Assessing the Mess at Citi

By Justin Fox

This story features a man named Prince, an actual (Saudi) prince, a billionaire financial legend, a former Treasury Secretary and a British knight with a German accent. That, plus tens of billions of dollars in losses and a financial crunch that Americans may feel for years.

The man named Prince is Chuck Prince, who lost his job as Citigroup CEO on Sunday, Nov. 4. The immediate precipitating event was $8 billion to $11 billion (they don't know for sure yet) in fresh losses for his company related to subprime mortgages. Stepping down, Prince said, was the "only honorable course for me to take."

Not that he had a choice. Former Citigroup chief Sandy Weill, who created the financial colossus by merging his Travelers Group with Citicorp in 1998, had traveled to Saudi Arabia to tell Citi's biggest individual shareholder, Prince Alwaleed bin Talal, that the other Prince had to go. Alwaleed reportedly wanted Weill to return to the helm, but there was little appetite for that on Citi's board.

Instead, former Treasury Secretary Robert Rubin became chairman, and German-born, London-based Sir Win Bischoff was named acting CEO. A search party of board members is looking for a new boss while, six blocks south of Citi's Manhattan headquarters, the man whom Weill once saw as his obvious successor but booted in 1998, Jamie Dimon, was leading archrival JPMorgan Chase through the credit market's troubles with far less drama.

Almost Shakespearean, no? True, the Bard didn't offer much in the way of collateralized debt obligations (CDOs) or special-interest vehicles--two key sources of Citi's pain. He did, however, understand diversification. "My ventures are not in one bottom trusted, nor to one place," said Antonio, the Merchant of Venice. "Therefore, my merchandise makes me not sad."

Such an insight was supposed to be a great strength of Citigroup, which combined a venerable global bank (founded as the City Bank of New York in 1812) with the upstart financial supermarket that Weill, the Brooklyn-born son of Polish immigrants, put together in the second act of his remarkable career.

Geographical diversification certainly is helping Citi--the company made twice as much money in Latin America as in the U.S. in the past quarter, and did even better in Asia. But while Weill and Prince did make a few big foreign acquisitions, that global footprint is mainly a legacy of the old, patrician Citicorp. What Weill's Travelers added was big-time investment banking, brokerage and storefront consumer finance. And it's from those parts of the business that most of Citi's woes have stemmed.

Before Travelers, Weill had built a small New York brokerage firm into the second biggest in the land, Shearson Loeb Rhoades, which he sold to American Express in 1981. Boxed in at Amex, he quit and later started over with Commercial Credit, a Baltimore consumer-finance company. To that he added Smith Barney, his old firm Shearson, Salomon Brothers and Travelers insurance.

Then came the merger with Citi. It was tumultuous--a power-sharing agreement between Weill and Citicorp's John Reed soon fell apart--but at first very profitable. Amid the corporate scandals of 2001 and 2002, though, Citi's investment-banking arm landed in more than its share of controversy and legal trouble. One last big suit, filed by Enron Creditors Recovery Corp., goes to trial in April.

Prince, a lawyer, became Citigroup CEO in 2003 largely on the strength of his skill in resolving these legal hassles. But he led Citi smack into the next big financial scandal: subprime-mortgage lending. Over the past five years, Citi went from also-ran to leading issuer of the CDOs that take subprime mortgages or other loans and reprocess them into purportedly low-risk securities. Market jitters and ratings-agency downgrades have sent CDOs into a free fall--and now the banks have to account for the losses.

Merrill Lynch, which has also lost a lot of money and a CEO lately, followed a similar path. But Merrill at least began pulling back this year. Not Citi. "As long as the music is playing, you've got to get up and dance," Prince told the Financial Times in July in a quote that will follow him to his grave. "We're still dancing."

The music stopped for good the day Prince resigned, when Citi announced that it had $55 billion in subprime-related securities, mostly CDOs, still on the books. It also disclosed that it's holding almost $135 billion in securities for which there are no observable market prices--meaning that their valuation is determined by guesstimation--and is involved with another $167 billion in off-the-books CDOs and special investment vehicles. The normally mild-mannered stock and credit analysts who follow the firm reacted with downgrades and criticism--their main complaint being that Citi had been so slow in fessing up to problems that they fear more to come.

"How do you know when management is lying?" began a favorite saying of Sallie Krawcheck, one of the top securities-industry analysts of the 1990s. "Their lips are moving." Now Krawcheck runs Citi's wealth-management division, a bright spot in the most recent earnings report, and she's a dark-horse contender for the top job. Rubin, already known for the cryptic nature of his utterances at Treasury, seems to have taken her words to heart, letting little slip in public.

Or it may be that figuring out how to restore Citi's luster in the face of a halting economy has left him speechless. After 15 years of mostly flush times and five of downright bingeing, the business of lending may have run into a wall, at least in the U.S. Household debt grew almost three times faster than income from 2000 to 2006. Now the country appears to be tapped out, and a recession may result. Neither of those things is good news for Citigroup.