Slouching towards nationalization

By J Saft
November 26, 2008

James Saft Great Debate — James Saft is a Reuters columnist. The opinions expressed are his own —

The Citigroup bailout is sure to succeed, but only if you count avoiding making unpleasant but needed decisions as success.

It won’t work if you define success as building confidence and attracting private capital back to the banking system. It fails to work out a clearing price for rotten assets, and though it underwrites $306 billion of them even this huge sum is not enough to suspend disbelief.

It won’t even work if you define success as jump starting Citibank lending to private borrowers. The bankers have every reason to keep their heads down and pray they can slowly rebuild capital rather than lending into the biggest downturn in two or three generations.

At best it buys Citibank some time, though heaven knows what they can do in the next little while to stave off a cascade of writedowns in their housing and consumer loan books, much less their emerging market businesses.

It also, and I think tellingly, avoids taking a credible decision on whether Citigroup, and by extension the U.S. banking industry, can avoid explicit as well as effective nationalization.

We are in a really dangerous moment when is it apparent not only that no one really knows what to do, but that the people making decisions now are not the ones who will be left to sort them out once a new administration takes power in Washington. That provides a ready excuse to simply kick Citigroup’s can along the road.

One thing is very clear; the terms extended to Citigroup were a lot less difficult to bear than other earlier bailouts. I would guess that this is because the government is terrified that they have become the only game in town. The government is in a double bind; they must extend capital to banks or see them fail but every time they do it they make the banks less attractive to private money.

Any more radical solution would be difficult for a lame duck administration to attempt, and given the size of the banks involved, very daunting.

The United States will invest $20 billion in Citi preferred shares which will pay an 8 percent dividend.
The government will get 10-year warrants to buy $2.7 billion of common stock at $10.61 per share, as against Citi’s $3.77 price just before the deal was announced.

The government will guarantee $306 billion of Citi assets, with Citi taking the first $29 billion in pre-tax losses and the government on the hook for 90 percent of the losses after that. These assets will remain on Citi’s balance sheet and it will continue to get any income they generate but Citi will issue $7 billion of preferred stock, which will also pay 8 percent, as a fee. These assets will only be 20 percent risk weighted, which will free up an estimated $16 billion of capital. All in all, it was enough to underwrite a more than 70 percent rally in Citigroup shares.

Crucially, we’ve not yet seen any indication that we will get a full accounting of exactly how that $306 billion was valued, other than it was agreed between Citi and the United States. It is another example of the U.S. saying: “Don’t worry,  we will make it all OK,” without exactly specifying what “it” is.


And of course without being able to see what the assets will actually fetch, especially in a declining economic environment, who would want to buy the pig in the bank’s poke?

That being the case, and in the firm expectation that loan losses will mount as the economy worsens, it’s a fair bet that the vicious cycle of writedowns and capital need will continue. In the absence of some real clearing mechanism for banking assets, and a willingness for government to pick up the pieces for those banks that can’t survive, expect more requests for life support from more banks.

But governments are finding it increasingly frustrating, at least publicly, that they pour money into banks yet see little in the way of lending come out the other end.

“The heart of the fear for all of us that still value free markets is that governments will eventually decide to nationalize whole swathes of the global banking system to ensure that the money they’ve invested in the recapitalization trade filters through into the wider economy,” Deutsche Bank credit strategist Jim Reid wrote in a note to clients.

“Ironically there may be a time when banks have to decide whether they need to make loans that may prove to be loss-making just to avoid governments losing patience and nationalising them.”
It is really a worst of all worlds, a circle of cynicism; governments prop up the good and the bad in the banking system, which in turn makes loans it doesn’t really think make any sense.

It’s a heck of a way to allocate capital, and almost as bad as the old system.

— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. —


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This is what you get when you let government officials who have contempt for the law and the constitution, get away with wholesale looting of the treasury. Did anyone ever stop to consider that there are big winners here? In any economic system, no one loses without someone gaining that amount. If you look at government policy and notice that it is in conflict with its stated aims, you may well consider what the hidden agenda is and who benefits. I find it stunning that the media is accepting all of these inconsistencies as simply incompetence and the result of a lame duck administration.It is surreal. Kind of like watching a bank being robbed and commenting that the robbers are using an off brand of wheelbarrow.

