Citigroup: Another Ad Hoc Bailout

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:

1. 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.
2. 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%.
3. 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.
4. 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.).
5. 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

Comments

[nw:]

Citi can pay a $0.01 per share dividend, not a 1% dividend.

"Institution is prohibited from paying common stock dividends, in excess
of $.01 per share per quarter, for 3 years without UST/FDIC/FRB consent.
A factor taken into account for consideration of the USG’s consent is the
ability to complete a common stock offering of appropriate size."

2008 Nov 24 11:26 AM

[Reinko:]

Indeed, it is only one cent for three years.

And the fractional reserve banking is out of the window for some time now, see the next link from the FED AGGREGATE RESERVES OF DEPOSITORY INSTITUTIONS AND THE MONETARY BASE:

www.federalreserve.gov.../

In the third column (the 'non borrowed' column) you see the real reserves are negative...

Isn't it strange to name the real reserves the 'non borrowed' ones?

2008 Nov 24 11:44 AM

[websmith:]

Unlike the auto bailout, this bailout doesn't allow us to keep our jobs or generate commerce plus, they were not adversely affected by the economic crisis. They caused it. After already giving them $25 billion, they are still foreclosing on our homes, charging us loan shark rates on our credit cards, and refusing to loan money to business resulting in more lost jobs and no commerce whatsoever. We should first demand a management change and a plan. What is to guarantee that, after we bail them out, they don't just go out and do the same things that got them to this point all over again only to have us left holding a lot of worthless stock. Get rid of those corporate jets and the high salaries and bonuses. Otherwise this is just more money after bad.

ewebsmith.com/gov/Bank...

2008 Nov 24 01:32 PM

[Detox pads:]

Very good update.Thanks for sharing

2008 Nov 25 12:28 AM

[Detox pads:]

Ur blog looks very interesting!Keep updating your blog.

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2008 Nov 25 12:31 AM

[siew_wah:]

Mr Edwad Harrison- you're a serious, responsible and truthful contributor to Seeking Alpha readers. Keep it up !

2008 Nov 25 03:28 PM