There are many reasons Citigroup should be perceived as a safer investment today than before the financial crisis, but towering above them all is its reduced reliance on the so-called repo market to fund its operations.
To appreciate why this matters, it's important to keep in mind that the banking industry is innately susceptible to panics. By my count, we've experienced 17 of these since the American Revolution. That equates to one every dozen or so years.
Many hundreds of banks fail each time a panic occurs. More than 800 failed in the aftermath of the Panic of 1893. Nearly 5,000 went out of business during the rolling agricultural crises of the 1920s. Almost 5,500 closed during the Great Depression. Upwards of 2,800 failed throughout multiple crises in the 1980s and early 1990s. And more than 500 lenders closed following the crisis of 2008-2009.
It's worth pointing out, moreover, that panics like these are increasing in frequency, not decreasing. This is a central point that bank historian Gary Gorton stresses in his latest book The Maze of Banking: History, Theory, Crisis. Gorton cites research showing, among other things, that "the frequency of banking crises in the 1945-71 period was virtually zero; but since 1971 ... crises became much more frequent."
Importantly, we don't know exactly why this is happening. But we do know that it is, and we also know that any bank that's worthy of an investment must operate at all times as if another one were right around the corner. This is a central tenet of every good banker. As JPMorgan Chase's Jamie Dimon emphasized in the lead-up to 2008: "No one has the right to not assume that the business cycle will turn! Every five years or so, you have got to assume that something bad will happen."
On a fundamental level, this means that a bank must shore up its funding sources. When a crisis strikes, the existential issue is rarely solvency; it's more often liquidity. In the old days, depositors lined up to withdraw their money. Nowadays, particularly following the advent of federal deposit insurance, the problem is that institutional creditors do the same thing in the repo market -- that is, where banks access funds on a highly short-term basis, oftentimes overnight.
The problem with relying on the repo market for financing is twofold. First, unlike your prototypical depositor, the creditors in the repo market are sophisticated enough to recognize when trouble is afoot in the financial markets. And second, because of the short-term nature of repo financing, they can pull their funds with very little notice merely by refusing to roll them over when they mature the following day.
It's for this reason that investors can feel marginally better about Citigroup today than they did before the crisis. In 2006, nearly a quarter of the bank's core financing came from the repo market. Today, that figure has dropped to less than 13%.
Just to be clear, this shouldn't be interpreted as a ringing endorsement of Citigroup's stock. Citigroup has long been one of the worst-run banks in the United States from the perspective of shareholders' return on investment. What it should be interpreted as, however, is evidence that the New York-based bank is headed in the right direction.
The article 1 Reason Citigroup Is Safer Today Than It Was Before the Financial Crisis originally appeared on Fool.com.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Apple, Bank of America, and Wells Fargo. The Motley Fool owns shares of Apple, Bank of America, Citigroup Inc, JPMorgan Chase, and Wells Fargo and has the following options: short April 2015 $57 calls on Wells Fargo and short April 2015 $52 puts on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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