The failure of Citigroup, which looks increasingly likely to happen in the near future, would mark the end of the beginning of the financial crisis. Until now, the prevailing view has been that the crisis and recession will pass in a year or so, after which things will go back, more or less, to the way they were, with a few less financial institutions, and a bit more regulation. A Citigroup failure would put paid to that idea.
Citi is not only too big to fail, it’s too big to rescue with any of the half-measures that have been tried so far. Only outright nationalization is feasible, and that will probably require joint action by a number of governments; Citigroup’s global operations are too big for the US to handle alone. After that, the kinds of tinkering discussed at the G20 last week will be irrelevant. It’s now unsurprising to read (on CNBC!) predictions that all US financial institutions will be nationalized within a year. That’s probably an overstatement: as long as the economy doesn’t really crash, there are plenty of small banks and credit unions that will survive, but few of the big names will be among them.
Not only major institutions but whole national economies are up for grabs now. The national bankruptcy of Iceland seems likely to followed by something similar for Switzerland. As Citi itself points out, UBS and Credit Suisse are bigger, relative to the Swiss economy, than Kaupthing was for Iceland. Felix Salmon (also predicting doom for Citi, has been all over this).
Given a failure and rescue, Switzerland would probably have to follow Iceland in a rush application to join the EU (which might have its hands full rescuing some of its own members). It’s a safe bet that the end of secret bank accounts, “wealth management” through tax minimisation and the like would be part of the price. The UK isn’t quite as vulnerable, but seems likely to be forced into the eurozone before long (for a contrary view, see Martin Wolf) And this will be accompanied by a big structural shift away from the dominance of these economies by the financial sector.
If even part of this plays out as it seems likely to, the financial system that emerges from the crisis will be radically different from the one that went in: massively smaller, with far fewer institutions and products, and tightly regulated where it isn’t under outright public ownership.
But before we can even get to that point, we’ll have to survive a global recession which is already the worst in decades, even though it’s still in the opening phase where unsold inventories pile up on wharves. Obama’s inauguration is going to look a lot like that of FDR in 1933.