Friday, November 14, 2008

Citigroup, Whachovia, Sheila Bair and a post I didn't make...

In the middle of the Citigroup/Wachovia thing I wrote a post which I circulated amongst friends but do not remember posting.  It was a little hot.

As speculation that Citigroup is insolvent is now widespread (see Felix for a recent example), I thought I might just post it.  Sorry dear readers to not give it you when it was more relevant:

Is Citigroup going under? Is Sheila Bair's erratic behaviour really her trying to save Citi? 

Readers will know that I think pretty lowly of the head of the FDIC. Maybe I am wrong. 

I have been puzzling this weekend – trying to work out what is going on using the assumption that all is part of a grand and competently executed strategy.

And the result was unsettling. The best hypothesis I came to is that Citigroup is going down and that Sheila Bair is trying to save it.

Sheila Bair – as readers will remember – forced Wachovia to sell itself in three days whilst other parties had not had anything like enough time to complete due diligence. She – unilaterally and incorrectly – told the world that this deal could not be done without government assistance. She unilaterally decided to issue a guarantee that on a pool of $312 billion of Wachovia assets Citigroup could not lose more than $42 billion. She made that decision even though Wells Fargo was telling her that all they required was more time to do due diligence.

Given that Wells Fargo was willing to acquire Wachovia at no-cost to taxpayers that looks like a very bad decision indeed. But this is the post assuming that Sheila Bair is smarter than all of us.

And so we need to understand the significance of that guarantee. The significance is as follows: Once Citi owns $312 billion in assets on which they can only lose $42 billion the remaining pool must be worth $270 billion. That $270 billion is guaranteed by the US Government – as the FDIC is a full faith and credit organisation. Citigroup can put that $270 billion (plus the $42 billion in non-guaranteed assets) in a pool and repo it – and as Treasuries yield very little they will wind up paying well under a percent of interest. The Sheila Bair decision was equivalent to a cash injection into Citigroup of 270 billion because the repo-market will turn government guaranteed loans into cash.

That cash injection is almost 40 percent of the size of the whole bailout package and it was given to Citigroup by Sheila Bair without congressional oversight. We got all stroppy at giving Paulson that sort of unilateral powers – but – hey – we are prepared to forget that Sheila Bair already has them.

Anyway – Citigroup buying Wachovia reliquefies Citigroup. Big time. Citigroup almost certainly knows this. Sheila Bair – if she is smart – knows this. That is why it is so important for Citigroup to complete the deal.

Now Wells Fargo have come to destroy the party. They are prepared to buy Wachovia without any government guarantee. The FDIC should be cheering as this removes all cost to the taxpayer – but Sheila Bair stands behind the decision to sell Wachovia to Citigroup.

Citigroup isn't looking to sue Wachovia for a break-up fee. They are looking to enforce specific performance on Wachovia. They are not interested in a $20 billion break-up fee – that does not save them. That is just too small. They are interested – critically interested – in the net $270 billion in guaranteed assets because that is the equivalent of $270 billion in cash – enough to save Citigroup from destruction.

Specific performance is very hard to enforce as numerous blogs have pointed out – here and here for example. But in this case it is necessary.

Sheila Bair is smarter than I thought and she knows it too. So I withdraw my demand that Sheila Bair resign – on the basis that it is probable that Sheila Bair knows more than me and she deemed it necessary to inject $270 billion in cash into Citigroup to stop their imminent failure.

Of course if this thesis is wrong Sheila should just save me the trouble of issuing a correction and resign forthwith.



John Hempton






Anonymous said...

an very useful insight and well explained, I would be interested to get your opinions on where we are now as CITI, by many observations, has fallen through previous support and looks to be going substantially lower so their not out of the woods yet.

Although the $270 B may be logically enough, the damage may already have been done from a sentiment/confidence perspective, keep up the good work

Anonymous said...

You wrote: "Given that Wells Fargo was willing to acquire Citigroup at no-cost to taxpayers that looks like a very bad decision indeed."

I think you meant to write: "Given that Wells Fargo was willing to acquire Wachovia at no-cost to taxpayers that looks like a very bad decision indeed."

Anonymous said...

John thank you for really good posting over last few days. Really insightful and interesting views.

John Hempton said...

Anon - I have fixed - Thanks.

Anonymous said...

