The Citigroup Bailout – SIGTARP Part III

We love to criticize the wastefulness of bureaucracy, the agency ass-covering, and the naiveté of government officials.  But it’s a surprising pleasure to read[1] The SIGTARP [2]  review of the government’s response to Citigroup’s near-death experience and its bailout in the Fall of 2008.

Here we have a US Treasury position created for the purpose of reviewing the government’s own actions in the heat of the crisis, and we might be excused for bringing low expectations to the table.  I have to admit, however, that my jaundiced eye opens wide with the quality of the analysis and indeed the downright feistiness of the SIGTARP report.

The report reviews the timeline of the crisis, the systemic need to bail out Citigroup, and the particulars of negotiating – actually, Treasury mandated – a $20 Billion preferred-equity capital infusion and a loss-absorbing backstop for a $300 Billion ring-fence around Citigroup’s riskier assets.

We do not know what would have happened without government intervention on behalf of Citigroup, but the SIGTARP nicely summarizes the case for Citigroup’s status as a Too Big To Fail (TBTF) Bank for those of us with short memories.  Citigroup was at the time the largest currency exchange bank, the largest consumer finance lender, the world’s largest credit card lender, the 2nd largest banking organization, the third largest mortgage servicer, and the fourth largest student lender, with over $175 Billion in uninsured domestic deposits.

SIGTARP shares numerous interesting details from the negotiations in October and November 2008.

First, the government needed to lie to itself and the public in the Fall of 2008 when it declared Citigroup a ‘healthy and viable’ banking institution[3], as a necessary condition for providing an initial $25 Billion capital infusion through the Capital Purchase Program (CPP) in October 2008.[4]  Treasury Secretary Paulson and New York Federal Reserve Board (FRB) President Geithner clearly felt at the time that they could only get Congressional support for the CPP if it came with a large dose of self-deception about ‘healthy and viable’ banking institutions.  Why would a ‘healthy and viable’ banking institution need an emergency $25 Billion capital infusion from the government anyway?  It’s a Potemkin Village type absurdity, and SIGTARP lets us enjoy the irony.

Next, Treasury, FDIC, and the FRB cut a pretty good deal for taxpayers in negotiating with Citigroup.  Most importantly, they announced to the public (and Wall Street) the ‘ring-fencing’ of over $300 Billion in Citigroup assets – government insurance against losses.  By ring-fencing, they separated presumably toxic assets on Citigroup’s balance sheet, and declared these assets would be treated in a special way to limit Citigroup’s total losses.

Here’s the clever part about the ring-fence; Citigroup remaining on the hook for the first $39 Billion in losses, with a combination of Treasury and FDIC absorbing the majority of the next $15 Billion in losses, and the Federal Reserve Board absorbing the rest of the loss risk via non-recourse financing.  While the announcement emphasized the government insurance for Citigroup’s riskiest CDOs, RMBS, CMBS, and auto loan ABS, loss-scenarios suggested only Citigroup would bear the losses on the portfolio.[5]

If you can’t figure, as neither Citigroup nor the market could out at the time, what the bank’s biggest loss could be on its portfolio, then the market would assume the worst and treat Citigroup as a soon-to-fail entity going the way of Bear Stearns, Lehman, and AIG.  But if you can precisely define, as the ring-fence did, the upper limit of the bank’s losses, then the market understands the known limit and the self-fulfilling prophesy of expected losses leading to financial wipeout can stop.   So, that’s clever.

Following this announcement, as intended, markets credibly believed Citigroup to be TBTF, with a perceived government guarantee on a huge portion of its riskiest assets.  The stock-shorting activity reversed, CDS spreads tightened, and we saw no world-wide run on Citigroup’s bank deposits.

SIGTARP’s feistiness surfaces most particularly in reviewing not only the actions of government leaders, but their disagreements with each other and with its review.  Numerous times throughout the report, we learn of requests by FDIC’s Sheila Bair to change or redact statements in the report.  We also learn that Citigroup successfully withheld a listing of its ring-fenced assets from publication by SIGTARP, citing propriety information[6], but SIGTARP is not afraid to respectfully disagree.

SIGTARP’s summary of the story emphasizes the ad hoc, but ultimately correct, decision of government leaders to massively intervene on behalf of Citigroup.  SIGTARP calls out our own government for what they failed to make Citigroup do; this distinguishes the report and makes for good reading.

SIGTARP gets to the heart of unsolved problems with the government interventions of 2008.  Citigroup, along with more than a dozen financial institutions, today remains TBTF.  Which means we could repeat the same crisis we all just survived. 

Not only that, but SIGTARP rightly states that the last bailout may increase the likelihood and severity of the next crisis, because the moral hazard problem also remains with us today.  High-risk takers, namely Citigroup creditors and counterparts, were not punished in the bailout, so they may reasonably expect to under-price similar credit and counterpart risk in the future, believing that the government provides an invisible safety net underneath high-wire risk taking.

