US Government Bails Out Citi, Who's Next?

After much see-sawing and several leaks to the press on Sunday, the government finally reached an agreement to bailout Citigroup.  The terms of the deal include splitting the bank's assets into a "good-bank/bad-bank" format.  Alas, the government will be guaranteeing the assets in the "bad bank" as well as administering spankings when appropriate.  The outline of the terms of the deal can be found here, but here are a few highlights:

$306 billion in bad assets will be "ring-fenced" in the bad bank.  Citigroup will absorb all losses up to $29 billion in addition to existing reserves.  Beyond $29 billion, the losses will be split, with the government taking 90% and Citigroup absorbing 10%.  For anyone who actually cares which of the institutions will be bearing the loss, the government has broken this out as well.  Although ultimately it is all coming from the same kitty, the breakdown matters because investors need to know how much is left in the TARP for other beleaguered institutions.  The US Treasury will absorb the first $5 billion, followed by the FDIC with $10 billion, with the Fed on the hook for the balance as it will be financing the debacle with a non-recourse loan at a rate of OIS plus 300 basis points.

What is the government getting in return for assuming all of this risk?  Citi will issue $7 billion in preferred stock with an 8% dividend rate.  However, Citi will retain the income stream from the guaranteed assets insuring that the government's investment has little upside and enormous downside.  Citi will be prohibited from paying common stock dividends for three years and, of course, compensation of executives will need to be approved by the government.

Frankly, this is a fantastic deal for Citigroup and a really lousy one for the government.  The maximum downside to the government on this deal is $209 billion.  Certainly that is if the assets go to zero, and nobody measures risk that way, blah blah blah.  But a failure of risk managers to consider catastrophic losses as a possibility is what got Citi in this mess to begin with.  The original purpose of the TARP, to purchase toxic assets from banks, has been revived, but apparently only for Citigroup.  I suspect that the market is going to continue punishing the stocks of all the banks, until the government agrees to do the same with any institution it deems as holding too many crappy assets.  Does this sound like a crazy conspiracy where the banking industry attempts to cannibalize itself in order to force the type of government bailout it wants?  Absolutely.  But a front page story in the WSJ detailing how traders at Merrill, Citi, Deutsche and UBS attacked Morgan Stanley in late September by purchasing credit default swaps in what may have been a coordinated attempt, points out how willing Wall Streeters are to punish each other.  Somehow, they don't seem to understand that forcing Morgan Stanley into collapse may pose irreparable damage for their own business.  Or perhaps they understand the business is doomed and only the government can save them now?  They want the TARP back and the governments seems only too willing to comply.