Alex Trias

Big Banks: The Consensus Is Cracking

breaking these puppies up would be the best thing for investors. There are some good businesses tucked away in all those folds of fat at places like Citi and Bank of America. And they don't play nicely with each other. At all. I wouldn't be surprised to see activist shareholders pushing for a break up - particularly if world governments (which are, after all, rather activist shareholders at this point) get the ball rolling. Expect enormous push back from management.

Underestimating Citigroup

I own some Citibank stock, only because when it was trading at around $1 a share, I just couldn't say no. That said, the real value in this company (assuming it is not entirely insolvent), would be break up value. Citi is a hodge podge of businesses, where one hand has no idea what the next is doing. Citi's balance sheet is too complex for any person to understand, and given the opacity of it's assets, liabilities and, frankly, real income, few want to own this company. The only reason to own Citi at these prices are (1) you bought it when it was a penny stock and you are in a very high income tax bracket; or (2) your placing a bet that in time, the company will be broken apart, spun off, sold, and otherwise dismantled, which would help remove clouds of uncertainty over the company's business model, assets, income, liabilities, and risk, and which removal would, in turn, harvest value for shareholders. Nevertheless, in my view, the company as currently configured is a poor investment to say the least, and a "bust up" arbitrage bet is not something appropriate for any investor other than those with a very high risk tolerance.

The Citigroup Anomaly Lives On

Fascinating article. Thanks for pointing this out. It would be very interesting to put this arbitrage failure into a broader context. For example, there have been a number of arbitrage opportunities cropping up within the fixed income and credit default swap markets over the last year and a half. An interesting (but very time consuming question) to examine would be to examine the cause for these market inefficiencies - which you have done in your article on Citigroup stock pricing. Late last year, I studied (and wrote a couple of articles on) panic being a cause of (or enabling factor for) inefficient asset pricing. I argued that panicking bulls enabled bearish investors to benefit from a number of arbitrage opportunities that should not exist for more than a nanosecond in an efficient market. Today, could it be that bearish investors are somewhat panicked, creating price anomalies as in the case of Citigroup's common share price relative to the synthetic/ preferred convertible share price? If so, then has the pendulum swung too far?

Not Buying This Rally

It's normal for bear market rallies to race up to their 200 day moving averages, which is about what we're seeing in various US, international and global stock indexes. This area often acts as resistance, and when it does, markets tend to fall. To where, who can guess? By the same token, we've seem some equities markets strike out high above their 200 day moving averages, in some cases, taking their short term buying momentum way above the long term selling momentum. This is true in many emerging markets and most notably in China. Whether broader markets will follow is anybody's guess, but at the moment, they have not and, in fact, are facing some stiff resistance indeed.

It is too soon to conclude whether equities are entering into a new bull market or simply bouncing up in the context of a very long term bear market. Why take a position one way or the other? Seems like a fine place to sell, if you asked me, but I wouldn't short anything either.

Why I'm Holding On to Citigroup Stock

A very interesting analysis of a very complex issue. I own some Citibank stock, but agree with many of the comments that it is a hugely risky investment. I doubt any one individual has enough information to understand Citibank's business, let alone the composition and quality of their assets. My only basis for owning this stock is that at current prices, the stock trades at a very low multiple of its' twenty year average earnings. The risk, as I see it, is that Citi will never earn anything close to what it has earned over the past two decades, and that it may yet go bankrupt or end up in a "virtual" bankruptcy situation like GM. I agree that Treasury would no doubt enjoy owning some upside if they are to take low quality bank assets onto their books (whether by guarantee or otherwise), but I do not share the view that Treasury so much as gives a passing thought to sharing any such upside with other holders of Citi common. Let's hope the author's predictions come true, but I wouldn't base an investment decision on such hopes alone.

How About Adjustable Principal Mortgages Instead?

You are onto something. I like this idea. Actually, you are onto something huge.

So, what are you doing to push this? Are you publishing? Sending proposals out? Whatever you are doing, you have a great idea, very simple, and expedient in terms of both moral hazard and in terms of shoring up asset quality as a means to get capital flowing again. With an idea this good, you really have to push it. If I can help you, send me an e-mail.


On Mar 08 11:32 AM User 366653 wrote:

> I still like my idea better. Here it is again.
>
> Like the author, I have sent this idea to everyone I can think of.
> Unlike the author, I have gotten no response.
>
> Here is my plan to help solve the bank crisis. It would apply to
> the nineteen largest banks, and would work as follows:
> The government would insure each bank's entire existing portfolio
> at the current value, subject to all applicable regulations and FASB
> valuation methodologies in force prior to adoption of FASB 157. New
> loans and investments would be subject to the same regulations, but
> wouldn't be insured by the government.
> As a down payment for this insurance, the bank would issue non voting
> common shares to the government representing twenty-five percent
> of the bank's common equity. For each year that the insurance remains
> in force, the bank would issue preferred stock representing an additional
> three percent of base level equity value to the government, for up
> to ten years.
> The bank would have the right to cancel the insurance at any time
> after three years.
> The advantages of this strategy are:
> Virtually no up-front costs to the taxpayer. In fact, the taxpayer
> would immediately receive tens of billions in equity.
> Public confidence in the bank(s) would be fully restored immediately.
> The fear of government interference, as a result of "nationalization",
> would disappear because the government's equity stakes would be non
> voting. Confidence in the entire financial sector would most likely
> improve dramatically and immediately.
> The value of the bank's common stock would probably appreciate immediately,
> resulting in a profit to the government/taxpayer. While this plan
> would dilute the existing common, it is very clear that the prices
> of most bank stocks reflect the risk of armageddon. Fifty percent
> dilution is not a problem if your stock has gone from 50 to 1 or
> 2 or 3. If you assume that profits could return to half of "normal"
> over the next five years, the newly diluted stock has plenty of upside
> from here.
> The value of the bank's preferred stock, trust preferreds, and debt
> would immediately increase dramatically. Credit ratings would be
> restored to legitimate investment grade. This means the bank(s) would
> now be able to raise new PUBLIC and PRIVATE capital, and would not
> need additional Government funds. In fact, the bank(s) would be able
> to use the proceeds of new preferred stock to repay TARP ahead of
> schedule.
> Furthermore, as compared to the plans already in place, and those
> being considered, the advantage of my idea is that virtually all
> the costs are POTENTIAL, and DEFERRED, rather than DEFINITE, and
> IMMEDIATE.
> Additionally, it is likely that gains in the bank's share prices
> would offset a significant portion of any losses that may accrue
> from the insured portfolio(s). Since implementation of this plan
> would certainly hasten the recovery of our national economy, the
> assests insured by the government would be more likely to improve
> in value than to decline any further. In any event, the government
> will be in a better position to absorb losses, since the TARP money
> will have been returned, and no additional TARP funds would have
> been dispursed.
> To summarize, my plan would "nationalize" the current loans of the
> banks, while leaving the banks intact, with no additional up front
> costs to the taxpayer. The "moral hazard" issue - helping the "shareholder"
> at the expense of the "taxpayer", is handled by making the taxpayer
> a shareholder. Confidence in the security of our financial system
> would be restored, and we could get on with trying to solve some
> of our other problems.
>
>
>

How About Adjustable Principal Mortgages Instead?

Thanks, Prudentinvestor. There is much more to your comment than appears on the surface. I take from it two deep questions. First, who pays for the loss? I am assuming (and this is a HUGE assumption on my part) that if the Treasury were to sell 30 year (or 20 year, or some other long time frame) put options on a Case Shiller Index, there would be no loss. My assumption is either (1) real estate prices increase over the 30 year period; (2) even if real estate prices fell over 30 years, the premiums paid to Treasury would adequately compensate for this risk, and Treasury could reinvest those premiums in sufficiently high-yeilding assets to pay for the losses on the put options once they expire. And yes, I am assuming European style options, which I did not make explicit in my article. So the short answer to your excellent point is "I am assuming no losses".
We all know where it ends, when someone says "I am assuming no losses". But that is the big assumption behind this short article, and you do an excellent job pointing it out.
If I had more space to write, I would have expanded the article to address your second point: who pays for the loss IF there is one (and when is there never a loss?)
The answer is: the US taxpayer. The basic concept here is to subsidize downside risk at the expense of society. This runs exactly COUNTER to how an efficient capital market is supposed to work (punish and reward risk takers), because what I am suggesting is to give the risk taker the upside, and give the US taxpayer the downside. Doesn't this lead to a risk of over-investment (ie., another even larger asset bubble?)
Answer: yes.
Question: Why is Alex suggesting we even consider this proposal?
Answer: to get people to take risk again.
See, the real issue that I am seeing is that nobody will take risk at the moment. The capital markets cannot function unless people are willing to buy risk, and right now, that willingness is falling apart. What I am suggesting is to really offer an "unfair" good deal for homeowners and banks, give them all this upside and give the downside to the US taxpayer, as a means to get risk appetite up again. And once banks are back into the business of taking risk, and people are willing to put some capital into real estate (or other risky assets) again, you pull the plug on my "adjustable principal" program. Get the US Treasury completely out of the business.
My reasoning boils down to just this. I was walking to my office this morning, and went past a Starbucks. They were handing out free coffee on the street. So, I took a free cup, drank it, and went in later this morning to buy another cup. I'm suggesting Treasury basically offer the markets a free cup of coffee to get investors back in.
End of society? Maybe. We're already down that path. We'll get real close to the edge by the time this is all done.



On Mar 08 10:39 AM prudentinvestor wrote:

> Your idea appears to be an extension of the the cramdown laws just
> passed by congress, except that you would dispense with the formalities
> of a bankruptcy court ordering the principal write-down.
>
> The same vexing question comes up, who is supposed to pay for the
> loss? By custom, in orderly civilised society, profits are retained
> (after tax) by those who generate them, and losses are borne by those
> who incur them.
>
> These notions lead one to wonder whether civilised society, based
> on a sound and fair legal foundation of contract law, may be getting
> closer to its end. This would be too high a price to pay for temporary
> expediency.

