The Financial Supermarket Is Dead

Citigroup (C) and the financial supermarket are dead.

Citigroup shareholders have been destroyed by a parade of gaffes that arrived courtesy of a hard driving, arrogant culture seeking to dominate everything. The corporate hubris has been repeated at Bank of America (BAC), American International Group (AIG), and to a lesser extent J.P. Morgan Chase (JPM). All parties have exhibited a desperation to compete with each other merely to merge and acquire the U.S. Banking system, as we knew it - into oblivion. Banks that are "Too Big to Fail" are simply too big.

How did we get here? How did we arrive at this ongoing spectacle of staggering billion dollar bailouts, sweetheart preferred stock deals, shotgun marriages that crush shareholders, and stifling government control?

We must revisit the 1933 Glass-Steagall Act.

Glass-Steagall was legislation enacted from the depths of the Great Depression in response to the outright collapse of the U.S. Banking system. Glass-Steagall constructed a wall between insurance, commercial banking, and investment banking. Bank holding companies that accepted deposits and loaned out money were therefore forbidden to underwrite and trade securities. The mandate held for the next 66 years - until it was curiously repealed amidst the height of a feeding frenzy of 1999 stock market dot-com speculation.

Casual observers blame the Republican Party and the 1999 Gramm-Leach-Bliley Act that destroyed financial services' delineation for promulgating today's credit bust mayhem. Of course, reality is far from simple.

Travelers Insurance and Citibank had already driven the deathblow stake into the heart of Glass-Steagall with a brazen 1998 merger that was technically illegal. Also, the Gramm-Leach-Bliley Act may have been introduced by a Republican triumvirate - but the bill was widely supported by legislative Democrats and signed by President Clinton. Citigroup, not the U.S. Government, shall serve as the primary catalyst of this mega-bank, financial supermarket movement.

Citigroup emerged as the most dominant publicly owned financial institution in the world behind the slick deal making of Sanford Weill and his fiery, number crunching lieutenant Jamie Dimon. Beginning from a Commercial Credit Baltimore backwater - the pair navigated the rubble of has-been financial entities to eventually lord over the banking industry.

The Playbook: borrow ridiculous amounts of money, buy decrepit banks on the cheap, slash costs, generate revenue to meet debt service, repeat.

The strategy crystallized into a dizzying decade of mergers and acquisitions from the late 80's and into the new millennium. Gulf Insurance, Primerica, Smith Barney, Shearson, Salomon Brothers, and Travelers were to fall underneath the Travelers Group umbrella.

Weill flouted the Glass-Steagall law with his 1998 Citicorp - Travelers merger, appropriately banking that the insurance-deposit-investments firewall was indeed, dead. Of course, former President Ford and Treasury Secretary Robin Rubin were recruited as board members and adequate insurance to promote the ultimate 1999 Graham-Leach-Bliley Act.

My, how time flies.

10 years later and Citigroup is the teetering $1 / share financial on the brink, Sandy Weill is out of banking, Jamie Dimon is now on the prowl for J.P. Morgan - seeking to destroy the Citi that he once built, and the Federal Government refuses to kowtow to Big Bank equity holders - effectively wiping them out with an irreversible spigot of tax payer dollars that has diluted every last shred of mega-bank ownership.

Opening checking accounts, peddling insurance, underwriting securities, rapid-fire trading all underneath one roof simply does not work. The complicated dealings and inevitable failures have been exacerbated by the shocking leverage strategies that arrived courtesy of such bloated balance sheets.

Basic mathematics indicate that gargantuan commercial banks could not compete in terms of profit margins with investment banks; whereas the Merrills, Goldmans, and Lehmans could never match the sheer firepower of a mega financial center - bankrolled with timed deposits that carry lower rates of interest available to our very own U.S. Government. All financial players upped the ante and levered up the risk only to cannibalize their own selves.

Lehman is dead. Bear Stearns is dead. Goldman Sachs (GS) is a bank holding company.

Citigroup, Bank of America, and J.P. Morgan control approximately one-quarter of U.S. deposits and the failure of either institution would be absolutely cathartic. Hence, the U.S. Treasury will methodically print money to bail out these big banks at all costs. We have officially entered the Lost Decade Japan Zone. Our financial backbone is controlled by a failed business model that is propped up by throwing good taxpayer dollars after bad money.

I am forecasting that the gridlock, bailouts, and capital infusions will last for several years - until these banks that are "too big to fail" are broken up into smaller, nimbler units.

Citigroup is Dead, Bank of America is on Life Support, and J.P. Morgan may be the next in line. Dimon seems hell bent upon mimicking the career path of his former Citigroup mentor. The toxic assets acquired via the Washington Mutual and Bear Stearns acquisitions are ticking time bombs set to implode at any moment.

