Citigroup - from Santa Fe, New Mexico to Park Avenue, New York
Team Latte
October 31, 2007

All of us respond to good times in the same way. However, each man responds to crisis and distress in his own particular way; and just as with human beings, so with the organizations.

Citigroup has recently announced around $6 billion in losses from the turmoil in the credit markets. And Chuck Prince & Co., i.e. Citigroup, has taken the lead in creating a "super-fund" of the size of $75 billion, to prevent structured investment vehicles (SIVs) from making panic sales of bonds linked to U.S. subprime mortgages. Recently, in some of the economics & finance blogs on the internet, we came across comments which essentially said that Chuck Prince and his entire team at Citigroup should be fired by the Board for concocting such a stupendously ludicrous and dangerous idea (of forming a "super-fund" to buy assets from the distressed SIVs). More savy investors and market professionals such as Warren Buffet and Alan Greenspan have also cast their doubts on this idea of a "super-fund".? Everyday, the criticism of this fund is growing louder. And even though the CEO and his senior management team are caught in the eye of the storm, for right or wrong reasons, they are unapologetic about the state of affairs at Citi. Apparently, the Board is also backing them.

Be that as it may, we believe that such a harsh criticism of Chuck Prince and the senior management of Citigroup are unfair. In fact, any criticism is unfair, almost meaningless. Super fund may be a ridiculous idea or untenable in the market place; it may set a dangerous precedent and may be the harbinger of yet more troubles to come. But this credit crisis is not about super fund or Chuck Prince or Citigroup or a bunch of Wall Street bankers trying to salvage their assets and investments.

This credit crisis is about models and economic theory, about our assumptions about financial markets and agency interactions in those markets. This credit crisis is about how we look at the markets and derivatives, how we navigate ourselves through the turbulence of economic head winds.?

Now, if we rewind the tape (well, this is one thing we can't do technically as this is the age of CDs and DVDs) 20 years backward, what do we see?

In 1984, a forty five year old banker, confronted by problems far greater in magnitude and complexity than perhaps what Chuck Prince, the CEO of Citigroup, is today faced with, took a different approach. He went looking for answers elsewhere, amongst some of the brightest intellectual minds of America at that time, like Professor Brian Arthur, the unconventional economist and Murray Gell Mann, the Nobel Prizing winning physicist. That forty five year old banker was John Reed and in 1984 he was elected the Chariman and CEO of Citicorp (the predecessor of modern day Citigroup). And he had just lost faith in the science of economics and all the mathematical models that this science had created to help us predict and manage the course of an economy.

The early eighties ushered in a massive turmoil in the debt markets triggered by the emerging market debts. In 1984 Citicorp was reeling under the burden of Latin American debt crisis. Citicorp had just lost $1 billion in one year and was holding on to $13 billion in bad debts. Financial markets, especially the western banking system, were in turmoil and banks had just discovered that approximately $300 billion had vanished from their balance sheets. And within a couple of years into the turmoil, in 1987, Reed broke with the conventional way of doing (banking) business and declared that Citicorp would take $3 billion in charges. No "super-fund" type solution here to save the day, but a "super-charge" on the balance sheet. As Fortune magazine in its June 22, 1987 article would say that it was anagnorisis, as in Greek tragedy "the climactic moment when the protagonist recognizes his fate, irreversibly changing the action of the drama."

But to Reed it was not just about a prolonged debt crisis, loss provisions on the balance sheet and loss of confidence in the financial markets. It was far more fundamental than that. It was a failure of the economic models that the experts have been using for their analysis; and models couldn't predict the crisis that was then engulfing the financial markets. If we take physics like models and use them to build economic theory then they should be as accurate in predicting the economic outcomes, at least to the tenth decimal place. He wondered aloud as why the best brains in Citibank and other banks on the Street had not seen this crisis coming. Why had no one - i.e. the model builders and analysts - foreseen any problems with Latin American loans? And above all, how could an isolated and a local event in Mexico cause such upheaval in the global financial markets?

Perhaps, this last question was quintessential to Reed's analysis of the situation. And perhaps this is what would ultimately endear him to the likes of Gell Mann, Arthur and others who were on the edge of defining the new science of Complexity. Gell Mann and Arthur were amongst the select group of scientists and economic thinkers who would go on to found the renowned Santa Fe Institute in the deserts of New Mexico. Some doubt whether Santa Fe would have ever happened without John Reed and Citigroup, that is without Citi's financial backing.

But the long and short of it was that John Reed saw the need to question the basic tenets of economic theory and the models that those theories spawned. He wanted to redefine the fundamental assumptions - for example, the assumption of "equilibrium" - that went into building economic models. He wanted to redefine and reinvent the science of economics. In 1987, Reed agreed to fund a cross disciplinary workshop on economics* at the Santa Fe Institute in New Mexico and from that point onwards Citicorp (now Citigroup) became one of the largest donors of the Santa Fe Institute.

John Reed knew he will not get answers soon. As Mitchell Waldorp quoted Reed in Complexity**: "My view was that I didn't think we were going to get something hard and concrete," Reed simply wanted new answers. He knew it would take time for the researchers and scientists at Sante Fe to deliver answers, but he wanted the process to get started, to start tinkering, perhaps in small quanta, with the science of economics; to see whether in the last 60 years the economists in their zeal in pushing the frontiers of this new discipline have left the foundations weak.

Perhaps, those answers have not yet arrived at Citi's headquarters in New York. Or else, Mr Charles Price and Company would have had better defense for this credit crisis than simply forming a lame "super-fund". How far is Park Avenue from the deserts of New Mexico? In distance, not much, but in time and in worldview they are separated by an infinite chasm. ?

Will the answers ever arrive? Is economics ever going to be a pure science with accurate predictive capacity and forecasting power? Or is it always going to masquerade as a pseudo-science with physics like math and theorems?

http://tesugen.com/archives/03/02/citicorpandsantafeinstitute
http://globaleconomicanalysis.blogspot.com/2007/10/super-sivs-fraudulent-attempt-at.html
http://www.softwaretimes.com/files/complexity%20and%20the%20fed.html
http://www.dialogonleadership.org/Arthur-1999cp.htmlhttp://money.cnn.com/magazines/fortune/fortune_archive/1987/06/22/69179/index.htm

The Origin of Wealth by Eric D. Beinhocker
* Beinhocker's book gives a excellent account of the origin of this workshop at SFI.
**Mitchell Waldrop's Complexity is an excellent work where he gives detailed account of how John Reed and Citicorp became involved with the Santa Fe project.

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