FT.com / Comment / Opinion – Citigroup bail-out is smart but not risk-free
The linchpin of this financial crisis has been “super-senior” investments backed by subprime mortgage securities and derivatives. These securities were labelled “super-senior” because they were viewed as ultra-safe and secure, protected by so much extra collateral that it would be an understatement to call them merely “senior”.
With the latest bail-out of Citigroup this week, the US government has embraced the “super-senior” methodology for its own balance sheet. It will now proudly hold a “super-senior” position in Citigroup’s most troubled assets. Commentators have praised the government’s new approach and financial stocks rallied along with expectations of similar deals from other banks.
The details of the new arrangement are straightforward. Citigroup has $306bn (€236bn, £199bn) of troubled assets. Before the deal, the bank was at risk of losing that entire amount, which was one reason why market participants were skittish about the bank’s future. After the deal, Citigroup will be at risk of losing the first $29bn. If the assets fall by more than $29bn, the government will bear 90 per cent of any additional loss.
Thus, Citigroup has a subordinate claim to the government’s senior position. Citigroup’s more junior claim provides a 10 per cent cushion to protect the government from losses, much as other junior claims – now largely worthless – once protected Citigroup from declines in the value of underlying subprime mortgages. Indeed, the government’s seniority is not as “super” as Citigroup’s initially was. Back then, subordinated claims gave Citigroup a cushion of more than 50 per cent. That was not enough.
The government’s maximum potential exposure on its new “super-senior” position is a quarter of a trillion dollars. But unless Citigroup’s assets fall by 10 per cent, the government will not lose any money and the bail-out will be free. “Super-senior” positions were toxic to major banks, but regulators hope they will be anodyne for the government. Can anyone imagine Citigroup’s troubled assets declining by $29bn?
Citigroup in effect has paid the government an insurance premium, in the form of dividends on newly issued preferred stock, in exchange for an agreement that the government will cover the losses on its troubled assets if they fall by more than 10 per cent.
via FT.com / Comment / Opinion – Citigroup bail-out is smart but not risk-free
Related Websites - Should We Bail Out Freddie and Fannie or Let them Fry? There's a great debate going on in the various offices...
- G8 just became G20. World leaders announced the Group of 20 nations is replacing...
- How Much Electricity Will Plug-In Hybrids Use? Dear EarthTalk: When the plug-in Prius is released, how much...
- How Do Closed End Bond Funds Differ From Conventional Bond Funds? Closed end bond funds are investment companies that sell shares...
- Shopping Professionally pt 1 One of the best ways that you can save money...
6 Responses
to “FT.com / Comment / Opinion – Citigroup bail-out is smart but not risk-free”
1 Trackback(s)
- Nov 28, 2008: » FT.com / Comment / Opinion - Citigroup bail-out is smart but not …
nice job, very thanks ,
Great post, well written!,
great site.
thanks for you.. nice good document!,
You made some quite good points there. I did a search on the actual topic at the same time as found most individuals will agree with your web log.