A Bailout for Citigroup?

October 14, 2007, 11:02 pm
A Bailout for Citigroup?
Posted by Dennis K. Berman

GOIH Commentary:

It appears that Wall St. was again saved by the market from having to realize the losses sitting on their books. The major banks hold billions in illiquid securities in SIVs off balance sheet debts. The banks use the off balance structure to avoid having to tie up regulatory capital, i.e., banks have to set aside a portion of their capital base as a reserve against any potential losses resulting from their investments in the SIVs if the assets were kept on the balance sheet.

Because the market has frozen up the banks cannot refinance the SIVs and would have been forced to bring the assets in the SIVs back on their balance sheet forcing the allocation of reserve capital against losses in the SIVs.

The structure of the Super Conduit will prevent the banks in group from having to set aside risk capital as a reserve against losses in the SIVs. It's rumor Citibank has more than $100 billion in SIVs and having to bring back that amount onto its balance sheet would caused a lockup in its ability to fund its operations and continue to makes loans to businesses and individuals.

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When does an “improvement in liquidity” represent a “bailout”?
We’ll be studying the details of the new “superconduit” when they’re expected to be released on Monday.
But in the meantime it’s hard not to look at the current details — ably scooped by Journal colleagues Carrick Mollenkamp, Deborah Solomon and Robin Sidel — as a big Treasury-blessed assist for Citigroup.

Consider that an estimated 25% of the total $400 billion SIV universe comes from Citigroup-affiliated SIV funds. And that Citigroup-affiliated funds have already sold $20 billion in assets.
At its most simple, the superconduit is a means by which a large collection of banks can keep “reasonable” pricing on some of their affiliated securities. And it is this pricing that is the key to the whole operation.

It’s obvious they won’t be priced at market rates because there’s not much of a market to begin with (and why the superconduit exists in the first place).
But where exactly do they get priced? To whose benefit? And by which standard?
Even without specifics, it’s clear that Citigroup has the most to gain from this operation. And it’s clearly bad if the balance sheet of the country’s largest bank were frozen for months on end as it poured money into contractual unwindings of SIV positions.

Liquidity syndicates were what helped save the day during the Panic of 1907. Given the partial return of investors to the LBO credit markets, there is plenty of reason to hope that investors will once again be buying SIV-related paper in the months ahead.
But until that time, four main points still remain oustanding:
* How much pricing confidence can be created in a market when banks are in essence buying paper from themselves?
* Might the mere existence of the superconduit create more doubts about the financial sector, stoking even more panic than the amount it was meant to quell?
* How will the banks structure their public relations to answer the simple question: Are they throwing good money after bad?
* What responsibility will be taken by the bank CEOs who blessed the rush into these structures in the first place? In other words, how will Citigroup CEO Chuck Prince explain this on Monday morning?