Familiar Trio at Heart of Citi Bailout
Rubin, Paulson, Geithner's Shared History Paved Way for $300 Billion Federal Guarantee

By David Cho and Neil irwin
Washington Post Staff Writers
Tuesday, November 25, 2008

The bailout of Citigroup, which put the government at risk of hundreds of billions of dollars of losses, was set in motion by three men whose professional lives have long been intertwined.

Treasury Secretary Henry M. Paulson Jr.; Citigroup board member Robert E. Rubin; and Timothy F. Geithner, the president of the Federal Reserve Bank of New York, have for years followed one another in and out of jobs in government and industry. Their close relationships helped pave the way for one of the largest and most dramatic government interventions to date in the financial crisis.

The bailout, announced late Sunday night, was designed to make a statement, officials said. In agreeing to protect Citigroup against potential losses on a $306 billion pool of troubled assets, the government made clear that it was not going to allow one of the nation's largest financial firms to collapse.

Yesterday, the markets cheered the rescue, sending Citigroup's shares soaring 58 percent while the Dow Jones industrial average climbed 4.9 percent, or 396.97 points.

The bailout came only days after Paulson made comments that many in the financial markets took to mean that he would leave any future bailouts to the Obama administration. But once Citigroup's stock price plunged 60 percent last week, Rubin, an old colleague from Goldman Sachs, told Paulson in phone calls that the government had to act, according to industry sources familiar with their discussions.

Geithner, too, shared a close relationship with the pair. He worked for Rubin at the Treasury Department in the 1990s and now is President-elect Barack Obama's nominee to follow Paulson as Treasury secretary.

As Citigroup's lead regulator, Geithner was deeply involved in the rescue of the firm, participating in meetings and conference calls with Paulson through the weekend. He did, however, withdraw from direct interactions with Rubin and other Citigroup leaders in these negotiations after his name was leaked as Obama's nominee, according to people familiar with the discussions.

The government is guaranteeing a total of $306 billion of Citigroup's assets against losses greater than $29 billion. In exchange, it is requiring the firm to hand over $7 billion worth of preferred stock, essentially paying the government an insurance premium.

The government is not firing Citi's executives, but it is requiring that their compensation be approved by federal authorities under terms that are not yet finalized. And it is requiring that the bank help people at risk of losing their homes avoid foreclosure by using the same aggressive approach that the Federal Deposit Insurance Corp. has required of IndyMac, a California-based bank it took over in July.

Regulators also prohibited Citigroup from paying dividends to common shareholders of more than a penny a share in the coming three years and required a dividend payment of 8 percent on the government's preferred stock -- higher than the 5 percent dividends that it required of institutions that took rescue money from the Treasury Department over the past few weeks.

The Treasury also has the option of buying warrants in Citigroup if the firm's shares recover. If that happens, the government would end up owning slightly less than 8 percent of the bank's shares.

"It strikes me as unbelievably generous," said a former Fed official who has been in touch with Citigroup. "I'm sure it will be controversial. . . . They are purifying the balance sheet with two intentions, so Citi's creditors and shareholders are reassured. And because the creditors are reassured, presumably their lines of credit won't be cut off. Citi, with that kind of confidence, can do what banks are supposed to do."

Wall Street's surge yesterday suggested that the bailout helped convince investors that Citigroup would survive the crisis. But shares are still trading for only $5.95; they were above $50 in summer 2007.

In the middle of last week, as Citigroup's shares were getting pummeled, Rubin had a message for Paulson, the two industry sources said: Send a signal to the markets that the government had faith in the bank.

Citigroup, like other banks, had exposure to bad debts, including securities based on real estate loans and credit cards and other consumer debt. But it had even greater exposure to losses from overseas operations, industry officials and market analysts said. And with a recession in the global economy accelerating, some investors began to doubt whether the bank would survive.

The firm's interconnectedness pressured regulators to act. Because of Citigroup's operations in about 100 countries, relationships with a broad range of institutions around the world and about $3 trillion in assets, the firm's collapse would wreak havoc on the financial system.

"Citigroup has been known to be in a somewhat weak condition," said William A. Longbrake, who is on the board of directors of First Financial Northwest and advises financial lobbyists. "Citigroup is the definition of a bank that is too big to fail," he added.

As the outlook for the global economy began to dim in recent weeks, investors dumped shares in financial services firms. Citigroup was hardly immune. Some investors began to bet outright that the bank's shares would plummet, using a technique called short selling.

Helpless as the stock price began to fall precipitously, Citigroup executives lobbied the Securities and Exchange Commission to institute a ban on short selling. But SEC officials, who had tried to temporarily limit the practice earlier in the fall, turned down the request. The earlier ban, they believed, caused more damage than good and compelled many traders to leave the market altogether.

As the short sellers' bets on Citigroup's fall increased, some regulators said they came to believe that these traders were essentially betting against the government's willingness to intervene to rescue the giant bank.

Making matters worse, several government and industry sources said, was testimony delivered by Paulson on Capitol Hill that left many in the financial markets with the impression that the government was done with its interventions to stabilize the financial markets until the end of the Bush administration.

Treasury officials denied that Paulson ever signaled that the government was done with its efforts to back the financial markets.

By the end of the week, with financial markets in disarray, U.S. officials concluded that they needed to counter the impression that the government would not act.

With Citigroup stock at $3.77 as of Friday's close, the company's options for raising cash were dwindling fast. Its clients, as well as other banks, could have refused to continue doing business with Citi, sending the company into deeper trouble.

Rubin called Paulson several times to make the case for intervention on behalf of Citigroup and the banking system as a whole, said two sources familiar with the conversations.

In an interview, Rubin explained his involvement by saying that, since arriving at Citigroup in 1999, he has had "a dual role of providing strategic advice or managerial advice and also to work with clients. And that's what I've done."

"I had operating responsibilities for 33 years. And I simply didn't want any operating responsibility, and that's been the case since I've been here," he said.

On Friday, Citigroup approached the Treasury and the Fed with a plan of its own, essentially asking the government to take on the risk of hundreds of billions of dollars in troubled assets on its books, but with little compensation for the government.

Over the weekend, there were marathon negotiations in which Citigroup officials spoke frequently with Paulson and, in place of Geithner, Fed governor Kevin M. Warsh. The four government agencies involved -- the Treasury, the Fed, the FDIC and the Office of the Comptroller of the Currency -- had to reach agreement on a deal, as did Citigroup's executives and board.

Geithner in the past directly negotiated with executives of firms receiving aid. But in this case, he left those responsibilities to others so that there would be no concern about a blurring of his two roles, as independent regulator with the New York Fed and future appointee in the Obama administration.

At the very minimum, the officials concluded, they could issue a statement of support from the government. But they worried that it would have proved dissatisfying to the market, taken as mere ineffectual words.

At the other extreme, they could have enacted a highly punitive complete bailout, like that of American International Group, requiring terms that strongly punish existing shareholders and give the government control of the Citigroup board, as well as firing the chief executive. They rejected that approach, preferring to try to give the existing Citigroup leadership team time to work through their problems.

The compromise was a set of tools that would allow Citigroup to remove some of the risk of continued losses on bad mortgage and commercial real estate loans on its books but with the government receiving compensation and with existing management in place to try to build the company's business in the long run.

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