Tuesday, November 25, 2008 0 comments ++[ CLICK TO COMMENT ]++

The consequence of bailing out the worst run firms

Bailing out Citigroup was necessary given the path that the US government and others have taken over the decades (namely, excessive de-regulation with no oversight of the financial industry.) However, bailing out one of the worst run firms will have detrimental results as I mentioned in yesterday's post. I know the government is very reluctant to nationalize the failing banks for various reasons, including their inability to run these behemoths (if the private sector can't run, good luck getting the government to run them.) But they should penalize these firms heavily and change their failed strategies from the past. In the case of Citigroup, it means forcing it to break up and dump their past strategies. Instead we have the CFO proclaiming that they are sticking with their past plans:

And Citigroup still has many problems. Vikram S. Pandit, the chief executive, is making some progress in controlling costs and managing its sprawling operations, but the environment is tough. Executives say they have no plans to change their strategy.

Mr. Crittenden [CFO of Citigroup] said that the bank intended to keep itself intact and stay on the course it had been pursuing since at last spring and even longer under prior management, but that as a matter of practice the bank did not rule out any options.


This is just ridiculous. Although the current management team wasn't the root cause of the problems, they have still largely kep intact the prior megabank strategy. Note that one of the market concerns right now is not really the subprime mortgages on their balance sheet, which have largely been written off as far as I understand, but, rather, their trillion-dollar off-balance sheet assets. A lot of the off-balance-sheet assets seem to be from foreign operations (I'm not familiar with Citigroup but that's my impression.) The only way they can increase the market's confidence in the company is if they unload their off-balance-sheet assets, along with the foreign operations. Selling the foreign divisions is tough and won't result in a good price but they really have to start breaking up.

The quoted New York Times article also talks about the issue I brought up yesterday. Namely, other banks are disadvantaged and the US government has explicitly ended up bailing out a failing firm, which in hindsight seems to have had little control over risk.

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.

“Citi has a decided advantage over them because of the loss-sharing agreement,” said John Kanas, the former chief executive of North Fork Bank of Long Island. While banks may hold out for now, it may be only a matter of time before they too line up, several analysts said.

Indeed, a big question is how Bank of America, JPMorgan Chase and Wells Fargo will respond. Spokesmen for Bank of America and JPMorgan Chase declined to comment on Monday. A Wells Fargo spokesman did not return telephone calls.

Each of these giant banks, like Citigroup, is sitting on piles of residential mortgages, credit card debt, and corporate and commercial real estate loans that are rapidly losing value. Each is trying to absorb new businesses that were recently acquired.

“Everyone is in the same soup,” said Meredith A. Whitney, a banking analyst with Oppenheimer who has been bearish on the industry for more than a year. “Citigroup has a host of problems, but Citi’s problem assets are not dissimilar from its rivals.”

Smaller banks could be even more disadvantaged. Depositors now have stronger incentives to put their money in bigger banks, given the government’s demonstrated willingness to intervene.

“It’s got to be frustrating for small banks. They don’t get special treatment,” said David Ellison, a mutual fund manager who specializes in financial companies. “If you are a big bank, you get special treatment. That is why everyone wants to be so big.”


The US government has to back the other big banks now. If there is a backlash (say massive runs on the small banks,) they may have to guarantee the small banks as well.


You may get the impression that I'm far more critical of Citigroup than, say, Lehman Brothers, and that's true. I hold so-called commercial banks to a higher standard of risk management than investment banks. Everyone sort of knows in the back of their mind, even if they don't admit it, that modern investment banks are simply gambling with the house's money (i.e. so-called proprietary trading is nothing more than this) and the fact that they are blowing up is not a surprise to me. However, banks like Citigroup, UBS, Royal Bank of Scotland, et al, can seriously harm the economy with their carelessness. Commercial banks should have higher risk controls anyway, since they aren't as profitable as investment banks during the good times.

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