Monday, November 24, 2008


This post is the first in a new series on the Prox called CrisisWatch. In it, economics professor and 'Prince' columnist Uwe Reinhardt will summarize the latest news on the ongoing financial malaise. What just happened and how worried should you be? Read on to find out.

Click here to open to the balance sheet of Citigroup, which has been rescued over the weekend by – you guessed it -- the U.S. taxpayers, through the good offices of the taxpayers’ agents: the U.S. Treasury (UST), the Federal Reserve (FR) and the Federal Deposit and Insurance Corporation (FDIC).

You will learn from Citigroup’s balance sheet that the highly paid geniuses who ran Citigroup until about a year ago had loaded up that balance sheet with so much debt as to reach a debt-to-asset ratio of 95 percent by December 31 of 2007. The numbers as of Sept. 30, 2008 look barely different. I doubt that, even after imbibing cases of Rolling Rock the infamous Tiger-Inmates™ of Prospect Street would come up with anything as foolish as that, certainly not after taking my ECO 100 course, in which we cover finance.

And who were the highly paid geniuses who earned (correction: were paid) hundreds of millions of dollars during their tenure for their great ideas? They include former Citigroup’s legendary CEO Sanford Weill, who cobbled the company together and his successor Charles O. (“We Must Dance [With The Market] As Long As The Music Plays”) Prince, ably advised by Clinton-era Secretary of the Treasury Robert Rubin, who received north of $10 million a year for his advice. This is what is meant by “reward for risk” on Wall Street: You get rewarded for imposing risk on others.

Among the assets Citigroup purchased with all that debt were dodgy mortgage backed bonds otherwise known by the elegant name “structured securities.” Structured securities are debt obligations whose promised cash flows are “secured” (using the term loosely) by the cash flows from other financial securities or activities which would then be said to have been “securitized.” (Recently I read a spoof, for example, according to which the pirates off the Somali coast are trying to securitize in this way the ransom money they expect to earn from their piracy. Is there any doubt that, for handsome fees, Wall Street bankers vintage 2006-07 would eagerly have helped the pirates in this effort and invested in the resulting “structured securities” themselves?. One can image the British comedy team Bird and Fortune having fun with it – see this for example).

The synthetic securities held by Citigroup had been concocted by so-called financial engineers, many of them disgruntled physicists and engineers who did not like the major they had chosen, and perhaps also Princeton grads endowed with our hallowed “certificate in finance”. They were cool securities, based on complex mathematical models, but now the financial engineers have no clue what these synthetic securities might be worth, most of them apparently having no clue either what actually goes on in the real economy – for example, that mortgages must be repaid.
Not even included in the $2.187 trillion assets shown on Citigroup’s balance sheet as of Dec. 07 reportedly are some $1.23 trillion assets stashed away in off-balance sheet entities known as “structured investment vehicles” (SIVs). The latter had been structured by clever lawyers and accountants to allow them to be off balance sheet. They probably are domiciled somewhere in the Caribbean, where U.S. regulators do not roam. The assets owned by these SIVs, many of which are feared to be toxic as well, most likely have been financed with a similarly reckless debt-to-asset ratio. Were they to be put on Citigroup’s balance sheet, the firm’s financial position probably would look worse, which is one factor reportedly causing last week’s panic that trashed Citigroup’s stock price.

You can learn the particulars that our agents at the UST, FR and FDIC negotiated with Citigroup at the link here. From the Term Sheet presented there you will learn that U.S. taxpayers will guarantee some artificially high value of $306 billion of dodgy, synthetic securities on Citigroup’s balance sheet, for which guarantee the taxpayers will get non-voting preferred stock with a stated value of $7 billion, on which 8 percent dividend will be paid, plus the right to buy about 254 million of Citigroup Common stock at a specified price of $10.61. The stock traded last Friday at around $4 per share. The $10.61 is a 20-day trailing average for the period ending Nov. 21, 2008.

In addition to absorbing the bulk of the potential, eventual losses on the $306 billion of Citigroup’s dodgy assets, the U.S. taxpayer injected another $20 billion of cash into Citigroup, on top of a $25 billion cash infusion earlier. In return, the UST will receive non-voting preferred stock paying an 8 percent dividend as well. Heaven forbid that U.S. taxpayers should ever get voting stock in Citigroup and have representatives sit on Citigroup’s Board. That right is reserved only for folks such as the potentates of the Middle East or Chinese and Japanese investors. After all, can you trust the agents of U.S. taxpayers at Citigroup’s Board table?
Oh, yes, lest I forget. We are told on the UST’s Term Sheet that “An executive compensation plan, including bonuses, that rewards longterm performance and profitability, with appropriate limitations, must be submitted to, and approved by, the USG.” Go figure what this might mean.

Uwe E. Reinhardt is the James Madison Professor of Political Economy and a professor in the Wilson School.


Anonymous said...

Uwe Reinhardt, what a baller.

Anonymous said...

As an ancient one (the name my children attach to me), I do not know what "baller" means. So I looked it up. Is this it?

"Definition of baller

"Always pronounced "balla." The trailing "r" is never pronounced.

a successful person. Typically used to refer to men, and often implies an abundance of money, women, nice clothes, expensive cars, etc.

You know that's a baller; he keeps three or four females at all times.
Submitted by Jose, Tuscaloosa, AL, USA, Jun 29 1998."

I wish!