What Sunk Citi?

Citigroup's partial spinoff of its Smith Barney brokerage operations this weeks heralds abandoning the conglomerate model of former CEO Sandy Weill. Author Andy Kessler explains what went wrong in Friday's Wall Street Journal:

Were their any real synergies from Citibank's one-stop shop? I doubt it. It failed because internal compensation incentives mainly stressed units, not the whole, the downside of all behemoths. Plus, I don't know how many customers bought stocks at an ATM machine, because almost simultaneous to his big merger, the Internet disintermediated most of Mr. Weill's businesses. The best rates and terms and service were in the Giant Supermarket on the Web, rather than just in Sandy's shopping cart. . .

For Citi, the sure-thing investment du jour was subprime loans, conveniently packed into mortgage-backed securities. You could borrow at 2% and get 4%-6%-8% yields. Who could turn this down? Leverage of 20 to 1 or even 30 to 1 was used to buy this stuff. Shareholders might have balked at so much leverage. Citi, unlike other big U.S. banks, kept this borrowing off its balance sheet in so-called conduits or SIVs (structured investment vehicles). This is how Citigroup grew its earnings.

The SIVs allowed for huge borrowings. There was an unwritten or "implicit obligation" for Citigroup to take the SIVs back onto its balance sheets in the unlikely event that something went wrong. Well, it did. The SIVs collapsed when short-term financing dried up, and are now on Citi's balance sheet. . .

Contrary to the reregulation crowd, it wasn't the repeal in 1999 of the Depression-era Glass-Steagall Act (which had separated commercial and investment banking) that killed Citi. It was bad management. J.P. Morgan and Bank of America and Wells Fargo didn't have SIVs -- and while they too were caught in the credit crunch, these institutions have emerged as net acquirers of broken banks.