Should a $12 Billion Profit on Citi's Bailout Thrill Taxpayers?

On Monday, we learned that the U.S. Treasury was selling the remainder of the common stock it held in Citigroup. And that's not all: the taxpayers will earn a whopping $12 billion profit on the bailout. For those keeping score at home, that's about a 27% return on the initial $45 billion "investment." Taxpayers, however, may want to hold their applause for a little longer.

While the government no longer owns an equity stake in Citi, its presence is not entirely gone. First, the Treasury still holds some warrants that it will presumably sell eventually. It is also entitled to $800 million in trust preferred securities that the Federal Deposit Insurance Corporation (FDIC) will provide if it doesn't incur any losses on guarantees it has on Citi debt.

This alludes to another way in which the government still has exposure to Citi. The firm still has some amount of debt guaranteed by the FDIC through its "Temporary Liquidity Guarantee Program." How much Citi debt is the government backing? The FDIC won't say. But one estimate from about a year ago put Citi's tally at $64.6 billion in guaranteed debt. That may have declined somewhat, but it's unclear by how much. The FDIC disclosed that the total guaranteed debt outstanding in the program has declined to $287 billion at the end of the third quarter from $307 billion a year earlier.

Looking at those numbers, it's pretty plausible that the FDIC still has a sizable exposure to Citigroup. The good news for taxpayers, however, is that these guarantees only last until the debt matures or the end of 2012, whichever comes first. So assuming that the banking sector doesn't suffer another crisis in the next two years, taxpayers might be okay after all. Indeed, even if there is some loss on these guarantees, the assets would have to be pretty rotten to eat up the government's entire $12 billion profit on the equity sale. We would be talking about a loss in excess of 19%.

If the U.S. does ultimately make a profit on the Citi rescue, that would be a pretty remarkable feat. Of all the banks bailed out during the financial crisis, Citi was viewed by many as the big bank with the most serious problems. A full exit by the government where Citi could walk on its own would signify that mostly uncertainty and fear were at the root of its troubles -- not fundamental problems that should have led to its demise.

And if Citi's near collapse was caused mostly by panic, then this raises a question: should Citi have been allowed to fail if its failure wasn't a systemic threat? Few appear to believe otherwise, as everyone just assumed that the government only saved the bank because it was too big and interconnected to fail. Instead, a different narrative might more accurate. Citi's fundamentals weren't great, but weren't so bad that it should have failed. Indeed, you could argue that almost no bank could withstand a deep credit crunch and financial crisis where panic overtakes the market. Perhaps Citi really wasn't that much worse-off than most other banks -- or at least not so much worse off that its fate should have been very different.

Of course, that leads to an important policy question: should a TARP-like program be put in place in perpetuity to stabilize financial institutions when fear grips the market? If the panic is so great that almost no bank could survive, then this isn't really a bailout, just a government effort to calm investors down. Once sanity resumes, so will bank profits and liquidity. If the intent of a government program is merely to stabilize a healthy financial system plagued by panic, then that's very different from a program seeking to bail out firms that should have been allowed to fail.