I'm writing this because this is how it was and is with Citibank and banking in general, and I have not seen it written elsewhere.
Let's assume, for the simplicity of math, that pre-crisis, Citibank had $100 billion in private capital (equity), $900 billion in FDIC insured deposits and $1trillion in loans (assets). Based on these numbers, Citibank would have a capital ratio of 10%. Notice this makes banks public/private partnerships -- 10% private and 90% public. Does this ring a bell? Remember the Treasury Secretary in 2008 adding new, unregulated public private partnerships to buy 'troubled assets' when we already had some 8,000 fully regulated and supervised public private partnerships called 'banks' that could readily do the same thing simply by the government allowing 'segregated accounts' with the same rules as the new public private partnerships.
This means once Citibank loses more than $100 billion, the FDIC has to write the check for any and all of the losses. So if all the remaining loans go bad and become worthless, the FDIC writes the check for the entire $900 billion.
When the crisis hit, again for the simplicity of math, lets assume Citibank had to realize $50 billion in losses. This would take their private capital down to only $50 billion from the original $100 billion. More importantly, this drops Citibank's capital ratio to just over 5%, as they now have only $50 billion in private capital and 950 billion in loan value remaining as assets. So now if Citibank loses only $50 billion more the FDIC has to start writing checks, up to the same maximum of $900 billion.
But Citibank's capital ratio is now below the prescribed legal limit. The FDIC needs a larger amount of private capital to give it a larger cushion against possible future losses before it has to write the check. The FDIC is supposed to declare Citibank insolvent, take it over, reorganize it, sell it, liquidate the pieces, as it sees fit under current banking law. However, the Congress and the administration don't want that to happen, so Treasury Secretary Paulson comes up with a plan. The Treasury, under the proposed TARP program, would 'inject' $50 billion of capital in various forms, with punitive terms and conditions, into Citibank to restore its 10% capital ratio.
Obama flies in, McCain flies in, it appears that they have the votes, then it appears that they don't have the votes. The Dow is moving hundreds of a points up and down with the possible vote, millions are losing their jobs as America heads for the sidelines to see if Congress can save the world. Finally TARP passes and hundreds of billions of dollars are approved and added to the federal deficit, with everyone believing we are borrowing the funds from China for our grand children to pay back. The Treasury bought $50 billion in Citibank stock, with punitive terms and conditions, to restore their capital ratio and save the world.
So then how does Citibank's capital structure now look? Nothing has changed from Citibank's perspective. They still have the same $50 billion in capital which takes any additional losses first. However, should additional losses exceed that $50 billion, the Treasury starts writing the checks, instead of the FDIC. And what's the difference between the Treasury and FDIC? There is no difference to the tax payers between the US Treasury and FDIC as the FDIC is legally backstopped by the Treasury, and the FDIC taxes the banks to try and stay in the black.
I have to conclude that no one involved had nor now has a sufficient understanding of what banking is and how it works to be considered qualified to deal with this issue. And now many of the same people, who still don't have a fundamental understanding of banking, are designing a regulatory reform bill. Good luck to us.