What if Citi had failed?

[Meadmaker]

So the government stepped in and injected 20 billion bucks into Citibank, and agreed to buy up a bunch of bad loans.

For all you taxpayers who contributed to this worthy cause, Citi thanks you.


But, why did we do it? I assume there must be a reason, but the more I think about it, the less I know. Why would we bother using our money to bail out Citigroup. What would have been the collateral damage if they went under?

Citi holds my mortgage. I'm guessing if they had vanished in a puff of smoke that I would still have a mortgage, paid to somebody else, under the same terms and for the same amount. I'm guessing the same is true for everyone else who owed Citi money.

Small-medium depositors would have their deposits protected by FDIC. No problem there.

So, big depositors would be in trouble. Of course, stockholders would be in trouble. However, so what? That's risk.

Bondholders would be in trouble. Maybe that's where the concern was? Sure, bondholders expect risk, but in reality, they expect that risk to be low. Did they have so much outstanding debt that the simultaneous failure of those bonds would cause other companies to crash?

Sometimes I hear people say that we have to make sure credit continues to flow, but why do I need Citigroup for that? There are plenty of banks left.

I know I must be missing something, but for the life of me I can't figure what it is. If Citi had been allowed to die, how would that have caused a chain reaction meltdown in the economy, such that using tax money for private purposes is justified?

 

[Francesca R]

If Citigroup stopped trading, it would not boost business for Santander or Mizuho, it would probably bring them down too. .

If GM were to stop trading it would not bring down BMW or Honda, it would probably boost business for them.

The difference between banks and auto companies is no reflection on the worth of the people who are employed by them--merely the nature of the role they fulfil for society/the economy.

(I know that wasn't your question, but I read it between the lines of your posts sometimes )

 

[Drewbot]

Much of the banking problems (Correct me if I'm wrong Francesca) stem from having minimum amounts of liquid reserves to meet federal banking requirements. And with stock values plummeting, and home values dwindling, the banks are having trouble meeting their liquidity requirements.

 

[The_Animus]

It would go bankrupt and other similar companies, or a new company providing the same services/function would take it's place. Hopefully they'd do a better job as well.

 

[Meadmaker]

If Citigroup stopped trading, it would not boost business for Santander or Mizuho, it would probably bring them down too. .

How?

I understand what happens if GM, Ford and Chrysler stop producing cars. I understand the mechanism involved. They go bankrupt. They don’t pay loans. They don’t buy parts. They don’t pay employees. This causes employees not to pay loans or buy stuff, and causes suppliers to go out of business. This means that suppliers don’t make parts, so even the competition, like Honda and BMW, at least briefly stop making cars until they can find a supplier for the parts they used to buy from now bankrupt tier one and two suppliers.

Meanwhile, between the employee loans and commercial loans that won’t be repaid banks go under. The ripple effects cascade and everything gets Bad.*

But, what about Citi? Suppose they cease operations. What happens? Their business is pushing money back and forth, and grabbing some of it as it goes by. So, their employees are out of jobs. That’s bad, but there aren’t a huge, huge, number of them. When in business, they collect loans. Someone else will collect them. They also make loans. Assuming someone else has money to lend, those other companies will lend it. When car companies go bankrupt, their suppliers go bankrupt, and stop making parts, which affects operations at other car companies. Is there something analogous in the financial industry?

How do the “ripple effects” from Citi pull anyone else under?

*At least, I assume that banks going under is bad.

 

[The Central Scrutinizer]

We're starting to hear about liabilities that are "off the balance sheet". And a lot of them involve derivatives, which Mr Buffett has labeled "weapons of financial mass destruction". And he (or Charlie Munger, I don't recall which) is quoted as saying that you should ask a company if they really understand their derivatives book. Anyone who says yes, is either crazy or lying.

That's why Citi has been hammered extra hard lately (along with BAC) - there are a lot of great unknowns in this "off balance sheet" jungle.

If "off balance sheet" and "derivatives" sound familiar, think Enron.

It's starting to smell.

 

[balrog666]

Citi has failed. But, so far, we have pumped $45 billion into the corpse.

I expect another $50 billion to follow within a week.

