Ben Bernanke, meet Gary Crittenden

When Ben Bernanke was appointed Chairman of the Fed, I remarked to several people how I wouldn't take that job for all the money they could throw at me. At the time I fully expected that the excess of 'Easy Al' Greenspan would come home to haunt us and eventually, Bernanke would be forced to choose between killing the economy, or killing the dollar. That was well before the 'credit crisis' hit.

Now we have a whole new set of problems that present themselves to the current Chairman. Most significantly, it appears the 'conundrum' that Greenspan faced in being unable to affect the long end of the yield curve in the last years of his term will now reverse itself for Mr. Bernanke. Helicopter Ben may find that no matter how many dollars he drops, the credit crisis he inherited thru the hangover of Greenspans excess liquidity will leave him unable to affect the short end of the curve. In other words, dropping rates in an attempt to save the economy may not translate into lower rates for borrowers.

With the market clamoring for lower rates to save it, and banks signaling their intention to tighten credit ans raise rates, what is a Central Banker to do?

An Effort to Stem Losses at Citigroup Produces a Renewed Focus on Risk

By FLOYD NORRIS
Published: January 16, 2008
Ben Bernanke, meet Gary Crittenden. While you’re easing credit, he is tightening it.

The Federal Reserve’s open market committee, headed by Mr. Bernanke, is widely expected to cut interest rates by at least half a percentage point when it meets at the end of January. The committee’s intent will be to ease credit and help the economy.

Mr. Crittenden, the chief financial officer of Citigroup, had a different message on Tuesday, as Citi disclosed an $18.1 billion write-down. He told analysts that Citi was raising rates on credit cards and tightening the amount of credit it would extend. Asked by an analyst whether credit card lending was an area where Citi might want to “pull back or increase pricing,” he responded, “All of the above.”

He said the most attention was being paid to credit card holders in five states that accounted for two-thirds of Citi’s credit card losses: Arizona, California, Florida, Illinois and Michigan.

Citi is also reducing the amount of residential mortgage loans it is making. In the fourth quarter, it lent $29.5 billion to American homeowners, down 16.4 percent from the same period in 2006. It was the lowest total for any quarter since the first three months of 2005.

Citi is not alone. While the tighter credit market has not stopped credit-worthy individuals or companies from obtaining loans, it has made loans more expensive for many of them, and left those with the greatest need for cash far less able to obtain it.

“They are parceling out credit with a keen eye on the balance sheet,” said John Garvey, the head of the financial services advisory group at PricewaterhouseCoopers. “There is a flight to quality and a renewed focus on risk.”

That trend has directly countered the Fed’s efforts. Compared with a year ago, before the Fed began to lower the federal funds rate — the rate at which banks can borrow — conventional 30-year mortgages are lower, but so-called jumbo mortgages of more than $417,000 are higher.

“Over the second half of last year, the fed funds rate fell by 100 basis points,” or a full percentage point, said Robert Barbera, the chief economist of ITG. “But almost any measure saw rising interest rates and tightened credit availability for many borrowers. The Fed needs to drive the fed funds rate down dramatically to get interest rates for the public and corporations to go down rather than up.”

Citi and its rivals are reacting to a period when credit standards were very loose, and many poor loans were made, leading to the current round of multibillion-dollar write-offs.

One measure of that came in a detail of the write-downs Citi announced. At the end of September, it put the value of some mortgage securities it owned at $2.7 billion. It had purchased those securities intending to repackage them as part of collateralized debt obligations and sell securities in the C.D.O.’s to investors.

The collapse of the C.D.O. market made such sales impossible, and Citi still owns the securities. But it has decided they are worth about 5 percent of what they had been, and has taken a write-down of $2.6 billion.

The write-downs taken by Citi, and by some rivals, are based on assumptions about how bad the mortgage and home-price problem will become. If those assumptions turn out to be too pessimistic, then the assets written down Tuesday will turn out to have greater value.

On the other hand, if the assumptions are too optimistic, more write-downs may come.

Many of the assumptions were not disclosed, but Mr. Crittenden did say that Citi was assuming that home prices would decline 6.5 percent to 7 percent in 2008, and by a similar amount in 2009. He did not say what Citi was assuming for later years.

Citi’s shares fell $2.12, to $26.94, a 7.3 percent loss that left the price less than half its level of a year ago.

That is bad news for investors for a reason other than the obvious one. The company plans to raise $14.5 billion by selling convertible preferred stock, with a 7 percent annual coupon. Of that, $2 billion will go to the public and the rest to a group of investors, including the government of Singapore and Sanford I. Weill, Citi’s former chief executive.

The conversion price of that new issue is to be 20 percent over the market price of Citi stock, but Citi refused to say over what period the market price would be calculated. The lower the price, the more dilution will be produced for existing shareholders.

Citi also reduced its dividend by 41 percent, but the payout remains high compared to the share price.

At 32 cents a quarter, the current annual yield is 4.75 percent, a quarter-point above the interest rate Citi pays on its “ultimate savings account.” A buyer of the stock gets a higher level of income, with better tax treatment and the possibility of capital gains.

But the share buyer also faces the possibility of capital losses. Perhaps investors recall what happened in 1991. On Jan. 15 of that year, exactly 17 years before Tuesday’s announcement, the dividend of Citicorp, a Citigroup predecessor, was cut 45 percent amid worries over losses from commercial real estate and loans to highly leveraged companies.

“I’m embarrassed,” Citi’s chief executive, John Reed, said then, of the dividend reduction. “I did not want to do it.”

Nine months later, the dividend was eliminated, and the stock fell well below the January price. “We clearly have picked up more, or at least our fair share of problems,” Mr. Reed said. The dividend was not restored until 1994.

Only two months ago, Citigroup arranged for its first big capital infusion of this cycle, with the government of Abu Dhabi investing $7.5 billion. It is guaranteed an 11 percent yield on that security, but only for a few years. Then the security will convert into common at a price that will vary based on Citi’s share price at the time. If Citi’s stock is at Tuesday’s level, Abu Dhabi’s $7.5 billion investment will be converted into common stock worth just $6.3 billion.

If all the bad news is out, and Citi can maintain the new dividend indefinitely, then the current share price will probably look amazingly cheap in a few years. The fact it has fallen so far shows how worried investors are that things can get worse