America’s financial firemen have tried all manner of measures to tackle the blaze engulfing its banks. Still the flames lick. Under an agreement hurriedly hammered out on Sunday November 23rd, Citigroup, a troubled giant with $3.3 trillion of on- and off-balance-sheet assets, won a government guarantee covering $306 billion of its most toxic assets, putting the taxpayer on the hook for another large slug of distressed debt. The government also stumped up $20 billion in cash in return for $27 billion of preferred shares. Though the share price of the troubled giant rose on Monday the banking system remains in danger.
Citi’s problems are not as acute as were those of Lehman Brothers, which failed in September: with access to central-bank loans and the government already backing its debt and deposits, it is not about to seize up. But thanks to its vastness, any crisis of confidence has systemic ramifications. America’s most valuable and iconic bank before the crisis, Citi’s shares slumped over the past fortnight to a level at which some pension funds were barred from holding them and trading partners and customers were growing twitchy. Officials would have taken little time to decide to shore up the bank, given the fragile state of all markets for risk assets.
Though its huge losses from residential mortgages have peaked, Citi faces a second wave of write-downs on credit cards, commercial property and corporate loans as the recession deepens. Another worry was that the government’s recent decision to abandon its plan to buy duff assets in auctions, and concentrate instead on injecting capital directly into banks, would leave Citi unable to rid itself of its most poisonous securities.
This, in turn, fuelled fears that Citi could run short of equity, despite its strident protestations to the contrary. Quick to raise $50 billion from private sources when that was still possible, it has since secured another $25 billion from the government’s Troubled Asset Relief Programme (TARP). Even if that had given Citi a plump enough cushion for its balance sheet, it may not have been enough protection against the bank’s exposure of $1.2 trillion to a motley collection of assets held off its books. Included among these is $667 billion of securitised mortgages, some of which it may be forced to take back. Citi insists it could ride this out, but these days few are inclined to give it the benefit of the doubt.
The rescue is a blow for Vikram Pandit, who took over almost a year ago amid high hopes of a turnaround. He may have been undone by his sincere belief that Citi be kept in one piece. He shook up management, risk controls and compensation, but he balked at the sort of grand gestures some had long been calling for, such as a break-up. A plan to cut the headcount by 20% was bold, but came too late.
Universal banks had, until now, been considered the great survivors of the crisis, which has claimed many an independent investment bank and one-trick lender. But they look less impregnable in light of Citi’s near-death experience. Though in better shape than its crosstown rival, JPMorgan Chase too has suffered as the downturn becomes more synchronised across asset classes and geographies. Banks with a large, stable deposit base have an in-built advantage, but that alone is no longer enough to guarantee survival. Still, those heavily skewed towards investment banking, such as Goldman Sachs and Morgan Stanley, remain more vulnerable than the likes of JPMorgan and Bank of America.
With markets for mortgage-related securities feeling renewed stress, the authorities have apparently now accepted the need to deal with the tinder of illiquid securities on banks’ books. America’s Treasury will face pressure to offer similar schemes to other banks, not least because singling out Citi for special treatment puts them at a competitive disadvantage. But it may yet have to go further still. The rescue does not take the assets off Citigroup’s balance-sheet in the same way that the Swiss transferred $60 billion in hard-to-sell securities from UBS to a fund owned by the central bank. A system-wide bad bank could well be the next stage in the effort to douse the flames.