Abort, retry, fail ?

Every now and then back in the Dark Ages, I would have to deal with the late, unlamented MS-DOS operating system. It wouldn’t be long, as a rule, before I encountered the message “Abort, Retry, Fail?”

Of these, “retry” sounded the most hopeful so I’d choose it a few times, but I don’t think it ever worked. Usually the best thing was to shut down the machine and start again.

This trilemma struck me when looking at the options for US-based banks, and Citigroup in particular.

Like lots of others, I think the only serious option is “abort”, that is, to take the whole thing into public ownership, sell off what can be sold, and eventually return a drastically cut-down version to private ownership, under much tighter regulation than in the post. There are some big problems along the way, most importantly how to treat the holders of Citi’s debts, but these problems have to be addressed sooner or later.

The alternative, recently advocated by US Senators Shelby and McCain with specific reference to Citigroup is “Fail”. They haven’t spelt out what they mean, and perhaps (as suggested by Calculated Risk) it’s really just a semantic variation on the standard FDIC practice of nationalising failed institutions for which no buyer can be found. It’s worth looking, though, at the idea of closing down the US retail banking operations and repaying the depositors out of FDIC funds, then putting the rest of the group into bankruptcy as was done with Lehman Brothers. Citi has at least $100 billion in insured deposits, so this stage won’t be cheap, and since Bank of America and others would almost certainly fail as well, the FDIC would be up for the best part of $500 billion.

The bigger problems will be the potential for failure to bring down lots of counterparties, and the international operations. In the case of Lehman, the immediate consequence of failure was the collapse of AIG (which had written lots of credit default swaps on Lehmans a few days later). This threatened total collapse of the global financial system, and AIG was expensively rescued.

But the international ramifications are even scarier. Just before it went under, Lehman’s extracted $8 billion from its European operations, to reduce the losses of its US home office. When Iceland looked set to pull the same trick a few weeks later, the UK government invoked the Anti-terrorism, Crime and Security Act against it, to freeze the assets of Icelandic banks and the Icelandic government. A “Fail” policy for Citigroup would present governments around the world with the choice between allowing a Lehman-style expropriation, or seizing what US assets they could at short notice.

After the Lehman debacle, “Fail” is to scary for anyone actually in charge of policy to contemplate. But the Obama administration is still unwilling to go for Abort. As the NYT says, the Treasury is “pursuing a strategy that seeks to avoid either the failure or nationalization of the biggest banks” which is a bit like wishing for a pony that can win the Grand National.

So, every week or so, Geithner and Summers have pressed “Retry”, announcing some variant or other of recapitalization, good bank/bad bank or similar. Perhaps they will keep on doing that until Shutdown brings the whole process to a halt.

Update 10/3 Andrew Leonard talks about Citigroups global sprawl and the difficulties it poses for nationalisation Sixteen Candles psp . As I note above, the difficulties are far greater with the “Fail” option

32 thoughts on “Abort, retry, fail ?

  1. Hmmm.. and a few months back MH, that same Citi was bombarding us to shift any outstanding credit card amounts over to them at generous holiday and teaser rates. They were wasting their time unless they wanted to live on merchant kickbacks.

    Oz is not far behind the ROW as the layoffs are beginning in earnest(not the biggies that hit the meeja but the ones, twos and tens breaking out all over the place at present)and all I can say is beware the Ides of Easter now, because 2 days pay with oncosts isn’t to be sneezed at by small biz under the pump. We’ll see if the Rudd Govt can print jobs with that new IR legislation of theirs. That sop to unions on top of Easter Bunny is no doubt the last straw for decision-making for many SMEs right now.

    As for our financial sector, we’re probably streets ahead of most countries, partly due to better management and Govt, but no doubt mainly due to the fact our banks were only bit players on the world stage. The question remains how solvent are they in a world hungry for cash and if they face a similar crisis, how well prepared are our authorities to do better than their OS counterparts?

