Felix Salmon

Citigroup’s horrible conference call

Felix Salmon
Apr 17, 2009 22:00 UTC

The Seeking Alpha transcript of this morning’s Citigroup conference call runs 12,000 words; it makes for incredibly boring reading, and I can fully understand John Carney’s pain in having to listen to the whole thing live.

The most interesting thing to me was how the brand-new CFO, Ned Kelly, not only was at pains to praise his predecessor, Gary Crittenden, but even went so far as to unnaturally pump up this quarter’s result’s — the one quarter for which he can’t really bear any responsibility at all. Here’s how he kicked off:

This is the strongest quarter we’ve had in well over a year on many measures. Perhaps more vividly reflected in positive net income…
Slide one shows our consolidated results for the quarter. We reported revenues of $24.8 billion, that’s nearly double year over year and $19.2 billion higher sequentially.

He’s referring to the slides in this presentation; “sequentially” is Kelly’s way of saying “quarter-on-quater”.

Kelly’s comments were echoed by Derek Thompson:

Another day, another big first quarter announced by a struggling bank. Citigroup today reported that for the first time in a year, it’s turned a profitable quarter with revenue rocketing up 99%, following in the steps of strong earnings from Goldman Sachs and Wells Fargo.

Thompson added some caveats, but not about the net income or the revenue. The fact is, however, that neither of them in reality is nearly as impressive as Kelly would like to make them sound.

For one thing, Citigroup’s earnings per share were negative, which puts the positive income figure into some perspective. For another, Citigroup would have been operating substantially in the red were it not for the fact that it managed to book $2.5 billion of income from the fact that its debt securities plunged in value over the course of the quarter. Since the mark-to-market value of its liabilities is now lower, it’s allowed under US accounting rules to register a profit. But that’s not income as most people understand it.

And the rise in revenue is even more illusory. Here’s Bloomberg:

The company took $5.62 billion of writedowns on subprime- mortgage-related securities and other investments in its trading division, reflecting a further erosion in their market value. That compared with $14.1 billion of writedowns in the first quarter of 2008, for a positive $8.47 billion revenue swing.

In other words, despite the fact that subprime write-downs in the first quarter of 2008 were mind-bogglingly enormous, and continued through the next three quarters of the year, there were still another $5.6 billion of writedowns to be taken this quarter. Will they ever cease? No one knows. But through the magic of year-on-year comparisons, Citigroup can actually show a revenue gain just because its subprime writedowns this quarter were lower than they were a year ago.

Later on in its presentation, Citigroup shows how important net writedowns are to its reported revenue figures:


Suddenly that 99% year-on-year surge in revenues isn’t quite as impressive: if you ignore the writedowns (which Kelly always refers to as “marks”), then revenue only rose from $25.5 billion to $26.9 billion year-on-year.

Given that this chart is so prominent in his presentation, one wonders why Kelly was so keen on pushing the soaring-revenues story: wouldn’t it have been better to simply be honest about why it’s silly to compare revenues over a period of time when writedowns have been so enormous? Instead, you get utter comedy like this back-and-forth with Meredith Whitney, who keeps on trying to cut through the Kelly verbiage, to little effect:

Meredith Whitney: What happened in securities and banking in Europe during the quarter to have such outsize results?

Ned Kelly: My suspicion is and somebody will quickly correct me if I’m wrong. I think the marks by and large are basically booked in New York. The European results reflect the fact that the marks are booked in New York so the relative out performance of Europe on one level given that in terms of that $4.2 billion of traditionally disclosed marks is what drives that.

Meredith Whitney: Could you dumb that down for me please?

Ned Kelly: If you think about it we have $4.2 billion of what we described as traditionally disclosed marks. As you know, those are by and large in securities and banking. Those marks would predominantly be booked in New York rather then in Europe.

Meredith Whitney: Right, but on a relative basis Europe was stronger and that’s what I’m asking about not Europe relative to US, Europe relative to Europe.

Ned Kelly: First quarter ’08 I am told Europe did have the marks, this year they do not.

