Citigroup Untarped

The megabank remains the biggest challenge to Washington's muddle-through approach to the banking crisis.

Once again Citigroup looks like the sad sack of the bunch as banks exit TARP, thanks to its poorly orchestrated capital raising and the government's abortive attempt to sell down its own stake last week. But it pays to remember what a bad idea TARP capital injections were in the first place.
The nature of the problem was first apparent, ironically, in the rush of healthy banks to join Citi and friends under the so-called Troubled Asset Relief Program, fearing the lack of an imprimatur as a bank Washington had decided would not "fail."
That dynamic ran in reverse last week as banks rushed to pay back TARP money and shed the onus of government support. Bank of America had to be hurried out because Bank of America was looking for a CEO, and couldn't find one or pay one as long as it was laboring under Washington's populist pay restrictions.
Acknowledging TARP's perverse impact on Bank of America's CEO dilemma, Treasury and FDIC could hardly pretend it wasn't deleterious for Citi and Wells Fargo's ability to run their own businesses. Terms were quickly hammered out to let them escape too.

View Full Image

Getty Images

Citi CEO Vikram Pandit

Voila, a scheme designed to strengthen confidence in the financial system had become the opposite, in compounding fashion.

In and of itself, of course, there was nothing urgent about returning the government's capital. Warren Buffett, Wells Fargo's biggest shareholder, certainly made it clear he would prefer the bank rely on earnings to rebuild capital rather than selling cheap stock to the public to repay Uncle Sam. Rushing the paybacks only increases pressure on the other wobbly legs of Washington's bailout stool, which include regulatory forbearance (i.e., regulators gaming their own capital standards) and the Fed's loose-money policy, which may not be doing much for job creation but is certainly having a marvelous impact on financial industry profits.
Let's have a moment of realism: Policy toward these giant banks always had as its primary goal saving the government from having to take them over and run them, as it has (wretchedly) AIG. It was to avoid the disaster of nationalization.
Legs one and two (plus the FDIC's guaranteeing of bank debts) were always sufficient to meet this goal and keep the giant banks stumbling along under private management and control. TARP capital injections were not only superfluous but invited the calamity they were meant to avoid, with politicians running rampant in the hallways. Take the cautionary example of Fannie and Freddie, which today are not being "conserved' in federal conservatorship but are being used to prop up home prices. For the banks, exiting TARP at least reduces the risk of similar corruption.
Citi, though, is an especially borderline case. Citi was sued last week by its big investor Abu Dhabi, presumably the Arab state's way of expiating the classic sin of trying to catch a falling knife. Abu Dhabi's "rescue" of Citi with a $7.5 billion investment in late 2007 sent the stock market up 200 points. At the time Hank Paulson had just floated his idea for a "super SIV," a thinly disguised bailout of Citi.

OpinionJournal Related Stories:

Peter Wallison: Lack of Candor and the AIG Bailout
Peter Wallison: The Permanent TARP
John Thune: Time for a TARP Exit Strategy

It didn't fly. Abu Dhabi was about three rescues too early. It would take several more attempts by the triumvirate of Mr. Paulson, Tim Geithner and Ben Bernanke before Citi was seemingly stabilized, and by then Abu Dhabi was deeply underwater.
We say "seemingly" stabilized because Citi's floundering exit from TARP last week has destabilized it again. Vikram Pandit, Citi's CEO, is trying to rebuild its business the best he way knows how, i.e. not too different from Citi's previous business. That's presumably why he considers it essential to escape TARP so he can pay Wall Street-style bonuses in competition with Goldman Sachs and Morgan Stanley (and Bank of America and JP Morgan).
Washington chose not to dismantle Citi, so it should have expected no less. Oh well. In a crisis, politicians will look around for businesses "too big to fail," and any conceivable Citi would likely fit the bill, as it has since the 1970s. This problem may not be fixable, but what are fixable are the deeper antecedents of last year's troubles.
Fewer banks would have inflicted such damage on themselves if not for the government's role, eight ways from Sunday, in encouraging Americans to incur housing debt, with direct subsidies, tax incentives and the use of Fannie and Freddie to channel China's surpluses into a U.S. housing boom.
If the word "bubble" has any valence at all, it describes what happens to asset prices when the public believes it has been granted a one-way bet. Sadly, much of the history written in the past 14 months had redounded to the salvation of parties who will be tempted to make the same mistake again.