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Nationalizing Citibank

Let’s start with the simple case. The FDIC insures certain “depository institutions”, banks and thrift institutions. These are regulated either by the state banking authority for state- chartered banks, or the Fed or the Office of the Comptroller of the Currency. The process of takeover begins with the determination by the principle regulatory authority that the insured bank has failed, or is failing. Then the FDIC is appointed. Almost all of the time, the FDIC acts as receiver, and sets about liquidating the institution.

One alternative for the FDIC is the formation of a bridge bank, a newly chartered bank into which the FDIC puts some or all of the assets, including deposits, loans, and securities, and perhaps some of the obligations of the old bank. The new bank is governed by a board of directors appointed by the FDIC, and operates under close supervision by the agency. The remaining assets are retained by the FDIC and liquidated. The bridge bank operates long enough to show that both operational and asset issues have been cleared up, and eventually it is sold.

In at least two cases, the FDIC has acted as conservator, and operated the bank itself. The largest example is Indymac, a thrift bank. At the time it failed, there was no law permitting a bridge bank for thrifts, so this was necessary, and it remains an option. It was done the same way as a bridge bank, except that the FDIC itself operated the bank.

As an example, if the OCC thinks Citibank is insolvent, the OCC appoints the FDIC as receiver or conservator. Citibank is removed from the control of Citigroup, and falls under the control of the FDIC. Most likely, the FDIC forms a bridge bank, and appoints a new board of directors which appoints new officers. The FDIC puts the good assets in, or a mixture of good and bad, and adds back some of the debt (this is a complicated part of the transaction) and soon, we have a new bank, cleaned up and ready to sell. The FDIC owns all of the rest of the toxic waste, which it can isolate into a bad bank, and sell off, just like the Resolution Trust Corporation did with the mess left over from the S&L Crisis.

Nationalizing Citigroup

Citigroup is a bank holding company, which is a corporation that owns a bank, and can own other companies in businesses related to banking. A bank holding company cannot be an insured depository institution, and can’t be taken over by the FDIC. If it became necessary to nationalize Citigroup, the government cannot force that outcome.

If Citigroup is to be nationalized, it will be by consent. That could happen, because management knows that Citigroup is in great danger of failure and needs money from Uncle Sam. If the Treasury insists, the new money comes in exchange for majority control, and Citigroup is nationalized, by its consent. In this context, nationalized means that the US government controls this mammoth enterprise, and operates it, presumably through a new board of directors and officers elected by the Government, and probably under close supervision by a banking czar.

Consequences of Nationalizing Citibank

With the bank gone, Citigroup’s creditors and equity security holders have to look to whatever the non-bank subs can generate to get paid. This might include the credit card operations, the structured products group, and other businesses. The shareholders will be hurt, but the loss is unpredictable. There has already been a steep decline in the price of the stock, maybe enough to price in this outcome.

The holders of preferred stock, including the Treasury, are going to be hurt also. Remember that the $25bn that Paulson dumped into the company purchased preferred stock from Citigroup, not Citibank. That stock will take a serious hit if FDIC takes over Citibank.

Citigroup’s bondholders have no direct call on the assets of Citibank. Neither do the general creditors of Citigroup. Some of the Citigroup entities are creditors of Citibank, but under the law, they won’t be paid anything until all administrative expenses are paid, and all depositors are paid. The latter includes the FDIC, which is subrogated to claims of any depositors it pays off when it closes the bank. It also includes the uninsured portion of the money on deposit at the bank. The subsidiary companies may eventually get some money back, but it will take time.

What about the counterparties on Citibank’s credit default swaps? Purchasers of protection are at least partly secured creditors. They are protected at least to the extent of their collateral. Sellers of protection are probably still on the hook. Past that, it is hard to predict.

Consequences of Nationalizing Citigroup

The shareholders are diluted. That may or may not be an issue, since the price is already so depressed.

As to operations, nothing changes. There is a new board of directors, maybe a new group of officers, and the clean up begins. We hope new management, under the thumb of Sheila Bair, will do better. It may work better for Treasury’s preferred stock, and all the other creditors. Or it may turn out worse.

One More Thing

One thing that hasn’t received a lot of comment is the impact of the sheer size of this giant. Even after reorganization of Citibank, it may be so big it will be hard to sell. Citigroup and Citibank have operations all over the world. Splitting it up will cost a whole lot of money. We’d better hope the parts are worth more than the current sum of the parts.