Treasury and Citi

The WSJ reports on an Obama administration plan to convert US Treasury owned preferred shares to common stock. The plan seems to be an answer to the question “How does one save an insolvent bank without giving a windfall to current shareholders or nationalizing ? “

The government will convert its stake only to the extent that Citigroup can persuade private investors such as sovereign wealth funds do so as well, the people said. The Treasury will match private investors’ conversions dollar-for-dollar up to $25 billion.


The conversion will come at the most-favored price, meaning the government will get the best price of the private shares that are converted. Citigroup has already begun talking with preferred shareholders about the conversion, people familiar with the matter said.

Ah yes that’s it. Seems that smart people work for the US Treasury (OK I know that already).

Under the plan, current common stock will be diluted so much that it is basically worth zero even if Citibank survives. However, since the Treasury will obtain only one share for every share obtained by other investors, it can’t have a majority stake.

Other holders of preferred shares are being told that they have to trade their preferred shares for common stock or Citibank will be allowed to fail. The argument is that they can see how much they can get from Citibank or they can see how much they can get from a bankruptcy judge. someone with 100 preferred shares will free ride. Entities with large stakes will bargain with each other and Citibank and reach a deal. Nothing concentrates the mind like imminent bankruptcy proceedings.

after the jump, I speculate on the next step if this doesn’t solve the problem.

I suppose if Citibank is still insolvent after all institutions which own large amounts of preferred shares have converted to common stock, then the Treasury can announce a similar deal involving bondholders. If they convert the bonds to common stock the Treasury will buy identical bonds and convert them to common stock (inject more cash money for common stock).

In bankruptcy bonds are converted to common stock. The plan is to force large creditors of Citi do it now officially voluntarily without involving a judge, because otherwise there will be huge delays and losses.