In response to a request to reveal how bank bailouts funds have been utilized thus far, Assistant Treasury Secretary Neel Kashkari helpfully explains that when “you put in $1 into an institution, it’s impossible to follow where that $1 goes.” But nobody is really demanding a $1-for-$1 accounting from Mr. Kashkari. What taxpayers and investors want in hand is an unequivocal conceptual framework under which financial institutions have allocated the use of government aid. Without that, it is totally unreasonable to expect taxpayers to make any prudent assessments concerning the qualitative nature of the bailout exercise and investors to trade common shares of bailout recipients under any identifiable valuation umbrella.
As per an investment agreement signed with the Treasury Department on New Year’s Eve, Citigroup (NYSE:C) will undertake “reasonable best efforts” to provide use-of-proceeds details on a quarterly basis. As Paul Kiel (ProPublica, January 9, 2009) pointed out, this was nearly the 200th time the Treasury had executed such an agreement; but it was the first time that a recipient of taxpayer dollars was held accountable. Of course, certain critics of the Treasury’s actions since September are questioning why a “reasonable best efforts” clause was not replaced by a more affirmative statement for an agreement worth $20 billion. But what is more troubling is the fact that, without prodding from the Special Inspector General of the Troubled Assets Relief Programme, the Treasury may not have pushed for a disclosure clause in the Citigroup term sheet in the first place.
Little wonder then, that in the absence of any substantive information on the approximately $350 billion disbursed by the Treasury in supposedly controlling systemic risks, all kinds of troubling questions are propping up in the blogoshpere. Are the banks using taxpayer dollars to invest in the stock market? Are taxpayer dollars the cause of the last rally in equities? Since there is no evidence of a thaw in the credit markets, is the money being used to buy government debt or government-backed debt? Or, as one critic of the derivatives universe asked, has the bailout become a boon for the credit default swap and collateral debt obligations marketplace, with counterparties now willingly complying with settlement and delivery commitments?
The most important questions, by far, are for the Treasury. What were the valuation methodologies, if any, used to determine both yields on preferred stocks and strike prices for warrants? Why are the bailout stocks still trading when the fundamentals driving those stocks are not in the public domain? How can investors decide to buy or sell those stocks (AIG, AXP, BAC, C, GS, JPM, MS, WFC) if the impact bailout funds must have on earnings, solvency ratios and balance sheet risk profiles cannot be ascertained?
Last month, CNN’s efforts to get details on the use of the billions handed out by the Treasury were met with vague replies. A Bank of America spokesperson said that the funds were being used to “build our capital and make every good loan we can.” JPMorgan Chase has bought $1 billion of Illinois bonds, and plans to make loans to non-profit and healthcare companies. Wells Fargo refused to provide any details, and advised CNN to wait for the release of its next SEC filings.
But CNN’s frustration must have turned into shock this weekend: Morgan Stanley announced that it is likely to pay Citigroup as much as $3 billion for control of Smith Barney, Citi’s brokerage arm. A case of bailout candidates juggling bailout funds to create dubious value in an uncertain economic environment? Was not this money supposed to remedy the credit crunch in housing and business? Did Morgan Stanley, which recently reported a $2.3 billion loss for its fourth quarter, make sufficient loan- and asset-delinquency provisions in its own financial statements prior to offering $3 billion to Citigroup?
This writer’s short positions in the financial sector (NYSEARCA:XLF) incorporate the fact that lawmakers and regulators cannot let any of the bailout targets fail. They also incorporate another more compelling fact; numerous analysts who insist on issuing daily bullish calls on the beneficiaries of taxpayer dollars are unable to provide any factual basis for their price forecasts; as things stand, all the material facts required to credibly predict earnings are simply not available.
Disclosure: Author holds short positions in C, GS, JPM, XLF