End of the beginning?

by John Quiggin on November 21, 2008

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.

{ 48 comments }

1

Steve LaBonne 11.21.08 at 1:38 pm

Just to be even more cheerful, things move so fast nowadays that the 2 months of continued aimless drift between now and Jan. 20 is an eternity even compared to the wait until March for FDR’s inauguration.

We are so screwed.

2

Bill Gardner 11.21.08 at 1:38 pm

Only outright nationalization is feasible, and that will probably require joint action by a number of governments

Please say more about this. Are you saying that Citi will be owned jointly by a consortium of nations? Or that others will help the US finance the purchase?

3

Michael Turner 11.21.08 at 2:03 pm

John, I especially liked the Reuters story linked, in which one Sean Egan is quoted as saying, “Even though the Fed has done everything it possibly could to support the banks it seems like they are rolling a rock up a hill.”

Cultural literacy being what it is these says, I suppose I’ll have to say that Treasury, in opening a massive liquidity conduit last year, was diverting a river in the hope that it would clean a lot of horseshit out of a huge stables. I’d have to say that Phil Gramm et al., in deregulating the banking sector, opened up this box that held a whole lot of bad things on wings that then flew out all over the world, plaguing everyone. I’d have to say that even if Ben Bernanke applies the wisdom accumulated from his deep study of the Great Depression, and somehow saves the day, the way he saves it will leave him so hated by certain Powers That Be that they will chain him to side of that mountain down which that rock rolled and smashed those stables (which then got swept away in splinters in that river). And he will lie there, struggling, helpless, in agony, as his ever-regenerating liver is torn in perpetuity by flying Republican attack monkeys.

(Can you tell that if I had kids, I’d nag them every night, saying “No Harry Potter until you’ve finished all of your Edith Hamilton”?)

4

cervantes 11.21.08 at 2:23 pm

This is all very amusing but while we’re restructuring our institutions and what not a whole lot of people are going to be cold, hungry and even dead. Sometimes those cold and hungry people cause trouble. Just sayin’.

5

The Raven 11.21.08 at 2:27 pm

Cervantes, oh, you mean, like electing Sarah Palin President?

Caw!

6

Steve LaBonne 11.21.08 at 2:45 pm

cervantes- cold, hungry and dead are awful things but trouble is a GOOD thing (as I expect you agree.). Trouble is what forced FDR out of his conventional, conservative Democratic cocoon and into the arms of genuine reformers. So let’s hope you’re right.

7

Steve LaBonne 11.21.08 at 2:47 pm

Raven- just like they elected Alf Landon in 1936, right?

8

Michael Turner 11.21.08 at 3:02 pm

Sometimes those cold and hungry people cause trouble. Just sayin’.

Look on the bright side: the dead ones won’t. Unless you make the mistake of trying to dig them up and put them back to work again.

9

Russell Arben Fox 11.21.08 at 3:10 pm

I really didn’t expect the really big names to start falling so soon; I figured the Congress or the good Lord would manage to buy off Depression 2.0 until after the Christmas holiday, or something. Perhaps that was my mistake. Oh well. My hopes remain the same.

10

matt 11.21.08 at 3:23 pm

But Matthew Yglesias reported a few days ago that some Swiss bankers told him, hand on heart even, that the Swiss banks were fine, no trouble there at all, none. Are you suggesting that a Swiss banker might have _lied_ to him?

11

cervantes 11.21.08 at 3:45 pm

There’s good trouble and there’s bad trouble. It remains to be seen which kind we get. Probably some of both. Buckle your seat belts.

12

Michael Turner 11.21.08 at 3:46 pm

Depression 2.0 will at least be a major upgrade, Russell. I hear Depression 3.0 will be the first really usable version, though. I’m going to wait for that one. So what if I won’t have anything to flash around immediately after Christmas. Who cares. Everyone I know is planning to spend less on Christmas this year anyway. And it’s worth waiting, I think, to have a Depression with fewer crashes.

