May 09, 2009

Elastic Shortfalls

Anybody reading this space knows I have been a huge fan of Obama and Geithner, but this week they lost me.

The way to recognize a project in trouble is not to ask for a single assessment - the way is to compare today's assessment to the one from a few weeks ago. A troubled project is elastic, stretching to absorb forever more amounts of time and money.

This week's SCAP results release revealed that our bank failures are elastic. Geithner is not doing a good job at calling the situation and driving the bank crisis to a close.

Citibank's Elastic Shortfall

Take Citibank. Back at the end of February, in the middle of the stress tests, regulators pushed Citibank to measure up the size of the problem and move to close their capitalization gap by "voluntarily" defaulting $27b of their preferred shareholders down to common. (It is almost comical how, when wiping out guarantees for Asian and Middle Eastern sovereign wealth funds, they made a show to point out that these investors went along "freely.")

But now, just a few weeks later, the stress tests are done and Citi has discovered that they need another $5.5b that they didn't figure out earlier, and that they should have gone to the preferred shareholders for $33b instead - which they are trying to do now.

Yet instead of owning up to the fact that the problem is even bigger than they recently thought, the Fed's stress test report hides the too-small-$27b-plan-in-progress in a big stinking pile of $58b of recapitalizations that Citibank has announced, hasn't executed, yet still gets full credit for. It's like giving a student an A because they announced they will show up for the test.

Half of my disappointment is in the fact that the Citibank problem seems to have grown by 20% in 60 days. The other half of my disappointment is that the Fed and Citi are twisting their numbers to try to smooth over Citi's shortfalls.

That's not the only bizarro piece of elastic in the Citibank story.

Citibank's Elastic Revenues

Currently, Citibank is making much of its current revenue through huge "trading profits" that come from betting against their own business using credit default swaps (basically, profiting off a rising cost of insurance against their own bankruptcy).

Citibank's profiteering over its own lack of faith in itself makes its latest earnings report look like a pronouncement from Alice and Wonderland.

To survive the stress test, Citibank is projecting healthy revenues in the coming year, but besides the bizarro trading, revenues in Q1 should also be understood to have benefited from huge one-time subsidies by the Fed as it entered the credit markets as a massive buyer of loans. It is not likely that the Fed will make a routine out of printing a trillion dollars of new money to hand out to the banks.

The other surprising source of strength in Citi revenues, despite a collapse in commerce, is in consumer credit cards. How can you make money on credit cards when consumers have stopped spending? Their earnings report explains that they do it by screwing consumers with hiked up rates and fees on old debt, even as the Federal Reserve has lowered Citibank's cost of capital to zero.

In other words, when Citibank is not trying to stay afloat by betting against themselves or taking on newly printed money, they're trying to keep their head above water by kicking vulnerable borrowers. It is not nice. And frankly, it is also a stupid business move because abused customers will head for the exits if they can afford it, or be driven into default if they can't.

Citibank earnings reveal an organization that has pulled out all the stops to achieve a single number, with total disregard for the health of their long-term business or anybody who touches them.

Yet instead of calling an end to the madness, the Fed has put their stamp of approval on the shenanigans. Citi and Bank of America have earned themselves 30 days to fabricate the next fanciful six-month plan.

Elastic Foreclosures

In related news, at a time when 22% of homeowners - and one third of California - owe more on their mortgage than their home is worth - Obama let us down by letting Durbin's cramdown amendment go down in flames.

The result is that the banks can continue to claim that the stress tests were "more stressful than reality," and they will be able to continue to hide behind wishful thinking to string along bad loans indefinitely.

News flash: 2007 home prices are not coming back. We should force banks to realize their losses as quickly as possible, and wipe out shareholders of any banks that can't survive the ordeal.

Clearly Geithner is worried about triggering another round of disorderly Lehman-style collapses. But it's disappointing to me that he doesn't seem to recognize that we live in a different world now than in October 2008. In May 2009, investors have come to terms with the fact that banks are sick. Defaults for Citibank and Bank of America are already priced into the equity and swap markets. It is time recognize the losers and shoot them in the head instead of letting them drag everybody else down.

Why are we accepting Citibank's wishful estimates of $49b more hallucinogenic revenues for the next two years? Why are we letting banks put off until tomorrow what cramdown could force them to face today?

Here's hoping that Geithner decides to pull the trigger to end the madness soon.

Posted by David at May 9, 2009 10:47 PM

A great post.

Of course, as a fiscal conservative I come at this from the other side (keep your hands off my money Obama, I didn't earn it to fuel your social experiments). However I share a huge concern over this issue.

Here is another example of elasticness, this time in deficit projections:

The deficits get larger with each new report, even when the economic projects are so rosy that no one believes them.

When Obama won, I was disappointed, because I don't agree with his socialist nature - however I at least had some joy around the refreshing idea of an intellectual, magnetic person leading the country. What new heights could we reach.

But each day has lead to an erosion of that hope. How can any intelligent person think the country can run deficits indefinitely and survive. It's baffling.

And I hate the outright hostility to the creation of wealth. Instead of encouraging us productive people to work harder and go faster to restore the nation - we are pilloried. All bankers are greedy idiots. Auto execs too. Hedge fund managers following their fiduciary duty to protect their clients' assets (by objecting to the UAW's less senior debt resulting in 50%+ of the Chrysler, where their more debt gets 10% - when in traditional bankruptcy court the UAW would be wiped out) are the absolute worst. Anyone earning over $250,000 is an undeserving money pot. It can be a bit depressing.

Even cap-and-trade feels wrong. I love the idea of saving the planet. I'm willing to spend money on it. But it's hard to understand how a single-country cap-and-trade is not counter-productive: isn't it just an economic message to industry to move all factories to other countries without such a tax? And a country that doesn't produce anything can't buy anything. And of course, those execs who follow the economic motives and move their factories away to save money for their shareholders will be pilloried as unpatriotic.

I understand that I'm not going to agree with many of Obama's politics. But I wish he would at least start making sense.

Posted by: Peter H. at May 12, 2009 10:59 AM

Great comments Peter.

Posted by: Mary at June 3, 2009 02:30 PM
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