The Politics Of The Citibank Tango

Citibank is teetering on the edge, with its shares trading under $2 as of Friday, and, almost as importantly, with the bank's alleged/perceived/unacknowledged solvency issues becoming part of the political culture.

Today, regulators, Treasury officials and bank executives are working through a plan that would inject the bank with billions in new capital. At the same time, they're asking Wall Street to calm its collective nervous system. The government won't pull Citibank into receivership, but a jittery stock market might force their hand.

A senior administration official said that the goal in issuing an extraordinary statement this morning asserting that Citibank was "well capitalized" was both reassurance and pressure: "We are not rushing towards nationalization at all," the official said.  "But capital flight requires capital infusion."   The worst thing that could happen, from Treasury's point of view, is that a major sell-off would force the bank into receivership by pulling the price down to a buck or below.

"All these Jim Cramers crowing about the free market need to put up or shut up," the official said.

Citigroup's market capitalization is around $11.25 billion dollars right now, and its shares trading at around $2.15 cents. The government already owns $45 billion worth of Citigroup preferred stock -- about 25% of the bank's overall equity.

The government proposes to convert its preferred stock into common equity, which poses a problem: it'll be very hard for the government to retain less than 40% ownership stakes when the conversions are complete; the conversion price would have to be around $20 dollars per common share, which is almost ten times as much as a common share is now worth. In theory, the government can set an arbitrary conversion price, but that level of intervention would be precarious.  So -- the government wants to talk up the price of Citigroup stocks and it can talk up the price a bit.

A Citigroup official said that the company and the government are working on the specific convertible formula. Because the conversion terms would dilute the existing pool of stock, "The question we're trying to answer is whether this is something that would need shareholder approval," the Citigroup official said. An annual meeting is scheduled for April.

If all of this internal maneuvering smacks of government control over Citigroup, that's because the government essentially has the leverage it needs right now. And this informal arrangement is mutually beneficial. The government gets to restructure the bank without acquiring majority ownership stakes; Citigroup remains private and gets to rebut claims that it is insolvent. They can take more government money if they're worried about the stress tests, but as of today, the government considers Citibank well capitalized.