CNBC reports that massive layoffs are being planned by Citigroup Inc., America's largest bank. Faced with huge fourth quarter losses the bank is under pressure to cut costs and another round of job cuts may be the only way out(Citi has already cut jobs once earlier this year).
What really ails Citi? Citi has been growing a bit too fast for some time now.It has been picking up foreign banks and brokerage firms wherever it can, without giving too much thought to managing what it already has. The Nikko Cordial bid, picking up a stake in a brokerage firm in India, the Grupo Financiero buyout in Central America and continuous investments in China reinforce the image of a company that is growing by acquisitions rather than focusing on organic growth.The global sphere of its operations ( it is present in over 100 countries) has naturally led to a huge increase in expenses.In fact this increase had become significant enough for Prince Alwaleed bin Talal to remark to the effect that 'draconian measures need to be taken to curb expenses.' Incidentally the Prince is perhaps the largest single shareholder in the bank.
The tipping point has been the sub prime crisis.Citi has unveiled losses of $6.8 billion for the third quarter and it may lose a further $8 to $11 billion loss in the fourth quarter.Analysts expect the pain to continue into 2008 with expected losses of $4 billion.Citi has a direct sub prime exposure of $55 billion of which $43 billion is in CDO's. It has $135 billion in 'level three' assets.These include those assets which are not heavily traded, such as mortgage backed securities which are difficult to value, more so after the sub prime shakeout. According to Goldman Sachs Citi would need to write off $8 to$11 billion this quarter on account of sub prime losses and have placed it on' America's Sell List.'
Prince Talal acted swiftly and Charles Prince put in his papers Nov. 4th after an emergency board meting.But to say that Prince lost his job solely because of the sub prime investments would not be entirely correct.It had been rumored for several months that Prince's job was on the line unless he could show either impressive revenue growth or noticeable operating improvement. Shareholders were getting restless as the company's stock had not been going anywhere for several years. The only saving grace being the dividend of over 4%. The economy was clearly not in a position to allow the first option, so it had to be the second. After the sub prime loses came in it was unlikely that he could have continued.
It has been suggested that given its large workforce of almost 300,000 Citi can cut its workforce simply by reducing hiring and letting attrition do the work for them.But this strategy has the drawback that it affects all divisions uniformly and takes a bit too long to work out. The company needs to show decisive action and that it means business before the stock market will take notice and reward the decision taken. It is not too difficult for financial firms to find surplus workforce which can be laid off. There are always back offices and IT activities that can be hived off or outsourced. Fortunately for Citi, given its brand name it will be easy for it to find buyers for any such division if it ever decides to do so.The costs of cutting the workforce would be substantial, but small change for a company like Citi. But Citi has to ensure that its actions do not appear to be an act of desperation. Too large a cut and it may scare away potential investors in the short term due to the uncertainties surrounding the impact of such an action on its operations.
Meanwhile Citigroup shares were quoted at $30.47 in early morning trade Tuesday after the Abu Dhabi Investment Authority said it will invest $7.5 billion in Citigroup Inc. Sheikh Ahmed Bin Zayed Al Nahyan called Citi 'a premier brand and with tremendous opportunities for growth.' After this investment is converted into equity shares it will outrank the holding of Prince Alwaleed bin Talal. This investment is significant and it is likely to signal that the free fall in US financial stocks is coming to an end.
The Falling U.S. Dollar And The Sub Prime Crisis
The year 2007 will be remembered for a long time as the year in which the US dollar fell sharply in value and the US economy faced a crash in the housing sector.The dollar hit a new low of 1.4966 to the euro Friday and everybody is asking how much further it will fall and what is the Fed going to do about it. The worst affected by the fall are China, Saudi Arabia and Japan as these countries have the largest dollar holdings.The value of their huge dollar denominated assets has already shrunk dramatically this year.China and Japan are export driven economies and the falling dollar is hurting exports. Talking of exports even the EU nations are affected by a weak dollar.The US on its part seems to be content to let the dollar decline in value as long as the fall is orderly.In fact its exports have benefited immensely from the dollar weakness, rising 15% in the last 12 months, while prices of imports,except oil, have not risen in proportion as the exporting nations have been reluctant to increase prices in order to protect market share.The only section of the population to have been adversely affected are those traveling abroad for whom a decline in the value of the dollar translates into a decline in purchasing power.
At the recent OPEC summit in Riyadh, Iran And Venezuela called the dollar a worthless currency and floated the idea of an alternative currency.Although their remarks were certainly to spite the US, other nations like China,Japan and those in the Middle East seem to be quietly diversifying their holdings, although there is no large scale sell off of dollar denominated assets as yet.
