CITIGROUP AS EXAMPLE: NATIONALIZE THE BANKS!

Vincent Ferraro

The Ruth C. Lawson Professor of International Politics
Mount Holyoke College

AB, Dartmouth College; MIA, Columbia University; PhD, Massachusetts Institute of Technology 

Professor Ferraro doesn't necessarily endorse the findings of this article.  He provides it as a resource on his website.  He certainly has nothing to do with my post title.

The Nationalization Option: Considering a Government Takeover of Citigroup
by Robert Weissman

Citigroup is among the world’s largest financial institutions. As of July, it is also one-third owned by the U.S. government. Without the various subsidies and guarantees — totaling hundreds of billions of dollars — made available to Citigroup, it is very likely the bank would be insolvent. Many believe that — even with the government supports — with an honest accounting, it would be insolvent today. In the case of the failure of Citigroup, it would be taken over by the Federal Deposit Insurance Corporation (FDIC) which has a long record of “resolving” failed banks — albeit not banks of the size and reach of Citi.

The existing government stake in Citi, and the lingering prospect that the government might have to up its control share still further, raise the questions: Should the government exercise its ownership powers? And if so, how?
In the government-managed bankruptcies of General Motors and Chrysler — which has made the government the majority shareholder in GM — the Obama administration has explicitly adopted the position that it will act only as a business investor would. It has advanced this principle with regard to other ownership positions acquired in major businesses amidst the financial crisis. In this framework, the government is either a passive investor, or interested only in the return to profitability of the companies in which it holds an ownership stake.

This approach has a political appeal, as it protects the administration from claims that it is leveraging its investment intervention to advance narrow political interests. It operates from the premise that the government should sell its stake as soon as possible, and that such investment is only appropriate in emergency situations. It aims to alleviate concerns of those with an ideological opposition to government involvement in the economy.
Yet the failure to exercise an ownership stake comes with significant costs. Although the ownership power only applies to individual firms — and not to an entire industry — it is far greater than regulatory authority. The government-as-owner does not need to establish prohibitions or set boundaries on permissible activity; nor does it need to incentivize desirable activity. The government-as-owner can simply instruct its firms to do and not do certain things.

The ColossusPresent-day Citigroup is a financial colossus resulting from the passage of the 1999 Financial Services Modernization Act (known as the Gramm-Leach-Bliley Act for its lead Congressional sponsors). Prior to passage of Gramm-Leach-Bliley, the prevailing rule had been that commercial banks could not combine in one firm with insurance companies or investment banks. Pressure from big banks steadily eviscerated that rule — embodied in the Depression-era Glass-Steagall Act and subsequent updates — in the last few decades, but it remained in place until 1999. Citigroup played the central role in obtaining final repeal of Glass-Steagall, a prerequisite to government approval of the already consummated merger of Citibank and Travelers Insurance.
Ironically, Citigroup spun off Travelers Insurance in 2002, but the company remains a far-flung financial conglomerate, with operations located across the globe and ongoing commercial bank and investment banking divisions.
In its 2008 annual report, Citigroup presented itself as organized into five distinct segments.

• Citigroup’s credit card segment, Global Cards, is the largest consumer business within Citi and “the world’s largest provider of credit cards.”

• Citi’s historic core mission is consumer banking.

• Citi’s “Institutional Clients Group” includes its hedge fund activities, and its securities trading, which is responsible for massive firm losses, mostly on subprime mortgages, including $17.5 billion in 2008 alone.

• Citi’s Global Wealth Management segment includes its Smith Barney brokerage subsidiary. Citi has now merged this into a joint venture with Morgan Stanley, in which Morgan Stanley holds a 51 percent majority stake.

• Citi’s corporate segment serves the company’s other segments.

Earlier this year, Citi announced that it was organizing these segments into two groups, Citicorp and Citi Holdings. In Citicorp are the credit card segment and consumer banking, along with the corporate segment. The Institutional Clients Group and Global Wealth Management are in Citi Holdings.
Citi’s restructuring, says Heather Slavkin, legal and policy adviser with the AFL-CIO’s Office of Investment, “appears to have been an attempt to create a good bank/bad bank structure within the Citigroup umbrella. Citicorp [in the words of CEO Vikram Pandit] is the ‘global bank for businesses and consumers’ (i.e., the good bank) and Citi Holdings includes businesses ‘that are not central to our core operating strategy’ (i.e., the bad bank).”
Citi’s plans follow a general consensus among investment analysts that the financial behemoth is unwieldy and must be broken up.
“They’re in a difficult situation,” says John Jay, senior analyst with the Aite Group. “They are too big and [have] operational problems.”
Sandy Weill — the former head of Travelers who became CEO of the merged Citi-Travelers entity — “was the one that put everything together,” says Jay. He “wanted it to be an institution for institutions as well as for consumers. A large part of what they do is in the capital markets at the wholesale and institutional level. As that sort of unfolded, from the late 1990s to 2005, it eventually became very unwieldy.”
Jay believes the financial conglomerate model can work for some firms — he points to J.P. Morgan as evidence — but says it requires the kind of superb leadership that has been absent at Citi.
Matt McCormick, vice president of Bahl & Gaynor, agrees. “It’s tough enough to keep one ball in the air much less 16 or 17, which is clearly what they have on their plate right now,” he says.
Besides the problems of complexity, McCormick says, Citi’s sheer need for capital will force ongoing sell-offs. “If you look at what’s happening right now with Citi, there are some things they can control and some things they cannot. They can control cost cutting, they can control their lines of business,” he says.
In this sense, Wall Street echoes the views of many progressive economists and advocates, who emphasize the importance of re-imposing the divide between government-insured commercial banking and the highly risky business of investment banking.

