Spero Consulting

Posts Tagged ‘Citi’

The Wall Street Jour­nal has an excel­lent edi­to­r­ial in today’s edi­tion: The $100 Mil­lion Banker.

Why do we say the edi­to­r­ial is “excel­lent?” For the usual rea­son; it is nearly iden­ti­cal to what we’ve writ­ten in the past: give Mr. Hall his money and ban prop trad­ing at reg­u­lated banks.

If you missed those posts, see these two recent ones: Prop Trad­ing and Pay at Banks and The Chil­dren Who Have Eaten Their Cake… Those two pro­vide links to many related ones, too. The lat­ter one promises an addi­tional new post about the dis­pute, but we’ve not had time to fin­ish it, and it won’t hap­pen today.

Yes, reg­u­lar read­ers will notice that this is a very short post for us. While we’re nearly sur­rounded by a tem­per­ate rain for­est, if the lawn is not mowed today, the for­est will be that much closer tomor­row. That what hap­pens when it rains and shine nearly every day for sev­eral weeks in the mid­dle of the sum­mer. (And, yes, dear reader, like Tol­stoy, we enjoy toil­ing in the field with the (other) peasants.)

We hate it when one of our favorite quotes is used against us, but that is the nature of our queen and chair­man. (Although she does it in a good-​natured, light-​hearted, and humor­ous way, there is steely resolve in her teas­ing words.)

Actu­ally, she didn’t use the exact quote; instead, she updated it and made it more rel­e­vant to the sit­u­a­tion at hand. That made it all the more painful. Her ver­sion with ref­er­ence to today’s lunch, or shall we say the absence of lunch was: “The chil­dren who have eaten their Pani­nis are the nat­ural ene­mies of the chil­dren who have their (left-​over) pizza.”

That’s not very dif­fer­ent than Jeremy Bentham’s orig­i­nal quote from 1844. “The chil­dren who have eaten their cake are the nat­ural ene­mies of the chil­dren who have theirs.” In some sense, she just Ital­i­cized it.

By the way, we think Bentham’s one-​line quote, and the sur­round­ing text, which we show below, per­fectly describes the pet­ti­ness and envy that is exem­pli­fied by the Congress’s behav­ior regard­ing the AIG bonuses in the Spring, the cre­ation of the Obama administration’s silly “pay czar” posi­tion, and the recent pub­lic­ity regard­ing Andrew Hall’s $100 mil­lion pay dis­pute with Cit­i­group. Envy and power – much like in the Russ­ian Rev­o­lu­tion and many other sim­i­lar set­tings – are a ter­ri­ble combination.

Very shortly we hope to pub­lish our say on ways to resolve the dis­pute between Mr. Hall and Cit­i­group. It is a very inter­est­ing prob­lem: like a three-​person game of chicken. In fact, we were gath­er­ing our thoughts by the pool, when we decided to ven­ture into the house for her left-​over pizza. Unlike our gov­ern­ment or the Bol­she­viks, we had no chance to behave opportunistically.

How­ever, rather than dis­cussing Mr. Hall’s par­tic­u­larly prob­lem, which involves the government’s (and pos­si­bly Citi’s) ex post oppor­tunis­tic behav­ior, we’d pre­fer to men­tion a quite gen­eral and viable solu­tion. It is so viable, that it is pos­si­ble that trad­ing firms have already imple­mented sim­i­lar schemes, but we doubt it.

We have in mind very for­mal and objec­tive shar­ing rules for daily trad­ing gains and losses com­bined with other objec­tive, long-​term per­for­mance (and risk) mea­sures. We think it would be worth­while to have cre­ate indi­vid­ual trust accounts, admin­is­tered by an inde­pen­dent third party, which set­tle each trad­ing day to accu­mu­late a trader’s share of his pro­pri­etary gains and losses. A sim­ple lin­ear con­tract that pays a per­cent­age of gains and the same per­cent­age of losses could work, but any­thing cal­cu­la­ble and under­stand­able would work, also. Each day, the account would set­tle – like any other daily set­tle­ment or clear­ing­house agreement.

Note that noth­ing in the pre­vi­ous para­graph pre­cludes such a con­tract from being long-​term in nature, nor does such an arrange­ment nec­es­sar­ily per­mit the trader to with­draw the funds at will (although like many 401K plans, firms could per­mit traders to bor­row against the accrued bal­ances at some mar­gin or hair­cut). More­over, noth­ing men­tioned above would pre­clude the use of claw­backs or other long-​term fea­tures – as long as they are objec­tive, and con­tractible in nature, and (there­fore) administer-​able by a third party.

