Citigroup – bullet dodged, but bailout is an outrage: Kohler

The US Government bailout of Citigroup takes the financial crisis to a new level, but it is an outrage that cannot be seen as a template for future action.

The US Government bailout of Citigroup takes the financial crisis to a new level, but it is an outrage that cannot be seen as a template for future action.

The US authorities, outgoing and incoming, are plainly taking it one crisis and one fumble at a time; the scale of the official ineptitude up to this point is staggering. It almost matches the banking incompetence that led to the problem.

In a matter of months Citigroup has gone from rescuing Wachovia and claiming to be in excellent shape – one of the survivors – to sacking 52,000 people and identifying a pool of $US306 billion in problem assets that need to be 90% guaranteed for 10 years by the Government if the company is to survive.

Along the way it picked up $US25 billion in Government cash on what looks now to be pretty good terms. Certainly the terms for the $US20 billion as part of yesterday’s bailout are much worse.

And yet the Citibankers keep their jobs, although according to the term sheet of the bailout their salaries “must be submitted to, and approved, by the USG” (US Government).

This is not a “good bank, bad bank” rescue. It’s true that $US306 billion in bad assets have been “bagged and tagged”, as Mark Thoma of Economist’s View put it, but they will remain on Citigroup’s balance sheet.

The first $US37 billiob to $US40 billion of losses will go to Citigroup shareholders, the next $US5 billion go to Treasury, the next $US10 billion to the Federal Deposit Insurance Corporation, and the rest go to the Fed.

But Citigroup has more than $US3 trillion of assets – only $US2 trillion of which are on its balance sheet with at least $US1 trillion off balance sheet.

Will a bailout that provides a specific Government guarantee for just $US15 billion – or 0.5% of total assets – and a general provision against 10% of total assets prove to be adequate? Unlikely. How long before Citigroup will be back for more?

But at least the “USG” did not repeat its first big mistake of letting Lehman Brothers fail in September.

Lehman seems to have been similar to an outfield catch in cricket or baseball, where two fielders call for each other to go for it and the ball falls between them. In this case the two fielders were Federal Reserve Board chairman Ben Bernanke and US Treasury Secretary Henry Paulson. Over the weekend of 14 September, it was a matter of “yours…yours…oh, whoops”.

Then as the financial crisis became catastrophically worse as a consequence, Paulson and President Bush refused to contemplate an all-encompassing Swedish model of nationalising the banks and quarantining their bad assets, so the “good banks” could get on with lending.

Instead they flip-flopped around with the Troubled Asset Relief Program (TARP), eventually investing $US250 billion into the banks, which instantly disappeared with a slurping sound.

They then failed to use the money to buy mortgage securities, which led to a collapse in the market prices of those securities and with it a collapse in the prices of bank shares.

That, in turn, led to Citigroup’s share price falling 60% last week because of concerns about its massive exposure not just to mortgage securities, but also to over-the-counter derivatives and emerging markets.

And suddenly, as a result of its own mistakes, the Bush administration became the one over a barrel. Because it is “too big to fail”, Citigroup gets 10% of its $US3 trillion assets guaranteed by the Government plus another $US20 billion in new preferred equity with very few string’s attached.

It is hugely favourable to Citigroup, not transparent and probably unrepeatable.

Can the already-indebted US Government really just keep guaranteeing hundreds of billions in bad bank assets, recapitalise the banks on favourable terms and leave management in place?

Then again, maybe they will simply have to. Two IMF staffers, Miguel Segoviano and Manmohan Singh, this month published a staff working paper entitled Counterparty risk in the over-the-counter derivatives market in which they attempt to scope the cascade effects of counterparty risk in the OTC derivatives market (mainly credit default swaps and CDOs).

They conclude: “In the case of a single institution failure, the total loss could be as high as $300 billion to $400 billion depending on the FI; but when cascade effects are taken into account, the total loss could rise to over $1500 billion.”

We got a taste of that with the collapse of Lehmanm and the effects of it are still cascading. Citigroup’s collapse would be a multiple of that.

This article first appeared in Business Spectator