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How Citigroup's Payback Plan Will Ultimately Screw Taxpayers

We've reached the epitome of crony capitalism, yet the government has given no indication that any action will be taken.

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"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."

But you wouldn't guess any of this from reading the Wall Street Journal's coverage of the situation. The Journal even has the audacity to argue that the government could profit by up to $14 billion on the Citi deal, without explaining how it arrived at that figure, or making any mention of the beating the taxpayers' common stock stake is going to take. As David Enrich and Deborah Solomon write in the Journal:

The government could earn a profit of about $14 billion on its investments in Citigroup once the New York company completes a stock offering and other moves that are part of its deal with regulators.

Nor would you figure out how badly taxpayers are getting treated from reading the Washington Post article on Citi by David Cho and Binyamin Appelbaum. To their credit, however, Cho and Appelbaum nail down Citi's primary motivation for repaying the loan:

Banks have chafed at some of the conditions placed on the federal rescue money, such as limits on executive pay.... Beginning in 2010, Citigroup no longer will be subject to special federal supervision, including limits on compensation for top executives.

An article by Eric Dash and Andrew Martin in the New York Times does the Post one better by mentioning that the deal is bad for common-stock shareholders, but still fails to note that the government is one of those shareholders: 

"It's terribly negative," said Richard Bove, an analyst at Rochdale Securities. "Management has shown that it is willing to take any action to harm shareholders as long as the executives get paid more money."

Mr. Bove said the payback did nothing to improve Citigroup's overall financial health, nor did it remove the bank entirely from government control. Instead, Citigroup's management had 'ruined' the stock price for the next three or four months, he said."

The points I make above are a critique only of the Obama administration's handling of its investment in Citi, but there are two other problems with the Citi bailout worth mentioning. Back in November 2008, when Citi received its second round of bailout funds, the Bush administration provided it with significantly more money than the company's stock market value at the time. Citi's market value was around $12 billion, and the government provided it with $20 billion. For the price we were willing to pay, we could have bought every share of Citi's common stock and more. Since the company is today worth about $90 billion, taxpayers would have earned a profit of $70 billion on that deal simply by demanding something close to a market rate of return on our investment. Instead, we've been getting paid 8 percent interest.

"We would own Citi. We would get all of the upside," says Black. "If you just thought about it from a conventional finance perspective, we are the fool in the market."

More important, Cit's ability to raise capital in the private sector at all is completely dependent on an implicit guarantee from the federal government. No matter how concerned investors might be about Citi's fundamentals, having watched the government bail out Citi twice last year, they know the government will not let the company fail. That fact eliminates a significant portion of the risk from investing in Citi--if Citi makes great banking decisions and the stock goes up, you make money. If Citi makes terrible choices and teeters on the brink of collapse, an investor knows the government will step in and spare them at least some of the pain. The government should not be giving companies this kind of advantage. It's unfair, and it violates every market-based principle in the book. But we certainly shouldn't give a company this kind of advantage without demanding something very significant in return. Instead, we're going to cut Citi loose from all government restrictions, and pay the bill if the company gets into trouble again.

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