Although Dimon was lauded as a Savior and even blasted as an opportunist for these fire sale acquisitions sponsored by the U.S. Government - the combined intrinsic value of both banks is $0 at most. Frankly, J.P. Morgan shareholders should have been dutifully compensated for being forced to accept this waste.

The Financial Super Market is Dead.

Disclosure: JPM - none, C - none, BAC - none, AIG - none, GS - long

Comments

[Jason Rines...:]

Won't take seven years before U.S. government decides to stop it with the trick-down strategy of bailouts. 2010 elections have a lot of House of Reps up for reelection. The American public have begun there research into the corrupt and inept. I expect the banks to be nationalized by fall latest.

Mar 09 11:43 AM

[Nick Waddell:]

These mega banks, if they exist at all, will be pared back to become smaller and more focused. In time one of them will begin to find niches in the banking business that haven't been exploited. Some astounding record quarters will follow. This new bank will become a media darling for its innovative practices. Later, it will then be co-opted, earnings will begin to slip and eventually the bank will be seen as bloated, out of touch, and its practices will be seen as possibly illegal or immoral.


Anyone care to speculate on the the timeline for this scenario?

Mar 09 01:31 PM

[bricki:]

I don't think this is news to anyone.

However I am not optimistic that this sector will ever recover to its former glory. Risk aversion and regulation will limit return on capital. Size through merger will limit profitability and keeps expenses up.

Mar 09 05:45 PM

[anarchist:]

I expect the midterm elections to be a non-event. There is enough pork in all these bailouts for most Representatives to survive, it's always the other guys Representative that "should be sent walking", not mine.
I wouldn't venture a guess as to what will become of the banking industry as we see it now but I will predict that BofA will survive. When CEO Kenny Lewis got cold feet in the purchase of Merrill I am sure the Government, maybe Paulson, promised BofA would survive no matter what if they went ahead with the deal. The promise may not have been worded quite that way but BofA will go down even after JPM if at all.


On Mar 09 11:43 AM Jason C. Rines wrote:

> Won't take seven years before U.S. government decides to stop it
> with the trick-down strategy of bailouts. 2010 elections have a lot
> of House of Reps up for reelection. The American public have begun
> there research into the corrupt and inept. I expect the banks to
> be nationalized by fall latest.

Mar 09 05:47 PM

[misiosnechacz:]

It's all depends how long it will take before banks will start to make money again. Even Goverment has some limits.
They simply can't afford to sponsor them all for very long. They are quite streched already. If all those (if they will survive then we are doomed) banks will start to earn money then the very slow recovery will start.for me it will be IVQ or IQ of 2010.
Election 2010 that will be better show than 2008 Olimpics. Detroit and some other parts of USA look intresting (in negative way). It will be new show let's start the BLAME GAME.

Mar 09 06:40 PM

[William Cowie:]

Government broke up AT&T with great success. Why don't they simply break up the big banks? Those who want to preserve these obtuse organisms of obfuscation might argue that's way too complicated. It isn't. It's been done before, it can work again.

The smaller banks with healthy balance sheets (yes, the real America is still alive somewhere) are being asked to pay for the banking mess with higher FDIC premiums. In exchange, let them bid on the pieces of the dinosaurs. That way they at least get something in exchange.

Mar 09 09:05 PM

[Moon Kil Woong:]

First it is not easy to break up a big bank because it sparks credit events. Creditors don't really like it when you take the good part of the business and separate it so they can't get to the assets to pay for the bad part. Also, the big banks simply don't want to break up because they wouldn't be able to hold the US economy hostage anymore and thus couldn't justify more bailout money and sweet deals. You will have to pry their empire of filth from their cold dead megalomanic gambling CEO's hands.

It is true, no one really opposed the Graham Leach Bliley Act. All politicians were greased heavily by loads of bank financial money. And oh how it paid off for them (not you). First it paid off in billions in windfall bonuses on fictitious derivatives gains and shoddy loans. Now it pays off in trillions in bailout money and government backstops and tacit loan guarantees (TARP is just the tip of the iceberg. Look at the Fed's guarantees and liabilities). It's really the gift that pays on and on and on.

Banking institutions are now rallying against a re-installment of the Glass-Stegall Act because they know when it all comes down to the wire, you must draw a line between what the public will pay for and what the public won't and then make sure FDIC and others have enough funds to cover the shortfalls. Megabanks don't like that idea since it means they won't be able to gamble it up and hold the public hostage for the tab anymore.

If FDIC had enough funds to finance Citibank's demise, do you think it wouldn't be in liquidation? I think not. Let's be clear and frank, we are supporting it because depository insurance can't cover it. Clearly, the author is right that we have let these institutions get too big and gamble to extravagantly on the public's dime.

As long as government backs banks, they must play by the rules in terms of how much risk they can take on. gambling it up with the brokerage industry, low to no collateral packaged loans, and insurance like derivatives should be a no no.



