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The Toxic Giant and It's Own Black Hole

Wall Street Metes Out Street Justice to Citigroup

by PAM MARTENS

After years of receiving slaps on the wrists by regulators for helping insolvent companies hide the true state of their finances from investors, Citigroup’s day of reckoning has arrived in the form of "street" justice.

Wall Street colleagues are publicly challenging the adequacy of Citigroup’s capital, its accounting practices, and its own black hole-Cayman Islands debt structures. Some of the oldest Wall Street firms are also refusing to pony up billions for a grand scheme endorsed by the U.S. Treasury, ostensibly to unfreeze debt markets. Wall Street firms see it as a bail out of Citigroup and just one more free ride from the Feds.

Citigroup has been repeatedly charged in investor lawsuits with creating off balance sheet structures to hide the debt of large U.S. firms such as Enron. In each case, it has been allowed to pay millions to regulatory bodies and billions to private plaintiffs to settle the charges without an admission of guilt and avoid a public trial. These trials, however, might have provided critical transparency and an early warning to the public and its colleagues on Wall Street.

But next year, Citigroup will face trials in both Italy and the U.S. in two separate actions for creating off balance sheet structures that plaintiffs contend were significant contributors to the bankruptcy of the giant Italian milk company, Parmalat. Citigroup named one of these structures Buconero, Italian for "black hole." Another structure Citigroup set up for Parmalat sold commercial paper, backed by fake invoices, to U.S. money market funds. Citigroup contends it was "the victim" in all matters related to Parmalat.

The U.S. trial, set for May of 2008 in a New Jersey State Court, is not being brought by a U.S. prosecutor, but an Italian trustee for Parmalat, Enrico Bondi.

Dave Serchuk, a reporter for Securities Week at the time, reported in its February 2, 2004 issue that Citigroup had bundled essentially worthless Parmalat debt and sold it in the form of asset backed commercial paper to what U.S. investors thought were among the safest and most liquid investments: money market funds. Unfortunately, the incendiary Parmalat/Citigroup money market story failed to get picked up by mainstream media.

Now, once again, one of the most troubling aspects of the current Citigroup debacle that has gone unreported is the extent to which these opaque and convoluted debt instruments managed by Citigroup, called CDOs (collateralized debt obligations), got dumped into Cayman Islands SIVs, transmuted into AAA-rated commercial paper, landed in the so-called safe money market funds in the U.S., including an astonishing amount at Citigroup’s competitor, Merrill Lynch.

According to Standard & Poor’s Structured Finance research reports, Citigroup is managing the following Structured Investment Vehicles (SIVs), incorporated in the Cayman Islands and not consolidated on Citigroup’s balance sheet: Centauri Corp., Beta Finance Corp., Sedna Finance Corp., Five Finance Corp., and Dorada Corp. (1) In addition, according to press reports, Citigroup created two more SIVs as recently as November 2006: Zela Finance Corp. and Vetra Finance Corp. (2) These SIVs contain approximately $80 Billion in what is increasingly being viewed as toxic debt.

Knowing the history of Citigroup and knowing the safety and liquidity requirements for money market funds, how did one of the oldest and most sophisticated firms on the street, Merrill Lynch, end up with a boatload of this SIV paper in its various money markets? The most troubling of its money market exposure as of its July 31, 2007 filing with the SEC is its Citigroup managed SIV commercial paper positions in what one would think would be the safest of all its money market funds, the Merrill Lynch Retirement Reserves Money Fund. Merrill’s SEC filing shows $52.9 Million in Beta Finance, $53 Million in Five Finance, $10 Million in Sedna Finance, and $10.7 Million in Zela Finance. (3)

In a research report written by Meredith Whitney for CIBC World Markets on October 31, 2007, there is a key clue to why Citigroup has finally lost the confidence of the street: "While Citigroup has stated that it will not consolidate the assets of these 7 SIVs, it will continue to provide liquidity. As such, Citigroup’s assets would increase as it extends short term funding to SIVs. With a bigger asset base, or denominator, Citigroup’s capital ratios would decline. While not specifically disclosed, we know that part of the 6% sequential increase in Citigroup’s 3Q07 total assets was from the addition of commercial paper issued to SIVs." (Translation: it can’t find a new sucker to roll over its maturing SIV commercial paper; it has become the sucker of last resort along with its balance sheet.)

Citigroup’s ignoble beginning foreshadowed its sorry state today. It is the Frankenbank created back in 1998 out of the body parts of Travelers Insurance, Salomon investment bank, Smith Barney brokerage, and retail banking giant Citibank, with the brain of Wall Street titan, Sandy Weill, implanted firmly to run a confidence game of unprecedented proportions. (Mr. Weill retired from the firm a few years ago after it made him a billionaire.)

Citigroup’s creation required the repeal of depression-era investor protection legislation (Glass-Steagall Act) put in place to prevent stock brokerages and investment banks that are prone to high risk, speculation and collapse from merging with commercial banks that hold deposits earmarked for safety by a frequently gullible public.

I recently found in my files from that time a letter addressed to me from one Robert Frierson, Associate Secretary of the Board of Governors of the Federal Reserve System. The letter is dated September 23, 1998. It is one of those quixotic examples of the relics of "we the people" government struggling for air in the "we the corporations" era.

The letter is formal and polite and on watermarked paper with a faint outline of our Nation’s capital silhouetted underneath its ominous text. The letter advises me that Frankenbank is going to move forward but my testimony had been considered.

