Citi Citi, bang bang

Readers wanting a peek into the intriguing world of big finance and the nexus between regulators and big banks will find Borrowed Time:Two Centuries of Booms, Busts and Bailouts at Citi a fascinating read. James Freeman and Vern McKinley spin a fascinating story about how the Citigroup hurtled from one crisis to another, since its inception in 1812 to the near-death episode in 2008.

While the book helps us understand why the US regulators and government have been so kind to a bank that had mismanaged its operations and taken excessive risks, over and over again, the history of Citigroup also has good takeaways for banks across the globe.

Friends of the state

The history of Citigroup is probably the history of US banking itself. It was formed from the ashes of the First Bank of United States set up by private investors, holding 80 per cent stake, and the US government that held 20 per cent. The bank’s job was to print money, provide a safe place to keep public money, collect tax revenues and provide commercial banking service to the burgeoning American economy. It, however, had an expiry date of 20 years. It had to cease operations if another law wasn’t passed to extend its charter.

It worked very well for the private investors to hold a stake in this financial power house and it is not surprising that they were not happy when the charter of the bank was not renewed and it had to shut down. City Bank of New York filled the gap left by the First Bank of United States, with 50 per cent capital being provided by the shareholders of the latter.

Citigroup continued these initial links with the US government, many times to its advantage, helping pass laws that would help it diversify into new segments and geographies. With many of the top ranking officials of Citi, over the last two centuries, formerly in US government service and vice-versa, the links have only grown stronger over the years.

The 2008 crisis

Citi’s close association with Washington can explain the events that unfolded during the 2008 crisis. Washington’s basic deal with big finance was that institutions should loan lots of money to borrowers that politicians viewed as deserving and, in return, the institutions were allowed to run with high leverage. And enjoy explicit or implicit guarantees that taxpayers would be there to break their fall if they ever got in to trouble.

While most US banks were in trouble due to lending to sub-prime sector and dabbling in mortgage derivatives that had been given AAA ratings, Citi was in worse shape than others and received the largest bailouts. It recorded $28 billion of losses in the six quarters to December 2007. By 2007, Citi’s $2-trillion balance sheet was much riskier than it looked. And Citi had stashed away another $1.2 trillion in assets off its balance sheet in such a way that it allowed it to hold virtually no capital against losses in those assets.

Around $517.3 billion of money was extended to bailout Citi by the Fed, the FDIC, the US Treasury and tax payers. To put this number is perspective, the market capitalisation of Citi towards the end of 2009 was just $20 billion.

But what came as a surprise to many was the manner in which the bank was allowed to go free without any meaningful supervisory measures after the bailout. There are those such as Sheila Bair, Chair of FDIC, who think the entire crusade, “Save Citigroup at all costs” was probably an over-reaction and the perceived negative fallouts of allowing Citi to be wound up were grossly exaggerated.

Lessons for the banking sector

The history of the Citigroup shows that the bank did very well when it followed prudential practices. It flourished under Moses Taylor, described as ‘perhaps the greatest American Businessman most Americans have never heard of’. Appointed in 1856, he ran the bank for 26 years. Taylor’s rules were simple — when making loans, he wanted to ‘avoid people disposed to overdo everything... and live by their wits.’ Just in case the bank erred and advanced loans to such people, the goal was to have enough capital — the equity investment made by banks’ owners — to absorb the cost of bad loans so that money deposited by customers was never in danger.

In contrast to Taylor’s prudential practices, the risks taken by other chiefs to take the bank into newer avenues, eventually led to major disasters. For almost a century after its founding, Citi had largely been accepting deposits and making loans. But soon, it began to change into a financial conglomerate that would also act as an investment bank, under-write issuances of stocks and bonds and also trade in such securities. Since the regulators frowned on this, an affiliate, National City Company, was formed in 1911 to carry out non-banking activities. The business of this affiliate grew to such an extent that there were questions raised later, whether Citi was responsible for the stock market crash of 1929 and the Great Depression that followed.

Another Citi Chief, Walter Wriston succeeded in persuading the US government that lending money to governments in developing countries was nearly risk-free. When Fed Chairman Paul Volcker began to express concerns about this, Wriston replied “They’re the best loans I have. Sovereign nations don’t go bankrupt.” Wriston had his way and US banks went on a binge lending to developing countries, especially in Latin America such as Brazil and Mexico that dealt them a knock-out punch in the crisis that followed in 1990s.

City’s aggressive strategy to expand overseas to too led to excessive risk-taking. In late 1914, the first foreign branch was opened in Buenos Aires. In 1919, 33 branches were opened, to cater to the boom in the sugar trade due to sky-rocketing sugar prices after the World War. This cost the bank dear when sugar prices fell from 20 cents a pound to less than 2 cents once European producers came back to market after the war. With borrowers unable to make payments, Citi had to face yet another crisis. And many others followed, triggering a chain reaction of crises and rescues, often, at the cost of taxpayers.

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