Proceeding with Nationalization: Where to Begin

Until this point government stuck to preferred stocks instead of common stocks traded in the market. Preferred stocks are not exactly ownership, as there are no voting rights, and this arrangement between government and the banks is deliberate.

Preferreds are closer to debt than to equity. With yesterday’s announcement, that might change with the government trying to convert its preferred holdings into common stocks. When it holds a majority of common stocks, it would then be defacto nationalization.

http://www.federalreserve.gov/newsevents/press/bcreg/20090223a.htm

Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory. Previous capital injections under the Troubled Asset Relief Program will also be eligible to be exchanged for the mandatory convertible preferred shares.

How much can the government take?

The Treasury’s current preferred investments in Citi (C) for example is 5x times its market cap and theoretically government could take Citi 5 times over. In Bank of America (BAC), it is 2X, in AIG and GM it is probably 100X J, 33% in JP Morgan (JPM), etc. So, if the government wants to nationalize it can do so with its current holdings without spending anything extra. As I have mentioned earlier, we are very close to seeing some blockbuster nationalization (most likely Citi).

Chart source: http://en.wikipedia.org/wiki/Troubled_Assets_Relief_Program

How to proceed with the Citi nationalization?

The scale of announcements the last few days means that it is a matter of just a few hours / days before the receivership, and what will be most interesting is how government is going to run it. Unlike AIG, Freddie Mac (FRE) and Fannie Mae (FNM), Citi is far more complex and far more global. Insurance was pretty highly regulated and hence they could take receivership and slice off the portions, whereas investment banks are not.

The biggest concern why the President is postponing the day of reckoning is the global mess and confusion this will generate. What will happen to the 100+ global divisions of Citi – will they all be taken over by the US of A, or will it be left for the local authorities to manage? This must be negotiated with all the major stakeholders and it is a real problem.

So, in short the devil is in the details. Citi cannot survive under the current form, but government ownership can cause serious issues to the long-term survival of the industry. In Sweden the government kept banks at arm's-length to prevent political interference. You cannot rely on the U.S. government to do that.

My plan would be to split Citi into potentially good divisions (Smith Barney-Global Wealth Management, Citicards, Banamex) and sell them in the market now. The rest of the assets should be put in a separate account managed by the government and got rid of, slowly. The most important point is to remove the cancer cells from the healthy ones, and also keep the government out of running the well-run divisions.

The government has no experience in running Smith Barney and the rest of Citi’s private banking division and should not mess with it. The government should sell all of them (there can be good buyers given that those divisions make money) and retain only the toxic assets for a while, and dispose of them slowly.

Comments

[athena:]

Such a sad day indeed. No one yet has seen the implications. We have become a banana republic. Without the bananas.

Feb 24 02:45 PM

[Hopefull:]

No.What is needed is a valuation of CITI assets on a discounted cash flow hold to maturity value.This will determine the real value of C.Nationalization is just a way to have an unthinking sale of the mortgage backed securities at firesale prices.The government wouldn't care what price they sold them off for as they are dealing with our money and they would get political credit for cleaning up the banks. Why should the shareholders of C put up with this? It is the buyers of these assets probably with purchase financing from the government that will make out like bandits.

Feb 24 03:25 PM

[Ron T:]

This is just welfare for the rich. The people would be better off with this debt going in a fire sale liquidation to the vultures. Because then the people could settle their debts for 20 cents on the dollar with the new buyers of the debt. ‘Nationalization’ is a fake argument by the bondholders and counterparties to protect their own narrow interests at the expense of the taxpayer who would be much better off in a bankruptcy of these banks. The government never wanted to ‘nationalize’ the banks in the sense of a socialist country at all. But the bondholders and counterparties are using this argument to prevent a well deserved bankruptcy of these banks. An RTC style receivership would bankrupt Goldman Sachs et al as counterparties and that is why they have manipulated the government into saving these banks. Remember 10% of the population owns 85% of the stocks and, more importantly, bonds. The people are paying for the back door monetization of this debt. Would anyone except the government pay $45 billion for a 40% non controlling stake in Citigroup? I think not. This is just a backdoor giveaway of taxpayer money, that Wall Street hopes the public won’t notice.

Feb 24 06:23 PM

[Mad Hedge F...:]

So nationalize the banks already! Get it over with! Call it whatever you want: partial nationalization, temporary nationalization, socialization, liverwurst, or rutabaga. Just get it over with! This tortuous slow drip of on again, off again, stop gap measures is going to cost us more than if we executed the politically incorrect “N” word. Of course, a government takeover is the worst nightmare for many Republicans. But now that former Fed governor Alan Greenspan and many fiscal conservatives are on board, this shouldn’t amount to political suicide for Obama. The FDIC’s Sheila Bair already does this on an almost daily basis with smaller regional banks, like Washington Mutual, but for some reason the top nine “too big to fail” banks are sacrosanct. Their deposits have been effectively nationalized with government guarantees since last fall. The market is already selling us that many of these once hallowed institutions are now worthless. This is what Citigroup (C) at $1 and Bank of America (BAC) at $2 are telling us. Just wipe out the pitifully little the common shareholders have left, clean them up, and resell them in five years after the credit markets are restored. Every government that ever did this, like the UK in the eighties and Hong Kong in 1998, made a fortune. I was involved with both, and serious coin was made by the sellers and the buyers. Not to drive a stake through the hearts of these de facto “zombie” banks really would risk a Great Depression II and an “L” shaped lost decade. The markets would love decisive and surgical action like this and rocket.

Feb 25 07:45 AM

[normthefedup:]

And yet another voice in the wilderness is heard from. I hope you own about 25,000 shares of Citi because you and those of your ilk who keep spouting your negatives opinions are a substantial part of the problem we're now experiencing. You must be related to that other moron, Chris Dodd....oh...he's the head of the Senate Banking Committee. Another one who doesn't have to worry about his 401K or IRA or feeding his family through retirement after this mess finally comes to an end. Of course not, because people like me will be paying to feed HIS family, too. Shut up, author. Keep your opinions to yourself. We don't want to hear it anymore. It's time to turn this economy around and you are NOT helping.

Feb 25 08:32 AM

[James Wilson:]

Take over the Federal Reserve and you control all banks !

Just one action!

Bankers are lending !

Banking insiders are borrowing to buy cheap foreclosed homes and load up on cheap stocks while the market is down.

Rich get richer just like all the banking crisis it is the bankers who own more of the USA and the citizens own less.

Feb 25 08:59 AM