If further proof were needed that the world financial order has changed, the $20 billion bailout of mighty Citibank is it. It is one of America’s oldest and most innovative banks. Citibankers were always of a subtly different cut from their fellow bankers. Citibank went into overseas markets long before its competitors and often secured an inside track by attending to the financial needs of government elites and leading local organizations. Arguably since the heyday of CEO John Reed, that ability to size up a market and act to the best advantage deserted top management, who finally allowed the bank to be dragged along with the rest of the crowd into the subprime debacle.
Citibank is receiving its new capital injection from the US taxpayers because like insurance giant AIG, which is getting $40 billion, it is simply too big to fail. The cash comes from $700 billion allocated to the purchase of stakes in ailing financial institutions. But this is only a fraction of the burden the US budget is now being asked to bear. Among other financial commitments, there is now up to $800 billion in Federal Reserve support for mortgage and consumer credit markets, up to $600 billion in Fed purchases of US dollar commercial paper and certificates of deposit, up to $1.8 trillion in Fed purchases of top-rated US dollar commercial paper and up to about $1.9 trillion in new Federal Deposit Insurance Corporation guarantees for banks. It would be wrong to imagine that all this committed money will actually be spent and indeed some will be recouped. However, analysts now say the rescue money on the table for the US alone is approaching $8 trillion. This will have to be financed through a combination of new government debt and printing dollars.
If Washington along with many other governments is partially underwriting the bad debts of a failed financial system, a key question arises. If these debts were so bad commercial investors were not prepared to risk them, why should governments shoulder them on behalf of taxpayers? Is this not simply akin to squeezing an air bubble further down, rather than outside of a pipe?
To press the point further, the reason the markets collapsed in the first place was a sudden plunge in investor confidence. Now governments are stepping in where private investors feared to tread. But these governments must themselves find ways to fund their financial system rescue packages. They will, therefore, issue debt. How much more confident are investors likely to be when effectively the same distressed underlying assets are presented to them, this time repackaged with government guarantees?
There is still a lot of investment cash out there looking desperately for value. However, the flood of governmental debt will not all be equally inviting. Investors will pick and choose and governments which are already deeply in shock will pay high prices, if they can move their paper at all. Little Iceland and Latvia already face bankruptcy. Far bigger fish may follow.
