It will not surprise anyone to learn that I am asked every day by someone where the trillions of dollars in world capital that were here on one day disappeared to on the next. No doubt many of our astute readers are getting the same questions from their friends and associates.
Perhaps some readers out there wonder where $245 billion of Citigroup, Inc. (NYSE: C) capital has gone and why they are surviving by a thread only at the graces of the American taxpayer. (Citi hit 97 cents a share during the day, closing at $1.02.) I will give you an example.
You have a home worth $500,000 with $50,000 in equity; a bunch of people start bidding up the price in a frenzy while winking and nodding at each other that it's really worth $1,000,000.
An appraiser, loan officer, underwriter and Wall Street genius who all think they can make money pretending along with everyone else decide to loan you $990,000 on that value, which you use to buy fertilizer at bargain prices to spread around your home so that everything looks green... and for a season you are the envy of the neighborhood.
Relatively soon thereafter, the wind shifts: you get some rainy days and your investment seeps into the ground or washes away. Your house starts to smell, bringing down property values and you now have a house leveraged 99 to 1, but if you you walk away you lose you original equity and your credit score goes straight off a high cliff.
Your lender is very concerned because your default means that they will have to put the property on the open market at a significant discount and also add to their reserves at a 1 to 1 level (100%), not the approximately 5% level of cash deposits at the bank. If this happens too often (which it is) the bank might fail and the FDIC will have to step in. The FDIC is out of money so all this pretending has led to a very real economic firestorm.
In the case of Citigroup and other institutions, they basically walked up to a roulette wheel, picked a number and were shocked to find they won the first time they tried, against all odds. They grossly miscalculated their 38 to 1 odds (1 thru 36 plus 0 and 00) since from their misguided perspective they had a 100% success rate after the initial bet.
I still say that others played a bigger role in the catastrophe. They did blindly bet the bank and lost. However, they were greatly influenced by the Fed's low interest rates, the rating agencies' stupid and faulty AAA ratings on bad debt, and the SEC's shirking its responsibility for overseeing the entire mess.
I think we may soon see the initials of a certain federal institution adding another letter when it is forced to take over the company -- we might see "FDIC-C."
Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture & planning firm. He writes the columns Chasing Value and Serious Money. Disclosure: I do not own shares of C.
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Reader Comments (Page 1 of 1)
3-05-2009 @ 6:22PM
william lindblad said...
I don't know whether the word "pretense" is apt. My version is fairy tales. "When you wish upon a star your dreams come true"
And that is what was happening - dreams were coming true and I echo Schiff to the outcome. A disaster.
Amazing what this folly has accomplished.
Citi, GM, F, AIG and more of the U.S.'s major corporations are now penny stocks. In the midst of all of this carnage companies that have decent reserves are finding that they are not immune as fear and suspicion rule the roost This was not a house of cards, but a house of lies and it is those lies that now make the truth hard to discern.
Months ago I started to call these circumstances a DIM for depression in making. Everyone loves acronyms these days and I don't want to disappoint those that are used to calling the various debt packages the myriad of unknowns. They should settle on PILL for pig with lipstick-loser. Anyway, we now have the Harvard economics department giving this economy a 20% chance of the "D" word.
Here and now I give it 90% - and by Sept. 2009.
I wonder what Peter Schiff has to say.
By the way, I said March 09 would be when commercial real estate would start to show on the radar and I think that was back in Nov. 08. Guess what?
3-05-2009 @ 8:48PM
Driver X said...
Let's send Geitner to Disney and let Mickey Mouse run the economy. We'll all be better off.