The Wall Street Journal-20080116-Too Big to Succeed-
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Too Big to Succeed?
The first goal of any new CEO taking over at a time of trouble is to clear out the other guy's losses and move on. For Citigroup CEO Vikram Pandit, the job also seems to include traveling the world with a tin cup begging for new capital. Once he's done with that, maybe he'll ask whether the oft-troubled bank has become too big to succeed.
Citi announced its latest black-eye yesterday, a nearly $10 billion loss for the last quarter, driven by $18 billion in writedowns on its mortgage and other fixed-income investments. The bank will also -- finally -- cut its dividend by 41%, though given the losses you have to wonder why the bank is still paying any dividend at all.
The bank urgently needs capital, and the easiest place to get it is to retain more of its own earnings. Yes, that would upset certain big shareholders who like their quarterly checks. But Citigroup is one of those banks that taxpayers would have to rescue if it ever became insolvent. We'd have thought that the Federal Reserve and Treasury would want the bank to save every dollar it has as it tries to ride out this financial storm.
Instead, Mr. Pandit, former CEO Sandy Weill and board member Robert Rubin are undertaking a global fire sale. Singapore's Government Investment Corp. will get a stake, as will the Saudi prince who bailed out Citi during its last crisis in the 1990s. Mr. Weill will inject some of his fortune, as will New Jersey's investment arm. The China Development Bank was reportedly also looking to buy in, only to back out in the end. We hope it wasn't scared off by Citi's books, but it's a bad sign if the Chinese are wary of American financial assets.
On the positive side, this capital infusion means the bank is finally fixing the mess it took so long to acknowledge. One of Mr. Pandit's first moves was to bring the so-called structured-investment vehicles (SIVs) the bank marketed in its name back onto its own balance sheet. This guaranteed bigger losses, with accountants demanding immediate writedowns. But in the longer term, such marking to market was inevitable.
It is also better for the overall financial system, notwithstanding the short term pain. One cause of the recent credit panic has been that, in our brave new world of securitization, no one was sure who owned what and how much. This caused lending to freeze up generally. With assets moving back onto bank balance sheets, at least regulators can begin to assess the real size of the problem. They can also begin to address the mess by working with banks to raise capital, arrange mergers if need be, and in the worse case call in the Federal Deposit Insurance Corporation.
On the last point, few have yet noticed that this current crisis could become the first test of a 1991 law that addressed the so-called "too big to fail" problem with banks. The Federal Deposit Insurance Corporation Improvement Act was passed in response to the high number of bank failures amid the savings and loan crisis. The law required the recapitalization of the federal Bank Insurance Fund, but in the name of protecting the taxpayer also limited the FDIC's ability to resolve bank failures.
The law was a typical overreaction by the politicians to the mess they had created. But the law did leave an exception for "systemic risk," which as everyone knows refers to a potential failure by a really big bank like Citi. Notwithstanding Citi's capital-raising binge, no one knows what its ultimate losses will be. That answer will only be determined when real-estate prices hit bottom and the market begins to "clear," as the economists say.
Which brings us back to Mr. Pandit's task, which we hope includes an assessment of whether Citigroup is too large considering its persistent ill-management. Mr. Weill made a bundle building Citi into a financial conglomerate, but the bank has run into problem after problem. From the sovereign debt crisis of the 1980s, to its entanglement in Enron's fraud, and now subprime and the SIVs, Citi has shown a knack for finding the middle of whatever financial mess is in the news. Over the years, Citi's size has not so much provided stability as a place for problems to hide.
Many of the company's units continue to be great businesses, and they could be sold off to raise further capital. Certainly, that would be better than having to resort to a taxpayer rescue. Making Citigroup smaller would also reduce the moral hazard that attends the belief that it is too big to fail.
Mr. Pandit presumably won his job by convincing the board that he wanted to run Citi, not dismantle it. But he's also a newcomer to the company, so he is in a position (with help from regulators) to take a dispassionate view of whether the Citigroup of today makes sense. If it has become too big to fail but too large to succeed, a breakup might be better for all concerned.
