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Banks vs. bank holding companies
I continue to see many bloggers suggesting that bank nationalization is a fait accompli and that anyone who isn't on board right now is in denial. It is far less common that bloggers give serious consideration to the difference between a bank and a bank holding company. In fact I usually don't see that critical distinction mentioned at all.
If the government nationalized (or "pre-privatized"...whatever) Citibank, Citicorp would go bankrupt and we would be back at a Lehman Brothers scenario again. So the government would have to take over Citicorp too. That goes way, way beyond anything the Swedes did or for that matter it goes well beyond WaMu. Shall I turn the mike over to Wikipedia?
Citigroup was formed from one of the world's largest mergers in history by combining the banking giant Citicorp and financial conglomerate Travelers Group on April 7, 1998. Citigroup Inc. has the world's largest financial services network, spanning 107 countries with approximately 12,000 offices worldwide. The company employs approximately 300,000 staff around the world, and holds over 200 million customer accounts in more than 100 countries. It is the world's largest bank by revenues as of 2008.
You can read about Travelers Group here.
Thinking through the implications of said nationalization for the counterparty positions of a bank holding company, or its role in the commercial paper market, is mind-boggling. Neither the FDIC (which generally does an OK job) nor any other government agency is in any way prepared for this kind of management task. It has very little to do with standard FDIC procedures. All I hear about is "bank" this, "bank" that, etc. but again little or no talk of the bank holding company.
Of course this is only a problem for the five or six biggest financial institutions but those are precisely the issue at hand.
On nationalization, Bernanke is very much on the ball. He said this:
Federal Reserve Chairman Ben Bernanke said this week, is “that you tend to lose the franchise value, that the counterparties and others don’t want to deal with you because they don’t know your future.”
I usually don't like to speak so negatively, but it's the advocates of nationalization who are in denial. There is a belief that Obama, Bernanke, and/or Geithner are somehow spineless or in the pocket of the banking lobby. The sadder truth is that they understand just how ill-prepared the U.S. government, or the Fed, would be to run such an enterprise.
I do understand that if all the water runs out of the sink, as it may, nationalization will come in some form or another, however disastrous that may be. But the desire to postpone it until the last possible moment, and the desire to pursue even a small chance of avoiding nationalization, are signs of wisdom, not cowardice.
When you read about nationalization, and see only the word "bank," and not "bank holding company," be very afraid of the advice on tap.
Addendum: Here is a different but related piece on banks vs. bank holding companies.
Posted by Tyler Cowen on February 21, 2009 at 07:43 AM in Economics | Permalink
Comments
In a WSJ column on 2/18, Harvard professors Coates and Scharfstein argued that "the bailout is robbing the banks" because the TARP money has been going to bank holding companies rather than banks. If this is a fact, then they are right about the consequences of handling the money to the holding companies. It is additional proof, however, of the stupidity of Paulson, Bernanke, Geithner and the many others that have worked on TARP as well as that of the many economists that have been advancing proposals without taking into account what happened in other experiences. This was a serious problem in Chile's financial crisis of 1982-83-- I know because I was the economic adviser to the holding company of the largest private bank. When all those people stop trying to reinvent the wheel and start to pay attention to how other crises were solved, then there may be a solution.
Posted by: E. Barandiaran at Feb 21, 2009 8:01:43 AM
There is a missing step in the argument. If Citibank is "nationalized', why is Citicorp necessarily immediately bankrupt? Isn't it possible that getting rid of the junk is a way for the healthy remainder to better survive? Can you fill in the blank please?
