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Treasury Official Blames Fed For Citigroup Fiasco

First Posted: 03/18/10 06:12 AM ET Updated: 05/25/11 04:00 PM ET

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A top Treasury official blamed the Federal Reserve on Thursday for Citigroup's botched attempt to raise funds to pay back its federal bailout. The finger-pointing comes a day after the market rejected the government and the Fed's assertions about the health of Citigroup, turning back the bank's effort to raise $17 billion by selling common stock.

The rebuke is a blow to the administration's effort to withdraw itself from its ownership stake in major financial institutions and a reminder that many Wall Street banks, despite planning to pay sky-high bonuses this year, have yet to turn things around.

Major Wall Street banks are rushing to refund TARP money, in part so that they can get out from under compensation restrictions that come along with the assistance. Despite analysts' warnings that Citigroup still wasn't healthy enough, Treasury and the bank went ahead with the attempted payback.

When Citi failed to raise the money it needed from the market, Treasury backed away from selling its shares. "Based on today's offering price, Treasury has decided not to participate in the equity offering," a Treasury official told HuffPost in a statement. "We expect to divest the government's ownership stake in Citi shares over the next 12 months, and have agreed to extend the lock-up period to 90 days."

But why did they think it was a swell idea in the first place? How did they so badly misread the market?

Ask Time's man of the year, said Assistant Treasury Secretary Herb Allison at a House hearing today.

"We don't make the determination of when Citi can repay the Treasury for our investment in the company. That decision is made by the regulator," said Allison.

The hearing's chairman, Rep. Dennis Kucinich (D-Ohio), asked him to clarify what he meant by the regulator.

"The regulator meaning the Federal Reserve in this case. Also in consultation with the FDIC," Allison said.

Though Federal Reserve chairman Ben Bernanke may have lost the confidence of the market regarding Citi's health, he got some good news today -- he was approved by the Senate Banking Committee today by a vote of 16-7 and his renomination now heads to the Senate floor.

But did Treasury have a choice? The shares, of course, are owned by the Treasury Department, which can decide not to sell them, as they demonstrated the day before.

Allison is assistant secretary for financial stability and oversees the Troubled Asset Relief Program. He was testifying before Kucinich's Oversight and Government Reform Domestic Policy Subcommittee.

Kucinich continued to press Allison about how much of a say the department has over its own shares, resulting in the following exchange:

Kucinich: "So it's the Federal Reserve that decides when to exit the TARP and the Federal Reserve does it at their choosing, or who chooses? How do we know who makes the choice whether to exit the TARP? How do we know if it's the banks that are deciding or the Federal Reserve? Do you know?"

Allison: "The regulators decide, Mr. Chairman, on when it's appropriate for a bank to repay the Treasury."

Kucinich: "Is that a transparent process, Mr. Allison, or is that pretty much done over at the Fed without any report to you?"

Allison: "That's a matter for the regulator, that's--"

Kucinich: "Well, they're the regulator, but we're the shareholder. When do we find out? When do you find out? Do you find out when you read about it in the newspaper?"

Allison: "When the regulator informs us that it is--"

Kucinich: "Fed. When the Fed informs you."

Allison: "Yes sir, in this particular case, or it could be another one of the--"

Kucinich: "But it's like what, the Fed informs you?"

Allison: "Yes."

Kucinich: "The Fed doesn't ask you if you have any position on this, they just tell you they're doing it. Is that what you're saying?"

Allison: "We don't exercise regulatory oversight over the banks. That's a matter for the regulatory agencies."

Kucinich: "But we are holding all these billions in shares. Shouldn't the government have any ability to decide when the banks would exit from TARP?"

Allison: "We're following the laws enacted by Congress, Mr. Chairman, as to how we will dispose of the shares, and that is with the approval of the regulator."

Kucinich: "Do you have to agree with the banks whether they're healthy or not, or does the Fed agree with the banks whether they're healthy, and you don't talk to the Fed, you just go along with whatever they tell you?"

Allison: "We have conversations with the regulatory agencies, but we do not make the decision as to when a bank is able and ready to repay us."

Kucinich was left with the impression of an investor holding billions of dollars worth of shares with no say over what the company does or when those shares are sold. "This is a strange system we've set up here," he said. "We're not only talking about passive shareholders, we're talking about shareholders who don't know nothin'."

A Fed spokeswoman didn't immediately respond to a request for comment.

The failure of the Citigroup stock sale raises a range of uncomfortable questions for the administration. How rigorous were the "stress tests" which claimed that the banks would be just fine if the market says otherwise? Have the accounting changes that the administration has allowed puffed up the banks' books to the point where the market doesn't believe in them? What kind of investment does the Fed have in Citigroup and is it really, as they claim, risk free?

Rep. Pete Stark (D-Calif.), with a background in banking himself, had a more basic question.

"Why did the president put all these Wall Street guys in his cabinet?" he wondered in response to the failure. "They can't even save their buddies, much less poor working people."

Rep. Alan Grayson (D-Fla.), a longtime opponent of allowing banks to change mark-to-market accounting rules, said that the failed stock offering is the flip side of the benefit the banks get when they make up numbers.

"The chickens have come home to roost regarding the accounting fictions that they've employed. The price that you pay for cooking the books is you reach a point where nobody believes what you say on your books. The market manifestation is that you can't sell equity or debt because nobody believes what you're saying," he told HuffPost.

Grayson also argued that the failure of Citi to raise capital shows that the earlier investment the Fed made in it was not risk-free, as it is required to be by law.

"They undertook these transactions under a specific statutory authority that required them to conclude that these transactions had no risk. Clearly that's not the case. If you have an asset you can't sell, then clearly that's a risky asset," he said. "The fiction that these were transactions that represented no risk to the Fed has now been exposed."

Joshua Rosner is managing director at the independent research consultancy Graham Fisher & Co. He told HuffPost that the failure of the stock offering raising a host of questions - and provides a few answers.

First of all, Treasury failed investing 101 by announcing that it would sell a large share of its holding now and another large share down the road. "They created a huge overhang," he said.

Treasury also sent mixed signals, said Rosner, by asking to extend TARP until October while at the same time claiming that the banks are doing fine.

Perhaps more importantly, said Rosner, the failed sale indicates that Citi is not worth what the government has said it's worth. "If the market is supposed to be a place where assets can price in some semblance of their value, the markets just told you that with 50 percent of Citi for sale it's not worth what Treasury seems to think it is. Moreover, the markets are telling you that they are not confident that Citi should've been let out of TARP yet," he said.

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