Meredith Whitney: On the sequential basis the difference they didn’t have the marks last quarter?

Ned Kelly: They did not have the marks last quarter.

Meredith Whitney: They had the marks last quarter they don’t have the marks this quarter?

Ned Kelly: First quarter ’08 Europe had the marks. Not since then. So I was right.

Meredith Whitney: I’m looking at it on a sequential basis.

Ned Kelly: Sequential basis, apples to apples no marks.

Meredith Whitney: It’s materially stronger and I’m just wondering what’s in there if its not marks what is it?

As Carney says of Kelly:

Much of what he says is so obscure that it is not only unquotable but incomprenhensible to anyone but an expert in Citi’s balance sheet. JPM, on the other hand, managed to sound comprehensible and, therefore, candid. When someone is talking jibberish, it’s hard not to think they are pulling something over on you.

To give just a flavor, from Kelly’s opening remarks:

There are three items we added to our traditionally disclosed marks this quarter which amounted to $4.2 billion and which are detailed in the appendix on slide 26. These additional items started with on the mark side $1.2 billion in private equity losses and then these items were offset partially by a $2.7 billion net benefit from CBA on our non-monoline derivative positions and a $541 million benefit in revenue accretion on non-credit marks in certain securities in banking assets we had moved from mark to market to accrual accounts last quarter.

Is this English? No. Is it useful? No. Is it the kind of thing that investors in Citigroup in any way want to hear? No. Even Vikram Pandit didn’t seem to have the time to sit through this kind of stuff: he wasn’t on the call at all, leaving Kelly to deal with the analysts on his own.

I’m not sure why Pandit replaced Crittenden with Kelly, but judging by Kelly’s first earnings call, the change is not clearly for the better. Citigroup would have been much better served by someone who was clear and direct about what was going on within the company, financially, rather than someone who considers his job to be to put the best possible spin on a mixed-bag of numbers. The only way that investors will ever take the CFO seriously is if they feel they can trust him. And after today’s performance, that day is likely to be a very long way off.


You are right, he was very cryptic in his presentation, but he gave us some interesting information regarding the conversion of preferred shares to common. He personaly took credit for moving the conversion day to after the stress test result will come out. Add the fact that only 4.4 billion new shares were registered with the SEC. This tells me that stress test result will reveal how much Citi will need to raise capitol/ convert preferred to common to comply with stress test. Citi feels confident that 4.4 billion share conversion, plus the sale of the japanese unit will raise enough capital to comply. There-by limiting dilution of their common. This limited convertion might put a squeeze on Arb players, as there won’t be enough shares converted to cover the huge short position. Also the conversion of $3.25 a share is an illusion. Preferred shares are carried as debt under liabilities. If you reduce $3.25 from liabilities and in turn add it to assets/stockholders equity (conversion), the net gain for every share converted is $6.50 a share. 4.4 billion shares converted from preferred to common has a net gain on tangible assets of $28.6 billion, add the $6 billion from japanese sale and your your balance sheet improves by almost $35 billion.

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Judging hedge funds

Felix Salmon
Apr 17, 2009 14:55 UTC

Dan Molinksi wades into the hedge-fund benchmarking waters:

Rutgers also stresses that the sharp losses by hedge funds in 2008 were not nearly as bad as the huge decline in U.S. stock markets. It’s an argument that’s also been used repeatedly by the hedge fund industry itself in recent months to put a positive spin on their losses.

But William Bernstein, author of “The Four Pillars of Investing,” questions whether this comparison is sound, adding that “it’s human nature to pick the benchmark that makes you look the best.”

Some say hedge fund performance should instead be benchmarked to a typical portfolio of 60% stocks and 40% bonds, and say that one should also discount about 5% from the initial investment to account for fees and other costs.

If one uses this gauge, and considering the aggregate bond index rose by 5.24% last year, hedge funds’ 19% losses look bad, indeed, and should perhaps be questioned more thoroughly by their investors.

