Citigroup (C): Not the Reaction a Bailout Should Get
November 25th, 2008 by 
James Cullen
“Going back to Walter Bagehot, Central Banks should lend without limit at a penalty rate during a crisis. That rate should hurt, but it is better than no access to credit. To do otherwise is to shortchange taxpayers, and place the value of the Dollar at risk. That is what we are doing now.”
-David Merkel, “Bailouts Must Be Odious”
Today’s reaction across Citigroup (C) securities – from the common stock up through things like the trust preferreds – shows that the net effect of the government’s capital injection and asset guaranty were positives. This should never be the case. Look at how the spreads on the trust preferreds rallied:
One-day percentage gains there ranged from 30% up to 60%. And then when you factor in things like the common, up 58%, it’s pretty clear how people putting money into Citigroup view this. As someone who will be paying for those losses out of future tax dollars, I’m not a fan of this. It isn’t that I’m opposed to government lending in times of distress, but it should really be a penalty rate – and 8% preferred stock is not a penalty rate. Citi had a 7.9% trust preferred (XX, or G series) that was trading at 40 cents on the dollar – and that’s subordinated debt. Now, charging Citi 20%+ interest might not ultimately conducive to the government’s goal of stabilization (at least, that’s what I assume they’re trying to do), but the terms need to create some pressure/impetus/incentive to get things done. I don’t see this deal accomplishing that.
I say all of this while acknowledging that capital injections at financial institutions, even at a senior and/or preferred status, probably help my personal investments. So this is something of a case of mixed emotions, where my investment outlook is being confirmed (Treasury/Fed are loathe to let a large financial fail) to the detriment of my personal feelings (this is only postponing the recognizance of the real problem, too much leverage against bad assets).
Credit default swap spreads on investment grade debt tightened slightly, coming off record highs.
A final thought: this would complicate things, but I believe that future situations like this should force an immediate vote by existing shareholders on renewal of the board of directors, as well as the CEO. How Citi’s board and executive management remain in place through this, I don’t know.
And, going back to what I quoted David on in the opening, while I’ve been behind the Dollar for two months against the Euro, I no longer have the same degree of conviction given the size of the rally… and the recent awareness by European central bankers that there are problems in the global financial community.
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November 25th, 2008 at 2:27 pm
James, the governments cost of borrowing is extremely low. So an 8% yield is still favorable. So, it’s not really ‘at the expense of the taxpayer’. These days the treasury is colloecting money from nearly every corner of the world at a very low cost (and in fact a negative real cost in the case of the short term rates).
Another important point to bear in mind is that a huge factor in todays crisis is lack of confidence. Investors, counterparties, customers have all lost confidence in the financail sector. The cycle of negativity must be broken. The government isn’t saving the banks out of the kindness of it’s heart. It’s trying to save the economy. Had they ‘punished’ Citi as you put it, Citi and even more importantly other banks would have been even less able to carry on with their day to day business.
November 25th, 2008 at 10:22 pm
Simon,
I understand that there is a large yield spread between where the government is borrowing, and where it’s lending. But that ignores the losses they might take in backstopping $300 billion of Citi’s assets. And really, I don’t have a problem with this being a for-profit operation by the government at the expense of stockholders in financial institutions.
I look at the confidence issue from another perspective - why does it exist? My feeling is that is has to do with many of these companies being effectively insolvent at present, i.e. they used too much leverage to acquire overvalued assets. A liquidity crisis is easier to fix than a solvency crisis, IMO. In the former scenario, you can’t defer the pain forever…
Now, I might be missing how tagging Citi with a 15% interest rate or similar will harm other banks. As far as I know, JPM and WFC didn’t have to come back for another round of desperation financing on the government’s tab yet.
November 28th, 2008 at 9:31 am
And Citi’s already repaid the taxpayer by raising rates across the board on its credit cards by 3% points last week…
December 5th, 2008 at 10:24 am
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