The non-​opportunistic admin­is­tra­tion of the trust by a third party is the key. It elim­i­nates the pos­si­bly sub­jec­tive, capri­cious, and arbi­trary types of arrange­ments that we dis­cussed in Claw­backs: the Good, the Bad, and the Ugly. (We also men­tioned them in Incen­tives at UBS and in Gen­eral and Risk Con­cen­tra­tion, Con­cen­trated Losses and Incen­tives and a host of other posts.)

We’ll likely write more in the future on this type of arrange­ment. In our mind, if senior man­agers of trad­ing groups can’t spec­ify the major pro­vi­sions of such con­tracts, then they prob­a­bly don’t under­stand what their traders are doing and prob­a­bly shouldn’t be senior man­agers. So, if direc­tors forced such arrange­ments into trad­ing areas, there is a chance that over­all man­age­ment and con­trol would be improved. (After writ­ing that, we real­ize how hope­lessly naïve it reads.)

Of course, the above sug­ges­tions apply only to pro­pri­etary trad­ing, not for hedg­ing or trad­ing with cus­tomers. Also, because we – as a tax-​payer – have absolutely no desire to sub­si­dize prop traders – we get none of their gains – we think prop trad­ing at insured insti­tu­tions should be banned. More­over, we cer­tainly believe that the gov­ern­ment has the right to limit pay at insured insti­tu­tions, but those lim­i­ta­tions should be known and spec­i­fied before the con­tracts are signed, not after­wards as in the AIG exec­u­tives’ cases or pos­si­bly in Mr. Hall’s case.

Finally, if you found this inter­est­ing, you may like these related analy­ses: Incen­tives and the Finan­cial Cri­sis and Busi­ness Schools, Incen­tives, Uncer­tainty, and the Finan­cial Cri­sis.

There is an arti­cle in today’s edi­tion of The Wall Street Jour­nal that attempts to frame Citi’s pay “dilemma” with trader Andrew Hall of its Phi­bro unit as some type of Gor­dian Knot: Citi in $100 Mil­lion Pay Clash. It’s not.

It seems that Citi­corp will legally owe Mr. Hall about $100 mil­lion for his com­pen­sa­tion in 2009, but Citi’s senior man­agers are con­cerned about the polit­i­cal ram­i­fi­ca­tions of pay­ing such a large amount. The last time we checked, Citi had taken about $45,000,000,000 – yes, $45 bil­lion – from wealthy, middle-​class, and poor tax­pay­ers, and those tax­pay­ers had guar­an­teed losses of a few hun­dred bil­lion more.

We sup­pose that folks at Citi are con­cerned that the Obama admin­is­tra­tion and the pop­ulists in Con­gress will attempt to penal­ize the firm – or pos­si­ble incrim­i­nate the man­age­ment – for mak­ing such large com­pen­sa­tion pay­ments. (Note: since at least the found­ing of the FDIC in 1933, Con­gress has had the leg­isla­tive power to have ban such con­tracts, but has cho­sen not to do so.)

We’ve writ­ten a few times about the impor­tance of the rule of law, and it’s quite shame­ful that many of our elected offi­cials and rep­re­sen­ta­tives place such lit­tle value on it. (These are exactly the indi­vid­u­als that our Found­ing Fathers tried to pro­tect against.) It’s almost as shame­ful as Mr. Obama stu­pidly insert­ing him­self into the Gates/​Cambridge Police mess; he does need to learn to shut-​up.

We wrote about the AIG pay con­tro­versy in It Truly Is Dis­grace­ful! and Con­fis­ca­tory, Abu­sive Tax­a­tion: It’s Ali­men­tary (and Dan­ger­ous), and we don’t see this emerg­ing con­tro­versy as being any different.

That being said, we do believe that prop trad­ing should be elim­i­nated at insured insti­tu­tions, includ­ing Citi­corp, because we see no rea­son that tax­pay­ers, includ­ing our­selves, should sub­si­dize their risk-​taking. We first rec­om­mended it in Octo­ber in the aptly titled, Elim­i­nate Pro­pri­etary Trad­ing at Insured Insti­tu­tions, and men­tioned it many time since then, includ­ing our recent post, Paul Vol­cker Has It Right.

It seems that Mr. Hall earned his huge com­pen­sa­tion award because he and his trad­ing group gam­bled and won big. How­ever, it was quite pos­si­ble for him to have lost (and lost big). That would have increased the size of Citi’s losses and required addi­tional tax­payer subsidization.

We don’t know Mr. Hall, but we do wish him every suc­cess in the world. We just have absolutely no desire to back­stop him (and it’s not just his pen­chant for mod­ern art).

