All Bailed-Out Banks Can Get Citigroup's Good Deal -- And Guess Which Party is Raising the Alarm?
The wall-to-wall media coverage of President Obama's speech last night pushed the growing controversy over bank nationalization into the business pages this morning, but Federal Reserve Chairman Ben Bernanke made a stunning admission yesterday before the Senate Banking Committee.
The government's latest rescue offer to Citigroup, in which Uncle Sam would convert its preferred-stock investment in the bank into common stock -- forgoing the 5% dividend and extra rights that preferred shareholders enjoy -- isn't just available to Citi, as Bernanke said yesterday. Any of the 19 banks that are in line for upcoming Treasury Department "stress tests" can get a preferred-to-common conversion if expected capital losses materialize.
Giving major banks another break at the taxpayers' expense would seem to be a highly controversial proposition in Congress, particularly when the conversions are expressly designed to help Citigroup and its cohorts do better on the "stress tests." But so far, the only lawmakers raising red flags on the stock conversions are Republicans.
"Candidly, it's very troubling," Sen. Bob Corker (R-TN) told me after the Bernanke hearing, calling the stock conversion plan "creeping nationalization" and likening it to the often-haphazard initial bailout concocted by the Bush Treasury Department: "It's more of the same on steroids."
Sen. Lindsey Graham (R-SC), who has already supported a temporary government takeover of banks that fail the "stress tests," wondered whether the description of major banks as "too big to fail" is a more palatable way of saying they're "too big to liquidate quickly."
"Does it make sense to infuse more money into AIG?" Graham asked me by way of example, before offering a qualified answer. "What if you could show me that the failure of AIG would hurt more ... if you could show me that converting preferred stock to common stock [would be a better deal]?"
To be sure, opinions on government control of the banks transcend party lines and are constantly shifting. Banking Committee Chairman Chris Dodd (D-CT) yesterday backtracked a bit on his recent acknowledgment that nationalization would have to be on the table. But Dodd's GOP counterpart on Banking, Richard Shelby (AL), is already wondering whether Citigroup-style stock conversions are nationalization with a prettier face.
Here's how Shelby put it at yesterday's hearing (mistakenly referring to Citigroup by its old name, Citicorp):
I think you can take over a bank by converting the preferred [to common shares] and, as you were talking about Citicorp or some of them are doing about doing, and you have -- if you had 40 percent working control of Citicorp, you basically would -- you wouldn't own it all, but you'd own working control probably. And you would be the -- the big power in the boardroom, so to speak.
Another Republican, Chuck Grassley (IA), was the first out of the gate criticizing the preferred-to-common stock conversion. In a Monday letter to Treasury chief Tim Geithner, Grassley noted that converting government stock would likely exempt Citigroup from the new executive compensation limits that Congress added to the stimulus law -- which amounts to a major victory for K Street, achieved through the back door. Grassley said:
Common stock is riskier than preferred stock. The American taxpayers are already shouldering a lot of risk these days. This move could expose taxpayers to even more risk. Also, if it allows Citigroup to circumvent executive compensation restrictions, that will add insult to injury for the taxpayers. We all need to know what Treasury hopes to accomplish here and whether the risks are worth any benefits.
Will these GOP skeptics press their party to take an active stance against the stock conversions for bailed-out banks? It's very unlikely, given that no Republican has offered a workable alternative to the "stress test" approach.
And Bernanke even admitted yesterday that the government has no rule book to "address the potential failure of a systematically critical firm, like AIG," asking Congress to give the Federal Reserve instructions on the issue as part of its upcoming financial regulation package. "[U]ntil it's safe to close down a big firm ... you're going to be forced to take actions to avoid it," Bernanke said.
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I have been wondering why the “dead mega-banks walking”, such as Citi and B of A which are essentially insolvent, aren’t made to financially separate their healthy commercial banking operations from their moribund investment banking operations, thus protecting the assets accrued from depositors and borrowers and hanging the esoteric, so called “toxic”, debt instruments on the stock and bond holders who bet on them.
The folks at Financial Crisis and Recession, using Citi as an example, propose just that, in that the bank’s assets would be divided between a new good bank and a bad bank.
February 25, 2009 1:03 PM | Reply | Permalink
Preferred stock is really less less risky than common stock.
If a company goes into dissolution, its true that preferred stockholders are thoretically in line ahead of the common shareholders for anything left over after the creditors have been paid in the event of dissolution. However, that doesn't happen unless every creditors has received each and every cent it is owed. Meaning that when the dissolution is due to insolvency and/or bankruptcy--and that's the only kind of dissolution anyone is worried about here, isn't it?--the preferred stockholders are just as screwed as the common stockholders.
Although you can agree to put just about any superpowers you want into a class of preferred shares (so I don't really know about the ones the feds are taking from the banks), ordinarily, common stockholders have greater voting rights than preferred stockholders, especially when the preferred stockholders are entitled to dividends ahead of the common stockholders--that's the usual bargain: preference on dividends in exchange for control. Additionally, even if you have a preferred class that does have voting rights, converting those shares to common shares dilutes the voting power of the other common shareholders and increases the voting power of former preferred stock holders--especially given that the you can agree to exchange one preferred share for more than one common share.
This is why the Republicans are upset--in effect, the deal being discussed is effective nationalization, just one that occurs by diluting the private shareholders total interest to less than 50% of all common stock outstanding, rather than just wiping them out and creating a new class of common shareholders. I suspect, however, that that's going to be (slightly) less upsetting to the current common shareholders--as opposed to pols who are ideologically panty-bunched--than having their shares extinguished entirely.
What I don't get is why anyone on the left who is presumably among the people who've been clamoring for nationalization, would find this upsetting. The idea that we're giving up the right to dividends presupposes that dividends were going to be paid by an insolvent entity and that the dissolution preference was meaningful. Neither was the case. As best I can tell, the pretense of selling the feds preferred shares was just a way to protect the common shareholders from dissolution and to keep the feds from being able to elect the entire board.
February 25, 2009 1:08 PM | Reply | Permalink
That last line should read "protect the common shareholders from dilution," not "dissolution."
February 25, 2009 1:09 PM | Reply | Permalink
And the first line should be "is not really less risky."
Jesus, one bad night and I lose the ability to communicate.
February 25, 2009 1:11 PM | Reply | Permalink
Since we, the US Treasury, now owns the banks, when is the government going to fire the current executices?
February 25, 2009 2:20 PM | Reply | Permalink
Graham asks a sensible question.
Treasury et al are still making deals behind closed doors and not showing even the rationales. Let's have some answers.
And don't assume "failure" is necessarily catastrophic, think managed reorganization.
I'm particularly interested in knowing how much cream has been, and might be, skimmed off the top by derivatives held by gamblers or crooks.
February 25, 2009 2:26 PM | Reply | Permalink