Tuesday, November 25, 2008

Citigroup Bailout

Until the last several weeks, a majority of Americans had probably not heard of Citigroup, or at least did not have much of an idea of what kind of company it was. Following recent news about a massive federal bailout, many more now know. What's going on, what should be going on, and what can be learned from this situation?

Citigroup, based in New York, with assets at year end 2007 of $2.19 trillion, revenues of $159 billion, total staff of about 358,000, and an incredible 200 million customer accounts, has been operating the world's largest financial services network spanning as many as 107 countries. The company has been one of the world's largest players domestically and internationally in consumer banking, corporate banking , private wealth management, investment banking, credit card issuance, travel services, and many kinds of insurance. However, their senior management and board of directors have not served them well. The company essentially grew out of control due to poor management and got greatly caught up in the current economic recession and financial crisis. One of their major problems is that, like the case with many other financial industry companies, they've ended up holding several hundred billion dollars of bad, so-called"toxic" assets, which are not worth very much at present.

While Citigroup reported net earnings in 2007 of roughly $3.6 billion, far less than in 2006, they reported a loss of $2.8 billion for the third quarter of this year alone, and no doubt will have a huge loss for the year as a whole. Their stock has fallen from a 52 week high of $35 a share to a low of $3.05 and has recovered a little in recent days to a present level of about $6 a share. As a result, their market capitalization has fallen dramatically. Since it has been a stock widely held by both institutions and individuals, its great reduction in value has had a major adverse impact on investment portfolios across the board. Bankruptcy has been a serious possibility that many experts have felt could have widespread negative repercussions on other large financial institutions and the economy as a whole.

Due to widespread concern with a potential bankruptcy, the Bush Administration, generally supported by President-Elect Obama's transition team, as I understand it, has approved a very substantial federal bailout announced late last Sunday, consisting primarily of a capital injection of $20 billion and a loss sharing agreement on a $306 billion pool of some of their bad assets, under which three government agencies, and we taxpayers, are exposed to $249 billion of bailout costs. The capital injection will be in the form of preferred shares paying an 8% dividend. This bailout is on top of the $25 billion capital injection by the U. S. Treasury under the $700 billion Troubled Asset Relief Program (TARP) announced last month.

Obviously we're talking about a huge amount of taxpayer support to help a very major financial institution which has been poorly managed for at least several years, even though the company reported substantial earnings through 2006. Financial industry and congressional supporters of Citigroup's rescue and bailout by the federal government believe that this action is needed to help restore confidence and stability in our financial markets, to unclog frozen lending pipelines, and that Citigroup is just too big to fail. These supporters may well be correct, but surprisingly there seem to be many very critical elements apparently missing from this bailout. However, I may have just missed hearing about them, because I was trekking in Nepal for half of October.

Missing from my vantage point as a career banker, to start with, is a requirement to provide a compelling business plan demonstrating specific actions senior management will take, and how these should enable the company to successfully compete in the current global economy. The plan should also provide credible financial projections that will allow government negotiators and monitors to calculate what risk-adjusted returns the government can expect for their investments. If Citigroup and its advisors cannot provide a compelling plan with credible projections, the bailout should be seriously reconsidered and perhaps should not go forward without substantive adjustments. But it's virtually certain this won't happen. The bailout will go forward.

Furthermore, what about Citigroup's senior management and its board of directors who, as a group, have performed poorly? Government negotiators decided not to push for the ouster of CEO Vikram Pandit, because he didn't take up his position until last December, although he was there in charge when it became clear that the sub-prime mortgage crisis was brewing. What about all the others? Should not at least some of them be replaced, both on the management team and on the board? To what extent is that happening? It's not, according to an editorial piece in the respected Wall Street Journal yesterday. Reportedly, not a single senior manager or director will be let go as a condition of taxpayer assistance!

A large number of key board members have been in place for many years, and therefore cannot argue they cannot be held accountable. Former Treasury Secretary Robert Rubin has been on Citigroup's board for ten years, for much of that time as chairman of their executive committee. Chairman Sir Win Bischoff has held senior positions in the company since 2000. Six other directors have served for more than ten years. Didn't they know what was going on? Why not?

I trust there won't be any bonuses paid out to members of management for their work in 2008, but that should be checked. There should also be an independent review and appropriate adjustments of senior management salaries, severance payment agreements, and retirement benefits, considering their individual responsibilities for the company's problems. Is that taking place?

What can we learn from this bailout, considering the implications and huge taxpayer costs? First, our government, representing the voters and taxpayers, cannot, and should not, rescue every failing company, even if it's very large and in a key industry. Second, as almost everyone agrees, we need more, intelligent oversight, regulation, and effective coordination with the other major industrial countries to minimize the possibility that a similar financial crisis can happen again. Third, given the widespread belief that Citigroup is "too big to fail," perhaps the government should review existing antitrust laws and enforcement practices to see what steps should be taken to keep companies in key industries from growing too big and dominant. Fourth, since this seems to be a common problem in failed companies, we need to have established stronger and clearer accountabilities, with appropriate enforcement, for board members of public companies. Finally, the new Obama Administration, working with the Congress, needs to put together a prudent plan for how they should deal with any more very large failing companies, including specific requirements for any financial support.

With the Bush Administration technically still in the lead for another seven weeks or so, our federal politicians will gain some good practical experience dealing with the CEO's and their advisors of General Motors, Ford, and Chrysler in the weeks ahead.

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