We pre­fer that he work for a trad­ing unit of a non-​insured insti­tu­tion or run a hedge fund so that we don’t have to sup­port him if he fails. In fact, a very short arti­cle in the Journal’s Heard on the Street sec­tion, Hedge Funds’ Pro­pri­etary Advan­tage, describes how many hedge funds are cur­rently doing quite well (after many recent dis­as­ters last year). That’s the nature of the busi­ness. Let those will­ing to take the risks, reap the rewards AND bear the con­se­quences of fail­ure. (Is it too really much to ask?)

Per­haps Mr. Hall would like to pur­chase the Phi­bro unit from Citi and accept those same risks and rewards that other fund oper­a­tors face. It seems that clos­ing the sale before the end of the cal­en­dar year would (or could) be a grand out­come for both Mr. Hall and Citi. We think that ban­ning prop trad­ing at insured insti­tu­tions as of Jan­u­ary 1, 2010, would go a long way towards slic­ing through sim­i­lar knotty sit­u­a­tions at other banks.

One final note: in the tra­di­tion of horrendously-​arranged gov­ern­ment web sites, see the above-​mentioned FDIC site. It’s ugly and busy and has no focus, and it’s just what we expect from our bureau­cracy. Does the reader have any higher expec­ta­tions? Be honest.

The Wall Street Jour­nal has an edi­to­r­ial in today’s paper – Jan­u­ary 14 – that seems to be ripped from our head­lines: it calls for the dis­mem­ber­ment of Cit­i­group, and it implies that Citi has lost its right to exist. (See When Is Enough Enough?, for exam­ple, or any of our calls to nation­al­ize it.)

As we’ve seen in var­i­ous news reports, Cit­i­group has lost about $30,000,000,000 or so in the last five quar­ters and has received about $45,000,000,000 in TARP funds, and the fed­eral gov­ern­ment has guar­an­teed another $250,000,000,000 or so of its debts.

And yet, and yet, Citigroup’s stock price is about $5, which gives it a mar­ket value, accord­ing to Google Finance of about $32 bil­lion. That’s less than 10% of its share price two years ago and about 20% of its share price this time last year.

As a point of com­par­i­son, if the fed­eral gov­ern­ment gave us $45 bil­lion, we would be worth $45 bil­lion. (Well, almost $45 bil­lion, but a lot closer to $45 bil­lion than $32 bil­lion. And, yes, we know there is a dif­fer­ence between the government’s pre­ferred invest­ment and mar­ket value of the com­mon shares.)

Hmmm, with­out both­er­ing to check the tax impli­ca­tions, let’s gross-​up the loss of about $30,000,000,000 to the $45 bil­lion. That means that the gov­ern­ment has sub­si­dized all of the rec­og­nized losses to date.

So, despite the guar­an­tee of debt, which could be val­ued the same way that banks esti­mate val­ues of their insured deposits, and despite the addi­tional deposit insur­ance cov­er­age, etc., soci­ety and the world econ­omy think that Cit­i­group isn’t worth a whole lot.¹

Dili­gent, and younger read­ers with good mem­o­ries, may recall that as far back as Sep­tem­ber we sep­a­rated the mort­gage fiasco from the larger, and far more seri­ous, liq­uid­ity cri­sis in con­fi­dence. (Here’s an entry from early Octo­ber: Even A Per­fect Bailout Will Fail.)

We cite Cit­i­group as prima facie evi­dence of that dis­tinc­tion. Based upon equity val­ues – despite the government’s mas­sive injec­tion of funds and its guar­an­tees – we’d say that the mort­gage fiasco has informed investors through­out this coun­try and across the world that’s Citi’s man­age­ment excels at value destruc­tion, and that’s the con­sen­sus prospec­tive esti­ma­tion. That is, of course, unless investors esti­mate that rec­og­nized losses, which appear on finan­cial state­ments, are only a frac­tion of Citigroup’s true losses so far.

This wouldn’t be the first time that Cit­i­group under-​estimated its losses. As the Jour­nal edi­to­r­ial notes, in Octo­ber, 2007, Citi offi­cials claimed that it had only “$70 mil­lion in indi­rect expo­sure to sub­prime assets.” Now, how many orders of mag­ni­tude is that from the truth? So whether clue­less or duplic­i­tous, “why trust them?” the mar­ket seems to be saying.

In this case, it seems hard to argue with that logic.

By the way, the front page head­line of today’s paper is “Cit­i­group Ready to Shrink Itself by a Third.” We won­dered – in jest – why the sec­ond line didn’t read, “In Small Attempt to Align Assets with Equity Values.”

