Citigroup CEO Another Casualty of Subprime Meltdown
MICHEL MARTIN, host:
And now it's time for the money coach. Normally, we talk about personal finance issues. But we couldn't help but notice that the subprime mortgage meltdown claimed another victim over the weekend.
The chairman of Citigroup, Charles Prince, quit after it was reported that Citigroup is going to take another so-called write-down on profits of an additional eight to $11 billion. That's on top of a nearly $6 billion charts the company reported in October. So we wanted to ask what does that mean for the markets and really, what does that mean for the rest of us.
Here to talk about all these is Alvin Hall, our money coach. He's in our New York bureau.
Mr. ALVIN HALL (Financial Expert): Thank you, Michel.
MARTIN: So, first of all, for people who don't know, what is it mean to take a write-down?
Mr. HALL: That means they're taking a loss. They have no idea really how to value the remaining investment products that they have in the subprime mortgage market. So therefore, they're just saying this is what we think they're worth. This is the loss we have on them. Let's just take the entire loss now.
MARTIN: So - let's put this in sort of layman's term. Let's say your car is tolled.
Mr. HALL: Yes.
MARTIN: You're really not sure how bad the damage is.
Mr. HALL: That's it.
MARTIN: And you're saying, you know what? I'm just going to write the whole thing off because I don't really know how much it's going to cost to fix this thing. So just I'm going to dump the whole thing.
Mr. HALL: That's a very good analogy. Except in this case, they're sitting on investment products, which probably do have residual value. The problem is they can't tell what the value is. What they're left holding are what they called nonperforming mortgages. These are the mortgages of people who have abandoned their homes. Some of them did damage of the homes. They're not making their mortgage payments on them. So therefore, the mortgages are sitting there and there are no cash flows coming into the mortgage.
Now, think about this. Every mortgage involves three cash flows: the interest that you have to pay every month as a part of your monthly payment; the second cash flow is the normal principal amortization, the amount of the principal that your payment represents; and the third is any extra payments that you have. When people stop making those payments, there are no cash flows into that mortgage pool.
How much of those mortgage is going to be when the bank sells those defaulted properties? Nobody knows. So they have to come up with a number and then write down that value.
MARTIN: Are all these losses related to problems in the mortgage industry, specifically the subprime mortgage industry?
Mr. HALL: The majority of them. This is what I call mathematical wizardry. They looked at the mortgage market and then pooled all these mortgages together and then took out the equivalent of a Ronco economic Vegematic and sliced and diced all these mortgages up into smaller pieces and sold off the smaller pieces, saying to people, you know, this is a really secure asset because it's backed by people's mortgages, and people are unlikely to default on their mortgages.
So everybody bought the same promise. And now, everything has gone wrong.
MARTIN: How is it possible? I thought the idea - the whole idea was that the subprime mortgages was for a very small part of the market. These are for people with bad credit or not a lot of credit that - you know what I mean.
Mr. HALL: Yes.
MARTIN: I thought that this was kind of like a specialty product. So how is it possible that the repercussions could be so broad?
Mr. HALL: Because the returns look so good and while they recognized the risk was there, they also thought they had hedged the risk. Hedging is essentially doing an opposite or complimentary transaction that gets rid of the risk if something goes wrong. What all of these models forget is human psychology. That's the thing that is not predictable. It does not take into account what real people would do in the market when real events happen.
MARTIN: So Alvin, bad news for Citigroup investors. It looks so, you know, fourth quarter earnings are going to be wiped out entirely.
Mr. HALL: Yes.
MARTIN: So sad for them. Sad for Charles Prince, who resigned under pressure or retired under pressure as I could say.
Mr. HALL: Exactly.
MARTIN: But what about the rest of us? Does this mean anything to the rest of us?
Mr. HALL: If I work for Citibank, I'll probably be crying because I'm not going to get a bonus this year. But for you and me, I think we're going to see the repercussions of this in the overall financial markets. I think these are jittery times. We've seen the market run up 165 points one day, down over 300 points the other day. This is directly related to people's feeling of uncertainty about the credit markets, how many people are going to default, how much bad news is remaining to be disclosed in the marketplace. So I think that you and me, we will watch as our 401(k) programs, our mutual fund investments may have a period of extreme volatility, may even drift down over a period of time before the market settles.
I still think there is still some bad news looming out there. But maybe I'm wrong. I hope that I'm wrong. But for some reason, the way this has been handle, I keep thinking other companies are having the same problems at Merrill Lynch and as Citibank had.
MARTIN: You know, my mother always say this. If you're so smart, why aren't you rich?
(Soundbite of laughter)
Mr. HALL: Because not everybody loves money the same way. That's why.
(Soundbite of laughter)
MARTIN: Good point. But I guess what you're telling us this is not a good reason not to go crazy on a Christmas shopping, right?
Mr. HALL: Yes, Michel. I think you're right. This is the time to look at what's important to you, to try to be very conservative with your money. I think 2008 may not be as strong or as positive as we hope economically. So be prudent at Christmas. Save a little cash just in case 2008 proves to be a rainy day.
MARTIN: All right. Alvin Hall is our financial expert. He joined us from our bureau in New York.
Alvin, thank you again.
Mr. HALL: Thank you, Michel.