When Citigroup was formed a decade ago, in a merger that reshaped banking, the deal’s architect, Sandy Weill, basked in the limelight and admitted to feeling like a rock star. The boss these days, Vikram Pandit, must feel more like a busker. Humbled by a devastating, Lehmanesque run on its shares, Citi has become the latest, and largest, financial institution to need rescuing. The giant bail-out gives the bank breathing space. But it also leaves Citi in what a prominent financier calls a “financial no-man’s-land”: still too leveraged for comfort and too cumbersome to manage effectively, yet far too big to fail.
The rescue comes in two parts: it provides $40 billion in fresh capital and capital relief, and it ring-fences $306 billion of illiquid assets on Citi’s $2 trillion balance-sheet. The bulk of any losses on these, beyond the first $29 billion, will be borne by government agencies. One official describes the arrangement as “catastrophe insurance” for Citi. The deal, a new version of intervention in a crisis that has already seen a few, is the strongest sign yet that the government will do whatever it takes to maintain confidence in banks, says Torsten Slok, an economist at Deutsche Bank.
The immediate benefit is to reinstate Citi as a trusted trading partner: though there was no doubt it would be propped up, clients had begun to pull money. And the loss-sharing agreement leaves the bank with a substantial capital surplus, if (a big if) you trust the way it values its dodgier assets. But the plan, crafted in a hurry over a weekend, has several flaws.
Ain’t no sunshine
First, no one has been forced to take responsibility for Citi’s woes. Keeping Mr. Pandit on was understandable: in the job for less than a year, he was dealt an awful hand. But the longer-serving board has plenty to answer for; and Robert Rubin, formerly head of its executive committee (and professionally close to both the outgoing and incoming treasury secretaries), encouraged its disastrous foray into collateralised-debt obligations. Shareholders also get an easy ride. Losing the dividend for three years is a small price to pay for not being all but wiped out, as has happened in previous rescues, such as that of American International Group, a giant insurer, and Fannie Mae and Freddie Mac, the two vast mortgage agencies.
Moreover, the deal marks a return to the patch-by-patch approach that preceded the $700 billion Troubled Asset Relief Programme, or TARP. This may have been unavoidable, given the ferocity of Citi’s decline. But it sows uncertainty, just weeks after the government attempted to bring more coherence to its bail-out policy.
Third, it is not big enough to guarantee that Citi can avoid returning to the trough. The cloistered $306 billion includes the bank’s most noxious holdings, such as mortgages, commercial-property loans and leveraged loans. But its huge credit-card and overseas-loan portfolios remain outside, and are degenerating fast. Nor are Citi’s off-balance-sheet exposures—$1.2 trillion at the end of September—included.
Some facets of the deal look like smoke and mirrors. It releases $16 billion in regulatory capital to Citi, by giving a generous 20% risk-weighting to the partially insured assets (previously booked at 100%). As a result, it will have to hold a mere $5 billion of tier-one capital against 60 times that in questionable debt, on which it must bear the first $29 billion in losses.
Last, the rescue does nothing to establish a clearing price for the impaired assets on banks’ books. This was the original aim of the TARP, using auctions, but it was dropped earlier this month in favour of direct capital injections. Officials would like to see Citi and others using their excess capital to buy securities cheaply in the secondary markets—in other words, to take on the role the government abandoned. For the time being, this is a vain hope.
Imperfect though it is, the rescue appears to have been designed to be used as a template for future interventions. “This is now the most effective way to show our commitment,” insists an American financial regulator. It may also be expedient for the Treasury, which has only $20 billion left from the first $350 billion tranche of the TARP—Congress is yet to release the second half—since the new approach rests primarily on insurance, not hard cash.
But is it the right approach? Some would have preferred to see Citi hive off its troubled assets into a separate “bad bank”, tasked with disposing of them in a way that minimised downward pressure on financial markets. This approach worked well in several past financial crises, including Sweden’s in the 1990s (see article). In this one, it has been used to unburden UBS of up to $60 billion of dross, which will be managed by the Swiss central bank.
In economic terms, the bad bank may be little different from the type of backstop used by Citi; in both cases, toxic holdings are isolated. But a bad bank may have a more positive psychological impact on markets, because it signals a clean break. It also removes a big distraction, allowing managers of the good bank to focus on the healthier businesses. On the other hand, bad banks can be difficult to set up in the thick of a crisis, when it is still unclear which assets should be transferred. And for the institution being helped, it reduces the potential upside, should values recover. Citi will reap gains from some of its walled-off assets as markets stabilise.
But that is for the distant future. For now, Citi’s challenge is to regain its balance. Then it will have to prove that it has become less accident-prone. The bank has been heavily involved in most of the past quarter-century’s nastiest blow-ups, from the sovereign-debt defaults of the 1980s to the dotcom bust. It was even temporarily banned from launching new takeovers in 2005, after a string of regulatory lapses. Built in a hurry by Mr. Weill, the group that Mr. Pandit inherited lacked a solid culture. Its risk management was not up to scratch. Its investment bank was a patchwork of acquired shops and poached teams. “It was the greatest roll-up in history, but it is yet to sing,” admits a Citi executive.
The genial Mr. Pandit is working on creating more harmony and tightening controls. He has also shaken up the way Citi allocates capital and pledged to cut staff numbers by 20 percent as part of a broader overhaul. He wants Citi to go back to doing “the basics”—retail banking, corporate services, merger advice—really well. That would seem to rule out a much talked about tie-up with Goldman Sachs, dubbed Sachs and the Citi.
But he has admitted he could have moved faster, and more dramatic action may now be needed. Though they have made no explicit demands, regulators want a slimmer, safer Citi. Shareholders want to see proof that the financial-supermarket model works, or else a break-up. For what is the point of a bank that is too big to fail but too unwieldy to succeed?