Like always, we may edit this post in the future, in case our early-​morning, frost­bit­ten fin­gers have erred.

Copy­right © 2009 Spero Consulting.

Foot­note:

Last Mon­day, The Wall Street Jour­nal pub­lished a small sur­vey of mostly aca­d­e­mic econ­o­mists in Experts’ Rx on How to Get Out of This Mess. (Per­haps “aca­d­e­mic econ­o­mist” is redundant.)

We couldn’t tell whether a few of the replies were poorly edited or were inher­ently trite, e.g., to para­phrase we need long-​term solu­tions, new risk mea­sures, and the abil­ity to sep­a­rate the good and bad firms. You don’t say!

Any­way, we did like Dou­glas Diamond’s response: “You have lots of car­rots and no sticks right now.”

The reporter, Justin Lahart, must have para­phrased the rest of Mr. Diamond’s reply because there were no other quo­ta­tion marks. He wrote: “One alter­na­tive would be leg­isla­tive changes that would allow reg­u­la­tors to quickly wipe out exist­ing share­hold­ers at prob­lem banks with­out invok­ing bank­ruptcy, and con­vert long-​term debt issued after the leg­is­la­tion went into effect to equity. That would effec­tively recap­i­tal­ize the bank with­out the need for gov­ern­ment money. And it would give big incen­tives to investors to buy banks’ debt, and to banks to raise cap­i­tal in order to keep their share­hold­ers from being wiped out.”

Now, we’re not­ing his remark a week after that arti­cle was pub­lished because, today, we saw on the same web site that it’s esti­mated that Citi lost another $10,000,000,000 in the fourth quar­ter of 2008. That means that it’s lost about $30,000,000,000 since Hal­loween, 2007, and that seems like a lot of money to us. We haven’t both­ered to check it, but that $30 bil­lion would be after-​tax, which means gross losses were even larger.

Of course, Citi was one of the firms that “res­cued” by the gov­ern­ment, and of that much has been writ­ten about that by many peo­ple, includ­ing at our site.

Sadly, today we also saw Mr. Bush request the “other” $350,000,000,000. (When the Feds decide to uri­nate our tax dol­lars away they do it on a scale rarely seen out­side of Nia­gara Falls.)

These recent losses and the government’s will­ing­ness to sub­si­dize make us ask: when is enough, enough?

To be clear with our read­ers, we don’t do this out of vengeance or spite or envy nor, unfor­tu­nately, even a sense of amuse­ment. In fact, we write in the spirit of the fol­low­ing excerpt from Leviti­cus 19:17 — 18, which we saw in our Mag­ni­fi­cat last week:

You shall not bear hatred for your brother in your heart. Though you may have to reprove your fel­low man, do not incur sin because of him.

Take no revenge and cher­ish no grudge against your fel­low coun­try­men. You shall love your neigh­bor as your­self. I am the LORD.

In that spirit, and con­sis­tent with Mr. Diamond’s rec­om­men­da­tion, we ask, when do we get to see the offi­cial reproof? When do these folks lose their right to con­trol assets, and when do these cor­po­ra­tions – legal enti­ties – for­feit their exis­tence and charters?

If you’re famil­iar with our writ­ings, then you know that we think they are far past that point of no return for many cor­po­ra­tions. Exactly how less trust­wor­thy must they become before the gov­ern­ment inter­venes per ours or Mr. Diamond’s recommendations?

The Curi­ous Case of Robert Rubin

The week­end edi­tion of The Wall Street Jour­nal has a front page inter­view with Robert Rubin: Rubin, Under Fire, Defends His Role at Citi.

We’ve crit­i­cized Citi’s board in the (recent) past, and we’re still par­tic­u­larly fix­ated on the fact that few direc­tors had finan­cial indus­try expe­ri­ence. That seems nei­ther wise nor even pru­dent for a finan­cial insti­tu­tion with over $3,000,000,000,000 of assets. (That’s $3 tril­lion, but we like to write it out for effect, because it seems like a lot of money.)

As the arti­cle men­tions, Mr. Rubin was “the only board mem­ber with expe­ri­ence as a trader or risk manager.”

Since 1999, Mr. Rubin has made about $119 mil­lion from Cit­i­group while hav­ing no oper­at­ing respon­si­bil­i­ties. We have absolutely no prob­lem with that, and, in fact, are look­ing for sim­i­lar “work” our­selves. (Inter­ested par­ties may use our con­tact form.)

