CITIGROUP BAILOUT: It's Up To $306 Billion in Guarantees Plus Equity Infusion

The United States government will guarantee up to $306 billion of Citigroup assets, as part of a major bailout of Citi.

In addition, Citi will receive a capital injection of $20 billion. As part of the capital injection, the U.S. government will receive warrants exercisable at $10.61 on 254 million shares. Given the stock closed Friday at $3.77, this is a non-dilutive deal on a per share price basis for Citi shareholders.

THIS IS THE FIRST DEAL DONE BY THE GOVERNMENT WHERE SHAREHOLDERS HAVE NOT BEEN FORCED TO TAKE HUGE HITS ON THEIR STOCK POSITIONS. Freddie and Fannie shareholders are likely to lose everything. Lehman Brothers is in bankruptcy and Bear Stearns shareholders received less than 50% of the closing price on the last day Bear Stearns traded before the government rescue. In this deal, if the warrants are exercised, the government will pay more than 280% above the closing price on Friday.

It pays to be the Robert Rubin wing of Goldman Sachs.

UPDATE: Unlike Freddie, Fannie, Bear and Lehman, no one at Citi in senior management will lose their jobs. Bobby R. has their back.

As The World Crashes....

Bear Stearns..Gone.

Fannie Mae...Government hearse has arrived.

Freddie Mac...Government hearse has arrived.

Lehman Brothers....A priest has been called.

Washington Mutual...On life support.

Wachovia...Alarm buzzer in Emergency Room is screeching.

AIG...Being rushed to hospital.

Merrill Lynch...High fever.

Goldman Sachs (Where Henry Paulson was Chairman and CEO before heading the Treasury).....Today's closing price: $153.47 per share.

-Robert Wenzel

Alert: Paulson Appears Before Congress Tuesday September 16 Re: Fannie and Freddie

Details:

Tuesday, September 16, 2008, 10:00 a.m. EDT
Secretary Henry M. Paulson, Jr.
Testimony on Recent Regulatory Actions Regarding Fannie Mae and Freddie Mac
Senate Committee on Banking, Housing and Urban Affairs
538 Dirksen Senate Office Building
Washington, D.C.

-EPJ Newsdesk

Rockwell: Stop The Bailout

Lew Rockwell nails it:

Let me state this very plainly: I do not believe for one second that if the government fails to nationalize Freddie and Fannie, that the world as we know it will come to an end. Those who are saying that are trying to scare the population, the same as with every other major demand by the regime. It was the same with Nafta, the WTO, the war on terror, the war on bird flu, the nationalization of airport security, and everything else.

If the government did nothing but sell off the assets of the mortgage giants, we do not know for sure what would happen, but the market has a way of finding value and readjusting. I would expect about 18 months of difficulties. Banks would fail just as many businesses in the free market fail every day. Housing prices would fall more, just as all market prices are subject to change. But the process of readjustment would be smooth and rational. Most important, we would all stop living a lie and believing an illusion

His complete column is here.

-Robert Wenzel

Treasury Statement on Senior Preferred Stock Purchase Agreement Wth Freddie Mac and Fannie Mae

The Treasury issued the following "Frequently Asked Questions" Statement today with regard to its recent takeover of Freddie Mac and Fannie Mae.

September 11, 2008
HP-1131

Frequently Asked Questions:
Treasury Senior Preferred Stock Purchase Agreement

Can the U.S. Congress or the Executive Branch change the terms of the preferred stock purchase agreement?
This preferred stock purchase agreement is a binding legal obligation between two parties. The agreement is designed to prohibit any amendment that would decrease the amount of Treasury's funding commitment or add funding conditions that would adversely affect debt or mortgage-backed securities holders.

Some may speculate that a future Congress could pass a law that would abrogate the agreement. But any such law would be inconsistent with the U.S. government's longstanding history of honoring its obligations. Such action would also give rise to government liability to parties suing to enforce their rights under the agreement.

The U.S. Government stands behind the preferred stock purchase agreements and will honor its commitments. Contracts are respected in this country as a fundamental part of rule of law.

Can the U.S. Congress or the Executive Branch change the covenants in the agreement, such as the covenant requiring the reduction of the companies' portfolios?
As with any contract, the parties to the agreement may modify the covenants by mutual agreement only.

Does the senior preferred stock purchase agreement protect debt and mortgage backed securities issued or maturing after 2009?
Yes. The holders of senior debt, subordinated debt, and mortgage backed securities issued or guaranteed by these GSEs are protected by the agreement without regard to when those securities were issued or guaranteed. Debt and mortgage backed securities issued or guaranteed both before and after December 31, 2009 are protected by the agreement.