13

Steve LaBonne 11.21.08 at 3:50 pm

I hear Depression 3.0 will be the first really usable version, though.

But not until the first service pack comes out.

14

lemuel pitkin 11.21.08 at 3:53 pm

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

Good point- altho I thought the inventory cycle was supposed to be a thing of the past. John, do you recommend any books/articles on th historical dynamics of recessions?

15

John from Concord 11.21.08 at 3:54 pm

I didn’t realize that Depression was a Microsoft product.

I thought it was mostly a Goldman deal, actually.

16

marcel 11.21.08 at 4:01 pm

Michael Turner:

With your flying Republican attack monkeys, you seem to be confusing Prometheus with Oz, a classical legend with a modern fairy tale. I’m trying to figure out if there is some hidden meaning or connection that I can wring out of this, but I’m at a loss. Republicans = eagles = the US?
an updated populist allegory?

Help me out here.

17

Russell Arben Fox 11.21.08 at 4:03 pm

But not until the first service pack comes out.

I think they’re planning on that being bundled with every Ipod sold. Or ever food stamp cashed. or both.

18

Michael Turner 11.21.08 at 4:49 pm

Oh, marcel. Remember what Ralph Waldo Emerson said: “A foolish consistency is the flying Republican attack monkey of small minds.”

(Or was it William Jennings Bryan who said that? I forget.)

Sometimes those monkeys wing in with good news, though, if you know how to interpret their brainless chatter: Donald Luskin can’t see a market bottom anywhere, anymore. So we’re probably just about at the bottom.

19

Sock Puppet of the Great Satan 11.21.08 at 5:20 pm

“Donald Luskin can’t see a market bottom anywhere, anymore. So we’re probably just about at the bottom.”

That’s the first hopeful news I’ve heard all week. If Larry Kudlow also starts predicting DOW 5,000, then the recovery can’t be far away.

20

ajay 11.21.08 at 5:48 pm

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

Unshippable, not unsellable.

21

Barry 11.21.08 at 5:56 pm

Michael Turner: “Donald Luskin can’t see a market bottom anywhere, anymore. So we’re probably just about at the bottom.”

Sock Puppet of the Great Satan: “That’s the first hopeful news I’ve heard all week. If Larry Kudlow also starts predicting DOW 5,000, then the recovery can’t be far away.”

That *is* good news about Luskin, but what if a Vengeful God decides that this is a perfect first time for him to be right?

22

matrullo 11.21.08 at 6:10 pm

what would JesusThomas L. Friedman do?

23

Barry 11.21.08 at 6:14 pm

What’s worse is what Luskin said (http://www.smartmoney.com/Investing/Stocks/Rescuing-the-Big-Three-Is-a-Necessary-Evil/):

“Congress certainly isn’t. With the world heading into a severe recession, you’d think it would be a no-brainer to give the Big Three auto makers early access to $25 billion in aid they’ve already been promised, to help them through an intense cash-flow squeeze that threatens their very viability. I’m a conservative, and I hate the idea of bailouts. But it’s clear even to me that this is something we should be doing under the circumstances, especially considering it’s money that’s already been committed anyway.”

This means that the bailout is a bad idea (since he supported it, and scr*w the fact that GM even touching the third-rail of bankruptcy is Real Bad Right Now), or that Luskin is right, which means that things are so bad that Luskin could be right. Which is very bad, indeed.

If the WSJ editorial board (or, as I like to call them, the Urinal) start calling for sane economic policy, then I’ll just go down in the basement with my canned food and some guns.

24

Ciarán 11.21.08 at 6:15 pm

Ajay, probably both.

25

Doctor Science 11.21.08 at 6:37 pm

*Switzerland*?!? For reals?

26

Rich Puchalsky 11.21.08 at 6:59 pm

The problem with these kind of piecemeal nationalizations is that you end up owning all the bad stuff. Who really wants to own Citigroup?

27

The Raven 11.21.08 at 7:21 pm

Steve La Bonne, “Raven- just like they elected Alf Landon in 1936, right?”

