The final straw with Citi

July 23, 2009

 “We have and will continue to exit several forms of proprietary risk-taking. Where we continue to take principal risk, we will only do so when we have proven teams and a clear source of advantage.” – Citigroup CEO Vikram Pandit on January 16, 2009. 
Don’t be fooled by Vikram Pandit’s playing the part of a prudent banker.

Instead of scaling back risky hedge fund-style trading, Citi is doing just the opposite. And that raises big questions about why the federal government continues to bail out this basket case of a bank, and why Pandit is allowed to remain at Citi’s helm.

Here’s the scoop on this latest bailout outrage: Citi is planning to commit at least an additional $1 billion in capital to a team of stock-focused proprietary traders, say people with knowledge of these strategies — a move seemingly at odds with Pandit’s earlier vow. 

These traders buy, sell and short a wide variety of stocks, including telecom, technology, healthcare and consumer financials. And the profits and losses on those trades all go straight to Citi’s bottom line. 

In all, I’m told that this team of nearly three dozen prop traders and analysts at Citigroup Principal Strategies will get to play with some $2 billion of house money. 

That’s roughly the same sum of Citi capital the group had under its belt before Lehman Brothers melted down last September. Citi sharply scaled back the operation soon afterward. 

By the end of 2008, the Citi Principal Strategies trading group’s committed capital had dwindled to under $800 million. But that was when Citi was fighting for its very survival. Now it appears Pandit has no qualms about ramping up the bank’s prop trading group after getting $350 billion in capital infusions and asset guarantees from U.S. taxpayers. 

To be sure, $1 billion in capital is chump change compared with the size of the bailout package that Citi has received. And it’s a mere footnote against the $1.8 trillion in assets on Citi’s balance sheet. 

And maybe it does make business sense for Citi to resume equity prop trading if its main competitors on Wall Street are doing the same. 

But it’s the principle here that matters. A bank that’s still a ward of the state has no business running its own internal hedge fund. Actually, Citi Principal Strategies is a collection of seven mini-hedges, each controlling between $250 million and $300 million in Citi — or should we say taxpayer? — money. 

To me, this is the final straw with Citi and in particular with Pandit. It’s hard to take anything Pandit says seriously after this quiet step-up of proprietary trading. In my book his credibility, which already was wobbly, is shot. 

Citi, for its part, isn’t commenting on the return of prop trading as a business strategy.

I’m sorry, but a “no comment” just doesn’t cut it. Goldman Sachs might be able to get away with that non-response, but only because it isn’t effectively owned by the federal government.

(Yes, Goldman is able to make billions from prop trading because it has the implicit backing of the government behind it, but that’s the subject for a different column). 

Citi, on the other hand, has an obligation to come clean with its biggest shareholder — the U.S. taxpayer. 

Back in April, The Wall Street Journal reported that Citi won the Treasury Department’s permission to pay special bonuses to “many key employees” in order to remain competitive with other Wall Street firms. 

It’s fair to assume the prop traders might be some of the “key employees” Citi had in mind when it begged Treasury Secretary Tim Geithner for the right to lavish such pay packages on some workers. 

Before the collapse of Lehman, traders with Citi Principal Strategies used to get to keep a percentage of the profits they made. Is that still the case with these traders — some of whom, a person familiar with the operation tells me, used to work for Pandit’s failed hedge fund Old Lane, which Citi acquired in 2007? We simply don’t know. 

In the second quarter, it appears that stock prop trading paid off for Citi. On July 17, Citi reported that “strong results in derivatives, proprietary trading and cash trading” contributed to some $1.1 billion in equity markets revenues. 

But trading is risky and there’s always the chance that Citi could lose money on its equity prop trades in future quarters. 

The bank bailout saved the world financial system from collapse, and that certainly was a good thing. But in keeping sick institutions like Citi afloat, the goal should be getting them well enough to resume lending to businesses and consumers. 

Until Citi can pay back the government, it has no business going back to the way things used to be. 

So if a taxpayer-subsidized executive like Pandit wants to get into the hedge fund business he should head for the exit right now and open up his own shop.
(Editing by Martin Langfield)


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