Citigroup Settlement Shows Low Cost of Lying to Markets

The news that Citigroup will pay a $75 million fine to settle chargesthat it misled investors about its exposure to the subprime market is a stark reminder that despite all the hullabaloo about reforming the financial system, we’ve done very little to address the lack of transparency in our major financial institutions.

Citigroup Center
Citigroup Center

In 2007, Citigroup told investors that it had just$13 billion of exposure to the market for subprime home loans. It bragged, in a number of forums, that it had responded to an increasingly rocky housing market by reducing its exposure from $26 billion.

None of that was true. In fact, Citi had closer to $50 billion of exposure. It had just decided—wrongly, as it turns out—that most of that was too safe to bother telling investors about. The exposure was from “super senior” tranches of CDOs and “liquidity puts”—promises to buy commercial paper of its CDOs if the market rates got too high—that Citi believed were too safe to worry about.

This kind of high-handed sleight-of-hand on the part of bankers helped deepen the credit crisis that led to our economic downturn. In boom times, investors and creditors were willing to ignore the lack of transparency and accounting shenanigans on Wall Street.

But when the market began to turn, bond investors grew wary of lending to banks, banks stopped trusting each other, investors sold shares—all because they could not trust the information they were given about the health of the balance sheets of banks.

In many ways our banking crisis was a crisis of trust. We resolved the banking crisis not by restoring trust so much as giving investors and creditors confidence that the biggest financial institutions would be bailed out by the government should the need arise. In short, we recapitalized the trust deficit with the value of the government put.

Despite the repayments of TARP funds by the largest banks, almost nothing has changed when it comes to the level of transparency in the financial sector. The geniuses on Wall Street once again expect investors and creditors to supply them with capital based on their financial acumen rather than on detailed explanations of the assets bought and trading strategies employed.

The paltry fines paid by Citi and two of its executives should be a reminder to investors and creditors: the potential rewards for financial shenanigans are great, while the likely costs are minor.

Surely, this lesson won’t be lost on the Wall Street executives charged with explaining their quarterly earnings.