This Weekend’s Contemplation #2 – Words From Someone Who Has Been There

Former Chairman of Citigroup, Mr. Reed, talks about why banks keep getting themselves in hot water. Interesting comments from a man who has “been there, done that”. Text in bold is my emphasis. From the WSJ:

In a world full of bosses with short memories, too many bankers stand out as amnesiacs.

First came a series of ill-fated loans to the developing world in the 1980s, followed by massive defaults on real-estate lending in the early 1990s and worrisome exposure to the collapse of hedge fund Long-Term Capital Management in 1998. Now banks must contend with the subprime-lending mess. In each case, they have vowed to be more careful next time. So far, they haven't been.

How could so many well-paid, well-educated people get trapped in multiple boom-and-bust cycles? And how should they extricate themselves this time? Some intriguing insights come from John S. Reed -- one of the most cerebral bank chief executives of modern times -- who seemed to spend the bulk of his career creating or digging out from one lending mess after another.

The 68-year-old Mr. Reed ran America's largest bank, Citigroup, or its predecessor, Citicorp, from 1984 to 2000, before losing a power struggle with his co-chief executive at the time, Sandy Weill. Mr. Reed is retired from banking today.

Most scorecards on Mr. Reed's tenure are sharply mixed. Overall, Citi's stock beat market averages handily during his tenure, but his aloof style and periodic stumbles tarnished his record. Still, Mr. Reed's familiarity with bad-debt workouts is in a class by itself. In a 2½-hour interview last week, he shared the lessons of those campaigns.

What Mr. Reed knows, he learned the hard way. Citi struggled in his first few years at the helm because of its huge exposure to soured Latin American loans. Then the bank nearly came unstuck in 1991 because of problem real-estate loans. It took the watchful eye of U.S. regulators and an equity infusion from Saudi Prince Alwaleed bin Talal to help Citi get back on course.

During his banking career, Mr. Reed usually portrayed Citi as a strategic leader trying hard to execute its plans in a turbulent world. Now, he is more candid. Everyone in banking points to risk management as a top priority, he says, but that is often just lip service. Risk analysis can easily become a series of routine chores that offer little protection from the unexpected.

What is more, with banks often under pressure to meet earnings targets, there is a tendency to allow any department that's booking big profits to keep sprinting ahead. Mr. Reed says it took encouragement from Citi's outside directors in the early 1990s to install early-warning systems, or tripwires, that could get the bank's lending departments to rethink business assumptions before it was too late.

As obvious as such precautions seem -- they are the banking equivalent of checking the mirrors and buckling up before a highway drive -- it is surprising how many people don't always bother. And if lenders aren't gazing widely enough, nasty surprises will be inevitable.

Mr. Reed has some sharp words, too, for the ways that banks pay risk managers. "If they get stock options, or get rewarded for earnings per share, they'll approve everything," he cautions. (I have seen this often.)

Cash bonuses make it easier to reward risk managers' most vital task: blocking ill-advised deals even when star executives want to charge ahead. Other incentive systems don't fully recognize such bravery.

Mr. Reed's most provocative warning: Be careful who you listen to.

When real-estate loans went bad in 1990, his early briefings came from top specialists in those areas. These lenders were articulate and chock-full of details, he recalls. "But they were so imbedded in the situation that they didn't see the full extent of the problems," Mr. Reed recalls. "They believed the market was overreacting. You had to distance yourself sufficiently so you had better context. If I had kept listening to my real-estate guys, I would have been fired."

As Citi worked through its problem loans, the bankers who originated those credits often were excluded from key talks. "They fought it," Mr. Reed says. "They felt it wasn't fair."

But he says his approach made it easier for Citi to reset its lending compass, often by heeding federal regulators or investment-bank advisers at Morgan Stanley.

Mr. Reed repeatedly waved off detailed questions about the current lending debacle. But a few of his maxims from past downturns remain relevant today. "Your first guess is about half of what you end up writing off," he says. He started the 1990-91 downturn thinking Citi needed an extra $2.5 billion of real-estate-related reserves; it ultimately needed about $5 billion.

It just isn't possible to see the full extent of problems right away, Mr. Reed says. As a result, bankers need to be careful about making premature public estimates of bad-loan exposure if they don't want to be in the awkward position of repeatedly increasing that number.

When times get really tough, Mr. Reed acknowledges, banks face plenty of calls to sell off assets -- a strategy that amounts to shrinking to survive. He refused to go that route in the early 1990s, preferring to cut the dividend and take in new equity, albeit on painfully dilutive terms.

Citi's stock ultimately rebounded smartly, led by strong earnings from businesses such as credit cards, which otherwise might have been sold.

Citi these days is looking for a new permanent chief executive, after this month's departure of Chuck Prince. Mr. Reed has appeared on a few lists as a long-shot contender, but a full comeback appears unlikely. Mr. Reed says he is comfortable in retirement. "I'll do anything to help Citi, including shutting up," he quips.