Safehaven | Enron Accounting at Citigroup

October 19, 2007

Enron Accounting at Citigroup
by Mike Shedlock

In the aftermath of the collapse at Enron, new rules were put in place to prevent corporations from holding assets off the books. However, anyone reading about massive SIV problem knows Citigroup and other banks are Still Operating in the Shadows of Post-Enron Rules.

Changes enacted after Enron Corp.'s collapse were supposed to prevent companies from burying risks in off-balance-sheet vehicles. One lesson of Enron was that the idea that companies could make profits without taking any risk proved to be as ridiculous as it sounds.

Regulators made a great show of slamming closed that loophole. But as the current situation makes clear, they not only didn't close it all the way, but the new rules in some ways made it even harder for investors to figure out what was going on.

My comment: Banks never want anyone to know what they are doing for the simple reason no one would trust the system if they did. In addition it allows them to operate in the shadows making huge profits when all goes well, and requesting bailouts from the Fed when they do not.

SIVs, along with vehicles called conduits, don't get recorded on banks' books because regulators and accounting-rule makers gave banks a pass when crafting post-Enron rule changes meant to curtail off-balance-sheet activity.

No one is saying, of course, that the big banks are literally shams like Enron.

My comment: Although the initial setup was greed and stupidity at Citigroup vs. greed and fraud at Enron, the latest master liquidity enhancement conduit (M-LEC) proposal is every bit the cover-up that was happening in the latter stages at Enron. The worst aspect of this bailout is that it is sponsored by the Treasury.

A spokesman for the Financial Accounting Standards Board, which drafted the current rules, declined to comment.

Citigroup, for example, has nearly $160 billion in SIVs and conduits, but its shareholders wouldn't get a clear view of this from reading the bank's balance sheet. Instead, footnotes only disclose that the bank provides "liquidity facilities" to conduits that had, as of June 30, $77 billion in assets and liabilities.

My comment: That's one problem right off the bat with this mess. No one really knows how big the problem is. So far I have seen three figures for Citigroup: $80 billion, $100 billion, and now $160 million. To be fair the latter includes both SIVs and "conduits". However, I suspect most thought that $80 billion figure was all inclusive. Now we see the all inclusive number is twice that.

Are more disclosures coming? I think we can count on that. In addition, many hedge funds have executed the same fatal strategies as Citigroup (borrowing short and lending long) on mortgage related assets outside of SIVs and banking relationships. For more on the follies of borrowing short and lending long please see Duration Mismatch Causing Severe Stress Everywhere

That lends the question: how many hedge funds have held off marking these assets to market? Potentially massive future writeoffs are hidden by both banks and hedge funds playing shell games, or Don't Ask - Don't Sell strategies which are nothing more than fraudulent attempts at concealment. Is the total amount of money bet on such strategies double, triple, or quadruple what has been disclosed? No one knows. No one wants us to know either.

"Generally, the company has no ownership interest in the conduits," the bank's second-quarter filing, the latest available, states. The Citigroup filing makes no mention of SIVs. In a letter to investors in August, Citigroup disclosed that it had about $100 billion in SIV assets, although that has since declined to about $80 billion.

My comment: Therein lies the problem. That problem is called ownership. Apparently the post-Enron rule for banks was that if you did not own it, you did not have to put it on the balance sheet. So sham corporations were created, banks lent money at short-term rates to those corporations at a markup. Those corporations in turn invested in long term securities like mortgages.

With "borrow short lend long" strategies everything is fine as long as asset prices rise. However, all hell breaks loose when the value of those long term assets sinks.

In adverse conditions, banks are no longer willing to provide short term financing, and instead want their money back. Unfortunately there is no money to give back because the borrowers bet it all on mortgages or other asset backed securities that are now dropping like a rock.

Such strategies caused the complete destruction of two hedge funds at Bear Stearns. See The Redemption Trap & Merrill Lynch Cover-Up for more on Bear Stearns.

Banks typically agree to acquire the assets of their affiliated conduits if they can't roll over their IOUs. But they only backstop a portion of SIV assets. That might make it seem like the banks have some liability, and indeed some have had to step in. But backstops aren't a sign of ownership under accounting rules, though. In fact, most off-balance-sheet vehicles, conduits and SIVs included, don't have "owners" in the traditional sense. Rather they are like corporate zombies and are typically set up in offshore tax havens.

My comment: This is indeed how banks ducked the ownership rule. And now that Citigroup has bent every rule under the sun to avoid Post-Enron Rules, it now is seeking a bailout that will allow it to do exactly what Enron was doing: hide a horrendous balance sheet and in effect keep two sets of books. Paulson calls this a "market based solution". It is anything but a market based solution. The true definition would be called Enron Accounting at Citigroup Sponsored by the Treasury.

How Big is the Problem at Citigroup?

With a hat tip to Polecolaw for the idea, let's compare net tangible assets at Citigroup to the amount at risk at SIVs and conduits. Let's use $160 billion figure for the combined SIV and conduit numbers and see what comparisons we can find.

Citigroup Net tangible assets as of June 30 2007 are $65.5 billion. That's kind of interesting isn't it? Citigroup has $65.5 billion in net tangible assets but $160 billion invested in off balance sheet SIVs and conduits.

If a fire sale of those SIVs and conduits resulted in a 25% loss, Citigroup would have net tangible assets of $25.5 billion. If a fire sale of SIVs and conduits resulted in a 41% loss in those SIVs and conduits, Citigroup would have zero net tangible assets.

Does Paulson, the Fed, or Citigroup want to find out what those assets are worth? Of course not. That is the reason for a Don't Ask - Don't Sell policy and approval of Enron Style Accounting by Paulson.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Michael "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Visit http://www.sitkapacific.com/ to learn more about wealth management for investors seeking strong performance with low volatility.