The sovereign exit strategy for bank shareholdings

By Felix Salmon
March 30, 2010

There are very few investors for whom a 0% return is just another arbitrary point on the real-number spectrum. In theory, the difference between a +10% return and a +15% return is the same as the difference between a -3% return and a +2% return. But in practice, the latter is much more important, because it spans the crucial zero bound: it’s the difference between making money and losing money.

Much has been written on the behavioral economics of loss aversion, where the pain of losing a certain amount of money is nearly always greater than the pleasure of gaining an identical amount. And what’s true of a country’s citizens is often true of its government, which is why the question of whether or not governments are making a profit on their bank bailouts is an interesting and important one.

Which is not to say that the super-smart dsquared was wrong when he left this comment about whether it would constitute speculation for Treasury to hold on to its Citigroup shares. Quite the contrary, he’s absolutely right:

I had heard the saying “an investment is just a speculation that went wrong”, but it’s a joke, not a sensible principle of money management and not something that can be reversed to give an exit target. If the Treasury is speculating now, it was speculating when it was in the red.

But the point is that if Treasury continues to speculate now, it’s mere speculation. When it was underwater on its investment, it at least could say that it was holding on to its stake until the share price rose enough that it could get its money back. Yes, that’s a form of speculation too. But it’s somehow a more acceptable form of speculation to hold onto an investment in the hope that you won’t lose money than it is to hold onto a profitable investment in the hope that you’ll make even more money.

Indeed, the whole argument about whether or not banks should mark their assets to market is at heart an argument about this very question. If banks hold loans on their books at par, even if they could never get 100 cents on the dollar for those loans in the secondary market, they’re essentially speculating that the value of the loans will return, over time, to more than they lent out in the first place. But they don’t call it speculation, they call it “commitment to our valued clients through thick and thin”, or something like that.

Sovereign investments in banks, it seems, work much the same way:

Switzerland made a profit after selling a 9 percent stake in UBS in August, saying it was confident the bank was on a solid enough footing for it to retreat.

Britain is expected to start selling shares in Royal Bank of Scotland and Lloyds, although that would not happen until after the general election, expected in May.

Share prices for RBS and Lloyds have risen close to the average price at which Britain bought its stakes and the government is becoming increasingly confident of making a profit on the billions of pounds it has pumped in.

A full exit could take many years in many countries, however. Sweden, which pioneered NAMA-style schemes, is still a big shareholder in Nordea after it stepped in to rescue lenders in the early 1990s.

The pattern here, from the U.S. to Switzerland to Britain to Sweden, is clear: you hold on to your stake until you’re in the black, and then you sell it. Yes, that’s a form of speculation. But it’s clearly an acceptable one.


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The US should handle all of our investments as deftly as it has managed its Citi stake. Or was it luck?

Posted by Story_Burn | Report as abusive

Felix, there’s no reason to pretend that it matters whether the government makes $10b or loses $10b on its equity investment in Citigroup. Buying or holding a stock like Citigroup is a speculation at any price. Selling is a speculation that today’s buyer is the greatest fool. Once you have a government taking minority common equity stakes in possibly insolvent financial companies, making up the rules as they go along, to pretend that something rational is going on turns you into a fool. What’s the government’s cost of capital? What are the externalities of a government investment in Citigroup? What are the transaction costs and minority investor/large block seller costs?

The only difference between the U.S. and Iceland/Ireland is that our government is currently big enough to credibly bail out its banks and attract new private capital into them. Our government should be taking advantage of this status while it lasts to get as much dumb money into C as possible, force asset sales, and get federal money out. The AIG model is working pretty well – the fact that people are still eager to hold the common of a company that has systematically sold its best assets and retained its worst ones is an amazing testament to the willingness of dumb money to hold the bag.

If you want the government to be in the business of investing in U.S. businesses, please hire me to run the Social Security Hedge Fund. I think I can outperform the bail-out-and-hold Citi strategy or the 100% Treasury strategy. If I blow up and lose all the money doing leveraged Greek debt trading, well, sometimes that happens when you “invest”.

Posted by najdorf | Report as abusive

If man is so averse to losses (and I don’t disagree with that contention), why is there such a clamor for short sales and mortgage cramdowns on housing? Remember, it’s not just politicians who have been calling for this but homeowners as well.

I realize this is a bit of a sidetrack, but it suggests that loss aversion isn’t nearly a universal feeling.

Posted by DaveFriedman | Report as abusive

Hi Felix
I tend to agree with your view on the fact that peoples relationship to losses and profits is not symmetrical. However I feel that some of the gains in banking shares are not likely to persist. This means that whilst the US taxpayer may well make a profit on its stake in Citi it is handing a problem to the buyers many of whom will be US taxpayers.
I have been reading on the dangers going forward for both the Irish and the UK banking sectors from all their commercial property investments on the notayesmanseconomics web blog. From this analysis I am afraid there are further problems ahead for many of us.

Posted by Sally32 | Report as abusive

“it spans the crucial zero bound: it’s the difference between making money and losing money.”:

I disagree, it is about making the lowest relative loss, like the least negative NPV in a range of negative NPV projects,

Or maybe its simply opportunity costs and income ?

Why are you guys so scared of ‘real vs nominal returns’? Maybe because it will cause mass hysteria and panick ?

Posted by Ghandiolfini | Report as abusive

The crossroads of politics and economics, underwriting the American system.

Conceptually, how distasteful would it be to consider giving the US Treasury or Federal Reserve decision makers monitorial performance bonuses for the performance of their Citi rescue/investment? Now the unwinding process is being monitored and measured. Will it be, awkwardly-said, political dividends that is a take-away of this otherwise apolitical rescue – it certainly shouldn’t be. It would signal a shift from a traditional neutral stance.

The unwinding story has been for the US to rollout of its position without hurting the prevailing price (a “kinder way”* planned) thus far. Profiting from this, though unwritten, is distasteful.

Moreover, saving Citi saved a firm literally too large to fail – if any. It’s vindication for a systematic approach that worked and an American partnership that saved and preserves what was otherwise “on the brink” – pun intended from Mr. Paulson book.

US “stands to earn about $7 billion (4.6 billion pounds) profit if it can sell near current values” * 2S33J20100329?type=companyNews

Posted by RayAmani | Report as abusive

I’ll try and send you an email on this subject, but for the time being I just wanted to note (and nobody who has not experienced the agony of pedantic spectrum disorder can understand what motivates me to say this) that you can’t “straddle the crucial zero bound”. If you can cross it, it isn’t a bound.

Posted by dsquared | Report as abusive

One of the numerous problems with Treasury investment in banks which deserve to fail is that it makes the public an accessory after the fact to the reprehensible set of circumstances that got these banks into that state in the first place. As such, it was never an investment worth making, nor is it one that is ever liable to show up on the books as having been good for the public.

In the fullness of time, it will have become an invisible accounting item: too big to be argued about, not small enough for tea-partiers to comprehend.

When the Treasury is politically ready to sell, its intention to do so will be telegraphed long before such sale takes place. Not good poker.

Definitely not good investment, not really investment at all. A “fix” would be the better term – private gain from public liability by any other name.

Posted by HBC | Report as abusive

Holding on to an investment cannot really be classified as speculation. A fundamental concept of accounting is a going concern concept. If I believe that the business is a going concern, then holding on to my investment rather than trying to generate higher returns by churning the portfolio cannot be termed as speculation.

Posted by Mustu | Report as abusive