The Financial Panic Was a Government Panic, Too

Here’s one of the questions from last year’s Bespoke roundtable followed by my answer:

2) What do you believe are the most important lessons to be learned from the 08/09 financial crisis?

When market participants panic, governments panic as well. Not a new lesson but a good example of an old one.

Yesterday, the Inspector General’s office of the TARP (known as SIGTARP) released a fascinating report on the government’s action to prevent Citigroup from going under.

Here are the official SIGTARP report and part of an article from the AP:

The government’s $45 billion bailout of Citigroup met the goal of restoring the market’s confidence in the nation’s third-largest bank in the wake of the financial crisis and limited taxpayers’ risk, a new watchdog report says.

The report was issued Thursday by the office of Neil Barofsky, the special inspector general for the $700 billion bailout of the financial industry and automakers. It found, however, that the government’s decision to aid Citigroup in the fall of 2008 wasn’t made coherently, and seemed to be based on “gut instinct” and “fear of the unknown” rather than objective criteria.

Also, the report says that by bailing out Citigroup, the government encouraged high-risk behavior by signaling that big financial institutions would be protected from failing.

The report makes it clear that Citigroup was very close to going under. The government pushed for a management shake-up that didn’t come…and has never come.

I think this report severely undermines two of the current narratives. One is the conspiratorial narrative: that the government and the bankers knew exactly what they were doing. They didn’t. They made up their plans as they went along. The report criticizes that “strikingly ad hoc” nature of the process.

The other isn’t a narrative but is the belief that government can serve as a rational actor to prevent the irrational exuberance of the private sector. In reality, the government was just as clueless as everyone else was.

Ultimately, the government got lucky. Taxpayers made a nice $12 billion profit but the public’s investment in Citi was hardly a sober-minded affair.

My guess, and it’s just a guess, is that the genius of the TARP program wasn’t that it bought preferred shares but that instead, it bought time. Shares of Citi didn’t bottom out until the following March. I think the key is that the TED spread gradually compressed which took some pressure off of Citi and other banks. Next time we may not be so lucky.

Posted by on January 14th, 2011 at 8:03 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.