US govt bails out Citigroup, but will it survive?

“Amazing how much damage the lame ducks can do in the time remaining.” — Paul Krugman, Noble Prize Winner in Economics, on the bailout of Citigroup by the incumbent US government
America’s cup of woes is spilling over, rather messily, with its long-venerated financial institutions suddenly faced with obliteration and forced to seek a bailout.

Citigroup, the latest in a list getting longer, has just been promised a $20 billion cash injection, besides a whopping government guarantee for its troubled assets and mortgages.
As its stock price fell 60% over last week, the world’s largest financial services firm with revenues of around $159 billion last year, kept repeating over and over that it had “very strong capital.”

US govt agrees to $306-b rescue plan for Citigroup
It took just one weekend for it to go from very strong to very weak, necessitating a bailout of this order.

On Friday, the stock tumbled by over 60% to $3.77, down from a peak of $56 in 2006.
Predictably, the bailout news did it some good on Monday. At the time of writing this piece, the stock had gained around 61% to $6.08 on the New York Stock Exchange.

Barclays gets $10 b as Citi rescue resounds
DNA Money attempts an overview of the situation, the intervention and its implications near and far.

What’s the rescue all about?
The US government has decided to guarantee $306 billion of troubled mortgages and other assets of Citigroup. The Treasury department will also inject $20 billion of cash into the firm.
This will be over and above the $25 billion Citigroup got under the Troubled Asset Relief Programme (TARP, as the $700 billion bailout package is officially named).

On its part, the firm will issue preferred shares worth $27 billion to the government and pay a dividend of 8% a year.

Analysts following the firm have been expecting this move. “While the conventional wisdom says Citi is too big to fail, the reality is it’s too big to manage,” wrote Vernon Hill, founder and former chairman, president, and chief executive officer of Commerce Bancorp on www. seekingalpha.com a couple of days back.

“As a result, the company has become a publicly traded incarnation of Murphy’s Law: anything that can go wrong almost certainly will — and probably sooner rather than later. And $25 billion in TARP money isn’t going to do much to turn things around.”

What will be the cost of the bailout?
Citibank will have to pay a dividend of $2.16 billion per year to the government on the preferred shares. It will also have to pay $1.25 billion @5% on the $25 billion it received through TARP. This means the bank will have to make a profit of more than $3.41 billion before the shareholders can take home anything.

Citigroup shareholders will be diluted in the “near term by the cost of the incremental preferred stock,” Morgan Stanley analysts Betsy Graseck and Cheryl Pate wrote in a report on Monday.

Who will absorb the losses?
Citigroup will have to absorb the losses to the extent of $29 billion, including the reserves. Beyond that, any losses will be shared between the government and Citi. The government, through its three agencies — the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp — will take on 90% of the losses, leaving 10% for Citi to bear.

What are the conditions associated with the bailout?
Under the terms of the deal, the institution has been prohibited from paying common stock dividends of more than $.01 per share per quarter, for the next three years, without the approval of the US government. Further, any executive compensation plan including bonuses to employees must get the approval of the US government.

But experts aren’t happy with this move. Robert Reich, a former labour secretary of the US government under Bill Clinton wrote on his blog : “This is not a particularly good deal for American taxpayers, but it is a marvellous deal for Citi… The senior executives of Citi, including those who have served at the highest levels in the US government, have done their jobs exceedingly well.”

Ironically, the same executives who got Citi into the mess in the first place, continue.

Who was responsible for the mess?
Like other banks and financial institutions in the US, Citigroup also got carried away while investing in sub-prime mortgages. Also, its risk management system had stopped working.
New York Times said in a report said that Charles O Prince III, Citigroup’s chief executive before Vikram Pandit took over, learnt for the first time in September 2007 that the bank owed $43 billion in mortgage related assets. At that point, Prince asked Thomas G Maheras who oversaw trading at the bank if things were okay.

Maheras replied in the positive, then and every time the question cropped up. By the time the risk management team of the bank got around to assessing the risk related to these mortgages, it was too late. The bank had to announce billions of dollars in losses.

Analysts are even questioning the business model of Citigroup. They feel the company had spread itself too thin. “The whole idea behind Citigroup was flawed from the start. Unbeatable scale in financial services? Forget it. We now see the good Citi’s size has done for investors: the company has an incoherent, unworkable business model. It is run by a senior management team that’s largely unproven, with scant experience, operating a large financial institution,” wrote Hill.
Will the bailout and the guarantee be enough?
This is a tricky question. Citigroup has assets worth nearly $2 trillion on its books. It also has nearly $1.23 trillion in off-balance sheet assets.
“The roughly $300 billion pool of assets that are included in the rescue plan represent only a sliver of the company’s more than $3 trillion in assets, including its holdings in off-balance-sheet entities. Jitters about such “hidden” assets helped trigger the nose-dive in Citigroup’s stock last week. Among the off-balance-sheet assets are $667 billion in mortgage-related securities,” the Wall Street Journal reported.

Also, the troubled assets are not being taken off Citigroup’s balance sheet, and this has not gone down well with analysts.

What next?
Analysts are sceptical of the bailout.
“No one knows who’s going to lead it, over the medium term; hell, nobody knows who’s going to own it, over the medium term. The US government might have guaranteed a chunk of Citi’s assets, but it’s done nothing about Citi’s liabilities, including hundreds of billions of dollars in unguaranteed deposits,” Felix Salmon, a widely followed analyst in the US wrote on www.seekingalpha.com.

“Nothing in today’s announcement makes Citi immune to a bank run, which means there’s a very good chance the stock will remain under significant pressure. Given that it was the tumbling stock price which was responsible for this deal in the first place, one wonders if there was any point to this exercise at all,” Salmon wrote.

Analysts also feel that after the Citi bailout, it will be very difficult for the US government not to bail out the likes of General Motors, where so much more is at stake.

Source: DNA Money