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The legacy of Sandy Weill at Citigroup has been hard to break. The market has known for years that the 'big balance sheet, financial supermarket' strategy didn't work.
The stock has traded for less than the bank's breakup value for years, but the management and the board refused to recognise the obvious, even as recently as November 17, when the virtues of Citigroup's global universal banking strategy were again extolled at a town meeting for analysts.
A few days later, the bank was forced to issue another $27 billion of preferred stock to the government, bringing the government's total investment to $52 billion. These infusions, after five consecutive quarters of sizable operating losses have effectively turned Sandy's once-celebrated creation into a zombie.
Unlike AIG, in which the government took an 80 per cent common stock interest in exchange initially for an $80 billion facility and a new CEO, Citigroup was provided with a much sweeter deal.
It was required to give up only an 8 per cent interest in the common stock and the investment came with minimal conditions: no common dividends and no excess management compensation or perks. No management or board changes were required though, after helping to negotiate the deal. Bob Rubin, chairman of the executive committee, announced his retirement.
Since then, the FDIC has been putting pressure on the bank to sell unnecessary assets and to increase capital. Reluctantly, the bank agreed to sell a 51% interest in its retail brokerage business for $2.7 billion in cash (which somehow created an accounting gain of $10 billion) despite the fact that, in late November, Vikram Pandit said he 'loved Smith Barney' and never wanted to sell it.
Apparently there are other plans to discontinue proprietary trading and to segregate $600 billion or so of non-essential assets on Citigroup's balance sheet, which apparently would be held for sale.
But even so, the part of the bank to be retained still represents the core of the original strategy -- a post-Glass Steagall banking/investment banking combine operating all over the world, presumably with the intention to return to an annual growth rate of 15 per cent in assets and income, once it's freed up again to do so.
On January 12, Larry Summers, the director-designate of the new administration's national economic council, sent a letter to Congress expressing the incoming government's plans for the TARP, asking to have the second half of it released.
In it, he said they would use some of the money to prevent further home foreclosures, insure strict accountability of the money spent, ride herd on the banks the government has invested in and try to figure out how to get the government's investment repaid as soon as possible.
Mr Summers, who appears to be the key player on the Obama economic team, ought to call on John Reed, Citigroup's former co-CEO, for advice.
Reed has two special qualifications for giving such advice. First, he was a new CEO at Citicorp in the 1980s, when it was high on the government's list of troubled banks and widely considered to be close to failure but for strong, unpublicised support (but no equity investment) from regulators.
For eight years, Reed carefully steered the bank out of trouble by beefing up the cash flow from its consumer banking business to write off the enormous heap of non-performing loans to companies and governments that the bank had undertaken during a previous lending heyday.
In the process, Reed sold every non-banking asset he could, cut costs vigorously and told the bank's large wholesale clients that he was dropping them. By 1992, most of the losses had been absorbed and the bank was ready to think about expansion again, but it would be without the wholesale business, which he knew would have further heydays in the future that would involve lending excesses that could endanger the bank.
Reed's second qualification is that he was an architect of the modern Citigroup, after the 1998 merger with Travelers, and came to realise that the whole thing, as he said, "was a mistake." He might initially have bought in to the global universal banking concept, but he now knows it doesn't work and the colossus ought to be dismantled as quickly as possible.
But the dismantling needs to be done by someone who believes that it's the right strategy for recovering shareholder value. It has to begin with management changes that will lead to separating the bad assets from the good and refloating the good assets as a Citibank redux.
The bad assets could be sold to the TARP or a private equity group or distributed to shareholders. The rest of the businesses, including the formidable Salomon Smith Barney investment banking business, should be sold or spun off to shareholders as Lehman Brothers was by American Express in 1994.
As the total amount of assets is reduced, the proceeds should be used to repay the government, to get it out of the capital structure as soon as it can. This may take some time, perhaps as long as it took Reed to pass the pig through the python, but after it has done so there may be enough left in the restructured, reinvigorated residual bank to be worth something to shareholders.
At around $6 per share, the bank's market capitalisation is now only about $30 billion, down from a high of $250 billion in 2006, about the same as Goldman Sachs but well below all its former rivals.
The shareholders will have the most to gain by burying the legacy of Sandy Weill, and freeing the zombie, than from anything else the company might do.
Roy C Smith is a professor of finance at New York University's Stern School of Business.