Citi, USA

There have been reports this week that the government is considering an even bigger stake in Citigroup, a stake possibly as large as 40%. I can't figure out how this is in the taxpayer's interest, but I can imagine a scenario where it is in Citi's.

The larger stake would come from the conversion of the currently held preferred stock (the stuff purchased with TARP money) into common shares.

With the preferred shares, the U.S. government had shares that pay a much higher dividend than common shares. The preferred shares have the additional benefit of being ahead of common shares in any claims on the bank's assets.

Of course, converting to common shares would greatly reduce the value of the shares that are currently held. But at least one report I read indicated that Citi's management has actually asked the government to take the proposed larger stake. Why? First, of course, the dividend on the preferred shares would no longer have to be paid. But could there be another reason that this would be in Citi's interest?

A bankruptcy and liquidation (call it nationalization, receivership, the 21st Century Resolution Trust Corp., whatever) will result in the value of common shares being wiped out. Now imagine that the U.S. government owns 40% of the common shares. Under this scenario would the government ever, regardless of what any stress test shows, declare that Citi is insolvent and should be liquidated? This would require Geithner or Obama to stand at a podium and announce that the money used to buy the preferred shares is gone, wiped out.

They could try to pin the loss on Bush/Paulson, but this is one case where I doubt that line would even make it out of the briefing room. Besides, you know Karl Rove would have an Op-ed in the Wall Street Journal the next day claiming the purchase of preferred shares had the chance of being a moneymaker for the taxpayers of this nation.

The illusion of value with the preferred shares may be just that, an illusion, but I can't believe that the Obama administration would convert the preferred shares to common only to turn around and force Citi to dissolve. If they were too big to fail before, now they will be too valuable. After all, they received taxpayer money under the TARP.

Could Citi see a 40% stake in the form of common shares held by Uncle Sam as an insurance policy against ever being forced to close its doors?

The possibility of government action, both the possible conversion to common shares and the possibility of a goverment imposed liquidation have kept Citi share prices down. If the government does become a large common shareholder I would guess that private money may flow back into Citi shares on the belief that there is no way the Obama administration will force to Citi to liquidate when it holds so many shares. (Hey TARP Results Blog, you still have those Citi calls?)

So, let's see. For the taxpayers, conversion to common shares would mean no dividend and would guarantee that the TARP money would be lost in the event that Citi closes for good. For Citi the conversion means a reduced dividend payment and the tacit backing of the U.S. Government.

Of course, I could be way off on all of this. I mean, I'm no Gordon Gekko. In fact, I didn't even see Wall Sreet. But this sure sounds like more of the same from the last six months: heads they win, tails we lose.