It’s terrific news that 10 large financial firms are going to repay the TARP funds. But we’re still a long way from restoring market processes in the financial sector and getting taxpayers off the hook for Wall Street’s mistakes.
The problem goes deeper than the myriad of explicit government guarantees that continue to socialize risk. Even if these we’re pulled back we’d still have the very problematic situation in which large complex financial institutions benefit from the implicit guarantee that they are too big to fail, that there will not be another Lehman Brothers.
Worse, the government lacks credibility to withdraw this implicit guarantee. For years the government said there was no implicit guarantee of Fannie Mae and Freddie Mac. Everyone from Barney Frank to members of George Bush’s Treasury Department described the notion of a guarantee as a mistake or a “false belief.” But it turned out that the mistake was on the part of the deniers: when push came to shove, Fannie and Freddie’s creditors got bailed out.
So what to do? The Wall Street Journal says that the government needs to restore market discipline by making it clear that failure is an option once more. And probably the best way to do that is by seizing Citigroup.
It’s not enough to say the banks that pay back the TARP are on their own — “and this time, we really, really mean it.” The markets won’t believe it, and over time these banks will have a lower cost of funds because lenders will assume, a la Fannie, that they will be rescued. One possible answer is a new mechanism for regulators to resolve — that is, seize, then sell or recapitalize — the biggest banks. But while we’re waiting, one way to minimize the too-big-to-fail assumption is by showing that at least one big institution can fail. Last fall, at the height of the panic, regulators deemed this too dangerous. But this need not be an eternal truth.
It happens that we have a test-case at hand in Citigroup. Regulators remain at odds over how much trouble Citi is in. But this spring’s stress tests revealed Citi to have a $63 billion hole in its balance sheet, which the feds papered over by giving the bank credit for converting its government-owned preferred into common shares, a move that will put no new money into the bank. Citi has also been slow to raise private capital since the stress-test results were revealed, even as the capital markets have opened up to its competitors. More broadly, Citi has proven itself unmanageable by having already failed three times since the 1980s, requiring government bailouts in one form or another during the sovereign debt crisis in the ’80s, the 1990s real-estate bust and again, twice, during the panic of 2008. Its turnaround plan has also been less than impressively executed.
The FDIC has been agitating for changes to Citi’s top management, but we think there’s a case for going further. We’re told that regulators differ on whether they have the authority to roll up a financial supermarket such as Citigroup, but former regulators with impeccable credentials argue that they do. And given everything that the Fed and Treasury have done over the past year and a half, now seems a strange time to argue that they lack the legal authority to act to resolve a bank that has $300 billion in insured deposits, some $63 billion in FDIC-guaranteed debt, and another $300 billion or so in taxpayer guarantees of its toxic assets.
Resolving Citi — by either forcing it into a strategic partnership, if anyone will have it, or selling off its assets and breaking it up — wouldn’t be cheap, but it would have a number of benefits. It would remove the leading candidate for zombie-bankdom from the financial system. It would also, finally, put an end to the slow bleeding of taxpayer money into the bank.
That’s a big undertaking, but Citi has already received $45 billion in direct capital injections along with tens of billions more in debt and other guarantees. The $63 billion in loan guarantees alone could have been avoided if regulators had moved on Citi earlier. And with the FDIC’s debt-guarantee program slated to sunset at the end of this month, regulators may be forced to act anyway if the markets conclude that the bank can’t be counted on to pay its creditors.
Nobody wants a return to the depths of the mid-September panic in the credit markets. But a resolution of Citi, together with the exit from TARP of the stronger institutions, need not freeze the markets. In fact, it would signal that regulators are starting to cull the weakest institutions in earnest, which could be good for confidence in the overall system. It would also signal to those buying their way out of the Hotel Geithner that there is no rewards program for repeat guests.
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