Citibank Takes the US to the Cleaners

Oh Citibank, how many ways to you game the system? This dovetails nicely with that post about conning America.

Beat the Press (Dean Baker):

March 28, 2010

Did the Federal Government Make Money Bailing Out Citigroup?

The Washington Post is anxious to tell its readers that the government made a profit on its bailout of Citigroup. This claim gives a whole new meaning to the notion of "profit." The government gave enormous amounts of money to Citigroup through various direct and indirect channels. It is only getting a portion of this money back in its "profits," the rest is going to Citigroup's shareholders (e.g. Robert Rubin) and its millionaire executives who are highly skilled at getting the government to hand them money.

First, it is worth noting how the government got the shares of common stock which it is now selling for a profit. On November 23, 2008, the government bought $20 billion in preferred shares in Citigroup. It also received another $7 billion in preferred shares in exchange for guarantees on $300 billion in bad assets. At the time, the combined value of the investment in preferred shares and the guarantee on bad assets exceeded the full market value of Citigroup stock on November 21st, the last trading day prior to the deal. In other words, for the same financial commitment that the government made on that day, it could have owned Citigroup outright.

The government subsequently held onto to its preferred shares until Citigroup's stock had nearly tripled in value. In September of last year it traded its preferred shares for common shares that were priced at a level that only give the government a 27 percent stake in Citigroup. These shares have have now risen enough to give the government an $8 billion profit on its investment. While the Post tells readers that:

"The windfall expected from the stock sale would amount to a validation of the rescue plan adopted by government officials during the height of the financial panic, when the banking system neared the brink of collapse. A year ago, Citigroup's stock hovered around a dollar a share, and the bank's future seemed in doubt. On Friday, the stock closed at $4.31."

The logic of the Post's assertion that the profit on Citigroup stock validated the bailout is not clear. By making capital available to Citigroup at below market rates, the government effectively subsidized the income of Citigroup's shareholders. It also allowed its top executives to make millions of dollars because they were smart enough to be able to get taxpayers to subsidize the bank. The current market value of Citigroup is $123 billion, with only $33 billion belonging to the government. This means that the government has effectively given $90 billion (@ 25 million kid-years of health care provided through the State Children's Health Insurance Program or SCHIP) to Citigroup's shareholders and billions more to its executives by not demanding a market price for its support.

It is also worth noting that the government has supported Citigroup through other mechanisms. The Fed created various special lending facilities that allowed Citigroup to borrow money from the government at extremely low interest rates. Since one of the main uses of this money was buying government bonds, Citigroup was essentially getting free money from the government. If it borrowed $200 billion at near zero interest and lent it back to the government by buying 10-year Treasury bonds at 3.7 percent interest, then the government was effectively handing Citigroup $7.4 billion a year for nothing. This money is not deducted from the Post's estimate of the government's "profit" on its dealings with Citigroup. (The Fed refuses to tell the public how much money it lent to Citigroup and other banks at below market rates.)

It is possible that the losses at Fannie Mae and Freddie Mac, as well as the Federal Housing Authority (FHA), may also have helped to subsidize Citigroup's profits. Fannie and Freddie lose money when they pay too much to banks to buy mortgages. It is likely that Citigroup was one of the banks that Fannie and Freddie overpaid for mortgages. Similarly, the FHA loses money when it guarantees mortgages without charging a high enough insurance fee. It is likely that many of the mortgages that the FHA guaranteed, which went bad, were issued by Citigroup.

It is also worth noting that government policy has helped to boost Citigroup's profitability in other ways. Citigroup is at the top of the list of "too big to fail" institutions. This has allowed it to continue to borrow money from the private investors at interest rates that are far below the rates it would have to pay if it did not rely on a guarantee of support from the nanny state.

Also, the government's efforts to support the economy more generally have proven a boon to Citigroup. Specifically, by pushing down interest rates it has enormously raised the value of the loans on Citigroup's books. The value of long-term loans rises substantially when interest rates fall. If the Fed's program of buying mortgage-backed securities lowered the interest rate on 30-year mortgages from 5.5 percent to 5.0 percent, then this would raise the value of Citigroup's outstanding 30-year mortgages by more than 7 percent. If Citi had $500 billion invested in mortgages or related assets, then the action by the Fed would have effectively given Citi $35 billion.

