Monday, February 23, 2009

place your bets

So, yeah, I've been railing about the government giving free money to poorly-run banks in order to prop them up so that their shareholders don't lose their investments. Now, I'm thinking it is time to quit swimming against the tide and just, well, become one of those shareholders.

Especially now that Citigroup is trading around $2.00. It closed today at $2.15. On Friday it was as low as $1.68. This stock is trading at a low price because the market believes the the company may be insolvent. But the recent dip over the last few days is because the market fears that a takeover by government regulators may be imminent. This may be true. Despite many opportunities to do so, the Obama administration has not denied that this is its intention.

Sure, they've made some statements which were intended to downplay this possiblity, but they have all amounted to non-denial denials. For example, here is WH spokesperson Robert Gibbs today: "The president believes that a privately held banking system regulated by the federal government is the best way to go". Well... duh. No one has ever suggested that the country would have anything other than a "privately held banking system". But the FDIC takes over banks in the general course of its operation. It happens rather frequently these days. They come in, seize the bank, and undertake an orderly sell-off of its assets while making good its FDIC-insured liabilities. You might refer to this as "nationalization" of the target bank. But the more usual term is "receivership".

The point is, this is not unusual. What is unusual is for this to happen to a huge institution like Citi or Bank of America. These are companies with lots of political clout and large, influential shareholders. So, rather than treating these banks like HomeTown Bank Inc., the government instead writes 45 Billion dollar checks to them (as with Citi and BoA) while taking in return something called "preferred stock". Preferred stock is somewhat of a hybrid between a bond and a share of common stock, but basically it is a form of note.

In any event, the Treasury department is about to embark on the process of conducting "stress tests" on the 20 largest banks, presumably (because they don't exactly say this) to determine which banks are solvent (and therefore worthy of receiving continued government largesse) or insolvent (and therefore not worthy but rather soon-to-be victims of "nationalization"). The difference between these two possiblities is not as clear cut as it might at first seem. Because, on the one hand, with the "continued largesse" approach, the government may still insist on an equity stake, which will dilute existing shareholders, and might further insist on changes in management, or restrictions on what actions may be taken by management -- essentially acting as a heavy-handed "activist shareholder". And on the other hand, even the "nationalization" approach might not entirely wipe out existing shareholders, and some or all of the existing management might be allowed to remain in place, and the government would surely seek to re-privatize rather quickly whatever parts of the company remain. Which is all to say that there is a wide continuum of various actions which the government might take depending on the results of the stress test, the creativity of those in charge of the process, and, of course, the political considerations involved.

But I said all that to say this: within the last eighteen months Citigroup was trading above $50. Now its at $2. Of course, since it was trading at $50 we've learned lots of bad things about this company. No one knows how much liability it has, but the concensus is: a lot. But even after all the misfortunes came to light in September, the company was still trading at a much higher share price than it is now. On October 1, it was at $23. On November 4 it was above $14.50. It's December high was above $8, and just last month it was still over $7.

And although the government may well take the drastic step of "nationalizing" Citi and zeroing out existing shareholders, there is a significant chance this won't happen. If the government takes some other action (in the best case scenario, leaving the company essentially as-is and giving it lots of free money; in the scenario now being discussed, taking a 40% equity stake and giving the company lots of free money), it is a certainty that the stock will quickly go higher (because the current price reflects the market's nationalization fears -- in financial pundit speak, this is "baked in the cake"). And at the current price, any significant upward move would be a huge gain. For instance, if you buy the stock at $2 and get a favorable government outcome in the next couple of weeks, you might reasonably expect the stock to go back up to its December high of $8 soon thereafter, which would represent a 400% gain in a matter of a few weeks.

This type of risk is something that large institutional investors are highly averse to. For someone like me (a frequenter of casions), it might represent the opportunity to purchase that M3 I've had my eye on.*

*Just kidding. I may be a gambler, but I'm not a degenerate.


Kingfish said...

Up next on the greatest depression is nationalization of banks and automotive. Plus some retail I suppose. Their so buried down the list of "who's who of the too big to fail in America".

There is no liquidity, then all of the sudden there will be, but the damage is done in more ways than just pocketbook. Psychologically the deal is rotten. Why? Because it is.

I like your thinking and during normal times of perceived value being close to actual value, I would agree. But this Keynesian tactic will fail again.

Buy maybe not.

HHL said...

i may have not been very clear, but my whole point was: this is not normal times, and the BET is that the gov will give free money to this company rather than take it over. i put a few dollars toward the former proposition, and though i will root for it because i now have a personal financial stake in the outcome, i don't necessarily believe it is the right or proper outcome. but that is the BET, and such an "opportunity" would not exist if such a fucked up situation did not obtain.

and as an update: the stock was up 30% the last time i checked, though it could very easily (and likely will) go to ZERO at any time. not much different than pushing some chips out onto the craps table, right?

Anonymous said...

it would be interesting to compare C and JPM in a year to see which investment would have been better. I'd say JPM if they hadn't cut their dividend (was like 7%).