Frankly, I think that's all the (non-negative) "franchise value" that's left in Citi, and several of its peers.

From Interfluidity:

"Our financial system is not the same as "our" big financial institutions

I've just listened to NPR's recent interview of Timothy Geithner. Adam Davidson did a great job of trying to get answers from Mr. Geithner. I felt sorry, at a personal level, for our Treasury Secretary, a very smart man imprisoned in a series of talking points, desperately afraid of the consequences of holding an honest conversation.

As an aside, we've come to take it for granted that policymakers ought to be circumspect for fear of provoking traumatic moves in the markets. But isn't that dumb? Markets are supposed to be about aggregating and revealing information. In what sense is it "more responsible" to hide information or ideas so that markets do not move on them? And if markets do misbehave so wildly that public officials can no longer afford to be candid because of market consequences, does that suggest an incompatibility between the kind of financial markets we have and open democracy?

Anyway. Taking for granted the constraints of the interview, what struck me most was Geithner's repeated conflation of our "financial system" and our "institutions". Mr. Geither's unspoken assumption is the fixing our financial system implies ensuring that incumbent troubled financial institutions are "strong". But that's not right. Our financial system is composed, in part, of financial institutions, but it is supposed to be larger and more robust than any specific firm. Three years ago, Mr. Geithner would have readily conceded that financial institutions are supposed to come and go, rise and fall, succeed and fail as a matter of market discipline, and that our system is made stronger by that flow of creation and destruction than it would be if some state-manged cadre of crucial banks were at its core. Of course, we all knew three years ago that some institutions had become "too big/complex/interlinked to fail", but we viewed that as unfortunate, and would have foreseen that if any of those banks got badly into trouble, the goverment would be forced to intervene and resolve the bank at some taxpayer cost, as it had in the case of earlier TBTF banks. Three years ago, no one would have suggested that the strength of our financial system and the strength of Citibank are inseparable.

We should not let this verbal slip go unchecked. The idea that certain large, politically connected private firms are essential to commonweal and must be supported at all costs by the state is quite the essence of "Mussolini-style Corporatism". Fixing our financial system is not the same as rescuing any one or several financial institutions. Household names can, do and should come and go in a capitalist economy, and it's pretty clear that quite a few familiar financials have failed the market test. What's good for Citibank is not what's good for America.

Did you catch this bit from Warren Buffett's letter?

Funders that have access to any sort of government guarantee – banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government’s umbrella – have money costs that are minimal. Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to Treasury rates, are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be.

This unprecedented “spread” in the cost of money makes it unprofitable for any lender who doesn’t enjoy government-guaranteed funds to go up against those with a favored status. Government is determining the “haves” and “have-nots.” That is why companies are rushing to convert to bank holding companies, not a course feasible for Berkshire.

Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one.

"Lemon socialism" has costs beyond the direct cost to taxpayers of socializing losses. It prevents assets from being shifted from inefficient to efficient firms, and penalizes healthy, well-managed companies by forcing them to compete against subsidized competitors. I don't see how preventing healthy good banks from harvesting the organs of our megabanks "strengthens our financial system".

I think it's time to move beyond the nationalization/preprivatization debate and start talking about how to replace rather than reorganize failing firms. That doesn't mean that we would shutter all of Citi's branches. It implies having troubled banks continue to operate in a kind of run-off mode (something like Arnold Kling's #2) while the government backstops some obligations and seeks buyers for the bank's assets, operating as well as financial. In other words, it's time to move beyond nationalization and talk about state-managed liquidation. I look forward to an America with a strong financial system. I think that's more likely in a world where Citi's logo goes all retro chic like Pan Am. Frankly, I think that's all the (non-negative) "franchise value" that's left in Citi, and several of its peers.

Steve Randy Waldman — Sunday March 1, 2009 at 5:12pm "

Me:

Don the libertarian Democrat (mail) (www):

That might be true for Citi or AIG, but here's Ken Lewis last week:


"KEN LEWIS:
02:58:00:00 Well, the-- the-- the downsize is that you-- downside is that you don't-- that you don't win. And so, you've got a company that may be bankrupt that you've got to take. Or that you get sued for a jillion (PH) dollars and-- and so that's-- they just thought the downside was so severe that-- and-- and the-- the hit to the system, in us not doing it-- and then-- and then the interrelationship between-- you know, what's good for America's also good for Bank of America. 'Cause we're so intertwined that it just made sense."

