Where did all our money go?

On October 26, Citigroup, Inc., announced the terms of the preferred stock and the warrant sold to the Treasury for $25bn as part of the bailout. The terms demonstrated that Paulson is a weakling who doesn’t care as much about taxpayer investors as much as he does about his Wall Street buddies.

The financial condition of Citigroup is opaque to the average investor. For example, here is part of the discussion of the exposure of the company to derivatives from its most recent SEC filing

Counterparty and own credit adjustments consider the estimated future cash flows between Citi and its counterparties under the terms of the derivative instrument, and the effect of credit risk on the valuation of those cash flows, rather than a point-in-time assessment of the current recognized net asset or liability. Furthermore, the credit-risk adjustments take into account the effect of credit-risk mitigants such as pledged collateral and any legal right of offset (to the extent such offset exists) with a counterparty through arrangements such as netting agreements. All or a portion of these credit value adjustments may be reversed or otherwise adjusted in future periods in the event of changes in the credit risk of Citi or its counterparties, changes in the credit mitigants associated with the derivative instruments, or, if such adjustments are not realized, upon settlement of the derivative instruments. A narrowing of Citigroup’s credit spreads would generally adversely affect revenues.

To me, this says “trust me, our models are just fine and so is the company.”

The notional value of the Citigroup derivative portfolio seems to be about $38 trillion, up about $1.2 trillion from last year. The company seems to have recorded $3.9 bn in losses for the 9 months ended September 30, 2008, on this portfolio. I can’t make out much of anything about these financials, and like everyone else, I’m just hoping it isn’t as scary as it looks to be, and that the Treasury does understand it.

This is the company we just gave $25bn. What did we get?

1. Cumulative preferred stock, paying 5% for three years, and 9% after that. The stock cannot be called except with funds raised from sale of preferred or common stock totaling at least $6.25bn.

2. A warrant to purchase about 3.7% of the common stock of Citigroup at $17.85, which is the average closing price for the 20 trading days prior to issuance, good for ten years.

3. We get no voting rights unless the company misses 6 consecutive quarterly dividends, in which case we get two directors, elected by vote of our stock and any other preferred stock of equal voting parity. Judging by the terms of the contract, I’m guessing all preferred stock shares this right. We have some other limited rights to vote. If we exercise the Warrant, we don’t get to vote the shares. Section 4.6 of the purchase agreement.

4. The company can’t pay dividends on common stock until we are paid all cumulative dividends. Common stock dividends cannot exceed the last publicly announced dividend, which I think was $.16 per share per quarter. The company cannot repurchase its common stock.

5. And the piece de resistance, the statutorily required limit of executive compensation:

4.10 Executive Compensation. Until such time as the Investor ceases to own any debt or equity securities of the Company acquired pursuant to this Agreement or the Warrant, the Company shall take all necessary action to ensure that its Benefit Plans with respect to its Senior Executive Officers comply in all respects with Section 111(b) of the EESA as implemented by any guidance or regulation thereunder that has been issued and is in effect as of the Closing Date, and shall not adopt any new Benefit Plan with respect to its Senior Executive Officers that does not comply therewith. “Senior Executive Officers” means the Company’s “senior executive officers” as defined in subsection 111(b)(3) of the EESA and regulations issued thereunder, including the rules set forth in 31 C.F.R. Part 30.

6. There is a covenant that all of the company’s derivatives, broadly defined, were entered in the ordinary course of business and on ordinary business terms.

The limits on dividends will force Citigroup to conserve cash, and presumably bear some relationship to the new obligation to pay $1.25 bn per annum to the Treasury. The money to buy the preferred stock comes from issuance of more Treasury debt, which probably bears a lower interest rate than the preferred stock, so we should make a bit of money there. We should also make money off the warrant, eventually.

What this doesn’t have is controls that would make a difference in the behavior of the company. It has no actual limits on compensation. It only contains the minimal limits in the bailout bill, which have been roundly criticized. It doesn’t have requirements for overnight lending to other banks, requirements for maintenance of certain financial ratios, or limits on the purchase and sale of derivative, or requirements for handling of mortgages it holds on the homes of Americans, or any of the other things Paulson could easily have demanded.

The existence of the covenants shows that the idea of limits on corporate behavior are standard operating procedure in the documents creating the securities we are purchasing. I have been arguing that this tactic would permit us to carry out real reform and get control over these rogues. Paulson is such a weak stick he wasn’t willing to actually control their behavior through obvious and common procedures, used by every real lender which is driven by a desire to insure its own safety, and isn’t an absolute patsy.

This is in part the failure of Congress, which was an absolute patsy and refused to put real limits on compensation into the bailout bill. It is one more proof that greed is still in control, that lobbyists will demand the money for the rich, even in a financial crisis that supposedly threatened the foundations of capitalism. It is one more proof that socialism is for the rich, at the expense of the rest of us.

I was taught that in a capitalist system, success is rewarded and failure is punished. I guess my teachers got that backwards.