Citigroup – Donald Marron

How Blurry is the Line between Monetary and Fiscal Policy?

Economists have traditionally drawn a sharp distinction between monetary and fiscal policy. Monetary policy should try to promote growth and limit inflation by setting short-term interest rates, managing the money supply, and providing liquidity during times of financial stress. Fiscal policy should also encourage growth and, more broadly, promote the general welfare through careful choices about spending, taxes, and borrowing. The Federal Reserve has responsibility for monetary policy, while Congress and the President handle fiscal policy.

That clean distinction was one of many casualties of the financial crisis. As credit markets froze, the Fed pursued unconventional policies that blurred the line between fiscal and monetary policy. For example, it purchased more than $1 trillion in mortgage-backed securities (MBS) issued by Fannie Mae and Freddie Mac, created new lending facilities for commercial paper and asset-backed securities, and provided special support for such key financial institutions as AIG, Bank of America, and Citigroup.

Those actions differed from conventional monetary policy in two ways. First, they exposed the Fed to more financial risk. Short-term Treasury securities, the Fed’s usual fare, carry no credit risk and almost no interest rate risk. In contrast, the Fed’s new portfolio has healthy doses of both. Second, in several cases the Fed offered to purchase financial assets at above-market prices or, equivalently, to make loans at below-market interest rates. In effect, the Fed chose to subsidize some specific financial activities.

Both changes increased the Fed’s fiscal importance.

Most visibly, Fed profits have jumped as its portfolio expanded and it acquired higher-yielding assets. Indeed, the Congressional Budget Office (CBO) projects that Fed profits will hit $77 billion in 2010, up from $32 billion in 2008. That makes them the fourth largest source of federal revenues, after personal income, social insurance, and corporate income taxes, but ahead of estate and excise taxes. Actual returns could be higher or lower, however, depending on how well its investments perform.

Also important, though less visible, are subsidies implicit in some of the Fed’s financing programs. The Term Asset-Backed Securities Loan Facility (TALF), for example, offered favorable long-term funding to investors who wanted to finance investments in securities backed by auto loans, student loans, and certain other types of debt. Similar programs provided favorable funding to support commercial paper markets and to assist AIG, Bank of America, and Citigroup. CBO recently pegged the initial cost of the resulting subsidies at $21 billion.

Not all programs created subsidies, however. CBO concluded, for example, that the MBS purchase program did not involve subsidies because the Fed made its purchases at market prices.

To be sure, the Fed’s fiscal initiatives were dwarfed by the explicitly fiscal actions taken by Congress and Presidents Bush and Obama. The Troubled Asset Relief Program (TARP), for example, was originally estimated to involve subsidies of $189 billion (a figure that has fallen as financial markets have healed), and support to Fannie Mae and Freddie Mac has added tens of billions more. Still, CBO’s estimates do highlight the Fed’s move into fiscal territory as it battled the financial crisis.

Those steps were appropriate given the severity and suddenness of the crisis, but have fueled concerns about the Fed’s scope of authority. Some members of Congress, for example, have questioned whether the Fed should be able to engage in even moderate amounts of fiscal policy without congressional oversight. Their increased interest in Fed oversight, in turn, has raised concerns about defending the Fed’s traditional independence in making monetary policy.

As Chairman Ben Bernanke argued in a speech last week, maintaining the Fed’s independence in monetary policy would be easier if policymakers would “further clarify the dividing line between monetary and fiscal responsibilities.” Let’s hope such guidance comes along before the next financial crisis strikes.

This post first appeared on TaxVox, the blog of the Urban-Brookings Tax Policy Center.

How Did Treasury Vote Its Citigroup Shares?

The United States Treasury is Citigroup’s largest common shareholder, owning 7.7 billion shares, or about 27% of the company. Which raised an interesting issue at today’s annual meeting: how should the Treasury vote its shares?

Treasury answered as follows:

As we have previously stated, Treasury is a reluctant shareholder in private companies and intends to dispose of its TARP investments as quickly as practicable. When it acquired the Citigroup common shares, Treasury announced that it would retain the discretion to vote only on core shareholder issues, including the election of directors; amendments to corporate charters or bylaws; mergers, liquidations and substantial asset sales; and significant common stock issuances. At the time of the exchange, Treasury agreed with Citigroup that it would vote on all other matters proportionately–that is, in the same proportion (for, against or abstain) as all other shares of the company’s stock are voted with respect to each such matter. Treasury is abiding by the same principles in the few other companies in which it owns common shares, which are very few, as most TARP investments were in the form of nonvoting preferred stock.

Those sound like good principles. So how did Treasury actually vote?

