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Generational Dynamics Web Log for 5-Nov-07
Citibank announces additional $8-11 billion losses in mortgage meltdown

Web Log - November, 2007

Citibank announces additional $8-11 billion losses in mortgage meltdown

And there may be a lot more to come.

As of September 30, Citibank officials believed that they'd finally gotten things under control. They'd written off $2.2 billion in near-worthless securities, and the rest of the $55 billion in mortgage-backed securities (collateralized debt obligations which are collateralized by asset-backed securities, ABS CDOs) where in good shape.

These securities had nominal values of $55 billion, and they're in the highest quality (lowest risk) tranches of the ABS CDO marketplace. There were no securities safer than those.

On Sunday, Citibank (actually, Citigroup Inc), issued a press release announced the following:

"Citigroup Inc. announced today significant declines since September 30, 2007 in the fair value of the approximately $55 billion in U.S. sub-prime related direct exposures in its Securities and Banking (S&B) business. Citi estimates that, at the present time, the reduction in revenues attributable to these declines ranges from approximately $8 billion to $11 billion (representing a decline of approximately $5 billion to $7 billion in net income on an after-tax basis)."

Citibank went on to explain that the addition writedowns became necessary because ratings agencies have downgraded sub-prime mortgage-related assets.

I mentioned this point a few days ago in an article leading up to the Fed announcement. The ratings agencies are doing this on a volume basis now -- downgrading tens of billions of dollars in CDOs every week.

Merrill Lynch had a similar double embarassment, initially predicting $4.5 billion in writedowns a few weeks ago, and then announcing an $8.4 billion writedown last week.

The Citibank press release gets very interesting when it explains WHY it doesn't yet know the extent of further writedowns:

"Although the principal collateral underlying these super senior tranches is U.S. sub-prime RMBS [[residential mortgage based securities]], as noted above, these exposures represent the most senior tranches of the capital structure of the ABS CDOs. These super senior tranches are not subject to valuation based on observable market transactions. Accordingly, fair value of these super senior exposures is based on estimates about, among other things, future housing prices to predict estimated cash flows, which are then discounted to a present value. The rating agency downgrades and market developments referred to above have led to changes in the appropriate discount rates applicable to these super senior tranches, which have resulted in significant declines in the estimates of the fair value of S&B super senior exposures."

Note the tricky word play here. The phrase "super senior tranches" makes them sound like they should be super safe. But no, this paragraph says that they're super-unsafe. Why? Because they can't be valuated in the marketplace, since there's no market for them.

Instead, their values must be ESTIMATED, based on, "future housing prices to predict estimated cash flows."

Wow! Do you really think anyone knows what future housing prices are going to be? A year ago, officials were telling us that the housing crisis was over, and that housing prices would start going up again this past year. Well, that didn't work out did? This past year, housing prices have tumbled, sales have tumbled, and foreclosures have surged. And it's only beginning, since the stream of "adjustable rate mortgages" (ARMs) that are going to reset to much higher interest rates has only just started, and will really surge next year.

The Citibank press release continues as follows:

"The fair value of S&B sub-prime related exposures depends on market conditions and assumptions that are subject to change over time. In addition, if sales of super senior tranches of ABS CDOs occur in the future, these sales might represent observable market transactions that could then be used to determine fair value of the S&B super senior exposures described above. As a result, the fair value of these exposures at the end of the fourth quarter will depend on future market developments."

Now, this is REALLY heavy. Up till now, Citibank has valuated all these securities by using computer algorithms ("mark to model"), based on ratings assumptions that are turning out to be fault.

But the really DREADED situation will occur when somebody actually SELLS some of these CDOs in a fair market. This will establish a market value for the CDOs, and will force OTHER holders to re-valuate them using "mark to market."

Everyone's absolutely dreading this, because there's an enormous fear out there that the market price of these CDOs will be NOTHING, or close to it. That's what happened to Bear Stearns when it announced in July that its hedge funds are almost worthless.

That's the reason for these SIVs (structured investment vehicles) and the mind-boggling "M-LEC," or Master-Liquidity Enhancement Conduit or "Super-SIV" (Structured investment vehicle). The purpose of these structures is to allow Citibank and other banks to sell these worthless securities to each other at artificial prices, which is fraud, but it's OK because the government says it's OK. Anything's better than any free market in these things.

So, what Citibank is saying is that it has NO IDEA how much more it's going to have to write down. Of the $55 billion they thought they had, they're writing down $8-11 billion. That leaves around $45 billion left. How much of that will be written down? They have NO IDEA. They're just hopin' and prayin' that it won't be too much.

And now, Dear Reader, let's talk about Y-O-U. Do you have investments in money market funds, hedge funds, pension plans, or any of a wide variety of investment vehicles? Are your investments safe?

Oh, really? You say they ARE safe? How do you know? How can you possibly know? If the brilliant financial engineers at Citibank and Merrill Lynch don't know, then how can you know? Are you really that much smarter than the financial engineers at Citibank and Merrill Lynch?

Recall that, according to a report from the International Monetary Fund (IMF) that I analyzed last month, there were $415 trillion dollars of CDOs and other credit derivatives outstanding globally, as of December, 2006. Ron Insana on CNBC says that the figure is up to $750 trillion now. This is in a world where the total GDP (value of all products and services produced in the whole world) is only $45 trillion.

So there's an unbelievable amount of pain yet to come, as the marking down process continues. The writedowns will affect mutual funds, investment trusts, hedge funds, savings banks, pension funds, college endowments, money market funds, insurance companies, and any other institution with money -- possibly including institutions that hold YOUR money.

From the point of view of Generational Dynamics, this has all been caused by the debauched and depraved abuse of credit by people in the Boomer Generation and Generation-X. These are the first generations with no personal memory of the starvation and homelessness of the Great Depression, and have convinced themselves that nothing like the Great Depression can ever happen again. They're going to be shocked by what happens, just as the officials at Citibank have already been shocked to learn that many of the securities that they thought were OK turn out to be worthless. (5-Nov-07) Permanent Link
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Generational Dynamics Web Log for 5-Nov-07 Citibank announces additional $8-11 billion losses in mortgage meltdown

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Generational Dynamics Web Log for 5-Nov-07
Citibank announces additional $8-11 billion losses in mortgage meltdown