Even short of a repeat crisis, we know that the implied government guarantee for TBTF institutions constitutes a massive subsidy to Citigroup and its brethren via lowered borrowing costs and collateral costs.  This subsidy provides huge advantages over smaller financial firms, but, more troublingly sets the taxpayer up for unlimited liability for private institutions, with little discernible public benefit.  Citigroup, the big red umbrella, is still not paying us citizens for the giant insurance policy we offer them.

I don’t criticize the government, and neither does the SIGTARP, for preventing a Citigroup collapse in the Fall of 2008.  I do blame the US government, and thankfully SIGTARP does too, for allowing TBTF banks to continue their invisible but nevertheless powerful draw on free taxpayer support.

Ultimately, as SIGTARP rightly (and depressingly) points out, we cannot know the cost of this Citigroup bailout until we know the cost of the next bailout, partly born out of this one.

Two concluding thoughts make me optimistic, however.

First, although SIGTARP is part of the government, it plays the ombudsman role fairly, critically analyzing what other parts of the government have, and have not, done since the acute crisis subsided.  There’s hope in a system which can criticize itself and thus correct its future course.  Course change is hard, but a report like SIGTARP’s makes it possible.  I made this thematic point in an earlier post, but it’s worth emphasizing.  I’m not sure we’re improving, but I am sure that critical thinkers within the system, like SIGTARP, give us a chance at improvement.

Second, throughout the narrative of Citigroup’s near collapse and rescue, we see instances of massive government intervention but not a massive government power grab.  This too bears remembering.  The United States has a tradition of public official respect for private enterprise, which is both understood and credible  – but not always recognized by politicians wanting to score points. [7]

A market collapse and an overwhelming government bailout naturally give rise to conspiracy theories on the political fringes.  Many, if not most, societies in the rest of the world would fit the Citigroup events into a conspiratorial, but ultimately unhelpful narrative.  The specific history of Citigroup as told to us by the SIGTARP, however, reminds us that even if the government did not get everything right, they actually did pretty well, considering.


Please also see SIGTARP Part I – Truth in Government

SIGTARP Part II – Biggest Banks Still Too Big To Fail

SIGTARP Part IV – Which Small Banks are Going Under Next?

and SIGTARP Part V – The AIG Bailout

[1] Assuming you like wonkish reviews of the government’s response to the 2008 Credit Crunch as much as I do.

[2] Special Inspector General for the Troubled Asset Relief Program, aka SIGTARP, aka Norse God of Financial Accountability.

[3] Both Treasury Secretary Hank Paulson and FDIC Chair Sheila Bair used this description in written and spoken statements.

[4]A banking institution had to be “healthy and viable” to be considered a “Qualifying Financial Institution,” as only “Qualifying Financial Institutions” could receive this capital infusion.

[5] As, in the end, it turned out.  When the $300B guarantee program unwound in the Fall of 2009, only Citigroup had suffered losses.  So we’ve got that going for us.  Which is nice.

[6] In pointing this out we get to share SIGTARP’s undoubted chuckle about the ‘special sauce’ of proprietary information Citigroup keeps from its competitors, which contributed to one of the most catastrophic losses in human financial history.  Seriously, guys?  No one wants your special recipe of assets that contribute to financial Armageddon for your bank.

[7] Anti-market and anti-government cranks both see vast conspiracies and vindication of their own warped views in the events of 2008, but thankfully they mostly troll the Internet commentary pages and do not reflect, you know, reality.

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In Praise of SIGTARP Part II – We blew it on the repayment of TARP funds by the largest financial institutions

See related post In Praise of SIGTARP Part I here

We are now at the four year mark on the deepest part of the Great Credit Crunch and Great Recession, so I’m moved to ask:

When it comes to avoiding the next financial blowup and bailout we need to ask “Are our bank protections better off now than they were four years ago?”

A Congressionally-mandated investigative entity, SIGTARP[1], AKA the Norse God of Financial Accountability, does not think so.

We know the United States government leaped into bailout frenzy throughout 2008, attempting virtually every permutation of intervention to keep the country’s largest financial institutions – and by extension – the world economy – from complete collapse.  The US government used mergers, direct investments, shotgun marriages, bankruptcy, receivership, loan guarantees, voluntary asset sales, forced asset sales – the whole toolkit.

While the bailout process could best be described as ad-hoc, we hope that the delicate unwinding of the government safety net for Too Big to Fail institutions will be more thoughtful, and less chaotic.

We hope, however, in vain.

According to the SIGTARP report the bank’s exit from government protection has been quite ad-hoc as well.  Worse, we[2] let weak TBTF banks pay back public funds before they were really steady on their feet with enough capital.  The same banks – Citibank, Bank of America, Wells Fargo – remain weakly capitalized.  This matters a whole lot because taxpayers continue to silently subsidize the safety net for TBTF banks.

SIGTARP’s report on repayments by the TBTF banks raises and answers key questions, such as

  1. Why did banks want to repay TARP money so quickly, before they were fully ‘ready’ to access private markets for their funding?
  2. How do we know the process was ad-hoc and rushed?