Posted by Jonathan Cole | Report as abusive

I am reminded that the Golden Age in Athens was ‘kicked-started’ by a massive debt-forgivness policy of the then King. Ancient Athens was drowning in a sea of debt – sound like today?- and these current bail-outs look to me suspiciously like nothing more than debt-forgiveness for banks, but not for private individuals or tax-payers.
Perhaps the simplest solution to this mess is to do like the Athenians and let everyone off the hook and start all over again. Just think of the economic stimulus and boost to consumer spending that would bring!
Perhaps it could be combined with far more stringent control of borrowing – maximum $1,000 limits on all credit cards, much stricter controls on the size of mortgages, etc. so as to avoid getting into this mess again.
This could be the real change that the incoming president offered and we too could have a Golden Age – we sure could use it!

Posted by David Goodfellow | Report as abusive

Fannie Mae and Freddie Mac were encouraged to continue issuing mortgages and credit to keep the economy afloat through federal legislation. I am not aware of any functional difference between the previous system of banking and the present.

It should by now be a foregone conclusion that government will continue to enact policies to stimulate and direct the economy. If we still believe we live in a democracy, the only question is how we choose to have government move forward and what goals we seek to achieve to that tend.

I believe we as a people have the ear of our elected officials for the first time in over eighty years. The simple fact is we must wait two months for our change in government. We as citizens should give much consideration to how our government should move forward and let our representatives know how we feel every step of the way. The U.S. has been the leader of the world through out much of it’s history. Once again we are thrust into the position of having to lead. The fate of a planet and civilization hang in the balance.

Posted by Anubis | Report as abusive

It wasn’t that long ago when trading companies started to take the opposite side of equity positions and pulling from inventory rather than facilitating market transactions. To me it seemed like a big conflict of interest and an unfair advantage for the market makers. Then of course the trading companies assumed the same role in the bond markets. I thought maybe after the dotcom bust these investment institutions would have learned their lesson. Now the government is stepping in using tax-payers dollars to buy low – with the anticipation of higher prices ahead. It’s a rampant level of abuse and market manipulation that I didn’t think was possible – especially in the United States, of all places.

Well, I personally feel the market is like pond with predatory fish. Once all the little guys are driven out of the water, the big guys will have nothing to eat. It’s the geometry of trading. The most successful players have the most to lose. I know a lot of governments want to unload their holdings at a later date. They buy all of the so-called bad debt and then drive down the interest rates, hoping for a technical increase in market values. I’m just surprised the United States has become so mysteriously interventionist. It’s sad to see this sort of iron-curtain mentality developing here.

Posted by Don | Report as abusive

Jonathan Cole:I agree, the notion that this is all coming about due to massive blunder and mismanagement seems SO unlikely. It was planned- give the people enough rope (credit) and they’ll hang themselves. The most valuable- and disturbing- thing that is being gained is control. Control the money, and you control the population. Yet again, the government and the mass media create an atmosphere of fear and panic, and, under the guise of helping a desperate situation, the “powers that be” gain more control over the people.

Posted by Joanne Connolly | Report as abusive

Could this be a final clash between capitalism and socialism, or as it always happens historically,
an spyral mixing of the two.

Posted by manuel | Report as abusive

as i see it econimics is a zero sum game. that means that a profit has a matching loss, and a loan is much like a tax/spend policy (run the presses but get it back with interest) which always leaves the system with less.

Posted by steve | Report as abusive

Not with my money!! I don’t want my grandkids paying back all these Federal giveaways caused by people who were either very DUMB or very crooked. You want world Govt. and the thousand points of light then YOU PAY FOR IT! John

Posted by John D. | Report as abusive

James Saft is an artist…. Once again he offers up scary scenarios, but fails to supply any solutions…. True artistry at work….

Posted by Jim Edgcomb | Report as abusive

I agree with james that no one knows what they are doing with all these bailouts. One thing is certain that it is the end of American style of capitalism because we need Chinese to buy our debt. I wonder why our great business schools have not come up with any other solutions to fix the economy.Even Harvard Business School finances is in a mess now. Wonder when will they dump their case methodology and begin to reeducate themselves on the “fundamental of economics” rather than wasting time devloping exotic financial engeneering derivatives which have brought about this unprecedented crisis.

