The only way to restore sanity and security to finance is to stop banks growing so bigby Jonathan Ford / November 18, 2009 / Leave a comment
In June of this year, Richard Bove, a banking analyst at an American brokerage, Rochdale Securities, wrote an upbeat research report on Citigroup, the distressed giant banking conglomerate. Though he works for a small company, the white-bearded Bove has a big following. His opinionated stance and regular cable television appearances have made him one of Wall Street’s best-known commentators on the financial crisis.
Bove argued that Citigroup’s shares, then trading at just $3 each, could more than quadruple in coming years. This was, to say the least, bold. The bank has been one of the biggest casualties of the crisis, surviving only through massive state support. Earlier this year, its shares—worth $55 each in early 2007—fell below $1 on fears that it would be nationalised. It wasn’t, although the government has guaranteed a chunk of its trashiest assets and now holds a 34 per cent stake.
Bove’s tip was not based on the quality of the underlying business. “Citigroup is an unusually controversial company because its loan losses are at a level that suggests that the company would have difficulty surviving without government assistance,” he wrote. Indeed, Bove admitted that the bank’s loan book was possibly “one of the poorest ever written.” But there was a magic ingredient that would save the bank from the knacker’s yard: Uncle Sam. Since the government had deemed Citigroup “too big to fail,” he observed, it would be able to survive in private hands and possibly rebound down the line. “Some companies have developed such unique positions that their elimination would cause harm to others,” Bove said. “I believe Citigroup is such an organisation.” On this basis, he recommended its shares to investors.
Citigroup is a perfect illustration of the “too big to fail” problem. The global financial crisis, and subsequent action taken by governments, has shown that investors in banks of systemic importance—that is, those whose failure could bring down the financial system—enjoy a one-way bet. They get to keep the profits in the good times and are able to pass the losses to taxpayers in the bad.
Look more closely at Citigroup’s own case. Since 2007, it has written off more than $105bn—far more than the equity capital it had going into the crisis. Most of the bank’s capital came from depositors and other debt investors. None of these lenders has lost anything. Even equity investors, who should have been first in…