ItsJustMe

Don’t Worry About a Return to ‘70s Stagflation

Fiasco is right - inflation is not calculated the same way today that it was in 1975 and the other responders are correct that outsourcing our manufacturing may be a Godzilla that is about to come ashore.

The author does make one point that is pertinent: today's economy is not like 1975's economy. That means tomorrow's problems will be totally unlike yesterday's problems. We're about to find out if that is a good thing...

Meredith Whitney Threatens Severe Deflation For Your Portfolio

Philip, I'm aware that the market is forward-looking. Citi isn't going back and adjusting prior years for the losses they're about to swallow and give refunds to prior investors.

I used the last 5 years for comparison purposes to show you the income pain that is about to occur for the NEXT 5 years. The losses began coming off last year and they will come off this year, next year and the years after.

Also, dividends are paid out of equity and have no part in calculating income or loss. And yes, when they report their losses for the next few years, they'll get tax refunds from their previously reported profits. However, tax refunds are usually an irritating consolation for the investors who weren't expecting the depth of the losses...

Meredith Whitney Threatens Severe Deflation For Your Portfolio

Also, I forgot to add that another way of valuing Citi is to look at the hit to their equity. As of 12/31/07, they had equity of $113 billion with 5 billion shares outstanding for a "book value" of $22.60.

If we subtract $80 billion in bad debts off their $2.1 trillion of assets, that leaves them with equity of $33 billion against 5 billion shares. In other words, a book value of $6.60 per share versus the current market value of $20.83.

Ignore total assets Philip. Banks love to measure themselves by total assets but the only things that really matter to a bank are equity, income and consumer trust. Citi is vastly over-valued on the first two and is desperately trying to salvage the third. And if they lose that battle, the first two numbers become irrelevant as Bear Stearns learned...

Meredith Whitney Threatens Severe Deflation For Your Portfolio

Okay Philip, now I see where your analysis is getting screwed up. You point out that even if Citi's share of the mortgage losses is $46 billion, that is still only a tiny fraction of their $2.1 trillion in assets.

That is correct. However, it is a HUGE percentage of their bottom line profits for many years to come. Did i mention the word HUGE? Over the last 5 years (2003 to 2007), Citi has reported net income of $83 billion dollars.

Now take your $46 billion in mortgage writedowns and add in an additional $20 to $30 billion in commercial and consumer writedowns due to the resulting recession and you have a bank that realistically hasn't made a profit in 5 years and is trying desperately to delay confessing that catastrophe to investors.

I happen to agree with you that our country isn't in a doomsday scenario because the overall banking system will survive a trillion dollar writedown. However, certain institutions like Citi and the investment banks own a much bigger share of that problem than other banks like Wells Fargo.

Quite frankly, I happen to disagree with Meredith Whitney that the troubled banks should just confess their losses all at once. I agree with both them and the Fed that it could spark a worldwide panic that would do much greater harm than good.

I see what Citi and the investment banks are doing with their long, drawn-out "disparage and then beat" income strategy and I would do the same thing in their shoes. Playing for time while they swallow their medicine is their only chance at survival and I'm sure the "Plunge Protection Team" is blessing it.

Ms Whitney is a thorn in their sides and heeding her advice could be catastrophic. But that doesn't mean her analysis is incorrect. Ignore her at your peril...

Meredith Whitney Threatens Severe Deflation For Your Portfolio

Philip, as I mentioned above, Citi's quarterly financials in 2 weeks will tell us nothing. Last week, I was long on Citi, this week I went short and I'll switch to long again before they report.

The reason? All of the rating agencies - not just Oppenheimer - are giving earnings warnings on Citi and with mark to market, Citi can pick a few more of their assets to write down and still easily beat expectations.

However, it's all a game. Long term, Citi is struggling for survival. I'm not sure where you're getting your worst-case debt scenarios, but GS just estimated home mortgage write-offs alone to be $460 billion (only a quarter of that has been written down so far) and other analysts I respect because they've proven right so far have projected that commercial debt writeoffs and credit card writeoffs will gradually push the total credit catastrophe to well over $1 trillion over the next 2 years.

Citi has a very unhealthy chunk of that slow-grinding catastrophe and advising your clients to go long on Citi because you think they've hit bottom only 8 months into a real estate collapse which will take years to unfold is a real good way to lose your clients...

Meredith Whitney Threatens Severe Deflation For Your Portfolio

By the time the banks confess to all of the losses sitting on their balance sheets, Citi's profit for the last 3 years will be completely wiped out. I believe that would make Ms Whitney's 2004 statements accurate.

Warren Buffet warned years ago to be wary of investing in banks because they can easily hide huge problems. As a CPA who is somewhat familiar with bank accounting, I can tell you that he was accurate (as he usually is).

Right now, the financial industry is playing a game with their income statements in order to make their price collapse occur in slow motion over a couple of years rather than in a single panic-inducing drop which Ms Whitney is suggesting.

They are sending out earnings warnings on each other to slowly drive their price down and then producing income statements which "beat" those reduced expectations in order to prevent a total collapse.

All companies play this "lower the expectations and then beat them" game, but with mark-to-market accounting where "market" is a guessing game, the banks can pretty much name their bottom line to be whatever they need it to be. If their stock price is falling too rapidly, the banks will reduce their write-offs and beat the expectations.

That is why the Fed - and the banks - were desperate to prevent Bear Stearns from going bankrupt and having to sell their assets on the open market. Everyone in the industry knew they were worth significantly less than what Bear was showing (see Chase's market valuation of BSC) and a sale would have produced a KNOWN market value for mortgage backed securities rather than the INFLATED value all of the banks are carrying them on their balance sheets...

The Fed is Deflating: 10 Reasons Why

"The Euro is given second thought as China will roughly equal U.S. GDP in 2011 (or near there)..."

Jim, you're losing me here. Just off the top of my head, I believe that China's GDP was roughly 3 trillion last year and growing at 11% annually compared to the US's 12 trillion which is growing at 3% annually.

Yet, you're saying China's GDP will catch the US in 3 years? Based on my math, even if the US economy stops growing completely, it would still take China 13 years to catch our economy at their present rate of growth.

Most economists are predicting 30 to 40 years for China to catch up because the US isn't going to stop growing and like Japan and Korea learned, 11% growth isn't sustainable over long periods of time - especially when you're dealing with several hundred million uneducated peasants that China in particular will have to feed.

I still remember the 1980's when everyone (including the Japanese) were predicting that Japan's economy would overtake the US by the turn of the century. Japan doesn't have near the intrinsic problems the Chinese have and we're still waiting on that prediction...

Tuesday Outlook: Market Manipulation?

What about that consumer price index last week that stated we had no inflation worries because energy costs were flat?