If the preferred stock purchase agreement protects senior and subordinated debt securities issued at any time in the future, how can the agreement ever be terminated?
Treasury's funding commitment in the agreement would terminate under three events:

The funding commitment terminates if the commitment is fully funded by Treasury.
If a GSE liquidates its assets, its net worth deficiency is computed at that time and the GSE can call upon the Treasury to fund under its preferred stock purchase agreement. After that final funding, the funding commitment in the agreement would terminate.
When a GSE satisfies all of its liabilities, whether at maturity or by making some other provision for payment in full of its obligations, the funding commitment will also terminate.
Why is the preferred stock purchase agreement limited to $100 billion? Is that enough to protect against even the worst downside scenario? What happens if losses exceed $100 billion?
Treasury deliberately chose a large number to give confidence to the markets.

If Treasury has already received $1 billion in senior preferred stock, how can you say that no investment has been made yet?
The companies each issued $1 billion in senior preferred stock to Treasury in connection with Treasury's commitment to maintain a positive net worth in the GSE. No taxpayer money was spent to receive this stock.

How is it legal for this preferred stock purchase agreement to be valid beyond the December 31, 2009 expiration of Treasury's authority?
Treasury received the preferred stock and received warrants for common stock as of Sunday September 7, 2008 and will not need to purchase any additional shares relative to this agreement. No payments by the Treasury will be made under this agreement until and unless necessary to prevent a negative net worth position for either GSE.

If the Treasury makes payments under its funding commitment, the liquidation preference of the Treasury shares will increase accordingly

What happens to the declared dividends for investors of existing GSE preferred stock?
Dividends actually declared by a GSE before the date of the senior preferred stock purchase agreement will be paid on schedule.

Can the government exercise its warrants whenever it wants, even if it is disadvantageous to the companies?
Yes. Treasury can exercise its warrant for up to 79.9% of the common stock of each GSE on a fully diluted basis at any time during the 20-year life of the warrant.

What do the rating agencies think of this agreement?
All of the rating agencies have reaffirmed the United States' current rating status.


-EPJ Original Document

Is Goldman Sachs Behind Rumors About Lehman Bros.?

Apparently, Lehman's CEO Richard Fuld Jr. think's so.

Fuld called Treasury Secretary Hank Paulson's old firm in June, according to WSJ:

Mr. Fuld grew increasingly frustrated about chatter over Lehman's future and rumors that counterparties were shying away from trading with the firm. At one point, Mr. Fuld contacted Goldman Sachs Group Inc. CEO Lloyd Blankfein. "You're not going to like this conversation," Mr. Fuld told Mr. Blankfein, according to people familiar with their talk. Mr. Fuld said he was hearing "a lot of noise" about Goldman traders who were allegedly spreading negative rumors about Lehman. Goldman declined to comment.

I tell you, honest, it's all coincidence that everyone on Paulson's enemies list is getting blown out of the water: Bear Stearns, Fannie Mae, Freddie Mac, and now Lehman teetering with rumors coming out of Goldman.

It's not that Lehman doesn't have a highly leveraged problem balance sheet. It's just that almost every one on the Street and in commercial banking has the same nutty balance sheets. It's just interesting that the nutty balance sheets are causing the most problems for Paulson's enemies.

-Robert Wenzel

Insurers and Banks Face Huge CDS Losses

This could freeze up the CDS market.

Reports out of FT indicate that the Treasury takeover of Fannie Mae and Freddie Mac has triggered the default of up to $500 billion of Fannie Mae and Freddie Mac credit that could result in billions of dollars of losses for insurance companies and banks who offered credit insurance in recent months.

The potential losses, as well as uncertainty about exactly how the derivatives contracts will be settled and unwound, is putting strains on the unregulated $62 trillion credit derivatives market.

-Robert Wenzel

Paulson's Takeouts: Is Lehman The Last?

It's quite curious that all the major bankruptcies, and the like, that have occurred in recent weeks are all companies that have been out of favor with Treasury Secretary Paulson.

Bear Stearns has been on Paulson's list since they initially refused to help bailout Long Term Capital Management. Paulson has never liked Freddie Mac and Fannie Mae. Now, there is one more ticking time bomb, Lehman Brothers, where George Soros has a 9.47 million common stock position.

Soros is no friend of Republicans and, in fact, is a major backer of Barack Obama. Thus, it is a perfect target for Paulson, but Lehman is fighting hard for survival. Only time will tell how this one plays out,there are strong players on both sides, so it is too close to call, but there is a slight advantage too Paulson.

