The one big question on everyone’s mind was the fate of Citigroup. After the crashes of Lehman and then Merrill, people have now become wary and the feeling today is that no company, how so ever big it might be, is immune – any company can go down like the Titanic, sink into the oblivion.
The news that Citgroup might sell part of its assets or even all of it came as a shocker. The plunge in its share price was also worrying, threatening to engulf other big banks. But finally, this dark looming cloud seems to be dissipating. After a tense, round-the-clock bout of negotiations that stretched until almost midnight on Sunday, a bold plan seems to now have emerged.
The US Govt knew that this is one collapse, which its economy could no longer afford to have. And rescue Citigroup, it had to do! Hence a plan, mooted jointly by the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp (FDIC) will now provide the required crutches to the maimed group.
As part of the plan, apart from taking a $20 billion stake, the Treasury and the FDIC will guarantee against the “possibility of unusually large losses” on up to $306 billion of risky loans and securities backed by commercial and residential mortgages. Under the loss-sharing arrangement, Citigroup Inc. will assume the first $29 billion in losses on the risky pool of assets. Beyond that amount, the government would absorb 90% of the remaining losses and Citigroup 10%. Money from the $700 billion bailout and funds from the FDIC would cover the government’s portion of potential losses. The Treasury Department will use its bailout fund to assume up to $5 billion of losses. If necessary, the FDIC will bear the next $10 billion of losses and losses beyond that would be borne by the Federal Reserve.
In exchange, Citigroup will issue $7 billion of preferred stock to government regulators. In addition, the government is buying $20 billion of preferred stock in Citigroup, which will pay a 8% dividend and will marginally erode the value of shares held by investors.
Apart from this complex plan, as a condition of the rescue, Citigroup is barred from paying quarterly dividends to shareholders of more than 1 cent a share for three years unless the company obtains consent from the three federal agencies. The agreement also places restrictions on executive compensation, including bonuses.
Investors are happy that this bank too has been rescued but the dissent amongst the smaller banks, which could also have been rescued if the Govt had taken timely action seems to now be growing. Why was Lehman allowed to go down? Couldn’t it too have been rescued with a timely action plan? Another growing worry is that these actions could put billions of taxpayers’ dollars in further jeopardy. Moreover, it would encourage financial companies to take excessive risk on the belief that the government will bail them out.
Collapse of Citigroup was one more crisis which could have toppled the US economy and to some extent, sent the global economy into a longer drawn out recession. Citigroup, America’s largest and mightiest financial institution today is sitting on a loss of $65 billion and more than half that amount comes from mortgage related securities created by one man – Thomas G. Maheras, who repeatedly assured the bank that everything was alright and stated that there were no losses. The bank, which is actually a worldwide conglomerate, relied on the words of this one man and allowed the bank to collapse. And by the time the risk management team took over, it was too late. The question that comes to mind once again – how can such a large bank rely on the words of just one man? The near collapse of Citigroup is symbolic of the madness, which had taken over the entire Wall Street – to get rich fast, two hoots to management and risks! And today, the whole world is paying a price. This is the price we all have to pay for depending so largely on one super power.
For now, one more crisis has been averted. But are there any more lurking in the background? How many more bailouts to go?