 

[Meadmaker]

We're starting to hear about liabilities that are "off the balance sheet". And a lot of them involve derivatives, which Mr Buffett has labeled "weapons of financial mass destruction". And he (or Charlie Munger, I don't recall which) is quoted as saying that you should ask a company if they really understand their derivatives book. Anyone who says yes, is either crazy or lying.

That's why Citi has been hammered extra hard lately (along with BAC) - there are a lot of great unknowns in this "off balance sheet" jungle.

If "off balance sheet" and "derivatives" sound familiar, think Enron.

It's starting to smell.

Derivatives are bets. So, I speculate that the problem here with Citi is that it made a bunch of losing bets, but doesn't have the money to pay the winners.

Meanwhile, without the money from the winning bets, a lot of companies wouldn't have the money to continue operations? Those companies were using the derivatives as a hedge against some horrible economic conditions? That's why Citi can't be allowed to go belly up?


I don't suppose the winners would be satisfied just breaking the Board of Directors' knees?

 

[Bodhi Dharma Zen]

Citi failed, plain and simple. As the entire financial system failed, as the automakers failed. The last surviving ideology from the 20th century is falling right in front of our eyes.

They have to be rescued by "daddy government" because the implications of letting them crash are (supposedly) bigger than the cost of rescue them.

Funny thing is that their CEOs CFOs, high ranking employees, etc can happily live their lives as if they were making money. Actually, they DID make tons of money for themselves, and the system allows them to keep everything they have earned with their "hard work".

 

[Francesca R]

How? [ . . . ] How do the “ripple effects” from Citi pull anyone else under?

There is a lot of literature on the subject of financial contagion, bank-runs* and the like (although--not much on wiki). This is a good resource.

Put simply, if a big car maker goes under, that does not necessarily cause everyone else in the world to stop buying cars, even momentarily. If a big bank does, there is a more significant mechanism by which everyone else in the world does pull out of banks. Fine if nobody really needs banks, but most everyone does (not least, car makers).

I am not disputing that there are up and downstream negative effects from a car maker collapsing.

*You could point out that a run on Citibank by depositors is already forestalled by the (recent) blanket federal guarantee of all deposits. Perhaps, but (1) there is not, in fact, enough money in the federal kitty to honour this obligation and it would have to be done via monetisation if such an event happened, so nobody wants to countenance any danger of it happening, and (2) to point to the guarantee would be to endorse one act of public "bailout" already as useful--so why then risk undoing its benefit unless one thought that things were truly hopeless and the time had come to pull the plug.

 

[Meadmaker]

There is a lot of literature on the subject of financial contagion, bank-runs* and the like (although--not much on wiki). This is a good resource.

Fascinating. To oversimplify things, it's a psychological phenomenon. A crisis of confidence.

There's only one problem. As others have pointed out, Citi did fail. For the moment, investors have faith that the government can prevent future failures and stop the contagion from becoming a pandemic. Unfortunately, that faith can't last, because the government can't succeed in future bailouts.

A couple of months ago, I saw the figure 60 trillion dollars, which was the value of the credit default swap market, and concluded that the situation was hopeless. The more I read, the more it reinforces the conclusion. There are a lot of bad bets out there, and the losers aren't going to pay. They can't. They don't have the money.

Put simply, if a big car maker goes under, that does not necessarily cause everyone else in the world to stop buying cars, even momentarily.

What people outside the industry rarely grasp is that it does stop everyone else in the world from making cars, at least momentarily. There are around 3,000 pieces that go into every car. If one of them isn't available, that car doesn't get built. My company makes parts for every single car company in the world, but if GM, Ford, and Chrysler went out of business suddenly, we would stop making parts for Toyota, Honda, and the others. There's not enough money to keep the lights on if the Detroit 3 stop buying.

Of course, that situation would be temporary. The machines still exist. The drawings are still there. Others can pour plastic. If we and our competition collapse (they would fail for the same reasons we failed) production could be restarted. However, make no mistake. Foreign owned car companies will shut down their North American operations if the Detroit 3 die a quick, painful death, and the plants elsewhere in the world won't be able to ramp up production quickly enough to meet the current level of demand.


This is in contrast with banks. It's a lot easier to get a bank going than it is to find someone to provide side view mirror holding clips.

