Ex-Prince of the Citi Wall Street Journal (editorial) November 6, 2007
Only last week, Citigroup was telling anyone who would listen that it had a mere $70 million in "indirect exposure" to the subprime mortgage mess. This week, Citi CEO Charles Prince has resigned, Citi is looking at another $8 billion to $11 billion in writeoffs, and some observers are questioning whether Citigroup has the resources to absorb all of the losses.
Mr. Prince certainly earned his resignation, even as the management shakeup does little to inspire confidence that the problems are over for America's largest bank. Former Treasury Secretary Robert Rubin is the newly appointed chairman of the board, but he has also been Mr. Prince's sounding board and chairman of the bank's executive committee. Only recently he was singing Mr. Prince's praises and saying the CEO could stay in the job for years. Mr. Rubin and the rest of the Citigroup board were lax in their oversight, and shareholders can be forgiven for thinking that the house-cleaning should include everyone on duty when Citigroup saw $15 billion (and counting) go poof.
Whoever is in charge, the first order of business is finding out -- and disclosing -- how deep the financial problems are. Like Merrill Lynch, Citi has been slow to acknowledge them, and that has extended the market uncertainty about how widespread the damage is, both at Citi and throughout the financial system. The bank will also have to come clean about what's in those SIVs, or structured investment vehicles, that the bank marketed but kept off its own balance sheet.
While Citigroup denies any plans to cut its dividend to shore up the balance sheet, it seems inevitable that it will have to add capital to cover the losses. One issue will be how to do that. Perhaps it can raise enough by cutting the dividend and issuing preferred stock. But if a merger needs to be arranged or if solvency is an issue, then federal regulators will get involved. The phrase "too big to fail" is already being bandied about regarding Citigroup, and we can expect to hear more of it in the weeks to come.
But failure can take many forms. Citigroup is not about to disappear from the face of the earth, taking its assets and liabilities and leaving counterparties empty-handed. An orderly process that imposes market discipline and involves genuine price discovery would be far preferable to one in which a bank that has stumbled this badly is propped up by government regulators.
Deregulation allowed banks to take on bigger risks, along with meeting higher capital standards. Putting those risks on taxpayers' backs would combine the worst features of a highly regulated system with the private profits that in good times came from expansion and consolidation. If it comes to putting new capital into Citigroup, the bank's current equity holders need to bear most of the pain.
Speaking of shareholders, Saudi Prince Al-Waleed bin Talal's large stake in the bank will raise the issue of a possible Saudi-led cash infusion. That could create some domestic political opposition, raising the question of whether America's largest bank belongs in the hands of an effectively sovereign foreign investor. We'd advise everyone to just say no to that possibility.
Citigroup and other banks made some bad lending decisions, but part of the blame for this entire mortgage fiasco also rests with an easy-money Federal Reserve policy that created a subsidy for debt. That same Fed mistake has also contributed to a global commodity price boom that has enriched oil exporters like the Saudis. We'd hate to see the Fed and U.S. Treasury now turn Citigroup over to the Saudis as a kind of second unearned bonus.
As the losses pile up, we'll all learn more about what went wrong and who was responsible. We'll also learn a few lessons about the way these structured finance deals were made, marketed and rated. Some of those problems are not yet fixed, but we suspect it will be some time before any investor buys a AAA-rated "collateralized debt obligation" just because it has Citigroup's name on the marketing. That's progress.