Emphasizing the policy importance of imposing such a divide on all firms, not just Citi, Nomi Prins, a senior fellow at the New York-based think tank Demos, and a former managing director at Goldman Sachs, says, “I think returning to a segmented banking system, à la a modern version of Glass Steagall, is the best, most sensible way to regulate the industry and protect the rest of the population from practices based on reckless, hyper-competitive behavior.” Citi should be divided between its commercial banking and investment banking components, she says, and “all entities should be restricted legislatively so as to avoid the kind of off-book, over-leveraged, excessively risky practices of investment banks.”
To Hold or Sell Off?One key initial question is if the government should hold on to Citigroup after nationalization, or aim to re-privatize it as fast as possible.
This is not necessarily an either-or proposition. There may be arguments for permanently maintaining some aspects of Citi in the public domain, while selling off the rest.
Professor Gerald Epstein of the University of Massachusetts, Amherst posits a range of benefits for maintaining Citi as a public bank (shorn of some components).
First, he suggests, it “can specialize in funding for ‘green initiatives,’ both small and large. These can include lending to business with new technology ideas; serving some of the role of venture capitalists but not requiring such a massively high rate of return and hurdle rate as they do; and smaller business loans directed at projects such as home and building refurbishing, etc. that is directed at greening the economy.” A public bank could also underwrite “government bonds issued for important social goals such as green technology, education funding, mass transportation, etc. There have been massive problems reported of price fixing and other corrupt practices in the municipal and state bond markets. Having a large player in the public bond arena that can compete with and try to keep more “honest” the other players in this market would be of great use to states and locales.”

Epstein notes a variety of other possible functions for a public bank. It could issue reasonably priced student loans. It could address abuses in consumer credit provision through direct service. “The government is discussing a new bill to create consumer protection in the provision of credit card and other consumer services,” notes Epstein. “One way to enforce such provisions is to make the law and enforce them through monitors. Another way is to create an institution — i.e., a large public bank — that actually implements these rules and thereby imposes competitive force in the marketplace that can help force private lenders to obey by the same rules.”
Finally, notes Epstein, a public bank, by providing a competitive alternative, could serve to discipline abuses by private banks. “Public banks, if they have enough market power, can help enforce standards in the financial marketplace in those areas where demanders of bank services will prefer these higher quality services. In other words, a large bank that enters the marketplace enforcing higher standards can help promote a dynamic of a ‘race to the top’ in the provision of high quality banking services.”
A different idea for a public bank is that it be smaller and more focused. In such a scenario, a piece of Citi would be maintained in the public arena, with the rest sold off.
States Epstein: “A second approach would be to carve out a smaller bank with one or more specialized goals. For example, the government could create the ‘Green Bank of America’ or ‘Green Citi Bank’ that would specialize in lending to private businesses and governments for green activities. Another example would be the ‘Education Bank of America’ and/or ‘The Infrastructure Bank of America’ which would focus on underwriting (possibly in public-private partnerships) the creation of more infrastructure, particularly those meeting social goals such as green transportation, etc. In this case, the government would then divide the ‘good bank’ into two or more parts and sell off those that would be privatized and retain those that would specialize in these actions. Of course, they would have to try to retain the depositor base in order to fund these more specialized activities.”

The Utility of CitiA different vision for a post-takeover Citi involves re-privatizing the firm, but requiring it to operate on the model of a public utility.
The regulated utility model suggests an entity that provides a specific public service without discrimination and, according to government-specified standards, is constrained from undertaking other activities in related fields and is permitted to obtain a reasonable profit but no more.
Longtime financial regulatory expert Jane D’Arista suggests how this might be done operationally: “If Citi is declared insolvent, its deposits (for which the FDIC is already liable) should be segregated to create a new bank backed by as many good assets as needed from (or can be found in) the existing balance sheet. Capital should be provided by transferring TARP [government bailout] funds already given to Citi to the new institution.”
Then, she contends, “The institution that emerges should be viewed as a utility created for the purpose of providing new loans to U.S. non-financial borrowers and primarily engaged in portfolio lending. It would, obviously, be under new management. It should be prohibited from making leveraged investments, engaging in investment banking or proprietary trading or excessive borrowing from and lending to other financial institutions. Decisions about relaxing these prohibitions should wait until regulatory reforms have been enacted.”
“I like the public utility model with a variety of ownership options ranging from local private ownership, cooperative ownership or a community corporation model,” says David Korten, author of Agenda for a New Economy and co-chair of the New Economy Working Group. We should be highlighting the variety of such possibilities. Overall, I’m inclined to make the argument that money fits within a category of services like electricity and water that are best managed as public utilities.”

