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Time to Pay the Piper

Written By Brian Hicks

Posted October 1, 2007



"Too many pieces of music finish too long after the end."

-Igor Stravinsky

The house lights have gone up, the punch bowl is empty, and the music has stopped playing. That’s the story today at least at Citigroup Inc. (C: NYSE), where the company’s wild dancing of late has definitely come to an end.

The nation’s largest financial institution warned the markets this morning that its third-quarter earnings are likely to decline by 60%.

The culprits naturally came from what has now become the list of usual suspects.

Big losses in writedowns for underperforming mortgage-backed securities and loans tied to the recent corporate buyout frenzy cost the lender big time. The tab for it all added up to more than $3 billion.

Of course, it was a mere three months ago when CEO Chuck Prince told the Financial Times that the party in liquidity had much longer to run. Prince told the Times in July:

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing."

Prince also added: "The depth of the pools of liquidity is so much larger than it used to be that a disruptive event now needs to be much more disruptive than it used to be. At some point, the disruptive event will be so significant that, instead of liquidity filling in, the liquidity will go the other way. I don’t think we’re at that point."

But according to the Bernanke Fed and all rational observation, that point has now clearly been reached, since the market’s newfound lack of liquidity has led to the worldwide credit crunch. What a difference a few months make.

Joining Citigroup at the confessional today was UBS AG, the world’s largest wealth manager. The Zurich-based company reported its first quarterly loss in almost five years. The company revealed that it now plans to write down $3.41 billion dollars in assets, including securities tied to U.S. sub-prime mortgages.

Additionally, UBS said it would also shed 1,500 jobs in its investment bank, meaning that 7% of that division’s staff would be sent packing–a sharp reversal of its recent build-up.

Like many banks and funds, UBS has had to drastically cut the value it attached to its asset-backed bonds after buyers for those securities disappeared over the summer and failed to return this fall. The move provided yet another sign of the widespread damage done by the collapse of U.S sub-prime mortgages.

But as bad as these writedowns were today, they will hardly be the last. That’s because now that the lights are up, the markets are finally having their moment of clarity after so many years of excess.

 "I think that Citigroup, Bank of America, JP Morgan, Wachovia, as well all the big brokers and Merrill Lynch are gonna be taking write-offs of this nature for a while," said banking analyst Dick Bove.

The music has stopped playing and it’s time to pay the piper.

By the Way: Netbank Inc., an online bank with $2.5 billion in assets, was shut down on Friday due to an unsustainable level of mortgage defaults. It marked the largest failure of a thrift since the savings and loan crisis over 14 years ago.

An Internet institution with no physical branches (no run on the bank here), Netbank had $2.3 billion in deposits as of June 30, according to the FDIC.

The FDIC, as you know, insures deposits up to $100,000. But Netbank had $109 million in deposit accounts that exceeded the FDIC limit, leaving those depositors as out in the cold as creditors in the bank’s receivership.

Netbank sustained significant losses last year "primarily due to early payment defaults on loans sold, weak underwriting, poor documentation, a lack of proper controls and failed business strategies," according to a statement issued by the Office of Thrift Supervision.

Of course, that’s a dirty laundry list of problems that could be used to describe numerous actors these days on the banking side of the business.

Word to the wise: Scale back your big bank accounts to the $100k level in deposits insured by the FDIC. What you don’t know about your bank could cost you big time.

Just ask the folks over at Netbank that exceeded the limit.

Wishing you happiness, health and wealth,

Steve Christ, Editor