Bernstein is right: the whole point of investing in a hedge fund is that it’s an absolute-return vehicle and does not benchmark the S&P 500. If there’s any benchmark, it should either be Libor (or some other simple ultra-low-risk rate of return), or else it should simply be zero.

On the other hand, I don’t think that hedge fund losses do “look bad, indeed” against a typical portfolio.

Let’s say Peter and Paul both started 2008 with $100. Peter invested $60 in stocks and $40 in bonds; the stocks fell to $36.90, exactly mirroring the S&P 500, while the bonds grew by 5.24% to $42.01. At the end of the year, he had $78.91.

Meanwhile, Paul invested $100 in a hedge fund which lost 19%, and paid a 2% management fee on top. At the end of the year, he had $79.38, slightly outperforming Peter.

If you calculated things a bit differently, and ignore the 2% management fee while instead discounting Paul’s initial investment to $95, then Peter does come out slightly ahead: Paul ends up with $76.95. But really there’s not a lot in it.

What’s more, almost nobody invests solely in hedge funds: substantially all hedge-fund investors also have stock-market investments. So even if Paul might have been slightly better off investing his $100 in stocks and bonds rather than in hedge funds, the fact is that he already was invested in stocks and bonds: the question is whether he should invest everything in stocks and bonds, or rather diversify out of public markets by putting $100 into hedge funds. All things being equal, a more diversified portfolio is a better idea than a less diversified portfolio, so once again Paul doesn’t feel too bad about his decision to invest in hedge funds.
On the other hand, Molinski is entirely right about the sleazy underbelly of the hedge-fund world, as most recently displayed in the Barrett Wissman case. Because hedge funds aren’t allowed to advertise their services overtly, a dank and secretive ecosystem of often-unpleasant middlemen has evolved with the purpose of putting funds and investors together. This world involves all manner of backhanders and dodgy-looking “fees”, and is largely ignored by the press, except for when it erupts into outright fraud. It’s a good reason to avoid hedge funds, especially when you’re introduced to them by smooth-talking salesmen who are less than fully transparent about how they’re being paid or how exactly they found you in the first place.


Can you explain how easy it is for someone’s 401K or IRA account to be transferred in entirety to a hedge fund on the advise of one’s financial adviser without any fiduciary responsibility on either the part of the adviser or custodial institution who launders someone’s life savings when it turns out that the hedge fund is a fraud? This would be most appreciated.

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The Detroit face-off

Felix Salmon
Apr 17, 2009 13:01 UTC

Bankers are never particularly popular at the best of time. Pyschologically speaking, if I borrow $100 from the bank, that $100 is now mine. Yet if I lend $100 to the bank — if I put $100 on deposit at the bank — then psychologically that money is mine as well. Logically, the money can’t belong to both depositors and borrowers at once. And the result is that people hate banks for both charging them fees on their own deposits and also being unreasonable when it comes to loans.

Banks are used to dealing with such emotions when it comes to their small clients. But now they’re facing a tougher issue — how to deal with the biggest client of all, the government. One way, it seems, is to go crying to the press:

At a meeting with executives from four of the nation’s largest banks earlier this month, the chief of the government’s auto task force, Steven Rattner, delivered a message that shocked some in the room.

To save Chrysler, he told them, the four banks and several other financial firms would have to surrender their claims to most of the $7 billion the automaker owed them. And what would the banks get in return for this sacrifice? Nothing.

“People’s jaws just dropped,” said a person familiar with the discussions.

Lemme guess, that person familiar with the discussions was a banker, right?

The fact is that the bankers don’t have much of a leg to stand on here. The government is asking them to take about 15 cents on the dollar — which aligns almost exactly with the market price of Chrysler’s debt. The bankers, meanwhile, are holding out for more — as much as 50 cents on the dollar — based on pointless hypotheticals about how much money they might end up getting repaid in a liquidation.

The WaPo story continues:

The banks — J.P. Morgan Chase, Citigroup, Morgan Stanley and Goldman Sachs — have all since balked at the government’s proposal. This week, they are drafting a counteroffer.

