I have been saving up for Mr. Pandit because he is the quintessential crony capitalist. Like all good provocateurs, I am going for the throat here and I’ll start out by referring to him by his popular street name: Vikram Bandit. As we all know, Mr. B is the CEO of Citigroup, the organization that received $45 billion from taxpayers to bail out Citigroup.
By all accounts Mr. B is a brilliant man. A graduate in electrical engineering and Ph.D in finance, and a long stint at Morgan Stanley where he built up a sizable reputation for being able to understand complex financial strategies. He is from a wealthy Indian Brahman caste family and is quite loyal to his family and traditions.
From what I read about him, he is a low-key person who shuns confrontation and loves to solve problems. The one time he stepped out of line was when he joined up with a group of dissident senior managers at Morgan Stanley, and got fired with the bunch when the CEO, Phil Purcell, discovered he had more pull than they did. Purcell said, “I don’t understand. Vikram was my guy,” he told a friend. “I saved his job three times.”
Mr. B then struck out on his own with several other “liberated” Morgan guys and started a hedge fund, Old Lane Partners in 2006. Mr. B was the supposed “genius of the group and headed it up. They had about $4.4 billion under management but did poorly. Their first year yielded a 3% return for investors. Then the magic happened.
Robert Rubin, Citigroup adviser extraordinaire and another classic crony capitalist, lobbied to get Citigroup management to buy Old Lane for a remarkable $800 million in April, 2007. Rubin saw Mr. B as a potential Citigroup CEO. To cut to the chase, Mr. B received about $165 million for his share, and another $48 million in options for a tidy total of $213 million. The funny thing is that Citigroup closed Old Lane down a year later because of losses. At the time of the acquisition the Wall Street Journal said the “$00 million may end up looking like a bargain.” To celebrate his new fortune:
With his windfall, he bought a ten-room, $17.9 million co-op apartment on Central Park West, the former home of the late actor Tony Randall. [Robert] Rubin made little pretense about why Citi had spent so much money: He publicly called Pandit “a genius.”
This had to be one of the worst deals of the century and it smacks of incompetence. The Old Lane managers were incompetent, just sliding along with the boom times. Mr. Rubin and his cronies at Citigroup were incompetent by wildly overpaying for Old Lane, and then setting Mr. B up as CEO in a business he knew nothing about. If Mr. B had any moral sense about this, he would return the money and go back to losing investors’ money.
We all know where this is going. Mr. B became CEO of the $250 billion Citigroup in December, 2007, a company which had a presence worldwide (59% of its revenue). And then came October, 2008 when everything collapsed.
Citigroup was engaged in the same kinds of things all the other banks and investment houses were doing. It would be kind to say that they had no real appreciation of risk. On the Charlie Rose show, Mr. B defended himself and Citigroup’s problems by saying that nobody saw this coming. Well, for sure, neither Mr. B nor anyone else at Citigroup saw it coming. Citigroup had problems before the crash and Mr. B did manage to sock $60 billion away for a rainy day. It wasn’t enough relative to the risk they were taking. He was one of the first to step up to the Treasury window when beckoned by Hank Paulson for TARP (bailout) money. Within a couple weeks Citigroup had borrowed $45 billion, a rather substantial amount. Without it, the likelihood was that Citigroup would have fallen into bankruptcy and its empire split up and sold off.
In my opinion that is exactly what should have happened. I do not believe that their failure would have been the end of the world. Messy, yes, but there were no shortages of banks lining up to take its business. In bankruptcy, a trustee could have looked at all the cross-dealing and cozy transactions like the one whereby Mr. Rubin rewarded Mr. B with company cash. It might have been possible for the court to unwind the Old Lane transaction and get the money back. Who knows, the transaction was old and cold, but incompetence would have been revealed rather than having been papered over.
Yes, you could argue that Citigroup is now starting to make money ($1.31 billion last quarter). Who wouldn’t if they had a $45 billion rescue? Actually if you look at why they are making money, it doesn’t have that much to do with management: the banks are improving their bottom lines by writing off bad loans and dumping had assets, which allows them to convert loan loss reserves accumulated for these assets, and move them back into the profit side of their balance sheets. But they did pay the government back. As a result Mr. B’s star is rising again on Wall Street. It’s enough to induce nausea.
The economic problem here is one of moral hazard. By rewarding bad behavior, there is nothing to stop these actors from doing the same things they did before. Why worry when you know the taxpayers will bail you out if you are too big to fail? And that is exactly what Mr. B is doing now. In effect they are doing the same things as they were doing before. And they still don’t understand risk.
Recently Simon Johnson wrote a scathing criticism of Mr. B’s insistence that increased capital requirements will harm credit and slow down the economy. One of the few needed reforms from the Crash was the requirement of additional Tier 1 capital for banks. Mr. B said with regard to the higher capital standards proposed by Basel III:
“There is a point beyond which more is not necessarily better. Hiking capital and liquidity requirements further could have significant negative impact on the banking system, on consumers and on the economy.”
There you go again Mr. Bandit.
Johnson points to a letter written by economists with whom I would mostly disagree, but which is right on point:
High leverage encourages excessive risk taking and any guarantees exacerbate this problem. If banks use significantly more equity funding, there will be less risk taking at the expense of creditors or governments.
Bankers warn that increased equity requirements would restrict lending and impede growth. These warnings are misplaced. First, it is easier for better-capitalized banks, with fewer prior debt commitments hanging over them, to raise funds for new loans. Second, removing biases created by the current risk-weighting system that favor marketable securities would increase banks’ incentives to fund traditional loans. Third, the recent subprime-mortgage experience shows that some lending can be bad for welfare and growth. Lending decisions would be improved by higher and more appropriate equity requirements.
If handled properly, the transition to much higher equity requirements can be implemented quickly and would not have adverse effects on the economy. Temporarily restricting bank dividends is an obvious place to start.
Nothing has changed.