The Citibank Fudge

This is why you should not believe a word a banker tells you. Alternatively, bankers seem all to aspire to careers as illusionists. Today we are told that Citibank has reached an agreement with the government to convert most of the preferred stock the government acquired when it saved the bank fro collapse. The conversion is into equity. As a result Citibank has $58 billion of shiny new equity sitting on its balance sheet and we, the taxpayers, are now proud owners of about 36% of the bank.

I feel richer, don’t you? And Citi is now powering itself out of trouble. No?

“Sleight of hand accounting tricks do nothing to clear the air, improve the bank’s position, or resolve the policy issues surrounding our need for sources of credit to help sustain an economic recovery.”

Vikram Pandit the failed CEO of the bank blathers on in his press release about how the deal instantly makes Citi one of the world’s best capitalized banks.

Ummm.

Let’s take a breath here and try to ignore the obfuscation. Just how much new capital was infused into the bank via this deal?

None. That’s how much.

This was a switch of book entries. Preferred stock was eliminated and equity took it’s place. Here’s the magic: equity sits at the bottom of the balance sheet, while preferred stock sits a little bit higher up. Both count in the regulator’s calculation of ‘Tier 1’ capital. But, and this is the trick, only equity falls into the bucket known as ‘Tangible Common Equity’ [‘TCE’]. So if your standard for a bank’s capital strength focuses on TCE, Citi appears suddenly to be a whole lot stronger. Hence Pandit’s silly comment. But if you look at broader measures of capitalization, at Tier 1 capital for instance, not much has changed.

There is no new cash. No new capital. This is an accounting change not an economic one. It is trickery. The kind of balance sheet shiftiness that helped cause the economic crisis in the first place. As long as banks lie about the substance of their balance sheets with such abandon and apparent earnest nothing will be done to produce an actual fix of the mess they are in.

In order for the trick to work you need a compliant audience willing to go along. We have that too: our regulators have shifted their attention, right on cue, to TCE. Tier 1 is so yesterday. That they all huffed over it for the best part of two decades is neither here nor there. TCE is ‘in’. The shift in emphasis means we don’t have to annoy the poor banks any more. And we don’t have to do nasty things like pressure them into bolstering Tier 1 capital ratios. Apparently TCE is ‘better’ quality capital, untainted by things like the terms and conditions usually attached to preferred stock. Quite right. I agree with that. Which is why I wondered about the original capital infusion. Why didn’t we taxpayers take an equity stake right up front.

Oh wait. I know why. The amount of cash we handed over would have meant we nationalized the bank: Citi’s stock price was so terrible at the time that the same pile of cash would have bought practically the whole lot, rather than the paltry 36% we now get. So part of the trick turns out to be that the regulators had to be willing to get less in return. They had to bide their time and convert our preferred into equity only after it was clear we wouldn’t … well you know … own the bank. We don’t want to do that. So we provide capital in the form of preferred which sits in Tier 1. That makes the bank stronger in reality since it has more cash. the market loves that. It drives the stock price back from oblivion and up to about $3 a share. Now at $3 a share our cash only buys 36% not 100%. Blushes and embarrassments are saved all around. the only remaining trickery is to make it look like the conversion is a major step along the road to rehabilitation of Citi. that’s where Pandit’s stupid comments come in.

Voila! The administration avoids nationalization by accepting less for its investment. And Pandit looks heroic for adding ‘quality’ capital.

Oh, the wonders of bookkeeping.

Other banks have raised real capital recently. They got cash. That’s a real economic improvement. At least they are being more honest about resolving the disaster they wrought on us.

But this news from Citi demonstrates just how far we are from having transparent and honest discussions when it comes to the truly weak banks. We, and by this I mean the administration, the regulators, the media, and the bank managers, just do not seem able or willing to acknowledge that some of our largest banks are still in dire condition. Sleight of hand accounting tricks do nothing to clear the air, improve the bank’s position, or resolve the policy issues surrounding our need for sources of credit to help sustain an economic recovery.

We cannot heal ourselves if the players in the game keep bending the rules so they don’t have to take tough decisions.

Or do simple things: like telling us taxpayers the truth.

The next thing you know they’ll be paying us back the TARP cash with our own money. I wouldn’t put it past them.

Addendum, 3:45 p.m. June 10:

Hidden in the weeds of today’s Citigroup announcement is a ‘poison pill’ clause. This seems to be an explicit acknowledgement that the bank could be a take over target, or maybe subject to fun and games speculating by hedge funds. The clause allows shareholders to double their holdings at half market price if someone who owns over 5% of the outstanding stock adds to that holding. The idea being to stop anyone new accumulating over 5% and stopping those currently with over 5% from adding more. They would be stopped because their efforts to accumulate would trigger a flood of new shares being issued and hence diluting all existing holdings – the effort would be be pointless.

This is an odd poison pill though because the real cause for concern appears to be the tax law. The IRS will prevent a company with highly concentrated ownership from fully using tax loss carry forwards. Since Citi has managed to lose a pot load of money is would want to avoid falling prey to that IRS ruling. It wants to use its tax losses to generate after tax income and thereby augment capital. Hence the stop on accumulation. The IRS defines concentration as a company where over 50% of all the shares are owned by people with more than 5% each. The Citi clause, which went into effect today, doesn’t include the government.

That’s good because we may need to give them more cash sometime and it would be awkward if an internal clause stopped us.