    How solid are the banks? Well let me give you an insight into that. Case study-young lady, 21, finished training, first job about 2hrs drive from Adelaide, skills in high demand and safe bet recession wise, needs new car after old car insurance writeoff. No problems for a loan with her Big4 bank and mum and dad’s CU. Just a problem with choice of car and beating off the salesmen. Now get this. Bank interest rate 13.4%. CU interest rate 7.8% and no penalty for fast repayment. What does the Big4 bank know that small CU doesn’t or which one is book-building here with deterrent rates for borrowers? When you’ve answered that question then ask yourself how prepared are our authorities if that Big4 bank’s concerns prove justified? I put it you my solution for any Oz bank in trouble in future is the only one that can avoid all the disastrous dithering we’ve seen OS and we should pave the way right now. Reduce the Govt deposit guarantee to 60% and announce the proposed solution to the other 40% should a solvency issue arise. Nothing else I’ve heard could possibly deal with a run on our banks as speedily and effectively as that with negligible risk to taxpayers and at the same time free up other financial markets immediately. The current 100% guarantee is nonsense and our Govt and Opposition should know better. My hunch is their metoo stupidity and lack of finacial nous will be tested quite soon.

  2. And come to think of it, if the Govt wants to increase liquidity after a bank failure and imposing my solution, it can always stand in the market and buy depositors’ shareholdings afterwards. That’s called not paying too much too soon for toxic assets or willing buyer meets willing seller. OTOH, how are all those OS experts doing with their speedy valuations and liquidity provision by the way?

  3. D. none of the above

    ” March 10 (Bloomberg) — Citigroup Inc. Chief Executive Officer Vikram Pandit said his bank is having the best quarter since 2007, when it last posted a profit.

    “I am most encouraged with the strength of our business so far in 2009,” Pandit wrote in an internal memorandum obtained today by Bloomberg. “In fact, we are profitable through the first two months of 2009 and are having our best quarter-to-date performance since the third quarter of 2007.” The bank had $19 billion of revenue in January and February before disclosed writedowns, he added. ”

    http://www.bloomberg.com/apps/news?pid=20601087&sid=avjYcESZ4uqs&refer=home

  4. “Citi will offer to exchange common stock for up to $27.5 billion of its existing preferred securities and trust preferred securities at a conversion price of $3.25 a share. The U.S. government will match this exchange up to a maximum of $25 billion face value of its preferred stock at the same conversion price.”

    http://online.wsj.com/article/SB123573983418294221.html?mod=googlenews_wsj

    In other words, if the Citibank common stock price exceeds $3.25 a share, the US government will be showing a profit on their investment.

    As of 11.56 AEST, 10 March. The Citigroup share price was %1.29.
    Let’s see whwere it is a week from now.

  5. Interesting to note how 2 months of profits by Citi can see stock markets roar back relatively speaking which should be a clear message that their is no shortage of capital, just a shortage at uncertain prices, compliments of interfering Govts everywhere. It might be interesting to speculate where we’d be now if Lehmans was instantly recapitalised with 40 or 50% of depositors and bondholders dough in the manner I suggested and their subsequent shares publicly listed for those who want to cut and run.

    The problem for interfering Govts printing money and driving down interest rates to zero to prop up bad assets is, apart from being deleterious to sound investments, it’s a massive problem on the upswing. Essentially it takes a lot for an infinite bond price to halve if interest rates naturally need to rise from say 4-8%, but next to nothing should they rise from 0.5-1% and guess where the barons of bailout have left us all now?

  6. Try, Retry, ..?

    Hype Real Estate (Germany)is still in trouble.

    Krugman wants Germany to ‘stimulate’ and he is alleged to have made some remark about Chancellor Merkel’s intellect, while Merkel and the CDU/CSU – SPD government are preparing laws to nationalise troubled German banks irrespective of major US shareholders.

    http://www.spiegel.de/international/business/0,1518,612729,00.html

    http://www.spiegel.de/international/business/0,1518,608396,00.html

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