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A Bailout Steeped in Irony

By Steven Pearlstein
Tuesday, November 25, 2008

Of all the rescues mounted by the government this year, none carries with it more symbolism, or more irony, than that of Citigroup.

Until recently, Citi was not only the largest U.S. financial institution, but the very embodiment of the new financial order. Under the relentless empire-building of Sandy Weill, it was Citi that brought down the old regulatory wall that had separated commercial banking from investment banking and insurance.

The combination of Citibank with Salomon Smith Barney under the bright red umbrella of Travelers Insurance was accepted with a regulatory wink and nod by the Federal Reserve until Fed Chairman Alan Greenspan could persuade Congress to make it legal. The hurdle was the Glass-Steagall Act, put in place during the Great Depression to prevent another market crash like that of 1929. Now that another market crash has required the government to rescue a commercial bank done in by its investment banking subsidiary, there will certainly be those who wonder whether the New Dealers didn't have it right all along.

The rationale for saving Citi is that with $3 trillion in assets, more than 300,000 employees and operations in more than 100 countries, this was a bank that was too big and too connected with the rest of the financial system to be allowed to fail. The question now is whether an institution of that size and scope is also too big to succeed.

Sandy Weill stitched together his Citi empire from more than a hundred acquisitions. No sooner was his work complete, however, than it began to unravel as the result of soured investments and embarrassing ethical scandals that cost shareholders tens of billions of dollars and eventually cost Weill his job. In the years since, it has become obvious that the promised economies of scale had been over-hyped, the synergies across business lines never developed. The whole thing was simply too big and too complex to be managed.

It has also proved too big to be regulated. Over the past 20 years, the Federal Reserve, Citi's chief regulator, has been unable to get a handle on the bank's excessive risk-taking and corner-cutting. Time after time, Citi rushed to jump aboard the latest gravy train -- loans to developing countries, commercial real estate, Internet stocks, subprime lending and securitization -- and time and again, the regulators failed to spot a problem until it was too late.

The Fed launched what amounted to a rescue of Citi back in the early '90s, opening its lending window and lowering interest rates to avoid a collapse. This time, the problem is even bigger and the rescue more explicit, with the Fed itself having to put its own balance sheet at risk to fix a problem that could have been contained if its regulators had been more vigilant.

While it was Weill who created the modern Citi, it was his handpicked and hapless successor, Chuck Prince, who steered the company into the ditch. It didn't have to be that way.

In John Reed, the former chief executive of Citibank, Weill had had a co-chief executive who was an MIT-trained engineer deeply skeptical of Wall Street financial engineering and committed to consumer banking and sound commercial underwriting. Weill ousted him in a boardroom coup. Later, in Jamie Dimon, Weill had a lieutenant who was both a brilliant strategist and disciplined banker who could have saved Citi from following the Wall Street herd over the cliff, if Weill had only been willing to name him heir apparent. Instead, Dimon went on to save Citi's rival, J.P. Morgan Chase.

Surely neither Reed nor Dimon would have been as clueless as Prince about the risks taken by his subordinates. Nor would either have been so determined to run with the Wall Street herd, as Prince clearly was when he told the Financial Times in the summer of 2007 that, though he recognized there was a huge credit bubble, Citi had no choice but to keep dancing as long as the music was playing.

There is one top executive, however, who served alongside Weill and Prince, as well as alongside the newest chief executive, Vikram Pandit, with surprisingly little damage to his own reputation. He is, of course, Robert Rubin.

As Treasury secretary, Rubin joined with Greenspan in supporting Citi's campaign to repeal Glass-Steagall. And when he resigned from the Treasury in 1999, Rubin accepted Weill's offer to become what amounted to vice chairman of Citi, where he has quietly worked the back channels to Washington and other international capitals while serving as strategic counselor to the chief executive and the board of directors.

Rubin has been cagey about defining his role at Citigroup -- and at one point he got caught making a phone call to the Bush Treasury in a bid to help out Enron, a Citi client, during its death throes. What is indisputable is that all of the decisions that have led to Citi's recent troubles were taken while Rubin was chairman of the executive committee, and made by executives with whom he worked closely. He defended them repeatedly and unequivocally, and as a director, he approved compensation packages that rewarded them (and himself) handsomely for judgments that proved disastrous.

Now, the government has been forced to save Citi by investing $45 billion in new capital and by putting a floor under its losses. By any measure, it is a sweetheart deal for shareholders, who will suffer minimal dilution of their shares. Most startling of all, however, is that Rubin and other directors and top executives have been allowed to remain at the helm. You have to wonder how much more money this crew would have to lose before the Treasury and the Fed would demand their resignations -- $100 billion? $200 billion? $1 trillion? Why weren't they dispatched as were the executives at Fannie Mae, Freddie Mac and AIG?

The ultimate irony is that just as Rubin & Co. were being bailed out at Citi by the Bush administration, President-elect Obama was announcing a new economic team drawn almost entirely from Rubin's acolytes.

That's not to take anything away from the qualifications of Tim Geithner, the new nominee for Treasury secretary, who owes his appointment as president to the New York Fed to Rubin's aggressive lobbying; or Larry Summers, who was Rubin's deputy secretary at the Treasury and whose appointment as president of Harvard was championed by Rubin as a member of the university's government board; or Peter Orszag, the soon-to-be-named nominee for budget director, who was hired by Rubin to head a Democratic think tank on economic policy that he founded.

No doubt about it -- it's a fabulous team. But perhaps the next time Obama thinks about assembling his group of wise men to give advice on the economic crisis, he might at least have the good sense to leave Rubin out of the mix. At a minimum, it's a glaring conflict of interest. More significantly, it sends a terrible signal about accountability and corporate governance.

Steven Pearlstein can be reached at pearlsteins@washpost.com.

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