Posted by sanjay | Report as abusive

Great, the bright sparks responsible for this mess are given tax payers life lines to continue. These are the criminals who are responsible for this sinful crime are now claiming economic armaggedon if they are not rescue. So US government, Fed, Treasury provides more tax payers money.
See they are bright sparks. After milking one round, they are now on round two. With the rescue packages to them they can now do a lot of share buy back, push the share price up, sell their portion they own, maybe exercise options, keep their high paying jobs, corporate jets, declare more bonuses for themselves. Yes continue to throw more life lines to these Ivy Leagues crooks. Where is the transparency when the money goes to them? Are there any clear distinction on what is and not distressed assets? Are they colored differently? Wake up America. Your are still sleeping.

Posted by Tang kin Meng | Report as abusive

US Treasury and Federal Reserve are throwing a lot of good Money after bad.They are behaving exactly as the reckless Wall Street Bankers did,without thinking of consequences.If printing Currency can rescue the US Economy none of the African nations would still be poor.
Credit pipelines are jammed because Solvency of Firms is the real issue.Governments and Central Banks cannot play God by saving weak Firms falling prey to dynamic Business Cycles. The results of reckless Fiscal profligacy now being enacted will set back Economic progress for America,by many decades.America is putting Paulson and Bernanke through a tough test in Basic Economics.I am giving them 1/10 for their solutions.
Where are the Credit rating Jokers? AAA for America?Do these farts know the A B or C of Economics?They are going to be sued for Billions.Will the Government bale them out too?

Posted by goldchest | Report as abusive

Let us assume that history will demonstrate that the various bail outs were the turning point in resolving the crisis. This is only the starting point because you make a pivotal statement which is central to the success of this initiative. You say…..”But governments are finding it increasingly frustrating, at least publicly, that they pour money into banks yet see little in the way of lending come out the other end.”

The people in the various troubled banks who caused the crisis are not capable of sorting out the problems. They are deal making hot shot movers and shakers with no lending skills. What is needed is people who can:

1/ Work on a recovery program of regularising all the non performing bad loans
2/ Use the injection of government funds to make GOOD well structured new loans.

We are talking about experienced lending and risk managers. I suspect that one of the reasons why new loan flows are so constipated is because there are simply not enough good lending bankers left to recover all the bad loans and make new loans. The banking industry is top heavy with all the wrong skills and they need to get the right skills on board PDQ

Posted by anton kleinschmidt | Report as abusive

Dave Goodfellow, about your “massive debt-forgivness” proposal. In today’s economy, most people’s savings are debts that the banks owe to their customers. A massive debt-forgiveness will wipe out the population’s savings and retirement funds as well as eliminating the insurance companies and the finance industry.

In fact, this is easy to do. Just keep issuing infinite amounts of printed money, until massive inflation wipes out all savings and debts, Weimar Republic style. The only problem with that, is that the Weimar Republic’s inflation didn’t create an economic boom followed by prosperity and democracy, but had a less happy consequence.

Posted by Johnny Wiseguy | Report as abusive

The banking system has brought the crisis on itself, now let it figure out how to solve it. They loaned out money for housing that was as low as one third the actual lending rate. People who had those loans were paying far less than the actual interest and therefore loosing equity in there homes. This allowed people to by far beyond their means to pay. They were buying million and multi million dollar homes with the hopes that by the time the loan was due to be reset to the real interest rate, that they would be able to handle it. At the same time auto loans were put on longer terms so that they could buy hundred thousand dollar automobiles to go with their milion dollar homes. To bail out the big banks is to place a burden on the American people that will do away with freedom in our country. Someone has to pay the debt and no one can and still survive. Bailing out the banks does nothing to curb inflation in fact it will raise inflation by trillions of dollars. Those are dollars that the poor and middle class must pay. The best thing that can happen to America is to let the big banks along with those who have used unwise spending go bankrupt. Yes, this will throw the country into a depression and times will get very hard for awhile, several years, but the inflation that the bailout will create will only make the eventual depression harder and longer. The nation needa to go back to the gold standard and put something behind the dollar, which now is only writing on a piece of paper. The federal reserve needs to be owned by the government and not by the big money people. The free trade agreement needs to be done away with and the jobs brought home. Do we not realize that if we went to war with China or one of it’s allies that we could not even put shoes on our soldiers. We couldn’t buy steel to build machinery with as most steel now comes from Japan, which has no defence against China. We in America need to quit living in a dream world and start living in reality. We need to face the fact that money is not free, we don’t need million dollar homes. If we think that there is a magic way out of this we’re wrong. Buying out or bailing out the big banks puts us in the exact position that the people living in the comunist countries were under for many years. Let’s face it, whoever bails out the banks controlls the world, they decide who is going to pay for it and how it is to be done. Be assured that it won’t be the money people and that the banking system will only get worse. Fiat money has to be done away with, that was a plot by the banking system to allow them to lend as much as ten times what their actual assetts were and the American people bought it because it was named Federal Reserve and the government doesn’t own one dime of it.

