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.


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.

um, it's not like AIG -- a holding co. -- wasn't resolved without the world collapsing...

also re: chile mpettis -- -- points to a nice paper:

oh and chile was just written up favourably for its counter-cyclical measures - “being a Keynesian means being one in both parts of the cycle†

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.

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).

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.

Tyler has said nothing but "Too big to fail." Not convincing.

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:

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.

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?

For folks interested in understanding Citigroup better, there is a website that shows regulatory reports on Bank Holding Companies called the National Information Center.

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:

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.

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!

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?

Here is a video on the stimulus you should all watch. Tyler, what about a thread on the finer points of this video?

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.

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.

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.

Bank nationalization is possible for the small banks Manchester that operate in a rather small geographic area. But when it comes to giants like Citicorp, such a prospect is not possible because of the globalization of it's services and holdings.

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