It looks like we have a solution to Citi’s crisis. The U.S. Government agreed to bailout Citigroup, backing $306 billion of debt in exchange for preferred equity and warrants plus a host of other details I will enumerate below. On the whole this looks to be a better deal for the U.S. Government and American taxpayers than the AIG deal. However, it is yet another ad-hoc band-aid when a comprehensive solution is preferable.
The most salient points of the deal hammered out in around-the-clock negotiations this weekend are below:
- The U.S. Government will guarantee $306 billion in toxic mortgage-backed and other troubled assets of Citi’s total $2.2 trillion in assets. Citigroup will cover the first $29 billion in potential losses (pre-tax). The government will then pick up the tab on 90% of the remainder not provisioned for. These guarantees are in place for 5 years on non-residential assets and 10 years on residential assets.
- The troubled asset classes include residential and commercial mortgages, leveraged loans and structured investment vehicles (SIVs). I have not seen anything about credit card-backed debentures.
- The government will provide Citigroup with $20 billion in equity capital in exchange for preferred shares. This money comes in addition to $25 billion in capital already provided to Citi under the Troubled Asset Relief Program (TARP). The stake is dilutive for current shareholders. The preferred shares will pay a dividend of 8%.
- The preferred shares come with warrants that give the government the opportunity but not the obligation to buy a further 254 million shares at a strike price of $10.61. Note that this is potentially dilutive to current shareholders.
- Citigroup must cut its dividend to common shareholders. The company can pay out no more than 1 cent in dividends on common shares per quarter for the next three years. This means a significant cut to the current dividend of 16 cents per share.
- There have been no announcements suggesting that any executives were required to resign.
Shares are rising across the board in the pre-market due to this announcement and Citigroup has seen its shares skyrocket to above $5 per share in pre-market trading despite the dilutive nature of the deal.
All in all, this is a better executed deal than the one with AIG. However, I would have liked to see pay caps and resignations as the present executive staff at Citi bears much of the blame or the company’s state of affairs.
This deal does beg the question as to why the U.S. Federal Government has dragged its feet on a Nordic-style comprehensive solution. The Swedish model or the S&L model or the Depression-era model — these are all precedents that should be used to craft an approach that is not ad-hoc in nature. If we have learned anything during this crisis it is that the banking system is more fragile than many anticipated. We should also have learned that “free-market” solutions can allow panic to spreading times of crisis.
Because fractional reserve banking is inherently reliant on depositor, investor, and counter-party confidence, we risk further episodes of a similar nature unless toxic assets are stripped out of the system and potentially insolvent banks are swiftly dealt with by government.
Perhaps Obama’s economic team is aware of the perils of inaction. Let’s hope they can offer a more comprehensive solution than the free-market ideologues of this Administration.