The City of Citigroup

If I were to tell you that all the economic pandemonium we've experienced is only one crisis in a series of three, would you believe me?

By ASSAF KEDEM
citi bank 88 (photo credit: AP)
citi bank 88
(photo credit: AP)
My friends: In my previous note, I told you to be more concerned with the credit markets than the stock markets. But there's one stock that's trying to tell us something about the future - and we should all carefully listen. I'm talking about Citigroup, once the nation's largest bank at about $50 a share last year, but now at a laughable $3.77. Laughable, but hardly funny. What's going on? Well, I've seen the future, and here's how it looks. If I were to tell you that all the economic pandemonium we've experienced since the beginning of 2008 is only one crisis in a series of three (two of which have yet to unfold), would you believe me? If not, take a closer look. Sub-prime mortgages Crisis 1.0 unfurled when sub-prime mortgages began to default en masse, causing residential mortgage-backed bonds to default, causing investors to flee, causing major financial institutions to either collapse, mark down their balance sheets or become nationalized by the government. All this should be stunning enough. But crisis 1.0 originated in sub-prime, which is only a subset of the residential mortgage market, which is only a subset of the general mortgage market, which is only a subset of the overall credit market. Yikes. Commercial mortgages Welcome to crisis 2.0 - the commercial-mortgage crisis. The news is beginning to surface: Businesses are defaulting on their commercial real-estate mortgages. Those mortgages, too, are bundled, packaged and sold to investors in the same fashion as sub-prime. And commercial-property values are now in free fall as companies downsize and office space becomes vacant. Sounds familiar? Now get ready for this. The commercial real-estate market dwarfs the sub-prime residential market in value. Additionally, businesses are choking, and banks aren't extending any credit. So we may be talking about a scale of commercial loan defaults that would make sub-prime look like a drop in the bucket. And we haven't even touched on crisis 3.0. Collateralized debt obligations Economically distressed Americans are defaulting on their credit-card debt in growing numbers. That debt is bundled and sold to - whom else? - investors, in the form of collateralized debt obligations (CDOs), yet another invention we may come to regret. By now, you already know where this is heading. Which brings me to Citigroup's share price of $3.77. Citigroup is so huge that it's basically a mirror to the world's financial markets. In other words, when Citi's in trouble - we're all in trouble. So what's the story here? The story is that Citigroup's financial position actually improved over the past several weeks, but shareholders nonetheless seem to be dumping its stock in utter hysteria. Why? Certainly not because they're stupid. It's because when they look at Citigroup's balance sheet, they have no idea what they're looking at. And even the smartest of them couldn't possibly figure it out. I can't blame them. Who's to default next? A sub-prime borrower? A commercial borrower? A credit-card holder? What bond is John Smith's $15,000 Mastercard bill tied to anyway, and who will foot it if he can't pay? And what about the declining value of Class A office space all over the country? Some economists are beginning to talk about nationalizing all US banks as the only solution to this impossibly complicated situation. If you ask me, that's a plausible scenario. For now, Citigroup's balance sheet is the world's balance sheet. And these days, the world is a pretty scary place. Expect the worst and hope for the best, Assaf askedem@yahoo.com Assaf Kedem is a senior financial writer on Wall Street who has held various positions at Morgan Stanley, J.P. Morgan Chase, Merrill Lynch and BlackRock.