Weekly Wrap

The charade is over. Citigroup's busted stock offering late Wednesday has exposed the banking industry's game of "extend and pretend." Flash back to last March, when investors recognized that Citi and many other banks were hopelessly undercapitalized for a coming tsunami of loan defaults in commercial and residential real estate and in consumer credit-card debt. Citi was trading at a buck, Bank of America at three. Wells Fargo traded briefly at a hat size, and the two Morgans, Stanley and Chase, were teenagers.

Then ensued a seven-month rally that saw these stocks triple, quadruple, even quintuple. The rally was aided and abetted by the U.S. Treasury Department, which first injected tens of billions of TARP dollars directly into the banks, then certified their health with feeble "stress" tests. The Federal Reserve helped by bidding for toxic assets, taking some off the banks' balance sheets and enabling an artificial mark-up of what remained. Smitten investors bought the lipstick. New share offerings were snapped up as investment banks bulled (and underwrote) each other's stock. For two quarters, losses turned to profits, thanks largely to inflated asset prices. The government's pump-and-dump scheme seemed to be working.

Treasury actually got cocky. Earlier this month Treasury Secretary Timothy Geithner blithely announced that almost all of the $370 billion jettisoned by TARP in last year's bail-out frenzy would be recovered. Then the Department reached for $90 billion of it just in the past week, allowing Bank of America, Citigroup, and Wells Fargo to repay government loans. Mission accomplished? Not yet, according to bank regulators, who remain unconvinced that the Three Amigos (particularly Citi) are ready for prime time on their own.

Which may be precisely the point. With a flood of foreclosures coming after the new year, Geithner must have realized that zombie investors will soon wake up, closing the window for new capital raises. He therefore fired his starting pistol, and the race to the window was on. Bank of America got there first, followed quickly by Wells Fargo. By the time Citi got there, the window, while not completely shut, was on the way down. Citi had to discount its shares by 20% to clear the merchandise.

Citi's $20.5 billion offering is the largest in U.S. history. There are now enough Citi shares in circulation to allocate four to every human soul now walking the planet. To placate regulators, Treasury had stipulated that Citi repay the TARP loan entirely with fresh capital--in sharp contrast to BofA and Wells Fargo, required to raise only half of their TARP refunds. Treasury still owns an equity stake in Citi and was hoping to ditch some of it on the heels of the offering, but postponed those plans when the new share price put its investment--our investment as taxpayers--underwater. My expectation is that Citi's stock price retreats from here, that we'll be so far underwater in the next six months that we'll be feeling the bends.

The Federal Deposit Insurance Corporation's budget for 2010 was approved by its board earlier this week, expanding from $2.6 billion in 2009 to $4 billion. Why the 54% jump? Simple. Bank failures will accelerate in the coming year because of the above-mentioned tsunami of loan defaults. The FDIC's job is to clean up the mess, transferring assets to healthy banks and making depositors whole.

The FDIC is an independent agency, funded not by Congress, but by premiums paid by banks and thrift institutions for deposit insurance coverage. Established during the First Great Depression, it is not part of the federal budget process and has its own fiscal year. The agency expects to boost its staff by 1,600 (23%) to handle the coming workload. Its job is to protect $4 trillion (with a "T") of deposits, and right now its Deposit Insurance Fund stands at--could this be?--negative $18.6 billion.

That's the new balance after seven more banks folded late today, bringing the total for 2009 to 140 (with an overall hit to the DIF of over $30 billion). As these magnificent seven were deep-sixed, a new concern arose: there may not be enough healthy banks left to take over the casualties. For two failed banks in Michigan and Illinois, temporary "bridge" banks were set up to handle customer accounts. The affected Michigan depositors will have 45 days to get their money out before the temp closes. Depositors at a failed Georgia bank will simply be mailed checks.

The new mantra for orphaned clients of a damaged industry: What's in your mattress?