Monday, November 05, 2007

Citigroup: Now, matters are worse

Citigroup's Chuck Prince resigned as CEO, after the board scheduled a emergency meeting over the weekend to consider his fate. It was inevitable that Prince, who had faced heavy criticism prior to the Great Subprime Meltdown of 2007 got started, would face the guillotine after Citi reported large subprime and bridge loan related losses.

With O'Neal and Prince both fired, I'd expect both companies to announce further losses. The new CEOs will want as clean a slate as possible. Really any company with subprime holdings should come clean now, since the market is punishing their stock anyway. Unfortunately, it doesn't look like Citi went this route, and we'll just have to wait and see who else might also be sitting on additional losses.

Meanwhile, reports that Citi has more losses ($5-7 billion) to report is roiling the markets this morning. I'm working on a post which will show that holding subprime exposure through a CDO is far more dangerous that holding a subprime loan directly. I believe that's one reason why bond insurers are trading weaker in the CDS market than banks with larger direct subprime exposure. There could be some interesting consequences to this fact: we may see more subprime losses turn up at traditional insurance companies. P&C Insurance companies love high-quality shorter duration assets. There is a good chance that some insurance company loaded up on ABS CDOs, which were the highest-yielding among highly rated, short-duration assets during most of 2005-2007.

This is starting to feel more and more like 2001. After Enron and Worldcom, there was a mad dash to find who else might be tainted with poor earnings quality. Many companies who were guilty of aggressive accounting tried to quietly mend their ways, only to get pummelled by the market. Today's search for subprime losses feels very similar. The only question is will be get an Enron-sized default to complete the metaphor?

7 comments:

Gavin said...

(per yves at naked capitalism) Citi hasn't yet marked down anything of its $55B exposure to subprimes.. which is far worse than Merrill's. That's before taking the SIV's into account.

Translation: If Citi applied the same value Merrill is using, it's instantly insolvent due to SIV and on-balance-sheet losses.

I don't think Citi's too big to fail.. they did it to themselves.


Pertinent question for AI: How will the bond landscape change if Citi BK's?

It's clear the financial world wouldn't end, because many regional US banks didn't dabble in subprimes at all.. and so they'd be able to fully replace Citi by expanding their regions and books of business.

Accrued Interest said...

Well I think its going to be clear that Citi needs an infusion of equity capital. I'd be surprised if they wind up actually insolvent, but the odds sure seem higher today than 30 days ago.

As for the too big to fail concept. Its a toughie. I don't think any institution is actually "too big to fail" if you define the concept in terms of actual economic impact. But if you define it as "will cause potentially disasterous panic" then even someone like Countrywide might be too big to fail.

I think if Citi is actually near insolvency, the Fed will orchestrate some back room deal to infuse capital into Citi, ala LTCM. The Fed would then come out and reassure the market that Citi has plenty of performing assets and the capital infusion was to prevent undesirable contagion.

Of course, the market would be plenty spooked by this turn of events. Not unlike when the MLEC was announced, because we'd all be disturbed that such actions are necessary.

Now if Citi actually went BK, it would be the defining event of all our careers. Citi bonds are so widely held by such high-grade PMs, it would touch most managers directly, nevermind the contagion.

FWIW, I've never owned Citi bonds. I never trusted them. It always seemed like they were smack in the middle of whatever the bad trade of the day was. From Enron to Argentina to subprime. That was always just a gut call, never any specific reason to think they'd go under.

DAB said...

Enron and Citi are linked, but I do not think that the comparison between the Enron situation and what we have now is valid.

The fundamental problem with Enron is that a former colleague of mine, who was an Enron refugee, was wrong. She believed that Enron's collapse should have not happened because Enron's collapse did not serve anyone's interest (except the bankruptcy lawyers). The flaw in that reasoning is that Enron's existence also did not serve anyone's interest outside of their employees, and even then only the top management were REALLY benefiting. Employees couldn't wait to get out of Enron, even in its heyday. Particularly in 2001 after they had shed a lot of their assets, and had demonstrated willingness to shed the pipelines, there was no economic purpose served by the existence of Enron.

Is there an economic purpose served by the existence of Citi? On balance, hopefully one of the largest (the largest? My memory is not serving me just now) banks in the world serves an economic purpose of some sort… Now, would there be more economic value in a breakup, negating the Weil/Prince strategy, and in decent management fixing their wrong side of the trade issue are different issues entirely than would anyone be indifferent to its lack of existence currently.

If Continental Illinois was too big to fail, Citi damn sure is…

MattJ said...

I have a question about the SIVs; as I understand it, Citi does not have a legal obligation to bring the SIV assets onto their books, but a reputational one; if they let the SIV investors take the losses, their reputation will be damaged. Is that the case? If so, it seems illogical to me to think that the SIVs could force the bank into insolvency; surely they would take the reputational hit rather than go under.

If not, if they actually do have a legal obligation to keep the SIV investors from bearing the loss, that sounds like a real legal accounting problem to me.

Accrued Interest said...

I'm not trying to say Enron and Citi are the same. I was merely saying the market attitude reminds me of the Enron credit sell-off.

Gavin said...

dab:

Citi was in this exact position under 20 years ago.. and a Saudi prince bailed them out. These writedowns have already burned through 4 billion of his dollars. And to think I don't like paying $2.90 for gas..

Citi is in the realm of too big to fail only because they've leveraged themselves that far.. not because they're that useful.

If there was an economic purpose served by the existence of that company, their assets would have a greater value than their liabilities. Today, that's simply not the case.. and although you can certainly play enough accounting games to keep them in the black, it's rearranging deck chairs on the Titanic.

Accrued Interest said...

Matt J: SIVs are bankruptcy remote, and I agree, Citi obviously would choose to take the hit to rep before they'd choose BK.