Where we do have a prob­lem is his insis­tence that none of Citi’s prob­lems is his respon­si­bil­ity. As the inside head­line reads: “Rubin Blames Citigroup’s Woes on the Broader Finan­cial Cri­sis.” He almost seems to imply that Cit­i­group is a hap­less, unwit­ting vic­tim of some­thing big­ger than itself – some­thing it couldn’t be expected to con­sider, man­age, of fathom: “Nobody was pre­pared for this…”

In that case, exactly what type of stew­ard­ship, guid­ance, and pro­fun­di­ties did he provide? 

Sup­pose it is true that Citi and its board were fault­less. Shouldn’t they have been able to con­sider how they might be dam­aged by a gen­eral down­turn or a finan­cial cri­sis that was no fault of its (their) own. Thus, our lit­tle proof-​by-​contradiction shows the silli­ness of the argument.

More­over, we doubt that even the gullible buys the story that Citi was sim­ple a vic­tim of exoge­nous fac­tors, which were unpre­dictable and beyond its control.

There is a cri­sis of con­fi­dence, but that cri­sis erupted and sur­vives because mar­kets and investors real­ized the large finan­cial insti­tu­tions, includ­ing Citigroup, were far less com­pe­tent invest­ing and trad­ing than they pre­vi­ously believed, i.e., that in ret­ro­spect, pre­vi­ous reported prof­its were unreal and unsustainable.

Citigroup’s share price of $8.29, which is about dou­ble where it was last week­end, has lost about 85% of its value in two years. (In the first three years of the Great Depres­sion – 1929 — 1932 – the Dow Jones Indus­trial Aver­age lost the same per­cent­age with­out a back­stop by gov­ern­ment.) That is an indict­ment against Citigroup’s way of doing busi­ness far beyond the gen­eral con­dem­na­tion of the finan­cial ser­vices indus­try in gen­eral and with all of the sub­si­dies pro­vided by tax pay­ers through the var­i­ous recent gov­ern­ment guar­an­tees and bailout measures. 

Clearly, investors find fault with Citi’s strate­gic and oper­at­ing deci­sions. So, if Mr. Rubin wasn’t mak­ing oper­at­ing deci­sions, what type was he mak­ing? If they weren’t strate­gic, what remains? As other crit­ics note, Mr. Rubin is “try­ing to have it both ways.”

Of course, his pos­tur­ing is silly, as it was he, him­self, who pushed senior man­age­ment to bear more risk in 2004 — 2005. If that’s not a strate­gic, board-level, decision, what is? From our read­ing, it seems that he may now be try­ing to blame a con­sul­tant for sug­gest­ing the board instruct man­agers to take addi­tional risk.

He also blames senior man­age­ment for not exe­cut­ing the strate­gic plans prop­erly and risk man­age­ment for, well, weak risk management. 

“I wouldn’t run a finan­cial insti­tu­tion based upon someone’s view about what mar­kets would do.”

Of course, as the arti­cle explains that is exactly what he did in 2004 — 2005. (We wouldn’t doubt that he did it at other times, too, but don’t have the time or energy to search for quotes or sto­ries.) Well, he didn’t do it based upon some­one else’s view; instead, Citi’s strat­egy seemed to be based upon his own views. (We could well imag­ine board­room dis­cus­sions where inex­pe­ri­enced direc­tors imme­di­ately defer to the for­mer Trea­sury Sec­re­tary and Gold­man Sachs Co-​Chair.

Now, Mr. Rubin should know that devel­op­ing and acknowl­edg­ing such a world-​view is exactly how finan­cial insti­tu­tions are run, whether that view is explic­itly stated or not. (If it is not explicit, then not pro­vid­ing such a view and or con­sid­er­ing its impli­ca­tions seems neg­li­gent at worst and imma­ture at best, ergo, our title.) What else could strate­gic and oper­at­ing plans be based upon? How else could risks be mea­sured, uncer­tain­ties be con­sid­ered, and con­tin­gen­cies be planned? Or are those con­sid­er­a­tions too much like work? If so, it is not dif­fi­cult to see why Citi is where it is at this Novem­ber, and that is com­pletely con­sis­tent with both a spe­cific and the more gen­eral cri­sis in confidence.

As we see it, Mr. Rubin is seventy-​years-​old. He should grow-​up and accept the respon­si­bil­i­ties that come with his posi­tion and rewards, and stop behav­ing like a petu­lant teenager.

Bill’s and Bill’s, Bill’s and Bill’s
It’s bailout time, for the Citi
Plead-​a-​ling, hear them sing
To-day, it is our bail-​out day!