-Robert Wenzel

A Gross Bailout

In the days leading up to Treasury's bailout of Fannie Mae and Freddie Mac, Bill Gross had been hyperventilating on CNBC and other media venues, aggressively calling for a government bailout of the two. 

FT with  details of the Gross result:

The Bill Gross-managed Pimco Total Return fund reaped a $1.7bn payday following the US government takeover of home loan giants Fannie Mae and Freddie Mac.

While shareholders in Fannie and Freddie suffered deep losses, the world’s biggest bond fund saw its highest ever one-day rise against its benchmark index on Monday, benefiting from the bet made by Mr Gross on mortgage bonds issued by the agencies.

Gross had made a big shift out of US Treasuries and corporate bonds over the past year and into agency bonds, betting that the government would support Fannie and Freddie Mac. By May this year, more than 60 per cent of his $132bn fund was in mortgage debt.

-Robert Wenzel

The Carlyle Group During The Bush Years

The PEU Report cranks out the numbers:

While the average citizen's personal income stagnated under the Bush Presidency, one politically connected private equity underwriter (PEU) made out like bandits. The Carlyle Group went from managing $5.8 billion in assets in 2001 to over $89.3 billion in 2008.

In 2000 the mean household income was $57,047. By 2007 mean household income rose to $67,609.

Carlyle grew its asset base by 1,440% while income rose 18%. Adjusted for inflation, the 18% rise disappears.

...and this all occurred before Randal Quarles gets to perform his magic act for Carlyle's banking division. The players are in the right places. As the PEU Report puts it:

Carlyle senior advisers just landed key jobs as CEO of Freddie Mac and CFO of Wachovia. Why are these moves important? Carlyle expressed interest in buying chunks of troubled banks and government backed mortgage underwriters. They now have people on the inside who can work that same agenda.

-Robert Wenzel

Bunning Rips Bailout Of Fannie And Freddie

"This takeover of Fannie and Freddie is a calamity for our free market system. This arrangement just props them up when they should be dismantled. Fannie and Freddie have been operating under a failed business model and it should not be allowed to continue" said U.S. Senator Jim Bunning in a prepared statement.

"By directly investing in the mortgage market, the Treasury Department is acting like it is a hedge fund. Building up a portfolio of mortgage-backed securities is part of what got Fannie and Freddie in trouble, and now Secretary Paulson is doing the same thing by using taxpayer dollars to prop up housing prices. This is not a free market system. Secretary Paulson is turning America into France of twenty years ago. Simply put, it is socialism.

"Over a month ago Secretary Paulson came before the Senate Banking Committee and told us that just because Congress gave the Treasury Department the authority to bail out Fannie and Freddie it didn’t necessarily mean it would be used. I knew better at the time, though, and pressed Secretary Paulson on the matter asking him why he would request such sweeping powers if he didn’t plan to use them. Not surprisingly the Treasury Secretary couldn’t answer my question. And now we know why.

"As I suspected back in July, Secretary Paulson knew more than he was telling us during his appearance before the Banking Committee. He knew that Fannie and Freddie were in an irreversible state of damage. He knew all along he was going to have to use this authority despite what he was telling Congress and the American people at the time. And yet Congress was foolish enough to give him a blank check for this irresponsible bailout. I hate to say it, but I told you so."

Paulson Had Special Future Tax Break Written For Fannie and Freddie

How's this for a smack on the side of the head. Not only does the government bailout Freddie Mac and Fannie Mae, but if they become profitable down the road, they won't have to pay income taxes on billions of those earnings. This  tax break will amount to tax free earnings for roughly  the first $14 billion of any future Freddie and Fannie net income. Treasury Secretary Paulson had the special tax rule written for Freddie and Fannie, so that they will be eligible for the huge tax break. It won't apply to any other companies.

Paulson ... had the IRS issue Notice 2008-76, which essentially allows the two government-sponsored enterprises to retain all of their [net-operating losses] NOLs, despite a change of control of ownership, tax expert Robert Willens told CFO.com.

Under the tax code — specifically Section 382 — NOLs are severely limited when there is a change of control. But not for Fannie and Freddie, thanks to the change in rules, just for them. The rule is generally in place to prevent acquiring companies from buying up targets just to gain access to their NOLs. The NOLs for Fannie and Freddie are substantial. Over the last four quarters, Fannie and Freddie recorded about $14 billion in aggregate losses.

