Years of Poems and Spirits

The news of the Citi bailout came with a pretty detailed term sheet. The center piece of the deal is that Citi will take on the first batch of sure losses. After that, the U.S. will absorb additional potential losses up to $250B. In return for this guarantee, Citi agrees to pay a quarterly premium of $0.4B.

So at what point does this deal makes sense for tax payers? I did some basic math trying to find out.

The calculation is more difficult than I thought because the 8% is not compounded return! To proximate, let’s say it is.  The result: if time horizon is set to 3 years, the threshold is 22% (or, as long as those assets don’t lose that much, the bailout was worth it). If it is 5 years, it is 25%. 10 years, 31%. (The numbers: $306B, $29B citi’s share, 10-90 split after that, excluding $15B from TARP and FDIC (considered pre-allocated), 2% T Bill/risk-free rate, $20B PV/Investment, 4 payments a year, 8% int. rate)

In short, the deal does NOT look like a sure winner in the short term (again, I was compounding the 8% where I shouldn’t)

However, since the public has become a vested partner in the deal, then what prevents the government to artificially inflate the assets’ value? It is a scary thought, since the government–and ONLY the government–has the power to do so (through monetary policy or its equivalent). Especially now people are talking about “forgetting the deficit”, where is the sanity check except real inflation?

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