from the hip

In a previous post I pointed out that the Citigroup bailout, viewed in light of the previous US bailouts, seemed to indicate a clear lack of principle and consistency in the US bailouts that we have seen so far. Every time there is a problem, US government comes running to fill coffers that needs filling or shore up towers about to topple, but the underlying principles with regard to how to spend taxpayers money seem to be lacking. As well, there is no consistency in the methods employed.

In one instance, a bank is more or less given to another bank (Lehman), with a promise of public money if the deal is bad. In another case, the government hands out tax payers’ money, but takes a dominant position, so that the tax payers at least get stock in return (AIG). In a third instance, a badly performing bank (in reality, its stockholders) is given a huge cash gift, again from the taxpayers, but with little to show for it in terms of stocks (Citigroup).

Now the new head of the Congressional panel monitoring the bailouts, expresses concerns about the bailouts as well. Lacking strategy is the major concern. New York Times writes:

The head of a new Congressional panel set up to monitor the gigantic federal bailout says the government still does not seem to have a coherent strategy for easing the financial crisis, despite the billions it has already spent in that effort.

Elizabeth Warren, the chairwoman of the oversight panel, said in an interview Monday that the government instead seemed to be lurching from one tactic to the next without clarifying how each step fits into an overall plan.

“You can’t just say, ‘Credit isn’t moving through the system,’ ” she said in her first public comments since being named to the panel. “You have to ask why.”

It is surprising that more critical questions have not been raised so far. There ought to be a set of principles guiding the handing over of public money to the private sector. Those principles ought to say something about when to do it, what the government should get in return, how assets acquired this way is to be handled, and so forth. As well, there must be consistency from case to case. If these two elements are lacking, government bailouts will sooner or later be challenged, and many will view then as illegitimate. Handing over public funds, giving some companies competitive advantages over others, and so forth, can easily be viewed as highly unfair and inequitable – both by voters and tax payers, as well as by competitors in business – unless the underlying principles are widely accepted and the actions taken are  viewed as being according to and consistent with the principles.

As well, unless the US government figures it has unlimited funds – which is not a reasonable assumption given its staggering debt – there ought to be a larger plan, a strategy, behind the interventions. Even the government may not be able to fill all the holes that needs filling in the next year or two.

So far, the bailouts have some pretty serious shortcomings from these points of view. In my opinion, that is.

I was stunned by the Citigroup bailout. That is, not by the fact that the US government chose to do it, that was as I expected, even thought I thought and still think it was wrong (see my earlier post on this). But what stunned me was the terms of the bailout. Then, later, I have been stunned by the total lack of critical discussions of the terms of the bailout deal. That, more than anything about the Citigroup story, still amazes me.

My understanding is that the government has agreed to pump 20 billion US dollars into a company that that had a market cap of less than $21b on the Friday before the deal, and then only getting a single digit share of its stocks? That really has to be the worst deal for the taxpayers ever, and a clean gift of tax money to Citigroup’s shareholders? I mean, they could have bought a larger share cheaper on the market? At least 5 times bigger?

Second, for guaranteeing $250 billion of risky assets the government acquired the right to buy C stocks – that is, warranties – for 280 mill dollars at a price of USD 10.64. But the stock price was 4 dollars. Who else would want to buy warranties, linked, as in this case, with the risks associated with 250 billion of bad loans, at a strike price 2.5 times the price of the stocks in the free market? That, to me, seems simply wild. It really means the bad loan insurance if for free, and that the government has acquired some badly priced warranties.

Thirdly, by insuring the bad debt of Citigroup, the government also has created a competitive situation where C can now borrow money at lower rates than its competitors. That is, in competitive terms, the better performing banks have been twice punished – first by not getting the same gift and then by having to compete unfavorably by a bank they outperform every day of the week.

All this seems to me to indicate a level of unprincipled thinking by the government and its negotiators almost beyond my grasp. I totally understand Citigroup. They mucked it up, but then made a good save. Well done boys, I say to them! You rock! But the government, they are harder to understand. Their solution is bad and does not follow the pattern of earlier bailouts. And clearly, this also is a type of operation that can’t be repeated over and over, which means others can’t expect similar treatment in the future. So, we can’t expect this to be a new type solution that will be followed consistently in future cases.

