Why CitiGroup is About to Be Bailed Out and Not General Motors

Citigroup was once the biggest U.S. bank. General Motors was once the biggest automaker in the world. Now, both are on the brink. Yet Citigroup is likely to be rescued within days. General Motors may not be rescued at all.

Why the difference? Viewed from Wall Street, Citi is too big and important to be allowed to fail while GM is simply a big, clunky old manufacturing company that can go into chapter 11 and reorganize itself. The newly conventional wisdom on the Street is that the failure of the Treasury and the Fed to save Lehman Brothers was a grave mistake because Lehman’s demise caused creditors and investors to panic, which turned the sub-prime loan mess into a financial catastrophe — a mistake that must not occur again. But GM? GM is only jobs and communities. Citi is money.

The Street’s view of the world is fundamentally flawed. Banks are important to the economy because they’re financial intermediaries. They connect savers with investors and borrowers. This is a vital function, but there’s nothing magical about it. At any given time the world contains a vast pool of money that can be put to all sorts of uses. Financial intermediaries simply link the pool to the uses.

To be sure, savers need to believe that intermediaries are trustworthy; otherwise, savers will prefer the underside of their mattresses. That’s why governments regulate intermediaries, insure deposits, and do whatever else needs to be done to make savers feel safe. What governments and societies fear most are “runs” on banks — panicked efforts by depositors to pull their money out all at once, before banks can possibly collect the money from all those who have used it to borrow or invest. That’s what happened in the 1930s.

But the current panic on Wall Street is not a “run” in this sense. It has almost nothing to do with banks’ roles as financial intermediaries. It’s about money that’s been lent to or invested in the banks themselves, in order to profit off of the banks’ profits. Lehman’s demise cost many investors and creditors lots of money, to be sure, but they were investors and creditors in Lehman, not in the real economy.

Before the asset bubbles burst, financial institutions were generating whopping profits, so naturally they attracted many investors and creditors. After the burst, the profits disappeared. These days, you’d be hard pressed to find many people who want to invest in or lend to financial institutions. Citigroup had a market value of $274 billion at the end of 2006. Now its value is about $21 billion. That’s awful news for Citi, its executives and traders, and its investors and creditors. But it’s not necessarily awful news for the economy as a whole. Even if Citigroup were to go belly up, the real economy would not be seriously harmed. The mutual funds, pension funds, and deposits overseen by Citi would be safe; fund managers would find their way to other banks.

In other words, Citigroup is not much different from General Motors. It’s a company that once made lots of money but, through a series of management blunders, is now losing money hand over fist. Just like the shareholders and creditors of GM, Citi’s shareholders and creditors are taking a beating.

So why save Citi and not GM? It’s not clear. In fact, there may be more reason to do the reverse. GM has a far greater impact on jobs and communities. Add parts suppliers and their employees, and the number of middle-class and blue-collar jobs dependent on GM is many multiples that of Citi. And the potential social costs of GM’s demise, or even major shrinkage, is much larger than Citi’s — including everything from unemployment insurance to lost tax revenues to families suddenly without health insurance to entire communities whose infrastructure and housing may become nearly worthless. I’m not arguing that GM should be bailed out; as I’ve noted elsewhere, GM’s creditors, shareholders, executives, and workers should have to make substantial sacrifices before taxpayers should be expected to sacrifice as well.

Nonetheless, Citi is about to be bailed out while GM is allowed to languish. That’s because Wall Street’s self-serving view of the unique role of financial institutions is mirrored in the two agencies that run the American economy — the Treasury and the Fed. Their job, as they see it, is to keep the financial economy “sound,” by which they mean keeping Wall Street’s own investors and creditors happy.

