In October/November, 2008 New York-based CitiGroup received $45 billion in preferred shares from the U.S. Government. At that same time the Government agreed as a further ‘backstop’ to absorb up to $250 billion of just over $300 billion of ‘toxic assets’.

An article yesterday said as a result of a conversion of up to $25 billion of that $45 billion in preferred shares to common stock, the U.S. Government will boost its common shareholding in CitiGroup to up to 36% in circumstances where private investors convert a like number of preferred shares to common shares. The result could be that existing common shareholders will be diluted by up to 74% - leaving them with as little as a 36% common share interest in CitiGroup. This conversion (characterized in the article as “the latest rescue”) does not inject more capital into Citigroup. What it does do is give “the government more of a voting stake and far greater influence over the bank’s operations, short of outright nationalization”. The agreement will boost Citigroup’s tangible common equity ratio , a measure of capital, to between 5.4 % - 8.1% from the fourth quarter’s 3.0%.

The article states that “Shares of Citigroup closed down 39 percent on Friday, and touched their lowest level in at least 18 years. The market value of what was once the world’s most valuable bank has fallen to $8.2 billion from a peak above $270 billion roughly two years ago”. Moody’s Investors Service cut Citigroup debt one notch to “A3,” its fourth-lowest investment grade, saying Citigroup is likely to shrink”. Standard & Poor’s affirmed its “A” rating, a notch higher.

Concurrently, Citigroup will halt dividends on preferred and common stock, but maintain payouts on trust preferred securities.

My Comments: First, I had to read two articles carefully and make a number of calculations in order to ‘sort out’ exactly how (I think) this complex arrangement works. I should not have had to do that if those reporting the transaction better understood how to explain share conversions and dilution percentages. Second, based on my assessment of the arrangement, it does not strike me as commercial. In the ‘private sector’ world as I know it ,the existing common shareholders would end up with little or nothing as contrasted to 36% of the potential number of common shares ultimately outstanding. I can only assume the:

• assume private investors who apparently have agreed (according to the articles referenced in this blog) to convert preferred shares at a price based on $3.25 per common share must believe their preferred shares are worth little if anything without this deal;

• assume the fact that the U.S. Government and the existing common shareholders each potentially end up with a 36% common share position is not coincidence and that, consistent with what it has been saying for the past several days, the U.S. Government does not want to nationalize this (or likely any other) bank; and,

• conclude that on the balance of probabilities we have not heard the last of CitiGroup in the context of U.S. Government ‘bailouts’, and in the end the 36% common share interest owned by now existing common shareholders will be further diluted – and likely by not a small amount.

Read the articles I read when developing this post by clicking here (first article) and clicking here (second article).

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Fannie Mae (FNM.P) Thursday reported a $25.2 billion Q4 loss, and said it needs $15.2 billion under a senior preferred stock purchase agreement with the Treasury to fund a deficit in its net worth. In an article yesterday it was reported that Fannie Mae’s Q4 loss was 7X its loss in Q4 2007, and that it lost $58.7 billion in calendar 2008. The article quotes a Fannie Mae spokesperson as saying “We expect the market conditions that contributed to our net loss for each quarter of 2008 to continue and possibly worsen in 2009, which is likely to cause further reductions in our net worth”. The article also said that “Fannie Mae said the deterioration in housing and credit markets reduced the fair value of its net assets to a negative $105.2 billion in December from $35.8 billion at the end of 2007”.

My Comments: I summarized this article simply because I think it is an important bit of news. Those readers who have been reading my blog posts on a regular basis will know that while I would not have been able to predict the quantum of Fannie Mae’s now reported Q4 2008 losses that directionally I expected them. I also expect such losses to continue and likely escalate going forward. If I am right this will mean that the U.S. Government (read the U.S. taxpayer) will be required to fund more Fannie Mae losses going forward.

Read the article by clicking here.

