Sheila Bair and seizing Citigroup

I suggested that Sheila Bair might seize Citigroup precisely because it is the sort of irrational, arrogant and dumb thing she does.  She did after all force the issue at Wachovia – signing a government guarantee (to Citigroup) even though a fully private sector solution was available.

But people took my suggestion seriously.  Some thought I had “jumped the shark”.  Others thought that I was straight predicting it.

So now – just to lay out the issues – I am going to discuss – in all seriousness – what a government seizure of Citigroup would look like – and how it might affect the rest of the economy and other bank stocks.

It is open to Sheila Bair (and her fellow regulators) to seize Citigroup (deeming it unsound) and to leave at the holding company – and worth near zero – all the equity, preferred shares and holding company debt obligations.  Indeed this is precisely what she did at Washington Mutual.  What she did once she might do again. 

This will in fact result in a full successful resolution of the Citigroup problem at no cost to the government from Citigroup.  There is a darn strong case for doing it. 

Here is the liability side of the Bank Holding Company balance sheet from the last filing period:

 

 

I am sorry it is in thousands but it is a regulatory statement – and that is how they come. 

Click and look at it.  There are 17.5 billion in short term parent company debt and 117.5 billion in parent company debt with more than a year’s maturity.  There are a further 27.4 billion in perpetual preferred securities and 28.5 billion in subordinated debentures. 

If Sheila Bair confiscates Citigroup and leaves all those liabilities at the holding company then it is economically the equivalent of a 184 billion dollar equity injection into the remaining group.  A cancelled liability of course is the equivalent of new (non cash) capital.

The new Citigroup should be adequately capitalised – albeit government owned.  The FDIC could IPO the new Citigroup once this market mess had died down (and remit most the proceeds to former bond holders).  A shrinking Citigroup with an additional 184 billion in capital shouldn’t cost the government anything.

But Sheila Bair does not need to stop there.  She has the power to guarantee some assets of the new entity – and her guarantees carry the full faith and credit of the US Government.  She did this with Wachovia.  The new Citigroup could then put the guaranteed assets into a special purpose entity and repo finance the entity.  This would look similar to repo-financing treasuries – and the new Citigroup could thus obtain very cheap funding.  That cheap funding would guarantee its liquidity and its profitability – and hence ensure that the government does not lose anything further (other than borrowing capacity) from the Citigroup nationalisation.

Remember both steps of this Sheila Bair has performed before.  She confiscated Washington Mutual and left behind the parent company liabilities.  She guaranteed assets at Wachovia.  This is Sheila Bair’s proven style.  And she would look a hero because Citigroup would be resolved at no cost to taxpayers.

But…

And you knew there would be a but…

If Sheila Bair was to confiscate a really big bank and cancel all the parent company liabilities then no other bank in America would be able to raise parent company debt.  Indeed I think that has been the case ever since Sheila Bair did the reckless and irresponsible takeover of Washington Mutual… but it would certainly be the case if the parent company liabilities of Citigroup were cancelled.

And that would be a huge decision indeed because then every bank with parent company liabilities (meaning almost every bank in North America) would fail. 

Many – but not all – could be taken over in the same fashion at little cost to the government.  But almost all of them would wind up property of the US Government.

Full nationalisation, Swedish or Norwegian style, is an effective end to a financial crisis – and Sheila Bair has the power and has proved that she is willing to use it.  But it is a decision way above her pay grade.  (Where is President Obama’s new Treasury Secretary?)

My view is that Sheila Bair should not only not use the powers she has previously shown a willingness to use – but that she should resign immediately and admit that her previous decisions were in error.  She should resign now – or Citigroup is likely to be hers anyway.  

 

 

John Hempton

Postscript:  The Holding Company has several regulated subsidiaries - presumably in several jurisdictions.  All the regulated subsidiaries would have to be seized together - and if some came up short some form of solution would need to be found.

Postscript 2:  Actually I think the die was cast for Citigroup when Sheila Bair confiscated WaMu.  The lesson was learnt that bank debt could be treated very unfairly by regulators and hence banks were never going to be able to get finance again.  The worst decision of this cycle was to let Lehman fail so badly - creditors got very scared.  The second worst was the reckless way in which creditors of WaMu were treated - it made them even more scared.