So – lack of principled thinking and consistency in the government’s policies (compare it to the AIG bailout), giving tax money to shareholders, creating a competitive advantage for a bank that frankly has performed among the worst in its class, and giving one bank among the thousands of US banks something others do not get.

Spending tens of billions of taxpayer money and seemingly giving it away, and without any tracy of consistency in the behavior underlying the actions nor any traces or principled thinking. That is a tall order. And yet – there is hardly one – I repeat ONE – critical voice in the media. Not in Wall Street Journal, not in New York Times, not in Washington Post. So what is happening? All they all scared stiff by the recession? They too?

PS (12/04/08): New York Times today  wrote an article entitled Vikram Pandit Scores a Great Deal for Citigroup. They write:

as further details emerge on Citi’s government bailout, Mr. Pandit seems to have pulled off a truly fantastic deal.

Some details still haven’t been disclosed, and some haven’t even been entirely nailed down. So piecing together what is going on is a bit like solving a Rubik’s cube with some squares missing, Breakingviews notes. But judging from what has been made public, Mr. Pandit has shuffled off to Uncle Sam much of the downside in Citigroup’s $306 billion portfolio of riskier assets for what looks to be a low insurance premium, according to the publication.

See the story at The Daily Beast! It is pretty outrageous, actually. A commenter on the NYT article writes:

Inside sources have the value of Citi’s $306 billion portfolio at closer to $230 billion. That means taxpayers are locked in for a transfer of wealth of (306-230) x 90% (Citi takes 10% haircut – $29 (Citi takes first $29bn) = $42.3 billion. Taxpayers because of the incestuous Goldman Sachs relationship between Paulson and Rubin have forked over $42.3bn!!! to Citi shareholders. This is highway robbery and should be investigated at the highest authorities and be ultimately rescinded.

See also: Time Magazine: Why Government Intervention Won’t Last

Citibank (or Citigroup Inc.) is in trouble. Over the last year, its stock price has dropped from above 30 dollars to less than 4 dollars (3.77 at the close of NYSE today). Its value has been in free fall the the whole week, despite attempts by the bank to shore up it stock prices by asserting its value. Times writes:

Citigroup was the world’s biggest bank until February, when it was overtaken by the Industrial and Commercial Bank of China. Citigroup is now only the fifth-biggest in America, after falling behind US Bancorp, a Midwestern commercial bank, this week. Bank of America is the largest bank in the United States.

By now, this kind of rapid decline in value is a story we have seen before. We saw it with Lehman Brothers. We’re seeing it with GM and Chrysler. And others. in fact, in quite a few other cases.

And now the question is: Should government bail out Citibank or let it slide? The proponents of a rescue operation say that Citibank it too big, one can not let it fall. And they point out that if Citibank goes, the banking system will fall. And we have heard all those arguments before. We have, in fact, heard them every time there is a government bailout. As well, we have heard them repeated over and over by lobbyists for all those industries allegedly needing a bailout. (Just so that it is said, I have nothing against Citigroup, nor do I own or have traded its stock. And the argument I am trying to make is more general and applied to a large number of corporations, and not only to Citibank.)

But does that make the statement true? I think not. First, there is a difference between a bank and a system of banks. Letting a bank fail (Citibank has a positive cash flow, so it may not fall, but that’s not the point here) may actually strengthen the system of banks, as the bankruptcy process will weed out the gold from the dirt and clean the system of debris. As well, three Detroit car manufacturers, unable to cope with competition and having lost marked shares for 20 years, do not constitute the car industry – not in the world, not in America.

All those attempts to equate individual members of industries with the industries themselves are seeking to establish false identities between entities that simply are not identical.

The real question, to my mind is: If this depression is as deep as or deeper than the crisis in 1929, does the American government – or any government for that matter – really have the resources it takes to bail out every business deemed to be strategically important over the duration of this crisis? I think not. Not if government is also to continue to attend to its (their) core business – to provide regulation, defense, social services, health care, and all those other businesses.

This, I think, is likely to be the right perspective in which to view government intervention at this stage. And, if I am right, shelling out huge sums on failing businesses may reduce the ability to act in the future, possibly for greater benefits and facing even tougher challenges. And maybe, just maybe, the crisis is as much a political crisis – involving politicians and regulators in panic, deepening the crisis with every move they make – as a financial and banking crisis.