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David Morgan, a well-known silver commentator, recently wrote a Seeking Alpha article where he comments on how he (or as it turns out, another author) believes silver will perform in a deflationary period. He begins by stating his belief that based on history gold actually does best during deflations, rather than inflations – referencing what he calls ‘the seminal work on this topic … The Golden Constant – written by by Professor Roy W. Jastram of the University of California at Berkeley. Morgan says Jastram said that when writing The Golden Constant he found that throughout history silver was intertwined with gold – and then says Jastram asked the fundamental question “Just how does silver perform during inflations or deflations?” and that he concluded that “in most cases, the two metals, yes, both silver and gold, gained operational wealth in deflations”.

My Comments: When I researched the Post Series on this Blog I concluded that gold likely was a ‘safe-haven hedge’ in both inflationary and deflationary periods (read Gold as an Investment - Post 9 of 11 by clicking here). I find silver a far more complex metal to assess than I do gold, given in particular silver supply/demand equation influenced by the fact that much of the new silver produced each year is a by-product of mining activity aimed principally at other metals, and by the fact that approximately 70% of all silver used in the past ‘good economic time’ years has gone into industrial products. As a generalization I think that many ‘gold bugs’ are very locked into their beliefs and positions. From my discussions with ‘silver bugs’ and my reading of some of the commentary they produce, I think that if ‘gold bugs’ walk further out on a tree limb than I typically would, ‘silver bugs’ seem to me to be even more extreme in their outlook and behavior. Morgan’s article doesn’t include his own thoughts and conclusions but relies on those of Jastram. I have placed an order for Jastram’s book and will give you my views on what Jastram said after I have read it.

Read the article by clicking here.

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President Obama yesterday put forward his 2009 Budget Proposal. If implemented without change it forecasts a 2009 Budget Deficit of $1.75 trillion. His budget calls for a spending plan of $3.55 trillion that would boost taxes on the wealthy, curtail Medicare, and “make way” for a $654 billion down payment on universal health care. The budget inherently must assume U.S. Government revenues of $1.8 trillion for 2009.

My Comments: My review of public data on U.S. Revenues for 2007 and 2008 suggest they were $2.63 trillion and $2.66 trillion respectively (which seems too low). If these numbers are the correct ones to compare with what I think must be the assumed U.S. Revenue forecast for 2009 of $1.8 trillion, that suggests the U.S. Administration is forecasting an approximate 1/3 reduction of revenues in 2009 from 2008. Given the current economic circumstance it makes sense to me that U.S. Government revenues will be down in 2009 significantly. I have been unable to find other commentary on ‘by how much’, and I may in my analysis have picked up incorrect numbers. You can review the data source I used for 2007/2008 U.S. Government Revenues by clicking here. I will be reviewing this and commenting on further posts as I find more data. In any event, no business or household could survive for long by spending twice what it makes, particularly when it has prior accumulated debt equal to approximately 6X its current year expected income (calculated as assumed cumulative U.S. National Debt of $11.5 trillion/$1.8 trillion apparent 2009 forecasted revenue). I continue to wonder whether I am simply getting this all wrong and not assessing things sensibly – or if I am assessing things correctly (or even ‘reasonably’ correctly) how the end game is not a continuing U.S. economic deterioration.

Read an article summarizing yesterday’s budget announcement by clicking here. You can also play a video purporting to ‘grade’ President Obama’s Budget Proposal that accompanies the article.