Citi side­ways, Wall Street side­ways
Dressed in bank hol-​i-​day style
In the air there’s a feel­ing of Christ­mas
Bankers laugh­ing, taxes pass­ing
Wast­ing pile after pile
And on every street cor­ner you’ll hear…

Trill’s and Trill’s, Trill’s and Trill’s
It’s Christ­mas time for the Citi
Plead-​a-​ling, hear them all sing
“We want our own bail-​out day!”

*With all due respect and apolo­gies to Ray Evans and Jay Liv­ingston and their clas­sic, Sil­ver Bells, and for the truly clue­less, note that we’re abbre­vi­at­ing bil­lions and tril­lions to fit the tune.

Note: We’ll likely expand and edit this post in the morn­ing, but wanted to cir­cu­late the idea before bedtime.

We’re rather dili­gent – but not obsessed– about keep­ing up with finan­cial new.¹ We’ve heard many finan­cial firms announce lay-​offs and have read how at a few, like Gold­man, senior man­agers have decided to forgo bonuses.

As we recall, most banks have announced with­drawals from sub­prime mort­gage orig­i­na­tion and loans, which seems like a wise move, but given the mag­ni­tude of their errors and mis­takes, we’re very sur­prised that we haven’t read more about banks tak­ing dra­matic and dras­tic actions to limit risks and exposures.

We don’t mean hoard­ing cash and the knee-​jerk reac­tions not to lend. We’re think­ing more about their invest­ing, trad­ing, and struc­tur­ing operations.

Maybe the banks are elim­i­nat­ing desks and floors, but they just aren’t talk­ing about it, or maybe they have men­tioned it, but we’ve missed it.

We’d cer­tainly encour­age finan­cial firms to change their ways. In fact, while we’re close to Lib­er­tar­ian on many eco­nomic issues, we wrote on Octo­ber 11, to Elim­i­nate Pro­pri­etary Trad­ing at Insured Insti­tu­tions as a way to mit­i­gate moral haz­ard and pro­tect tax-​payer interests. (Once they’re insured, it is no longer a free mar­ket, and there should be quid pro quo, not just subsidization.)

On Sep­tem­ber 24, in our post Could a “Bailout” Pro­long the Finan­cial Cri­sis?, we wrote:

So, if the government’s pur­chase of these thin­gies is approved, we would expect to see a con­tin­u­a­tion of the pan­icky behav­ior until the secu­ri­ties are actu­ally trans­ferred to the gov­ern­ment because it is unlikely that any­one will know who has the worse ones so (means that) all remain sus­pect. (Also note that the most pan­icky firms might be ones who are pro­ject­ing their port­fo­lios onto oth­ers, and so might be the ones that other firms would like to avoid.)

Now that the TA is out of TARP, it seems that this week’s equity mar­ket per­for­mance, par­tic­u­larly among finan­cial firms, sup­ports our Sep­tem­ber 24^th pre­dic­tion above, i.e., the con­tin­u­a­tion of pan­icky behav­ior until actual trans­fers occur. We dis­cussed related issues on Octo­ber 7, in Even A Per­fect Bailout Will Fail.

Or maybe they’re just tak­ing a wait-​and-​see approach. That’s what we pre­dicted in early Octo­ber when we described the very high prob­a­bil­ity of fail­ure of TARP.

Today’s Wall Street Jour­nal reports that Citi Weighs Its Options, Includ­ing Firm’s Sale, and we won­der if it will sur­vive the weekend.

As we argued in Big­ger Is Not Nec­es­sar­ily Bet­ter way back in Sep­tem­ber, we see no rea­son to encour­age mega-​mergers and we based that argu­ment on both moral haz­ard and sys­tem­ati­za­tion of idio­syn­cratic risk considerations.

So, as we argued in around Octo­ber 10, we believe that It’s Time! to nation­al­ize the worst offend­ers leav­ing no share­hold­ers, except non-​executive employ­ees, with any own­er­ship inter­ests. We reit­er­ated much of the same argu­ment in a very long post from Wednes­day: OMG, Mr. Paul­son Agreed with Us Twice in One Week! (Yeah, we have a teenager.)

It seems that given its size of around $2,000,000,000,000, we tax­pay­ers will be on the hook for Citi, any­ways, so why not elim­i­nate the mid­dle­man and pro­vide any upside ben­e­fit to the true resid­ual claimants?

In two recent posts, The Fail­ure of Boards to Direct and When the Going Gets Tough…Quit, we’ve crit­i­cized the com­po­si­tion of Citigroup’s board because of their gen­eral lack of finan­cial indus­try expe­ri­ence. (We’re sorry, but that seems uncon­scionable to us.)