"I am not saying that the IRS ruling is a good thing, or a bad thing, it is just unusual," added Willens. "Then again, this is a very unusual situation."

One has to wonder what bizarre justification Paulson will have to come up with to explain, after putting billions of dollars of taxpayer money at risk to bailout Freddie and Fannie, that he then grants Frannie and Freddie special privileges so that they won't have to pay taxes on billions of dollars in income. 

Paulson's Formula: Use taxpayer money to bailout Freddie and Fannie. Write in special tax breaks so that Freddie and Fannie, if they turn profitable again (Thanks to the taxpayer bailout), won't have to pay billions taxes.

Fannie Mae and Freddie Mac CEOs to Get Golden Parachutes

Fannie Mae's Daniel Mudd and Freddie Mac's Richard Syron shouldn't have any trouble meeting their mortgage payments, now that they have both been axed.

Mudd and Syron will leave with an additional cash of $7.3 million and $6.3 million, respectively, as part of a severance package, according to an analysis by Paul Hodgson at the Corporate Library.

Randal Quarles Is Sleeping Well Tonight

Things are moving along according to plan for Randal Quarles.

Long time EPJ readers know Quarles as the ultimate insider, and that Quarles always shows up at the right place at the right time.

He has just done it again.

The new CEO of Freddie Mac is David Moffett. Guess where Moffett worked before grabbing the CEO stint at Freddie? Yup, the Carlyle Group, right along side Quarles, in the global financial services sector.

This is all coincidence of course. Paulson's hand was just forced a couple of days ago. And if you believe that,I have some Freddie Mac common stock I'd like to sell you, cheap.

Nonsense Talk From Sarah Palin

Expect more of this kind of talk, whenever she isn't speaking with the help of a teleprompter, since she doesn't have a clue.

This weekend, speaking before voters in Colorado Springs, Palin claimed that Fannie Mae and Freddie Mac had "gotten too big and too expensive to the taxpayers."

At the time of her comments, Fannie and Freddie were not under conservatorship and thus far from being "too expensive," the cost to taxpayers at that point was zero.

Mortgage Rates Fall on Fannie, Freddie Rescue

Mortgage rates are down 35 basis points today on news of a Treasury-led bailout of mortgage giants Fannie and Freddie Mac.

In trading today, the national average on a conforming 30-year fixed mortgage dropped to about 6.20% from last week's 6.55%, according to BankRate.

Hardball From China: "We Don't Know What The Bailout Means"

It's not an official comment from China, but this is certainly a hardball comment out of The People's Republic, which holds some $376 billion in U.S. government agency debt.

"The impact of the U.S. government's bailout of Fannie Mae on China's holdings in the mortgage giants is unclear, an official from the State Administration of Foreign Exchange said Monday," MarketWatch is reporting.

The official, who declined to be named, didn't elaborate, according to MarketWatch.

This is a difficult to figure. Given that the Treasury is basically guarantying the entire $376 billion portion of debt that is Freddie and Fannie paper, what else could the Chinese possibly want?

According to U.S. Treasury Department data, China was by far the largest investor in long-term debt issued by U.S. government agencies, holding $376 billion as of June 2007, which is the latest figure available.

It isn't clear how much China has invested in debt issued by Fannie and Freddie alone.

Your Only Hope: An Open Letter To Fannie and Freddie Shareholders

Dear Fannie and Freddie Shareholders,

You are screwed big time. I don't know what possessed you to continue to hold Fannie or Freddie common stock in recent weeks, when it was clear that Treasury Secretary Paulson was not going to protect  the common stock in a bailout. You obviously weren't reading EPJ. I warned in July, that common stockholders in the two firms would be diluted down to near zero in the bailout.  Maybe you were reading and following Dean Baker's useless advice.

Whatever the case, the worst still might be ahead of you. The Treasury has rights to a 79.9% stake in your companies for capital infusions of  $1 billion each, but it is very likely that further capital infusions may be required which would  dilute your pitiful stake even further.  

Here's what I would do if I were in your situation.

First, I would study the Chrysler bailout of a few decades back.

In December 1979, the Chrysler Loan Guarantee Act of 1979 was approved by the Senate, by a vote of 53 to 44. The Act provided for $1.5 billion in loan over ten years, provided that the company raised another $1.5 on its own. The act became law on January 7, 1980 when President Carter signed it. Chrysler raised the additional $1.5 billion and brought on board Lee Iacocca to run the company. 

