60% of its value to close at $3.77 (it was over $55 last year).

But not to worry, the U.S. government brain trust that has come up with one ineffective failed program after another to handle the credit crisis put together a bailout package for Citi over the weekend. If they are lucky, this one will work for more than just weeks, but will stabilize things for months before the next rescue package is needed (consider this to be the optimistic scenario). Citi will get another immediate cash infusion of $20 billion from TARP funds. Treasury and the FDIC will guarantee against the "possibility of unusually large losses" on up to $306 billion of risky (a code word for worthless) loans and securities backed by residential and commercial mortgages (please note that commercial mortgages are now collapsing). Citi will assume the first $29 billion in losses on this risky pool of assets. Beyond that amount, the government would absorb 90 percent of the remaining losses, and Citi 10 percent. Money from TARP and funds from the FDIC would cover the government's portion of potential losses (this is deposit insurance money). The Federal Reserve would finance the remaining assets with a loan to Citigroup of freshly printed dollars.

So that this bailout doesn't look like the handout that it is, the U.S. government is getting $7 billion in preferred shares of Citigroup. In addition, Citi will issue warrants to the U.S. Treasury and the FDIC for approximately 254 million shares of the company's common stock (4.5% of the total) at a strike price of $10.61. It is of course possible the Citi stock could hit this level, especially if the U.S. government provides at least $10.61 of funding per share. Citigroup is also barred from paying quarterly dividends to shareholders of more than 1 cent a share for three years (it makes no sense that it should be allowed to pay any dividends, since they are being funded by the U.S. taxpayer). Citi has to additionally take steps to help distressed homeowners.

New York Investing has repeatedly said in its talks in the last year that Citi is too big to fail and the government will bail it out no matter how big a financial black hole it is. This sentiment was echoed in press coverage of the most recent bailout effort with financial commentators saying things such as"If they didn't help, the damage would be beyond imagination" and "It would create chaos [if there hadn't been a bailout]". We have also discussed how Japan followed similar policies with it banks in the 1990s and 2000s. During that time, the Japanese economy has been unable to recover and the stock market has sold off for 18 years. U.S. policy makers will have to come up with a different approach than the one used by the Japanese if they want to avoid this scenario in the U.S. So far, they haven't.

NEXT: Geithner's Appointment to Treasury, A Golden Opportunity

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.


Anonymous said...

Where can I get Citi bank's financial health care plan - no premiums, only 10% copay, and a modest annual deductible?

movie buff said...

my initial thought upon hearing about Citibank's potential bankrupcy was, Yipee! this will cancel out the small fortune's worth of debt I have stored up on my trusty Citi-card... right?