Citi Is A Town Full Of Problems

Their exposure doesn't stop with sub-prime, with hundreds of billions in off-the-books liability, they still have hard times in front of them. Substantial problems in commercial paper, credit cards and autos are still to come, where do they go from here?

From an AP article on RGJ.com: “The government has decided that guaranteeing hundreds of billions of dollars in possible losses and injecting $20 billion more into Citi trumps the alternative: a panic that could leave retirement accounts and investment portfolios of millions of ordinary Americans in tatters and shove more people out of jobs.”
Analysis: Why Citi had to be rescued

View from the Radcliff India: “There's only one reason to agree to such terms, says Ellison: to stay alive."There are capitalists all over the place, but no one wanted to do the deal," he adds. "This is chemo. They need this capital to stay alive."”
If Citi's in such a mess, what about other banks?

From the WSJ online: “The Bush administration's rescue of Citigroup Inc. is creating new confusion about the government strategy to shore up volatile markets.”
Uncertainty on Strategy in Citi Rescue

From the Arab News: “Citibank went into overseas markets long before its competitors and often secured an inside track by attending to the financial needs of government elites and leading local organizations.”
Editorial: Implications of Citibank bailout


From an AP article in the Columbus Dispatch: “Citigroup Inc. said yesterday that it will slash 53,000 more jobs in the coming months… Earlier this year, the New York-based financial giant trimmed 22,000 jobs.”
Citigroup shedding 53,000 positions

Citibank is cutting another 53,000 from its payroll, on top of the 22,000 job cuts it has already announced. This follows at least 17,000 last year.

Previous Citibank articles

Some Unexpected Good News For The Economy

One and a half years ago I criticized numerous economists for their rosy opinions of our economy. Life is great and there is nothing to worry about from here to eternity. There were hundreds of economists snubbing those of us posting our opinions that there were clear and distinctive warning signs that the leveraging taking place by the biggest and most successful investments banks, Freddie & Fannie and a handful of brokers, like Countrywide or New Century that wanted to act like an investment bank, were in serious trouble.

But last week Phil Izzo printed the results from a team of 56 economists that comprise the Wall Street Journal Economist Board. The board believes by a margin of 89% that we are headed into a recession of at least 2 quarters. That is negative GDP for 6 straight months; some believe that it will last longer.

That is the best news I’ve heard in a long time because this is the same board was wrong about the effects that the housing downturn. If they were wrong then it’s a good bet that they are wrong now. I’m going out and buying options for January.

What Is A Derivative

No one is asking the right questions.

Since the government has now committed to purchase $700,000,000,000 (I think I’ve gotten all the zeros right) in the toxic paper that the banks, domestic and foreign, are holding as assets on their books, I felt it was time to give my vast audience my view of what the government will be purchasing with our tax dollars.

Dictionary.com explains simply: a financial contract whose value derives from the value of underlying stocks, bonds, currencies, commodities, etc. Riskglossary.com defines derivative as: A derivative instrument (or simply derivative) is a financial instrument which derives its value from the value of some other financial instrument or variable.

OK, that tells us that a derivative is a contract-on-a-contract. But what is in these contracts that the average American will now own. Why have the banks cut the value in financial instruments to the point that causes them to go out of business?

Money was raised for home and commercial mortgages by issuing bonds. The banks that originated the mortgage would sell it to someone like Fannie, Freddie or one of the other commercial banks. They would bundle the mortgages and send them to the rating agencies. The rating agencies would rate the best of the bunch as AAA and the rest could be divided up into 15 lower ratings. Since many pension funds, insurance companies, financial institutions or investment groups require a AAA rating on the bonds they purchase, the lower rated bonds have to pay a premium interest rate to entice the sale of these bonds.

That’s where derivatives come in. Thanks to the Community Reinvestment Act of 1977 and its’ reworking in 1995, Congress allowed the banks to become more inventive with the way they sell and fund mortgages. The lower rated bonds are re-bundled with other contracts that could be anything from options and warrants (a contract allowing the purchase of stock at a future date at a specified price), or other types of debt obligations to other bonds themselves. This process snowed the rating agencies to re-rate 96% of the lower rated securities as AAA.

