Citigroup: 36% stake by US government

The US government announced the conversion of $25 billion worth of preferred stocks into common equity, thus increasing their stake to 36%. This action forced GIC and Prince Alawaleed tfrom Saudi Arabia to follow suit. GIC now holds 11% in Citigroup. All parties forego their dividend and guaranteed cash flow for a stake in the embattled bank. Nevertheless, the threat of nationalization refuses to go away. Citigroup share prices drop to $1.50/share, the lowest since 1990. The US government still have another option to convert the remaining $20 billion in preferred stocks. This will boost its tangible common equity ratio to 4 or $81 billion. Previously it was below 2, which is considered weak. However, its Tier capital ratio at 11.6% is still the highest in the industry. But it doesn't mean much compare to the vast amount of toxic asset Citigroup is currently holding.

I just with Obama would just come and say "Read my lips, no nationalization, got it?" The flip flop statement by US government and politician in US Congress will only play into the hands of speculators and short sellers. Friday's Wall St 111 points drop is certainly due to Citigroup alone and it won't go away unless effective action is done to solve this problem once and for all. I have suggested creating a bad bank like Danaharta to sweep aside the toxic asset and recapitalize the US financial system. The current plan puts Citgroup in suspension mode. Firstly, Citigroup cannot get out from this mess because of write offs as their revenus would be insufficient to cover the write downs. Secondly, they are a "pariah" in the credit and equity market, unable to raise fund. Unwanted bastard! Thirdly, Citigroup is currently facing the second wave of credit crisis. The first one was just confined to sub prime derivatives instruments. Now it will extend to housing mortgage and credit cards as the economy worsem. I suspect Malaysian banks will be put to the sword end of this year. Finally, Citgroup faces very serious loss of confidence by the day. If this confidence is not restored soon, it will provoke a bank run. I remember 10 years ago, my mum and aunties were asking me whether it is save to put money in Maybank during the Asian currency crisis. Now, my mum ask whether it is save to put money in Citibank! I never thought it would come to this point. Also I remember, I told UTAR students at the beginning of sub prime mortage crisis, that Citigroup is rock solid even at a loss of $20 billion. How wrong was I! I believe all the financial guys were caught off guard. Temasek and GIC lost 30% of its value in 2008. The number is expected to be higher by now as it does not take into consideration the global financial meltdown that started in October 2008. At this moment, technical wise and fundamental factor seems to suggest that the worse is not over yet for Citigroup and the rest of US economy. The US economy contracted by 6.2% GDP last quarter. US companies continue to cut jobs and dividends. The lates is GE, which slashed 66% of its dividend. Earlier JP Morgan annnounced 87% cut in dividend. Even Buffet's portfolio has dropped. Looks like nobody is spared from this crisis, unless you are holding 100% cash or shorting the futures index. The gold continue to climb and oil price prices continue to fall.

US Dollar & the Equities Market

It is essential for investors and speculators to understand the linkages between the US dollar and global equities market as part of their financial risk assessment. Uncle Sam’s greenback is a much sought after currency during financial crisis and uncertain times. The simple reason is the US is the only superpower left in this world. Superpower in terms of political, military, cultural and of course economic might. No doubt, US faced twin deficits, namely budget and trade deficit. But the underlying strength of US lies in its value of Gross Domestic Product worth trillions of dollars, innovation, creativity and political stability. China might hold $1 trillion of US dollar as its reserves, but it still lacks the factors mentioned above. So Uncle Sam is not bankrupt or about to go bust. The irony is the greenback has been appreciating since October 2008. Compare that with July 2008. What a stark difference. During that time, US government has been printing US dollar bills at a feverish pace and yet its value appreciates. It didn’t go the way of the banana currency.

As global equities market collapse in panic (especially in 8 days of madness in the first 2 weeks in October), investors, speculators, fund managers and sovereign governments shifted funds toward US Treasury securities. Demand for US IOU bills push up its prices to record high while the yield reaches near zero. That means, thanks to the financial crisis, Uncle Sam is borrowing your money for free! The collapse of global equities market led to the price bubble of US Treasury securities. That explains why US dollar gains strength rapidly. Recently, the US Fed cut interest rate to 0.75% and this has contributed to the weakness of the US dollar. But that is due to interest rate factor rather than the lowering of risk aversion among investors. When investors are risk averse, funds will be parked in safe heavens like the US Treasury. Hence, one should expect the fall of the dollar again after calmness has returned to the global equities market. Investors would be more willing to take more risk by selling the dollar and switching into high yield currency asset. At this moment, I think investors are still risk averse. Another indicator one should look is the weakening of the yen. Due to low cost of borrowing, the yen remains a favorite carry trade strategy. In this strategy, speculators and investors will borrow in yen and convert into high yield currency asset.

At this moment there is a serious misalignment of prices in the financial and commodities market. The weakness of the US dollar is one of the chief factor of the stratospheric oil price last July ($147/barrel). Today, it is priced slightly above the $45/barrel. While the price has dropped 70%, has the US dollar appreciated by 70% against the basked major world currencies? As such, this misalignment cannot carry on for long. It is either the oil price will have to rise again or the US dollar will have to appreciate further. The facts are OPEC has cut production and new oil fields exploration has stopped due to low oil price. Once the economy stabilizes, the full impact of the fiscal measures by the Chinese government will be seen. With the severe shortage of oil supplies, prices will roll up again. Palm oil will follow suit. Its current price of $1700 is simply not sustainable. La Nina is expected in May which brings in heavy rainfall. We are already seeing the impact of global warming. Low harvest against high future demand will push prices up again. Thus, the morale of the story is in this complex and interrelated financial markets, one cannot function independently on its own. Now, you understand why La Nina can affect the prices of your butter and margarine.