Citigroup Deal Stinks

November 25, 2008, 9:00 a.m.

Change? Pocket Change, Maybe
But the Reality is Worse than the Stinking Citigroup Deal
Because It's Only Symptomatic
The Citigroup deal stinks to high heaven.












[Photo credit: Washington Post; "In this 1999 photo, then-Treasury Secretary Robert Rubin, right, addresses the media with Citigroup co-chairmen and co-CEOs Sandy Weill, center, and John Reed. Rubin joined Citigroup management after resigning as Treasury chief."]

Let's start with Steven Pearlstein's column in the November 24th Washington Post. Steven Pearlstein, "A Bailout Steeped in Irony," The Washington Post, November 24, 2008, p. D1.

He concludes:

What is indisputable is that all of the decisions that have led to Citi's recent troubles were taken while Rubin was chairman of the executive committee, and made by executives with whom he worked closely. He defended them repeatedly and unequivocally, and as a director, he approved compensation packages that rewarded them (and himself) handsomely for judgments that proved disastrous.

Now, the government has been forced to save Citi by investing $45 billion in new capital and by putting a floor under its losses. By any measure, it is a sweetheart deal for shareholders, who will suffer minimal dilution of their shares. Most startling of all, however, is that Rubin and other directors and top executives have been allowed to remain at the helm. You have to wonder how much more money this crew would have to lose before the Treasury and the Fed would demand their resignations -- $100 billion? $200 billion? $1 trillion? Why weren't they dispatched as were the executives at Fannie Mae, Freddie Mac and AIG?

The ultimate irony is that just as Rubin & Co. were being bailed out at Citi by the Bush administration, President-elect Obama was announcing a new economic team drawn almost entirely from Rubin's acolytes.

That's not to take anything away from the qualifications of Tim Geithner, the new nominee for Treasury secretary, who owes his appointment as president to the New York Fed to Rubin's aggressive lobbying; or Larry Summers, who was Rubin's deputy secretary at the Treasury and whose appointment as president of Harvard was championed by Rubin as a member of the university's government board; or Peter Orszag, the soon-to-be-named nominee for budget director, who was hired by Rubin to head a Democratic think tank on economic policy that he founded.

No doubt about it -- it's a fabulous team. But perhaps the next time Obama thinks about assembling his group of wise men to give advice on the economic crisis, he might at least have the good sense to leave Rubin out of the mix. At a minimum, it's a glaring conflict of interest. More significantly, it sends a terrible signal about accountability and corporate governance.

So what brought on our current, ever-increasing economic collapse? Many things, including either a greed bordering on criminality, or exceptional ignorance, on the part of leading financial CEOs and regulators. But what made it all possible was the repeal of a structural/regulatory protection that wiser heads put in place following the 20th Century's Great Depression: banks were forbidden to get into the investment business. It was called the Glass-Steagall Act.

Pearlstein reports:

The combination of Citibank with Salomon Smith Barney under the bright red umbrella of Travelers Insurance was accepted with a regulatory wink and nod by the Federal Reserve until Fed Chairman Alan Greenspan could persuade Congress to make it legal. The hurdle was the Glass-Steagall Act, put in place during the Great Depression to prevent another market crash like that of 1929. Now that another market crash has required the government to rescue a commercial bank done in by its investment banking subsidiary, there will certainly be those who wonder whether the New Dealers didn't have it right all along. . . .

As Treasury secretary, Rubin joined with Greenspan in supporting Citi's campaign to repeal Glass-Steagall.

And:

While it was [Sandy] Weill who created the modern Citi, it was his handpicked and hapless successor, Chuck Prince, who steered the company into the ditch. . . .

[W]hen he resigned from the Treasury in 1999, Rubin accepted Weill's offer to become what amounted to vice chairman of Citi, where he has quietly worked the back channels to Washington and other international capitals while serving as strategic counselor to the chief executive and the board of directors.

Rubin has been cagey about defining his role at Citigroup -- and at one point he got caught making a phone call to the Bush Treasury in a bid to help out Enron, a Citi client, during its death throes.

Here's more from the Post: David Cho and Neil Irwin, "Familiar Trio at Heart of Citi Bailout; Rubin, Paulson, Geithner's Shared History Paved Way for $300 Billion Federal Guarantee," Washington Post, November 25, 2008, p. A1.

The bailout of Citigroup, which put the government at risk of hundreds of billions of dollars of losses, was set in motion by three men whose professional lives have long been intertwined.

Treasury Secretary Henry M. Paulson Jr.; Citigroup board member Robert E. Rubin; and Timothy F. Geithner, the president of the Federal Reserve Bank of New York, have for years followed one another in and out of jobs in government and industry. Their close relationships helped pave the way for one of the largest and most dramatic government interventions to date in the financial crisis. . . .