Are you saying that he's deluded?

"Some companies are too powerful to fail": That's Our System

John Kay in the FT has interesting post this morning that echoes some of the points that I was using in talking about Yves Smith's post on the US fear of Nationalization:

"Great banks are “too big to fail”. The predictable consequence of governments accepting this argument is a queue of other companies “too big to fail” lining up at the front door of treasuries. Insurers were next. This week, the car manufacturers secured their subsidy."

It is predictable, but also, in some sense, necessary, because politically, it would be very hard for a bailout of just financial services to be accepted by the citizenry of the US.

"The failure of any business has ripple effects on suppliers, employees, distributors and customers. If the business is General Motors such effects are larger. But since GM is many times larger than most companies, the subsidy needed to keep going is correspondingly larger. There is no reason to think that the ripple effects are larger, relative to the size of GM, than the consequences of the failure of a smaller business relative to its size."

That's not the point, but he understands that.

"So the return on the taxpayers’ dollar is not likely to be larger if their largesse goes to a big company. Indeed, since the large company has readier access to a range of alternative funding options, a need for government support is more likely the result of deep-seated competitive weakness than temporary shortage of funds which can so easily cripple a smaller business."

Not exactly. The government is the implicit guarantor for these businesses at all times, and legislation has been passed favoring these businesses over time. It certainly can mean that they are competitively weak, but the system operates for the benefit of the weak and strong large businesses alike. It's a kind of insurance policy.

"That is true of the carmakers, whose problems are of much longer standing than the current downturn. In automobiles as in many industries, economies of scale are technological, the diseconomies of scale human. Human factors in business are generally more influential than technological ones in determining the long run fate of a company."

The automakers have been a major part of this system.

"The memory of a meeting in one of Britain’s largest companies – now no longer so large – is engraved in my memory. We discussed how best to persuade the regulatory authorities of the cost advantages arising from the company’s size. But the room was crowded with people who had nothing substantive to contribute. They were there to defend and advance their political position in the corporate hierarchy. The meeting itself demonstrated that the arguments we were presenting were false. Politics overrode productivity."

But Politics is important. So is Political Economy, which includes this kind of messy exchange between politics and productivity.

"As has been true in Detroit. Arrogant, complacent and only belatedly sensitive to competitive pressures and changing customer needs, the big three have been in relative decline for half a century."

True. That's why they've been lobbying congress throughout this period.

"But there really are economies of scale in political lobbying. The cost of presenting your case is independent of the size of the benefit you seek. The larger the business, the more likely that legislators will see constituency interest or political advantage in being helpful. Big companies have government affairs departments but for small groups the cost of access is prohibitive. Only large companies have access to the sharpest shooters."

That's the system.

"Too big to fail, but big enough to exert political influence. The malign consequences are evident in many areas of public policy. Large media and software companies write intellectual property rules, while the interests of users go unrepresented. Big pharmaceutical and defence companies employ thousands of lobbyists. Consumer interests come a distant second to producer interests in the formulation of trade policy. In the past two decades the financial services industry has become the most powerful and effective lobby of all. The cash contributed to political campaigns has now been repaid many times over from the public purse."

That's because lobbying is an investment.

"But few things corrode business efficiency and effective markets more insidiously than the discovery that it is more profitable to win the favour of politicians than to win the approval of customers. In Italy, and in some other European states, an inefficient large-business sector is parasitic on the vibrant small- and medium-sized enterprises, which are the mainstay of the economy."

That's true.

"The problems are worse in Russia and in many potentially emerging economies. In these countries, the nexus between the political and business elite undermines both democracy and business efficiency."

That's not good to hear.

"The populist trustbusters who framed anti-monopoly legislation more than a century ago feared that the cost and technical advantages of large companies would be more than offset by damage to economic efficiency and pluralist institutions from the political power they might acquire. These early trustbusters were right."

I agree. But the work to be done to dismantle this current system is going to be long and arduous because, again, that is and has been our system, and it seems very resilient and impervious to challenge and change at the moment. We need to plan and prepare for the the long run, and seek small victories that will allow us to get some important things done under the radar, so to speak, and before the system realizes that, this time, it really has a challenge from people who want a smaller and more effective and efficient and representative government. But anyone who says that they're surprised by the government response in this crisis needs to get out a bit more into the real world of Politics and Political Economy.