The federal government's 2008 rescue of Citigroup was successful and profitable - but it may have to happen again, worse next time, unless regulators do what Treasury Secretary Timothy Geithner says is impossible: Set clear criteria for when and how to bail out, break up, or close giant banks.
That's according to Neil Barofsky, Special Inspector General for the Targeted Asset Relief Program (TARP) in this report. See also this Bloomberg column. Writes Barofsky:
"Citigroup did not fail, and the global economy avoided the catastrophic financial collapse that many feared would flow from a Citigroup failure... The Government incurred no losses, and even profited on its overall investment in Citigroup by more than $12 billion.
"Nevertheless, two aspects of the Citigroup rescue bear noting:
"First, the conclusion of the various Government actors that Citigroup had to be saved was strikingly ad hoc... based as much on gut instinct and fear of the unknown as on objective criteria...
"Secretary Geithner told SIGTARP that he believed creating effective, purely objective criteria for evaluating systemic risk is not possible... If the Secretary is correct, then systemic risk judgments in future crises will again be subject to concerns about consistency and fairness, not to mention accuracy."
But last year's Dodd-Frank Wall Street Reform and Consumer Protection Act "created the Financial Stability Oversight Council (“FSOC”) and charged it with responsibility for developing the specific criteria and analytical framework for assessing systemic significance. That process is under way... An emphasis on the development of clear, objective criteria in advance of the next crisis would significantly aid decision
makers likely to be burdened by enormous responsibility, extreme time pressure, and uncertain information...
Second, "the Government’s actions with respect to Citigroup undoubtedly contributed to the increased moral hazard that has been a direct byproduct of TARP.... Citigroup... still remains, an institution that is too big, too interconnected, and too essential to the global financial system to be allowed to fail...
The Government, in rescuing Citigroup, "encouraged high-risk behavior by insulating the risk takers from the consequences of failure. Unless and until institutions like Citigroup are either broken up so that they are no longer a threat to the financial system, or a structure is put in place to assure that they will be left to suffer the full consequences of their own folly, the prospect of more bailouts will potentially fuel more bad
behavior with potentially disastrous results."