Published November 25, 2008

breakingviews.com
Citi survives, now the world can sleep

By HUGO DIXON
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CITIGROUP lives to fight another day. That's the good news in the government's mega bailout. The provision of yet more government capital - plus a guarantee for a US$306b 'bad bank' - should do the trick of restoring confidence. That's important not just for Citi, whose share price fell by a fearsome 60 per cent last week, but for all financial markets.

The Citi crisis came in the days after the outgoing US administration made clear it wanted to leave the tough decisions to the new Barack Obama administration, which takes over in January. But the authorities rose to the challenge - finishing up a complex rescue package late on Sunday night. Of course, there was a key transition figure to give the talks the needed energy: Tim Geithner, the New York Federal Reserve boss who is due to be Obama's Treasury Secretary.

There's good news - better a bailout package than nothing at all - but there's also bad.

First, Citi's terms are too lenient. The 8 per cent dividend on US$20b of capital the government is injecting in the form of preferred shares is more than the 5 per cent it paid for US$25b of government capital last month. But it is far less than the 12 per cent the UK authorities are charging troubled British banks.

Citi is also giving the state a further US$7b of preferred shares in return for guaranteeing the 'bad bank' - which will house a stockpile of troubled assets - and US$2.7b of warrants. The strike price on the warrants is generous to current Citi shareholders - nearly three times the Friday closing price.



Such lenient terms - even with the new restraints on Citi's ability to pay a dividend - could undermine the government's attempt to impose tough terms on near-bankrupt auto makers - or any other industry that comes with a begging bowl.

Second, the valuation of the assets that will go into the bad bank has not been determined. If the government pays much more than the market price, the government - and ultimately the taxpayers - could be on the hook for mega-losses. After all, Citi's rivals would be sure to demand similar packages.

Finally, it isn't absolutely clear that Citi is out of the woods. The package doesn't include any new common equity. As a result, if losses mount, questions about its core capital position could resurface. What's more, the rescue doesn't address the diffuse concerns that the bank is either unmanageable or badly managed.

Still, Citi has received an immense adrenalin shot - and markets can breathe a sigh of relief