Senator Schumer: Guarantees Preferable to Establishing 'Bad Bank'

Bloomberg and the Financial Times report that Senator Charles Schumer in a CNBC interview yesterday said he favored the guarantee of troubled bank assets rather than the establishment of a so-called “bad bank.” His views carry weight because he is a leading Senate Democrat and member of the influential Senate Finance Committee.

If Schumer's view prevails the guarantee of $301 billion of Citigroup (C) assets in November 2008 might very well serve as a template for any such guarantees. In that deal the U.S. Government agreed to "ring-fence" $306 billion (later modified to $301 billion) of loans, investments, and commitments. These assets remain on the books of Citi; however, it is responsible for only the first $39.5 billion loss plus 10% of any losses greater than that. Citi's total exposure on these toxic assets is therefore $65.65 billion.

In return for this guarantee, Citi issued $4.034 billion in 8% Cumulative Perpetual Preferred Stock to the U.S. Treasury and $3.025 billion in the same 8% preferred to the FDIC as a "fee". Citigroup also issued to the U.S. Treasury a warrant for an additional 66,531,728 shares of common stock at the $10.61 strike price, which was the average of the closing prices of Citigroup common stock for the preceding 20 trading days.

Interestingly, the arrangement is really like Citigroup buying an insurance policy with an initial non-cash premium of $7.059 billion, which is the sum of the awarded preferred stock, and a quarterly cash premium of $141.2 million. As the insurer, the U.S. Treasury is also given an equity kicker via the warrant.

Comments

[matthew riva:]

Thank you for your research. It sounds as if the worst is behind Citi(C) as they were the first to be unwound, therefore, the first to be healed.

Feb 04 03:08 PM

[MJJP:]

Shumer may have a point. After all why throw money at a problem that might not be a problem? Every effort should be made to collect on the loan. I don't buy the claim that homeowners(or business) can't pay on a mortgage(loan) for a home because its value has gone down.That happens all the time and it did for me. I would be hard pressed to sell my home for what I paid for it along with a two room addition and garage. We are letting people off the hook way to easy at the taxpayer expense.

Feb 04 07:08 PM

[k9s-4-k8:]

It sounds like Schumer is finally coming around to the Republican House proposal before TARP was enacted.

Feb 05 07:31 PM