Citigroup Bailout Means Large Subsidy To Citigroup

As most of you have probably already heard, Citigroup became the latest financial institution to be bailed out by the U.S. government. The bailout comes in the form of a $20 billion capital injection combined with a guarantee that the U.S. government will cover up to $249.3 billion in losses. Formally, the latter is structured as Citigroup taking the first $29 billion in losses from a $306 billion portfolio, with the U.S. government taking 90% of the rest.

In return, the U.S. government gets preferred shares of $20 billion yielding 8%, as well as a warrant to buy Citigroup shares during the next 10 years at a strike price of $10.61 billion.

The capital injection part of this seems pretty good for the government as they will get significant compensation. The loan guarantee however could mean quite significant losses, despite the fact that Citigroup will take the first $29 billion. Potentially, the losses could be as high as $249.3 billion. But that requires that all of the assets in that portfolio become worthless, so that is unlikely despite the fact that we're talking about very troubled assets. Most likely, losses will exceed $29 billion, so the government is going to have to take some losses, but probably not anywhere near $249.3 billion. Just how much is impossible to say, but it seems safe to say that this bailout nevertheless represent a significant subsidy to Citigroup.