Plausible. Hard to get an idea of Citi's losses but IIRC they have a $2Bn balance sheet and another $1Bn off balance sheet. Lehman's example shows that with sufficient idiocy you can pile up a loss of around $120Bn on a $600Bn balance sheet. Assuming, perhaps pessimistically, that Citi is in the same league, then you have $400Bn of losses and another $200Bn in the VIEs. A dodgy read-across, to be sure, but not an unthinkable one. On that basis, the Citi capital raises to date are of the wrong order of magnitude, but the mechanism you are suggesting is a bit more like it.

Anonymous said...

Interesting, but you've got your facts wrong.

(i) Bernanke and Paulson pressured Bair into providing support for the deal. See WSJ 11-10 article, last column.

(ii) WFC was not prepared to buy Wachovia without government support. From S-4

Sept 28, "representatives of Wells Fargo proposed to, and discussed with, representatives of the FDIC and other federal bank regulators a possible transaction between Wells Fargo and Wachovia that would include a loss-sharing agreement with the FDIC whereby Wells Fargo’s exposure to losses would be limited with respect to specified Wachovia assets it would not have had an opportunity to review in depth."

Wells Fargo only agreed to buy Wachovia after Treasury granted $140B in tax concessions. The WaPo's been on this deal.

That said, I viewed the Citi Wachovia merger as an effort to consolidate bad apples before determining how to dispose of the rot.

Anonymous said...

What about the liabilities?? Do you realize the misunderstanding inherent in your argument? Under the proposed deal, Citi was assuming all liabilities of Wachovia: its bonds, its branch deposits.
Believe me, this was not a net $270bn cash injection.
Which is not to say that the FDIC-backed deal was not a very good deal, maybe too good to be true.
Thanks for the stimulating comment.

John Hempton said...

The last anon comment does not get the argument. Of course they were assuming liabilities (deposits mostly). But both Citi and Wachovia have assets they can't easily turn into cash.

By guaranteeing the assets the FDIC allowed Citi to turn Wachovia's assets into cash...


Anonymous said...

The 'deal' stunk from the beginning. If you are in negotiations with the FDIC, you are insolvent, and are no longer in negotiations with the FDIC, you are taken over by the FDIC.

There should not have been any gray area here. Wachovia was clearly insolvent, and should have been taken over by regulators.

That is not how it went, and to tell the truth in all of the back and fourth over this 'deal' I completely lost what ultimately happened.

What would happen to those assets if Citi were to fail? Would they be availiable to be sold again with the guarantee?

Your point on the give away is dead on, that's all it was. From the beginning it looked like taking two bads and making one really bad. To have the FDIC 'bless' this transaction adds insult to injury.

The banks that were anointed by treasury as too big to fail with the first short sale ban were a battle line. They brought the line back with the BAC/MER merger. Left behind were LEH, wamu and wac. LEH was toast the moment that deal was signed. Even Fuld knew it.

Will this battle line hold? Who gets thrown over the side with them?

Anonymous said...

I love this latest page in the story. The 180 degree pivot from "she is incompetent" to "she is smarter than I thought" is intriguing and a twist I didn't see coming.

Thanks for sharing your thoughts.

Anonymous said...

4:52 has it right. It's ridiculous to say that Wells did the deal with no support from the federal government. The tax consideration means that the Wells deal will likely result in a larger hit to the treasury than the Citi deal would have.

Anonymous said...

Sorry, this would be insightful and worth kudos to Sheila Bair perhaps if not for the fact that many of us knew Citi was insolvent many months ago. The continuing crime here is therefore that FDIC has continually elected to hoodwink the public, that they (and presumably Treasury) have effectively shut down the ratings agencies (who would surely be downgrading Citi, a spiral no one wants to see). Meanwhile, innocent individual investors and presumably idiotic mutual fund PMs continue to burn their and others' wealth, frankly to the benefit of folks like me who have been riding LEAPs for 4-5 months now (and still feel no particular urgency to book them). So, I'll thank Sheila, but you and the public certainly should not. BTW, there are many other banks in this situation, the Treasury has published the list for you (strangely enough, they didn't call it "Insolvent Banks - Place Your Shorts Here").

Anonymous said...

quite insightful & worthwhile -- but of course there's huge a cost to wfc's takeover of wb - the accelerated $100 billion + tax write off of wb's assets - just google for articles in the nyt or wsj

Anonymous said...

(who would surely be downgrading Citi, a spiral no one wants to see)

speak for yourself

Anonymous said...

Looks like you were right.

(Re the Citigroup 50k layoff news).

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