What happens when your stock price plunges more than 60 percent in a single week? Well, if you’re too big to fail, like Citigroup, you get another government bailout. Under the terms of the deal with federal regulators, which was unveiled Sunday, Uncle Sam will pop an additional $20 billion of taxpayer money into the New York company and backstop most of the losses exceeding $29 billion in a $306 billion pool of toxic assets. The latest rescue package comes with a variety of strings attached, such as more limits on executive compensation, a cut in Citi’s dividend, and mandatory implementation of the Federal Deposit Insurance Corp’s mortgage modification program. The development comes five weeks after Citigroup received its initial $25 billion capital infusion from the government.
Here’s what you need to know:
1. (Way) Too Big to Fail. The main objective of the new bailout package is to restore investor confidence in Citigroup, which--as its plunging stock price indicates--has grown painfully low. Citigroup has $2 trillion of assets--plus $1.2 trillion held off balance sheet. As such, the government considers the failure of Citigroup to be too risky to a financial system already in crisis. “With these transactions, the U.S. government is taking the actions necessary to strengthen the financial system and protect U.S. taxpayers and the U.S. economy,” regulators said in a joint statement. In short, the feds gave Citigroup $25 billion because it was too big to fail. Now it’s handing over an additional $20 billion because it’s way too big to fail.
2. Thanks, Hank. Investors grew more concerned about Citigroup’s ability to withstand the financial firestorm after Treasury Secretary Henry Paulson said in mid-November that he was abandoning his previously announced plans to buy up troubled, mortgage-related assets. Citigroup has tremendous exposure to these investments. And without the option to offload them on the government, investors worried that this exposure would lead to steeper losses and pushed Citi’s shares lower.
3. $230 Billion Stocking Stuffer. Whether a Citigroup bailout was on your Christmas list or not, American taxpayers now have exposure to hundreds of billions of dollars of toxic assets--just in time for the holidays. “The maximum potential loss to the government from the guarantee is approximately $230 billion,” David Hendler, an analyst at CreditSights, said in a report. “However, we believe that the eventual losses would be significantly less . . . depending on the ultimate loss rate on the assets.”
4. Will it work? The big question now is whether or not the government’s actions will be enough to halt the drop in Citigroup’s stock price. In the short term, the answer is a resounding yes: Citigroup’s shares surged in early trading Monday, jumping nearly 60 percent by noon. But Meredith Whitney of Oppenheimer says the longer-term outlook is less clear. “We are still cautious on the potential future dilution [of the value of Citigroup shares] from further prospective capital raises for the group as well as continued higher losses related to credit and asset deflation,” she said in a report issued before the market opened. In short: The jury’s still out.
5. New Model? With the government now willing to take exposure to troubled assets off the hands of banks, it’s possible that other financial firms will come knocking on Treasury’s door for similar treatment. Paulson has certainly been willing to change directions on the fly, so don’t be surprised to see similar troubled-asset guarantee programs introduced at other institutions.
6. Congressional Cringe. The Bush administration has already been sharply criticized for its often ad hoc approach to the crisis. Lawmakers were particularly steamed at Paulson for scrapping his plan to buy troubled assets at banks after telling lawmakers that such a program was essential to avert a financial meltdown. This latest audible at the line of scrimmage opens the Treasury secretary up to further criticism. “Congress is going to just get livid over the notion that we keep throwing large sums of money at FOP--Friends of Paulson,” says economic analyst Ed Yardeni, president of Yardeni Research.
7. Turmoil Far From Over. With credit indicators moving in the right direction, Paulson on November 12 offered a largely optimistic rundown of the administration’s efforts to combat the worst financial crisis since the Great Depression. “As I assess where we are today, I believe we have taken the necessary steps to prevent a broad systemic event,” Paulson said then. But the actions the feds took Sunday were just that--a government effort to prevent dwindling investor confidence in Citigroup from spilling over into a broader financial seizure. The development shows that panic-level fears are still running lose in the market, despite the government’s $250 billion-plus effort--so far--to instill confidence. This crisis is far from over.