Consider Letting Citigroup Really Fail

In order for the financial sector to regain true health, banks are going to have to learn to stand on their own. This means, particularly for the big firms that are now trying to get out of TARP, that they don’t rely on government guarantee programs. The biggest of these is the implicit “too big to fail” government promise of rescue. But, as The Wall Street Journal points out today, it is not as simple as just saying “this time we mean it, we won’t save you.” There has to be more.

Clearly defining the oversight role of regulators helps companies determine their best course of action. Clarity would have also helped guide the risk management of government-sponsored entities Fannie Mae and Freddie Mac who operated with an implicit open line to taxpayer funds. Clarity on roles, responsibilities, and expectations of the regulators is helpful for investors, so the market knows where the government is going to step in and where it won�t. This will help determine how to diversify a portfolio and how to assess the risk of the investment.

But how to really prove the government means it when it clarifies its new position? The WSJ suggests: let Citigroup fail.

Regulators remain at odds over how much trouble Citi is in. But this spring’s stress tests revealed Citi to have a $63 billion hole in its balance sheet, which the feds papered over by giving the bank credit for converting its government-owned preferred into common shares, a move that will put no new money into the bank. Citi has also been slow to raise private capital since the stress-test results were revealed, even as the capital markets have opened up to its competitors. More broadly, Citi has proven itself unmanageable by having already failed three times since the 1980s, requiring government bailouts in one form or another during the sovereign debt crisis in the ’80s, the 1990s real-estate bust and again, twice, during the panic of 2008. Its turnaround plan has also been less than impressively executed.

If the bank is unable to stand on its own after the alloted time granted by the stress tests, the zombie bank should not be saved. Mark-to-market laws have already been altered by the FASB so as to not drag other banks down with them, Citi shouldn’t live on if they can’t save themselves. Admittedly this process wouldn’t be clean:

Resolving Citiââ?¬â?by either forcing it into a strategic partnership, if anyone will have it, or selling off its assets and breaking it upââ?¬â?wouldn’t be cheap, but it would have a number of benefits. It would remove the leading candidate for zombie-bankdom from the financial system. It would also, finally, put an end to the slow bleeding of taxpayer money into the bank.

Such allowance by the government should show other firms that the days of TBTF are over. It would then be up to the government not to balk in the next game of bank-failure-chicken.