We won’t repeat all of our argu­ments for nation­al­iza­tion, but the expro­pri­a­tion of Cit­i­group would cer­tainly moti­vate other banks to act quickly and largely to mit­i­gate risks and sta­bi­lize cash flows. (It would likely stop insur­ance com­pa­nies and oth­ers from buy­ing small banks or S&Ls in their beg­garly attempts to become bank hold­ing companies.)

By the way, for new read­ers, we’re not just for the nation­al­iza­tion of a few banks, we actu­ally have a pri­vate solu­tion for the mort­gage cri­sis that involves pro­vid­ing the right tax incen­tives – like invest­ment tax cred­its – to indi­vid­u­als, firms, and fund man­agers. (Read about it here: A Bet­ter Solu­tion (than a gov­ern­ment takeover).)

That solu­tion to the mort­gage cri­sis stills leaves the larger liq­uid­ity or con­fi­dence cri­sis for banks. That has arisen because the mort­gage cri­sis has informed us (and oth­ers) that despite their pseudo-​sophistication and the veneer of objec­tiv­ity and sci­ence (almost), there is a very good chance that they don’t under­stand their envi­ron­ment or have reli­able ways to value many of their prod­ucts – despite their mas­sive invest­ments and activ­i­ties for those pur­poses. In terms of an adverse selec­tion prob­lem, they’ve reveal them­selves to be low types. (See last week’s Global Warm­ing and the Mort­gage Cri­sis for a dis­cus­sion on that topic.)

So, as a nation, we should want (and attempt to moti­vate) the banks to act quickly and deci­sively (and with their pri­vate infor­ma­tion) to get their accounts in order.

The ben­e­fits of TARP don’t seem to have pro­vided the cor­rect moti­va­tion to the bank­ing firms to act to main­tain their own liq­uid­ity and cap­i­tal posi­tions. We’d argue that this is an incen­tive prob­lem and that if the ben­e­fit of the TARP “car­rots” have been insuf­fi­cient moti­vate socially-​optimal behavior. So, per­haps a “stick,” like the threat of expro­pri­a­tion, induce clean-​up. More­over, it is seems that Citi will be ours any­way, so, why not give it a try on tax­pay­ers’ terms rather than tax­pay­ers’ backs?

Anal­o­gously: The Gangs That Can’t Shoot Straight

Last week in The Under­state­ment of the Year! we wrote, “The prob­lem, dear reader, is that few senior man­agers (and almost no board members) understand the val­u­a­tion and risk mod­els used for securitizations…”

Today, there is an arti­cle in The Wall Street Jour­nal, Citi Direc­tors Mull Replac­ing Chair­man, that pro­vides addi­tional evi­dence to sup­port our claim.

To be frank, unless it is we, we don’t really care who Citi selects as a chair­man, and we doubt that you do, also.

We’re more inter­ested in the way that the article’s writ­ers describe board mem­ber Richard Par­sons as “one of the few Cit­i­group direc­tors with expe­ri­ence in finan­cial services.”

One of the largest finan­cial ser­vice firms in the world, and only a few direc­tors with (any type of) finan­cial ser­vice expe­ri­ence. How could they lose? we ask sar­cas­ti­cally. There is a mul­ti­tude of types of expe­ri­ence with finan­cial ser­vices firms; so, we’d argue that while such expe­ri­ence is nec­es­sary, it is by no means suf­fi­cient to under­stand and eval­u­ate com­pli­cated prod­ucts, hedges, strate­gies, and risks.

To be faced with such inex­pe­ri­ence, it must be the case that either senior man­agers are par­tic­u­larly poor judges of tal­ent or those inex­pe­ri­enced direc­tors were nom­i­nated specif­i­cally because they lacked expe­ri­ence or despite their lack of experience. 

The for­mer rea­son for pur­posely select­ing the inex­pe­ri­enced is clearly cyn­i­cal and involves senior man­age­ment attempt­ing to nom­i­nate mem­bers who are much more likely to be weak and unable to pro­vide the req­ui­site level of oversight.

The lat­ter rea­son may or may not be cyn­i­cal. For exam­ple, an unknowl­edge­able direc­tor may have been cho­sen because he or she is par­tic­u­larly savvy and a fast learner (not cyn­i­cal) or because he or she has a mem­ber­ship at Augusta or Oak­mont or some other exclu­sive golf club where senior man­agers might like to play (very cynical).

Now, we’re will­ing to stip­u­late that in many mar­ket and eco­nomic set­tings, it may not seem to mat­ter. In fact, it is pos­si­ble in the over­whelm­ing major­ity of the cases that it doesn’t seem to mat­ter, but that doesn’t mean that such nom­i­na­tions are indeed consequence-​free.

