So Citigroup gets Wachovia. Why Citi? Citi is one of the ugliest of the super-huge banks. The credit spread on Citi is (as of Friday) more than two times the spread for JP Morgan Chase or Bank of America. More to the point, it’s more than two times the spread of Well Fargo, the other bidder for Wachovia. What makes anyone think Citi can afford to absorb $42 billion in losses (the FDIC has backstopped the transaction by agreeing to absorb any losses above $42 billion)? Since we know the government is engineering everything, why would they engineer an acquisition by Citi when Citi is already in trouble itself? Particularly since Wachovia got in trouble in the first place by buying Golden West? Don’t these people learn?
Two reasons. First, Wells Fargo may not really have been a serious bidder. They have their own portfolio of bad mortgage debt – and they’ve done less to write it down than Citi has already done with their portfolio. Taking over Wachovia would have forced them to mark their books consistently. They probably aren’t ready to take that write-down. Indeed, they may be counting on the bailout package to help them avoid needing to take the full hit.
Second, if Citi is too big to fail, but also arguably too big to save, you need to create stealth mechanisms for saving them. That $42 billion-strike put is one such. It’s effectively a one-company version of what the bailout is intended to be – a floor set by the government on falling asset values – except that Citi gets to be the sole calculation agent.
In further evidence that the government is making this up as they go along, Wachovia, unlike Washington Mutual, won’t fail. The senior unsecured bondholders will get par (we think). The guys who lose out this time are the common equity holders (obviously) and (to an as-yet unclear degree) the preferred holders. I guess Paulson figured out that people won’t lend to banks if the government is going to wipe out the lender in a bailout. Now he’s going to learn that a lot of banks raise capital in the form of preferreds. At least, they used to.
Meanwhile, if anyone thought this was only an American problem, note that Belgium just nationalized a big chunk of their financial system, Iceland has bought 75% of one of their largest banks, and Britain just nationalized a second large mortgage bank, Bradford & Bingley.
These transactions were a whole lot more straightforward than the trades our own Treasury has been executing, though. Those of you who’ve been following the AIG stealth bailout and the Goldman standard: did you catch this story?