Tuesday, November 25, 2008
It may be that the government's recent Citibank transaction heralds an important turning point in the financial panic of 2007 and 2008. Each of the prior government interventions (or, in the case of Lehman, non-intervention) into the financial services industry has had very difficult consequences for existing sources of equity, both preferred and common. Of course, in the Lehman case, debtors and even some customers were hurt in addition to the equity. With Fannie and Freddie, common and preferreds were wiped out. AIG shareholders were crushed. WAMU was seized by the FDIC, crushing the equity, including $7bn of very fresh capital. The bills were crisp and new when they were set aflame. Ouch.
With the exception of the TARP equity injections, which are quite dilutive if not punitive, each unique Treasury or Fed entry into the market has pounded the daylights out of somebody.
I think it can be said fairly that the Citi intervention is the first episode in this panic whereby the Fed and Treasury genuinely saved shareholders - they are better off today than they were prior to the Fed intervention and have a future. In addition to providing additional equity at a cost, the government insulated Citi from marking $300+ billion of assets below 85. That is a really valuable put, and the Citi shareholders should say thank you to the US taxpayer.
This is an important turning point because it signals private capital that the government isn't necessarily always going to put its moral hazard hat on and knock your brains out. Lots of investors put dough into Citi in the last 6 months - and it wasn't nearly enough. The one thing Pandit deserves credit for managerially is that he has been way ahead of the curve raising capital at any cost. He just couldn't keep up with the deterioration of Chuck Prince's balance sheet.
The government could have decided to wipe out all of those investors (who have put up like $35 billion in common and preferred recently). Had they done that, they might have been technically correct, but practically scared capital away from ever investing in banks again when they are in trouble.
We shall see how ongoing deterioration in corporate and consumer credit affect bank capitalization going forward, but it may be that private capital begins to return to the party. Let's see.
Update - oh, and I forgot one other thing. Citi has been a huge seller of everything it owns recently, and has been drowning the market in, particularly, mortgage paper. They were waiting for TARP to come in and buy theirs. When Paulson changed course, the AAA mortgage market widened 200bps (that's a 14 point drop, unheard of) largely, I think, because Citi had to purge. Anyway, now Citi can stop that selling, which probably helps out all the other banks.
Besides saving investors, could also be that the federal government saved itself. A lot of federal government agencies us Citibank for credit card services:
If Citibank tanked, imagine the nightmare of many federal government agencies' credit cards being closed and then having to scramble to sign on with either JP Morgan or US Bank (the only other two choices under the Smart Pay 2 contract). I have no doubt that Citi got bailed out because the federal government has its own vested interest in keeping it afloat.