Monday, February 23, 2009

Government to convert its preferred into common

This is being seen as another "step towards nationalization," and that's one way to look at it. I think of it as a step towards recognizing what's already taken place: government being on the hook for the losses of the money center banks. They've just been gradually working up the courage to insist a share of the profits when things recover (the preferred equity that the government/we currently hold is more like debt, where you just get your money back with interest).

People talk a lot about whether they "feel bad" for the bank shareholders or if they "deserve" their losses. This is a stupid discussion. These banks are insolvent, which to my mind is synonymous with the shareholders not owning anything. If shareholder equity is negative, and the government is compelled to assume the liabilities to prevent massive debt defaults and a run on the banking system, the shareholders are SOL.

The only way sympathy enters into things is if you propose government cushion the losses of equity investors, just 'cause they're probably nice people or something, which is clearly bonkers.

Anyway, the market is down 3% despite big rallies in the banks. Apparently people are taking this equity conversion as a sign that the government "sees value" in the common. I'm hoping the rationale is to own 40% of the common so that when it eventually has to be wiped out it will only be 60% publicly held.

In his post "Citigroup's Clever Plan to Screw Taxpayers Again," Henry Blodget makes the key observation that the government can either convert $45 billion of preferred into common equity or it can take only a 40% stake of the common. But doing both requires assigning a wildly above-market value to the common stock in the conversion (i.e. requires the government to give Citigroup free money.) This post wasn't misleading, since I didn't mention the $45 billion figure, just the 40%, but the fact that the story's numbers don't add up is a big deal.

If the government is going to get $45 billion worth of Citigroup common stock and be treated fairly, then the government won't own 40% of the company, it will own well over 90%.

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