But those four banks are themselves recipients of billions of dollars in government largesse. Collectively, they have received $90 billion from the rescue program for the country’s banks. Now, their critics say, the firms have an obligation to cooperate as the government seeks to save Chrysler.

“These are banks that have received substantial investments from the government,” said Rep. Gary Peters (D-Mich.), whose district includes Chrysler headquarters. “We hope they will understand that what was given to them was not for their benefit, but to get the economy moving again and maintain American jobs. People are angry that again it seems like the banks are standing in the way.”

While this might be the right poetic response to the banks, there are more mundane and less philosophical reasons why their plaints should be brushed off. Firstly, Chrysler is not going to be liquidated: that is not, and never was, an option — especially in the present economic environment, when the market for Detroit’s hypothetical cast-offs is, let’s say, highly illiquid.

And secondly, the only reason why the banks’ loans are worth anything at all is that the government has already poured billions of dollars of TARP money into Chrysler. If the banks continue to insist on talking about hypothetical liquidations, they should be asked how much money is likely to remain for them if the government is first in line for repayment.

Up until now, big and powerful creditors have done very well out of Detroit: just look at the way that the government blinked first when it asked GM’s bondholders to take a large haircut before any TARP money would arrive. They said no, and the TARP money arrived anyway. This time, it’s the government which will (please) stand firm. Washington holds all the cards, and the banks are ultimately going to have to do what they’re told. If the government blinks again, the probability that it will ever be able to seriously regulate these banks drops to zero.


Slip of the keys there — I meant that Chrysler is likely to be a contract -supplier- to OEMs. This is a not uncommon thing in Europe where a bunch of no-name companies make cars for the big brands.

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Can consumers shrink banks?

Felix Salmon
Apr 16, 2009 19:52 UTC

Reader Steve Santini emails to ask:

I am a big proponent of the idea that if something is to big to fail, it is too big to exist. I am also a big fan of the idea that the large banks need to be broken up, in addition to regulated further. However, I feel that the government is powerless to do this. Probably because they lack the ability and courage to do so. But what about the market. It occurred to me recently that in a theoretically free market the customer is the counterforce which acts against gross accumulation of power. If customers were to take their deposits from the large banking institutions and place them in cooperative banks and small regional banks, this would have the same affect of leveling the playing field. What are your thoughts on this matter? Big banks offer pitiful interest on money that they lend and they charge exorbitant fees which contribute significantly to their profit, so it does not even make sense to do business with them (although I understand the advantages – more ATM’s, theoretically more services, etc.)

It’s a great idea, but I’m not sure it’s likely to work, for a number of reasons. For one thing, America’s biggest banks generally got that way through acquisition, rather than growth. It’s all well and good banking with a smaller bank, but when that smaller bank is taken over by a larger one, are you really meant to go through the hassle of switching banks all over again?

What’s more, having a large deposit base is certainly a nice thing for any large bank to have, but it’s not necessary. Many banks fund themselves in the wholesale market rather than through deposits, and although that leaves them open to a lot of funding risk, Treasury and the Fed have repeatedly proved themselves willing and able to step in and make sure that they will act as the liquidity provider of last resort to any bank which is having difficulties funding in the wholesale market.

Finally, the obvious place to move one’s money is a credit union. I’m a huge fan of credit unions — I even sit on the board of one — but thanks to the effort of the banking lobby, credit unions are highly constrained in where and how they can operate. Any given American probably has a choice of no more than two or three credit unions they’re allowed to join, and many are allowed to join no credit unions at all which offer a remotely acceptable degree of accessibility and convenience.

So one way to bring down the power of the big banks would simply be to allow credit unions to accept deposits from anybody, rather than only from tightly-defined fields of membership. But the chances of that happening, right now, are precisely zero. In the meantime, the whole credit union system, and especially the smallest and most important credit unions, is teetering on the brink, thanks to the fact that highly responsible lenders, which have proved themselves able to underwrite loans so well that their default rates are very low, are being forced to bail out a small group of highly-irresponsible “corporate” credit unions, which don’t even have individual members, and which lost billions of dollars on mortgage-backed instruments.

