By Neil Irwin and David Cho
Washington Post Staff Writers
Monday, November 24, 2008
The government said last night that it will provide a multibillion-dollar backstop for Citigroup, revamping emergency efforts yet again to head off the failure of a company more deeply intertwined with the financial system than nearly any other.
The Treasury Department, Federal Reserve and Federal Deposit Insurance Corp. announced just before midnight Monday that they will protect Citigroup, one of the nation's largest banks, against potential losses on a $306 billion pool of troubled assets.
Citigroup would absorb the first $29 billion in any further losses on these assets, which are primarily securities backed by mortgages and commercial real estate loans, with the government stepping in to cover most of the losses beyond that amount. The distressed assets would be fenced off by Citigroup from the rest of its holdings, allowing the firm to insulate itself from the fallout.
The government in return is to receive up to $7 billion in preferred shares.
The Treasury also will invest another $20 billion in Citigroup on top of the $25 billion of taxpayer dollars already invested in the bank this fall. In exchange, the government will get even more preferred shares, paying an 8 percent return.
As a condition of the emergency assistance, the company will have to adhere to new restrictions on what it pays its executives and carry out an FDIC program to help homeowners avoid foreclosure, according to a statement by the three government agencies involved. The terms of the new cash injection are also less favorable for the company's shareholders than those of the initial infusion by limiting stock dividends to a penny per share in each quarter over the next three years.
In taking these dramatic steps, the regulators aimed to give investors and lenders faith in Citigroup's ability to continue operating after its stock fell about 60 percent last week to $3.77. The government's earlier investment this fall was meant to shore up Citigroup's capital, but those efforts are no longer preventing a dramatic erosion of confidence in the company.
The federal initiative would represent yet another massive government intervention in the financial system as officials have scrambled to try to contain a crisis that has already brought down a dozen of the nation's largest banks and investment companies.
This time, though, the company in jeopardy is truly gigantic. Citigroup is the largest U.S. bank by assets, with $2 trillion on its books. By contrast, Wachovia, which became the biggest bank to be done in by the financial crisis after being forced to sell itself to Wells Fargo this fall, has just over one-third as many assets.
Citigroup engages in almost every form of financial transaction available to banks and investment firms, making it heavily involved with almost every other large financial institution in the world. It is also deeply integrated into the nation's financial history.
In the 1920s, a firm called First National City Bank started repackaging bad loans from Latin America and selling these to investors as safe securities. These investments collapsed in grand fashion after the 1929 stock market crash and eventually led to a new wave of securities regulation. National City Bank became Citibank, which in turn became a major unit of Citigroup.
Citigroup has incurred billions of dollars in losses in the past 18 months, once again by partly repackaging bad loans into what were viewed as safe securities.
As investors intensified their pressure on Citigroup stock last week, federal officials assured that the company was capitalized and urged calm.
Officials at the Fed and Treasury do not generally get agitated over changes in the stock price of even a large bank as long as they think the underlying bank is sound. But in this case, the stock price has dropped so much that it raised the risk of a downward spiral for the company.
Senior government officials feared that a low stock price would prompt those who do business with Citi -- who loan it money, make deposits in its bank and brokerage units or engage in complicated financial contracts with it -- to pull their money out or refuse to do any more business with the firm for fear of its future.
That, in turn, could drive the stock down further, creating a vicious cycle. That is the scenario government officials are trying to prevent by promising to protect Citi against catastrophic losses.
So government officials view their initiative to save Citigroup as different from the March rescue of investment bank Bear Stearns or the takeover of insurance giant American International Group in September. In those cases, the institutions were considered insolvent, justifying action by federal officials to punish shareholders and fire the chief executives.
Heavily involved in the government's negotiations with Citigroup is Timothy F. Geithner, who is scheduled to be named President-elect Barack Obama's Treasury secretary today. Geithner is president of the New York Fed, which is Citi's primary regulator.
The deal was struck with Vikram Pandit, who has been chief executive of Citigroup for less than a year. Pandit inherited a difficult challenge and has made only limited progress in stabilizing Citigroup by slashing staff and expenses. The steep drop in the stock price last week reflected doubts among investors about whether Pandit can turn Citi around and make it eventually profitable.
The federal efforts to buttress Citigroup are a shift in approach in the government's massive efforts to stabilize the financial system. For most of the year, the Treasury and Fed have used an improvised approach to rescuing, or not rescuing, failing firms. They engineered takeovers of Bear Stearns and Wachovia, allowed Lehman Brothers to go bankrupt and nationalized AIG, Fannie Mae and Freddie Mac.
When Congress passed the Troubled Asset Relief Program on Oct. 3, the expectation was that Treasury Secretary Henry M. Paulson Jr. would use the $700 billion to buy mortgages and other toxic assets from the banks. Instead, he has used the bailout fund to directly inject capital into banks, including Citigroup. Meanwhile, federal officials have been arranging mergers between weak banks and stronger ones, sometimes offering financial help through either the Troubled Asset Relief Program or the FDIC to get a deal done.
The new backstop contemplated for Citigroup represents a different strategy, however, combining elements of several of these earlier approaches. It is similar to the original plan for the TARP because the initiative would deal directly with the troubled assets on the firm's books.
During its history, Citibank has been responsible for some of the banking industry's best-known innovations, including modern checking accounts and certificates of deposit. Citi was a pioneer in the development of ATMs.
After the 1929 stock market crash, spurred in part by those abuses at the former National City, the government passed a law separating ordinary banking from stock brokerage and other investment services. That law, the Glass-Steagall Act, was dismantled in the 1990s in part to allow the creation of Citigroup, which combined the merged Citibank, Salomon Smith Barney brokerage, Travelers Insurance and other entities.
The idea behind the mergers, engineered by then-Chairman Sandy Weill, was to have an all-purpose financial services powerhouse. However, the units have never worked together as effectively as envisioned, and the company spun off the insurance unit in 2005.