Because the public doesn’t understand the intricacies of finance, it’s easily persuaded that this is the same thing as keeping credit flowing to Main Street. That’s why the public and its representatives have committed $700 billion of taxpayer money to Wall Street and another $500 to $600 billion of subsidized loans to the Street from the Fed — bailing out the investors and creditors of every major bank, including , momentarily, Citi — only to discover, at the end of this frantic and unbelievably expensive exercise, that American jobs and communities are more endangered than they were at the start.

Originally posted at Robert Reich weblog and reproduced here with the author’s permission.

14 Responses to "Why CitiGroup is About to Be Bailed Out and Not General Motors"

  1. Demand Side   November 23, 2008 at 9:03 am

    The Citi bailout also illustrates the futility of the Fed’s program, the Bernanke prescription to address the financial sector meltdown. Propping up the banking institutions has not worked. The banking function needs to be reconstructed from the ground up. Focus on supporting the function, not the institution. Glass-Steagall never looked so good as when viewed over the bodies of these massive zombie corporations. Far from facilitating finance, they are smothering it.

  2. Shishir Manuj   November 23, 2008 at 11:28 am

    The article smacks of bias, than analysis (which ought to be unbiased). “but they were investors and creditors in Lehman, not in the real economy”- The argument that investors invested in Lehman (and Citi) and not in the real assets is ludicrous. Aren’t these banks and instituions supposed to park the money in real assets? Aren’t investors not expected to have good access to all real asset opportunities like manufacturing plant, a building, a jet plane, etc. etc. And hence they use intermediaries? I think the learned author has gone wrong from the word “go” by not unerstanding that creditors and investors in intermediaries were indirectly investing in the assets these intemediaries in turn lent to. It is just that the underlying assets invested in went bad.As far as jobs lost is concerned as a benchmark to decide which one should be bailed out, I am not sure if GM ranks any higher than Citi. The author has included the indirect jobs as well for conluding that GM should be the one to be bailed out. However, he is probably lacking in understanding the implication of losing one large FI as Citi and its impact on the real economy borrowers- which could include GM for that matter. Just imagine, in a credit squeezed market, who is the ultimate sufferer? It is the ones producign jobs in the real economy, who with a lag though, start to go down. And GM is the best example. So, Citi’s going down would mean all the assets-job producing borrowers will face problems, and could lead to more “indirect” job losses than GM’s closure would.And finally, all this rubbish about Citi’s model was a problem is just rubbish. Hindsight is always 20/20. As a student of strategy, we have all read the implications of specialisation and outsourcing, as much about that of consolidation and backward integration or diversification. To choose any one strategy is multi variable function. If becoming a universal banking entity was wrong, and backward (or forward integration) was so bad, Ford would never have come up this big. Wasn’t it the one which lent meaning to the word vertical integration? And isn’t universal banking model just an example of that? And finally, I am neither long nor short Citi or GM! I am unbiased.

  3. Guest   November 23, 2008 at 11:43 am

    citi engaged in bad loan practices like all of our banks, their CDS exposure is huge and why they will be bailed out. The cds market needs regulation…it is lack of oversight and regulation that caused this. bad loans to people with bad credit and they wonder why they are at their knees. i prefer to lose my job than bail out all these banks or to bail out a GM where the workers are living like it is 1950. their cost structure is too high, double toyota. so, bankruptcy for GM so they can get out of these horrible contracts that pay workers almost full salary when laid off! GM never invested like toyota in fuel efficiency and only now they tote it to get bailout money! all the bailout will not save a thing, the japanese tryed huge spending ofter their stock market and housing collapse…and it never recovered.

  4. anton kleinschmidt   November 23, 2008 at 12:16 pm

    A reductionist view.If GM goes the knock on effect will probably be fairly limited. Before too long other manufacturers will pick up the market slack and the peripheral industries have reasonable prospects of survival. If Citi goes then counterparties all over the world could well collapse and the USAs reputation as a major financial centre will be destroyed (not damaged…..destroyed). Nobody will want to do business with American banks for a very long time. To put it more simply, if GM goes the damage will be contained locally but if Citi goes the damage will be global and far more destructive. Think how the sovereign wealth funds will react.It would be nice if some of the clowns who created this mess could spend time behind bars

  5. Hal   November 23, 2008 at 12:24 pm

    Both should be put on the ‘block’ and sold in pieces.Any real value in them will then be determined by the market.Anything else is a waste of government resources that willbe sorely needed elsewhere.

