A Safety Net to Cover the Big Umbrella

The recent spate of bank megamergers raises several important public policy questions, not the least of which is: Who will pay for Travelers' other umbrella? I refer to the implicit federal safety net shielding giant financial companies like the proposed new Citigroup, so large they are "Too Big Too Fail" (TBTF).

The government umbrella protects Citicorp and other behemoth banks with federally insured deposits, because it is feared that a failure could trigger a confidence crisis and other major problems for the economy. Chicago's failed Continental Illinois National Bank, the nation's seventh largest, was bailed out by government in 1984.

This federal umbrella has not been used, however, to protect failed insurance and securities firms. But the planned Citicorp-Travelers merger would place under one roof banking, insurance, and brokerage units. The three functions would all wear the "Citi" name, long associated with banking and its safety net for depositors. Such blending of brokerage and insurance units into banking would result in increased taxpayer exposure, potentially all of the $700 billion in assets stuffed under this outstretched umbrella.

If there is a serious problem at one of the nonbank units, the company will be expected to do everything possible, including using assets from the bank, to save Citigroup. In a worst-case scenario, Washington would have no choice but to bail out the largest financial firm in the nation (and the world).

This fact of financial life represents a classic moral hazard as TBTF translates into TBTC (Too Big To Care), especially when taxpayers are the lenders and insurers of last resort. But, you can be sure Travelers' Sandy Weill, America's highest-paid executive, and his biggest stockholders like Warren Buffett, America's wealthiest investor, are not losing sleep over this. They'd be covered by the ultimate red umbrella. Red ink could color it, but not stain the Weills and Buffets huddled beneath it.

Ensuring their own rescue

It isn't unreasonable to suggest Travelers pay something in return for this implied extension of the federal rescue service beyond banking to include insurance and brokerage. Two suggestions follow:

At a minimum, Travelers, like its Citicorp partner, should be covered by the Community Reinvestment Act (CRA), which encourages banks to invest in low- and moderate-income neighborhoods. The recently revised CRA has a new "investment test" that would allow nonbanks to meet a CRA obligation through qualified investments, such as community development or affordable housing bonds. My new book defines a suitable level of such investment as 1 percent of assets annually or $7 billion for the combined Citigroup. These would, of course, be investments with a return to Citigroup, not just outright grants.

Separate insurance

Another more market-based solution is requiring Citigroup and the 20 or so other TBTF banks identified by the Federal Reserve Bank of Minneapolis to pay a separate TBTF insurance premium to the Treasury, similar to the deposit insurance premium banks now pay to the FDIC. How could Travelers, which wrote the first auto insurance policy in 1897, argue against the concept of paying for coverage that ensures eternal solvency?

The worst alternative is to do nothing and let exposed and unreimbursed American taxpayers continue to stand out in the economic storms of the future, holding the corporate welfare umbrella over Citigroup and other TBTF companies.

* Kenneth H. Thomas, PhD, is a lecturer in finance at The Wharton School of the University of Pennsylvania in Philadelphia. He is the author of 'The CRA Handbook' (McGraw Hill, 1998).

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