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Two articles yesterday reported on new-home sales, U.S. worker jobless claims, and manufactured goods demand. The articles reported that:

• new-home sales tumbled to a record-low annual pace in January with no relief in sight as “mounting damage from the collapsed housing market pushes the country deeper into recession”. Sales of new homes were reported as falling 10.2% to a seasonally adjusted annual rate of 309,000, the worst showing on records going back to 1963 – weaker than economist’s expectation of 330,000;

• the government said it would take 13.3 months at the current sales pace to exhaust supply, which puts even more downward pressure on prices;

• the median sales price fell by a record drop of 9.9% to $201,100 in January, while the average home price dropped 9.8% to $234,600;

• the number of U.S. workers drawing jobless aid jumped to record high in mid-February with the number of people remaining on the benefits roll after drawing an initial week of assistance increasing by 114,000 to a record 5.1 million in the week ended February 14. At the same time, initial claims for state unemployment insurance benefits increased to a seasonally adjusted 667,000 last week from 631,000 the prior week, the highest reading since October 1982; and,

• new orders for long-lasting U.S. manufactured goods fell to a six-year low in January. Durable goods orders dropped 5.2 percent to $163.8 billion in January, the lowest level since December 2002, from a 4.6 percent decline in November.

My Comments: Other than to say that if you work the numbers on new home sales through you find that economist’s were forecasting an approximate 4% drop in the seasonally adjusted annual rate, not the 10.2% reported. I continue to wonder how people trained as economists continually seem to miss accurately (or at least ‘reasonably’ accurately) forecasting ‘next month’s’ results for most things. One explanation is that things are deteriorating at an escalating pace that defies forecasting based on historic modeling. At one level (that of ‘economist credibility’) one can only hope that is the explanation. Other than to say I continually look for good news on the economic front but am failing to find anything, I don’t have anything to add to the foregoing numbers. It seems to me they speak for themselves!

Read the referenced articles by clicking here, and clicking here.

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In an article yesterday, American Brad Setser (who based on my reading I consider to be one of the better ‘blog writers’ on things economic) comments on his rhetorical question ‘Who bought all the Treasuries the US issued in 2008? And who will be the big buyers in 2009?’  I think this question currently is of paramount importance – see my blog post earlier this week on Hilary Clinton’s comments made in China during her recent trip there.  Setser agrees with me on the importance of this question.  He begins his article by posing and answering the question:  ‘and just how important is China — clearly now the largest single holder of Treasury bonds — to the market?  Setser goes on to say:

•    central banks and sovereign funds, led by China, were huge buyers of Treasuries in 2008. “The work I have done with Arpana Pandey suggests that central banks bought close to $600 billion Treasuries in 2008 — with China accounting for a bit over half the total”;

•    if the marketable Treasuries that the Fed sold to finance its lender of last resort activities are counted as increase in the outstanding stock of marketable Treasuries, sales of U.S. Treasuries topped $1.6 trillion in 2008 implying (if the Pandey/Setser estimates for official purchases are right) that private investors bought more Treasuries in 2008 than did the world’s central banks;

•    with global reserve growth slowing central bank demand for Treasuries is likely to fall, implying (or so Setser thinks) that the ability of the US to finance large deficits at low rates depends far more than it has in the past on the willingness of private investors to buy Treasuries;

•    having said that, Setser then says that if China suddenly stopped buying Treasuries in the way it stopped buying Agencies last June, it would almost certainly have an impact on the market unless the Fed stepped in — “but that too would have consequences”.

•    In Setser’s view a world with $1.75 trillion US fiscal deficit and a $500 billion US current account deficit only works if Americans are willing to buy an awful lot of Treasuries. He believes the borrowing need of the US government is now far too big to be covered by the (much reduced) growth in the emerging world’s reserves;

•    Setser believes the slowdown in global reserve growth implies a slowdown in central bank financing of the U.S.;

•    in Setser’s view the overriding assumption behind the stimulus is that a rise in US household savings (linked to the fall in US household wealth) will create a pool of domestic savings that will flow, given the ongoing contraction in private investment, into the Treasury market. The rise in private savings and fall in private investment will allow the US government to borrow more even as the US economy as whole borrows less from the rest of the world; and,

•    Setser’s guess is that the Treasury market will be driven by developments in the US – not developments in China – in 2009.

