Why Letting Citigroup Fail Could Cost Taxpayers Hundreds of Billions of Dollars

Why has the government injected $45 billion into Citigroup (C) rather than simply let it fail? Believe it or not, because of how much it might cost the taxpayer to do so. I know that might sound backwards, but consider the largest bank failure so far, IndyMac.

IndyMac had $32 billion of assets and its failure cost the taxpayer a whopping $9 billion (remember, the government insures customer deposits should a bank fail). Well, Citigroup has more than $2 trillion of assets, which makes it about 64 times larger than IndyMac. While the numbers won’t be exactly proportional, if you multiply 64 by $9 billion you get an estimated cost to the taxpayer, in the event Citigroup fails, of a staggering $570 billion.

Considering the FDIC insurance fund stood at $35 billion at last check, you can see the government doesn’t have the money to let Citigroup fail. That is probably one of the reasons why they might prefer to provide aid to Citigroup in exchange for an ownership stake. It is conceivable that would be far less costly to the taxpayer to keep them afloat than it would be to let them fail.

Full Disclosure: No position in Citigroup at the time of writing, but positions can change at any time

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6 Thoughts on “Why Letting Citigroup Fail Could Cost Taxpayers Hundreds of Billions of Dollars

  1. Chad Brand on February 24, 2009 at 12:55 PM said:

    I don’t necessarily buy the argument, I was just bringing it up.

    You seem to be suggesting, as Hussman does, that if we liquidated Citigroup tomorrow we could take a 35% loss on the stated value of their asset base and the deposits could still be repaid in full as long as the bondholders and stockholders were wiped out completely.

    The problem is, who could possibly buy these assets? We are talking about $1.3 trillion in that example. Banks don’t exactly have extra money sitting around.

    The other issue is that banks are typically the largest holders of preferreds and debt of other banks, so by wiping out $560 billion of bondholders, you are also wiping out billions in bank capital, which would need to be replenished by… the government.

    It doesn’t seem that we could let a bank like Citigroup fail and not be on the hook for a ton of money. I could be wrong, but if it was as simple as selling off Citi in pieces to other banks, and that wouldn’t cost us anything, why wouldn’t we do that?

  2. Chad, if you buy this argument, then I’ll point you to John Hussman’s weekly comment:

    Specifically on C:
    “Take a look at Citibank’s balance sheet as of the third quarter of 2008. The company had about $2 trillion in assets, versus about $132 billion in shareholder equity, for a gross leverage ratio of about 16-to-1. That’s not a comfortable figure, because it indicates that a decline of about 6% in those assets would wipe out Citibank’s equity and make the bank technically insolvent. Unfortunately, we saw credit default spreads screaming higher last week, while the bank’s stock dropped below $2 a share, so evidently the market is deeply concerned about the possible immediacy of that outcome.

    But keep looking at the liability side of Citibank’s balance sheet. There is over $360 billion in long-term debt to the company’s bondholders, and another $200 billion in shorter term borrowings. None of that is customer money. That puts the total capital available to absorb losses at $132 + $360 + $200 = $692 billion, which is about 35% of the $2 trillion in assets carried by Citibank. That’s a huge cushion for customers, who are unlikely to lose even if Citibank becomes insolvent. Should that occur, the proper response of government will not be to defend Citi’s bondholders at taxpayer expense, but rather, to take Citi into receivership, wipe out the shareholders and most of the bondholders, and sell the assets along with the liabilities to customers to another institution.

    Alternatively, the government could hold those assets in receivership, reappoint management in the interim, and eventually IPO the company – now stripped of debt obligations – as a new entity called, say, Citigroup. The proceeds of the issuance would be retained as statutory capital, and a small amount might be paid as a residual to the existing bondholders. That sort temporary “receivership” is the only sense in which the government response could be called “nationalization.””

    I don’t see how you’re addressing this argument.

  3. I heard the same argument that letting AIG fail would have been much worse, now after injecting $150 billion the government is considering injecting more tens of billions. Would it be more expensive to have let AIG fail?? The AIG bailout was more about rescuing Goldman Sachs (which had bought billions in CDS from AIG) than anything else.

    Hussman has a good point, but he forgets that it was Lehman’s bankruptcy that led a freeze in money markets, commercial paper, etc., and a wave of redemptions from money market mutual funds. With Citigroup failing, many money market funds would ‘break the buck’, causing more losses and redemptions.

  4. Hondo on March 4, 2009 at 11:20 PM said:

    FDIC insures deposits up to a $250K limit. Citibank does not have $2 T in deposits. In fact, its deposits are recorded on its balance sheet as liabilities, not assets. According to Citibank’s 12/31/08 OCC call report, its deposits covered by FDIC total $266 B.

    I acknowledge that $266 B is huge, but it’s nowhere near $2 T. So let Citigroup and Citi Holdings fail and investors can take the hit, and FDIC can take over, then sell, Citibank’s attractive deposit franchise. WaMu is the model here, not IndyMac.

  5. David on March 6, 2009 at 11:06 AM said:

    Chad, I don’t think Hussman was making the point that we should wipe out everyone except for depositors. He was making the following points (I think):
    1. The fear of depositors losing their assets is totally irrational.
    2. More importantly, in response to Rubens, Hussman doesn’t argue for Citi to fail (as Lehman did). The argument is to have the gov’t seize Citi (like Wamu) in a controlled manner such that the actual operations continue to run seamlessly and that every time the gov’t injects more money, the bottom of the capital structure should suffer. Rewarding bondholders and stockholders at the expense of taxpayers simply doesn’t make sense.

  6. GoldBuggg on March 17, 2009 at 5:34 PM said:

    The big banks and insurance companies are using economic terrorism as a way to get the public to back these huge bailout schemes. I just don’t really believe the public backs it anymore.

    Everyone has been betrayed on a colossal scale and we must defend ourselves by exiting all assets and hunkering into cash. We’ve been betrayed and lied to by bankers, politicians, military brass, and corporate chiefs. By the way, cash is prescribed in that perfectly crafted document called the US Constitution. Gold & silver are the only forms of money that can legally satisfy debts public and private.

    My rational and considered belief is that gold, as well as crude oil, will be anchors to the next global reserve currencies. What better route to stabilize both financial and commercial price systems? The following article will give you a good idea of where we’re headed in this global calamity: http://www.goldnewswire.net/gold-the-panic-phase#gold

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