As negotiators in Washington struggled to devise a plan to rescue
Wall Street and avert a global financial catastrophe, Citigroup CEO
Vikram Pandit noted during an interview at Wharton last week that even
with government intervention, global financial markets will need years
to recover. In a question-and-answer session with Wharton management
professor Michael Useem
just days before Citi announced its deal to acquire Wachovia's assets,
Pandit also described Citi's banking-focused strategy and urged
students to pursue careers that would let them do what they love.

MICHAEL USEEM: So Vikram, I want to thank you for
coming and in particular for coming this week.  And in particular for
coming today, no less, in that this has been the week that was.  If
you've looked at the web you realize that Congress has apparently come
up with a deal. They're walking over to the White House to talk that
through.

So I'm going to begin with a couple of questions, if you don't mind,
about the world of financial services the last couple weeks, and then
we'll probably get a bit more personal. But, to use a metaphor here, it
probably felt like a perfect storm the last couple weeks -- maybe the
[last] several months. You've been at the eye of the storm. What do you
think went wrong?  And, once we get that worked through, what do you
think we're going to need to put in place to insure that this scale of
systemic risk is not going to be looking at us in the eyes as it has
over the last year to year and a half. So what happened? What do we
need to do?

VIKRAM PANDIT: How much time do I have?

USEEM: Take the time you need. This is the big question.

PANDIT: First of all, I appreciate all of you being
here. It's great to see so many bright young faces. Your alumni have
done great things for us as a Citi, and we hope many of you will
consider what they've done as being something that you aspire to.  We
hope to see many of you at Citi in the future. I also want to say that
-- exactly, what Professor said here -- we've been through a very
interesting time. I just want to make sure that you all know that you
have been great at picking exactly the right time to be in school. This
is a perfect time to be doing what you're doing and I'm hoping, by the
time you all get out, we'll be on the other side of this.

There are many different ways of coming at this, and I don't think
there are any easy answers in terms of what happened, why we got here
and how we're going to think about the architecture of the financial
system going forward. You've got to put all this in context. If you
really think about where we are, in the U.S., we have a lot of
imbalances. Many of those are not new, but some of them are. When we
think about imbalances, there's a housing imbalance. There's just too
much housing compared to the demand, and it's not clear exactly when
and how the housing market [will be] cleared, where the prices stop.
There is a consumption/saving imbalance. Everybody thought they were
saving because their housing prices were going up. Well, they no longer
are. And the U.S. consumer has to start saving at some point. When you
look at the financial system around the world, [it became] overloaded
over a period of time. They have to figure out how to de-lever
themselves. And the last point, which I think is also important,
there's a lot of growth elsewhere in the world and the world is trying
to figure out how to grow without causing inflation. Each of these four
is very important rebalancing cycles that we're going to have to get
right as a country.

Any one of these would be incredibly difficult to get through, but
to have all four happen at the same time is quite important and quite
interesting, because it's quite a challenge. And how do these things
all rebalance? You all are students of finance and economics. [You know
that] usually what happens is the marketplace figures out exactly how
to make all of these things rebalance so you get from here to there.
And the reality is that, with these four things happening at the same
time, that's a lot of stress on the markets. You're expecting the
markets to clear a lot of information, which is very hard for it to
do.  And the result of that is some of the things you saw last week:
Markets breaking down and not being able to go from here to there.

Now, what's important-- because this is, by the way, for all of you
here-- it is a good time to be in school, because this is a challenge.
It's going to take some while for us to get out of this and I'm hoping
that we don't go through a couple of weeks like we just went through.
While we don't mind working weekends, it's something to be working 18
days straight. So I'm hoping we don't go through the same kind of
events we saw, but the fact is there are a lot of challenges ahead of
us and we need to be very realistic about that. How did we get here?
How did all of us get here? How did the industry get here? You know
that's difficult. I'll tell you a couple different perspectives on
this. The starting point was really post-9/11. It's an important point
in time because that's the last time that we had some concerns about
the economy-- what was going to happen-- and the result of that was a
lot of monetary stimulus into this market. You all know what that
means. The Federal Reserve Bank started printing money. And the impact
of all of that was interest rates coming down. That was also a point in
time when there were a lot of foreign surpluses because of exports and
whether it was ... funds or whether it was foreign central banks, there
was a huge demand for fixed income paper and you could never get enough
yield.

