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Did We Make a Profit on Citigroup?

Anyone looking at the full picture would see that it is silly to claim that taxpayers made a profit in our investment in Citi. But, hey the banks and the bankers did well, not much else matters inland.
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The Washington Post (aka Fox on 15th Street) once again proclaimed TARP a success. The cause for the latest revelry is the fact that the government appears to be in a position to make an $8 billion gain on the stock it holds in Citigroup. Before we join the Post in breaking out the champagne, it's worth taking a bit closer look at our investments in Citigroup.

Our ownership of Citigroup stock has it origins in the dark days of late November of 2008. At the time, Citi's stock price was rapidly descending toward zero and private investors would not go near the collapsing behemoth. The Treasury and Fed boys spent the weekend before Thanksgiving working out a rescue package.

They came up with a package that had the Treasury buying $20 billion in preferred Citigroup stock and guaranteeing the value of $300 billion in troubled assets. In exchange for this guarantee, the government got another $7 billion in preferred Citigroup stock. The total value of this deal -- $27 billion - exceeded the full market value of Citi's stock on the last trading day prior to the rescue. In other words, the government could have owned Citigroup outright for the money that it handed the bank that weekend.

Four months later, the government traded its preferred shares for common stock that gave it a 27 percent stake in Citi. While we had put up enough money in November to buy Citi outright, when Treasury did the conversion to common stock, taxpayers only got a 27 percent stake.

Citi's shares had risen in the interim. The highly paid executives at Citi no doubt attribute the rise in stock prices to their expertise and shrewd business dealings. The rest of us attribute Citi's recovery to the immense amount of aid and coddling that these highly paid executives got from the Fed and Treasury. If we try to put some dollar figures on our other handouts to Citi, it is clear that taxpayers have not come close to making a profit on this deal.

First on the list of taxpayer handouts to Citi would be the "too big to fail" (TBTF) subsidy. This subsidy is the result of the fact that investors know that the government will not allow Citi to fail because it would create too much disruption in the economy. In effect, taxpayers are implicitly guaranteeing Citi's loans. This allows Citi to borrow at much lower cost than if it had to compete in the market like other businesses. In a paper I co-authored with Travis McArthur last year, we calculated that Citi's TBTF subsidy could be as much as $4.4 billion a year.

If the markets expect this subsidy to persist (a safe bet given the current status of financial reform legislation), then the value of this subsidy would account for most of the current market value of Citi's stock. In effect, the government's profit is entirely due to the value of the government's guarantee. In Washington Post land, the government could make money by buying shares of a company's stock, offering to guarantee the company's debt, and then selling our shares at a gain when the market recognizes the value of the government's guarantee. Of course this strategy provides much larger gains to the other shareholders and allows the top executives to score billions in bonuses for being such shrewd managers, but in Washington Post land they don't pay attention to such things.

Of course this is just the beginning of the list of handouts to this sick financial giant. The rescue in November of 2008 was actually Round II. The first round took place the prior month when Treasury handed Citi $25 billion in TARP money. While we did collect interest payments on this money, in addition to stock warrants, taxpayers got far less than the market rate. The Congressional Oversight Panel for TARP commissioned an independent study to compare the value of the assets that Citi gave us with our $25 billion investment. In their assessment, we overpaid Citi by $9.5 billion.

Citigroup also borrowed money that was explicitly guaranteed by the Federal Deposit Insurance Corporation (FDIC). As recently as this January, Citi still had $64.6 billion in FDIC guaranteed loans outstanding. It was paying just a 0.91 percent interest rate on these loans due to the government's safety blanket. If we assume that this crippled giant might otherwise pay something close to 3.0 percent on these loans in a free market, then this subsidy would be worth almost $1.4 billion a year.

So far we have $4.4 billion in TBTF subsidies, $9.5 billion in TARP handouts, and $1.4 billion in FDIC subsidies. That's a total of $15.3 billion. This is in addition to only getting 27 percent of the company when taxpayers put up more than enough money to own Citigroup outright. But wait, there's more.

Fannie Mae and Freddie Mac have already lost close $120 billion. There is good reason to believe that more losses are on the way. (The night before Christmas, Treasury removed the $400 billion limit on their combined line of credit. This move would have been unnecessary unless there was some possibility that this limit would actually be crossed.)

Fannie Mae and Freddie Mac lose money by paying too much for mortgages and mortgage-backed securities. Undoubtedly some of these purchases were from Citigroup. Fannie and Freddie's losses were effectively Citi's gains, since if Fannie and Freddie were not there to buy the bad mortgages, Citigroup would have suffered larger losses on its books.

While some of these losses were undoubtedly incurred prior to September of 2008 when Fannie and Freddie collapsed, many of the losses likely were incurred after this date (remember more losses are on the way). If we cut it 50/50, then Fannie and Freddie incurred losses of roughly $60 billion after they went into conservatorship. Citigroup's assets and deposits give it roughly 10 percent of the market. If we assume that it accounted for 10 percent of the overpriced mortgages sold to Fannie and Freddie in the conservatorship era, then Citi's Fannie and Freddie subsidy comes to $6 billion.

We also have roughly $30 billion in losses incurred at the Federal Housing Authority (FHA) over the last two years. In this case, the FHA is guaranteeing mortgages that might not otherwise have been issued. The FHA's losses mean that the guarantee did not reflect the true risk being incurred. If we assume that Citi got 10 percent of the FHA's losses (this is a bit more of a leap, since in many cases the mortgages simply would not have been issued), then Citi's FHA subsidy comes to $3 billion.

There are also the various special lending facilities created by the Federal Reserve Board, in addition to its ongoing operations through the discount window. Through these facilities, Citigroup could borrow short-term money at near zero cost. At its peak, more than $2 trillion was lent through these facilities. The Fed refuses to tell taxpayers who it lent our money to, but let's assume that Citi got 10 percent of this stash as well, or $200 billion. If Citi lent the money back to the government by buying Treasury bonds that pay 3.7 percent interest, then it could earn more than $7 billion a year by lending our money back to us. Nice work if you can get it.

And, there is also the matter of the Fed's massive program to buy mortgage-backed securities to push down mortgage rates. If the impact of this program lowered 30-year mortgage rates from 5.5 percent to 5.0 percent, then this would raise the price of the 30-year mortgages on Citi's books by more than 7.0 percent. If Citi has $500 billion in mortgages on its balance sheets, then this would increase the market value of these mortgages by more than $35 billion. This gift will not be costless to the Fed. It bought $1.25 trillion in mortgages. If it ends up reselling them in a market in which the 30-year mortgage rate averages 6.0 percent, then it will have incurred a loss of almost 15 percent, or more than $180 billion.

In short, anyone looking at the fuller picture would see that it is silly to claim that taxpayers made a profit in our investment in Citi. But, hey the banks and the bankers did well, not much else matters in Washington Post land. (For a recent tally of how much money is still outstanding from the bailout see Wall Street Bailout Cost.)

The Post concludes its piece by repeating the dire warning that: "the country faced imminent disaster" when the TARP money was handed out. Actually, the country has gotten the disaster. It's called 9.7 percent unemployment. High unemployment is projected to persist for most of the next decade. But, the banks were saved and everyone is now happy in Washington Post land.