Bob Shiller in his book 'Irrational Exuberance' (2nd edition) has analyzed home prices in the US for the last 120 years. For 100 years they were almost flat with spikes of 10 to 20% on either side. Then starting in 1997 home prices shot up by 93% in real terms.Part of the rise can be explained by demography, rising incomes and low real interest rates.. But they basically went up because loose credit and easy money created a bubble.The problem with bubbles is that you don't realize you are in one till it bursts.Suddenly prices started falling last summer and the trend is getting worse by the day.Although the supply of new houses has fallen the demand has fallen even more creating excess supply. Add to it about 2.2 million homes the banks will be saddled with due to foreclosures and there will be further downward pressure on prices.Slowing credit to the sub prime sector contributes to further slackening of demand and fall in prices. About $ 1 trillion in ARM's is expected to reset next year. Many people will not be able to afford the higher interest rates and will be forced to sell at depressed rates. It has to be remembered that a large part of the demand was driven by the 'condo flippers,' that is people who were simply buying houses with the intention of selling them later at a profit. Now these people are stampeding to get out to save as much of their down payment as they can.
Goldman Sachs estimates home prices will fall by a further 15%. Shiller thinks it could be as high as 50%.This decline will have a wealth effect and people will reduce spending on other goods.Signs are visible in the fall in auto sales and even in manufacturing.This is worrisome because private consumption accounts for 72% of US GDP. The housing sector is only 5% of GDP and a slowdown there is not enough to trigger a recession but a slow down in consumer spending is dangerous.So to prevent a spillover of the housing crisis to the other sectors of the economy, which may cause the US economy to go into recession, the Fed will have to cut interest rates even at the cost of higher inflation. It is this certainty of a cut in interest rates which is behind the slump in the dollar.
The Fed also has to cut interest rates in order to protect the financial system. We neither know the exact extent of the losses on account of this sub prime mess nor who has lost money. Banks and other financial institutions have admitted significant losses but it is feared that they will report further losses in future. Other losers are the investors in the CDO's and other similar instruments.It is speculated that China and other West Asian nations flush with petro dollars had made large investments in such instruments. For an orderly winding down of these investments cuts in interest rates may be the only way out.
But in the end we all have to remember that the dollar can only fall this much and no more.Not only is the US the largest economy in the world , it also has the necessary policies and financial institutions in place which allows both the entry and exit of hundreds of billions of dollars that other nations wish to invest.So once this crisis plays out the and the US economy strengthens again the dollar is expected to regain its position as the most important currency in the world.
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At the recent OPEC summit in Riyadh, Iran And Venezuela called the dollar a worthless currency and floated the idea of an alternative currency.Although their remarks were certainly to spite the US, other nations like China,Japan and those in the Middle East seem to be quietly diversifying their holdings, although there is no large scale sell off of dollar denominated assets as yet.
Bob Shiller in his book 'Irrational Exuberance' (2nd edition) has analyzed home prices in the US for the last 120 years. For 100 years they were almost flat with spikes of 10 to 20% on either side. Then starting in 1997 home prices shot up by 93% in real terms.Part of the rise can be explained by demography, rising incomes and low real interest rates.. But they basically went up because loose credit and easy money created a bubble.The problem with bubbles is that you don't realize you are in one till it bursts.Suddenly prices started falling last summer and the trend is getting worse by the day.Although the supply of new houses has fallen the demand has fallen even more creating excess supply. Add to it about 2.2 million homes the banks will be saddled with due to foreclosures and there will be further downward pressure on prices.Slowing credit to the sub prime sector contributes to further slackening of demand and fall in prices. About $ 1 trillion in ARM's is expected to reset next year. Many people will not be able to afford the higher interest rates and will be forced to sell at depressed rates. It has to be remembered that a large part of the demand was driven by the 'condo flippers,' that is people who were simply buying houses with the intention of selling them later at a profit. Now these people are stampeding to get out to save as much of their down payment as they can.
Goldman Sachs estimates home prices will fall by a further 15%. Shiller thinks it could be as high as 50%.This decline will have a wealth effect and people will reduce spending on other goods.Signs are visible in the fall in auto sales and even in manufacturing.This is worrisome because private consumption accounts for 72% of US GDP. The housing sector is only 5% of GDP and a slowdown there is not enough to trigger a recession but a slow down in consumer spending is dangerous.So to prevent a spillover of the housing crisis to the other sectors of the economy, which may cause the US economy to go into recession, the Fed will have to cut interest rates even at the cost of higher inflation. It is this certainty of a cut in interest rates which is behind the slump in the dollar.
The Fed also has to cut interest rates in order to protect the financial system. We neither know the exact extent of the losses on account of this sub prime mess nor who has lost money. Banks and other financial institutions have admitted significant losses but it is feared that they will report further losses in future. Other losers are the investors in the CDO's and other similar instruments.It is speculated that China and other West Asian nations flush with petro dollars had made large investments in such instruments. For an orderly winding down of these investments cuts in interest rates may be the only way out.
But in the end we all have to remember that the dollar can only fall this much and no more.Not only is the US the largest economy in the world , it also has the necessary policies and financial institutions in place which allows both the entry and exit of hundreds of billions of dollars that other nations wish to invest.So once this crisis plays out the and the US economy strengthens again the dollar is expected to regain its position as the most important currency in the world.
More on Interesting Life
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