Once Citigroup's stock price plunged 60 percent last week, Rubin, an old colleague from Goldman Sachs, told Paulson in phone calls that the government had to act, according to industry sources familiar with their discussions.

Geithner, too, shared a close relationship with the pair. He worked for Rubin at the Treasury Department in the 1990s and now is President-elect Barack Obama's nominee to follow Paulson as Treasury secretary.

As Citigroup's lead regulator, Geithner was deeply involved in the rescue of the firm, participating in meetings and conference calls with Paulson through the weekend. . . .

The government is guaranteeing a total of $306 billion of Citigroup's assets against losses greater than $29 billion. In exchange, it is requiring the firm to hand over $7 billion worth of preferred stock, essentially paying the government an insurance premium. . . .

Regulators also prohibited Citigroup from paying dividends to common shareholders of more than a penny a share in the coming three years and required a dividend payment of 8 percent on the government's preferred stock -- higher than the 5 percent dividends that it required of institutions that took rescue money from the Treasury Department over the past few weeks.

The Treasury also has the option of buying warrants in Citigroup if the firm's shares recover. If that happens, the government would end up owning slightly less than 8 percent of the bank's shares.

"It strikes me as unbelievably generous," said a former Fed official who has been in touch with Citigroup. "I'm sure it will be controversial. . . ." . . .

Rubin called Paulson several times to make the case for intervention on behalf of Citigroup and the banking system as a whole, said two sources familiar with the conversations.

In an interview, Rubin explained his involvement by saying that, since arriving at Citigroup in 1999, he has had "a dual role of providing strategic advice or managerial advice and also to work with clients. And that's what I've done."

"I had operating responsibilities for 33 years. And I simply didn't want any operating responsibility, and that's been the case since I've been here," he said.

On Friday, Citigroup approached the Treasury and the Fed with a plan of its own, essentially asking the government to take on the risk of hundreds of billions of dollars in troubled assets on its books, but with little compensation for the government. . . .

[T]hey [federal regulators] could have enacted a highly punitive complete bailout, like that of American International Group, requiring terms that strongly punish existing shareholders and give the government control of the Citigroup board, as well as firing the chief executive. They rejected that approach, preferring to try to give the existing Citigroup leadership team time to work through their problems. . . .

The New York Times editorializes:

Both men [Larry Summers and Tim Geithner], however, have played central roles in policies that helped provoke today’s financial crisis. Mr. Geithner, currently the president of the Federal Reserve Bank in New York, also has helped shape the Bush administration’s erratic and often inscrutable responses to the current financial meltdown, up to and including this past weekend’s multibillion-dollar bailout of Citigroup.

Given that history, the question that most needs answering is not whether Mr. Geithner and Mr. Summers are men of talent — obviously they are — but whether they have learned from their mistakes, and if so, what. . . .

As treasury secretary in 2000, Mr. Summers championed the law that deregulated derivatives, the financial instruments — a k a toxic assets — that have spread the financial losses from reckless lending around the globe. He refused to heed the critics who warned of dangers to come.

That law, still on the books, reinforced the false belief that markets would self-regulate. And it gave the Bush administration cover to ignore the ever-spiraling risks posed by derivatives and inadequate supervision.

Mr. Summers now will advise a president who has promised to impose rational and essential regulations on chaotic financial markets. What has he learned?

At the New York Fed, Mr. Geithner has been one of the ringmasters of this year’s serial bailouts. His involvement includes the as-yet-unexplained flip-flop in September when a read-my-lips, no-new-bailouts policy allowed Lehman Brothers to go under — only to be followed less than two days later by the even costlier bailout of the American International Group and last weekend by the bailout of Citigroup.

Editorial, "Mr. Obama's Economic Advisers," New York Times, November 25, 2008.


So What Can Be Said About All This?
Citigroup Only Symptom The Citigroup deal stinks. That's for sure, and by now well documented. But that's not the most important point. It's merely symptomatic of what's going on and who's doing it.

Obama to Govern From "Corporate Right" Candidate Obama may have tried to woo us and wow us with a rhetoric designed to make many of us think he would govern as a progressive populist. But when called on it he replied, accurately, that he never said so explicitly and that indeed his past history should have alerted us to the fact he would likely govern from the corporate center-right.

We Are to be Ruled by the Eastern Establishment's Elite Much of the nation's power, however measured, is to be found in a corridor running south from Boston, along Interstate 95, and the Amtrak line, to Washington. That's where you'll find a goodly number of our most prestigious colleges and universities, corporate headquarters, wealthiest Americans, most powerful politicians, most influential media, military brass, manufacturing, those who make or influence foreign policy, and the financial community. That is where you'll find much of America's "elite," or "Establishment" (what C. Wright Mills titled his book as The Power Elite) -- in the descriptive, rather than the pejorative, sense of the word.

