What is Wall Street Management Thinking?

Good Evening: When this weekend’s G-20 meeting produced little more than promises and photo ops, market participants decided to focus on the news flow surrounding the U.S. economy and Citigroup. Not liking what they saw, investors hit stocks once again, and the fortress once known as Citigroup now looks more like a sandcastle eroding with each new wave of losses and layoffs.

The first news to hit the tape this morning was a report on CNBC that Citigroup would announce massive layoffs today. The on air prediction of 50,000 was close to the mark, as Citi’s CEO announced 52,000 fewer staff would be employed by the financial services giant within a year (see below). This total will be achieved not entirely through pink slips, but will also be effected through attrition and asset sales. Since I spent more than ten years working in the castle Sandy Weill built, I feel sorry for my friends that still (for now) call Citigroup home. The scale of this sad news helped cast a pall over the markets this morning (Citi declined 6.6%), and it happened even before more disappointing economic news could be released.

The Empire manufacturing survey set an all time low of -25.4 this morning, a figure just about in line with forecasts. According to Merrill Lynch, however, the guts of the release were even worse upon closer inspection, and survey participants noted a worrisome and extensive shrinkage in available credit (for Merrill’s take, see below). Industrial production rose 1.2% in October, but here too there was actually less than met the eye. The gain was largely wiped out by a downward revision to the already horrendous September figures. Capital expenditures, once supportive of GDP growth, now look set to drop. And topping off the economic news was a report from our nation’s business economists. Shockingly, they now think the U.S. economy is in recession. This blinding glimpse of the obvious by this notoriously near-sighted group comes on the heels of its previous forecasts that steadfastly maintained the U.S. would avoid recession. Hearing some gloom from these guys almost makes me want to turn bullish, but I will wait until National Bureau of Economic Research (NBER) “officially” announces a recession has washed ashore before reassessing whether an economic downturn has fully been priced into to equities.

Given Friday’s weak close and this morning’s equally weak economic data, stock market participants earnestly undertook to price in the worsening backdrop for equity shares. Opening just more than 1% lower, the major averages were quickly down between 2% and 3%. Bouncing off the 850 mark, the S&P led a fairly spirited rally that carried the indexes back into positive territory at mid day. Stocks then hovered just over and under the unchanged mark before breaking back to the lows in the final hour of trading. The Russell 2000 (- 1.15%) hung in better than the other averages, while the S&P (-2.6%) saw the most selling pressure. It should also be noted that the KBW bank index (-4.7%) closed at a level not seen since 1996. Treasurys were able to make some headway while stocks leaked, and yields fell between 3 bps and 6 bps unevenly across the coupon curve. The dollar perked up again, closing today with a gain approaching 0.75%. Predictably, the greenback’s strength came at the expense of commodity prices. Yet another decline in crude oil and metals prices paced the CRB to a loss of 1.5%.

During the summer of 1998, the Vice Chairman of Salomon Smith Barney paid a visit to the Chicago office. With the proposed merger with Citibank yet to be completed, he wanted to rally the troops and reassure us that the merger would be a great success. When he sat across from me, he asked me how much company stock I owned. “The bare minimum” was my forthright response, and it shocked him. “Why, he asked, would you not take on more stock when we’re doing so well?” I told him I was already “double long” the company and thought putting more eggs into an already crowded basket was unwise. He pressed me for a further explanation and so I told him, 1) I was long the company and the industry via my job with the firm, and 2) Part of my compensation was already in company stock. To buy more would give me a three pronged exposure to the company. He thought I was nuts at the time, but then Long Term Capital hit less than a month later and halved the value of what was then Travelers (now Citigroup). With today’s close of $8.89, Citi is now 40% below even the panic lows set during the LTCM crack up.

I relate this story for two reasons. The first is to always understand where your overall exposures lie, including the ones embedded in your job/career. The second reason has less to do with the specific manager I spoke with ten years ago and is more about the blindness to risks I see in so many managers in Wall Street. As you’ll see by reading the final two Bloomberg stories below, management at the top of our financial institutions hasn’t learned much during the past decade. And, for their latest feat of bone-headed risk assessment, I call attention to a special blindness for political risk.

Perhaps the industry has grown accustomed to buying influence on Capitol Hill, but Bank of America’s plan to pay $7 billion to increase its stake in a Chinese bank displays a special form of either brazenness or cluelessness. BAC just took $25 billion from the TARP, and instead of plowing that money back into the U.S. economy, senior management at Bank of America is willing to spend a chunk of it in on a bank in China. I can’t think of a move which would anger politicians and voters more than for BAC to be seen sending taxpayer funds overseas. And into China, of all places!

In the interest of fairness, and to give BAC management equal time, they claim not a cent of taxpayer money will be used. Well, that argument won’t wash with an increasingly angry electorate. BAC will likely also trot out the “competition forces us to take this action” argument, but it will ring every bit as hollow as the ones now made by insurance companies trying to buy risky savings and loans in order to get their hands on TARP funding (see below). Management in Wall Street has not improved in the ten years since I had my desk-side chat with the former SSB Vice Chairman. If anything, it’s gotten worse, and not even the smart gesture today by senior Goldman managers to forego bonus payouts this year will change this perception. At a time when our financial system sorely lacks confidence, the absolutely wrong message our nation’s financial executives can send is for them to be appearing to buy Chinese banks using taxpayer funds, or to be seen buying dodgy U.S. S&Ls to gain similar access into our pockets. It’s moronic moves like these which may just open the door even wider to the type of political intervention that can only make our problems worse down the road. What are these guys thinking?

-Jack McHugh

Further sources:

U.S. Stocks Fall on Economic Concern; Alcoa, Citigroup Retreat

U.S. Recession to Extend Into 2009, Business Economists Say

Citigroup’s Pandit Targets 52,000 Jobs to Eliminate

Bank of America to Double China Construction Stake

Lincoln, Aegon May Buy S&Ls With `Unsafe’ Practices to Get Aid

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