Posted by: ken at Feb 21, 2009 8:26:33 AM
um, it's not like AIG -- a holding co. -- wasn't resolved without the world collapsing...
also re: chile mpettis -- http://mpettis.com/2009/02/will-china-have-to-choose-between-social-stability-and-long-term-growth/ -- points to a nice paper: http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4132
oh and chile was just written up favourably for its counter-cyclical measures http://www.economist.com/world/americas/displaystory.cfm?story_id=13145570 - “being a Keynesian means being one in both parts of the cycle”
Posted by: glory at Feb 21, 2009 8:35:17 AM
The first step in either nationalizing Citibank or reorganizing it (my preference) would be to wipe out the shareholders, i.e. Citigroup. It seems unlikely that the latter could survive this. But it's not clear to me why the government needs to know how to run Travelers Group in order to nationalize Citigroup as a whole; surely all they need to know is how to sell it off? (Unless the term "holding company" has come to denote a much more tightly integrated structure than it did when I first learned it, Travelers' own management can keep running it during the interim.)
If Cowen turns out to be right about all this, though, the first thing we ought to do once the crisis passes is break up all bank holding companies and never, ever let them re-form.
Posted by: Paul Zrimsek at Feb 21, 2009 8:49:43 AM
I agree with what you've said. I just have to wonder, how would the growing but still underdeveloped staff at the Treasury Department be able to handle even more responsibilities? I'm not underestimating the Obama administration's ability to assemble a highly qualified team, but simply suggesting that because as many, like you, have argued, this task will be ludicrously complex should it come about, and that being unfortunately light on manpower isn't going to make it any easier.
Posted by: Brian J at Feb 21, 2009 9:42:29 AM
But the desire to postpone it until the last possible moment, and the desire to pursue even a small chance of avoiding nationalization, are signs of wisdom, not cowardice.
But the people in charge have no idea what to do other than nationalization:
They give no details on their plan, telling us someone else will describe them. Then the person who's supposed to give the details has none, because they just scrapped the plan.
They announce that they are going to start giving taxpayers a measly about of money per week on April Fool's Day.
They want to restrict foreign trade (NAFTA revisions and America first provisions).
They say too much spending is the problem and that government debt to encourage more spending is the solution. (One sentence followed the other.)
They are giving $30,000 per homeowner to people who made bad economic decisions.
They are encouraging states to put more people on welfare.
They want to increase the cost of energy.
They think inflation is the answer to everything.
We aren't getting more resources by waiting. We're only getting less able to solve our problems.
Posted by: Jason (the commenter) at Feb 21, 2009 9:50:00 AM
I have already made a comment on a different but related point. Now I'd like to comment on what Tyler calls signs of wisdom. After 6 months and having a lot of money to hire the best experts to design a plan and an army of accountants and lawyers to implement it, Tyler argues that Bernanke and Geithner are wise people. Look carefully at what happened in all other financial crises: never before a government was better prepared than the US government was in mid-2008 to deal with a financial crisis and never before a country was lucky enough to have the opportunity of changing government constitutionally at the beginning of a financial crisis. Bernanke and Geithner have had the best conditions to deal with a crisis that one could desire--I have been there many times and I know how lucky they have been except for their incompetence. They have already failed and it's time for them to go home (or to teach).
Posted by: E. Barandiaran at Feb 21, 2009 10:28:14 AM
"Thinking through the implications of said nationalization for the counterparty positions of a bank holding company, or its role in the commercial paper market, is mind-boggling."
Tyler, could you or someone else plz tell me in the most basic terms (one sentence would do) why wiping out the bondholders is bad?
The counter party risk is just everyone with bonds and stocks or is it the taxpayer exposure via FDIC insurance?
Holding companies encompasses investment banking, poisoning the value of banks, rneding both negative (it appears).
Posted by: Phillip Huggan at Feb 21, 2009 10:37:18 AM
Why on earth do you think the government has to manage anything? You just force the holding company into bankruptcy, pay off the insured depositors, and auction the assets, fast. The auction only takes a long time if you are delusional enough to believe that the assets are magically going to become more valuable if you hold them. The FDIC is first in line for the proceeds of the auction, and the court then apportions the remaining funds among the secured creditors. Counterparties, shareholders, and unsecured creditors get zip. Next time they'll be more careful about lending to overleveraged firms.