Treasury voted FOR three ballot proposals:

15 Nominees to the Board of Directors
To issue $1.7 billion of “common stock equivalents” to workers in lieu of cash incentive compensation (a way to conserve cash that Citi agreed to in a deal to repay some TARP money)
Reverse stock split

Treasury voted PROPORTIONALLY on the remaining proposals:

Ratify KPMG as the firm’s accountant
An increase in shares for a stock incentive plan
Executive compensation (nonbinding “say on pay”)
A “Tax Benefits Protection Plan” which discourages ownership changes that would reduce the value of Citi’s $46 billion in deferred tax assets
Six shareholder proposals covering such issues as corporate governance and political activity.

Treasury emphasizes that its proportional votes don’t mean it lacks an opinion on these proposals. Referring to two corporate governance proposals, for example, Treasury noted that it may have a policy preference but:

Treasury believes that it would be inappropriate to use its power as a shareholder to advance a position on matters of public policy and believes such issues should be decided by Congress, the SEC or through other proper governmental forums in a manner that applies generally to companies. For this reason, and because voting on such matters was not necessary in order to fulfill its EESA responsibilities, Treasury refrained from exercising a discretionary vote.

Although Treasury expressed that view with respect to the corporate governance provisions, I can’t help but wonder what it felt about the “Tax Benefits Preservation Plan.”

You can see all the proposals in Citigroup’s proxy statement.

Disclosure: I own no Citigroup securities of any kind (see this post for a summary of my previous thoughts about Citi securities).

Lessons from the Fall of Lehman

As you have undoubtedly noticed, this week marks the one-year anniversary of the fall of Lehman Brothers–the moment at which the financial crisis became a severe economic crisis.

I did an interview on Fox Business on Tuesday to discuss some of the lessons learned. (My wife’s comment on the interview: “You need to straighten your collar next time.”)

Going in, I had two basic points I wanted to make:

First, the fall of Lehman Brothers was the moment that the abstract threat of “systemic risk” became tangible to many policy makers and the public. As we progressed from propping up Bear Stearns to taking over Fannie Mae and Freddie Mac, many observers began to suffer from policy fatigue, and, in some circles, there was concern that the scale of the government actions might be disproportionate to the alleged, but little-seen, risk of a systemic crisis. That changed when Lehman fell, and the dominoes started toppling.

Second, we still have our work cut out for us. The major items on our to do list include:

(1) Taking steps to avoid such enormous shocks in the future (e.g., by increasing capital requirements and reducing allowed leverage for financial firms).

(2) Fixing the problem of too-big-to-fail (or, if you prefer, too-interconnected-to-fail). Unfortunately, this problem has worsened, in many ways, since the crisis began. Some gigantic firms have grown even larger. And the necessary interventions to prop up the financial sector have reinforced the idea that the government will prevent these firms from failing in the future.

(3) Disentangling the government from private firms, so that it can again act as a referee, not as a player. That will take time given the enormous investment portfolio that the government has amassed in financial firms and the auto companies. It is heartening, however, that even Citigroup is beginning to ponder how to raise outside capital and reduce the government stake.

Citigroup & Efficient Markets

The Citigroup pricing anomaly may be in its final days (earlier posts here and here).

Investors must submit their offers to exchange preferred shares for common shares by this Friday (which may require contacting your broker several days earlier). The common shares will then be delivered to investors on July 30.

The pricing gap between the common and preferred shares remains large (about 10% at the close on Monday), but has narrowed as the exchange date has drawn near.

It thus seems an appropriate time to reflect on what, if anything, the Citigroup anomaly illustrates about economics and finance more broadly. Happily, this week’s Economist carries a quote from Dick Thaler (previously quoted in my post about Catherine Zeta-Jones) that summarizes the lesson perfectly:

Mr Thaler concedes that in some ways the events of the past couple of years have strengthened the [Efficient Markets Hypothesis]. The hypothesis has two parts, he says: the “no-free-lunch part and the price-is-right part, and if anything the first part has been strengthened as we have learned that some investment strategies are riskier than they look and it really is difficult to beat the market.” The idea that the market price is the right price, however, has been badly dented.

To me, the Citigroup anomaly illustrates the strength of the “no-free-lunch” part of the EMH, and the limitations of the “price-is-right” part. Continue reading “Citigroup & Efficient Markets”

Beyond the $23.7 Trillion Headline

Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program (affectionately known as SIGTARP), is making headlines with his estimate that the government has provided “potential support totaling more than $23.7 trillion” in fighting the financial crisis. That estimate will be officially released on Tuesday morning in the SIGTARP’s latest quarterly report (you can find an early copy here – ht WSJ).

SIGTARP Totals

As the media are already noting (e.g., WSJ and Yahoo), there are many reasons to believe that the $23.7 trillion figure is overstated. For example, as noted in the footnote to the table above, the figure “may include overlapping agency liabilities … and unfunded initiatives [and] … does not account for collateral pledged.” In other words, there may be double-counting, some of the programs won’t happen or are already winding down, and the estimates assume that any collateral is worthless. For example, to get to $5.5 trillion in potential losses on Fannie Mae and Freddie Mac (part of the $7.2 trillion Other category), you would have to assume that all GSE-backed mortgages default and that all houses backing them are worthless.