My Comments:  I think readers of this post ought to read Setser’s article in its entirety.  It seems to me that if he is right in his analysis and conclusion that the U.S. is in an oxymoronic cycle that causes serious economic problems.  If I am right in my continued assertion that the U.S. consumer must spend to bring back growth in U.S. GDP – and I can’t see how I am wrong when in recent years the U.S. consumer has accounted for approximately 70% of that GDP – then how can the U.S. consumer both save and buy U.S. Treasuries, and spend on goods and services at the same time.  A better thesis might be that wealthy Americans, Investment Funds, and Hedge Funds et al might buy them, but who would want to put vast amounts of money into U.S. Treasuries with a fixed principal amount and a low yield in the economic climate.  I wouldn’t, but then again I am seriously beginning to wonder what I am missing.  I encourage your comments letting me know what it is.

Read Setser’s article by clicking here.

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An article yesterday sets out details of a new U.S. Treasury Department program pursuant to which capital injections will be made into the 19 largest U.S. banks based on a “stress test”.

In summary, the 19 banks will have six months to raise private capital after a review of their financial statements before they can be eligible for new (i.e. incremental to government advances already made) capital injections. Under this approach government regulators are looking at each financial institution’s balance sheet and evaluating how much capital will be needed over the coming two years. This process is expected to be completed by April 30. Based on its analysis, the government would let institutions exchange taxpayer-funded preferred shares for common shares when losses forecast by the stress test actually occur.

To evaluate whether banks need capital infusions, the article says the Treasury Department has designed two economic scenarios to estimate expected losses over the next two years. Apparently government officials will take into consideration a financial institution’s projected losses or profits based on a pair of alternate economic forecasts for 2009 and 2010 that look at GDP growth, unemployment rates and other factors. One forecast is expected to reflect a “deeper and longer” recession scenario. The forecast will also take into account changes to the residential house prices for 2009 and 2010. The 19 banks will be asked to analyze their loan and securities portfolios to estimate their future losses under each of the two scenarios. The banks that have received the convertible shares will be able to exchange them for common stock with regulatory approval at a price that is a 10% discount to the “prevailing level of the institution’s stock price as of Feb. 9, 2009.”

The article says existing common shareholders of the 19 banks are concerned about this plan because:

• preferred shares rank higher in the capital structure of a company than do common shares. In the event that a firm goes bankrupt and is liquidated, preferred shareholders could be in line to collect something, while common holders likely would get nothing; and,

• conversion of preferred shares into common shares would make currently existing shares worth less through dilution. In other words, the more shares of common stock outstanding, the less valuable each common share is.

My Comments: First, the concerns the article expresses on behalf of existing common shareholders of these banks are ridiculous. An inherent risk of holding common shares in any company is that if the company is unsuccessful its common shares may be worth little or nothing, and if new capital is infused common shareholders almost inevitably get diluted. If the common shareholders of these 19 banks really believe these things, and have spokesmen voicing these types of concerns, they ought to have a stiff drink and drown their sorrows in the reality of their common share ownership positions. Second, I find the concept of alternate forecast scenarios interesting. I would like to know whether there will be open disclosure of the ‘GDP growth’, unemployment rates, housing prices, and ‘other factors’ that are adopted in these forecasts. I wonder whether in all the current economic circumstances it makes any sense to forecast ‘GDP growth’ as contrasted with ‘GDP retraction’. I would also like to know whether the U.S. Administration has a contingency plan in the event the ‘worst case’ forecasts for each bank prove to be optimistic. My current thinking is that the degree of U.S. government interference in the private sector banking industry is a recipe for disaster, and is completely contrary to the ‘capitalism concept’ that served America well for many decades.

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An article yesterday said Fed Chair Bernanke is confident U.S. inflation can be kept at bay. Bernanke is reported as telling the House of Representative Financial Services Committee he has an exit strategy from the U.S. central bank’s recent massive monetary expansion that will keep inflation under control as the economy recovers, and that “we are quite confident that we can raise interest rates, reduce the money supply and do that all in a timely way to avoid any inflationary consequences”.

