May 032009


By Kalidas Ref: 0905-027 of 4-May-2009

So they did it again. The investors applauded. CNBC reported that the financial sector appears to have bottomed out, and the market is up 10% in just under 3 days. The market could not have been wrong. They say the market is ahead of the events by 6 months. If that was so, why did we lend into deepest recession in post-war history. Who remembers that? The people’s memory is like RAM (Random Access Memory) which remains so long is the power up and running. The moment the power is switched off, the memory is gone forever.

It was carefully planned conmen’s game. The crooks are always suggestive so that the target does exactly what is required of them.

Look at the past events, only 2 months back. Note the following:

1.      Citigroup was in dire trouble. The President and Senate were obliged to release $ 45 billions in cash in the form of Preferred Perpetual Shares with 10% coupon. It was Paulson’s brilliant idea. He may have told the President, Senators and American tax payers that they would earn 10% income by way of dividend, in addition to rights to subscribe to Citigroup’s shares under warrants attached.

a.       Everyone believed them. Wow, we are getting 10% return when we are getting only 1% while lending to various banks. Excellent. And we will make money in equity too. What a fantastic idea.

b.      No one asked them how Citi is going to earn when dividend servicing cost of this deal alone will be $ 4.5 billions annually. This is in addition to similar servicing costs payable to other large Middle East investors.

c.       Money was released in the name of TARP. As soon as this purpose was achieved and the money was already in the kitty, these guys allowed a few days to pass. They observed that direct injection of cash was not helping them. The losses will have to be written off in the books of the bank and any money they receive from the Fed or Treasury will straight away go to write off that debit. No money will go to the market by way of lending.

d.      The trio thought that this was a problem. We do not want to write off the amount from the Citigroup’s books. It also needs another does of $ 300 billions. The President and Senate will not simply release more funds if Citi goes on showing more and more losses.

e.       The devil’s mind started working. Target: to get $ 300 billions; Aim: Not to show any losses in the books of Citigroup, otherwise it will be officially bankrupted. What to do?

f.         IDEA – a Great Idea – Paulson appears to have screamed in the sound proof cabin.

i.  Hey, Pandit – you do the following:

1.      We will not give you cash, because it is impossible.

2.      We have given you $ 45 billions. You better give the treasury $ 7 billions of guarantee premium and we (US government) will guarantee your obligations falling due.

3.      Those junk assets when backed by the AAA rating of US government will soar. Those holders can discount those bonds with their bankers because they are backed by the guarantee and full faith of the US government.

4.      Since these bonds have become realizable assets, you do not have to make any provision in your books. Although it is your bad assets, it will not be bad assets any more. They are now fully insured by the US government.

5.      So you will not write off these bad assets in your books. They will now be US government’s troubled babies.

6.      When you get the demand for payment under these bonds, simply redirect them to US government and ask them to pay under the guarantee for which you paid guarantee premium of $ 7 billions.

7.      Pandit: Wow, great. You gave us the brilliant idea; we no longer have to write off any more bad assets. But US government will have to write them off one day in their books.

8.      Paulson : Yeah, one day. By then, you will not be there, I will not be there, and perhaps this Bernie too may not be there.  And who cares?

9.      Pandit: Excellent. But what do I do for $ 45 billions already borrowed. I do not have money to pay even 10% dividend, forget the principal.

10.  Do not worry… Bernanke will take care of it. Hey, Ben, you better convert those PPS (Perpetual Preferred shares) into common equity immediately so that Pandit does not have to bother about the dividend servicing.

11.  DONE. I will take care of that. Said the Bernanke

12.  Now Pandit, since you do not have to make any provision for $ 306 billions and you do not have make any payment of dividend on preference shares, you can write a memo to your staff that you have the best quarter since 2007. Your stock will soar.

13.  Did you buy any? Pandit asked.

14.  I have the right to remain silent, said the other guy.

This is what appears to have happened a day before.

When the Citi lost $ 45 billions and Fed gave them $ 45 billions as capital, following entries could have been passed.

1. Debit     :     $ 45 billions -Cash account (being sum received from the Fed)
2. Credit    :     $ 45 billions -Perpetual Preferred Share Capital (to US government @10% div CPN)

3. Debit     :     Profit & Less Account $ 45 billions (Amount written off)
4. Credit    :     Toxic Assets (Toxic debt assets – also contra of Toxic liability)

5. Debit     :     $45 Billions – Toxic Liability to Customers (could be X? We do not know)
6. Credit    :     $45 billions – Cash withdrawn to make the payment to the creditors

7. Debit     :     $45 Billions – Perpetual Preferred Shares (to US Government) to convert to common.
8. Credit    :     $45 Billions – Common Stocks issued to US government

9. Debit     :     $45 Billions – Common Stocks Issued to US Government (Capital written off)
10 Credit  :     $45 Billions – Profit & Loss Account (Under Item 3)

Final result – TARP fund issued by US government for issue of Perpetual Preferred Shares is finally written off by first converting into Common stock and then by way of reduction of capital of common stock to write off the debits in profit & loss account (now intangible assets)

Under above scenario, the losses are written off in the books of Citigroup because the TARP fund issued for PPS capital were required to be shown in the books of Citigroup. Also note that there was no need to convert Perpetual Preferred Shares into Common Stock in the name of boosting capital of Citigroup because both were Capital – one was Preference shares and other common stock. (Equity). Under the law, both were acceptable form of the capital, ranking subordinated to debt. What was the motive? Here is the possible answer.

