Michael Steinberg has a different perspective on the Citigroup "crisis of confidence" drama playing out this week — forget moral hazard and stop the equity prices from plummeting.
Treasury Secretary Paulson’s Policies Accelerate Citigroup’s Implosion 
Courtesy of Michael Steinberg at Click Broker
The New York Times “Citigroup Tries to Stop the Drop in Its Share Price” reports the latest post Lehman financial meltdown is due to Treasury Secretary Paulson’s abandonment of the original TARP purpose. At least the purpose he came to Congress with, whether he had any honest intent in his words or not. Mortgage securities were artificially supported by the premise that Paulson would create a market for toxic assets as Part 2 of the TARP. The banks waited in anticipation. Now trading is starting to resume without a safety net. This, along with renewed fears of consumer lending, credit card defaults and commercial mortgages have fed the latest bear raid on financial stocks.
The stock market has completely lost confidence in the reactionary Paulson and Bernanke’s Federal Reserve throw money at everything policy. They have both been so creative in their multitude of programs that no one understands their objectives. Only one objective is crystal clear: stockholders will suffer. As we entered Citigroup’s (C) crisis of confidence this week, the market clearly understood this. New York Fed Governor and likely Treasury Secretary Geithner needs to convince Paulson that any government support for Citigroup cannot hurt shareholders. A healthy Citigroup share price is imperative to restoring investor confidence in all banks. Just look at the fall in Bank of America (BAC) and JP Morgan (JPM) on Friday. Goldman Sachs (GS) dropped below its offering price of $53 in 1999.
Bloomberg “Citigroup May Get Government Rescue, Investors Say” reports that Citigroup capital is $50B over well capitalized. Deutsche Bank AG analyst Mike Mayo wrote that Citigroup’s $25B reserves and other resources “should be enough to cover estimated cumulative losses of $50 billion on loans.” There does not seem to be a clear indication that Citigroup is encountering a liquidity crisis. But, the renewed focus on consumers in the upcoming “depression” economy was enough to trigger the bear raid.
It is not enough for the government to add new capital to Citigroup. The government must restore confidence in the common stock equity. Falling common stock equity triggers ratings downgrades by S&P (MHP), Moody’s (MCO) and Fitch; and just as important shakes the confidence of depositors. That’s right, falling equity prices directly trigger bank runs.
Geithner’s number one issue is how can the Treasury increase investor and depositor confidence without destroying the banks’ common equity. The first step is to provide FDIC insurance on all deposits. The second step is to merge banks only as a last resort; don’t be trigger happy as in the case of National City (NCC) and PNC Financial (PNC). And finally, provide liquidity as needed, at reasonable interest rates, without diluting common shareholders.
The history of the last two years has taught us that inflicting moral hazard on shareholders has actually been quite expensive for the government. With each infliction of pain, investor confidence has fallen exponentially. Paulson got scared when bear raids began on Goldman Sachs and Morgan Stanley (MS), yet he still did not learn his lesson. Let’s hope Geithner becomes more assertive on building investor confidence as he emerges from Paulson and Bernanke’s control.
History has also taught us that the way to stop Citigroup’s implosion is to stop its stock price implosion. This can only be done by throwing moral hazard out the window. Don’t count on Bank of America, JP Morgan and Wells Fargo (WFC) raising any new capital after this week’s route.
Paulson gave us a history lesson earlier this week on everything he did right, including letting Lehman go down. Not one word was uttered to lead us to believe there wouldn’t be another Lehman, or forced merger to the detriment of shareholders. Yes, we have plenty of reasons to fear Paulson.
Disclosure: Author is long BAC, C, JPM and WFC.