The only reason you would want to go slow with any of this is if you think that Citi, BofA, etc., are unique irreplaceable entities that provide huge positive externalities to the country. Given recent history, I'd say that's quite a stretch.
Posted by: Jeff at Feb 21, 2009 10:45:22 AM
Who said anything about the government managing Citigroup? Nobody wants that. There must be another insurance company that would take Traveler's at a steep discount. There have been many news stories about how Citigroup isn't nearly as integrated as they pretend to be: Barney employees still answering the phone with "Solomon," etc. Those parts could be split off.
A breakup and sale plan can be prepared by the government, details kept secret, and the trigger not pulled until and unless it's determined that Citigroup's position is irreversible.
If Citigroup's write downs are forced by mark to market and the bulk of their assets have in actuality not defaulted, then delaying nationalization is warranted and we should be looking at relaxing mark to market rules for the time being. If the losses are permanent then I think it's the delayers who are in denial.
It's been long enough since this started that bank portfolio models could report a reasonable intrinsic value. If it's significantly higher than market I think we would have been told, but maybe not in all cases. That's very valuable information while it's asymmetric.
Posted by: David at Feb 21, 2009 11:10:03 AM
Tyler has said nothing but "Too big to fail." Not convincing.
Posted by: John at Feb 21, 2009 11:14:23 AM
A surge of sanity. Thank you.
Posted by: JKH at Feb 21, 2009 11:37:43 AM
This is amazing. Many of us have been urging a version of the Swedish plan since September. At that time, I had no idea if or how many banks might have to be seized. No one was giddily crying for nationalization as an end in itself or for the hell of it. The point was to put in place a modus operandi that could seize the major banks if it were to be necessary. That's what Sweden did. The argument was that is was a plan, model, map, that could help us maneuver through this crisis, just as the Swedish Plan was influenced by the RTC. The alternatives, doing nothing, for those of us worried about Fisher's Debt-Deflation, seemed a poor choice, as did a hybrid government/banking sector plan, which would have any number of serious problems. To see if those of us who were worried about the Hybrid Model were even near correct, simply read the GAO report on TARP.
We will obviously need to adapt the Swedish Plan to our needs. No one was claiming that we have to follow their plan blindly. That would be silly. We also saw that simply using normal FDIC swooping procedures might not work in the case of the big banks, which is why you either had to create a particular FDIC entity for these big banks or, better yet, set up a separate procedure from them. In other words, a version of the Swedish Plan.
I'm already taking up to much space, but you're also ignoring the criticisms of the alternatives, which I believe have been spot on. In seeing the flaws of TARP in its various guises beforehand, we also feel that our fears of a costly and messy response have largely come true, although they have done some good.
Finally, this report via Real Time Economics makes some good points:
http://www.clevelandfed.org/Research/commentary/2009/0209.cfm?DCS.pr=20090212
Posted by: Don the libertarian Democrat at Feb 21, 2009 12:02:15 PM
I absolutely don't understand the point here. If Citibank is bankrupt and the rest of Citigroup is not, then Citigroup is subsidizing Citibank. And the real question is what claim on the assets of Citigroup the FDIC has in the case of Citibank going under. If Citigroup isn't solvent without a solvent Citibank then it would seem that the jig is up anyway.
So, either the other Citigroup subsidiaries can bail out Citibank (to which I say 'huzzah') or they can't in which case nationalization/bankruptcy, whatever seems like the natural course.
Posted by: jermentr at Feb 21, 2009 12:05:51 PM
Even if you grant the premise that the government couldn't run Citigroup, which as has been previously discussed isn't necessarily salient, you still want to do whatever you are going to do as quickly as possible. The banking system in general can't possibly return to any kind of sane or normal behavior while no one knows what is going to happen to their capital structure. The idea that you would drag it out because you think that nationalization is a very bad outcome is bizarre--I can't believe it would be worse than the current uncertainty.
