Plenty of intelligent people are arguing that the Wells Fargo deal for Wachovia would actually be more expensive for the government than the Citigroup deal. The idea is attractively counter-intuitive but it’s probably wrong.
At first glance, the Wells Fargo deal looks like a far better deal for taxpayers. Citi agreed to take up to $42 billion in losses from Wachovia’s portfolio but the deal would have required the Federal Deposit Insurance Corp. to take all of the additional risk, which would amount to $270 billion of potential losses. The Wells Fargo deal doesn’t ask the FDIC to take on any additional portfolio risk
Of course, it’s not likely that all those Wachovia assets would be fall to zero. Wells Fargo estimates the actually losses would be closer to $74 billion. Less Citi’s $42 billion, that would mean the FDIC’s cost would be $32 billion.
Critics of the Wells deal, however, argue that a change in tax regulations made last week could wind up flipping the metrics. Here’s how the Washington Post, which broke the story, described the change:
Companies are allowed to shelter profits from taxation based on their past losses. When a profitable company buys a company with losses, however, the government historically has limited the profitable company’s ability to shelter its income based on the acquired company’s losses. In the case of Wells Fargo, the company could only have sheltered about $1 billion in income each year, said [tax expert Robert] Willens, the accounting expert.
The Tuesday change, however, specifically removes limits on the income banks can shelter based on the losses of acquired companies. In announcing its deal for Wachovia, Wells Fargo estimates it would write down $74 billion in losses on Wachovia’s loan portfolio.
So what would that cost in terms of tax revenues? If Wells Fargo avoiding corporate taxes on up to $74 billion in income, the government would collect around $25 billion or so less than it would have without the tax deal. “They said they’re doing it without federal assistance, but in reality they are doing it with federal assistance. It’s just tax assistance,” Willens tells the Post.
You’ll probably notice that $25 billion of lost tax revenue is less than $32 billion of FDIC losses. But because Citi can take advantage of the same tax provisions that would benefit Wells Fargo, it would be able to shelter $42 billion in income, which would mean the government would collect around $15 billion less from Citi. Add the FDIC cost and the lost tax revenues from the deal and you see the total public cost is $47 billion from the Citi deal, easily dwarfing the lost revenue from a Wells deal.
There are some complicating factors. As part of its deal with the FDIC, Citi was going to contribute $12 billion of its stock to the FDIC. Even if we pretend to believe those shares won’t be worth less in the near future, that still leaves the Citi tab at $35 billion, or $10 billion more than the Wells deal.
The Washington Post’s story implies that it isn’t fair to count the cost to the FDIC as part of the cost on the Citi deal because the FDIC is funded by contributions by banks. That’s true enough but probably won’t be true for long. For a decade from 1996 to 2006, the FDIC didn’t charge banks any premiums. Now the FDIC will be hard pressed to cover the costs of bank failures, and asking teetering banks to contribute more is counterproductive. It’s very likely that the FDIC will have to turn to the Treasury for more money, leaving taxpayers on the hook. Expected losses from the Citi deal make this more likely not less. In short, counting the FDIC losses as taxpayer costs is more than fair because we’re going to end up paying those bills.
The notion that the Citi deal is cheaper for taxpayers is cleverly mischievous. But the numbers don’t add up.