Citigroup Nationalization: How It Might Go Down

The Bronte Capital blog lays out what I think is a fairly reasonable scenario for the nationalization of Citigroup -- and probably other big banks, too. It would go like this:

1) The FDIC (led by Sheila Bair) seizes Citigroup after declaring it unsound. Sorry stockholders and debtholders. "Indeed this is precisely what Bair did at Washington Mutual. What she did once she might do again."

2) Uncle Sam (a.k.a. taxpayers) recapitalize Citigroup.

3) The FDIC could "IPO the new Citigroup once this market mess had died down (and remit most the proceeds to former bond holders)."

But here is the big ramification:

"If Sheila Bair was to confiscate a really big bank and cancel all the parent company liabilities then no other bank in America would be able to raise parent company debt. Indeed I think that has been the case ever since Sheila Bair did the reckless and irresponsible takeover of Washington Mutual… but it would certainly be the case if the parent company liabilities of Citigroup were cancelled. And that would be a huge decision indeed because then every bank with parent company liabilities (meaning almost every bank in North America) would fail.

Many – but not all – could be taken over in the same fashion at little cost to the government. But almost all of them would wind up property of the US Government. Full nationalisation, Swedish or Norwegian style, is an effective end to a financial crisis – and Sheila Bair has the power and has proved that she is willing to use it. But it is a decision way above her pay grade. (Where is President Obama’s new Treasury Secretary?) ... 

Actually I think the die was cast for Citigroup when Sheila Bair confiscated WaMu. The lesson was learnt that bank debt could be treated very unfairly by regulators and hence banks were never going to be able to get finance again. The worst decision of this cycle was to let Lehman fail so badly - creditors got very scared. The second worst was the reckless way in which creditors of WaMu were treated - it made them even more scared."

Me: The core truth here: The problem is confidence, confidence, confidence.