A random sampling of the stupid.

Saturday, November 22, 2008

As the share price goes, so goes the company

Citigroup's share price has plunged over the past week, from an already abysmal $10 to about $4. This gives it a market capitalization of $20 Billion, for a bank with $2 trillion in assets. This same behavior precipitated the takeover of Bear Stearns, Fannie/Freddie, and as I've written about before, in the UK.

Bloomberg has an article speculating on the takeover of Citi by the federal government:

The U.S. government may step in to rescue Citigroup Inc. after a crisis in confidence erased half the bank’s stock-market value in three days, according to investors and analysts.
The only possible justification for this would be Citi becoming insolvent. If any company is too big to fail, it's the the ginormous financial behemeth which is Citigroup.

But what the hell does the share price have to do with anything? Really? The only problem is if they don't have enough capital on hand to cover immediate obligations. As a fractional reserve bank they're vulnerable to bank runs, even if they're solvent (in theory). The shareholders would get wiped out, so if people were worried about Citi going under it would make sense to sell.

It doesn't work the other way, though. If the market thinks Citi is insolvent, so everybody sells their shares, that doesn't affect the capital they have on hand to meet liabilities. At all. A drop in share price could trigger other things, like creditors recalling loans, which would affect the capital ratio, but the share price itself is not something the government should care about.

Error rating: 7. MARKETS FLUCTUATE


No comments: