05/29/2010 05:12 am ET | Updated May 25, 2011

Washington Post: Taxpayer Bailout Profits From Citi Are A 'King's Ransom' [UPDATE]

Over at, Sarabeth flags a story in the Washington Post for containing "the dumbest statement we'll read in a major newspaper all year." I think she's giving major newspapers a little too much credit -- the year is still quite young -- but even still, this contention from David Cho is deeply confusing:

Among the banks that rule Wall Street, Citigroup got a bailout that was bigger than the rest. Now the company is about to pay a king's ransom for its federal rescue.

That's the lede. It basically prepares you to read about the terrible price that's being exacted from Citigroup for having been bailed out. But what Cho goes on to describe isn't a "king's ransom." It's not even a penalty!

The Obama administration is making final preparations to sell its stake in the New York bank, according to industry and federal sources. At today's prices, the sale would net more than $8 billion, by far the largest profit returned from any firm that accepted bailout funds, and the transaction would be the second-largest stock sale in history.

On paper, the government's 27 percent stake has grown in value to $33 billion. The size of the deal in the works has Wall Street buzzing. Only the stock offering by Japan's Nippon Telegraph and Telephone, which raised $36.8 billion in 1987, was larger, according to Thomson Reuters.

Yes, see, the federal government bailed out Citigroup with taxpayer money. In return, they got common stock. The value of that stock went up. And so: profit! This isn't some net negative for Citigroup -- this is how these transactions work! Moreover, Cho seems to be struggling with the time-space continuum here: this deal was consummated years ago. Playing this like a new development sort of elides over the fact that taxpayers have owned this stock for months and months.

Anyway, as Sarabeth points out, "when a company's stock price goes up, it is really not the norm to allege that the company's stockholders have somehow succeeded in gouging the company."

This $8 billion was not pried from the grasping hands of bankers, as "ransom" implies -- even if it was, it's hardly a blip for Citigroup, which paid out $25 billion in bonuses in 2009. If anything, Citigroup can take some comfort in this news, because it only makes taxpayer bailouts of "too big to fail" institutions look more attractive. This is something that I'm not sure Cho understands, having written this:

The windfall expected from the stock sale would amount to a validation of the rescue plan adopted by government officials during the height of the financial panic, when the banking system neared the brink of collapse. A year ago, Citigroup's stock hovered around a dollar a share, and the bank's future seemed in doubt. On Friday, the stock closed at $4.31.

If the sale proceeds as planned, Citigroup would be able to cut nearly all of its ties to the $700 billion Troubled Assets Relief Program. Meanwhile, the administration could highlight the profit generated from the rescue of big banks.

I'm not sure it does taxpayers any good to characterize this transaction as a "ransom" or a "windfall." Citigroup exists today because of taxpayer largesse -- this is something that Citigroup's other investors have benefited from, as well. Smash-cut back to Sarabeth:

However, once David Cho engages in this muddled thinking, one has to wonder what he makes of the $22 billion profit that the remaining 73% of Citigroup's stockholders have made since September 2009. At least, the government's $8 billion was their king's ransom for the federal rescue. Without even a quid pro quo, that $22 billion, though, must look to Cho like pure highway robbery, grand larceny on the grandest scale.

I don't want to make too big a deal about this, but if taxpayers got the preferred shares that Warren Buffet got when he injected $5 billion into Goldman Sachs, the payout to taxpayers would have been much larger. But Hank Paulson wasn't interested in negotiating the best deal back then, and as long as we're making this $8 billion out to be some sort of pound of flesh, no one will be interested in making a better deal the next time taxpayers have to bail out a "too big to fail" institution.

UPDATE: For some additional perspective on this, I recommend this December 2009 piece, from Zach Carter in The Nation. Taxpayers has $20 billion invested in preferred shares of Citi's stock, in the form of a "loan." How did Treasury allow Citi to pay back that loan? Well, it did so in a way that jacked the taxpayers and their 34% stake in Citi's common stock:

The value of our 34 percent stake in Citi's common stock, by contrast, depends on the stock's trading price. The government bought its roughly one-third stake in February for $25 billion. On Friday, the last trading day before Citi announced plans to repay TARP, the value of that stake had risen to $30.7 billion, for a gain of $5.7 billion. That's a terrible return given the risk taxpayers were taking, but it's still a return.

On Monday, Citi said that in order to have enough money to pay off the government's $20 billion loan, it was going to raise about $20 billion by issuing more shares of common stock. The company's financial health has improved; it can raise money from the private sector and pay back the taxpayers. Sounds great, right? Wrong.

Taxpayers are getting screwed. Citi's stock market value at the end of Friday was roughly $90 billion. If Citi issues another $20 billion in common stock, the company does not magically become more valuable. It's still got the same credit card and mortgage problems it had last week, and the same shaky profit prospects. Since $20 billion is about 22 percent of $90 billion, everybody who owns a stake in Citi's common stock, including the taxpayers, will see the value of their investment decline in value by about 22 percent.

How big a deal is this? Well, 22 percent of the government's $30.7 billion stake is $6.8 billion. That means Citi's plan to "repay" the government actually ends up costing taxpayers money. Not only will our $5.7 billion profit be wiped out, but the value of our common stock investment will actually drop below what we first paid for it in February.

By paying back that $20 billion, Citi was able to offer their executives bigger bonuses. So, yeah, the Treasury really stuck it to Citigroup, didn't they?

MORE UPDATE: But Sarabeth counters Carter's contention, here:

Returning to the main theme, Zach Carter is invoking one of the great urban legends of corporate finance, the "dilution effect of stock sales". The notion is that any time you issue new stock you are diluting stockholder wealth -- because you've increased the number of shares but the company does not magically become more valuable, it still has the same assets, opportunities and problems it had before -- and it's just plain wrong. Moreover, the math that Carter produces -- if new equity brings in money equal to 22% of the previous equity value, then the value of the previous equity must decline by 22% -- would make anyone acquainted with finance laugh out loud.

Read the whole thing.

Balderdash in the National Press [1115]

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