What would an FDIC take over at Citi look like? John Hempton thinks that Sheila Bair could step in, confiscate the bank and wipe out the parent company debt. That’s pretty much what happened to Wachovia’s creditors.
Felix Salmon says there is no way Treasury Secretary Hank Paulson would let that happen. It would cause a tidal wave of financial devastation, and Paulson is definitely trying to be Mr. Stability these days. So we’re going to side with Salmon on this one. Still, we’re going to give you Hempton’s analysis just so you can see the potential risk to creditors of a government takeover. (Also, note that everyone assumes shareholders will be wiped out.)
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.
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.
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