There is nothing more difficult, more frustrating and more expensive than to keep a corpse from sinking" (Peter Drucker)
In bailing out Citigroup (NYSE:C) a second time (as you recall, Citigroup just received $25 billion from the TARP in October), the government has started the process of creating a bigger problem than the one it is trying to solve. What problem could be bigger than the complete meltdown of the United States' financial system? The complete bankruptcy of the United States.
I thought the TARP was actually being implemented correctly at first. The TARP capital was essentially being used to re-capitalize relatively strong banks. This capital was being used to help strong banks take over weaker ones, which accelerated the process of moving assets from weak hands to strong hands without a complete melt-down in the system. However, from the start, Citigroup should have gone on the "weak bank" list, rather than the "strong bank" list.
Unless the government stops backing up failed institutions such as AIG and Citigroup, I don't see how any money will be left over for stronger institutions. Among the many things the government is terrible at doing is cutting its losses. Once it begins a program or a course of action, it continues it indefinitely no matter how stupid or costly.
This lack of government risk management is a problem because Citigroup is a bottomless financial pit. Rather than being bailed out, Citi needs to be broken up and sold. Rather than buying its stock and giving it more capital, the government needs to act as an investment banker by separating the parts that buyers want - the branches, Salomon Smith Barney, the money management arm - then spliting off the parts hardly anyone wants. Rather than guaranteeing the toxic assets currently on Citigroup's balance sheet, the assets need to be placed into a separate entity that can be sold to private equity investors at a steep discount (with some government financed money, if necessary).
Right now, the government is actually backing up a company with absolutely no real capital. The government is trying to keep a corpse from sinking. Jonathan Weil explains Citigroup's capital situation clearly in his article "Citigroup’s ‘Capital’ Was All Casing, No Meat" on Bloomberg yesterday...
There’s something very wrong with the way Citigroup and the government measure capital.
To see why, let’s dig into just one portion of Citigroup’s capital that has been soaring in value this year. It’s called deferred-tax assets, or DTAs, which now make up a big part of Citigroup’s book value and Tier 1 regulatory capital.You won’t see anything about these assets’ values in Citigroup’s third-quarter report to shareholders. The bank buried them on its balance sheet in a line called “other,” and it discloses them in its financial-statement footnotes only once a year. You can piece together how much the values had grown, though, from Citigroup’s filings with the Federal Reserve Board.
Deferred-tax assets typically consist of tax-deductible losses carried forward from prior periods, which companies can use to offset future tax bills. Under generally accepted accounting principles, such carryforwards are valuable only to companies that are profitable and paying income taxes.
To the extent a company doesn’t expect to use these assets, it’s supposed to record an offsetting valuation allowance to reduce their value. DTAs also can take the form of carrybacks, which let companies claim refunds of past taxes paid.
As of Sept. 30, Citigroup’s net DTAs were about $28.5 billion, after subtracting deferred-tax liabilities. That represented 29 percent of the bank’s common shareholder equity and a whopping 80 percent of tangible equity, which excludes goodwill and other intangible assets. On a gross basis, DTAs were even bigger; the bank hasn’t disclosed how much.
By comparison, Citigroup’s stock-market value finished last week at $20.5 billion. The longer Citigroup goes without chopping its DTAs, the more investors should be wary of any of its numbers.
Now look at some of the other fluff in Citigroup’s $96.3 billion of Tier 1 capital, as of Sept. 30.
-- The Tier 1 figure included $23.7 billion of so-called trust preferred securities issued by Citigroup, which are treated as debt under GAAP.
-- About $27.4 billion was preferred stock, which is debt from a common shareholder’s standpoint. (Citigroup raised an additional $25 billion from the government last month in exchange for preferred stock.)
-- The Tier 1 measure excluded $10.8 billion of paper losses on various securities and derivatives, even though these reduced GAAP equity. It also included $12.7 billion of intangibles.
So, in truth, Citigroup had little, if any, real capital, even if the values for all its toxic loans and mortgage-related investments had been accurate. Most of the above-listed items won’t help the bank absorb losses. Rather, they are the kinds of things that cry out for more capital.
What we need from America’s banks is for their leaders and regulators to start speaking with credibility.
We’ve had enough funny numbers
Giving government money to healthy banks and "encouraging" them to consolidate the bad banks is a reasonable course of action. However, Citigroup probably still has over $1 trillion of toxic assets "off balance sheet" and no capital to back up those "assets". The entire company is insolvent. For Citigroup to be fully rescued, it alone would need the entire $700 billion TARP to bail it out. The current round of $305 million of loan guarantees are not going to save the company any more than the first $25 billion of TARP money did. All the current bail out does is buy time for someone else to take over the problem. Get your hard hat on, Timothy Geithner.
And if the government continues with it's current plan,the United States government's cost of borrowing will eventually rise. Currently, the cost is low - Treasury bills yield 0.3%. However, as the financial contagion spreads across the world, fewer and fewer other governments will be able or willing to purchase our debt. That will be a problem when the United States government asks for another $1 billion for TARP II.
Eventually, our country's creditors will realize that the United States government is insolvent. Short of selling Alaska to Russia, there's no hope for the United States to pay back an $11 trillion loan. If our creditors refuse to loan us money at reasonable rates for TARP II, the United States will have to go to the International Monetary Fund ((IMF() for help. Of course, the IMF will tell us what it tells all its borrowers...devalue the currency and implement austerity measures. That inevitably leads to a depression.
I think this second Citigroup bailout is the beginning of the end for the United States. The only course of action that will stop this inevitable slide into insolvency is for Citigroup to be broken up and sold in pieces. Otherwise, Citigroup and AIG will suck up the rest of the TARP money designed for healthy institutions. And after that, I believe the jig will be up for additional bailout money.