Posted by: matt wilbert at Feb 21, 2009 12:24:13 PM
It will be extremely amusing to see the walk backs and/or scrambling to come up with explanations when the inevitable happens with these banks. Incredibly complicated or not, it's going to happen. And it'll be okay, much to the dismay of the horde of right wing economists sitting on the sideline, letting the challenge before them paralyze them into inaction.
Posted by: Hal at Feb 21, 2009 1:01:35 PM
Sell to whom? These are large. Even parts of them are large. Why do you suppose FDIC normally sells an insolvent institution to a larger institution? It is simply beyond the capabilities of smaller institutions to absorb vastly larger ones. What would they buy them with? There would be nothing quick about this. They would have to operate it while they divide it up into profitable and unprofitable chunks and would likely not even be able to sell them but only spin them off as independent entities. All the while potential investors would be wondering, is this part really solvent, is it profitable, will the economy make it insolvent, will the rules be changed to wipe it out in the future, why on earth would anyone want to take the risk?
Posted by: Lord at Feb 21, 2009 1:56:12 PM
Tyler,
I would add a few points.
1. There is no ability to "nationalize" a bank holding company. It is normal bankruptcy proceedings. The FDIC can not close Citigroup, only the several Citibank subsidiaries in the US.
2. A bankruptcy of the holding company would likely be an event of default on derivatives throught the entity due to cross-default provisions. Citi stoll owns Salomon Brothers.
3. Citigroup is not just Citibank; it has banks and subsidiaries world-wide. Citigroup is more international than domestic.
Citigroup is more central to the financial system than Lehman, as international as AIG, is one of the largest providers of corporate credit in the world, and is integral to payments and settlement flows globally.
Posted by: [Name redacted to protect the innocent] at Feb 21, 2009 2:24:54 PM
For folks interested in understanding Citigroup better, there is a website that shows regulatory reports on Bank Holding Companies called the National Information Center.
http://www.ffiec.gov/nicpubweb/nicweb/NicHome.aspx
Looking at something called the Parent Company report show:
Parent compant total assets..........$379.044 billion
Investment in subsidiary banks.....$15.666 billion
Investment in nonbank subsidiaries...$57.912 billion
Equity investment in subsidiary bank holding compamnies...$86.021 billion
There is also a rather long organizational heirarchy on the site:
http://www.ffiec.gov/nicpubweb/nicweb/OrgHierarchySearchForm.aspx?parID_RSSD=1951350&parDT_END=99991231
Posted by: [name redacted to protect the innocent] at Feb 21, 2009 2:48:11 PM
"And it'll be okay, much to the dismay of the horde of right wing economists sitting on the sideline, letting the challenge before them paralyze them into inaction."
Anyone who describes anything right of center as "right wing" reveals enough of an intellectual bias to be easily dismissed, but I'm glad you're able to twist a devastating global economic crisis into something that is "amusing" for you personally.
Posted by: MM at Feb 21, 2009 3:52:50 PM
If Obama just concedes to what all these people are saying, we'll have another Iraq that is equally unwinnable but with far more impact on American soil. Most wanted an invasion of Iraq on grounds of just sheer dumb fear, and that's what the Krugman's of the world are counting on with the banks. It's ideological, and it's a simple attempt at an irreversible shift in the way this country operates. A lot of people are finding themselves with the perfect opportunity to use their title as economists to try to push a political agenda.
Posted by: Peter at Feb 21, 2009 4:10:00 PM
I agree that with the commenters who have said that the government does not have to manage anything. I was once a Citi shareholder (thank God that was some time ago) and i don't recall being consulted on managerial decisions. All government has to do is replace the shareholders & assume ownership. The very top executives would have to go, of course, but much of the rest of the management could probably stay in place. The necessary writedowns will be made and the gov't can worry about selling down the road. I would argue against selling any assets into this market. In lieu of strong competitive bidding for whatever profitable components Citi might still have, hold on to them. One of Citigroup's major problems right now is that they can't get good prices even for their non-toxic assets. Nationalization relieves them of the time pressure, and it is absolutely essential. Probably for BAC, too, and then we'll see about Wells and JPMorgan..
