[UPDATE: Please note that I neither endorse nor condemn the Citi bailout here, only comment on the opportunities presented by the financial crisis we now face.]
My grandfather, a small business entrepreneur, used to say, “Borrow a thousand dollars from the bank and the bank owns you; borrow a hundred thousand from the bank and you own the bank.”
The times were simpler then. But if you add a few zeroes, as represented in the sometimes shaky yet astronomical loans made by major US lending houses over the past decade-and-a-half, you get some sense of why after lengthy, tense negotiations, the US Treasury Department, the Federal Reserve, and the FDIC agreed to bailout troubled banking giant Citigroup late on Sunday. In a phrase that seems to be gaining currency, whether applied to Citigroup or by some, to Detroit’s Big Three automakers, this company was too large to be allowed to die.
The plan has two key features:
First, the U.S. Treasury and the Federal Deposit Insurance Corporation (FDIC) will backstop some losses against more than $300 billion in troubled assets.
Second, the Treasury will make a fresh $20 billion investment in the bank. The government has already injected $25 billion into Citigroup as part of the $700 billion bailout passed by Congress in October.
In return for the latest intervention, the government will receive an additional batch of preferred shares – $20 billion for its direct investment and $7 billion as compensation for the loan guarantees. Citigroup will pay an 8% dividend rate on those shares.
The government will impose other restrictions as well. Citigroup will be prohibited from paying out a dividend of more than a penny per share and will face limits on executive compensation. Plus, it will be expected to adjust mortgages for troubled borrowers, according to procedures outlined by the FDIC.
For years, both home mortgage loans and property were overvalued, based on the lending industry’s bet that property valuation would always inevitably increase. Those who, in this largely unregulated period, bought with no down or with little capacity for keeping up with payments, were convinced by lenders and, possibly their own wishful thinking, that property value increases would grow them out of debt. This would allow them, or so it was thought, to refinance and boom their way out from under their mortgage obligations. That set of tall assumptions has suddenly come to roost, impacting millions of home-buyers, investors, and the entire economy.
The assumptions of an endless real estate cash cow proved wrong and so property that was grossly overvalued just a few months ago may actually be undervalued now. Citigroup, holder of a great chunk of mortgage paper, has seen its own value more than halved in the past year.
So, is this bailout plan justified?
Because of my position as a pastor, readers will know, I don’t express opinions on such political matters.
But I can tell you, I have been chagrined by some of the psychology surrounding the current crisis, which has also seen the devaluation of stocks and mutual funds, on which many current and future retirees depend.
I have also been saddened to see more than 1.2-billion Americans lose their jobs.
Above all though, I think that this crisis presents the US economy with an enormous opportunity to retool itself, beginning with how we think about money, finances, and the economy. It has the potential of helping us to do so in ways that we might have found impossible to consider just last year. What chages are needed in our thinking?
First, we need to change our expectations about consumer spending. On the NBC Nightly Report with Lester Holt on Sunday, a reporter rattled off the percentage decreases of consumer spending on men’s and women’s clothing, major electronics items, and other merchandise. Over against spending in these categories during the first two weeks of November, 2007, spending went down about 20% for the same period this November. The information was given in foreboding tones.
But changes in consumer spending doesn’t seem horrible to me, even if we weren’t facing a recession. For decades now, economists have been warning Americans that Chinese and Japanese consumers are better at saving than we are. That has helped fuel China as a major insurer for US private and public spending, including US spending on the prosecution of the Iraq War. Over the long haul, national and economic security probably hinge on Americans exercising self-discipline over our spending and refusing to overuse credit. We already seem to be starting to exhibit these traits. If this recession gets us into the healthy habit of thriftiness, that would be a great thing for lots of reasons.
Second, we need to demonstrate less fear. In his 1933 Inaugural Address, new President Franklin Roosevelt noted that “the only thing we have to feat is fear itself.” The market is so dependent on emotion and for over a month now, the prevailing emotions have been those of fear and apprehension. In fact, I would say panic has prevailed.
But when I talk with bankers and businesspeople or when I go to the malls, the indications are that consumers are spending. They’re not doing so at the rate we would ordinarily expect and unemployment is, of course, unacceptably high. But we’re nowhere near Depression-era levels of 25% unemployment. Caution seems warranted under current circumstances. So does a willingness to let the incoming President and Congress experiment, employing a spaghetti method–tossing up all sorts of attempts to stimulate the economy, and seeing what sticks, not worrying about what doesn’t. And we need get over our fear.
In fact, the fears incited by our current economic failures should be seen as unique opportunities. In the history of the world, it’s those vanquished by economic or military experiences who bounce back stronger. Once failure has smacked us down, we’re open to finding new ways of doing things, no longer encumbered by a mindless faith in the old routines and orthodoxies.
The failures of Citigroup, other financial institutions, and other large corporations now mean that they know lots of things that don’t work. They’re free to innovate. The number one cause of failure, as these fat cow corporations have learned, is success. But the number one cause of success is failure and the mind-clearing openness to experimentation and risk that it fosters.
The Citigroup agreement appears to impose some rules on the bank, rules that would curb executive compensation and restructure the payback timetables for consumers currently in trouble with their Citigroup creditors.
That’s to the good, but I also harbor the hope that, as was true of my grandparents’ and parents’ generations in the face of the Great Depression, we will be chastened into exercising greater self-discipline.
But I also hope that the tide of new home construction, the building of behemoth structures erected in increasingly remote exurbs around our major cities, will come to an end in the United States.
I’d love to see the federal government impose outer circle boundaries around our major metropolitan areas. Within those circles, developers could put up new residential and commercial properties.
More importantly, the developers could also redevelop usable housing stock in our core city center areas and their first and second-ring suburban communities. Cheap credit has for a decade-and-a-half now, allowed people to buy McMansions in new suburbs where once there was arable farmland and thriving small communities. Even in a Third Wave world, no country would want to forgo also possessing robust, affordable, good-paying First and Second Wave economies.*
The added benefit of placing geographic restrictions on exurban sprawl is that it will help us to address our energy crisis, acting as a catalyst for what I would call the immediately needed “bridge technology” of cars and trucks that can take us shorter distances, while we await vehicles that will go farther and faster between cities.
Back in the 1970s, under Republican governor Tom McCall, Oregon imposed such a limit growth on Portland. There have been employment, environmental, and property value gains from this approach.
For the short-term, people a lot smarter than me believe in my grandfather’s maxim: Some large businesses may simply be too large for the federal government to allow them to fail.
But if we don’t use this crisis to change the way we spend, save, fuel our cars, and enhance the quality and diversities of our cities, we will have missed a great opportunity.
*The waves, from Alvin Toffler’s Third Wave, are in order: agriculture, industry, information