Despite a financial rescue that could end up costing taxpayers billions and billions of dollars, the US government still has not come clean on the value of the mortgage-related toxic assets on the books of Citigroup, the banking behemoth.
The word buzzing through the canyons of Wall Street during the Thanksgiving holiday, according to my sources, was that the $306 billion of assets that we—the American taxpayer—guaranteed for Citigroup a week ago actually have a market value closer to $230 billion, not $306 billion. The guarantee for a “bad bank” of ringed assets was part of the eleventh-hour rescue plan that Treasury Secretary Hank Paulson engineered with Robert Rubin, his predecessor at Treasury and Goldman Sachs, and a Citigroup senior executive and board member, whereby another $20 billion from the Troubled Asset Relief Program went to Citigroup—on top of a previous $25 billion. Citigroup will assume the first $29 billion in losses on the risky pool of assets, with any remaining losses absorbed 90 percent by the government and 10 percent by Citigroup. The firm’s stock has soared some 122 percent since the announcement, opening this week at $8.29 per share (and closing Monday at $6.45, down 22 percent).
If the Citigroup assets we just guaranteed are only worth $230 billion, then for starters the American taxpayers have just flushed $42.3 billion down the drain.
Of course, had the government agreed to value the assets for what they were really worth—the $230 billion—Citigroup would have had to write off the $76 billion difference against its equity account, effectively bankrupting the world’s most pervasive symbol of American capitalism. Apparently there was way too much at stake to allow that to happen, proving, yet again, that in war the first casualty is always the truth.
Moreover, if the assets we just guaranteed are only worth $230 billion, then for starters the American taxpayers have just flushed $42.3 billion down the drain in a week. (The math is 90 percent of $76 billion minus $29 billion.) And if Citigroup’s balance sheet is still not marked properly, then the $45 billion of equity that Paulson just took from the TARP for Citigroup may also be shaky. The chance that almost $90 billion is now at serious risk is a rather unsettling thought.
Indeed, when all is said and done in this financial crisis, one of the many underlying causes of it—along with rampant greed and an acute absence of regulatory oversight—has been the ongoing lack of transparency. The government’s actions with regard to Citigroup merely compound this problem.
Right from the start, as toxic mortgage securities began to clog the arteries of the system, no one dared value them at anything close to what they suspected they were really worth. People deluded themselves into thinking that as long as the securities didn’t trade, their true value could be hidden from investors. No trading meant no requirement to mark-to-market. Mark-to-myth became the new mantra of Wall Street. But, as is now crystalline, nearly every firm in the securities industry that was a leader in manufacturing and distributing mortgage securities—among them Bear Stearns, Merrill Lynch, Citigroup, and Lehman Brothers—was bankrupt, or close to it, as soon as the huge losses in the Bear Stearns hedge funds became apparent to the outside world in May 2007.
The extent of the opacity of Wall Street’s balance sheets became apparent to the world outside Wall Street soon after Paulson released TARP, version 1.0. The original TARP would have shined a disinfecting light on the mortgage-related securities for the first time since the crisis began. The plan was for the Treasury to use its new $700 billion fund to buy the sludge from Wall Street and to put a price on these assets. If the price the government paid proved too high, then the taxpayers would yet again play the sucker for Wall Street. A fairer price—but one below where a securities firm had previously marked the assets—would cause the firm to take a corresponding write-down, wiping out an increasingly large chunk of its equity account.
What Paulson et al. quickly came to realize was that Wall Street continued to mark the assets too high and so any TARP sales would be below those marks, causing huge—and potentially devastating—write-downs. That could have caused the remaining firms—JPMorgan Chase, Citigroup, Bank of America, Goldman Sachs, and Morgan Stanley—to go the way of Bear Stearns, Merrill Lynch, Lehman Brothers, AIG, Wachovia, and Washington Mutual. There was no way a former CEO of Goldman Sachs could let that happen on his watch.
Enter TARP, version 2.0. On November 12, Paulson scrapped the idea of buying the toxic assets from Wall Street in favor of the government taking large equity stakes—to the tune of $125 billion—in the remaining Wall Street firms to shore up their balance sheets. Paulson forced all the firms to take the new capital, whether they felt they needed it or not, as a way to cloud the reality that others among them—read Citigroup—remained in dire straits.
Whereas TARP 1.0 would have been a boon to transparency, TARP 2.0 muddied the waters badly once again. The market—which loves transparency when it can find it—responded predictably, falling nearly every day for the next two weeks until Paulson unveiled TARP, version 3.0, the rescue plan for Citigroup, which was about to go the way of Lehman Brothers. Why the market has responded so positively—up generously in the past four trading sessions—can only be because there remains a lack of understanding in the market of how bad the situation remains.
Our only hope of emerging from this crisis with our financial institutions and our capitalist system—to say nothing of our dignity—anything close to intact is if we demand that our elected and appointed officials follow the admonition of former Supreme Court Justice Louis Brandeis: “Sunlight is the best disinfectant.”
William D. Cohan, a former senior-level M&A banker on Wall Street, is the author of The Last Tycoons: The Secret History of Lazard Freres & Co. Cohan's House of Cards: A Tale of Hubris and Wretched Excess on Wall Street, will be published by Doubleday in 2009. He also writes for Fortune, ArtNews, The Financial Times, and The Washington Post.