And as a result of that, the engineers on Wall Street started
figuring out, what do we do? How do we satisfy this demand for yield?
And what they did as a result of that was they looked all the paper and
assets that were around and figured out you could actually take this,
we can securitize it, slice and dice them into pieces, sell them,
provide good yields to the other side. And it worked. It was beautiful.
And, by the way, that's exactly how capital markets should work. You
all understand as finance majors and business school students,
arbitrage is a key part of what keeps markets going. That arbitrage was
incredibly important. A lot of demand for high, fixed income yield and
securitized paper to provide that yield. That part was good. But Wall
Street ran out of inventory of paper. So what happens? "Let's go create
some new paper." And that's when the housing industry started taking
off, because you needed to create new mortgages, so that you had enough
inventory to create securitizations to sell the yield to the other
side.

That was the beginning of the housing price cycle, housing prices
going up. So far, so good. You keep going and say okay, now what
happened and how far did it go?  And we all know it went a very long
time. There were a couple of things that were really important, though,
that got everybody sort of out of kilter. Usually when these bubbles
happen, it's almost always because of the fact that you miss the forest
for the trees. And the way this cycle- People missed the forest for the
trees. They relied on the rating agencies, the paper coming off was
triple-A. Triple-A paper. Think about that. If you're a risk manager
and you say, "This is a triple-A piece of paper." And they stress it.
How bad can it be? I'm not so sure too many would say it could go to zero. I can understand it can go
down, but there are not too many people in any risk management area
that's going to say it's going to go down to zero. So that was the
first thing. The second thing that everybody relied on was while this
securitization.  And this paper was made to satisfy the fixed income
demand out there, this paper was distributed wildly. The risk was
distributed-- so back a year ago, in July, when all this started,
people were pretty relaxed about it. They said, "You know what? This
risk, I know there's risk, but it's fully distributed. Each one of us
own $3.50 of this, so what's the big deal? We can take the losses, move
on."

The other major surprise was that 15 to 20 large financial
institutions owned basically all the risk. Now, you know. So the reason
why we're here today is, in many ways, the fact that a large group of
people missed the forest for the trees. It's not that they weren't
managing risk correctly. They were. But how do you think about risk in
a triple-A bond? It's very hard to figure out what that is. It's not
that they weren't thinking, "Well, you know, I want to make sure these
things are priced correctly." They were. But they assumed everything
was fully distributed. You make very different assumptions if you
thought 15 people owned all the risk. And the net result of all of that
is that through everything that happened, the real shock to the
financial system was that the banking industry, as a result, did not
have enough capital to cover the losses that were coming through.

And the result of that is what you're seeing in the markets today. A
lack of lending by banks. It is a mad fervor to say, if I am too
overleveraged as a bank, how do I sell assets to de-lever and in that
cycle, what happens is that you get to the kind of strains and stresses
that occurred over the last couple of weeks, where people say, "Well,
you know, if these financial institutions have taken losses and they
have to de-lever, I am not so sure I want to own their stock or their
bonds. I don't know what the risk profile is." And it creates a little
bit of panic.

So that's what happened. Now it was important for me to share that
with you. I can do this in sound bites, by the way, very well as well.
But you are all students of finance and I wanted you to sort of
understand, sort of piece by piece, what came together. I don't know if
you're ever going to stop this "forest for trees" problem and I'm not
so sure that's an objective, ever. No risk means no business. So the
reality is that it's not about removing the risk of having these kind
of things happen; it's about trying to find some balance and optimizing
and finding a financial system architecture that can help you deal with
these things so you don't get to the kind of stages we got to. One
thing we all have to keep in mind is that the architecture, the
regulatory architecture of the U.S. was set in the first 30 years of
the last century and there were changes to it, but not enough. ... Now
the principles haven't changed but the technology has changed a lot,
and so a big part of what we have to do is re-do the regulatory
architecture of the U.S. financial market. And when you think about
that, it's going to have to be as comprehensive as it was, following
the '20s of the last century and what happened in the '30s -- '33 Act,
'34 Act, '35 Act and on and on and on. That's [what] we're headed
towards.

Right now, we've got to deal with what's going on today, how do we
get out of it, how do we get to the other side. As I said, we still
have a lot of challenges, but there will be enough people thinking
about this, there will be enough dialogue on what is that financial
services architecture that we want that's probably the best answer to
how we're going to make sure that we have the ability to see the forest
for the trees. Because the regulatory architecture and the regulators
have the best ability to do that.