Bailout unfurls under shroud of uncertainty

Editor's Note: A new blog out of Duke University's Fuqua School of Business (www.dukeresearchadvantage.com) allows faculty to provide insights and analysis on various aspects of the financial crisis. This post was written by professor Campbell Harvey:

It wasn't that long ago that Citigroup was considered a "good" bank.

Remember Oct. 1, 2008? Citigroup announced it was acquiring Wachovia with the help of the FDIC. You had to be strong to do a favor to the government like that.

Citi was also a recipient of $25 billion in the first tranche of the $125 billion Troubled Asset Relief Program money.

However, we know now Citi was not healthy. On Friday, Citi stock closed at $3.77, implying an approximate market cap of $19 billion -- just a few weeks after the Treasury had injected $25 billion in capital. This implied that the government was throwing $25 billion at something that was worth -$6 billion! It is the classic throw of good money at bad.

I am fully aware that some type of intervention was necessary. Citi falling would have created even worse chaos in markets.

But the injection of a further $20 billion and huge government guarantees on troubled assets is a spectacularly bad deal for the American taxpayer. ... One of my sticking points is the small size of the equity stake. The government is getting only 254 million warrants. Citi has over 5 billion shares -- so this amounts to less than a 5 percent stake.

To make things worse, the strike price for the warrants is $10.61 per share -- triple the Nov. 21 close.

Look, this is a firm that probably would not have survived until Monday. The government dumps another $20 billion of cash and backstops more than $300 billion of their troubled assets. The government gets chump change -- some preferred stock and deep out-of-the-money warrants.

This is a raw deal for the American taxpayer. ... The real cost of the Citigroup deal is the future long lineup of banks that will want a similar deal. ... A year ago, we could have prevented this crisis with about $500 billion. I estimate to clean up the balance sheets will cost $1.5 trillion -- and that does not include bailout dough for nonfinancials like autos, airlines, retailers, etc.

Transparency? Opaque is the wrong word. Shrouded seems better.

Citi was considered a good bank. Now it is a bad bank. What about the other 8,500 financial institutions?

The wild swings in the market are being influenced by the acute uncertainty. It is hard to say which banks are good and which are bad.

A banking system relies on confidence of both depositors and borrowers. The lack of transparency works against confidence building.

We cannot get back on track until we, at least, know how dire the situation is.