Or Hitler in Germany. Scared cold hungry hominids in large numbers are dangerous. Obama had better be a blessed genius, or you-folk will be feeding us corvids in large numbers again. Don’t wish for hardship–it does not bring out the best in hominids, regardless of what you may have heard.

28

Steve LaBonne 11.21.08 at 7:36 pm

The hardship, alas, is coming whether we like it or not. The question is whether people will suffer passively or will organize as they did in the 1930s. Despite the obvious risks of the latter (which you pointed out in such Godwinesque fashion) it’s the only chance that serious reform will come out of the suffering.

Right now the popularity of right-wing Republicans is somewhere between that of child molesters and bubonic plague- people know exactly who to blame for this clusterfuck. I’ll only be worried about a rightward backlash if the Obama administration fails to deliver meaningful relief. I don’t think that will happen, but some street-level pressure on them not to backslide would be a good thing.

29

cervantes 11.21.08 at 7:45 pm

Mr. LaBonne, as my earlier comments indicate, I am not so sanguine. We have already seen a very ugly upsurge in racist acting out and actual physical assaults and murder of people perceived as Latino immigrants. Racism is far too deeply embedded in the psyche of this country not to be a part of the mix in any populist uprising. The Republican campaign did its best to capitalize, and although it failed to get a majority of the votes, it got quite enough thank you. Palin’s crowds were whipped into a murderous frenzy and I really don’t think all that energy is going to quietly fade away.

30

Steve LaBonne 11.21.08 at 7:51 pm

The Republican campaign did its best to capitalize, and although it failed to get a majority of the votes, it got quite enough thank you.

Well, I would argue the contrary-look at the Congressional results, there have now been two straight Democratic wave elections, which is actually pretty stunning. (And by recent presidential standards Obama’s margin of nearly 53% to just under 46% is actually a damn good thrashing as well.) And right now the Republican brand is in the crapper.

31

Barry 11.21.08 at 8:00 pm

What I worry about is that, even if Obama does a job which the poli sci, econ and B-school people laud for the next century, it’s likely that we’re in for at least one Very Bad Year, and then a Bad Year, and then, maybe, if we’re lucky, one or two or three recessionary years.
In other words, we haven’t hit bottom yet, even though the initial course has been locked in.

In 1932, FDR came in after three years of failure, which hammered the USA until it was clear [1] that Hooverism had failed; this was an advantage in terms of giving him the political clout to make fast, radical changes.

-Barry

[1] Except for those who refuse to be persuaded; I’d use the term ‘denialists’, but it’s anachronistic, so I’ll use the term ‘d*mned fools’.

32

Robert Worstell 11.21.08 at 8:36 pm

Good thing I live where the “chicken littles” of mainstream media aren’t able to cluck around and scare everyone half to death. Looks like we’ll put in a bigger garden this year…

33

Martin Bento 11.21.08 at 9:37 pm

Maybe we should start asking some different questions:

1) Have any top executives at top financial firms, through shell companies or whatnot, been short their own firms?

2) Have any been short their competitors’ firms such that they are net short the industry or close to it (with the bailouts compensating those who have been invested in continued success, while not punishing those who have been short in the proper way, a hedge not strongly weighted to long (counting for this purpose your own stock options and such as effectively a “long” position) would still profit as the losses would be compensated for, at least partly, by the government and the gains stand.

3) Related to all this, do we know what the Fed is really up to (http://www.bloomberg.com/apps/news?pid=washingtonstory&sid=abYTR9BqGlBo)?

34

David Galbraith 11.21.08 at 10:58 pm

Although, as you say, Felix Salmon spelled out doom for Citi a while back, he points out that this isn’t the systemic failure you claim, since the credit markets aren’t now terminal.

