Black Friday - the collapse of Citibank

November 21 2008

Seems to be another black Friday, Citibank shares trade below $4.00, Bank of America is on the verge of becoming a single digits stock, the once mighty JP Morgan has seen its stock tumble 50% in the last month.

Why is this happening?

One clear reason can be laid firmly at the door of Treasury Secretary Paulson. Lack of Confidence.

I have this picture in my mind of Fort surrounded by bad guys and on the verge of having to give up its defense, all hope rests in the arrival of a relieving force. But a smoke signal is seen in the distance from the relief force saying that they are going home! the Fort will just have to wait for another force to arrive in a few months. This is effectively what Paulson said this week in front of Congress. The TARP [troubled asset relief program] would no longer be used by the current administration to buy bank assets. Whoosh! Shock!

From the moment Paulson said this, commercial mortgage assets, credit card loans assets, auto loans assets on bank balance sheets have seen spreads widen, and once more raising the specter of bank failures.

History will judge Paulson once we have a better view of these events with the advantage of perspective. However Paulson is already trying to write his own version of history, his press conference earlier this week attempted to set out a defense of events surrounding the demise of Lehman as being caused by "insufficient authority" vested in Treasury and the Federal Reserve. This is a tacit admission that the demise of Lehman was a turning point in the crisis and a mistake, one in which ensured this would be a major crisis and one that would be difficult to arrest. For my two cents – history will not judge him kindly.

I for one believe Lehman could have been saved in some form. Lehman's demise taken together with the effective confiscation from equity holders that resulted from the Conservatorship of Freddie, Fannie and AIG has resulted in the equity markets collapsing - there are no buyers of equities. Why would you buy equity when you are unclear what you are buying and risk confiscation by the government?

As the equity market collapsed, holders of equities are forced to liquidate generating even more downward pressure. The final collapse has caused hedge funds that held equities as glorified mutual funds to report large losses and start a stampede of withdrawals from all hedge funds.

So what started as a housing crisis is no longer a housing crisis and those that say in order to fix this crisis the housing market must be shored up are no longer correct. The issues now lie in commercial loans, commercial mortgages, credit cards, auto loans, hedge funds, manufacturers or just about everybody. It is very difficult to see how confidence in balance sheets, businesses and our economy can be restored.

Management of Citi were right in saying that the share price should have no affect on the ability of the bank to operate normally. Oh how we wish this was true! Unfortunately Citi needs to continue to roll over its short-term finances! Who will lend Citi the money? As the share price falls, the price of funding increases, at some point the bank is no longer viable. We have seen this play out many times. But we are at a place now that the only buyer of Citi is the government and we all know the price of that is! So selling Citi shares at $4 seems very rational. Back to Paulson - he's been very inconsistent, very unfair and is provided no leadership - expect a bad weekend!

One last point - the administration has allowed huge financial corporations to be created! We are back to where we were in 1928! before the Glass-Steagall Act that resticted bank holding companies own other financial firms. Is this really a good idea?