Published November 24, 2008

breakingviews.com
First Nationalised City Bank

By ROB COX
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A HALF-CENTURY ago, the bank today known as Citigroup merged with a rival and changed its name to the First National City Bank of New York. With its next big deal, it may need to consider renaming itself the First Nationalised City Bank. That's because, as the biggest American bank by assets quickly runs out of survival options, full or partial nationalisation looks increasingly difficult to avoid.

What went wrong? There is no one obvious illness, investors have simply lost confidence in the ability of the institution and its management to weather the crisis

What's the matter with Citi? That may seem like a dumb question. After all, the stock has fallen by a half in the past week. But to propose a cure requires a diagnosis of the problem. Yet there's no one obvious illness. Rather, investors have simply lost confidence in the ability of the institution and its management to weather the financial and economic crisis.

That creates a negative feedback loop whereby counterparties and creditors demand extra protection against a Citi failure. That's reflected in the credit default swaps market, which then kicks the stock price down a notch. The worry is that the blinking red of the share price further damages Citi's ability to fund its businesses and perhaps even leads depositors - the lifeblood of its balance sheet - to flee.

Again, there's no single event that caused this lack of confidence, but rather a confluence of them. A week ago, a report emerged suggesting that some of Citi's directors were agitating to replace chairman Win Bischoff. Citi denied the report in a manner that still left the impression that the board was divided over leadership.

Then the bank said that it would acquire US$17.4 billion in assets held by structured investment vehicles that it could not offload, and that it would cut 50,000 jobs. That's a lot of bad news - even if much of it was already known or expected. To make matters worse, chief executive Vikram Pandit's delivery of it all - in a town hall with staff - didn't inspire great confidence.

So what options does Citi have to restore faith? It can't really sell itself whole, as there are no obvious buyers. While its market value of US$22 billion puts it within reach of HSBC, US Bancorp or Royal Bank of Canada, for instance, outstanding questions over the value of the assets on its US$2 trillion balance sheet should keep sensible buyers at bay.

Citi does have some valuable businesses. But it's unlikely that any of them - from the Smith Barney wealth management arm to Mexican subsidiary Banamex - would attract sufficient interest at the moment to warrant anything more than fire-sale prices. The time to hive off businesses has passed - though it should be revisited when Citi returns to stability.

That leaves the US Treasury's Troubled Asset Relief Programme (Tarp), from which Citi has already received a US$25 billion injection of preferred stock. Unfortunately, though, another infusion on the same terms wouldn't necessarily do the trick - nor would it be easy to pull off.

For one thing, a further US$25 billion might not be sufficient to allay concerns over a balance sheet the size of Citi's - particularly if there has been any erosion in its US$880 billion deposit base in recent weeks. It would also be politically toxic, given the weak constraints of the Tarp and this week's refusal by Congress to help the car industry in a hurry.

But Tarp money could be used to take a substantial equity stake in Citi, something akin to the UK's bailout of Royal Bank of Scotland. That deal will likely leave the British government owning some 58 per cent of RBS. Through the Tarp, the Treasury could buy, say, US$50 billion of new Citi common stock. Existing shareholders could be given the right to participate too. Call it a rights issue underwritten by the US government.

Such a sizeable infusion of new capital - along with the de facto recognition that Uncle Sam is behind the systemically critical institution Citi in more or less the same way it now backs Fannie Mae and Freddie Mac - should restore confidence. And when more credible executives are put in place and eventually break the business up into manageable pieces, the government would probably even make a profit.