Constructe now known as Moon Kil Woong

Mar 09 11:34 PM

[donzelion:]

Goodness, Constructe/Moon, that's a bit conspiratorial of you. Let's think of it this way: banks are supposed to earn their money the old-fashioned way; offer 3% interest to depositors, lend at +3%, and off for golf at 3.

What got us into trouble is that they discovered a new "rule of three" - out of every 30 minutes an investor spends speculating on how well an investment will perform, about 3 seconds are devoted to understanding how the company earns its money. If people think of banks as earning money the old-fashioned way (through the interest spread between deposits and loans), they'll ignore it when the interest rates drop to nothing and yet the banks still earn ungodly sums.

The problem here - and it's a harder one to fix than merely cobbling new regulations together - is that banks can easily "play by the rules" while taking on risks that a shareholder would never tolerate, if the shareholder knew what it was and how it worked. Shareholders, however, don't really care about the risks - we just go pleading for help when our investments fail to operate in accordance with the magic algorithm.

Mar 10 04:18 AM

[currency x com:]

Printing money to keep bailing out is like using oil on a wooden leg... There is a limit and the best practice here is to cut and slash.

Mar 10 05:29 AM

[aarc:]

This is the height of pessimism on banks. Time to buy.

Global trade or global marketplace have changed dramatically from the 1930's. Hence the requirement to repeal G/S act.

Nothing has changed. The global marketplace is still the same as 2007 before this global downturn. China is still the dominant manufacturing center of the world. India still dominates software production. Taiwan is still the dominant computer parts manufacturer. Russia still produces oil, Japan is still the leader in auto-manufacturing. etc, etc.

The global marketplace did not suddenly returned back to the 1930's status where only a few western countries dominate global trade and emerging countries did not return back to their pre-third world country status. Cars and airplances are still the major mode of transportation instead of steam ships and horse carriages of yesterdecades.

We still have the economies of developed countries and the developing countries operating as of a year or two before albeit at greatly reduced capacity instead of full bore. Their economic engines did not disintegrate beyond repair. And if they do, they will be rebuilt based on today's standards rather than the 1930's standards.

What changed is the western world psychology of profligate living as their few hundred millions baby boomers start entering their twilight years.

The 1.5 billion of baby boomers in the developing countries such as China and India have not changed. They are still as optimistic of the future as they are before this downturn. They are young and relient while we are getting old and hard headed. Stop looking inwards and look out a few thousand miles beyond our horizon and the picture is not actually as dire as ours. Then look back from beyond our horizon and we will see our losses are paper losses, we did not have a grassroot revolution similar to the onset of communism in China where everything and anything considered "modern" at those days were demolished and destroyed and never to be repeated for decades. We are not living in communes and municipalities and using our own hands to feed ourselves off the land.

The developing countries have started attempting a decoupling in the last few years from the western countries; they cannot succeed in a mere 5 to 7 years to wean out of decades if not centuries of dependency on the United States and England. But they are going to increase their efforts of economic decoupling in the near future as they realize much more starkly how their dependency severely affects their economies. It is going to take decades. Plenty of years ahead.

Megabanks served a purpose in a cohesive global marketplace of the 20th century. The whole world is not going back to the 19th century - and so are megabanks. Much like supermarkets serve their purpose in our modern day lives. Are supermarkets going to be dismantled too? We built too many of them, trim the fat not remove all flesh from the bones.

Most likely, they are going to modify their business structure in order to mitigate the domino effect of one or more parts of their operations severely affecting the whole structure.

Mar 10 10:52 AM

[Moon Kil Woong:]

Donzelion: Thanks, I agree that investors should spend time understanding the machinations of the executives of a company. When a company gets too big and unwieldy for people to understand its model then it should be discounted or very hard to get new investment. Rather than that there are 1,000 investment banks chomping at the bit to get mutual funds and institutions to dump them more money. It's exactly what people like Jon Stewart are talking about, fast money and people using loads of others money to enrich themselves. Anyway...

Yet I am a bit cynical and believe that big banks are after protecting their own ass at the expense of others. No one could understand Citibank's books. No one still can. All their losses are hidden in unmarketable derivatives (well the big amounts not the petty cash 10-20 billion a quarter).

Right now yes banks get a great spread at near zirp and lending at 5-6%. It helps pay for their past transgressions. Unfortunately, those are quite big (nearly insurmountable is another word you can use). That's why they like to charge you 15-21% on your credit card. Yay, and their off to golf again (Only the execs. They make the others stay behind and clean up their mess every day).

Anyway, thanks for your comment. I think rules will help the average investor who is actually the owners of a company force execs to reveal to the owners what exactly they are doing. It would save investors from dumping even more money into insolvent empires. We can only hope investors grow more savvy over time.

That's why we blog seeking alpha.

Mar 13 05:14 AM