The next chapter in Citigroup’s saga is unfolding

[RedEarth]

At a time when the price of an ounce of gold is now about equal to the value of 500 shares of Citigroup, we are about to witness the next chapter in the evolution of the federal governments role in shoring up the banking system. Under discussion now is the conversion of the preferred stock owned by the government into common equity (WSJ, Feb. 22, 2009, 8:25 PM). We expect this process to continue. It may end with the federal government owning large shareholding positions in numerous banks.

Will this be voluntary as the talks with Citigroup and various government regulators appear to indicate? Or will this become a mandated method of adding to the assistance to banks by forcing banks to accept these terms? Is this a dimension of Geithner’s stress test? It is too soon to tell.

The first round of Treasury Secretary Geithner’s new bank salvage plan was met with distain by the markets. Geithner created more uncertainty because his plan lacked details. Others have now exacerbated things with references to nationalization of banks by former Fed Chairman Alan Greenspan and by Banking Committee Chairman, Senator Christopher Dodd.

The insiders in the Obama Administration have avoided mentioning nationalization. They must stay silent. If anyone who holds a position within the administration mentions this possibility the markets will immediately respond with intense volatility as a reaction. President Obama, Secretary Geithner, and adviser Summers know that this time they must be clear and specific.

This leads us to believe that the story circulating about Citigroup is a way for the idea of nationalization to get vetted. Once markets realize that conversion means that the preferred shares become tangible common equity, the debt markets will see this as a positive force and may narrow credit spreads. Equity market prices in the shares of the banks that are the subject of these stories (like Citigroup) will not like it because of the possible dilution of the existing shares. But overall reaction in stock markets may be better than some expect.

The reason simply is that markets have been on edge due to uncertainty. Clarity in a plan and action which is measurable will calm markets. With clarity, agents in markets will be able to make their own estimates of value. Right now they have great difficulty doing so. And they feel the rules are constantly changing so they wait.

Like it or not nationalizing banks and our financial system is already at hand. It is here in substance due to the massive use of federal guarantees. It is the form which is not yet clearly resolved. That will soon change.

http://www.ritholtz.com/blog/2009/02/the-next-chapter-in-citigroup%e2%80%99s-saga-is-unfolding-as-the-oscar-winners-are-revealed/

[HamdenRice]

1. I've been saying this would happen since the first bailout -- of AIG

The financial system will be nationalized.