The timeout between Citigroup, Wachovia and Wells Fargo is set to end today at noon. It’s very possible we’ll hear that they’ve negotiated a deal to split Wachovia before then. That certainly seems to be what the Fed is hoping will happen. But why is the Fed favouring a negotiated settlement? Today’s Wall Street Journal’s editorial page implies that maybe it fears Citi will go down if it doesn’t get a piece of Wachovia.
Ever since the FDIC arranged the marriage between Citi and Wachovia at rock bottom prices, people have been speculating that the purpose was as much to prop up Citi as to rescue Wachovia without a full bailout. Citi would obviously benefit greatly from capturing a huge deposit base at an enormous discount, especially since the FDIC agreed to take on most of the downside risk in the deal. If it wasn’t intended to bailout Citi, it certainly would have had that effect.
The Journal explains that there is no way Citi can get the deal it worked out with the FDIC.
But a moment’s reflection reveals that Citigroup has already been expelled from the paradise in which it acquired most of Wachovia for $1 a share with the FDIC taking most of the exposure. Wachovia’s board cannot voluntarily accept that deal in favour of Wells Fargo’s $7 a share offer; if it did, it would be sued by its own shareholders.
At the same time, if the terms of the deal are changed — if Wells and Citi agree to split the baby, or Citi agrees to raise its price — Citi would almost certainly lose the FDIC’s guarantee on any losses above $42 billion. Citigroup presumably doesn’t want that, either.
But if Citi won’t want whatever deal might be available now, why is the Fed pushing for a negotiated, split-the-baby settlement? The answer doesn’t look pretty for Citi.
We suspect its real agenda has little to do with who gets Wachovia’s branch network and mortgage portfolio and everything to do with convincing investors and other banks that Citigroup isn’t itself in trouble. The feds appear to be acting on the belief that if Citi were left on the outside in this deal, the markets would take that as a sign that it is being culled from the federally protected herd.
But if the agenda is to shore up Citi and send a signal that it is, in fact, too big to fail, there are more direct means available to get that done. Any terms on which an agreement could be reached over Wachovia are likely to be worse than the ones set down last week, so it’s far from clear that a deal there would even help Citi much.
If the feds want to prevent a full-scale rescue of Citigroup, now might be a good time to take Treasury Secretary Hank Paulson’s new powers out for a spin. If Citi needs to raise capital, let the Treasury inject some, along with appropriate housecleaning on the management side and upside for taxpayers. Playing Solomon on the Wachovia deal is riskier business, and could make any future intervention more expensive for everyone.