SIGTARP released a new audit report, Extraordinary Financial Assistance Provided to Citigroup which should shock and awe.

Citigroup was bailed out in November 2008, with $20 billion dollars plus $301 billion in asset guarantees. Now the Special Inspector General of TARP has gone back and done an audit, a forensic accounting of what really happened.

It appears Citigroup poses systemic risk was just screamed from the roof tops like Chicken Little and the solution was to throw money at it. No one bothered to check if this was even true, that Citigroup presented a systemic collapse of the global financial system if it failed. Even worse, while systemic risk is so complex, kind of a domino theory of multi-dimensions, yet to ascertain the possibility, it was implied why bother? From the report:

First, the conclusion of the various Government actors that Citigroup had to be saved was strikingly ad hoc. While there was consensus that Citigroup was too systemically significant to be allowed to fail, that consensus appeared to be based as much on gut instinct and fear of the unknown as on objective criteria. Given the urgent nature of the crisis surrounding Citigroup, the ad hoc character of the systemic risk determination is not surprising, and SIGTARP found no evidence that the determination was incorrect.

Nevertheless, the absence of objective criteria for reaching such a conclusion raised concerns about whether systemic risk determinations were being made fairly and with consistent criteria. Such concerns could be addressed at least in part by the development, in advance of the next crisis, of clear, objective criteria and a detailed road map as to how those criteria should be applied. Treasury Secretary Timothy F. Geithner told SIGTARP that he believed creating effective, purely objective criteria for evaluating systemic risk is not possible, saying “it depends too much on the state of the world at the time. You won’t be able to make a judgment about that’s systemic and what’s not until you know the nature of the shock” the economy is undergoing. He also said that whatever objective criteria were developed in advance, markets and institutions would adjust and “migrate around them.”

Gee wiz! I'm having systemic risk, please give me $20 billion dollars! I can't prove it, but I just feel it in my gut, in here, ya know?

Geithner's statements are amazing and also inaccurate. There are a host of analysis on derivatives models being mathematical fiction, computational fiction, a series of studies on institutions being too large.... there is the possibility to analyze, objectively, institutions which pose systemic risk.

The story of what happened to classify Citigroup as a systemic risk starts on page 12 of the report. Some of the details are most bizarre, namely it all seems to be coming from Someone at the New York Federal Reserve (read Tim Geithner) and a former Citigroup Treasurer (read Robert Rubin et. al connections). Below are choice words others said during that time:

Citigroup CEO Pandit stated he did not know what the systemic effects of a Citigroup failure would be, and, essentially, that no one wanted to find out.

The Citigroup CEO has no idea of the systemic or contagion effects of his own company, an astounding head in the sand, Ostrich mentality. Yet, in spite of this and his own global financial institution within hours of being shut down and causing a global bank run, Pandit is still in charge of Citigroup. Forget analyzing systemic risk, how about analyzing what kind of criteria is used to select a CEO in the first place?

Citigroup also was a major player in a wide range of derivatives markets, both as a counterparty to over-the-counter trades, and as a broker and clearing firm for trades on exchanges. At the end of the third quarter, the notional principal value of its derivatives positions was more than $35 trillion, the bulk of which was held by its Citibank, N.A., subsidiary.

The above is a brazen example of the absurdity of derivatives. No regulation, no oversight and especially no real analysis and safeguards to remove dependencies and limit the above situation so no institution is too big to fail.

Remember how we could not get derivatives reform in the financial reform bill?

People seemingly just fell in line and voted Citigroup a systemic risk in order to give them the bail out. Seems only one questioned this decision making process.

OTS Director Reich, an FDIC Board member, expressed the concern that there had been “some selective creativity exercised in the determination of what is systemic and what’s not,” and that there “has been a high degree of pressure exerted in certain situations, and not in others, and I’m concerned about parity.” In terms of Citigroup, an FDIC official told SIGTARP that the FDIC directors and other Government entities “made a judgment call.”

