Poor Risk Management Led The Way To Citigroup’s Troubles
It’s a familiar refrain on Wall Street: “too big to fail.” We heard it with Bear Stearns, Fannie Mae and Freddie Mac, American Insurance Group and Lehman Brothers. And each case, the opposite proved to be true. Government rescues in the form of multibillion-dollar bailouts prevented some of those supposed fail-proof businesses from going under. Now Citigroup, once the nation’s largest financial institution, is joining the ranks, as well, after succumbing to more than $65 billion in losses.
The government’s plans to prop up Citigroup were revealed on Sunday, Nov. 23, and include an additional $20 billion of taxpayer money for the bank, along with a guarantee on more than $300 billion of the firm’s most risky assets. In exchange for the guarantee, Citigroup will issue $7 billion in preferred stock to the U.S. Treasury and the Federal Deposit Insurance Corporation (FDIC).
So how did things get so bad for one of the country’s premiere financial services firms? In three words: reckless business bets.
Over the years, Citigroup created a multibillion-dollar business in mortgage-backed securities and collateralized debt obligations (CDOs). As profits grew, Citigroup got bolder, taking more and more risks. At the same time, the company employed tricky accounting practices that allowed it to move troubled assets into off-balance-sheet trusts that could then market the debts to other institutions. Once the assets had been moved off Citigroup’s balance sheets, it made it appear the bank was carrying less risk.
Appearances can be deceiving, however, for the simple fact they often mask the truth. To date, Citigroup has suffered four quarters of consecutive multibillion-dollar losses. It still holds $20 billion of mortgage-linked securities on its books, the majority of which have been marked down to between 21 cents and 41 cents on the dollar, according to a Nov. 22 article in the New York Times.
But the worst may be yet to come. Citigroup has another $1.2 trillion that is held “off balance sheet.” When it begins to move those questionable assets back onto its books, get ready for a whole new firestorm of losses to ignite.
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