“Banks’ capital structures can cope with this: once the common is eroded, the bank belongs to its preferred stockholders. It’s not the end of the world if Citi stock goes to zero”.

http://www.portfolio.com/views/blogs/market-movers/2008/11/21/this-is-not-financial-meltdown

35

BlueCollarDollar.com 11.22.08 at 12:33 am

Perhaps it will be the end of growth through acquisition, something that does little for the company’s long-term value while it appeases the shareholder. We are seeing giants falter for a good reason. These behemoths may have never been intended to survive. Too big and unwieldy to move quickly. So they bought everything. Eliminating the competition as we now know, is not such a good thing and when something big breaks, like a Citi, there are few smaller businesses standing at the ready to pick up the pieces and prosper. This may be what we need to learn. Business with a diverse amount of competition.

36

Keith M Ellis 11.22.08 at 1:50 am

I thought that the problem for Iceland was that all their debt was denominated in foreign currencies. Switzerland doesn’t have that problem; at least not to the same degree. Right? Or not right?

37

Barry 11.22.08 at 2:43 am

Robert Worstell 11.21.08 at 8:36 pm

” Good thing I live where the “chicken littles” of mainstream media aren’t able to cluck around and scare everyone half to death. Looks like we’ll put in a bigger garden this year…”

Considering that the ‘ “chicken littles” of mainstream media’ would have to include Paulson, Bernanke, Bush, most of the GOP Congress, and by now even the Sacred Oracles of the Wall Street Urinal, I think that note [1] of my previous comment applies.

38

John Quiggin 11.22.08 at 3:00 am

David G, I’m not claiming that a failure of Citi will cause a systemic financial meltdown; if anything the opposite. As the post title indicates, the beginning phase of the crisis (credit crunch, partial meltdown and so on) is probably over. So, if you thought that this was essentially a liquidity crisis caused by a breakdown of financial intermediation, you’d be predicting a reasonably swift recovery.

The fact that Citi is on the brink suggests otherwise. The problem now is that, given the likely severity of the real downturn, the accompanying rise in defaults, and the inability to bring down debt levels at anything like the pace that is needed, major financial institutions like Citi are effectively insolvent. This can’t be fixed by monetary easing.

Keith, the major Swiss banks have huge assets and liabilities in Euros, dollars and sterling as well as SFr. So, resort to the printing press wouldn’t help. Of course, the situation of the US is a bit different.

39

Corrupted Mind 11.22.08 at 11:03 am

I must say that this article is funny. The author displays a complete misunderstanding about why Iceland failed and why it is difficult to apply the ‘Iceland situation’ to Switzerland. I think we all can agree that UBS and CSFB’s balance sheets are extremely large (about $3tr) but the reason Iceland went kaput so spectacularly was because in economic shorthand, their failed to meet some of their obligations and the rest of the world decided that they couldn’t meet all of their obligations. Switzerland on the other hand have the 4th largest gold reserves in the world (after IMF, US and the EU combined) and the 18th biggest foreign reserves in the world (yes, chaps they are ahead of the US in that little game!) Their combined reserves are a shade smaller than the US and I’m sure everyone on this forum would agree that the US because of this fact would be considered as a solvent – even with its mamouth deficit – pls note that the swiss deficit isn’t even in the same universe. In summary, creditors would be willing to wait for the Swiss to pay. This might reflect why you’re yet to see any shorting of UBS or CFSB stock, especially since the SNB gave its guarantee. One final note, an effect of the economic shock has seen a strengthening on the price of Gold which rather randomly strengthens the Swiss economy in times of economic stress. But perhaps more importantly the Swiss have taken steps to balance its foreign exchange with less Dollars over the last 10 years (http://www.snb.ch/en/iabout/assets/id/assets_reserves) only 28% currently held in dollars as opposed to the near 50% it has in EUR – in shorthand by converting its foreign reserve to EUR at present its Forex is strengthening as the EUR strengthens against the dollar. In short they have a huge gold reserve, a huge foreign reserve – with both strengthening (despite the market being distressed) – If I was one of those faux US investment TV show presenters I would probably end this little comment with a – BUY!

40

vonbek 11.22.08 at 11:26 am

ajay 11.21.08 at 5:48 pm

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

Unshippable, not unsellable.

