The Blog

How Do You Solve a Problem Like Citigroup?

1:33 PM, Mar 2, 2009 • By JIM PREVOR
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They say the third time is a charm, and if you care about the U.S. taxpayer you'll hope the adage proves true as the federal government has concluded its third bailout deal with both Citigroup and AIG.

Yet with $496 billion committed either in cash or guarantees before an additional $30 billion to go to AIG, the cost has been astronomical and the market is not expressing any confidence that these are the last bailouts. That is why the stock prices of Citi and AIG remain so low, fueled by fear that additional dilution is on the way when the companies require more money.

The bailouts are really unconscionable. In order to avoid taking majority control of Citigroup, the Treasury will overpay for common stock so it will only get a minority stake. Bondholders get off free. Basically U.S. taxpayers will pay taxes so Citi bondholders can get paid.

Still, perhaps we could all hold our collective noses and approve of all this if it really lifted the poison that has fallen over the financial system. The problem, though, is that none of these bailouts are doing the one thing that needs to be done: assuring counterparties that the banks are sound and thus safe to deal with.

Perhaps President Bush and Secretary Paulson can be forgiven for thinking the crisis would simply pass, but, months later, no such charity can be extended to President Obama and Secretary Geithner.

What is required is not to give $30 billion or $50 billion or $500 billion. It is to establish that the banks are safe.

Some would argue that this is the exact purpose of Chapter 11 reorganization, that this is our system for deleveraging enterprises. But the same purpose can be accomplished outside Chapter 11. All they have to do is set up a subsidiary of Citigroup -- or any other troubled bank. The government would finance the subsidiary with enough cash to buy the operating assets of Citigroup -- the buildings, the logos, the computer programs, customer accounts, etc. -- at fair market value.The new subsidiary would get spun off to shareholders and the federal government would provide the newly independent bank with sufficient capital to conduct business, give loans, etc.

The federal financing would be in the form of a cumulative preferred stock, paying 2 percentage points above what the government pays for funds. No cash outlay is required, but the dividend accrues and no common dividends can ever be paid until the preferred is both up to date on the preferred dividend and all the preferred is purchased back from the Treasury.

Then we would have one fully functioning, well-capitalized bank and one closed-end investment fund, the original bank, which is dedicated to winding down its investments.

Some lenders to Citigroup, such as bondholders, might not get paid if assets can't be sold for high enough prices. But why should they? It is one thing to say that the U.S. Treasury has to act to keep banks lending and commerce flowing, and this plan does that. That is entirely different than saying the U.S. Treasury has to somehow persuade the markets that if you buy a bond from a big bank, one can never lose money.