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Thursday, 12 March 2009


Assume you know (from the 200 blogs here and of course everywhere else) about market and credit risk, volatility, VaR, fair value accounting, sub-prime, junk-bonds, transparency, hedge funds, credit crunch, and how all of this is to do with liquidity, funding gaps and market confidence, well then you must know metaphorically about Jitterbug, the dance-craze after the roaring-twenties, prohibition, Wall Street Crash, and at the end of Depression 1930s, and, extending the metaphor, I commend bebop as the 1950s music we have to get to when recovery returns. This is about the Citi CEO's 'Midnight Letter'. First, consider the Jitterbug - a very agitating way of dancing round and round or on the spot, like ice skaters flailing about to stay upright. This month the markets were spooked by jitterbugging-fears that Citigroup would be nationalised and or that Government might force bondholders in hard-pressed banks to convert their stock into shares! Short-sellers drunk on their 2008 successes e.g. Paulson hedge-funds $billions of bear-profits, became nervous about timing their short positions and cranked the rumour-mill helped by the Senate throwing down the Federal Budget, and Geithner's as yet empty plan, exaggerated fears about national bankruptcy and whether some big banks, e.g. Citibank, should be allowed to collapse; if small banks why not big banks, anything to avoid future tax-bills, maybe US Auto too. Of course, the sub-prime covered bonds are a scandal, but they still pay good money and have downside protection built-in. The market prices fell to the floor (mark-to-market tough-love fair value accounting) But we have jittered and shuddered beyond that into the recession that was on its way anyway! Recent weeks also saw media shock-outrage at further AIG money (when this was just drawdown on previously authorised TARP funds) and let's let all those financial insurance derivatives just get lost; why save AIG or its counterparties? When Senate Legislators talk that tough you have to wonder what they're politically medicating with, not just what the discredited bankers were smoking. (for detailed answers see: The data is surely clear enough. But, politics takes no prisoners, and outraged anger (US term: to be mad), the catcalls and cabbages were heaped by legislators and pundits on the Federal administration; boos and fears that bailouts and fiscal recovery are all just money-wasting and won't save jobs etc. There was other bad news, including titbits such as Citigroup's MerriLl-Lynch 'bonus bounce' (early bonus awards, in December, resulted in early price down-ticks before 1 January to thereby maximise 2009 performance). Bank shares remained volatile and Citigroup's postage stamp share price fell under $1. The effect of all the above was to knock Europe sideways. The cost of borrowing in European corporate bond markets reached record highs on Tuesday, in a sudden downturn in sentiment that could curb the rush of issuance so far this year. The main index of European investment grade corporate bonds saw spreads hit the highest levels on Tuesday, reaching 478bp, due to investor aversion to financial companies. Financial sector credit default swaps also reached new highs, as did key indices of investment grade and junk-rated corporate debt derivatives. The anxiety spiked Credit Default Spreads as surely as the collapse of Lehman Brothers in September wih inevitable ripples across the pond. Governments had to act and intervene to protect all their 'postage stamp banks', and, in the UK Lloyds Banking Group and RBS basket-cases, political pressures threatened outright public ownership. Quantitative Easing was launched in the UK (first time ever they say, though I can recall oher times when government debt was retired early?) plus the seemingly massive Asset Protection Scheme (together worth £655bn of Bank of England deposit cheques swapped for bank assets and buying-in £75bn of Gilts by end of this month). Bank shares have been wiped over the past 8 months by $hundreds of billions, and wiped out a lot of small shareholders directly as well as via pension and insurance funds. (Note: there is a severe pension cisis that will be variously addressed politically by next year in time for the UK general election. Will there be signs of recovery by then?) We probably won't see that value return for another 5-6 years. But these banks are not insolvent as cash-flow income-earners. They lost confidence of relatively few private sector funding sources. But these are now replaced mainly by Governments that within a few years will be showing large profits for this support, and that will appear as tax-dollar savings to be brought on-budget of government income and spending on public services.
Then came the simplest of all confidence-boosts, Vikram Pandit's “midnight magic” of a staff memo, sent just before the clock struck 12 on Monday night. Equity and bond investors could read that Citi is profitable in January and February, in fact, by a whopping $19bn in top-line gross revenues in the first 2 months of 2009 - best period since 3Q 2007. Citi’s battered stock closed up 40c to $1.45, 38%, nice if you were 'long'. Markets have focused too much on writedowns which are adjustment hits that will pass and failed to focus on the underlying strength of banks at the 'transmission-mechanism' centre of the economy's money flows. Market and media-comment jitters have encouraged a loss of perspective (on the double-entry book-keeping of financial accounting), and worst of all, have severely doubted the accuracy or truthfulness of banks published accounts. This does not help. It causes one-sided market bias that plays into the hands of short-sellers (of all kinds including those in politics and the media) not just those in stock-markets? Property, share prices, and other asset price falls have been extreme, but the impact is much less in cash-flow terms, and will, given time, recover. All other cash-flow losses are someone else's profits, and insofar as they live in the same national or global economy, again given time, some countervailing rebalancing will emerge! More than 1.87bn Citi shares changed hands on Monday alone – shorts feeling shorted - 4th-largest volume in US history - heavy buying/selling? Shares in Goldman Sachs and Morgan Stanley spiked up too as investors calculated that they, too, must have gained massive net interest income - maybe too some of the AIG drawdown. But the main gain, the Amtrak for postage stamps, is traditional retail banking gains - borrowing at historically low rates and lending at much higher ones - up too were Wells Fargo and Bank of America. The money markets must be in better balance, less jitterbuggered, more liquid! Is the credit crunch uncrunching? On the face of it, Citi’s profit estimates are not out of the ordinary. Excluding its enormous credit-related losses and loan provisions, Citi’s businesses have generated internal capital gain of more than $20bn in revenues per quarter even during the worst of the credit crunch crisis. Citi’s problem has been that of mark-to-market write-downs on toxic assets (plus some rising defaults on credit cards and other consumer loans) drenching cash-flow earnings, leading to over $18bn p/l loss for 2008. The financial asset losses in the US may be over a third ratio to GDP (National Income) but not a third of national income; that's only falling maybe at worst 6% in 2009 before a 4.5% boost from the government's fiscal stance? Property values are down maybe a third ratio to GDP too, but far less in income impacts. 5 million jobs have gone, but Government expects to recover three-quarters of that and private sector should do the rest over the next 2 years. Jitters all round, but not time for panic, or not if those in charge of policy including the legislators hold their nerve. The main panic seems to be public confusion about what is or is not tax-dollars. Three-quarters, perhaps four-fifths, of government financial measures have nothing to do directly with tax-dollars. Taxpayers may not like it, but Government has its own financial resources that are financially asset-backed and separate from tax-dollars! Maybe that is the steepest political-learning curve right now? That's a $100bn off the $500bn+ assets-for-sale, or about 80% of the bank's capital - but, hey, to experts (like me) that's just power-for-the-course, so why worry? Maybe Citi is gearing up for an April net profit announcement for the first quarter, maybe other big banks too, wouldn't that just be a great gift for the G20 colloquium in London on April 2.
