$7 billion to guarantee 90% of $280 billion worth of mostly-bad paper? With no equity kicker? You’re kidding, right?
Since the taxpayers are bearing virtually all the risk, why shouldn’t they get the bulk of the reward if the thing goes well?
Yes, it’s probably necessary to rescue Citi. (It’s probably necessary to prevent GM from going down, too.) And “punishing” investors in effectively bankrupt enterprises doesn’t belong high on the list of objectives.
But there’s no reason to just make huge presents of tax dollars to the stockholders. The stockholders of WaMu and Lehman walked away with nothing. The stockholders of AIG were allowed to keep 20% of the equity.
Something close to the AIG deal might have been reasonable in Citi’s case. This, on the other hand, is a giveaway.
Footnote The NYT story describes a $20 billion purchase of preferred shares with a face value of $27B, suggesting the extra $7B is in effect a premium on the default insurance the feds are writing. The FT story makes it sound as if Citi is getting $27 billion in cash plus the guarantee for $27B in preferred shares.
Preferred stock, for those of you fortunate enough not to know about this stuff, can be thought of as the junior-most form of debt. Preferred holders get only a fixed dividend, and don’t participate in any rise in the value of the company. In case of bankruptcy, preferred payments (dividend and principle) are in line ahead of any payments on common stock, but behind any payments on debt. Whether a preferred stock is valuable depends on the solvency of the company, the dividend rate, and whether it comes with “warrants” (options) to buy common stock or the right to convert the preferred to common at some pre-agreed rate.
The Citi preferred the government is getting pays 8%, which is a pretty mingy interest rate on a risk investment, with no convertibility and no warrants. Make the preferred convertible to common stock at Friday’s closing price, and the taxpayers would effectively own about 60% of the equity.
Update The Wall Street Journal says the deal does come with warrants, but doesn’t say how much, which suggests that the answer is “No enough.”
Second update Reuters says it’s $27B of preferred for $20B in cash, suggesting a $7B premium for a total federal insurance exposure of $250B. In addition, the Feds get warrants to purchase 10% of the common at about $10 and change, 250% of Friday’s close or about 170% of today’s close after the surge due to the bailout. Better than nothing, I suppose. But somehow I think that if Hank Paulson had been negotiating for Goldman instead of for you and me, he would have driven a harder bargain.
Third update Everyone seems to hate the deal.