What If Citigroup Had Bought Wachovia?

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There was a time not long ago when Citigroup (NYSE: C  ) was the savior, rather than the saved.  

Around this time last year, Citigroup struck a deal to buy Wachovia, a bank that surely would have failed without being bought. But just days after the Citigroup-Wachovia deal was announced, Wells Fargo (NYSE: WFC  ) came in with a far more lucrative bid and successfully acquired the bank soon after.

And thank goodness it did, really. Had the Citigroup-Wachovia deal gone through last fall, things would look a lot worse than they do today for just about all of us. Here are three groups in particular.

Citigroup's original deal called for taxpayers to back a good chunk of Wachovia's losses. Citigroup was to issue the FDIC $12 billion in preferred stock and warrants in return for having taxpayers swallow the losses on a $312 billion pool of Wachovia's assets, after Citi absorbed the first $42 billion of losses. This loss-sharing agreement was similar to JPMorgan Chase's (NYSE: JPM  ) purchase of Bear Stearns a few months prior.

Wells Fargo asked for no such help and offered to purchase Wachovia as is.                      

It's impossible to know what exactly was in the $312 billion pool Citi wanted quarantined, but it's safe to say taxpayers would have been on the hook for tens, perhaps hundreds, of billions of dollars. Citi essentially agreed to pay for 17% of the asset pool's losses, yet Wells Fargo marked down Wachovia's riskiest assets by a staggering 39% when it bought the bank. Some believe that even that amount might not suffice, as delinquencies continue to surge.

In fact, a recent Fitch report on option ARMs, a segment to which Wachovia had huge exposure through its 2006 acquisition of Golden West Financial, concludes that "expected losses for recent-vintage Option ARMs range between approximately 35%-45%, depending on the collateral quality of the underlying mortgage loans." Those kinds of losses could have put taxpayers on the hook for nearly $100 billion.

Safe to say: If there's one group that should be thankful Citigroup never bought Wachovia, it's taxpayers.

Citigroup bid for Wachovia in late September 2008. By November, it was effectively insolvent and surviving on life support only through a series of taxpayer infusions.

Citigroup would have grown its deposit base and gained geographic exposure with Wachovia. That's why it wanted Wachovia in the first place. But it also would have caused an already unwieldy balance sheet to balloon even further. The $700 billion of assets Citi was about to inherit would have brought its total assets to around $2.8 trillion, or about 20% of U.S. GDP.

That situation would have simply accentuated what brought Citi down in the first place: being too large, too widespread, too bloated, and too unfocused.

Citigroup's only shot at success is methodically slimming down and finding a profitable niche. Exploding the size of its balance sheet with a piles of delinquent mortgages is preceicely the opposite of that approach. Buying Wachovia would have made it "too big to fail" on steroids, with its tentacles dug into nearly every corner of the nation.

Financial markets
Discussing Lehman Brothers, New York Times columnist Joe Nocera said this over the weekend: "If Lehman had been sold to Bank of America (NYSE: BAC  ) , as originally planned, some other firm -- no doubt bigger, and posing more danger to the global financial system -- would have failed instead.

The same can be said of Citigroup and Wachovia. Regardless of whether the deal had gone through, the forces that ultimately destroyed Citi -- not enough equity and too many defaulting assets -- would have prevailed. Yet with Wachovia strapped to its back, the near-collapse would have been even more systemic, and it would have cost taxpayers far more and set off an even greater panic.

Citigroup started unraveling around the same time Bank of America announced that it tried to ditch its acquisition of Merrill Lynch. Had both acquisitions gone kablooey, it would have sent a signal to markets that there was no private-market solution to fixing the mess at hand. Had that happened, Morgan Stanley (NYSE: MS  ) and Goldman Sachs (NYSE: GS  ) would probably have been next in line on the chopping block, as both banks' business models were under attack and tremendously fragile at the time. Things would have become real ugly, real quick.  

Moving on
"Hindsight explains the injury that foresight would have prevented," as the old saying goes. So true. But how nice it is when hindsight explains the injuries that would have occurred had faulty foresight prevailed.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (23)

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  • Report this Comment On September 15, 2009, at 1:25 PM, Melaschasm wrote:

    This is a great example of why the government should not have subsidized the purchase of failing institutions by politically connected companies.

    It would have been much better to let the failing companies be bought by the strongest players in the financial industry at reduced (fair market value) prices. By pushing through TARP and similar programs, the government was making things worse, as usual.

  • Report this Comment On September 15, 2009, at 4:19 PM, ByrneShill wrote:

    We were merely lucky that Wells stepped in.

  • Report this Comment On September 15, 2009, at 5:49 PM, FoolTheRest wrote:

    A very well-written article, Morgan. Even the most observant of us tend to become short-sighted and forget the recent past. You remind us and give a thoughtful perspective.

  • Report this Comment On September 16, 2009, at 1:09 AM, Calculated4Risks wrote:

    I don't think it's luck that Wells stepped in. Wells Fargo walked away from negotiation before Citi announced the deal to buy Wachovia. I'm sure it is Benanke that realized FDIC totally crewed up in supporting Citi-Wachovia deal and asked Wells to step in to help.

  • Report this Comment On September 16, 2009, at 1:12 AM, automaticaev wrote:

    city would have been better off with time if it aquired wochovia.

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