April 23, 2009

Congressional Oversight Panel's Hearing with Sec. Geithner

For those wanting the complete video of the Congressional Oversight Panel's hearing with Sec. of the Treasury Geithner click here. The hearing starts around 17.5 minutes into the video (expanding the video size can help with adjusting the time slider).

Starting at about 50.5 minutes, Geithner offers an overview of the current economy-wide credit situation and broad economic goals, concluding everyone's opening remarks/statements. (The opening statements of panel members earlier will be interesting to many). Questions and answers follow.

Just past 66 minutes, comes Citigroup -- the issue (discussed on this blog here and here) of how little equity (future upside potential) taxpayers have gotten in return for all their money and having taken on the massive risk of bad Citigroup securities. This is a major question.

The question on Citi from Silvers here includes interesting charts and seems headed to the central issue of whether taxpayers have the appropriate upside potential in Citigroup that our taxpayer dollars should reasonably purchase. But then Silvers clouds this essential question with the irrelevant issue of exchanging the weak seniority of the current taxpayer-owned TARP-1 preferred shares (more "senior" investments take losses after other classes of investment lose first if Citi goes into receivership or gets restructured) vs. common shares (aka "equity", which takes losses first). Being second in line for losses after common shareholders is practically being first in line for losses (as the common stock would already be near $0, since the net value of Citi would presumably be significantly negative in that scenario, or only of value because of use of the taxpayer-funded guarantees of much of Citi's risky securities). Put another way, if taxpayer guarantees of Citi's risky holdings protect common shareholders enough for Citi stock to have value, then will taxpayers receive an appropriate amount of Citi stock in the end (regardless of stock price) if those guarantees cost taxpayers significantly? In other words, the question of seniority clouds the real issue.

The real issue is entirely whether taxpayers have upside in Citi in proportion to their total funds put into Citigroup including the taxpayer guarantees of risky Citi securities after a restructuring or massive actual guarantee costs. i.e. -- would taxpayers get a proportional share of new stock like any typical debt-for-equity swap (where bondholders and other bank creditors get stock in exchange for their loans to a business being restructured). Silvers recovers somewhat at the end, asking a more open general question, but the cloudiness makes the obscures the broad question.

Geithner then gives the standard response about saving the entire economy as being the taxpayer upside. Of course, Geithner cannot suggest Citi is insolvent (or would have been without the massive blank-check-like guarantees). As Sec. of the Treasury, he cannot suggest any particular bank is in any particular condition, until after the fact. But he does not address the essential question about why the rescue of Citi involves so little upside for taxpayers.

We can rescue Citi with or without transferring taxpayer wealth to rich bank investors.

Question we'd like to hear: "Why are we effectively transferring so much taxpayer wealth to bank investors when it was not necessary in order to rescue Citigroup or for bigger goals of restoring credit and system-wide stability?"

I use present tense because we do not have to make bondholders (senior bank investors) 100% whole at taxpayer expense. These bonds are already at some market discount (below their original value) exactly because they rely on what will likely become a semi-political decision as to what degree of losses they may eventually take. We should define that possible "haircut" precisely ahead of time, to remove uncertainty, and thus encourage private capital, as the Secretary no doubt wishes to do.

It's fair to guess that Geithner wishes to avoid adding extra complexity. Congress should specify the precise losses bank investors take in a restructuring or massive taxpayer guarantee infusion of funds so that the question is resolved. The "haircut" link just above is an example of how to do that.


There is much more in the hearing, and many will find it rewarding.

I especially recommend just past 84.5 minutes, where Warren raises the big picture issue of just what is on the table to address failing banks.

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