The Hindu Business Line : Bankrolling Citi

The US Government has stepped in, quite expectedly, to rescue the troubled banking giant, Citigroup. Apart from an immediate $20 billion direct cash injection, Washington is also providing a backstop against any default in the bank’s real estate related securities that are worth $300 billion. There is reason enough to believe that the ultimate fiscal burden to the US Government could be far in excess of the immediate cash outgo. These instruments are, after all, backed by commercial and residential properties that are gripped by the twin constraints of severe illiquidity and falling prices.

The latest US action will only serve to sharpen the debate over whether, in the long run, national economic interests are better served by a nuanced application of the principles of free markets, that permits the State stepping in to alleviate the distress of financial entities that are ‘systemically’ important. Indeed, the US Government began to entertain doubts over an evangelical belief in the principles of capitalism in the wake of the chaos that followed the failure of Lehman Brothers, the third largest investment banking firm in that country. These developments underscore the need for a wider debate on the architecture of a global financial system with particular reference to ownership and regulatory aspects. It is a matter of some irony that the US automakers who perhaps are in as straitened a circumstance as Citigroup, if not worse, find their case deferred. This has prompted people to wonder if those managing the world’s largest economy regard Wall Street as more significant than ‘Main Street’.

The travails of Citigroup are but a manifestation of certain larger issues affecting the macro economy that experts and economic historians are bound to debate in the days ahead. Is the crisis in the US financial system an inevitable by-product of a reward structure for economic agents that laid excessive emphasis on quantitative output targets? The system, as it evolved, rewarded mortgage brokers not by the quality of borrowers that they enlisted but by the values of deals signed up. The primary lenders could not be bothered about the loan quality as long as they could find an investment banker who could bundle future cash flows on these loans and offer them to prospective investors. These investors themselves were in desperate need of outlets in an environment where interest rates were abysmally low. Throw in credit rating agencies and helpful statistical models to warrant acceptable credit rating and the picture of irrational exuberance in the housing market was complete.

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