We don’t know what we’re buying. We don’t know what we’re paying for it. But we’re sure it is going to work and hey, we could even make something. This is from the people that voted multiple times against increased regulations to control Fannie and Freddie.

The point is that no one is asking the right questions. The banks and the rating agencies have records to show what is in each of these bundles, but I have not heard one banker or politician ask for that information. It’s time a little light is thrown on this stuff. How can we effectively regulate if we don’t know what we’re regulating. No more free passes.

Bear Stearns And The Fed

The question is can the Fed keep these banks afloat till after the election.

Last week BS was forced to close two of their funds that were leveraged 32 : 1. The current trend was to issue very short-term low-interest notes to pay for their higher interest debt that they had purchased, allowing them too subsequently book the difference in the interest rates as profit. When the market for these short-term notes dried up they lost their ability to redeem the ones that were coming due, creating a devastating margin call. This was the game that most of the investment banks were using to build their bottom lines over the last five years.

The next headache happens when the Fed is forced to react to inflation and raise interest rates to the point where these guys can no longer cover the cost of the longer term debt, which they are holding, with lower-rate short term money. Each time the Fed cuts rates, the game keeps going. It has only been a little over two years when the Fed started raising rates and the “biggies” started having troubles, this will happen again and again as long as the Fed feeds the cycle and prevents the unwinding of these debt instruments.

There is no Housing Crisis

There is no real estate crisis. There is a wash-out of speculators in the areas where prices were driven by that speculation along with a serious lack of interest for property in the great shrinking rust-belt. Quality loans at extremely low rates are readily available to “A” borrowers.

What it should be called is the “bad exotic vehicle bubble”. The investment banks made a ton by repackaging high-risk/high-interest mortgages into a more complicated structured investment vehicles like CDO’s and SIV’s. When a mortgage becomes part of one of these, the normally straight forward mortgage accounting rules get fuzzed-up, allowing the bank to book a greater portion of the anticipated interest as an asset. This became the trough that the fattest of the hogs ate.

The write-downs that are dominating the financial media space are just a reversal of the “profits” that these investments banks have already booked that would of never happened if normal accounting rules had applied in the first place. The 25 top players in this game lost more than $100 billion in 2007 and that number could be doubled if you add in the next 100 or so regional banks, retirement funds and investment trusts that bought into the higher rates that the CDO’s and the SIV’s offered.

As the default rate for exotic mortgages started to increase and the market for these securities dried up, the speculators lost their biggest tool that allowed them to acquire their properties. When the speculators were stymied, housing prices flattened out and in the most active areas, declined. This gave the creators of these investment vehicles, having New York as their play ground, an opportunity to blame their potential negative exposure on a housing crisis.

Our largest investment banks enticed the financial media by leaking the assumption that they had billions in exposure, all because of unscrupulous and corrupt mortgage brokers. The fact that none of these brokers would exist if it weren’t for the eagerness of the investment banks to purchase these loans, with very lucrative commissions attached, from the very brokers they now blamed. With sub-prime, alt-a and jumbo mortgages becoming prohibitively expensive, the housing market produced a constant supply of bad news that eventually sucked in even Congress. As expected they produced a landmark deal with the Treasury that accomplishes nothing, a months grace after three months of non activity is just the solution that will definitively save the market.

The financial media was also instrumental in determining the Feds current disposition. By presenting one economist, guru, potentate and mogul after another calling for rate cuts, they created a public ground swell that anything but substantial cuts would have demonstrated that the Fed was out of touch with the real world. This frenzy to inject liquidation into the economy has little to do with the housing crisis and all to do with the fact that Wall Street loves cheap money. These same investment banks are now able to book enormous profits because their cost of capital has come down so low.

When thecost of money comes down and liquidity is added to our system, the banks have money to put to work and credit standards loosen. The resulting effect of “easy credit” is always an upturn in the default rate and the banks respond by tightening those same standards. Our economy has always had swings from loose credit to tight credit and back again, the difference here is we are just entering a period where credit is starting to tighten and the Fed is literally dumping liquidity on top of a tightening market. At this point it just doesn’t matter how much money is available, if someone doesn’t qualify they will not get the loan.