The fact is that if the government isn’t going to force the banks to shrink, there’s nothing that consumers can do about the phenomenon of too-big-to-fail banks posing an enormous systemic risk to the economy. It’s out of our hands: it’s all up to Tim Geithner, the former CEO of the New York Federal Reserve. Whose shareholders are the largest banks in America. So don’t expect too much in the way of banking-sector shake-ups from him.


I am alittle shicked you are on the Board of a credit unionm, yet apparently know sl little about accessibility or availability.
Not only are there a number of very strong large national credit unions that anyone can join by being a member of an associatio (Pentagon, Alliant for example), but also many CU’s are members of a shared branching network. For example, I can access all branch services at moe than 1,000 credit unions by visiting a local member of the brach network. Try getting money out of a Chase account by going to a BOA branch !
Further, at least one national CU allows deposit items to be scanned in via you fax scanner without having to actually mail in the checks.

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Stress tests under stress

Felix Salmon
Apr 16, 2009 14:52 UTC

David Wessel has an interesting idea today: while the bank stress tests were a good idea at the time they were announced, in February, a lot has changed since then, and none of it in a good way. Most obviously, the tests’ worst-case scenario is now looking more like a base-case scenario, making the tests less credible. What’s more, the very announcement of the stress tests’ existence caused all manner of confusion and second-guessing in the markets, none of which was helpful. And most profoundly, Congress passed executive-compensation rules which mean that no banks have any interest in accepting government funds should they be found to have insufficient capital.

For me, the fact that all these things managed to happen so quickly after the stress tests were announced is an indication that the stress tests probably weren’t such a good idea in February after all. But never mind that: as Wessel says, “Treasury has to deal with the world as it is, not as it hoped it would be”. And that means being extremely transparent about both the tests themselves and their results.

Near the beginning of the crisis, in the early months of 2008, it was still possible for Treasury to attempt a “trust us, we know what we’re doing” approach to bank regulation. That won’t fly any more. Treasury has to internalize the show-don’t-tell rule which is commonly hammered into journalists. Because no, we don’t trust them to know what they’re doing. Especially when the official org chart still looks like this.


I am all for your idea of the financial blog being more
accessible for all. It’s time has come.
I appreciate the opinions from other countries where the
whole fiasco is playing out.I will however, be US-centric
here for a moment. Credit Suisse pegs the number of foreclosures at 6.5million by 2011. Run the presses day and night, there is not enough money in the world to soak this spill up. There is still NO floor under the US housing market.
I was boy during the Great Depression.I have many memories of life. This is playing out in a startlingly
similar fashion.No, the Depression was not an overnight
event. It took several years for the destruction of
the way of life we knew.VBe well. Stay strong.

Taleb’s data dump

Felix Salmon
Apr 16, 2009 14:02 UTC

Back in March, Rick Bookstaber published a blog entry entitled “The Fat-Tailed Straw Man”, which seems to imply that Nassim Taleb attacks Wall Street practices on the grounds that its practitioners believe in normal distributions.

The result of that blog entry, and of a few other criticisms of Taleb in various places, is that Nassim has now published an extremely useful technical appendix to The Black Swan. It includes substantially all his relevant scientific and technical papers, and essentially comprises a gauntlet being thrown down to those who would criticize him. If you want to attack my ideas, he’s saying, that’s fine, but please first do me the favor of looking at where they’re laid out in detail, as opposed to where they’re laid out in newspaper quotes or in a literary book.

There is certainly a lot of confusion in the public mind when it comes to philosophical arguments about fat tails and risk management, and it’s easy for journalists to distill things into easy soundbites about normal distributions and the like. I, for one, would like at some point to write about Taleb’s important paper on Errors, Robustness, and the Fourth Quadrant, which looks at the history of thousands of data series going back decades — but I haven’t found a very clear way of trying to explain its details in English.

