By Craig Torres and Robert Schmidt
Nov. 24 (Bloomberg) -- The U.S. government’s emergency rescue of Citigroup Inc. offers a new model for bank bailouts: explicitly insuring against losses on toxic assets, with taxpayers footing the bill.
The Citigroup plan extends the federal commitment beyond the previous framework of capital injections from the Treasury and credit from the Federal Reserve. Now, the U.S. is a partner in the performance of $306 billion in real-estate loans and securities, sharing losses beyond $29 billion on what are likely to be some of Citigroup’s worst holdings.
“Everybody and his brother has got to have their hand out now,” said Eric Hovde, chief investment officer at Hovde Capital Advisors, which manages $1 billion in financial-services stocks. “The whole problem is so much bigger and deeper than the Fed and Treasury ever understood.”
Taxpayers are likely to be at greater risk from the new template, which may be used to help more companies as debt writedowns continue to climb, analysts said.
“Every situation will need to be evaluated on a case by case basis, but obviously we are able to draw from our experiences as we work through these issues in the financial system,” Treasury spokeswoman Brookly McLaughlin said.
Citigroup’s crisis escalated as it was forced to take on its balance sheet a number of special units created to invest in riskier securities. The New York-based bank’s shares lost 60 percent last week, and then recouped some of those losses today after the government’s rescue. Other lenders remain vulnerable.
Weakened Banks
Wells Fargo & Co. is absorbing Wachovia Corp., the bank that regulators pushed in September to merge amid mounting losses from $120 billion in a portfolio of home loans. Bank of America Corp. has taken on both Countrywide Financial Corp., once the biggest independent mortgage lender, and Merrill Lynch & Co., the securities dealer hobbled by $24 billion of losses. Morgan Stanley slumped almost one third in the past three months.
Other banks “are going to show up” and ask for the Citigroup deal, predicted Joseph Mason, a professor at Louisiana State University in Baton Rouge who previously worked at the Treasury’s Office of the Comptroller of the Currency.
The loss-sharing plan is another twist in the saga of Treasury Secretary Henry Paulson’s management of the $700 billion Troubled Asset Relief Program. Since the rescue fund was approved by Congress and enacted last month, Paulson has been criticized by lawmakers and others for not having a clear design for using the money. President-elect Barack Obama joined the chorus today.
‘Confusion’ on Strategy
There has been “confusion on what the overall direction might be” of the Bush administration’s plans, Obama said in a press conference in Chicago today. At the same time, he pledged to “honor the commitments” of the outgoing team.
“The model is that there is no model,” said V. Gerard Comizio, senior partner in the banking practice at the Paul, Hastings, Janofsky & Walker law firm in Washington. “It is an improvisation battle plan.”
Under the terms of the agreement, Citigroup will cover the first $29 billion of pretax losses from the $306 billion asset pool, in addition to reserves it already set aside.
Citigroup will accept 10 percent of losses above that amount, with the government responsible for 90 percent. The Treasury is second in line, taking $5 billion in losses, and the Federal Deposit Insurance Corp. is third, absorbing up to $10 billion. If the portfolio plummets through those triggers, the Fed steps in with a loan for the remaining assets.
Tack at Fed
The Fed’s exposure in the deal also represents a tack in the way the central bank has approached the crisis.
Since what was an effective purchase of $29 billion Bear Stearns Cos. assets in March, Fed officials have shown a preference for providing short-term credits for firms facing a cash squeeze.
The central bank’s balance sheet rose by $1.3 trillion in the past year as the Fed auctioned $415 billion of cash to banks and purchased $272 billion of commercial paper.
Fed officials have pushed to keep the risks involved in future bailouts at the Treasury, which would be forced to negotiate with Congress about the use of taxpayer funds.
Now, the Fed is stepping outside the liquidity boundary once again. The central bank took a step toward risk sharing earlier this month when it opened two new facilities with up to $52.5 billion in loans to help American International Group Inc. wind down its portfolio.
“It is clear that regulators still lack a comprehensive plan to address problems in our financial markets,” Senator Richard Shelby of Alabama, the ranking Republican on the Senate Banking Committee, said through his spokesman Jonathan Graffeo. “It is unclear whether they have carefully considered the implications of their continued ad-hoc approach.”
To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Robert Schmidt in Washington at rschmidt5@bloomberg.net
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