The credit crunch is definitely spreading; lenders are tightening standards on all types of loans and investors have lost their appetite for “exotic” instruments that can’t be accurately valued. This is just a normal swing that happens after an abuse. The fact that “UBS AG and Credit Suisse Group last week announced the write-down of a combined $400 million” should not come as a surprise. In this atmosphere where write-downs are expected there will never be a better time to clean-up your books. They could even be tilting the books to favor future profits; this is not an unknown concept to investment banks.

As far as these write-downs being a forward looking indicator of the future doom that our corporations will experience, is quite a stretch. Our economic slow-down will have it’s casualties but for the most part our corporations are sitting on enormous cash positions, the street anticipates them to start spending these cash hoards providing the impetuses for another growth cycle in our economy.

CitiGroup Puts Our Oil Money To Work

Yesterday CitiGroup announced the Abu Dhabi Investment Authority will invest $7.5 billion in our nation's largest bank. The investment was made through the purchase of convertible bonds that pay 11% and will convert to common shares, at a maximum price of $37.42, anytime during the fourth year of the note.

Citi must need that money fast because under the above terms an 11% convertible (2% over junk bonds) would have been grabbed up by US investors. Then again there is the possibility of doing significant business with the sovereign investment trust in the future. With Citi pointing the way, many more opportunities should open up for the group.

Still, if CitiGroup’s stock regains half of its value, then these convertibles are extremely valuable and I would rather see Americans rewarded for their years of investment into CitiGroup.
If the company announces layoffs of in the 40,000 neighborhood, then their stock should take a good jump on the strong cost cutting news. There is also a consensus that CitiGroup would release significant value to shareholders if the company were broken up.

Joseph Altman, AP Business Writer wrote an interesting article: Citi Sells Stake to Abu Dhabi Fund

Pimco Financial And Bill Gross

Part of a series The Great American Write-Down

Pimco Financial: Bill Gross is the chief investment officer for Pimco, the world’s largest bond fund. When interviewed on CNBC he said: "A Fed cannot afford to let homes go down by 10 to 15 percent like we saw in Japan," Mr. Gross saw the turmoil our markets are experiencing more than a year ago and steered his fund away from the troubled sectors. The result is that Morningstar has listed his fund in the top 2 percent of all bond funds.

From a Brett Arends article on theStreet.com:

“Last week, Gross grabbed the headlines by warning that the housing slump could lead to devastating economic consequences. He argued that a 10% fall in prices nationwide could set off price deflation of a kind not seen since the Great Depression, while waves of mortgage defaults could undermine confidence in the financial system here and abroad.”

Mr. Gross sees the problem as being much worse than reported and is calling for immediate federal action to directly aid troubled home owners.

Jim Jubak describes the environment the bond market is in these days in his article, The Bond Market's Shaky Foundation on theStreet.com:

“The unstable foundation is built on overseas cash flows and currency manipulation by foreign central banks. Dry rot threatens the whole system of ratings. And some of the banks propping up the market for credit derivatives shake at the slightest touch.”

“The professionals in this market -- the traders, the underwriters and the more sophisticated investment banks -- know exactly how shaky the whole edifice has become. They're determined not to be the last out the door.”

Articles:
Housing bubble bust helps Pimco's Gross rebound
UPDATE 2-PIMCO: Fed "can't afford" to let housing crack
FACTBOX-Writedowns and losses at major global banks

The Great American Write-Down

The business of mortgages.
In The Mortgage Meltdown Part 1 I wrote “The widespread closures and layoffs in the mortgage industry is more than just a slow down or a shakeout, it directly points to a flawed business plan.” When you start doing No-Money-Down, Interest-Only, 100 Percent Financing, qualifying applicants on the lower “Teaser-Rates” and doing so on inflated home prices, leaves absolutely no room for error. The mortgage companies pile on significant fees and then sell those mortgages to various investment groups, many of which are listed below. Those banks sort and package those mortgages in order to either resell or issue bonds to recoup there expense. At each step the mortgage company or the bank takes their profit upfront adding to the cost of the mortgage. When the packages are funded they roll those funds into new mortgages and start all over.