Posted by A. C. Hinkle | Report as abusive

What is going on in the financial world is not an accident. A blind man could see more than that with his cane. When banks won’t make business loans because the get much greater returns from credit cards, and people can buy homes for as little as 2 to 4% with an adjustment in five years. Anyone with any amount of financial savy, knows that the bubble will burst. I was a small mortgage broker and I would not make any of those loans though the banks were pushing me to do so. It was easy to see that the people who needed that type of loan could never repay the debt at the time the loan would be adjusted to the full going rate of the day. The banks knew this, but they were in hopes that inflation would increase the value of the homes so that at the time they were reposessed their assetts would be secure.
Credit card debt is never ment to be paid off. If you ever buy anything new, the minimun payment will not pay the debt, but the banks don’t care whether the debt is paid or not so long as there is a constant flow of intrest coming in. If the debt is paid, they have to reloan the money, if it isn’t paid then thay just collect the interest. Lend at 18% to 21%, take off two to three percent for bad debt and you have a constant inflow of 16% to 18% and not have any risk. Why would you ever want to lend on a business with risk? The big banks have financed both sides all of the wars, with the exception of the Civil War, that we have ever fought. Wars create waste and waste has to be replaced, which can only be done from borrowed money. When we lend to a foreign country, there is never any hope of the debt ever being paid, they only want the interest. Let the banks solve the problems that they have created. You will find that the big banks will not go under, only the smaller ones, as the big banks controll the Federal Reserve.

Posted by A. C. Hinkle | Report as abusive

The Big Roulette Wheel of Capitalism and has been turning around faster and faster for ten years now with the big players borrowing lots of money from the house (and each other) to place even larger bets each day. The little players can barely see over the table to place just one chip on the table. But the wheel has an unseen yet inherent principal of physics attached to it. It is simple……..the ball must fall to the center sometime.

Well, the ball has finally fallen. Many of the big players placed too much borrowed money on Black. The ball instead fell on Red. The House says all wagering had ended and now demands that the losers pay the House.

But the big players are out of cash…..they bet wrong on Black. They owe the house very large sums of money. They cannot pay. They plead their situation to the House and make all kinds of excuses as to why they bet wrong. The car valets at the main door take the keys to their GM’s, Chryslers, and Ford F-250’s in the parking lot.

They find a glimmer of hope………Hank and his buddies are at the cash window with the BEN FED chairman willing to bail them out. They give the biggest losers more free money to pay the game again. Suddenly the big losers rush to the cash window for money………….what happens next?

In their rush to the cash window they ignore all the little people and many get trampled……….they have to cash-in their 401K’s, IRA’s, and other savings to keep their tiny houses and pay the bills. They have no faith left in the system.

They wake up one morning and realize they were lambs for the slaughter.

Posted by Hand in Cookie Jar | Report as abusive

Ethics – We have lost sight of an honest day’s work for an honest day’s pay.

Careful management – We have indulged our wants without the taxes or the prices or the cash to pay for them.

Oversight – Public relations and spin have replaced disclosure and transparency; casual yet complex accounting and accommodating rating agencies left us blissfully unaware of the problems, and we revelled in our ignorance.

Posted by TNT | Report as abusive