Market Overview

Is Citigroup Screwing its Clients Like Goldman Sachs?

Citigroup (NYSE: C) is the third largest lender in the United States and operates in both commercial and investment banking. Goldman Sachs (NYSE: GS) is not nearly as large a lender is primarily an investment banking firm that also acts as a bank-holding company. Despite the large differences, the two banks may be more similar than you think.

Goldman Sachs is notorious, at this point, for the Abacus CDO case. It was most likely singled out by the SEC to be used as a scapegoat in the shoddy market-making practices in the events leading up to the 2008 market crash. Did Citi also involve itself in shady practices like Goldman?

Today, it was announced that Citigroup would also be settling with the SEC regarding a misguided CDO case. While the deal's specific details are still being processed and negotiated, Citi will be paying the SEC $285 million to settle the damages. In light of Occupy Wall Street, the issue could not have become a public debacle at a worse time for the bank.

Although it has been said many times, Wall Street banks all pursued the same transactions, and Citi and Goldman Sachs are not the loners in the crowd. Other banks have settled with the SEC in the last year, but no one has paid as much as Citi and Goldman. Regardless, the underlying CDO transactions occurred like clockwork and were responsible for much of the banks' profits in the 2000's.

Much like Goldman, Citi was accused of misleading investors of specifics of the deal. Citi apparently did not directly tell its clients who bought the CDOs at questions that it was on the short end of the trade. While this may seem like an atrocious, manipulative act, that is the very definition of market-making. Market-makers exist as intermediaries to preserve anonymity in the marketplace. Negotiations would become muddled if everyone knew their counter-parties at all times.

Think about it like this: if you wanted to buy some shares of company X, but you found out as you were placing the trade that George Soros himself was the one selling you the shares, you would think twice about following through. If Soros is unwinding a position or even shorting the shares of company X, chances are, he knows more than you do. The same principle applies with trades in the world of complex derivatives. Liquidity and fair trades are extremely hard to preserve if everyone knows the other side of the trade.

Especially at the institutional level, when someone is dealing with securities like CDOs, they should know better than to assume some fool is on the other side, even without knowing specifics. Even if the long party had no clue that Citi was the short party, the long better should have assumed that the its counter-party was someone extremely sophisticated like a hedge fund or other professional investment vehicle. Regardless of which organization is the counter-party, there is a reason they are selling you the CDO. They clearly believe its value will go down, even though you believe its value will go up. Ultimately, investing is a zero-sum game.

Although these are technical aspects of placing the trade itself, Citi picked the asset portfolio used to construct the CDO. This is where the situation becomes unclear. Without access to confidential documents used to pitch investors, it is hard to claim that Citi did or did not represent the assets fairly. For example, if Citi touted the mortgages as investment grade loans that have high historical fidelity, then it would be clear that Citi misrepresented itself and the securities to the clients.

The overall situation is certainly a messy one that is sure to set back Citi a bit in the current quarter. While $285 million can be overcome easily by the large bank, it will still decrease net income and ultimately shareholders' value. It is probably in Citi's best interests to settle instead of wasting time and resources in pursuing the case in court, as well.

Citi is currently trading at $29.01, down about 38.75% for the year.

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