It was too much money aggressively searching for deals, which ultimately drove the appreciation in housing.
There was so much pressure to produce mortgages that brokers were working every possible angle to get someone to take their money; bad credit was no problem, no money down and we’ll find a way, payment too large and we’ll up the price and get the seller to cover some of the interest, need some cash out of the deal our appraisers know the true value of the property and we love speculators because they’ll bring us lots of deals. Everyone was happy as long as they could take their profit and pass it on. There was so much stuffed on top of an already bad deal that any speed bump in the housing market could cause a crash.

Mortgages are available to qualified buyers with conservative appraisals.
Now that both the property and the financial speculator are washed out of the system, mortgages are still available to qualified buyers and at good terms. Fannie Mae and banks that didn’t handle subprime products are getting burned because of their investments into the bonds, CDO's and SIV's that were secured by these blotted mortgages.

What’s next?
Bob Janjuah, the head of credit research at RBS, Royal Bank of Scotland, has estimated that the total asset value lost by the subprime mess will end up between $250 billion and $500 billion. So far the total write-downs from the 23 American companies listed below is about $71 billion just in the past eight weeks.

Everyone but Mozilo of CountryWide agree that next year will be more of the same. These numbers are only from a handful of our largest financial corporations. As listed in my article, Mortgage Industry Producing Lots of Unemployed, hundreds of smaller companies have closed and approximately 40,000 have lost their jobs in the mortgage industry. Those costs have been enormous but don’t attract the headlines and aren’t included in the headline numbers. There are also losses like CapitalOne who had a negative $670 million turn around in the third quarter when compared to the third quarter last year. These losses are also missed in the tallies.

These huge losses also ignore some very large companies like New Century, First Magnus, American Home Finance and NovaStar. The mortgage insurance industry has been devastated; most of the companies in that sector are near death like Radian, MGIC, PMI, Balboa and First American. With losses mounting in these bond portfolios, bond insurers are facing losses beyond anyone’s imagination. The rating agency Fitch has said that bond insurers have a $2.5 TRILLION problem. Ambac, ACA Capital, Security Capital, Assured Guaranty and MBIA could be looking at hundreds of billions in losses.

If you have a pension account then you have probably lost money.
Accounts in most major pension and mutual funds have lost value. Even names you wouldn’t consider when talking about mortgages like Prudential, AIG, H & R Block and E-Trade are taking losses because of their involvement into mortgages backed securities. This spreads across all spectrum's of companies that held investments because the bonds were considered safe and paid a slightly higher dividend.

When you mention to someone that CitiBank will write-off another $10 bil this year, they look at you funny and say so what. It’s not CitiBank’s money that is being lost; it’s the money from investors and pension funds. At the low end of the above prediction the average American household will lose $2,244 in asset value (investment and pension) and that number doubles to $4,488 if we hit the higher estimate.

The problem doesn’t stop at our borders.
The following banks have all had major losses and write-downs because of their U.S. investments: Deutsche Bank –Germany $3.2 billion, Credit Suisse-Switzerland $1.9 billion, UBS-Switzerland $3.6 billion, Societe General SA-France $920 million, AMP-Australia $1.4 billion, RBS-Scotland $2.7 billion, Barclays-Great Britain $2,7 billion, HSBC Holdings-Great Britain $3.4 billion and in Canada the Bank of Montreal, National Bank of Canada, Royal Bank of Canada, Scotia Bank and CIBC all had losses due to their holdings of US mortgage securities.

Take a look at the following 23 profiles of the losses recently taken by our financial community. I’ve listed them separately so individual companies can be identified and additional resources are listed for each one.