Posted by: Hugo Lindgren at Feb 21, 2009 4:14:11 PM
Any discussion of Citigroup and its importance should pay special attention to Robert Rubin and what he did to earn well over $100 million in 8 years there in different capacities. He resigned Citigroup on January 9, 2009, and I understand he's an advisor to BHO. Let us hope that Bernanke and Geithner can ask him for his advice on how to deal with Citigroup!
Posted by: E. Barandiaran at Feb 21, 2009 4:18:14 PM
Glass-Steagall is looking more and more like genius.
How could anyone think it was a good idea to eliminate the restrictions it placed on financial institutions?
The Sherman and Clayton Acts are looking more and more like genius.
How could anyone think it made sense to eliminate the power of the government those laws asserted?
How could anyone want to return to the past before those laws were passed?
;-)
Posted by: mulp at Feb 21, 2009 5:20:34 PM
Benrnake's logic is opaque and possibly wrong.
Bernanke argues that counterparties will deal with a firm only if its survival is reasonably ensured. Check Citi's share price or CDS. The firm's survival is obviously in doubt. Why is anyone, then, trading with Citi? According to Bernanke, they should not be. What makes Bernanke think that they would stop if the firm were nationalized? Its simply not clear.
What's also not clear is the impact of the Lehman bankruptcy on the financial system. As far as I could tell, interest rate, foreign exchange, and other OTC derivatives markets continued to trade smoothly. The commercial paper market was, arguably, disrupted, but with the current Fed back-stop that is not a risk going forward. The winding-up of Lehman CDS was orderly.
Lehman's bankruptcy did result in a credit spread spike and in concerns about other financial institution bankruptcies. This is not, however, the same as an interruption in the smooth functioning of the financial system.
Maybe I have it wrong, and its true we were on the verge of a financial meltdown. But the truth is, confidence, of a sort, was restored quickly. A failure/nationalization of Citi or BofA would hardly have the same impact as Lehman on confidence since it has been forecasted by the market for some time.
There you have it. Now, why, exactly, is nationalizing the Citi holding company a bad idea?
Posted by: David Pearson at Feb 21, 2009 10:40:51 PM
By the way, as others have noted above, Citi could be run, just as the GSE's are, under new, regulator-appointed senior managers. Sure, Congress could try to "run" the firm by interfering with regulators. I think the Keating 5 tried that once. Where did it get them, exactly? Well, at least four of them got in trouble. I believe the regulator for the Citi holding company is the NY Fed, which arguably is more independent than the OCC or OTS.
Which is better: compensate managers with current shares in a private Citi; or compensate them with shares in a nationalized Citi that will eventually be IPO'd? I'd say the latter is better for both taxpayers and managers.
Posted by: David Pearson at Feb 21, 2009 10:49:02 PM
Here is a video on the stimulus you should all watch. Tyler, what about a thread on the finer points of this video?
http://www.youtube.com/watch?v=uyPcRGvtu18
Posted by: Matt at Feb 22, 2009 12:14:48 AM
Could I see the hands of everyone here who's terrified of the thought that management of Citigroup could be taken out of the hands of the people who bet the firm on mortgage-linked securities and turned over to incompetents?
Posted by: Paul Zrimsek at Feb 22, 2009 9:23:47 AM
If nationalization results in an AIG style takeover, with a little more red meat for the benefit of Obama's supporters, then how is this going to cure the economic problems?
Is Citi not lending enough via its credit cards?
Are they out writing worthless loans to try to grow their way out of their problems?
Does anyone truly think we can just liquidate our way out of this?
