I’ve spent most of the past two weeks alternating between dizziness and sleep. Maybe the dizziness explains why I find myself in agreement with a WSJ editorial:
In a better world, Citi would have long ago been put into bankruptcy. The FDIC could have taken over and disposed of the bank’s assets, while protecting insured deposits as it always does. The profitable parts of Citigroup could then have been sold off to people who could better manage them.
Let’s do some elementary math in support of the WSJ position:
Taxpayers have already put more than $50 billion in capital into the bank, while guaranteeing $301 billion of its bad assets, and the bank still can’t stop its slide.
All right, I’ll work with the low number, which is the most optimistic estimate anyone has published recently: $50 Billion. The Big C’s market capitalisation (the Present Value of the Expected Unencumbered Future Cash Flows as expressed as the stock price times the number of shares) as of last night is $8.18 Billion.
Can we stop talking about the evils of “wiping out the existing shareholders”? They were wiped out more than $40 Billion ago.
The WSJ does make one mistake:
But in this vale of taxpayer tears, Citi is “too big to fail” and thus must be propped up lest it (allegedly) spread contagion through the financial system. While that may have been true last fall amid the worst of the financial panic, we don’t think the contagion would be the same now that the federal government has guaranteed anything in the financial system that moves.
Well, not exactly. By my count from the FDIC Failed Banks list, 28 banks have been closed since October of 2008, including two yesterday. And there’s no sign that that trend is ending. But this is spot on:
That isn’t the view at Treasury, which yesterday agreed to a stock swap that will buy Citi more time to, well, who knows? The feds will trade the preferred taxpayer shares for Citigroup common, which means giving up their 5% dividend and taking on more future risk in return for a 36% ownership stake.
Let’s review below the fold:
- The Fed has put at least $50 billion into The Big C.*
- The Big C is worth, according to its best-informed shareholders, slightly over $8 billion.**
- The Fed’s $50 billion will get it a 36% share in The Big C.
- Basic Math Interlude: $50B=0.36x => x = $50B/0.36 = $138.89B implied value
- Pause to repeat: The market thinks The Big C is worth just over $8 Billion. The current “book value” of the institution—a mythical number only an accountant could love, and her only because she is paid to love it—is just over $80 Billion. The Best Case Scenario for the Fed commitment is that The Big C is worth nearly $140 Billion.
- Remind the blogsphere of Simon Johnson’s answer to Question 8:
8. How many of the largest 5 banks will likely end up with government as majority owner?
– Any honest market-based valuation of bank assets will show a majority of large banks are presently insolvent but can be righted with substantial new capital.
– If the answer isn’t “at least two,” then either the Treasury does not plan to properly value assets, or someone is not yet prepared to tell the full truth.
- Point out that, if you believe the market, there are two banks that are currently Serious Outliers in Book-to-Market Value, The Big C and BofA.
- Decide not to discuss stress testing, which indicates that Wells Fargo is also seriously endangered, in this post, in large part because of its acquisition of WalkAllOverYa, which had previously acquired World Savings Bank. Leave for later; tell audience not to hold breath.
Now, let’s pretend that past is prologue and that Timmeh! is just making the best deal he can. (Pause for laughter to subside.) Let’s just Focus on the Future.
The Obama Administration is commonly described as planning to ask for $750 Billion in additional “bailout funds.” They are claiming that this should be shown on the budget as $250 Billion, since they expect to get about 2/3s of the funds back over time. [link added, h/t Frank Rich in the NYT]
Given the above details re: The Big C, and the abundant reports with multinational historic examples that shows nowhere near that size of return, why should we be expected to believe them?
With regard to The Big C, I’ll give the penultimate word, once again, to the WSJ editorialists:
Meanwhile, Treasury is forcing the bank to get some new, and presumably more competent, directors. Many of the current directors were going to leave later this spring anyway, but at least this imposes some discipline in return for the federal largesse. Citi’s management will stay in place, at least for now.
Again in a better world, the new board and Treasury would find better managers. But yesterday’s announcement included no roadmap for how the bank plans to restructure, if it even plans to do so. The hope is that it can earn itself back to profitability. More realistically, a bank that has failed as often as Citigroup needs to shrink until it is no longer too big succeed.
As followers of the Iraq War know, Hope is not a Plan. When the WSJ endorses nationalisation, it’s clearly an idea whose time has come.
*We can pretend the asset guarantees—a Really Stupid Idea from people Robert assures me are smart—are independent of the firm; that is, if Goldman or BofA owned them, they would have gotten the same deal.
**I maintain that the current stock price is approximately the price of a two- or three-year call option at a price marginally above the current level—say, $3 or $5—and as such we should rightly view the current stock value as $0.00. But that’s for another post.