Citigroup’s toxic assets should prolong any rescue attempt HARRY KOZA

Harry Koza is senior Canadian markets analyst at Thomson Reuters and a columnist for GlobeinvestorGOLD.com

November 28, 2008

Well, the Hank Paulson and Ben Bernanke Plunge Protection Team is at it again, coming up with a plan over last weekend to nationalize, er, rescue Citigroup from its imploding balance sheet. The Treasury, the Federal Reserve Board and the Federal Deposit Insurance Corp. (FDIC) will band together to bravely ring-fence a $306-billion (U.S.) pool of Citigroup’s "troubled" assets.

Citi will eat the first $29-billion of losses on that pool, and the U.S. taxpayer is on the hook for the rest. The government will take $7-billion in preferred shares in exchange for that backstop, and also pump another 20 billion clams into Citi for even more preferreds with an 8-per-cent dividend. That’s on top of the $25-billion the bank got from the Troubled Asset Relief Program or TARP - you know, the capital they said they didn’t need because they already had a "strong" capital position.

The price for the rescue is that the existing shareholders get hosed. Under the rescue deal’s provisions, Citi can’t pay more than a cent a share quarterly dividend for the next three years. They also have to help homeowners avoid foreclosure, which sounds to me like more mortgage book losses ahead.

Oh, and natch, there are new restrictions on how much executives can be paid.

It’d be more credible if, in addition to clamping down on excessive executive remuneration, politicians on both sides of the aisle gave back the millions that they’ve received from Fannie and Freddie over the years while enabling the inflation of the housing bubble in the first place, or at least, banned any further lobbying by the government-sponsored enterprises (GSEs). Don’t hold your breath waiting for that one to happen.

Anyway, Citi’s still too big to fail. But, man, you’d think they’d learn: It’s not like this hasn’t happened to them before.

Back in the Roaring Twenties, Citi, known then as the First National City Bank, coined it huge by repackaging bad loans from Latin America and selling them as "safe" investments, which turned out, in 1929, to be about as safe as tap dancing through a mine-field.

Talk about déjà vu. Then, as now, legislators, eager to shut the stable door now that the horse had escaped and been flattened by a semi on the freeway, created a new layer of securities regulation to ensure that it couldn’t happen ever again. As if.

At the end of that debacle, First National City Bank emerged as Citibank.

In the 1980s Citibank was heavily into emerging-market debt, or less-developed country (LDC) debt, as it was known back then. I remember then-chairman Walter Wriston’s famous remark on the subject: "Countries don’t go bankrupt."

Well, except for Argentina (a couple of times), Russia, and more recently, Iceland, which appears to be back on a cod-based economy (I mean the fish, not cash-on-delivery). Apparently, lending LDCs a billion a year so they could make the interest payments on their other debt - and Citi could pretend that they were still performing loans (with the appropriate regulatory forbearance, of course) - wasn’t that great a business model. Who knew?

Between 1989 and 1991 Citicorp blew its brains out in western U.S. commercial real estate - $13-billion worth of 80 per cent loan-to-value mortgages, almost half of them non-performing, what with commercial real estate being down roughly 40 per cent in value, making the loans the nineties’ equivalent of subprime. They also had huge exposure to Olympia and York when that commercial real estate empire collapsed, and to Donald Trump, Robert Maxwell, and Bob Campeau, among others.

By 1991, ratings on some of Citibank’s debt had been cut to junk, and by 1992, the bank had signed a MOU - a "memorandum of understanding" with its regulators, essentially admitting that it was nearly insolvent and required intensive regulatory supervision. Even then Citi was too big to fail: Instead, by 1998 it had merged with Travelers Group to form Citigroup.

Out of that nineties credit crunch and the LDC crisis came the Basel rules, a new set of global banking regulations designed to ensure that another similar mess could never happen again. That worked pretty well, but then the banks came up with Basel II, essentially designed to let them all get around the Basel I rules, which brings us to today.

The markets seem to think the Citi bailout was a good thing, that $308-billion is a good backstop, but I’m not convinced. Citi has roughly $2-trillion in assets on its balance sheet, but it also has about $1.2-trillion in off-balance-sheet assets. I suspect that the reason those assets are off-balance sheet in the first place is because they are, essentially, crap, which suggests that we haven’t seen the end of this bailout and that further government cash injections will be needed as those toxic assets come home to Citi’s balance sheet.