(By Brady Willett and Dr. Todd Alway)
Give a man to fish and you feed him for a day. Teach him how to print money and you feed him for a lifetime? Juxtaposed against this seemingly outlandish re-write of the popular Chinese proverb is the image of the U.S. trying to inflate away the ills of asset and debt deflation. To be sure, with zero-bound interest rates unable to revive the lending/borrowing/asset bubbling dynamic that has helped support U.S. economic growth for the better part of the last two decades, policy makers have resorted to directly buying toxic/illiquid assets, lending to unqualified borrowers, and investing in insolvent entities. And thanks to the power of the printing press (not to mention the continued kindness of foreigners), these activities are largely being funded out of thin air.
A good example of what the supposed bailout masters have hauled out of their tackle box can be seen in the story of Citigroup: The downfall of the World’s largest financial services company serves not only to remind us of the accounting insanity FASB and the SEC have allowed companies to get away with for decades, but also of how pervasive the accumulation of engineered financial assets was during the boom years. With these ‘assets’ now increasingly going bust, the bailouts have multiplied in kind, and this has led to questions aplenty. Does the socialization of losses augur for a sustainable recovery? Will the U.S. be able to print/cheaply borrow enough money to fund its bailout plans? Engrossed in trying to rig the markets from falling further, will the much needed and promised regulatory changes ever arrive to increase investor transparency?
2009 may not bring definitive answers to these and other questions, yet as policy makers increasingly take on the role of hedge fund manager and as hedge fund managers increasingly become unemployed or imprisoned, they are questions unlikely to materially change anytime soon.
The Big One That Got Away (from bankruptcy)
Citigroup’s ‘Consolidated Variable Entity Assets’ (VIEs) declined by 32% from $122 billion to $82 billion for the 9-months ending September 30, 2008, while during the same time Citigroup’s ‘Significant Unconsolidated VIE assets’ declined by only 8.9% from $356 billion to $324 billion, and ‘Qualified Special Purpose Entity’ Assets (QSPEs) increased by 6.9% (from 765 billion to $812 billion). All told Citigroup reported a stunning $1.225 trillion in off-balance sheet interests at the end of September 2008.
It doesn’t take much imagination to conclude that Citigroup, with only $62 billion in tangible equity, would not have been able to absorb the additional $380 billion hit that would have arrived if the company’s unconsolidated interests had fallen by the same percentage amount as its consolidated interests. On the other hand it takes a great deal of imagination to conclude that with nearly every consolidated asset on Citigroup’s books getting slaughtered its unconsolidated interests seemed to be doing just fine.
But whether or not Citigroup was/is hiding some losses off of its balance sheet or in Level 3 land is really immaterial. To be sure, given the widespread destruction in the financial markets in October and November it was obvious that already lame Citigroup would not be able to conceal insolvency for much longer. Faced with the prospect of another Lehman Brothers debacle, the bailout masters entered:
“As part of this agreement, Treasury and the Federal Deposit Insurance Corporation will provide protection against the possibility of unusually large losses on an asset pool of approximately $306 billion of loans and securities backed by residential and commercial real estate and other such assets, which will remain on Citigroup's balance sheet…In addition, Treasury will invest $20 billion in Citigroup from the Troubled Asset Relief Program in exchange for preferred stock with an 8% dividend to the Treasury.” Fed
Following news of the bailout, Citigroup shares quickly doubled – disaster had apparently been averted. Pleased that their efforts had helped forestall certain collapse the Treasury updated the language of its Asset Guarantee Program last week, offering added justification for its bailout of Citigroup (weeks after the fact):
“This program provides guarantees for assets held by systemically significant financial institutions that face a high risk of losing market confidence due in large part to a portfolio of distressed or illiquid assets. This program will be applied with extreme discretion in order to improve market confidence in the systemically significant institution and in financial markets broadly. It is not anticipated that the program will be made widely available.” Treasury
After having allowing the reckless borrowing/lending/asset bubbling dynamic to proliferate, and failing miserably to grasp the severity of the housing bust, U.S. policy makers are now assuring us that its most stunning bailout initiative to date will be ‘applied with extreme discretion’ and that ‘it is not anticipated’ that many other Citigroup-style bailouts remain. Talk about a good fish story…
Suffice to say, Citigroup represents the final final line in the sand by U.S. policy makers; the line that says anything deemed ‘systemically significant’ will not be allowed to fail. Period. There will not be anymore stress-filled weekends with policy makers covertly trying to orchestrate takeovers and conjure up new ingenious lending schemes, there is not going to be another lengthy and confusing TARP saga, and there will most definitely not be any more Lehman Bros. breakdowns. Rather, if, and more likely when, someone important is in trouble the Fed, Treasury, and FDIC will backstop losses, provide loans, and/or directly invest using taxpayer funds. This is the really big story of 2008 – one that engenders both confidence that that the worst is over and fear that the worst is yet to come.
Hidden within Citigroup’s VIEs and QSPEs are billions of dollars that are ‘invested’ in CDOs, SIVs, ABCPs, MBSs, CDSs, and other financial instruments. The Fed and Treasury, by their own admission, do not know how to effectively value these investments, and with many engineered financial products threatening to become endangered species it is unclear if any ‘value’ will soon be observable. There is, by contrast, the viewpoint that current market prices, or lack thereof, do not represent a fair value given the amount of cash some of these products may continue to throw off. As 2009 begins it is this speculation that leads to a particle of optimism insofar as the bailouts are concerned:
* Perhaps U.S.