The letter was a followup to the public testimony I gave against the merger on Friday, June 28, 1996 at the Federal Reserve Bank of New York. Galen Sherwin, then President of the National Organization for Women in New York City (now a civil rights lawyer for the New York Civil Liberties Union) and I, then a naively optimistic civil rights litigant against one of Weill’s firms, had planned to simply protest outside the building during the testimony by Sandy Weill sycophants. Instead, we were pleasantly surprised to be courteously ushered inside, giant protest signs and all, and afforded a slot to speak on one of the panels. (Both the Federal Reserve’s typed transcript of the testimony and my hastily hand scribbled remarks are permanently archived on the web site of this peculiar institution.) (4)

Here is an excerpt of what I had to say nine years and 90 Citigroup market manipulations ago:

"It is amazing how soon we forget. It was just 60 years ago that 4,835 of America’s banks went broke and closed their doors, leaving shareholders and depositors destitute. The underlying reason that this happened was the lack of moral courage by our regulators and elected representatives to just say no to powerful money interests. Instead of just saying no, Washington handed the banks the equivalent of an ATM card to the Fed’s discount window to speculate in stocks … We also want to remember that the political dynamics that created the backdrop for the banking meltdown in the ’30s grew from a corrupt, cozy culture between Wall Street and Washington … We can hardly look to the safekeepers of the public trust when they are falling over themselves to reap campaign windfalls from Wall Street. Washington and regulators are quick to criticize moral hazard when it is on foreign shores. Let’s look at the moral hazard incubating at Travelers and Smith Barney. In 1996, when the SEC and the Justice Department found that Smith Barney was one of 24 firms fleecing their own customers through six or more years of price fixing, no one went to jail. Within the last two years, when a special prosecutor found that Smith Barney had bribed the former U.S. agricultural secretary, again, no one went to jail. The firm is currently under investigation by various municipalities for the fraudulent markup of treasury securities, and that, in fact, is enough to hold up this merger, since a criminal charge against a primary dealer of treasury securities would lend its taint to one of America’s major money center banks … ."

Ms. Sherwin testified regarding the private justice system at Weill’s Salomon Smith Barney that barred employees from accessing the nation’s courts as a condition of employment. That system was successfully transplanted to the merged behemoth Citigroup and helps to explain how transparency vanished at what Ms. Sherwin predicted to the Fed in 1998 would "grow into a bloated corporate tyrant."

In the end, all Ms. Sherwin and I had for our efforts was a letterhead souvenir from the Fed and a web site archive reminding us we tried.

We were trumped by a stream of sycophants, nonprofits receiving money from the subject under scrutiny.

Here’s a representative example of what the Fed considered against our testimony. Note that this doctor admits he has "no special credentials in business economic matters" and then proceeds to urge the most dangerous financial merger in the history of the world because he likes Sandy Weill, whose name, by the way, is engraved on the building he enters each day to receive a pay check.

"My name is Alberto Gotto. I am the provost for Federal Affairs at Cornell University and the dean of the Joan and Sanford I. Weill Medical College in New York City. Here as the dean of the medical college in New York City, practicing physician and medical educator, I have no special credentials in business economic matters, but I do want to speak about an area in which I do have special and particular knowledge, and that concerns the excellent corporate citizenship of the Travelers Group and its Chairman and CEO Sanford I. Weill." (5)

The Bush administration would like to spin the current Wall Street crisis as the product of millions of hapless poor people with bad credit ("subprime") defaulting on their mortgages. Thus, it’s been dubbed "the subprime mess" in headlines spanning the globe. That poor people were tricked into unconscionable mortgages predestined for foreclosure by a Citigroup subsidiary, CitiFinancial, and other predatory lenders, is but a symptom of the real disease and crisis. (6)

The Citigroup debacle rises from the same ideology creating endless reports on failures of Federal agencies to perform their oversight roles in protecting the American people with the taxes we give them to do just that. Viewed collectively, one can only conclude that the Bush administration has reengineered these taxpayer supported agencies to stand down on corporate malfeasance with a mantra of corporate profits before people and the flimsy overt pretext that free markets will handily function in the place of regulators with subpoena power.

After millions of lead paint infested toys slipped by the Consumer Product Safety Commission, dangerous drugs were rubberstamped by the Food and Drug Administration (FDA), (only to be recalled after hundreds of thousands of injuries, including death), FEMA, the Department of Defense and Attorney General’s office discredited for political cronyism, along comes the Citigroup hubris as the poster child crying out for timely enforcement of rules and regulations.

Citigroup’s 10k filing with the SEC states that as a bank holding company it is subject to examination by the Board of Governors of the Federal Reserve. Having failed to heed the warnings nine years ago, perhaps the Fed will listen now and hold that long overdue examination.

PAM MARTENS worked on Wall Street for 21 years; she has no securities position, long or short, in any company mentioned in this article. She writes on public interest issues from New Hampshire.

(1) Standard & Poor’s on Citigroup’s SIVs

(2) Citigroup creates two more SIVs in November 2006

(3) Merrill Lynch’s holdings of Citigroup SIVs as of 7/31/2007 in one money market.

(4) PAM MARTENS’ and Galen Sherwin’s testimony to the Federal Reserve Board against the merger creating Citigroup. See Panel 25.

(5) Alberto Gotto’s testimony to the Federal Reserve. See Panel 20.

(6) Anita Hill reports in this Boston Globe article how CitiFinancial preyed on the uneducated and minorities.

See additional Congressional testimony here