A fellow author at Seeking Alpha has ventured to recommend Citi (NYSE:C) as a great long term investment, ostensibly on the grounds that it is too important to fail and implicitly backed by the government, among other considerations of global scope and overall market share. To avoid the hazards of paraphrasing, you may access this article in its entirety here.
Meanwhile, the Office of the Controller of the Currency has published statistics as of Q4 2008 showing derivative exposure as a percentage of risk-adjusted assets - classifying the top banks that in their opinion are overexposed to default risk. Citi stands at a whopping 286%.
Government subsidization of a failing institution is a terrible criterion for long-term investment because rather than being based strictly on growth prospects, management practices and fundamentals, it relies on fickle political headwinds. Citi fails on all counts. Suckling at the government teat doesn't count as a growth strategy. Vikram Pandit & Co. do not inspire confidence at all, and trading at below book value doesn't count as a fundamental in my book.
The mark-to-make-believe accounting fraud perpetrated by the FASB is allowing major banks and financial institutions to acknowledge revenues under circumstances that would have taught Arthur Andersen a thing or two. An estimated $2.5 billion worth of profits reported in the first quarter by Citi can be attributed to lowered revenue reporting standards, and the results of the much-touted stress tests were negotiated downwards substantially before public release.
The 'adverse assumptions' (which included 8.9% unemployment) that the stress tests were based upon have already come to pass since the civilian unemployment rate is now 9.4%. The Bureau of Labor and Statistics expects the unemployment rate to hit 10% before end-of-year 2009. Meanwhile, the International Monetary Fund expects writedowns of $2.7 trillion on US-originated assets before the end of 2009, out of a worldwide total of $4.1 trillion.
Investors lost their shirts buying Fannie Mae (FNM) and Freddie Mac (FRE) at the beginning of 2008 because they incorrectly assumed that they were ex officio risk free in spite of the fact that they don’t carry the same full faith and credit guarantees as Treasury debt. They saw the spread between Fannie / Freddie debt and US treasuries of comparable duration, dived right in, and were slaughtered when Fannie and Freddie collapsed later in the year. This is what happens when you ignore real fundamentals in exchange for government speculation.
If you want to buy Citi's preferred stock because you like the current yield as an income play and you're not too concerned about short term fluctuations in price, I can understand. Even so, there are much better, and safer, alternatives, such as the John Hancock Preferred Income Fund II (NYSE:HPF) or the BlackRock Preferred Income Fund (NYSE:PSY).
Better companies have had their stock prices stagnate for years in spite of high liquidity, consistent cash flows, little to no debt and strong management- Microsoft (NASDAQ:MSFT) and IBM (NYSE:IBM) come to mind. Citi has none of the above. As for all those who object that many traders made a fortune buying Bear Stearns Cos at $2 a share and cashing out at 10, I would like to point out that there were just as many investors who went in at $10 and watched it go to 2- after they were stopped out, I hope.
To say that Citi is “too important to fail” and ergo a “great long term investment” is an intuitive leap. I wouldn’t necessarily short it, however. The burial grounds of Wall Street are littered with the bones of recent traders who went toe to toe against the government, and we’ve been seeing all sorts of suspicious activity in equity index futures where huge countertrend positions appear out of nowhere just before the market closes. Nonetheless, Citi’s a dog, and just because it’s too big to flush down the toilet doesn’t mean it belongs on my dinner plate.
Disclosure: No positions.