What an incredible time we live in, or as a variation of the infamous Chinese Curse: “May you live in interesting times.” We are witnessing the potential collapse of the world's largest bank, CitiBank or CitiGroup as it now wishes to be known.
Seemingly yesterday, two Bear Stearns hedge funds failed, and Bear Stearns shortly succumbed to an old fashion run on the bank – not seen since the days of the Great Crash of 1929. Then Lehman Brothers failed; IndyMac, Washington Mutual, and Wachovia suffered similar fates. AIG, Freddie Mac, and Fannie Mae were bailed out by Uncle Sam. Merrill Lynch threw itself into Bank of America.
But CitiBank, heretofore the world’s largest bank, danced merrily, blindly along, seeing no problems with its hundreds of billions of toxic loans and CDO’s. It banked heavily, blindly, on risk, seduced by the large returns large risks can yield.
And now the real bears on Wall Street are shorting the once mighty Citi into oblivion. If Citi fails, then we are in for a long cold winter, rivaling that of the Great Depression.
Citi’s stock price fell 60% last week, 20% alone on Friday, to a close of $3.77, or roughly $20.5 billion in valuation. This plunge occurred shortly after the federal government invested $25 billion of capital into the bank, and after the bank raised an additional $50 billion in capital.
The collapse has been over 90% from its peak, just a short time ago.
The market’s saying someone is throwing good money after bad.
The market’s looking forward, already discounting the $65 billion in writeoffs so far, half of which are in mortgage failures, with more to come. Corporate buyouts and LBO’s may be unable to refinance or pay off their notes as they come due. Large commercial real estate transactions are under water because of the slumping economy, and Citi faces large writeoffs of credit card debts. It further faces refinancing of $54.6 billion of its own corporate debt through June 30, 2009.
If there is a bank too big to fail, then Citi is it with substantial operations in over 100 countries.
Fortunately for Citi, the bank has not witnessed the run on its deposits.
Fortunately for Citi, it is too big to fail.
As I write, the federal government has agreed to prop up Citi by creating a portfolio of $306 billion in toxic Citi loans. Citi will agree to cover the first $29 billion in losses, and then 10% of additional losses up to $56.7 billion. In exchange the bank gets yet another infusion of $27 billion in tax payer funds.
(And maybe by way of full disclosure, the few Citi shares acquired in my IRA through a merger, might regain some value, and I might even buy more if the price stays depressed).
Management gets to stay. They should go along with the Board of Directors. Clean sweep time!
The real problem for society is not the bailout, however large it may be. Nor is it the greed of the Citi execs who bet the firm’s existence with little understanding of risk. It’s not even incompetence reaching to the highest levels of management.
The underlying problem, which if unresolved, will trigger more disasters in the future is the 1999 repeal of the Glass-Steagall Act of 1933.
The Great Crash of 1929 witnessed the collapse of banks around the country, wiping out the savings of millions of Americans. President Roosevelt declared a bank holiday on assuming office to stabilize the market.
Banks failed because they over aggressively invested depositors' money into Wall Street speculations, risky mortgages, and into an overheated real estate market. (Sounds familiar)
Glass-Steagall separated commercial banking from investment banking. For example, the famous J.P. Morgan & Co. was split into Morgan Guaranty Trust Co. (commercial banking) and Morgan Stanley (the investment bankers). If risks were to be taken, they should be by investment bankers. Checking and savings deposits were to be protected, both through the creation of the Federal Deposit Insurance Corporation and by lowering the risk. Reisdential banking might be boring, but it would be safe.
Bankers chafed at the Glass-Steagall restrictions, which allowed investment bankers greater freedom of operations and higher returns.
Sanford Weill and Citi broke open the act in 1999 and Congress then repealed it. Citi’s commercial bankers led it to ever greater risks, the risks appropriate to investment banking. We are paying the price because we forgot the lessons of the Great Depression.