2008 November 28 Friday
Citigroup Government Deal Pressures Competitors

From just one bank the US taxpayers might be on the hook to the tune of $1000 per person. For net taxpayers the potential cost might be several times that amount. This assumes a worst case for future Citi losses.

Before long, anxious investors may start wondering which banks will be vulnerable next. If confidence fades, other big lenders will probably seek deals like Citigroupís, in which the government has pledged to pick up potentially $290 billion in additional losses. Regulators drafted the plan with an eye to using it as a template for future bailouts.

But there's no guarantee that Citi won't come back with massive corporate loan losses or credit card losses. The people laid off in 2009 are going to default on more mortgages, car loans, credit card loans, and assorted personal loans.

There are other worries for Citigroupís big rivals. Almost overnight, Citigroup went from being the sick man of the industry to an institution with an edge over its competitors. The government is guaranteeing $250 billion of risky assets and pumping an additional $20 billion into the bank.

With the government behind it, Citigroup may now be able to borrow money in the capital markets at lower interest rates than its peers.

This reminds me of Ford's position on a GM and Chrysler bail-out. Basically Ford is saying they have enough cash that they won't go bankrupt in 2009. But if GM and Chrysler get lower interest rate loans then it is only fair if Ford gets them too. Ford has a point. Lower costs of capital for competitors put it at a competitive disadvantage. Well, Citi's bailout puts JP Morgan Chase, Wells Fargo, and Bank of America at a competitive disadvantage. If they all get bailed out that puts all the smaller banks at a competitive disadvantage. The less efficient players survive and the more efficient players lose market share. That's bad.

But one of the problems with allowing a really big bank to fail is that large numbers of companies have their checking accounts with them. Deposit insurance does not cover their deposits since the payroll checking accounts and other accounts end up running into the millions and beyond.Companies will suddenly start bouncing checks which will cause their suppliers cash flow problems and this will propagate.

On the other hand, if the banks all get bailed out that cuts the incentive for avoiding risky lending. Plus, it becomes really expensive for the taxpayers. The mispricing of risk is incredibly expensive. We all pay for it.

The big open question at this point: How many big credit losses lie in the future for Citi, BofA, JPMorgan, and other banks? Will credit cards, corporate loans, and other kinds of loans cause new rounds of massive losses? Also, how can the banks be regulated in a way that reduces the size of future too-big-to-fail bailouts?

Bill Clinton's former Treasury Secretary Robert Rubin helped steer Citi down a path that made this debacle.

The bankís downfall was years in the making and involved many in its hierarchy, particularly Mr. Prince and Robert E. Rubin, an influential director and senior adviser.

Citigroup insiders and analysts say that Mr. Prince and Mr. Rubin played pivotal roles in the bankís current woes, by drafting and blessing a strategy that involved taking greater trading risks to expand its business and reap higher profits. Mr. Prince and Mr. Rubin both declined to comment for this article.

When he was Treasury secretary during the Clinton administration, Mr. Rubin helped loosen Depression-era banking regulations that made the creation of Citigroup possible by allowing banks to expand far beyond their traditional role as lenders and permitting them to profit from a variety of financial activities. During the same period he helped beat back tighter oversight of exotic financial products, a development he had previously said he was helpless to prevent.

So Robert Rubin did a lot of the regulatory loosening that the Bush Administration is blamed for doing.

Remember how Barack Obama was supposed to be about change? Obama is appointing former proteges of Robert Rubin. Meet the new boss. Same as the old boss.

Geithner is a protege of Summers' and of former Clinton administration Treasury chief Robert E. Rubin.

Will Geithner demonstrate more sense at the Treasury than Rubin did at CitiGroup?

More fundamentally: Will the bankers and the regulators learn enough lasting lessons from this disaster to prevent it from happening again for a few decades?

Robert Rubin doesn't want to admit he is part of problem. More top people in the bailed out banks should be fired.

Share |      By Randall Parker at 2008 November 28 10:15 PM  Economics Financial Regulation

A. Prole said at November 29, 2008 6:05 AM:

For a nation that is allergic to 'socialism' it seems that the good ol U.S. of A has lumbered itself with 'socialism' at its very worst.
Ie the profits have all been privatized, (which of course meant massive 'fat-cat' bonuses in the good times, times incidentally when the pay-packet of yer average blue-collar Joe never rose in more than 40 years), but all the losses (which are enormous and unquantifiable) have been 'socialized so that poor ol' Joe Sixpack will be in hock for decades (government has first claim on his pay-packet - so much for Trey's college fund)- to fund the private deals and bargains of people he never even knew about and cared less for.
At least in the socialism practised in Sweden Sven actually gets the benefit of excellent health care and social benefits in exchange for his hard earned - and not lining the pockets of the fat-cats who muttered 'white trash' as they sped by in their Porsches.
As the English say, 'Who's the cunt?'.

HellKaiserRyo said at November 29, 2008 3:24 PM:

You have accurately described the allure of Swedish socialism. However, it does not seem likely that Swedish socialism will be practiced in the UK or US.

Ned said at November 29, 2008 6:19 PM:

You make an interesting point - the bailouts reward the imprudent and penalize the prudent. Inefficient companies are protected from the consequences of their bad decisions and efficient ones get to pay the bill. As noted, this seems to combine the worst aspects of capitalism and socialism. It reminds me of the economic system that prevails in many Third World countries (e.g., Mexico), where special friends of the government are blessed with all sorts of great deals, the profits from which are then shared with those in power.

By the way, I read the entire WSJ article about Rubin - it's disgusting. Sort of like the captain of the Titanic blaming the iceberg rather than his own stupidity. At least that fellow had the decency to go down with the ship. How can anyone take Rubin seriously in the future?

Toadal said at November 29, 2008 11:36 PM:

I decided to close my family's Citibank checking, savings, and credit card accounts in 2005 when I learned they issued 'liar' mortgage loans to customers having no credit, job history, or legal status. Once I found a local credit union stating in writing they could not do business this way, I moved my accounts. It's hard to imagine a situation where we would ever do business with Citibank again.

Jerry Martinson said at November 30, 2008 1:41 AM:

From the NYT article:

"In September 2007 ... Citigroupís chief executive, Charles O. Prince III, learned for the first time that the bank owned about $43 billion in mortgage-related assets. He asked Thomas G. Maheras, who oversaw trading at the bank, whether everything was O.K."

From my very limited experience in setting up and analyzing small scale business plans in my puny chunk of the universe, I personally find it very hard to believe the idea that the executives of a major organization found out about this for the _first_ time in September 2007. Fundamental to the profits running any bank is the risk of deadbeats and simple fundamental analysis of mortgage assets shows clear macroeconomic hazards with a burst in the housing bubble. There is no way that this wouldn't be analyzed on a near-daily basis by the CEO and CFO in any competent organization as it is central to the business model.

To me it seems the execs were simply betting that the bubble would last until they could cash out. I remember during the Enron thing, I had the opportunity to regularly talk informally to a person who was a CFO of 2 publicly traded companies and he was adamant that there could be no company CFO/CEO that doesn't have an idea of where every damn dime and potential source of risk is.

We can whine all we want about the ethics of the people at the top that let this happen. But the problem is that solid ethics don't come so much from personal character as they do from having a system where you can't cheat without getting caught quickly. There are fundamental problems with American corporate governance where the execs can fleece the stockholders (and apparently taxpayers) by taking long term risks that can be made to look good in the short run.

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