Does Citigroup’s chief financial officer Gary Crittenden really believe that the bank’s share price doesn’t affect its ability to operate? If so, he should study some financial history. Shareholder confidence matters for banks because when shareholders panic, depositors panic next.
Steve Liesman just reported that Citi held a conference call with employees, assuring them that the terrible drop in the price of the bank’s shares would have no effect on the ability of the bank to operate. He couldn’t be more wrong.
- Institutional investors must sell. Many institutional investors, including pension funds and mutual funds, are barred from holding “penny stocks.” At $4 a share, Citi is well below the trigger requiring these big investors to sell the stock.
- Clients must withdraw non-guaranteed funds. Similarly, hedge funds and other active investors will be forced by their risk management officers to put funds into custodial accounts or withdraw from Citi altogether. With Citi on the brink of destruction, these funds simply will not be able to justify putting investor cash at risk. The collapse of Lehman Brothers shows that this counter-party risk is real.
- Counterparties will ask for more collateral. All the bigshot financial reporters will tell you this hasn’t happened yet. Don’t believe them. It took weeks for the world to learn that JP Morgan had demanded additional collateral from both Lehman Brothers and Merrill Lynch. With all the talk of a potential collapse of Citi and the stock market sending panic signals, counter-parties will have to ask for more collateral. Anyone who doesn’t should probably be investigated for lacking proper internal risk controls.
- Depositors may panic. Why does a drop in stock price sometimes trigger a run on a bank, when the two events are seemingly unrelated? After all, just because a bank’s stock drops in value doesn’t mean it can’t pay off depositors. Scholars looking at the 1930s bank runs have come up with an explanation that sheds light on why depositors panic when shareholders sell a bank down. The gist of their conculsion is that shareholders provide an important level of oversight for a bank’s activities. Particularly the activities of sophisticated shareholders and big institutions can act as a check against abusive or overly risky activity. A sell-off by these kinds of shareholders signals two things: risk at the bank has increased and the oversight mechanism is no longer in place. With those signals flashing, it is almost rational for shareholders to depart. Only almost rational because with the FDIC backstopping deposits, there is very little risk that depositors won’t get their money back.
As long as we’re giving Citi’s CFO lessons in economcis, we’ll add one more: a CFO at a public company should never, ever say that his company’s share price doesn’t really matter that much.
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