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November 24, 2008

A New Kind of Bailout (This is the Fifth Variation for Those of You Who Are Counting)

They are getting clever in their desperation and it's going to take some time to untangle the newest mess devised by Citigroup, Treasury, the FDIC, and the Fed:

Treasury has agreed to inject an additional $20 billion in capital into Citigroup under terms of the deal hashed out between the bank, the Treasury Department, the Federal Reserve, and the Federal Deposit Insurance Corp. Treasury officials will charge a higher interest rate for the capital injection -- 8% for the first few years -- than it has charged to dozens of other banks now borrowing money under the government's the $700 billion rescue package approved by Congress last month.

In addition to the capital, Citigroup will have an extremely unusual arrangement in which the government agrees to backstop a roughly $300 billion pool of its assets, containing mortgage-backed securities among other things. Citigroup must absorb the first $37 billion to $40 billion in losses from these assets. If losses extend beyond that level, Treasury will absorb the next $5 billion in losses, followed by the FDIC taking on the next $10 billion in losses. Any losses on these assets beyond that level would be taken by the Fed.

Citigroup would also agree to work to modify -- if possible -- troubled mortgages held in the $300 billion pool, using standards created by the FDIC after the collapse of IndyMac Bank.

The government is not expected to require any management changes, as that was seen as potentially being too destabilizing.

This is the fifth type of bailout in the past three months. We started with a fairly typical bailout for AIG (as typical as bailouts are, I mean) in the form of loan. Then came Paulson's Panic and the TARP to be applied across the financial sector. This was a rather pointed solution to a specific problem. But that wasn't good enough, so next came capital injection in lieu of the TARP. The $350 billion set aside for that has almost been exhausted. And then AIG got a new deal, in which the taxpayer was forced to assume the risk for AIG's bad investments.

This new bailout adopts some features of all of the prior bailout deals; it includes a loan with the likelihood of capital injection and the taxpayer gets to guarantee Citigroup's bad investments. Perhaps these strategies will be more successful in concert than they were alone, but I'm not holding my breath.

While I'm thinking about it, does Treasury, FDIC, and the Fed have the authority to make this deal? I mean as a constitutional and statutory matter.

Click over and read the whole article, as it has too many gems for me to steal. This should get some attention:

In Citigroup's case, the government's arrangement likely will be able to accommodate 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.

...

Last Monday, Mr. Pandit said an a meeting with employees that Citigroup was scrapping plans to try to sell about $80 billion in risky assets. Investors and analysts interpreted the move as a sign that Citigroup either was unable to sell the assets, or would have had to incur hefty losses in the process.

Two days later, Citigroup announced it was buying $17.4 billion in assets from its structured-investment vehicles -- complex entities whose holdings included risky mortgage-linked securities -- and faced a $1.1 billion loss due to their diminished values.

Congratulations, Citigroup. You have now achieved the coveted "too big to let fail" status. It is to weep.


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posted by Gabriel Malor at 12:48 AM

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