How Citigroup's Payback Plan Will Ultimately Screw Taxpayers

Taxpayers are getting a raw deal in Citigroup's plan to repay its bailout funds, but you wouldn't know it from reading the news. Policymakers are emphasizing the wind-down of the unpopular Troubled Asset Relief Program, and most media outlets are doing the same. But the sloppy structuring of Citi's repayment plan is going to cost the government literally billions of dollars.

The government has two types of investments in Citi: $20 billion in the company's preferred stock, and a 34 percent stake in its common stock. Preferred stock is basically a loan that Citi has to pay back with interest, while each share of common stock gives us partial ownership of the firm. With an interest rate of 8 percent on the preferred stock, the loan is well below market rates, since the government funneled the money to Citi when it was on the verge of collapse last year, and emergency loans like that carry a very high interest rate among investors. But we do at least get paid a return on that investment.

The value of our 34 percent stake in Citi's common stock, by contrast, depends on the stock's trading price. The government bought its roughly one-third stake in February for $25 billion. On Friday, the last trading day before Citi announced plans to repay TARP, the value of that stake had risen to $30.7 billion, for a gain of $5.7 billion. That's a terrible return given the risk taxpayers were taking, but it's still a return.

On Monday, Citi said that in order to have enough money to pay off the government's $20 billion loan, it was going to raise about $20 billion by issuing more shares of common stock. The company's financial health has improved; it can raise money from the private sector and pay back the taxpayers. Sounds great, right? Wrong.

Taxpayers are getting screwed. Citi's stock market value at the end of Friday was roughly $90 billion. If Citi issues another $20 billion in common stock, the company does not magically become more valuable. It's still got the same credit card and mortgage problems it had last week, and the same shaky profit prospects. Since $20 billion is about 22 percent of $90 billion, everybody who owns a stake in Citi's common stock, including the taxpayers, will see the value of their investment decline in value by about 22 percent.

How big a deal is this? Well, 22 percent of the government's $30.7 billion stake is $6.8 billion. That means Citi's plan to "repay" the government actually ends up costing taxpayers money. Not only will our $5.7 billion profit be wiped out, but the value of our common stock investment will actually drop below what we first paid for it in February.

The government doesn't have to let Citi get away with this. The Treasury could just tell the company to keep making its regular interest payments on the $20 billion loan, and pay it off once the company has scored enough profits from its ordinary banking activities. That would take time, but by footing the bill for the loan with profits, rather than through new investors, Citi could pay back one taxpayer investment without destroying the other one. But there are no indications that policymakers are taking the taxpayers' interest seriously -- instead, negotiations have centered around how much money Citi must raise from the private sector to qualify as healthy enough to exit TARP.

Why is Citi in such a hurry to pay back its loan? It wants to be able to offer executives bigger bonuses. When Citi pays back TARP, it will no longer be subject to pay czar Ken Feinberg's executive compensation restrictions.

"This is worse than bad," says former bank regulator William Black, who now teaches law and economics at the University of Missouri-Kansas City. "This is undeniable proof that the sole driver for most decision-making is executive compensation.... They're so desperate to avoid those restrictions, they're willing to take steps that actually weaken the company, and certainly weaken the position of the taxpayers."