Citigroup: Not the Reaction a Bailout Should Get

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”)

The 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:

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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.

Disclosure: no positions

Comments

[Emerald:]

Cit's board is an embarrassment. All board compensation should be cut to $1 for 2009 if they don't resign (which they should.) The top 25 executives at Citi should voluntarily agree to work for $1 with no bonusues (cash, restricted stock or options) for 2008. The next 200 executives should get no bonus for 2008 and have their salary capped at $150,000 for 2009. If you mismanage my investment in the common and eliminate the dividend, its the least you could do. Goldman tokk the lead; you should match it quickly. I sold 50% of my posiiton last week. Long "C"

2008 Nov 26 10:37 AM

[Drew149:]

When a bank like Citi is "too big to fail", the executives and board members will always look out to benefit themselves (i.e. take on huge amounts of risks to reap the most compensation possible) because they will ALWAYS get bailed out once their ship starts sinking.

2008 Nov 26 11:39 AM