With the appointment of Iacocca to head the company, Chrysler launched an all new advertising campaign, with Iacocca becoming one of the most recognizable businessmen in the world. In 1982, Chrysler became profitable. In August 1983, Chrysler paid off the federal loan guarantees seven years early, at a profit of $350 million to the U.S. government as a result of the government selling the warrants they received as part of the bailout package.

There was considerable talk in 1983 that the government should just give the warrants back to Chrysler, so as to not dilute old shareholders. The public outcry at such a possibility killed the idea, and the Chrysler shareholders experienced some dilution.

So what does all this have to do with you?

Freddie and Fannie are highly leveraged companies which means that when the housing market turns around (and it will at some point), Freddie and Fannie will become very profitable. If you can stop the Treasury from converting their preferred stock, which is where the dilution problem is for you, you are going to make a lot of money.

But to even attempt to stop the conversion, you need to start now to form a lobby group. Your  approach will have to be much more sophisticated than the Chrysler effort. You will need good lawyers, lobbyists , public relations people  and a good economist (uh, my email address is rw@economicpolicyjournal.com). 

There are very good reasons that you can make a case to the public that the current bailout was done to protect foreign governments at the expense of you guys. China alone holds some $300 billion in Fannie and Freddie debt, they are protected and American shareholders are not, what gives? And the government shouldn't be in the bailout and takeover game anyway.

Stopping the Fed conversion is a long shot, but it is the only shot you have.

Good luck,

Robert Wenzel

Editor & Publisher 

EconomicPolicyJournal.com

In The Time Tunnel With Dean Baker

We weren't going to bring it up, again, that Dean Baker completely blew the Fannie/Freddie call, until we went to his site, where he is taking credit for making the call correctly!!

To pull this off, Baker takes a time tunnel trip back to September of 2002, when he wrote:

If housing prices fall back in line with the overall rate price level, as they have always done in the past, it will eliminate more than $2 trillion in paper wealth and considerably worsen the recession. The collapse of the housing bubble will also jeopardize the survival of Fannie Mae and Freddie Mac and numerous other financial institutions

He quotes this in a post today that he titles: Fannie and Freddie Go Under: Yes, This Was Predictable

He starts the post off with this humble beginning:

Okay, this is a bit of gloating. After having debated the economists at Fannie and Freddie more than a dozen times over the past six years, I am going to take the opportunity to say that I was right and they are bankrupt.

Now, what really occurred is that Baker completely misunderstood comments made by Paulson just a few weeks back, blew the call and cost anyone who acted on his analysis a lot of money. He wrote:

I have yet to hear any explanation from anyone as to why the government is supporting the share price..

I replied to this with:

I have not seen anywhere a government proposal to give money to shareholders. The Treasury has suggested it may have to buy newly issued stock of Fannie and Freddie to keep them alive, but that is far different than buying shareholder stock.

The next Baker post began with this headline:

Yes, Virginia, Henry Paulson is Bailing Out Fannie and Freddie Shareholders

And, he then wrote, which clearly shows he misunderstood Paulson:

The Treasury is telling the markets that it is prepared to buy shares if the stock of Freddie and Fannie fall below a certain level. Without this commitment, short sellers would see these two bankrupt giants sitting there with positive valuations and push their price very close to zero.

I replied to this nonsense with:

I have not seen, anywhere where Paulson says he wants to bailout shareholders. In fact, Paulson will bailout debt holders, but if it comes to a rescue at the shareholder level where the Treasury comes in to buy newly issued Freddie or Fannie stock, current shareholders will be diluted down to pennies in value, for all practical purposes they will be wiped out. Baker just doesn't seem to get this. It really indicates an alarming lack of understanding of basic finance.

Yes, in some crazy Baker time machine, Baker nailed it. In the real world, it's lucky you are following our analysis instead of Dean "Yes, This Was Totally Predictable--Paulson Is Bailing Out Shareholders" Baker.

Update: Treasury Will Have Ownership Rights To 79.9% of Freddie and Fannie

As part of its announced bailout, the Treasury also said its senior preferred stock purchase agreement includes an upfront $1 billion issuance of senior preferred stock with a 10% coupon from both Freddie and Fannie, quarterly dividend payments, warrants representing an ownership stake of 79.9% in each firm going forward, and a quarterly fee starting in 2010.

With the government  getting 79.9% of  Fannie and Freddie for $1 billion, the  initial valuation for the 20% remaining for current comment stockholders will be $250 million, or approximately 25 cents per share for Fannie shareholders and approximately 39 cents per share for Freddie shareholders. And, its likely the Fannie and Freddie will need further capital injections, which means even more dilution.