Citigroup reported a supposed 1Q profit today.  The media is interpreting the release as a positive and a sign that the worst of the economic downturn may be over.  The following includes excerpts from a Bloomberg article detailing the 1Q performance and my perspective on the results.


Citigroup $1.6 Billion Earnings Beat Estimates on Trading Gains, Accounting Rule

April 17 (Bloomberg) -- Citigroup Inc., the U.S. bank rescued by $45 billion in U.S. taxpayer funds, ended a five- quarter losing streak with a $1.6 billion profit on trading gains and an accounting benefit for companies in distress.

Wow.  That sounds encouraging.  Maybe the media is right and things are turning around.

While the bank cut compensation costs and took fewer writedowns, it couldn’t halt rising delinquencies on home and credit-card loans.

Uh oh.  People are increasingly not paying their mortgages and credit card bills.  That’s not good news.  And rapidly rising unemployment is surely not going to help this trend.

Citigroup benefited from higher fixed-income trading revenue that also bolstered earnings at Goldman Sachs Group Inc. and JPMorgan Chase & Co.  “We’ve seen good trading results from JPMorgan, from Goldman Sachs and now from Citi,” said Gary Townsend, chief executive officer of Hill-Townsend Capital LLC. “There is a question about sustainability, but it’s clearly a good sign for the sector.”

So let me get this straight.  All the big firms benefited from trading gains associated with the recent run-up in the stock market.  They effectively benefited because they happened to be in existence as investment banks as the market rose more than 20% in a month.  These gains are not sustainable unless we see another equivalent stock market gain.  What happens if the market stays flat or “unexpectedly” declines?

The company took $5.62 billion of writedowns on subprime- mortgage-related securities and other investments in its trading division, reflecting a further erosion in their market value. That compared with $14.1 billion of writedowns in the first quarter of 2008, giving the company a positive $8.47 billion revenue swing.

Well I guess only writing down $5.6 billion is better than $14.1 billion but doesn’t that still seem like a problem.  And aren’t foreclosures continuing to rise?

Citigroup posted a $2.5 billion gain from accounting rules that allows companies to profit when their own creditworthiness declines. The rules reflect the possibility that a company could buy back its own liabilities at a discount, which under traditional accounting methods would result in a profit.

What???  Citigroup made $1.6 billion in the 1Q.  But $2.5 billion of it was because their creditworthiness declined.  So without Citigroup’s survivability being called into question they would have lost $900 million?  What a tremendous business model.  If they could only reduce the value of their bonds to zero they could really make some money!  I wonder how much money Lehman Brothers made off its own bankruptcy?

He (Pandit) also shifted some of Citigroup’s distressed trading securities into a long-term “held-to-maturity” investment status, sheltering them from further writedowns while betting the debt instruments will eventually pay off.

This is the direct result of suspending mark-to-market accounting.  Nothing has changed.  Citigroup still owns the bad and deteriorating assets.  But thanks to the magic of arbitrarily changing accounting rules whenever it is expedient to do so, Citigroup can pretend to not be losing money. 

It’s a nice fantasy that if you claim to want to hold assets until they expire that they will end up being worth more than their current market value.  But the reality is that they could also end up being worth less.  Isn’t the housing market still falling?  Aren’t property values decreasing?  Foreclosures set new records every day.  Each foreclosure permanently impairs the value of the securities that are now being held-to-maturity.

Anyone who concludes that Citigroup’s “profit” is real, or that the downturn is over for the economy or the company, is delusional.