It looks like we have a solution to Citi’s (C) crisis. The U.S. government agreed to bailout Citigroup, backing $306 billion of debt in exchange for preferred equity and warrants plus a host of other details I will enumerate below. On the whole, this looks to be a better deal for the U.S. government and American taxpayers than the AIG deal. However, it is yet another ad hoc band-aid when a comprehensive solution is preferable.
The most salient points of the deal hammered out in around-the-clock negotiations this weekend are below:
- The U.S. government will guarantee $306 billion in toxic mortgage-backed and other troubled assets of Citi’s total $2.2 trillion in assets.
- The government will provide Citigroup with $20 billion in equity capital in exchange for preferred shares. This money comes in addition to $25 billion in capital already provided to Citi under the Troubled Asset Relief Program (TARP). The stake is dilutive for current shareholders. The preferred shares will pay a dividend of 8%.
- The preferred shares come with warrants that give the government the opportunity but not the obligation to buy a further 254 million shares at a strike price of $10.61. Note that this is potentially dilutive to current shareholders.
- Citigroup must cut its dividend to common shareholders. The company can pay out no more than 1% in dividends on common shares per quarter for the next three years. This means a significant cut to the current dividend of 16 cents per share (which would be 1% only if the share price rose above $16.).
- There have been no announcements suggesting that any executives were required to resign.
Shares were rising across the board in the pre-market due to this announcement and Citigroup has seen its shares skyrocket to above $6 per share as of this writing, despite the dilutive nature of the deal.
All in all, this is a better executed deal than the one with AIG. However, I would have liked to see pay caps and resignations as the present executive staff at Citi bears much of the blame for the company’s state of affairs.
This deal does beg the question as to why the U.S. federal government has dragged its feet on a Nordic-style comprehensive solution. The Swedish model or the S&L model or the Depression-era model — these are all precedents that should be used to craft an approach that is not ad hoc in nature. If we have learned anything during this crisis it is that the banking system is more fragile than many anticipated. We should also have learned that “free-market” solutions can allow panic to spread in times of crisis.
Because fractional reserve banking is inherently reliant on depositor, investor, and counter-party confidence, we risk further episodes of a similar nature unless toxic assets are stripped out of the system and potentially insolvent banks are swiftly dealt with by government.
Perhaps Obama’s economic team is aware of the perils of inaction. Let’s hope they can offer a more comprehensive solution than the free-market ideologues of this Administration.
Disclosure: no positions