  6. Guest   November 23, 2008 at 1:19 pm

    Yes-reinstitute Glass-Steagal of course. However, CDS liquification should actually exacerbate asset sell offs but it will quicken the process somewhat. The question remains how big is the cdo-cds market that is not even tradable? Out of a market described by Senator Harkin as $500 trillion even if you could trade a ridiculously high estimate of 20% you still have a mountain of opaque securities of unknown value at settlement. ???

  7. Richard Wentz   November 23, 2008 at 5:22 pm

    I thought the whole idea of a free market was more Darwin than Keynesian or Friedmanesque. If both Citi and GM fail, then so be it. They should be left to the just results of years of stupidity and greed. Both, Wall Street and auto sales will learn to adjust.

    • J Selden, Monroe MI   November 24, 2008 at 11:39 am

      Behind your abstract “Darwinian Free Market” are the lives of real people And I just don’t mean the UAW workers you folks love to vilify. I’m talking about the millions of men and women who go to WORK everyday, pay their taxes, and built this economy. I took a lot of us to build it and relativly few Armani Wearing Elitists like your self to bring it down.

  8. Joyce Farnsworth   November 23, 2008 at 6:52 pm

    The simple role of banks as a “public utility” in “payments and collections” and as financial intermediaries in the “fractional reserve” system is different from their role in the “innovative creation” of derivative instruments to be traded and leveraged in a separate profit making endeavor. Likewise, the role of automobile manufacturers in the production and sale of cars and trucks is different from a responsibility for generating economic growth (a.k.a. “uneconomic churn”), jobs, and community stability. Maybe both the Citigroup and GM et.al. should be treated to Chapter 11 bankruptcy reorganization to discover their roots.

    • PhilT   November 23, 2008 at 7:36 pm

      Well put indeed …

  9. Jasper J.   November 23, 2008 at 7:04 pm

    Where is the root? I say the banks were created by labor and industry, not labor and industry by the banks. Let the bankers who have broken trust with their customers bear the burden of their mendacity. We must concentrate on healing the roots of the economy: industry and labor.

  10. Guest   November 23, 2008 at 10:21 pm

    “I was gambling in Havana. I took a little risk.Send Lawyers, Guns and Money. Dad get me out of this.” Warren Zevon.Its all cool telling everybody how we should just let it all melt down. But please tell me what are you going to do with the supermarkets don’t have any food?

  11. Guest   November 24, 2008 at 7:00 am

    I have enjoyed reading all the comments. I am not an economist just a person who saw how the Community Reinvestmant Act was a major cause in the corruption of our system. Simply, the government forced the GSE’s through Barney Frank and Chris Dodd and others to make these ridiculous loans which are the root cause of the problem. I saw day by day how the underwriting standards were lowered at Freddie and Fannie in order to make the quotes for CRA. Congress saw the GSE’s as an offshore piggy bank. I stood aghast and screemed to all the banks that I associate with not to get involved. Guess what today the conservator Lockhart says that the GSE’s must continue with making”goal-rich” loans aka more subprime. I hope these facts receive more light–read in business week about how FHA is our new sub-prime loan– This is an insane world.

  12. Eve   November 29, 2008 at 3:18 am

    An excellent article and one the educated non-economist can understand with no difficulty. It seemshuge sums of taxpayer money have gone to bail outfinancial insitutions and this may not even preventworse suffering. Can Obama change this? Will he?Do his appointments of Geithner and Summers mean the interests of Wall Street will ulimately prevail?I would appreciate comments on this matter from anyonewho wants to rep;y to my comment