There is one who called it right; Pimco Financial. Take a look, I’ve put him first. (Just above)

Bank of America

Part of a series The Great American Write-Down

Bank of America, (BAC) the nation’s second largest bank, said they will take a $3 billion write-down in the fourth quarter. When they announced that profits had dropped 32 percent for the third quarter they also had to include that they were going to let 3,000 staff go.

Every time a financial institution releases negative financials they feel that the next thing to say is that we are on top of things by letting people go. Of course 3,000 is a very safe number to throw out, with 198,000 employees, 3,000 can be done with little effort. What irks me is that Reuters out of London wrote that less than 100 of the cuts will come from Europe, Middle East or Africa, which leaves the good old US of A as the likely cutting field.

Articles:
UPDATE 2-Analysts cautious on Citigroup; BofA downgrades stock
BofA to take $3B write-down
Fewer than 100 BofA cuts planned for EMEA -sourcesFTC Clears $21 Billion Purchase: BofA deal could cost Chicago jobs

Bear Stearns

Part of a series The Great American Write-Down

Bear Stearns (BSC) wrote $820 million off in the third quarter and will take another writedown of $1.2 billion in the fourth. Moody’s and Fitch have stated that Bear Sterns still has too much exposure to subprime and CDOs.

Articles:
Ex Bear Stearns co-president Spector gets no severance
Bear Stearns sued over mortgage losses
UPDATE 2-Moody's warns on Bear Stearns, Fitch cuts

CapitalOne

Part of a series The Great American Write-Down

CapitalOne (COF) In June CapitalOne had a reported that they were writing off $300 million for the second quarter and stating that they are laying off 2,000. Now that they are reporting their results for an abysmal third quarter, they included another 1,900 to the chopping block. Since I couldn’t find a Press Release on their website I’ll assume that it’s an additional 1,900 and not part of the original 2,000.

I did find one item of interest in their Press Released was one titled Capital One Makes Pigs Fly!

For the third quarter CapitalOne had an $81.6 million loss as compared to a $587 million profit in the third quarter of 2006. That loss was made more drastic by the fact that revenues had increased by a whopping 23 percent.

Articles:
UPDATE 2-Capital One posts third quarter net loss
Capital One cuts 1,900 jobs, slashes profit forecast
UPDATE 1-Capital One cutting 2,000 jobs, sees charge

CitiGroup

Part of a series The Great American Write-Down

CitiGroup (C) wrote $2.2 billion off in the third quarter and estimates for the next two quarters are in the range from a low of $8 billion to a high of $21 billion.

CitiGroup just made an announcement that there would be a new round of cuts. The company has said that they have no numbers as of yet but estimates are that as many as 45,000 may lose their jobs. CitiGroup has 330,000 employees.

Maybe it’s just a coincidence, but I view the correlation between the companies that have aggressively off-shored, in the past three years, are also the companies that are experiencing the largest losses. I just believe that it’s a win-at-any-cost mentality.

Articles:
Citigroup Writedowns May Top $13.7 Billion
Citigroup debt protection costs hit new highs
Citigroup falls on "sell" after $15 bln writeoff seen
US STOCKS-Citigroup downgrade sinks Wall St
Citigroup Mixed Signals & None Good
Do You Work For Citigroup?

CountryWide

Part of a series The Great American Write-Down

CountryWide (CFC) In October CountryWide posted a $1.2 billion dollar loss, their first loss in 25 years. At the same time the company also put out a statement saying that the worst was behind them and predicted profits for the fourth quarter and 2008. The market bought into it and their stock jumped 32 percent.

From the beginning of the housing downturn Chairman and CEO Mozilo has viewed it as an economic correction; an opportunity to snatch up people and accounts from the hundreds of weaker mortgage firms closing up shop. They have been able to obtain much needed cash from Bank of America and George Soros.

It shouldn’t take to much time to find out if Mozilo is truly a wizard or charlatan. I’m voting for the later.