 

[a_unique_person]

Citi is going to buy more bad assets.
http://www.abc.net.au/worldtoday/content/2008/s2429038.htm

NEIL IRWIN: This is building on other equity investments that the Government has taken and Citigroup and the other major US city banks you know and central banks around the world, governments around the world have been doing the same thing with their own institutions. You know the question then is how that changes, you know as the crisis eases in the years ahead, will the Government be able to pull out without causing a new round of crisis?

Will the Government try to micromanage these banks? Will it try force lending into this area or that area and that could create a dangerous kind of situation in the future.

PETER RYAN: This time last year, Citigroup was best known as the world's biggest bank but it's exposure to toxic assets and the US housing slump has forced it down the financial league table.

But that's not stopping Citigroup from investing in similar assets that have been dramatically written down in value. Citigroup's chief financial officer Gary Crittenden is cautious but optimistic.

GARY CRITTENDEN: The way the institution grows is by investing in things that are productive, that are moving the company forward. And we're going to continue to do that obviously with the right risk parameters and the right customers. But these are assets which if you bought them in the market today you would find them incredibly attractive assets. And we think the appreciation potential here is substantial.

PETER RYAN: With $326-billion of taxpayers’ money on the line, Citigroup's investment strategy raised some eyebrows on when fund manager William Isaac heard the news on Bloomberg television this morning.

HOST: They're actually going to buy more distressed assets because they're very cheap right now, their view being that they're overly beaten up by them now, they'll go up in price, you make money, you help with the market moving again.

WILLIAM ISAAC: So he's actually saying that Citi's going to buy more?

HOST: Hmmm.

WILLIAM ISAAC: Ok.

HOST: Should the regulators allow that to happen? Does it make sense?

WILLIAM ISAAC: Well I do think these assets are marked way below their true value, that's one of the major problems we have frankly.

PETER RYAN: William Isaac believes that the imposition of mark to market accounting has not only destroyed asset prices, but perceptions about the strength of the banking system.

 

[Francesca R]

Fascinating. To oversimplify things, it's a psychological phenomenon. A crisis of confidence.

If you like. Confidence, trust and optimism are rather essential traits to modern civilisation. That's slightly more philosophy and political science than economics though.

There's only one problem. As others have pointed out, Citi did fail.

I would not quite qualify it as a "zombie company". But if you mean that its market capitalisation is actually lower than the government funds injected to it--yes. (So would GM's be of course)

What people outside the industry rarely grasp is that it does stop everyone else in the world from making cars, at least momentarily. There are around 3,000 pieces that go into every car. If one of them isn't available, that car doesn't get built. My company makes parts for every single car company in the world, but if GM, Ford, and Chrysler went out of business suddenly, we would stop making parts for Toyota, Honda, and the others. There's not enough money to keep the lights on if the Detroit 3 stop buying.

I respect your greater knowledge about that.

This is in contrast with banks. It's a lot easier to get a bank going than it is to find someone to provide side view mirror holding clips.

. . . but not about this. As you appreciate yourself, confidence and trust cannot be conjured out of thin air even if they are intangibles.

 

[Meadmaker]

. . . but not about this. As you appreciate yourself, confidence and trust cannot be conjured out of thin air even if they are intangibles.

Maybe I don't appreciate the high end customer's dilemma. A bank can build trust quite rapidly with me if it shows me the money. As a depositor, there's FDIC insurance. As a borrower, I really don't care if they go out of business. If the check doesn't bounce, I have confidence.

As an investor? I know when the crisis started hitting, I bought a few bank stocks, on the theory that those smaller banks who weren't pummeled were probably pretty well managed, and would be in good shape to pick up the pieces when things turned around. I wouldn't exactly take the word of some guy on the internet investing a few thousand from his IRA as a bellwether of investor confidence, but I'm pretty certain that people with money to invest can find people they trust with their money.

I, personally, would feel more confidence if I thought management was making prudent decisions, rather than growing at all costs and counting on government bailouts, but that's just me.

(Not particular relevant data: My bank investments since I made it: -9%. S&P during that period: -26%. BAC - 55%. Citi. We know about Citi. It's a lot more fun to beat the S&P on the up side than on the down side, but at least it's still winning, relatively.)