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Friday, November 21, 2008


the death of citi

citi has been spiralling for days, and it looks like it could be taken over this weekend in spite of gary crittenden's happy talk.

the big question is "how?" clusterstock forwards john hempton's critique of what an FDIC takeover might look like.

It is open to Sheila Bair (and her fellow regulators) to seize Citigroup (deeming it unsound) and to leave at the holding company – and worth near zero – all the equity, preferred shares and holding company debt obligations. Indeed this is precisely what she did at Washington Mutual. What she did once she might do again.

This will in fact result in a full successful resolution of the Citigroup problem at no cost to the government from Citigroup. There is a darn strong case for doing it.

There are 17.5 billion in short term parent company debt and 117.5 billion in parent company debt with more than a year’s maturity. There are a further 27.4 billion in perpetual preferred securities and 28.5 billion in subordinated debentures.

If Sheila Bair confiscates Citigroup and leaves all those liabilities at the holding company then it is economically the equivalent of a 184 billion dollar equity injection into the remaining group. A cancelled liability of course is the equivalent of new (non cash) capital.

The new Citigroup should be adequately capitalised – albeit government owned. The FDIC could IPO the new Citigroup once this market mess had died down (and remit most the proceeds to former bond holders). A shrinking Citigroup with an additional 184 billion in capital shouldn’t cost the government anything. ...


And you knew there would be a but…

If Sheila Bair was to confiscate a really big bank and cancel all the parent company liabilities then no other bank in America would be able to raise parent company debt. Indeed I think that has been the case ever since Sheila Bair did the reckless and irresponsible takeover of Washington Mutual… but it would certainly be the case if the parent company liabilities of Citigroup were cancelled.

And that would be a huge decision indeed because then every bank with parent company liabilities (meaning almost every bank in North America) would fail.

Many – but not all – could be taken over in the same fashion at little cost to the government. But almost all of them would wind up property of the US Government.

Full nationalisation, Swedish or Norwegian style, is an effective end to a financial crisis – and Sheila Bair has the power and has proved that she is willing to use it. But it is a decision way above her pay grade. (Where is President Obama’s new Treasury Secretary?)

... Postscript 2: Actually I think the die was cast for Citigroup when Sheila Bair confiscated WaMu. The lesson was learnt that bank debt could be treated very unfairly by regulators and hence banks were never going to be able to get finance again. The worst decision of this cycle was to let Lehman fail so badly - creditors got very scared. The second worst was the reckless way in which creditors of WaMu were treated - it made them even more scared.

don't look now, but shares of jpmorgan chase are falling precipitously as well as it bank of america. JPM is my TBTF home, and BAC is banker to half of american households.

UPDATE: hugh hendry of eclectica:

"All financials will be owned by the U.S. government in a year," Hendry said. "I bet you."

at least citi will have company.

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