Monday, February 23, 2009

Deducing the true character of Obama from the Citigroup incident

The details of the Financial Rescue Plan has yet to come out. 
Aside from the potential mandatory convertible preferred injection into all banks that don't pass the stress test, there are rumblings about government swapping its TARP preferred in Citigroup into common equity stake. I thought it would be interesting to record a snapshot of my analysis of the situation before the details are out, particularly because I want to analyze the TARP preferred to common equity swap in isolation. Even though the new equity injection may be more important when they come out, the way the Obama administration proceed with the preferred to common swap would reveal to me the true character of Obama.

Financial matters are always obscure to the majority public and the nuances of financial deals/structures are always beyond the comprehension of the mass. This is why it was so easy for Paulson to get away with injecting capital into troubled banks at favorable terms to the banks. This is why there has been no public uproar over the tens of billions of wealth transfer from taxpayers into the AIG bondholders. No one in the mass media gets too hung up on the fact that AIG bondholders should have taken a hair cut given the massive losses, and would have if the government hasn't been giving the rounds of windfalls to the bondholders.

But that was the Bush administration. So far Obama has done no such thing. Unfortunately, he is about to start. And it doesn't smell like he won't take advantage of the public's ignorance over financial matters to unjustly enrich the financial oligarchs. No conspiracy theory is necessary here. But it has always been common sense for politicians to steal money from someone who wouldn't know that it's being stolen from him. The side that you rewarded will find a way to reward you down the way anyway.

One key development to watch is how things would work for Citigroup. A good analysis of the situation will have to start with assessing whether Citigroup has lost more than its current Tier 1 structures can cushion. If it is probable that another $100BN losses or more yet to surface, then the government must not inject any more capital yet. For anyone fluent in banks financial statements, you have to be delusional to believe that Citigroup really has $29BN tangible common equity left. That's 1.5% TCE ratio. The government is about to boost its TCE ratio to more "overcapitalized" level. Call it 5%. This can be achieved simply by converting all $70BN preferred into common equity. But at what valuation? How about at the tangible book value? That's certainly generous relative to today's market valuation to banks, but it wouldn't be the most egregious thing that's been done by the government so far. That would give the government a 45% stake in Citigroup.

But the government could and should own more. They could seize the bank, wipe out all Tier 1 structures (even their own $45BN preferred) and own 100% of the bank. Then they could sell it to another bank or private equity buyers. It would own 100% of the bank instead of 45%. If it turns out that Citigroup is more than another $100BN under the water that the Tier 1 cushion wasn't enough to protect the debt, then either approach would lead to a complete wipeout of the government's investments thus far. If Citigroup's losses are not beyond its Tier 1 can cushion, then why would the government chooses to own 45% stake rather than 100%? If the government chooses 45%, it has given a windfall to the other 55% shareholders, no matter it's a willful act or just unintended side effects. The other 55% shareholders would have been wiped out long ago if not for the serial government capital injections, insurance wrap and funding backstops. The government doesn't want to consolidate the $2 trillion debt on its balance sheet? It can take a 79.9% stake like they did in AIG. It's still better. Triggering CDS? CDS were triggered in FNM and FRE's conservatorships and it went ok. It is an urban myth that triggering CDS is a systemic risk. No. It is the impairment of bonds such as what happened in Wamu or Lehman that caused the tsunami. Why do the Citigroup shareholders and preferred investors get such a preferential treatment compared to those of AIG, FNM, FRE, BSC, WB, WM and LEH? I've heard a lot arguments. None of them makes sense. If somehow Citigroup has equity value left in the Tier 1 structures, then that 55% ownership stake would represent what's stolen from taxpayers.

Unfortunately Citigroup has probably, though not certainly, lost enough that its Tier 1 structures have been completely wiped out as well. Whether the loss beyond Tier 1 is another $20BN or $200BN, it has to be borne by someone. Obama will have to choose between the taxpayers and the Citigroup bondholders. He will choose to pass the burden to taxpayers, because it is the less risky choice. Bondholders in the capital markets can revolt but taxpayers can't. That is, until they are angry enough.

No comments:

Post a Comment