On Feb. 11, near the end of three hours of testimony before the Senate Banking Committee, Treasury Secretary Tim Geithner made one of his clearest statements yet about how the government would deal with ailing financial institutions: "As a basic principle, conditions should escalate with the level of assistance."
Two weeks later, as rumors flew that Citigroup was asking its regulators to convert their current stake in the bank to common stock that could result in the federal government owning about 40 percent of the bank, those very regulators -- the Treasury, FDIC, OCC, OTS and the Federal Reserve -- issued a joint statement.
The critical paragraph (italics mine):
We announced on February 10, 2009, a Capital Assistance Program to ensure that our banking institutions are appropriately capitalized, with high-quality capital. Under this program, which will be initiated on February 25, the capital needs of the major U.S. banking institutions will be evaluated under a more challenging economic environment. Should that assessment indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital. Otherwise, the temporary capital buffer will be made available from the government. This additional capital does not imply a new capital standard and it is not expected to be maintained on an ongoing basis. Instead, it is available to provide a cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers. Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory.
Citigroup, according to news reports, is asking that the government convert its preferred shares into common equity shares right now. In the statement released today, the Obama administration appears to be expressing no fundamental resistance to this idea. But if the government gets a 40 percent voting stake in Citigroup, that represents de facto nationalization. And the question becomes: What are the conditions that will be required in return for such escalated assistance?
A breakup of the bank into smaller parts? The ousting of its executive team? A wipeout for bond holders? Geithner's "stress testing" of the banks is supposed to begin this week, but it's already clear that Citigroup wants more help. The question that needs to be answered, this week, is: In return for more aid, what will be the government's price?