While seeking approval of $ 700 billions under Paulson’s Plan, the Senators and President were told that they were going to give the funds to Citigroup with 10% dividend coupon. That is, US government was to earn 10% from Citigroup, that is, $ 4.5 billions per year (on $45 billions lent). By transferring to common stock, the dividend coupon was compromised, and the US government’s priority for preferential treatment of asset distribution in the event of insolvency was also compromised or watered down.

So first, these guys tell the Senators and President that US government or Tax Payers will earn 10% on amount lent to obtain their approval under TARP funds. Then, these guys convert PPS to common stock to forego 10% dividend, and then reduce the Equity capital to write off the debit in the Profit & Loss Account. In short, US government loses $45 billions within 6 months.

Now, see the interesting part for guarantee of $ 306 billions issued by US government for toxic debt held by the Citigroup.  In this case, the guarantee was designed in such a way that the losses are not written off in the books of the Citigroup. As result, the Citigroup would not be showing any losses for next 4 quarters. The losses would be ultimately written off in the books of Federal Reserve as under:

Current Position in the books of Citigroup:

11. Debit   : Toxic debt of $306 billions held by the bank (market value Zero)
12. Credit : Toxic liability of $ 306 billions payable to other creditors (could include X)

The item under 11 will need to be written off to the debit of Profit and Loss account if direct funds were received from US government under TARP.

To avoid the writing off such huge amount in the books of Citigroup, Paulson/Bernanke designed the guarantee route. They showed to US government that Citigroup would give $ 7 billions as guarantee premium to US government for arranging its guarantee. The US government is led to believe that it is just getting the income without letting out actual funds, because the guarantee does not involve movement of funds until it is invoked.

It is like we pay insurance premium to insurance company to obtain their guarantee for insured act. If the insured act materializes into real liability, then only the insurance company would be required to pay.

So these guys Paulson and Bernanke showed “moon” to the US government that they will get a premium income of $ 7 billions without telling them what it was getting into – massive deferred liability of $ 306 billions in near future.

As soon as the Toxic debt is guaranteed, the worthless junk securities are elevated to AAA credit due to the guarantee of  US government.

When the Citigroup faces the claim from creditors for $306 billions,

  1. It will hand over the corresponding toxic debt now guaranteed by US government to the creditors.
  2. It will pass the contra entry in its own books as under:

a.       Debit   : $306 billions Creditors Account in discharge of obligations

b.      Credit  : $306 billions of Toxic debt transferred to the creditors.

c.       In short, the Citigroup balance sheet size is reduced by $ 306 billions (both assets and liability of equal amount are reduced)

  1. The creditors have two options –

a.       either to demand the repayment of the Citigroup’s liability

b.      OR sell the Toxic debt to the market.

  1. When the ultimate market beneficiary of the guaranteed toxic debt needs payment, it will approach the Citigroup for payment. Citigroup, instead of making payment, will direct the claimant to the US government to demand the payment under its guarantee.
  2. In short, Citigroup will no longer need to write off the massive loss of $306 billions from its own book.  There will be no longer losses every month. It will begin to show the profit showing the world that recovery process has started working for Citigroup which is a myth.
  3. The US government when facing the claim of $ 306 billions under the guarantee, will need to write off the amount in Fed’s balance sheet. In short, the debit-able losses of Citigroup will be finally written off in the Fed’s balance sheet, not Citigroup’s balance sheet.
  4. Supposing a top Investment Bank (X) is owed by Citigroup by, say, $ 30 billions. Citigroup will hand over the US government guaranteed debt to X. X has two choices:

a.       To seek the payment of  $30 billions from Fed under its own name. However, it will expose its name for scrutiny later in the event of any enquiry.

b.      To sell the securities of $30 billions  to the market players say, A, B, C, D. These market players will ultimately demand the payment from Fed under their own respective names. Even if there is any enquiry, the name of the penultimate holder, that is, X, will not be disclosed. It can therefore avoid any scrutiny.

c.       The name of X as one of the creditors or counterparty of Citigroup is strongly suspected because the Treasury Secretary Mr. Paulson belonged to that group earlier in highest executive capacity.

d.      In short, Citigroup (and possibly X or its associates) were saved by the above exercise of “US government guarantee of Toxic debt held by Citigroup”. But the final victim would be the US government or American Tax Payers. They were obviously defrauded by the antics of Bernanke, Paulson and Pandit without the knowledge of the Senators, the President of the United States of America. Or American Tax Payers.

e.       When the $306 billions become finally payable, no further approval of Senate or the President would be required because the deal was already approved earlier for guarantee. US government, Senators or the American Tax Payers would not know what had hit them when they have to ooze out $ 306 billions at that time. It may happen 6 to 9 months from now on depending on the maturity profile of guaranteed debt.

It will be observed that good quarterly numbers of Citigroup or JPMC or BOA are not necessarily due to easing of credit crisis or recovery of the economy. These are the acts of window dressing. The balance sheets of most of the large banks are being white washed to look them better and more palatable to the investors. The credit crisis is in fact worsening.

It is therefore not too much to say that the “Citi is saved, the nation is destroyed”. It is a fact.

Kalidas, Hong Kong

4-May-2009 Ref: 0905-027