Tuesday, November 25, 2008

Citigroup: Brother Can You Spare A Dime?

NYC - Citicorp Center
Originally uploaded by wallyg

First, A Song For The Money Going To Citigroup and Everyone Else

I want to open this post with a throwback to 1932, when people who had gotten used to the working life, were suddenly relegated to standing in breadlines for food. Written by E.Y. Harburg during the Great Depression, the title reminds me of what is currently going on in the financial markets. The song is "Brother, Can You Spare A Dime", and here are a few of the lyrics:

They used to tell me I was building a dream And so I followed the mob.When there was earth to plow or guns to bear,I was always there, right on the job.They used to tell me I was building a dream With peace and glory ahead --Why should I be standing in line, just waiting for bread?

Once I built a railroad, I made it run,Made it race against time.Once I built a railroad, now it's done --Brother, can you spare a dime?

Once I built a tower, up to the sun,brick and rivet and lime.Once I built a tower, now it's done --Brother, can you spare a dime?

Citigroup Center: This Is Now The People's House

What do you think? Should we put our new house on the market? Should we throw the current tenants out and put new ones in? Just another decision to be made because we now have a stake in yet another public company.

The Terms

The U.S. government will be guaranteeing $300 billion in Citi's toxic commercial and residential real estate assets with strings that have yet to be fully determined attached. They are also providing them with $20 billion of TARP funds with Citi giving preferred stock in exchange with an 8% coupon. This is on top of the $25 billion that was originally provided from the TARP. They will also provide warrants for common with an exercise price around $10 good for 10 years. Just more of the same old same old type of deal that has been provided to financial institutions before. A run on Citi which could have been in the cards has probably been avoided.

Darn Those Short Sellers

In yet another attempt to look for a scapegoat for the problem, once again the short sellers have been pointed to as one of the sources for the problems that caused Citigroup stock to fall as low as $3.05 on Friday (is short covering the reason the stock, which some say may be worthless is trading up to $6?). That the failure of management, corporate greed, lax oversight of the banks operations, government complicity and other factors are a minimal factor.

There is no question that some of the basic rules of short selling that have been taken away have made it far to easy to lean on a stock (re: SEC Chairman Christopher Cox). Two of the major rules are the uptick rule and the process of having to actually borrow the stock before shorting it. With neither of these in place, I can tell you from experience, shorting stock becomes a breeze.

There are also large institutions that apparently have the ability through the use of credit default swaps to substantially weaken a target company. I provide a Wikipedia definition of a CDS below, but that is not really the point.

The point is that the failings of the underlying companies are typically to blame for the fact that they find themselves in the position that they are in now. If they had run their company's in the way that some of the unscathed institutions did, the toxic assets that are on the books would not be there. Short sellers did not put them there. The company's did. Are some large institutions perhaps complicit in the speed with which the situation has developed. Perhaps. But let's put blame where blame belongs.

The federal government for providing the rules and liquidity, and the corporations involved for taking advantage of it and for not having any of the management or compliance oversight to keep it under control.

Credit Default Swaps

This is how Wikipedia describes a Credit Default Swap:
A credit default swap (CDS) is a credit derivative contract between two counterparties, whereby the “buyer” makes periodic payments to the “seller” in exchange for the right to a payoff if there is a default[2] or credit event in respect of a third party or “reference entity”.
In the event of default in the reference entity:
the buyer typically delivers the defaulted asset to the seller for a payment of the par value. This is known as “physical settlement”.
Or the seller pays the buyer the difference between the par value and the market price of a specified debt obligation. This is known as “cash settlement”.
While little known to most individual investors, credit default swaps are commonly used contracts to insure against the default of financial instruments such as bonds and corporate debt. But they also are bought and sold as bets against bond defaults — a buyer doesn’t necessarily have to own a bond to buy the credit default swap that insures it.
Banks and other institutions have used credit default swaps to cover the risk of default in mortgage and other debt securities they hold.

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