The answer to question number one is simple.  Bank executives said it was to remove the shame and stigma of continuing to receive public bailout funds from TARP.  I think anyone who has spent time around finance executives, however, knows that shame could not possibly weigh as heavily on them as did the TARP restrictions on executive compensation. [3]

The answer to question number two forms the bulk of SIGTARPs report from September 29, 2011, and the details are fascinating.[4]

To get the full gist of the issue, we need some background first, which SIGTARP nicely provides.

The authority to directly invest in TBTF banks[5] via preferred shares came with a sensible proviso that banks could not repay TARP money for 3 years, but Congress reversed course a few months later in early 2009 with a new law[6]  that allowed banks to repay the borrowed capital more quickly.  Although TARP money came from Treasury, the Federal Reserve Board headed up the regulatory team[7] charged with setting criteria for repayment.

Nine reasonably well-capitalized banks[8] repaid TARP funds in June 2009, while another eight – including 3 of the 4 largest banks in the country(Citigroup, Bank of America, and Wells Fargo) – failed a bank stress test.  Among the criteria developed then for the weaker banks was a requirement that they raise a significant amount of TARP repayment funds – specifically 50% of the cash required for repayment — through common stock issuance.[9]

When push came to shove, however, we learn from SIGTARP’s report that regulators stretched, pulled, waived, and disagreed with one another about whether to make banks comply with the rules they had just put in place.  Treasury’s rush to encourage repayment, it turns out, trumped the regulatory need for strong banks.  And if you suspect large banks get better treatment than small banks, here’s your evidence.

Bank of America, for example, raised capital partly through preferred shares issuance, a less regulated type of capital.  Citigroup, as well, fell short of its required 50% issuance of common stock.  Wells Fargo attempted multiple times to wriggle out of the need for a fully dilutive equity issuance but ultimately raised the required amount at the end of 2009.  Regulators, nevertheless, signed off on all three banks’ 2009 repayment plans, waiving their own requirements mere months after setting them.

FDIC’s then Chairman Sheila Bair, however, stands out as a vocal critic of the regulatory cave-in to the combined Treasury and bank-executive pressure.

Treasury, FRB and OCC officials apparently claimed that private markets were too weak to support the admittedly massive equity issuance needed for the banks.  Paradoxically, at the same time Treasury, FRB and OCC implied the direct opposite, that banks were strong enough to pay back public funds.

As FDIC Chief Sheila Bair points out,

“The argument [FRB and OCC] used against us – which frustrated me to no end – is that [Bank of America] can’t use the 2-for-1[10] because they’re not strong enough to raise 2-for-1.  That just mystified me.  The point was if they’re not strong enough, they shouldn’t have been exiting TARP.”

Sheila Bair called out the impossible double-speak coming from Treasury, the Federal Reserve and the Office of the Comptroller of the Currency.

It makes sense to me that you can’t be both too weak for private capital markets but plenty strong enough to leave public protection.  Regulators blew it by letting the banks out of TARP too early.

As a result of the rush to re-privatize we missed the chance to control, from a regulatory standpoint, the destiny of TBTF institutions and our public exposure to the next big crisis.

SIGTARP’s September 2011 report has a ‘remains to be seen’ conclusion on whether banks are now strong enough to absorb future financial shocks.  That’s a pretty interesting negative-report from within the government, significantly doubting whether regulators have properly done their job.

Also, there’s this, from SIGTARP:

“Unless and until such institutions, either on their own accord or through regulatory pressure or

requirements, are restructured, simplified, and maintain adequate capital to absorb

their own losses, they will pose a grave threat to the entire financial system.”

That’s a compelling and scary argument right now, with Bank of America stock down 50% and Citigroup down 30% from when they repaid TARP in November 2009.


Also, please see In Praise of SIGTARP Part I here

SIGTARP Part III- The Citigroup Bailout

SIGTARP Part IV – Which Small Banks are Going Under Next?

and SIGTARP Part V – The AIG Bailout

[1] AKA Special Inspector General of the Troubled Asset Relief Fund.

[2] And by “we” I really mean primarily the US Treasury Department.

[3] When explaining bank executive behavior, always assume personal compensation comes first, until proven otherwise.  It’s just a rule I follow and it’s never steered me wrong.  Bankers feeling shame at receiving public funding to save their bacon?  Please don’t insult me.

[4] All of this is assuming you find financial regulatory reviews fun reading, as I do.

[5] Through the Emergency Economic Stabilization Act of 2008 of October 2008

[6] Through the American Recovery and Investment Act of February 2009

[7] Generally the Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency (OCC)

[8] GS, MS, JPM, US Bancorp, Capital One, Amex, BB&T, BONY/Mellon, State Street

[9] Regulators like common stock issuance because it improves a bank’s ability to absorb future losses, ie. it’s ‘capital ratios.”  Bank executives dislike stock issuance because it dilutes value for shareholders, including themselves.

[10] “2-for1” is the regulatory short-hand language to indicate that 50% of TARP repayment money must be raised as new common equity

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