Isn’t this entire financial fiasco overkill just to deal with some Somali pirates…

41

Barry 11.22.08 at 1:19 pm

Re: Michael Turner’s comment #3:

And that’s part of our problem – as we’ve seen, the right has neither forgotten nor forgiven FDR for saving capitalism from itself. Bernanke knows that he’ll never be forgiven by the group to which he’d like to suck up and toady, if he saved them, if that lost them their power, perquisites andprivileges.

42

John Evans 11.22.08 at 4:57 pm

The UK has just used drastic monetary policy — a huge base rate cut — to head off a bout of deflation. It couldn’t have done that in the eurozone.

The UK will not “be forced into the eurozone”, especially as an incoming Conservative government — probably in 2009 will be totally opposed.

43

woody 11.22.08 at 5:02 pm

You Ain’t Seen NUTTIN’ Yet Oh, well you cant access it unless you’re a subscriber, and if you were a subscriber, you wouldn’t NEED to access it on-line. So go buy the magazine, this month…Or follow the links: By John Gray, adapted from a September 28 column in the Observer of London. Gray’s Black Mass: Apocalyptic Religion and the Death of Utopia was published last year by Farrar, Straus and Giroux.

The end is just about here, friends. Brought on by the moronic triumphalism that attended the fall of the Soviets, after which an Utopian fantasy based on the infallibility of “markets” took over and led us to the precipice down which we are sliding now.

Screwed is when they overcharge you for a tune-up.

What we are is fu(ked…wholly, deeply, irremediably, and irredeemably…

44

J Thomas 11.22.08 at 6:25 pm

Bernanke knows that he’ll never be forgiven by the group to which he’d like to suck up and toady, if he saved them, if that lost them their power, perquisites and privileges.

How could they think they were saved, if they lost their power, perqs and privileges?

45

John Quiggin 11.23.08 at 3:55 am

#39 As a general observation, unless you have exceptionally strong grounds for your case, as opposed to some superficially plausible arguments, it’s a good idea to start out a bit more politely. The point about gold reserves is a red herring, since gold is a trivial component of reserves for most countries these days – even if the price goes up, it’s still trivial. According to this source total Swiss reserves are $64 billion, 22nd in the world, just ahead of Poland and just behind the US. That’s approximately the amount of the bad UBS assets they just took on, and a tiny fraction of the contingent liabilities implied by a guarantee of UBS and CS.

It’s true that the market hasn’t yet panicked about Switzerland, and it’s also true that, by the same criteria, the US looks weak as well. But if those are the best grounds you have for confidence, you ought to be pretty worried.

46

MQ 11.24.08 at 1:35 pm

Well, they announced the Citigroup rescue plan today, and it does sort of look like the same “half-measures that have been tried so far”. Although I guess the scale of the losses to be backstopped could change that?

47

Chris 11.24.08 at 3:39 pm

Naive non-economist question: What would happen if a government or combination of governments mandated a write-down of all debt by X%? Credit card, home and vehicle loan, bank-to-bank, everything gets repaid at 100-X cents on the dollar? Wouldn’t this un-default a lot of loans and re-secure some currently inadequately secured debt? Of course net creditors would take a haircut, but surely they of all people can afford it…

48

J Thomas 11.24.08 at 4:04 pm

Chris, if that’s across-the-board should it include the special T-Bonds that form the government’s IOUs to Social Security? People have argued whether Social Security is facing a big funding problem in 20 or 30 years, but if it was suddenly funded at 100-X cents on the dollar that would sort of slide it toward the funding problem side, right?

And of course a whole lot of loans are people’s retirements. But retirement isn’t all in the form of bonds, some people have a lot of their retirement money safely in the stock market, or in the value of their homes.

I think it would make a big difference if we could easily and simply cut the national debt by X%, and also the value of all foreign debt owed by the USA or by US citizens. We’d be a lot better off that way. Of course, if the foreigners cut their debt to us by X% also, who would come out ahead? I think it’s the ones who’d come out behind who’d be particularly against the idea.

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