Articles:
Countrywide Shifting Gears But Still Aggressive
UPDATE 1-Countrywide shares plunge, default swaps surge
Schubert & Reed LLP Issues Notice of Pendency of Class Action Against Countrywide Capital V and Others
Countrywide shareholders sue CEO Mozilo, board
UPDATE 8-Countrywide posts $1.2 bln loss, stock soars on outlook

E-Loans

Part of a series The Great American Write-Down

E-Loans is the mortgage division of E-Trade (ETFC) wrote $197 million off their books this month and made no forecasts for what is going to happen in the near future. The rumor mill has it that the problem may be significant enough to bring down the entire company. Only time will answer that one but their survival is not going to be painless.

Articles:
UPDATE 1-E*Trade CEO rules out bankruptcy-CNBC
Shares of E-Trade Fall on Plans for Mortgage-Related Writedowns in the Fourth Quarter

Fannie Mae

Part of a series The Great American Write-Down

Fannie Mae (FNM) had a $1.4 billion loss in the third quarter and they are scrambling; issuing bonds and floating addition shares to shore up their ailing finances.

Articles:
The Mess Won’t Stop At Fannie Mae
Freddie, Fannie to the housing rescue - not so fast
UPDATE 2-Fannie Mae, Freddie Mac debt protection costs rise
Big Ben's Dumb Idea for Fannie and FreddieFannie Mae Practices a Bit of Accounting Legerdemain

Freddie Mac

Part of a series The Great American Write-Down

Freddie Mac (FRE) reported a $2 billion loss in the third quarter, the TIMESONLINE.COM report that Freddie’s losses are $4.8 billion. From there Press Release Freddie lost $4.6 billion in the first three quarters of 2007. What isn’t getting press is that they lost $8.1 billion in net asset value in just the third quarter. Another quarter like that and they will be in non-compliance of the regulatory minimum capital requirement of $8.5 billion in excess capital. Just another $600 million and they will break the 30 percent mandatory target capital surplus directed by the Office of Federal Housing Enterprise Oversight (OFHEO. They are also in need of immediate funding putting their dividend at risk; both Freddie and Fannie are contemplating issuing convertibles or more stock, further diluting their shares value.

Articles:
Freddie Mac Reports Third Quarter 2007 Net Loss of $2.0 Billion or $3.29 Per Diluted...
Fannie, Freddie rout seen hurting major investorsUPDATE 1-Freddie Mac sued over mortgage problems

GMAC

Part of a series The Great American Write-Down

GMAC Last year Cerberus Capital bought a 51 percent stake in GMAC. Their mortgage lending unit, ResCap, lost $2.2 billion (25 percent) in value last quarter. GM was required by the sale covenants to capitalize ResCap with up to $1 billion if needed. They have done that but the company will still require additional funds to maintain a net worth level of $5.4 billion, also required in those sale covenants. Besides issuing $750 million in new bonds GMAC is considering purchasing a non-US mortgage company that will dilute the losses into a larger pool of mortgages.

Articles:
Now, What's Bad for GMAC Is Bad for the U.S.A.
GMAC Bids to Rescue ResCap
UPDATE 2-GMAC targets Northern Rock; sale of ResCap parts

Goldman Sacks

Part of a series The Great American Write-Down

Goldman Sacks (GS) wrote off $2.4 billion in the third quarter and no estimates have been made for the future.

The overall opinion is that Goldman is best positioned and have made the correct moves to weather this storm.

Huntington Bank

Part of a series The Great American Write-Down

Huntington Bank (HBAN) Huntington will have to cover about $300 million in the fourth quarter. Besides being hammered by the housing situation, Huntington let First Franklin Financial Corp borrow $1.5 billion that are secured by mortgages. Since Merrill Lynch now owns First Franklin I have to wonder how they plan to handle this.

Articles:
Huntington Bancshares Taking $300M Charge
Huntington sees surprise loss from mortgage client

IndyMac Bancorp

Part of a series The Great American Write-Down

IndyMac Bancorp (IMB). The third quarter was a rough one for IndyMac, posting a loss of $202 million or five times company estimates. Their credit rating is now BBB-minus, one more cut and they will have obtained junk status.

Articles:
IndyMac outlook now negative, was stable - S&P
IndyMac Bancorp posts 3rd-quarter loss
IndyMac loss dwarfs own forecast