In addition to the kinds of prohibitions outlined by d’Arista, a utility model would imply conditions on the terms of lending that banks could undertake. A utility might well be required to adhere to rules more strict than those likely to emerge from proposals for a consumer financial regulatory agency.
Citigroup at the City LevelThere are many cross-cutting issues implicated in a government takeover and subsequent management.
For example, whether or not a re-privatized Citi is regulated as a utility, there is a question of how the post-takeover company should be broken up.
As it happens, there is a fair amount of agreement among Wall Street analysts and progressive critics on a number of points: first, the unprofitable units should be sold off or otherwise resolved; second, the firm has grown too big and unwieldy and must shrink; and third — although they come to this conclusion for different reasons — the commercial banking and investment banking operations should be split.

But many progressives believe an additional set of considerations should be taken into account in reshaping Citi. The more modest concern is addressing the too-big-to-fail problem. If, as is now prevailing wisdom, large banks and financial institutions make excessively risky investments because they know they are protected against failure by a de facto government insurance program, then the government should take affirmative steps to shrink large banks. Where it takes over, or gains a dominant ownership stake in a too-big-to-fail bank, it should break it up into small enough pieces to escape this problem.
Suggests economist Dean Baker of the Center for Economic and Policy Research, “It was built up from regional banks. It can go back to being several regional banks.”

A more aggressive perspective on breaking up Citi aims not just to address the too-big-to-fail problem, but affirmatively favors small size. In this view, the ultimate objective would be, as David Korten recommends, “breaking Citi into the smallest viable pieces, each rooted in community by ownership and mandate.”
A bias for the local, notes Stacy Mitchell, senior researcher with the Minneapolis-based Institute for Local Self-Reliance, reflects “a lot of evidence that banks are most efficient and effective at much smaller scale.” Smaller banks generally are “the cheapest place to bank, and offer the best interest rates.” Smaller banks are better able to tailor services to local needs, including especially the needs of small business, “because they operate at eye level” with the community. Smaller banks also have much less political power than mega-institutions, and so are less able to undermine efforts to control the financial sector.

A separate issue is what, if any, special rules should be imposed on re-privatized Citi. The utility model suggests an approach to this question, but many of the kinds of restraints proposed by d’Arista could be adopted even in the absence of a full-fledged utility management scheme. One area — the only area — where the federal government has made at least some very tepid demands is in restraining executive compensation.
There is also the question of what, if any, affirmative requirements should be imposed on re-privatized Citi. No one advocates requiring the re-privatized Citi to make bad loans, but it is also clear that some affirmative duties can encourage or require profitable lending that would otherwise not take place. The Community Reinvestment Act, which encourages banks to make more loans to low- and middle-income communities and borrowers, is an example of how affirmative duties can be imposed on banks.
The environmental arena is one where new lending could be profitable and serve important public objectives. The new Citi could be required to include financing for retrofitting or solar panel installation, say, along with every home mortgage.
“There are all kinds of lending strategies that might be deployed on the retail banking side,” notes Michelle Chan of Friends of the Earth, “including so-called ‘green mortgages’ or location-efficient mortgages. A location-efficient mortgage applies to a home that is closer to public transportation. There’s a certain business logic to this. You can assume that when someone uses public transportation a lot they spend a lot less of their household income on their car, including gas, auto insurance, repairs and so forth. So they have more money to pay off their mortgage. And so therefore you can offer a slightly better deal — a couple of basis points off a loan — for a location-efficient mortgage. You could do the same thing for energy-efficient mortgages — homes that are more efficiently designed — since people will pay less for utilities.”
Washington on Auto PilotAfter appearing perilously close to collapse at the beginning of 2009, Citi’s prospects are now somewhat improved, especially after benefiting from a conversion of government loans into an equity stake, hundreds of billions of dollars in government guarantees on bad loans and new accounting rules, as well a calming of the global economy. Yet the U.S. government does already own a third of the financial giant, and future economic troubles could easily send Citi back into distress.
In Washington, what is notable is not the lack of agreement on how the government should shape Citi, but the assumption that this question should be off the table — notwithstanding the hundreds of billions of dollars in public supports provided to Citi. If the GM bankruptcy is a model, the question will remain off the table. Whether the public may arouse itself to demand some quid pro quo for its investment remains to be seen.