For President-Elect Obama (Columbia undergrad; Harvard law) to "go east, young man" as he looks for some of the 7,000 individuals to whom he will give presidential appointments is both naturally to be expected and to some extent commendable. But he has, so far, overdone it a wee bit. As David Brooks observed, after analyzing the schools attended by his appointees, "If a foreign enemy attacks the United States during the Harvard-Yale game any time over the next four years, we’re screwed." David Brooks, "The Insider's Crusade," New York Times, November 21, 2008.

Nowhere is this more of an incestuous problem, as the two excerpted items, above, demonstrate than in his choice of an economic team.

"What Did You Do With the Last Nickle I Gave You?" My father told the story of a farmer in the area of Kansas where he grew up. Sitting on the porch with him one afternoon, the farmer's young boy approached them and asked his father for a nickle, to which the farmer responded, "What did you do with the last nickle I gave you?"

That's kind of how I feel about Citibank.

I didn't support the initial auto industry bailout plan for a variety of reasons, not the least of which was the failure to provide anything resembling a business plan demonstrating how the $25 billion would be used, and why it could reasonably be believed to be the answer to their problems. Nicholas Johnson, "Auto Bailout: An Open Letter to Congress," November 19, 2008.

But Congress ultimately came around to that view and is now demanding something like what I was asking for.

What's the Citigroup story? Was a business plan demanded before the initial $25 billion bailout? If it was, it obviously wasn't a very good one; if it wasn't, it should have been. Was one demanded before this weekend's additional $20 billion -- and $300-billion-plus taxpayer guarantee of the bank's worthless loans?

Shouldn't the banks and Wall Street cronies at least be held to the same standards as the auto industry?

"What did they do with the last 500 billion nickles we gave them?"

Massive Debt's Costs and Consequences I have yet to see or read of anyone from the President-Elect, through his advisers, or members of Congress, provide a thorough overview of the downside of ever-escalating debt by the trillions. In addition to the $55 trillion in unfunded obligations, "The Debt Clock" reports that, as of the morning of November 25 our current national debt is at least $10.7 trillion. I say "at least" because I'm not sure it includes the $1-plus trillion we know the government has recently put on our credit cards, or the $2 trillion the Fed has added to that without telling anyone, or the additional $300 billion provided yesterday to Citigroup.

I'm not saying we shouldn't have run up this debt -- though my instinct is that we shouldn't have, and certainly not without exacting more conditions from the recipients and returns to the taxpayers. All I'm urging at the moment is that we are entitled to be able to confront, squarely and honestly, the fact that this is not free money, that there are consequences of running up such a debt whether for nations or individuals, and that we need to know some independent experts' predictions of what some of those consequences could turn out to be.

What's Your Share? Assume we have something like 120 million families or living units in America. (I'm going to use 100 million to make the math easier.) Assume all accumulated debt ($55 trillion, plus $11 trillion, plus, plus) is near $70 trillion headed for $100 trillion. The interest on $100 trillion, at 5%, is $5 trillion a year. Your family's share? How's $50,000 a year -- just for the interest alone -- sound? Your family's share of the entire debt? About $1,000,000. So what's happening is that these folks who've come from, and will be returning to, the Wall Street financial community, have decided to give you responsibility for paying off the mortgage on a one-million-dollar home -- but one you'll never get to see or live in (not incidentally because they're already living in it).

[Update: It turns out the nation's -- our, my, share of -- debt increases by the hour. Jeff Zeleny and Jack Healy, "U.S. Unveils $800 Billion Credit Program," New York Times, November 25, 2008 ("The United States government unveiled $800 billion worth of new loan programs and debt purchases on Tuesday, hoping another massive infusion of cash would smooth troubled credit markets . . ..").]

Priorities Note that this economic team from Wall Street is advising the President-Elect, as they've already advised President Bush, that the top priority in times of economic distress is to rescue Wall Street and the banks. That's understandable. Indeed, they may even believe what they're saying.

But it's like "the six blind men and the elephant." Ask farmers and the solution is price supports. Ask auto executives and it's a "bridge loan" for the auto industry. Ask trade unions and it's a "living wage," more favorable laws for union organizing, a jobs program, and extended unemployment compensation. Ask the working poor cleaning hotels and hospitals, or those working for less than the minimum wage in restaurants, and they'll say food stamps and help with rent and utility bills.

President-Elect Obama has chosen to ask Wall Street executives.

Franklin Roosevelt and Abraham Lincoln are not the only politicians and presidents to whom our new President-Elect can look for guidance and example.

The 18th Century political philosopher Edmund Burke is another. As he put it, "Society is indeed a contract [that] becomes a partnership not only between those who are living, but between those who are living, those who are dead, and those who are to be born."

Those who are dead not only paid cash, they were thereby able to leave money for their children. Those who are living have substituted consumption and debt for frugality and savings. To leave only that debt, with substantially more to come, to "those who are to be born" is not a partnership of which we can be proud.

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