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If you turned on CNBC, Bloomberg, or visited any of the leading financial news websites today, you may have noticed a common theme running through the headlines. The tide of woes in the banking world, assumed by many casual observers to be either eased or completely hemmed by the release of the first half of the TARP money, continue to rise in alarming fashion. While their have been no official bank seizures or failures for several months, one could easily make the argument that this lull has been a lull in name only.
On Tuesday, Citigroup announced that it would be merging its investment banking/brokerage business, under the Smith-Barney name, with Morgan Stanley, and that the financial giant would relinquish its controlling interest in the operation. By unloading Smith-Barney, Citi hopes to add approximately $2.7 billion of assets to its balance sheets, a sign that in spite of the $45 billion of cash that the federal government has committed to Citi, the bank remains starved for capital.
Bank of America, on the other hand, has clearly bitten off more than its strained balance sheets can absorb. The purchase of both Countrywide and Merrill Lynch in 2008 has caused them to go from a bank that was well-positioned to weather the financial crisis to Citigroup 2.0. On Wednesday, they limped back to the Treasury to ask for additional funds that were deemed necessary for them to complete their purchase of Merrill Lynch. B of A is asking for the government to guarantee their liabilities, as it has done with Citi. These are all the signs of a bank seizure, the only component lacking being an official announcement.
The larger impact of this situation, beyond Bank of America?s and Citi?s stock prices being obliterated, remains to be seen. The fact that Citi and B of A have tucked their tails between their legs and trotted back to the government indicates that private investors are not exactly lining up to assume any of their risks. The values of the more risky assets/liabilities on their balance sheets are not certain, given that the real estate market is no closer to bottoming than it was six months ago, and the second tranche of TARP money is the only capital available for the time being. There are more questions than answers at this point, namely how much risk can the government possibly take on before becoming insolvent itself?
More curiously, it would appear that the overthrow of the Glass-Steagal regulations (you remember that antiquated piece of regulation, which said that banks should serve their clients and investment banks should serve investors) has sown the seeds of its own undoing. Citi?s unloading of its brokerage service makes it apparent that the business model of commercial banks should remain unchanged, in spite of the temptation to dip a toe into the high-return, high-risk pool of investment banking. Remember the episode of Seinfeld where George realizes that his marital relationship has become so entangled with his social personality that he can no longer function as an independent entity? Think of the financial supermarket model that Citi emulated for its peers as the financial parallel of George?s dilemma. The commercial retail bank is the relationship personality, committed to helping its customers make sound decisions and retaining their loyalty. The investment bank is the social/independent personality, free to throw its weight around, make and lose all the friends its wishes, and essentially be accountable to no one buts its own self-interest.
Any attempt to merge the two entities will result in a compromise from one side or the other that will alter a component of each entity which was fundamental to its success and survival. Citi and Bank of America’s woes have arisen from their failed attempts to circumvent this logic. So maybe Seinfeld was about something after all.
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