San Francisco Chronicle – January 18, 2009

It’s time for Uncle Sam to be the ultimate activist investor.

Because the government has poured more than $200 billion in taxpayer money into financial companies and more may be on the way, little discipline has been required on the part of the nation’s banks.

That’s too bad because the government’s muscle is far stronger than any other shareholder and it should use it to force companies to fire executives and directors or sell off even profitable assets.

That might already be starting at Citigroup Inc., where CEO Vikram Pandit has had to reverse his recent insistence of no big changes for the bank with a broad restructuring that will dismantle its financial supermarket model.

“When the government says move, banks have to move. The government trumps any decision coming from management or the board,” said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware.

The unprecedented ownership stake the United States has taken in the nation’s banks has come by way of the $700 billion rescue program passed by Congress in early October.

Few restrictions so far

Financial companies were desperately in need of capital as losses mounted on their mortgage-related assets and other distressed debt. They were no longer able to raise funds from private investors and froze most lending as a result. The government helped by buying stock and warrants – which are like stock options – in many of the nation’s banks.

So far, the Treasury, through its Troubled Asset Relief Program, has provided more than $210 billion to 257 financial institutions. Treasury officials have said the goal is to provide banks with $250 billion of the first $350 billion in bailout money, and more could come after that.

For all that money, companies have to follow some modest restrictions on executive compensation and not much else. Federal officials never pushed for the kind of house-cleaning that was in order; instead they’ve kept a largely passive stance.

That has allowed problems at the banks to fester, as evidenced by the huge losses that are still mounting.

“Someone needs to say game over – now. That has the best interests of the U.S. taxpayers and the financial markets in mind,” said Roger Ehrenberg, a Wall Street veteran who now runs his own investment firm and writes a blog called Information Arbitrage focused on financial trends.

At Citigroup, the game is certainly changing – finally. The government has already lent $45 billion to the embattled bank and agreed to absorb the losses on a huge pool of mortgages and other troubled assets.

Even as Citigroup’s top brass went to the government with hat in hand last fall, they still refused to take aggressive action to shore up the bank’s capital. They stuck by Citigroup’s financial supermarket structure, a one-stop shop of everything from consumer loans to investment banking.

In late November, CEO Pandit said Citigroup was using the “right model” with its universal banking structure and the company’s strategy would continue as “the world’s truly global universal bank.”

But that spin just won’t hold up anymore, especially with Citigroup’s continuing losses. On Friday, the bank reported a fourth-quarter net loss of $8.29 billion – its fifth straight quarterly loss, together totaling $30 billion.

Citigroup also said Friday that it will split into two businesses – one focused on traditional banking, the other housing the company’s riskier assets that could be sold or spun off to raise cash. That followed Tuesday’s announcement that it would sell control of its Smith Barney brokerage to Morgan Stanley in a deal that will give Citigroup $2.7 billion in badly needed cash.

“The government is holding their feet to the fire,” said William Smith at Smith Asset Management, which has been calling for a breakup of the company for more than two years, with no luck.

BofA requires attention

Next up on the government’s hit list should be Bank of America Corp., which just secured an additional $20 billion from the government that will help the bank absorb the losses at its just-acquired unit, Merrill Lynch.

With the latest taxpayer-funded injection, BofA has received a total of $45 billion in capital injections from TARP, including $10 billion for Merrill Lynch.

BofA agreed to pay the government an 8 percent dividend on the new money, as well as comply with enhanced restrictions on executive pay and benefits. It also will implement an expanded program to modify mortgages in an effort to stem rising foreclosures.

But the government should press for more radical steps that would bolster the bank’s financial position.

“They have to decide what companies should be liquidated, fire the executives, get rid of the boards, spin off the assets and put them into the hands of people who have demonstrated the ability to manage money,” said Barry Ritholtz, director of research at the investment firm Fusion IQ.

That kind of government-driven dramatic action may be the only way to cure the financial crisis because clearly banks aren’t doing much on their own.

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