How Do You Value Trust?

In no-arb, efficient market fairy tale land, investors are assumed to be able to value a company by simply looking at its balance sheet, researching its market and business model and projecting into the future. Sound difficult? Why, yes, it's almost impossible to do, and even after a lengthy research project executed by a team of brilliant analysts there is a huge remaining uncertainty.

So what happens in the real world? Well, we apes with limited cognitive power and limited information rely on simple heuristics -- rules of thumb -- to guess what will happen in the future. That is, we say "Rob Rubin seems like a smart, careful guy, and top management at Citi (C) must know what they are doing, and surely the market knows what it's doing, so, yeah, $40 a share seems ok with me..."

Of course, after a while we might notice some data suggesting that the leadership at Citi has been dishonest ("we are adequately capitalized" -- CEO Vikram Pandit) and ignorant of their own business operations ("what's a SIV?" -- Chairman Rob Rubin, November, 2007), and suddenly decide that NO, they DON'T KNOW WHAT THEY ARE DOING.

• Yikes!: as reported on this blog, Rubin comments from November 2007.
• [SIV = Structured Investment Vehicle = (roughly, see link) CDO]

"I think the problem with this SIV issue is that it's been substantially misunderstood in the press," said Rubin, who has a considerable personal stake in the fate of Citigroup. The banking firm paid him $17.3 million last year.

"The banks appear to be in fine shape," he said. "That's not a problem."

The SIV issue isn't critical for the economy, he insisted.

"It's massively less important that it's been presented," Rubin said. "It's been presented as a sort of centerpiece of what's going on. I just don't think that's right."

The cost of the evaporation of trust? $200 billion dollars in lost market capitalization in the last year. The real reason Citi melted down is that people no longer trust their senior management to meet future obligations. This senior management was left in place in Treasury's latest sweetheart deal.

Tell me an efficient market story that explains Citi's recent history and I'll sell you a slightly devalued "Nobel Prize" in financial economics along with the Brooklyn bridge. (Click below for larger image.)

Disclosure: None