The Fed has cut benchmark overnight interest rates almost to zero and has pumped over $1 trillion into credit markets to keep them functioning after the collapse of the U.S. housing market sparked a global credit crisis last year. Bernanke defended the Fed’s cutting of interest rates to almost zero, and its infusion of over $1 trillion into U.S. credit markets, by saying that these steps and steps by others last October resulted in what Bernanke said he seriously believes resulted in the avoidance of “a collapse of the global financial system which would have led us into a truly deep and very protracted economic crisis”. He is reported as going on to say that “It is very important for us, once the economy begins to recover — as usual, the Fed would have to begin to tighten policy — it is very important for us to begin then to unwind our monetary expansion”.

My Comments: I assume the ‘others’ Bernanke referred to are Henry Paulson and his band of Merry Men. Its good to know Bernanke has an ‘exit strategy’ from ongoing U.S. monetary expansion. It would be nice to know precisely what it is. What is going on is such a ‘moving target – literally every day’ it is hard to accept that anyone, including Bernanke has a well-developed strategy for this or pretty much anything else related to the U.S. economy. If only it was otherwise! Again, the ‘recovery’ word is prominently featured in Bernanke’s remarks. Without U.S. economic recovery and growth both from where the U.S. economy is now, and where growth in GDP was before 2008, all the steps taken to date and prospective steps that may be taken by the U.S. Administration and the Fed are simply (or so I think) throwing good fiat currency after bad fiat currency – assuming fiat currency as a medium of exchange is a good thing in the first place. If I am right in this, there better be a quick swing in the U.S. unemployment numbers, and the U.S. consumer better begin to spend quickly from here and with serious vigor. Absent these two things happening I think Humpty Dumpty (the U.S. economy) that has fallen off the wall, and will remain in a smashed and continually deteriorating state (no pun intended). Comments agreeing or disagreeing will be appreciated.

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In another article yesterday Fed Chair Ben Bernanke is reported as telling Congress the Fed knows what it is doing. The article quotes Bernanke as telling the Congressional House Services Panel “We’re not making it up. We’re working along a program that has been applied in various contexts. We’re not completely in the dark”. He also is quoted in the article telling Congress on Tuesday “If there is one message that I’d like to leave you with, if we’re going to have a strong recovery, it has got to be on the back of a stabilization of the (U.S.) financial system. It is black and white. If we don’t stabilize the financial system, we’re going to flounder for some time”.

My Comments: I love Bernanke’s comment that “We’re not completely in the dark”. Is this to say the Fed is ‘somewhat’ in the dark. In current circumstances, how could it be otherwise. I also find it absurd that Bernanke felt it necessary to tell the Congressional Panel that the ‘Fed knows what it is doing’. If it doesn’t, the U.S.’s (and for the time being the rest of the world’s) economic problems look more and more worrisome.

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An article yesterday afternoon says “President Obama’s first budget will seek $634 billion over 10 years as a down payment on health care reform — a little more than half what it may ultimately cost to provide every American with medical coverage”. The article also says the budget will propose a mix of tax cuts for the middle class and tax increases for upper-income households. That includes extending beyond 2010 the $400 annual tax cut in the stimulus plan just signed into law.

My Comments: When are we going to hear about the revenue side of the U.S. budget equation. To date there seems to be an ongoing assumption that the U.S. is impervious to the long-standing rule that one must have a store of funds in order to be able to spend. There must be an assumption on the part of the U.S. Administration that foreign countries will continue to purchase, without complaint as to price, any amount of debt the U.S. Government issues. I am left to recall the old fast-food chain commercial ‘Where’s the Beef’. The current U.S. Adminstration must think that the standard of living of the average American can be improved while at the same time many of those ‘average Americans’ are losing their jobs, their homes, and have less to spend. None of this makes sense to me. Please comment on this post and enlighten me.

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