When the world’s largest bank has to ask its chief executive and chairman to go because up to $11 billion of its assets are actually not worth the paper they are printed on, you know that the global financial crisis has entered deeper into the unknown. Citigroup, whose nominal assets – and nominal is the operative word here - are larger than the annual value of the British economy’s output, parted company with Chuck Prince on a Sunday night of all things. Citigroup’s losses announced relate to just one portion of the bank’s business – the sub-prime housing market. This is a bank which grew its assets – primarily its lending – by an astonishing 48% over the past 21 months. Now questions are being asked the real worth of all these “assets”.
Prince’s departure came hot on the heels of the resignation of Merrill Lynch’s Stan O’Neal, who was in charge of the investment bank as it ran up losses of $8 billion on mortgage-related debt. These gigantic losses stem from the banks’ involvement in what is euphemistically termed the sub-prime market in the United States where people with no income, no jobs and no assets – Ninjas – were encouraged to take out a mortgage on the basis of rising house prices.
Many of these mortgages were sold by unscrupulous and little regulated mortgage brokers, who received handsome commissions for selling expensive and unsuitable products. Then mortgage companies sold the debts on as securities packaged into “collateralised debt obligations” (CDOs). These were then traded around the world as if they totally-secure government bonds and ended up in the hands of Citigroup and Merill Lynch, as well as European banks in Germany, France and the UK (where Barclays is rumoured to be in difficulties).
The trouble is, the bottom has fallen out of the US sub-prime market. There have already been 1.7 million foreclosure proceedings in the US in the first eight months of 2007, and up to 2 million families are expected to lose their homes over the next two years, according to estimates by the US Congress's joint economic committee. In Cleveland, Ohio, an industrial city on the banks of Lake Erie, one in ten homes in the city is now vacant because of repossessions. The company making the most foreclosures in Cleveland is Deutsche Bank Trust.
While the German bank has loads of properties on its books that no one wants to buy, Citigroup and institutions around the world are left holding worthless CDOs – worthless because they can’t sell them on as the market for CDOs has seized up as part of the credit crunch. Or as Citigroup’s statement said, its securitised mortgage-backed debt obligations "are not subject to valuation based on observable market transactions". Overall, there are over $1 trillion worth of sub-prime mortgage-backed securities outstanding throughout the world.
Just in case you thought the global financial system was in melt-down, you can be reassured by the soothing words of Alistair Darling, the British chancellor. He appeared on radio just after dawn today to tell us that concerns should be kept "in perspective" because British banks had “very strong balance sheets”. Yet the failed Northern Rock bank has already used up £23 billion in government-backed loans – which the state will never get back. Darling added: "We have a strong economy, its momentum will carry us through." That’s alright then, except that the UK economy’s growth is largely founded on an unprecedented rise in house prices combined with easy credit. One million people are estimated to use their credit cards to pay their mortgages. This can’t go on, and Darling knows it. The crisis at Citigroup is the latest twist in the unravelling of financial system rooted in fantasy, whose collapse will take the productive economy down with it. On bonfire night in Britain, bankers are piling up assets for putting on the fire.
AWTW communications editor