In short, the SIGTARP estimate is a way upper-bound on likely Federal support to the financial support. That fact shouldn’t detract, however, from the importance of the rest of this report.

Continue reading “Beyond the $23.7 Trillion Headline”

The Citigroup Repo

As I’ve noted in a series of posts (here’s the most recent), there’s an anomaly in the pricing of Citigroup securities. Several issues of Citi’s preferred stock are scheduled to convert into common by the end of the month. Yet the common stock has been trading at a significant premium to the preferred in recent months. As I type this, for example, the common is trading at roughly a 14% premium to the preferred common, even though the conversion is just a few weeks away.

As best I can tell, the only explanation for this pricing anomaly is that Citigroup common stock is very difficult to sell short. So arbitrageurs can’t bid the spread down to levels that would be normal for such a deal.

This anomaly intrigues me for two reasons. First, it appears to be a blatant rejection of strong versions of the efficient markets hypothesis. However, as I will discuss in a later post, the market for Citigroup securities is actually ruthlessly efficient in many ways. As a result, it’s extremely difficult to profit from the anomaly. Sharp financial types have already bid other prices — most notably those for Citi options — to a level where obvious profit opportunities don’t exist.

Second, the anomaly is a big dangling carrot for big-money types to get creative. Markets always try to find ways around imperfections like the limits on short-selling. So I’ve been wondering what creativity would come out of the woodwork. Well, today I got an answer.

Continue reading “The Citigroup Repo”

Citigroup & Berkshire Anomalies

Summary: Both Citigroup and Berkshire Hathaway continue to violate the law of one price.

Citigroup

In previous posts (this is the most recent), I’ve pointed out that there are three ways you can purchase common shares of Citigroup:

Simple: Buy shares of common stock.

Preferred: Buy shares of preferred stock that will convert into common.

Synthetic: Use call and put options to replicate the financial returns of owning common stock.

In a perfect world, these three approaches would give nearly identical prices. That’s the law of one price.

Over the past few months, however, Citi securities have been breaking that law. Investors who have been buying common shares have been significantly overpaying relative to the values implied by the prices of the preferred stock and options.

Continue reading “Citigroup & Berkshire Anomalies”

Progress on Auctioning TARP Warrants

Ten major banks repaid almost $70 billion to TARP in recent weeks. But they aren’t free from TARP just yet: Treasury still owns warrants to purchase their common stock.

I’ve previously argued that Treasury ought to auction these warrants to the highest bidder. Auctions would (a) be transparent, (b) provide full, fair value to taxpayers, (c) free banks from the TARP, and (d) give banks the opportunity, but not the requirement, to repurchase the warrants. As close to a win-win-win policy as one can hope for in Washington.

Unfortunately, as I noted in a follow-up post, the original TARP investment contracts include a specific process by which banks can negotiate to repurchase the warrants. As much as I like auctions, I believe even more strongly that the government should live up to its agreements. Which is why you haven’t seen me blogging about warrant auctions lately.

Until now.

Earlier today, Treasury announced the process by which it will divest itself of the warrants of banks that have repaid their original TARP investments. This announcement includes lots of good news: Continue reading “Progress on Auctioning TARP Warrants”

The Subsidies in TARP

How much is TARP costing American taxpayers? We know that Congress originally authorized up to $700 billion in TARP investments. And we know that $439 billion has been committed to various programs. But how much of that money are taxpayers likely to see again? And to what extent will they be compensated for making those investments?

The Congressional Budget Office took a crack at answering those questions in a report released last night. The headline finding is CBO’s estimate that subsidies in the TARP program are $159 billion. Taxpayers put up $439 billion and, in return, now own assets (including recent repayments) worth $280 billion.

The following chart shows the estimated value of the TARP portfolio (dark red) and subsidies (light red) across the major TARP programs:

TARP Subsidies

Key insights from the chart: Continue reading “The Subsidies in TARP”

The TARP Peace Sign

Wednesday was a rare day in Washington: the Federal government was actually cash-flow positive.

The reason, of course, is that ten major banks repaid $68 billion in TARP money. Smaller banks had previously repaid about $2 billion, so Wednesday’s action lifted total repayments to $70 billion, almost 30% of TARP support to individual banks.

TARP Peace Sign (For those who don’t get the title, this pie chart reminds me of a peace sign.)

As noted in my previous post on TARP, that means that two firms — Citigroup and Bank of America — now account for the majority of outstanding TARP support to banks. Citigroup has received $50 billion in three transactions, and B of A has received $45 billion in two transactions. Investments in all other banks now total “only” $79 billion.

Continue reading “The TARP Peace Sign”