More Stealth Bailouts
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?
That cutesy teaser link at the end isn’t very useful, since the Bloomberg site has a hard time loading the page it points to.
— sammler · Sep 29, 02:42 PM · #
Noah:
Do you think that Citi might have been a more aggressive bidder than Wells because they have a much higher need for a US branch network in order to secure a more stable dollar deposit base? (I’ll note that they only bought the “banking operations”, so that Waterhouse, money market funds and so forth did not go in the transaction – at least as I understand it).
Best,
Jim
— Jim Manzi · Sep 29, 04:06 PM · #
Jim: yeah, Citi wants – needs – the deposit base, but they are getting a heap of garbage along with it. That’s why the $42 billion-strike put was critical to making a deal work. Without that put, Citi could never have afforded the trade. Even with that put, though, the trade creates too many problems for Wells.
Problem is, the put is also an option for them to write down the mortgage portfolio very aggressively, and thereby get “free” money from FDIC. It’s a scary trade from the taxpayer’s perspective in that sense.
I’m really not sure about the structure of the deal – Citi didn’t buy anything but the bank, as you note, but it’s not clear how the remaining assets are organized, what the equity in Wachovia ought to be worth, etc.
I understand the deal. I understand why Treasury would want to do it, and why Citi would want to do it. But it still feels to me like a stealth bailout – yet another one-off trade in a market that has seen way too many such trades since Bear’s sale was arranged. The process is the opposite of transparent, the opposite of fair; nobody knows when the government is going to do what to whom, and who’s going to benefit. Which is a big part of why the interbank market is frozen and depositors and money market investors are all freaked out: to use the current phrase, it’s all tactics and no strategy.
— Noah Millman · Sep 29, 04:22 PM · #
Noah,
Yeah, I completely agree that this is a bail-out by another name.
— Jim Manzi · Sep 29, 05:04 PM · #