The End of the Credit Crisis

Interesting point - especially since I'm a tax lawyer. Discharge of Indebtedness income (which is what you're talking about) will hose this Homeowner. This is one reason I've been writing to Treasury on an almost monthly basis, suggesting a five year "patch" for suspend income tax on unemployment benefits and D.O.D. income.

Look, our tax code wasn't designed for today's realities. Period. Get on board and write to your Congress person about cleaning up the system. I am.

On Feb 27 10:17 AM User 365522 wrote:

> The author fails to account for the tax effect on the borrower. The
> $200,000 write down by the bank is considered taxable income to the
> borrower, payable immediately. That will put the borrower into the
> highest tax bracket (which is going up even further). The tax owed
> will be about $80,000. Where does the borrower get that money? The
> bank survives, it stock price soars, while the borrower gets hit
> with a tax bill he can't hope to pay (or discharge through bankruptcy).
> Great plan!

The End of the Credit Crisis

THanks for your comment. That's correct. I'm using a story about individual loans for simplicity's sake only - what I'm focused on are mortgage pools and securitized vehicles, and the mark-to-market accounting rules. In an earlier draft, I bundled Homeowner together with some others, and did a securitization section. But the article ended up being too long and convoluted.


On Feb 27 11:00 AM User 75493 wrote:

> You miss one thing - individual (nonsecuritized) loans aren't written
> down until they distressed - usually 90 days deliquent. This loan
> is still on the books at 500k until the homeowner misses payments
> or the bank is sure the borrower isn't going to pay it back.
> Therefore, there's no "writeup" ahead, only writedowns for the bank
> in your story. And if the "smart guys" get their cramdown wishes,
> you'll see a reduction in lending as bank equity takes a hit. <br/>That's
> one reason why the gov't is going to be putting so much more equity
> into the banking system - there's a lot of impairment to be realized
> in the near future

The End of the Credit Crisis

Yes, this morning was an interesting development - too bad I wrote the article yesterday! If we take the Citibank move as a template for further partial nationalizations (which is what I think we'll see), then the Volkswagon story will not play out here.

Thanks for your comment.


On Feb 27 09:38 AM J. D. Swampfox wrote:

> The shares in the banks that the government owns are newly issued
> shares, not purchased from the existing supply in the market. Further,
> IF the banks take "write-ups" from the scenario you lay out, the
> value of them to existing private shareholders will have been diluted
> by the percentage controlled by the government. In the case of Citi,
> as of today, this is currently about 40%, but it looks increasingly
> like it will soon be 80% a la RBC in the UK. Skyrocket from write-ups?
> Sounds tenuous, at best...

A Remedy for Short Selling Manipulation

Great article. The author raises a very fundamental issue: the main problem confronting how the government regulates the capital markets is that the regulators aren't traders. They haven't spent time at a trading desk, and most traders worth their salt aren't all that incentivized to do a stint at the S.E.C. and take a 2000% salary cut.

This article suggests a straightforward way to regulate the markets in terms of bid pinning. I'm going to suggest taking it one step further. If you are a trader who has already made a killing on the market and knows how it works, and you spot a problem, don't write about how to fix it. Get a job within the S.E.C. and do it. Take the pay cut, and chalk it up to public service. If you can't, then take your idea, paste it into a letter to any Senator on the Finance Committee. I'd start with Max Baucus and Chuck Grassley. Follow up with phone calls to their offices and speak with one of their aides.

The CDS Anti-Matter Bubble

You may have been too early in bringing this to the attention of the government agencies you mention. In my own personal experience, it simply takes longer for any agency to shift focus than it takes us in the private sector to shift focus. Patience and persistence is required when you deal with any large government agency, but fortunately, focus is shifting right now to this problem.

I suggest you continue your efforts to communicate specific information on specific trades and specific entities placing them to regulators - bearing in mind that there are plenty of legitimate CDS/ short trades. The issue is how to discern whether a trade is "manipulative" or not. I suggest that anyone buying CDS without any interest in the underlying debt is quite probably looking to manipulate equities prices. You may have other insights into how a regulator should distinguish manipulative trades from legitimate hedging transactions. That information would also be of use to securities regulators, prosecutors and to your congress person.

Keep pushing.


On Nov 26 08:04 AM TomArmistead wrote:

> Good article, this echoes what I have been saying for almost a year.
> I too complained to the SEC and the NY Attny General and the NY State
> Ins. Dept. They are looking into it, but nothing comes of it. <br/>
>
> Instead, we get the charges against Mark Cuban, an easy target but
> totally irrelevant to the crisis in confidence brought on by the
> stock manipulations described in this article.

The CDS Anti-Matter Bubble

I encourage you to contact Dave Markowitz at the Investor Protection Section of the New York State Attorney General's Office. These attorneys are keen to protect the integrity of the markets, and you have an opportunity to be a part of the solution if you are aware of specific (and potentially abusive) trades or entities placing them.

Thanks for reading!


On Nov 26 06:34 AM Gtarras wrote:

> Alex
> this piece is long overdue!!!! I personally know guys involved in
> this trade. hey, they profit all right. Destroying the system in
> the meantime. I also was bringing this up in many arguments i had
> with colleagues.
> Thanks!