Money for nothing

Citi has been bailed out. Again.

I will not delve into a discussion of the exact modalities of the deal, as it has been done here. I will however elaborate on why I think that the deal is wrong, very wrong and misguided.

Here's why:

1) It is expensive.
A 27bn equity investment. And then guarantees on a further 306bn. The size of the TARP so far, for only one firm!


2) It may be insufficient to turn the market - or - don't throw good money after bad.
Citi has over $2 trillion in assets and a further several hundred billions of dollars in off-balance sheet liabilities. Earlier capital injections have not been enough, so what makes this one different? In fact, it seems rather ill advised to put a ceiling on the size of the bailout at all, especially if the real commitment is meager relative to the size of the problem.


3) It has excessive distributional consequences.
Joe Sixpack is now paying for the Armani shirts of Jack the banker. Simple as that. It's not that Joe Sixpack is aware of it, or would even want the shirts, he would however need the money. Amazingly, the US government no longer appears to find it necessary to disguise the direct subsidy nature of this program. After all, the approach adopted to buy troubled assets over equity stakes is widely discredited, and the prospect of the government buying equity stakes at ~3x the prevalent market price is an affront to both socialists and capitalists. Indeed, it seems more like theft to me.


4) We're not being duped, so it won't work.
This crisis is about confidence. All measures currently adopted have been about shoring up confidence. After all, that is why they have to be so hastily put together and not scrutinized properly, as confidence is key (still trying to get my head round this one).

However, it does not appear to be working. The reason for this is largely point (2), but there is another, altogether more worrying element.

The US cannot really afford it.

Given US twin deficits and the already enormous debt and liability overhangs the US government is fighting with, US debt will most likely never be repaid without extremely inflationary policies on the part of the FED, which will bring with it new problems, most relevantly a crisis of confidence in the US dollar.

To put it simply, shoring up confidence in financial institutions is bringing to the fore a much more problematic issue: a potential crisis of confidence in the US Dollar, which remains the global reserve currency of choice.

Again, unfortunately, Switzerland is an example of a country which has chosen a similar route. Although Switzerland was in fact in a relatively healthy financial position, the UBS deal also mainly chose the path of buying up overvalued toxic assets to recapitalize the bank. The main difference is the size of the Swiss banking system relative to the size of the economy. Indeed, the balance sheets of UBS and Credit Suisse alone equate to several times the Swiss annual GDP. The UBS deal, which may prove to be insufficient to solve the problems of the bank, has taken up almost half of the balance sheet of the Swiss National Bank. It remains to be seen what the Swiss National Bank would do should the ~70bn CHF already provided prove to be insufficient, given that they already used up most of their conventional firepower.

This shoring up of confidence in theoretically private institutions at the expense of the confidence in currencies may prove to be a poor tradeoff by national monetary authorities.