The FDIC has been nationalizing banks left and right. If you include the forced mergers, it has worked its way through over 10% of the banking system. Only 40% were closed in the 1930's bank holiday. Those 10% already done plus Citi and BAC, which have been effectively nationalized via TARP 1.5 account for 1/3 of the system.
The banks are relatively stabilized. Move on to getting the economy running via stimulus.
Anyway, I would strongly advise leaving the relatively well functioning traditional banks the hell out of any big plans.
Posted by: Capvandel at Feb 22, 2009 1:33:17 PM
"Looking at something called the Parent Company (Citigroup) report show:
Parent compant total assets..........$379.044 billion
Investment in subsidiary banks.....$15.666 billion
Investment in nonbank subsidiaries...$57.912 billion
Equity investment in subsidiary bank holding compamnies...$86.021 billion"
Citi's toxic assets exposure has been valued at $833 billion to $1+ trillion. Citigroup is insolvent! No degree of handwringing can deny that action is required.
I agree with Paul Krugman's comments today: After Geitner's "stress test" reveals that Citigroup is insolvent, Geitner will echo a "Claude Raines moment" - Captain Renault (Casablanca): "I'm shocked, shocked to find that gambling is going on in here!" [a croupier hands Renault a pile of money at this time]
Posted by: DepressionAnyone at Feb 22, 2009 5:05:46 PM
I think the Obama administration is starting from the following assumptions:
1) Fixing the financial situation will require $1-$2 trillion more.
2) There is no chance to get funding beyond the $350 billion they have.
They are trying to leverage $350 to get to the $1-$2 trillion they need.
I believe leverage will not work. There are only two ways to get funding at the level required:
A) The fed can guarantee the bad assets of the banks and, as the assets are written off, make the banks good.
B) Have the banks fail. In this case we own them so resolving their issues is not an option.
No matter how difficult B) is I think it is far preferable to A). A) has huge moral hazard issues, is maximally expensive, is corrosive to democracy, and once the fed unwinds its recent increase in the monetary base I do not think its balance sheet is big enough to support this.
With B) the cost can be much smaller because bond holders and others can be required to take a haircut on their investments. B) also involves writing down many bad assets and helps the economy move to a sustainable level of indebtedness.
If you accept the above then proper course of action is to prepare to nationalize as efficiently as possible and do so once you are ready. Dragging things out means that healthy banks will be unable to gain access to new capital and investment decisions will be clouded by unnecessary uncertainty.
Posted by: at Feb 22, 2009 6:40:54 PM
Dave Pearson,
You've nailed it on Lehman with one possible exception. Credit spreads had already spiked in August, before the Lehman BK.
It was expectations of a bail-out and outright mendacity in Lehman's announcements and financials that prevented the market from a smoother write-off of its debt to expected recovery levels (actual recovery was circa 6 cents on the dollar, as I recall). One mutual fund "broke the buck" because its Lehman debt was wiped out, which led to the run on mutual funds and the collapse of the CP market (now Fed supported as you noted).
The markets still expect bail-outs (but it is now fashionable to call them nationalizations)--only yet more so due to the rescue of Citi in mid/late Nov. and the subsequent rescue of BofA after the MER financials blow-up. Any change in policy direction now would have even greater effects on confidence.
In Nov. we crossed the Rubicon. Now we're stuck with devising ingenious schemes to give these banks more money without making it too obvious. That is Giethner's task.
Posted by: d4winds at Feb 23, 2009 11:40:35 AM
For the record, Travelers was spun out of Citi a while ago. Then it merged with St. Paul, and the company is now called St. Paul Travelers. But that's just a detail.
Posted by: James Kwak at Feb 23, 2009 9:25:52 PM
Tyler, please post more on this issue, in response to comments. Your posts on this blog are generally concise and to the point, which is wonderful in its own way. But there are so many moving parts and so many issues at stake here that a (much) longer post seems called for.
Pretty please?
Posted by: Kent at Feb 24, 2009 5:25:46 PM
