Yesterday was another watershed day for New York and for American financial capitalism.

Last night, the US government — through the Fed, the Treasury, and the FDIC — came to a historic agreement to bail out Citigroup*. The feds have essentially engineered an FDIC transfer of Citi to a more solid entity, as it often does with flailing banks, except for this time, the government skipped the transfer part. Citigroup will stay Citigroup, with its current management, at least for now, but the government is transferring the bank’s biggest risks to the taxpayer. In exchange for a bigger stake in the bank and for ongoing management and compensation oversight, the feds will take responsibility for up to hundreds of billions of dollars in future losses on Citi’s asset-related loan and bond portfolios.

New York and its economic engine have been through so much this year. But it’s important to take a moment and digest what this particular event means. It is, officially, the end of an era. Citigroup was easily the global emblem of American financial capitalism. To the world, Citigroup and its home base are now emblems of the failure of the millennial financial model: the idea that any loan, bond or other bank asset could be sliced up and turned into an instantly liquid, price-able, and trade-able security, with all of its many risks engineered away. Now, because of the abject failure of that business model, Citigroup must depend on the US government’s explicit willingness to prop it up to save it from oblivion.

Optimistically, though, Citigroup’s fate is a testament to the power of markets. Starting 13 months ago, Citigroup and other banks, in concert with the government, began an effort to hide the very real losses that were starting to seep through the financial industry’s balance sheets and toward the government’s books. Their efforts — first the October 2007 idea to sequester what was thought to be the financial industry’s $100 billion or so in bad assets in an “off-balance-sheet vehicle” jointly owned by three big banks — couldn’t work, as was obvious from the beginning. The markets, themselves recovering from years of irrationality, knew, despite the soothing words from both big finance and big government, that something was very rotten at companies like Bear Stearns, Lehman Brothers, Merrill Lynch, and Citi. As financial and government executives insisted that everything was under control, the markets themselves became more and more insistent — forcing firm after firm to capitulate to reality. Because of the relative strength of our markets, despite everything, the biggest financial and political powers in the world could not hide the truth.

The government itself was the last such entity to capitulate. In September and early October 2008, it still thought, oddly, that it could continue to hide the extent of the financial system’s catastrophic losses through its plan to purchase bad assets from financial firms under the “Troubled Asset Relief Program” (Tarp). A few weeks later, after the markets had killed that idea, the government still thought that by handing out capital to a big group of big banks and guaranteeing some bank debt, it could hide which banks were actually desperate for the money. It couldn’t. The markets zeroed in on Citigroup until it had forced the government to admit explicitly that Citi, specifically, desperately needed outside help.

Markets are not perfect, and they badly need rational, countercyclical government regulations to save them from their own cyclical irrationality. But in the end, they work. If the nation and the city don’t lose sight of that fact, New York can regain its position as at least one of the big financial capitals of the world. But, sadly, the firms that defined the last 25 years of financial capitalism to the world won’t be leading the way. It will be hard to recover without them, but it would have been much harder, even impossible, to recover with them.

*The author has a small financial interest in Citi relative to a diversified investment portfolio.

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