As importantly, big banks, like Citigroup which may be about to cede 36% stake to the US government in return for more rescue capital asset swap, must prove they can sustain underlying earnings (capital generation) consistently quarter after quarter.
This is also a vital message to non-bank lenders into big banks MTN programs. That puts a great floor under government' risk planning and under everyone's stress-tests. Pandit gave few details of where Citi’s earnings come from but people close to the company told the FT it is not just trad-banking but also the investment bank did well in credit and equity underwriting as well as M&A. Investment-grade corporates tapped investors for $billions and rediscovered their appetite for mergers e.g. the two big pharma M&A, but also GE, AT&T and, of course, the banks themselves. Citi advised Spain’s Acciona $14bn sale of a stake to Italy’s Enel. Costs in Citi also fell $8bn and there were gains on the rising costs on Citi’s debt, a perverse but permissible accounting that boosts the bottom line.
The financial gyrations of big banks and why big is also too big to fail, brings us smartly to the jitterbug metaphor for the credit crunch economic-cycle. Ken Clarke, QC MP, UK Chancellor of the Exchequor, 1992-97, and current Tory shadow-business minister (who was not afraid of deficit spending despite always talking fiscal prudence) hosted a programme on radio 4 with Soweto Kinch on Charlie Parker and bebop and praise too for Dizzie Gillespie - music for our times? Are the '50s ahead of us again soon after the present war-economy (1940s) days as Warren Buffet and Jamie Dimon (JP Morgan Chase) metaphorically describe them? The dissidence of Jazz and swing from the late 30s to the 50s, saw Jitterbug become Swing (various types: Lindy Hop, Jive, West Coast Swing, East Coast Swing, or anyone dancing to swing) e.g. top-notch jitterbugging, jumping around, cutting loose and going crazy. The G20 London conference has as its aim to pin some global order on all corners of the global credit crunch recession. We just need to do all we can, pulling together (including severely curtailing the irresponsible leveraging of short-sellers) not to languish much longer in the war-economy equivalent of the '40s - when Europe and elsewhere failed to heed the message of democracy and economic recovery and governments everywhere had to control the commanding heights of the economny.
Jitterbug comes from a slang term for alcoholics who suffer "the jitters" (delirium tremens) and then became associated with dancers who dance with abandon or without formal knowledge of dance, 'jitterbugging', which just about sums up the public view of our 21st century investment bankers. They made up their moves, structuring deals every which way, and just presumed that funding would always be available, that someone else would always pay for musicians to keep on playing the same music. Structured products such as CDOs and credit derivatives could not be better described than by the jitterbug recipe:
If you'd like to be a jitter bug,
First thing you must do is get a jug,
Put whiskey, wine and gin within,
And shake it all up and then begin.
Grab a cup and start to toss,
You are drinking jitter sauce!
Don't you worry, you just mug,
And then you'll be a jitter bug!
Don't imagine, however, that structured product finance is over. It's biggest issues have been iin the last 8 months. ABS (RMBS and CMBS etc.) while arguably part of the cause of the credit crunch, they are also a big part of its solution. The difference now is that the government is paying the jitterbug musicians and calling the tunes. The surburban middle class (structured product brokers) learned to dance jitterbug by going to the black sections (credit risk rating agencies) learning to dance smoothly (ABS cash-flow smoothing), without hopping and bouncing around - The hardest thing to learn is the pelvic motion... somehow obscene (AAA ratings for junk and fat fee bonuses). You have to sway, forwards and backwards, with a controlled hip movement (dodging the historical default data), while your shoulders stay level and your feet glide along the floor (traditional net interest margins). Your right hand is held low on the girl's back, and your left hand down at your side, enclosing her hand (tail-risk sales-patter)..
Next stop is bebop. Taking the above culture and making it more sophisticated, culturally intelligent and working to a shared rhythmic sense. Whatever dissidences are contained in the new products will be comforting, interesting and enjoyable, not panic-making or stock-market jitterbugging.
For more on the US banking and economics see:
For the music listen also to:

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