When the Big Three automakers were finally settled in their chairs before the Congressional committee investigating whether they deserved a handout of $50 billion, they were asked a defining question; “How many of you flew commercial airlines to get here?”
No hands went up and they were sunk. Somehow the hubris of trotting about on private jets while asking for public money was simply too much for a suddenly stingy Congress.
No such questions were asked of the Citi bankers, in fact no hearings were even held, and they were given access to over $306 billion on the most favorable terms you could possibly imagine. This illustrates the power that the banking industry holds over our political process and it is a ruinous power. Why should Citi receive not only special treatment, but exorbitantly preferential treatment at taxpayer expense? I don’t know, but I’d like some answers.
First, check out the terms of the deal:
Citi’s Taxpayer Parachute
Another Sunday night, another ad hoc bank rescue rooted in no discernible principle. U.S. taxpayers, who invested $25 billion in Citigroup last month, will now pour in another $20 billion in exchange for preferred shares paying an 8% dividend.
Taxpayers will also help insure $306 billion of Citi’s mortgage-backed securities. Citi will cover the first $29 billion in losses on these toxic assets, and then taxpayers will cover 90% of the rest, in exchange for another $7 billion in preferred.
What’s so special about this deal? First, the next $20 billion only provides taxpayers with an 8% yield. This is well below current market rates and, as such, represents a giveaway. I would guess that the cost of capital for Citi should be in the vicinity of 15% (or more) right about now.
So $10 billion of that $20 billion is pretty much of an outright gift. Second, I am concerned about how the toxic assets have been valued when setting this deal. The fair way to do it would have been to mark them to market forcing Citi to eat the losses that are already baked into those assets.
However, the implication in every article I’ve read is that the Citi “assets” were valued at their full cost (not value). This means that they are overvalued by some 30%-50%, almost without a doubt.
But that’s not the worst of it. When I dug into the Treasury Department website the terms of the deal said this:
Treasury Statement on Citigroup
As a fee for this arrangement, Citigroup will issue preferred shares to the Treasury and FDIC. In addition and if necessary, the Federal Reserve stands ready to backstop residual risk in the asset pool through a non-recourse loan.
This is the most staggering giveaway I could have possibly imagined. To understand why, let’s review the definition of a non-recourse loan:
A nonrecourse loan is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender’s recovery is limited to the collateral. If the property is insufficient to cover the outstanding loan balance
This means that when, not if but when, Citi defaults on this loan there will be no mechanism for recourse for the taxpayers.
Why am I confident that Citi will default on this particular rescue loan? Because they are smart people and paying it off would be stupid.
The $300 billion of “assets” pledged as collateral for this loan are worth, perhaps, half that. Possibly as little as 10% if Citi has done its job and purged the worst of the worst from its balance sheet to tuck into this sweetheart deal.
So it’s very simple. Either Citi makes good on the loan and repays all $300 billion and then takes possession of perhaps $30 billion of damaged assets or it defaults and keeps $300 billion.
What would you do?
I am, again, more than a little angry at this deal. It seems that when productive industries or actual citizens are involved, money is hard to find and difficult questions are asked. When banks need the cash? The results are enormous, immediate, and exceptionally favorable.