If the Fed subsequently resells the $1.25 trillion in mortgage-backed securities it purchased in order to push down mortgage interest rates in an environment in which interest rates have risen, then it will lose money on these purchases. If it sells the mortgage-backed securities when interest rates are 6 percent, then it will lose close to 15 percent, or more than $180 billion on its purchases of these mortgages.

In telling readers that the profit on Citi stock "would amount to a validation of the rescue plan adopted by government officials during the height of the financial panic" the Post is ignoring all the other costs born by the government in allowing Citigroup to be restored to viability. It is also ignoring the enormous handout of taxpayer dollars to some of the richest people in the country. This is not good reporting.

--Dean Baker

The fraud of the Bank Run Scare

Where the case is made that it would have been better, cheaper, and less inflationary for the government to simply print money to replace the missing funds of failed banks rather than bail them out.

Dean Baker in Guardian.uk:

Was the bank bailout necessary?

Saving zombie banks supposedly prevented financial collapse. But would letting them fail really have been so bad?

US Treasury secretary Timothy Geithner says that we don't need to bail out the banks anymore based on the results of his stress tests. We should follow up quickly on his assessment and start shutting the special Fed lending facilities enjoyed by the banks, the FDIC loan guarantee programme and the AIG slush fund.

However, given the hundreds of billions that have already gone out the door, it is still worth asking whether this bailout was necessary. The argument made by many economists was that it would cost taxpayers more money to do an FDIC-type takeover of banking behemoths like Citigroup and Bank of America than the tens of billions handed over to keep them afloat. In their story, the taxpayer bailout of bank stockholders, bondholders and top management was an unfortunate side effect.

While the next step in this argument is a calculation of the cost of a bite-the-bullet now approach versus a handout-and-wait strategy. With the right assumptions, the handout-and-wait strategy can be shown to come out on top, so we really were just helping ourselves when we gave hundreds of billions of dollars to the bankers that wrecked the economy.

But this calculation not only requires a very specific set of assumptions, it also requires some really bad logic, a commodity supplied in abundance by nation's top economists. The economists claimed that killing the zombie banks would cost more money because it would effectively set in motion a bank run.

The argument goes that people would withdraw money even from insured deposits. The result would be that the government would suddenly be liable to make good on all the banks' deposits, which could easily exceed the value of their assets by more than $1tn. The economists argued that it was better to have costly bailouts than to deal with a massive collapse.

To see the fallacy in the economists' logic, suppose that the banks' depositors gathered together $1tn in cash. Suppose they accidentally set the cash on fire and burnt it up so that $1tn in cash no longer existed.

What if the government then stepped in and replaced the lost money. However, instead of borrowing money in the bond market, it simply printed up another $1tn in cash. In this case, there is no greater debt burden on the government in the future, since the $1tn has no interest costs.

Nor is there any threat of inflation as a result of the printing up an additional $1tn. The newly minted $1tn simply replaced $1tn that was destroyed. There is no more money in circulation as a result of this printing than there had been before the big fire.

In short, replacing the $1tn destroyed by the fire imposes no real cost on the government at all. (If this all sounds a little too fast and loose, it is. If we let the depositors suffer their $1tn loss, then the rest of us would be richer as a result. The depositors would have less claim on the economy's output, leaving more for the rest of us.)

How does this relate to the great bank heist of 2008-2009? It's very simple. If we actually got the scary bank runs described by the leading economists, then the Fed could just print the money needed to make the depositors whole. This additional money would not add in any real sense to the government's debt burden. We would just be replacing money that had effectively disappeared with new money. This would impose no additional interest costs, nor would it increase the threat of inflation.

The great benefit of going this route is that it would not use taxpayer dollars to reward the bankers executives who got us into this mess, and the bondholders and stockholders who were foolish enough to trust them with their money. We could honour all guaranteed deposits while allowing the bondholders and stockholders to enjoy the full fruit of their risk-taking. In other words, they would get wiped out, which is what is supposed to happen in a capitalist economy.

We would also replace the bank executives with more competent people, who presumably would work for much lower pay. As quickly as possible the banks would be restructured and then sold back to the private sector. That is the way things are supposed to work in a market economy.

In short, there were really no legitimate horror stories, at least from the taxpayers' side. The horror stories were only horror stories for the bank executives and their bondholders and shareholders. The economists who missed the housing bubble helped to deceive the public yet again and steer more taxpayer dollars in the pockets of this wealthy clique.