For such cases, we like the anal­ogy of a cop who is a par­tic­u­larly bad shot. That fact is almost never directly rel­e­vant as law enforce­ment offi­cers rarely draw their weapons and fire. So, it may seem that it doesn’t matter.

Unfor­tu­nately, the self-​aware offi­cer real­izes that he or she is a poor shot and acknowl­edges his or her inabil­ity to respond effec­tively to extreme sit­u­a­tions. This knowl­edge likely col­ors or influ­ences his or her behav­ior in all set­tings, includ­ing inci­dents where only a very small prob­a­bil­ity of esca­la­tion exists. 

Such behav­ior is usu­ally cor­rectly inter­preted by the other rel­e­vant par­ties as weak­ness. How­ever, in some cases the officer’s may over-​react or behave in an extremely risk-​averse man­ner due to his or her per­sonal inse­cu­rity. Regard­less, in both cases, the officer’s and society’s well-​being has been compromised.

It is much the same with gov­er­nance and risk man­age­ment within firms. Those direc­tors lack­ing ade­quate fire­power are unlikely to deter anti-​social behav­ior; thus, weak boards are more likely to induce exces­sive risk-​taking and increased odds of a dis­as­ter (although that real­iza­tion may not occur). Is that increased prob­a­bil­ity of dis­as­ter worth 18 holes at a world-​famous course? Don’t answer that!

We must admit, this is our first post that is truly in bad taste, but it seems so appro­pri­ate that we just could not help our­selves. TARP. TARP.

We’re try­ing to write seri­ously about the government’s – the Trea­sury Department’s – lat­est expe­di­en­cies and tac­tics to … well, we’re not sure of the objec­tive… pre­sum­ably, to make it all go away so that Mr. Bush and his appointees can enjoy their last Autumn and Christ­mas in D.C. (Why would any­one want to ruin Mr. Bush’s last Christ­mas in the White House by caus­ing the pos­si­ble finan­cial ruin of much of the world. Peo­ple can be so mean and self­ish some­times! Can’t we just use the tax­pay­ers’ money to pay them to go away!)

So here is our per­sonal prob­lem. Every time we think of TARP we are reminded of Garp as in John Irving’s The World Accord­ing to Garp. It has been a long time since we’ve read it; so, the details are slightly hazy, but we think we’ve remem­bered enough to draw the cor­rect analogy.

We’re not actu­ally reminded of Garp him­self, so much, but more of his father T.S. Garp, the critically-​wounded, WWII sol­dier, who spends his last days bedrid­den and sense­less in a state­side army hos­pi­tal. As we recall, he had been a ball-​turret gun­ner on per­haps the under­side of a B17 or B24, who took shrap­nel to the head dur­ing a bomb­ing raid over Germany.

“T.S.” were not his first two ini­tials, but rep­re­sented his rank, Tech­ni­cal Sergeant, which is about all of the back­ground his mother, an attend­ing hos­pi­tal nurse in the same ward, knew of his father.

As we recall, despite his dimin­ished state, T.S. Garp had one com­pul­sion, which he seemed to be able to do uncon­sciously and def­i­nitely not self-​consciously. Dur­ing these com­pul­sive episodes, he would repeat his name, “Garp, Garp.…” As his con­di­tion wors­ened, his mantra changed to “Arp, Arp…” and finally, just before his death to “Ar, Ar…”

In our mind, many of the Treasury’s recent tac­tics don’t seem that dif­fer­ent than T.S. Garp’s last efforts. How­ever, within a shorter period of time – less than two weeks – they seemed to have gone from “TARP, TARP…” to “RP, RP.…”

The injec­tion of cap­i­tal to “save the banks” seems to be noth­ing more than a Relief Pro­gram. Cor­po­rate wel­fare and crony­ism at its self-​indulgent best.

So did yesterday’s tough talk go like this? “We’re forc­ing you to take this money, which no one else will lend to you, and you won’t lend to each other. Fur­ther­more, to show you we mean busi­ness, we’re going to guar­an­tee your debt for a frac­tion of the true, underlying, insurance pre­mium, and finally, before you say any­thing, know that we’re going to insure your deposits, too. That should teach you to get into a mess like this, again.” Maybe Mr. Paul­son should read John Rose­mond, rather than con­tact­ing his for­mer employ­ees and his friends for advice on how to save themselves.

Once again, shame on them.

As they spend our money–all of our money–the cru­elty of those two near-​homonyms, sense and cents – all 70 tril­lion of the lat­ter – becomes bru­tally clear.