The Black Swan has proved to be a very popular book largely because it doesn’t even attempt to do that: instead it talks philosophically about the conclusions one draws after looking at the data. But if you want to attack Taleb for drawing the wrong conclusions, I think he’s right: you shouldn’t attack the book, but rather the empirical research which underlies it.


I would say the problem is that traders and risk managers focused far too much on complicated models and statistics. Those models will never be perfect and if they had spent more time thinking about the ways they could get in trouble instead of trying to improve the models it would have worked out a lot better.

Data visualization of the day, unemployment edition

Felix Salmon
Apr 15, 2009 22:06 UTC

Chris Wilson has the best graph of the day: an interactive map of US job losses since the beginning of 2007. Play the whole thing through once, and then take a closer look at what happens from month to month — especially from April 2008 to February 2009. And pity poor Detroit.

I do have a question about the scale, though: the “50,000 jobs” circle seems as though it has a much larger area than five of the “10,000 jobs” circles would have. But I don’t think they’re being silly and just working on the radius or the diameter, either. I wonder what they used for that.

Update: Chris Wilson provides graphical proof that the areas are right!




Humans aren\’t very good are perceiving differences in areas so cartographers have often resorted to perceptual scaling to compensate.

More than you ever wanted to know here

@Chris: Great map–we need more dynamic time-series displays on the web…


When default rates spike

Felix Salmon
Apr 15, 2009 20:08 UTC

Many thanks to Jeffrey Benner of Moody’s, who responded to my blog entry yesterday with some very useful information about downgrades and default rates.

Firstly, the 13.8% downgrade rate in the first quarter means that Moody’s downgraded 13.8% of all its corporates in the first quarter alone: it’s not an annualized rate, and Moody’s therefore downgraded a higher percentage of the companies it covers in the first quarter of 2009 than it does in a typical year.

As for absolute ratings quality, I haven’t managed to get good data on that. But Moody’s does have good data on default rates, and has even provided a couple of charts: the first shows how the spike in annual default rates is expected to surpass the 1991 and 2002 peaks, while the second puts those peaks into perspective going back to 1920.


default rates.tiff

The second graph is particularly interesting to me, since it really puts the Great Moderation in perspective. A couple of years from 2004 through 2007 doesn’t make a Great Moderation; for that you really want to look at the period from say 1943 to 1970. One of the consequences of the rise in the pace of financial innovation of late is that the global financial-services industry could take a really very short-lived decline in default rates and credit-market volatility, and turn it into something so dangerous as to create the worst global recession in living memory. Once upon a time, you could go for decades without seeing the default rate rise over 3%. Nowadays, the chase for return on equity won’t ever let that happen.

Ryan Avent lands at Market Movers

Felix Salmon
Apr 15, 2009 18:51 UTC

I’m very excited to see Ryan Avent off to a storming start at my old home; if you’re not sure who he is, he gives himself a pretty comprehensive introduction here. Ryan is one of the smartest and most perspicacious bloggers out there, and it’s great that he has thrown off the anonymity of Free Exchange: blogging does not generally work well with the kind of anonymous psuedo-omniscience that the Economist specializes in.

Ryan has already managed to encapsulate the problem with the government’s stress tests:

If the administration releases information suggesting that the tested banks are all basically fine, then the data is worthless. Markets will go on speculating on which banks are in the most trouble (and possibly be more pessimistic, generally, based on the government’s bungling of the tests). If the administration provides meaningful information of any kind, on the other hand, markets will naturally assume that the weakest looking banks are the weakest banks, and will begin trading accordingly.

The way out of this problem I think is for the government to recapitalize the weakest banks before it releases the stress-test results, and then to release post-money stress tests showing that, as a result of its recapitalizations, all the tested banks are basically fine. It’s a risky strategy, but I don’t think Treasury has much choice at this point.


Congrats to Ryan, but more importantly, does this mean that the Economist is now in the market for a blogger who can do their brand of pseudo-omniscient commentary for Free Exchange? If so, I’ve got the anonymous part of the deal down….