The report describes more details, but beyond the fact Citigroup was on the verge of collapse and anyone shorting bank stocks at that time knew this, it's amazing how little objective analysis or understanding of how things got that way, or even what would happen with a Citigroup failure is astounding.

There are so many people unemployed who I am sure would be more than happy to model doomsday as a job for the Treasury and Federal Reserve.

One thing Federal Reserve Chair Ben Bernanke noted during Citigroup bail-out weekend was the amount of foreign assets and deposits held by Citigroup.

They have $500 billion in foreign deposits that nobody can guarantee.

Hmmmm, now isn't that kind of the definition of systemic risk, allowing a financial institution to operate globally and when they go south, all deposits, not just the ones under the U.S. purview, are magically the U.S. taxpayer's responsibility?

Supposedly those very foreign assets were excluded from the asset guarantees provided by the New York Fed, yet deep in the report we have this minor detail that it took over a year to to find out.

One OCC examiner told SIGTARP that Citigroup did not have sufficient information from its computer systems about all the assets, and did not have the capacity to readily aggregate global data. As a result, Citigroup was not able to provide regulators with effective information about all of the assets during the initial review over Citi Weekend. Nor was it subsequently able to determine whether some of the originally proposed assets met the asset criteria. Similarly, PwC told SIGTARP it faced problems testing the asset pool, particularly in extracting data from Citigroup’s many different computer systems across several different entities. However, almost one year after Citi Weekend, on November 17, 2009, the Government was finally confident that the assets that did not meet its criteria had been excluded from the pool.

Can you believe this? A company with 80% of it's profits coming from foreign assets, operating in 100 countries and no centralized database to even find out what all of those assets were or if they even met the criteria for a bail out?

Here is SIGTARP's conclusion, which, like so many other reports, experts, testimony and insights, will of course be promptly ignored.

SIGTARP remains convinced that even if some aspects of systemic significance are necessarily subjective and dependent on the nature of the crisis at the time, an emphasis on the development of clear, objective criteria in advance of the next crisis would significantly aid decision makers burdened by enormous responsibility, extreme time pressure, and uncertain information. It is also imperative that FSOC not simply accept the adaptability of Wall Street firms to work around regulation, but instead maintain the flexibility to respond in kind.

Second, the Government’s actions with respect to Citigroup undoubtedly contributed to the increased moral hazard that has been a direct byproduct of TARP. While the year-plus of Government dependence left Citigroup a stronger institution than it had been, it remained, and arguably still remains, an institution that is too big, too interconnected, and too essential to the global financial system to be allowed to fail.

When the Government assured the world in 2008 that it would not let Citigroup fail, it did more than reassure troubled markets – it encouraged high-risk behavior by insulating risk takers from the consequences of failure.

Unless and until institutions like Citigroup can 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. Notwithstanding the passage of the Dodd-Frank Act, which does give FDIC new resolution authority for financial companies deemed systemically significant, the market still gives the largest financial institutions an advantage over their smaller counterparts by enabling them to raise funds more cheaply, and enjoy enhanced credit ratings based on the assumption that the Government remains as a backstop. And because of the prospect of another Government bailout, executives at such institutions might be motivated to take greater risks than they otherwise would.

The Dodd-Frank Act was intended in part to address the problem of institutions that are “too big to fail.” Whether it will successfully address the moral hazard effects of TARP remains to be seen, and there is much important work left to be done. As Secretary Geithner told SIGTARP, while the Dodd-Frank Act gives the Government “better tools,” and reduced the risk of failures, “in the future we may have to do exceptional things again” if the shock to the financial system is sufficiently large. Secretary Geithner’s candor about the prospect of having to “do exceptional things again” in such an unknowable future crisis is commendable. At the same time, it underscores a TARP legacy, the moral hazard associated with the continued existence of institutions that remain “too big to fail.” It also serves as a reminder that the ultimate cost of bailing out Citigroup and the other “too big to fail” institutions will remain unknown until the next financial crisis occurs.