naked capitalism

The irony is rich, and a bit sad. I had Citi as a client in the 1980s, and served them in a small way in their efforts to make inroads into investment banking. It looked like a quixotic effort with commercial banks seeming likely to remain relegated to the margins: smaller clients, simpler deals. JP Morgan, which seemed better positioned than Citi back then by virtue of having deeper relationships with the very biggest corporate clients, also had a huge uphill slog. If you looked at the return on JPM’s decade long pursuit of its goal in the early 1990s, when it was finally starting to get some traction (in the plan vanilla, lowest margin products) I am sure the return on investment would have been mighty unattractive.

But never underestimate what a determined competitor can achieve if he keeps at it. Ironically, commercial banks succeeded, just as Japanese automakers did, in becoming serious players in a market where no one thought they had much of a chance. But no Japanese carmaker has come to as sad an impasse as Citi, hoist on the petard of its ambition.

Now one can say it really isn’t sad, that Citi had pursued a model of serving too many customers in too many markets. I agree with that; I’ve long been a skeptic of the universal banking model (save perhaps in small markets, like single countries). The complexity of the organization grows way beyond management’s ability to exercise proper oversight. And when you have large chunks of the empire in the hands of traders and investment bankers, whose first loyalty is to their paycheck, any deficiencies in oversight will most assuredly come back to haunt you.

But more broadly, I have said in earlier posts that a Citi tidiing itself (provided it isn’t an emergency move due to a cash hemorrhage) is a very big step forward, not just for the bank, but for the economy. The banking sector needs to be restructured, rationalized, and recapitalized. Unwieldy bank (and Citi is the biggest sinner here) posed the biggest problem. Citi moving forward to a more manageable structure is an important step forward, And even if the constituent parts of Citi are still too big to fail (the jury is out here), it is easier to clean up smaller units.

Another big plus is that moves like this may help reduce the interconnectedness of the banking system. Citi so far is a lone actor, but its moves may be emulated elsewhere (in just about every field, you see consolidation waves followed by breakups to create “pure plays” with M&A pros profiting at every turn). Richard Bookstaber has argued that our financial system has become tightly coupled, that “events” propagate quickly through the system with no firebreaks or easy ways to interrupt these processes. Having smaller, more focused players will somewhat reduce the excessive integration of the financial system, and thus lower the odds of systemic failure.

From the Financial Times:

Citigroup is to break itself up by separating a large portion of its troubled investment bank and higher-risk US consumer finance businesses from its global commercial banking operations in a dramatic attempt to ensure its survival…

Yves here, My understanding is that the institutional banking operation has its own P&L and management information system, so this split would in theory not be hugely difficult to implement from an operational standpoint. Back to the piece:

Bankers said that the unwanted parts could be eventually spun off into a wholly separate entity but, until then, it was likely to operate as an arms-length unit of Citi, in an attempt to isolate badly-performing businesses and assets.

It would also limit its reach in the US, where Citi never had the extensive branch network of rivals such as Bank of America and JPMorgan Chase. Citi has been under pressure from the US government to raise capital and streamline its diverse portfolio after being rescued with a $300bn bail-out by the authorities in November. The decision by Citi, which has suffered more than $50bn in credit-related losses and is expected to report another huge loss next week in its fourth quarter results, will have repercussions for the global financial industry

US rivals such as JPMorgan, BofA and Wells Fargo could take advantage of Citi’s exit from consumer finance businesses while banks like Goldman Sachs and Morgan Stanley could benefit from its move away from many investment banking operations.