Bill Parish – Parish & Company Investment Management

Today Bloomberg followed up on what could be the first in a wave of public and private “bank runs” here in the U.S. Remarkably, investors today still don’t appreciate the difference between high quality money market accounts and those with derivatives. Even more remarkable are the number of such derivative invested funds in 401k and other retirement plans. Let’s be honest, these investments are not about higher returns but rather simply higher fees.Parish & Company recommends investing only in derivative free monehy market funds composed of exclusively government backed securities.

Meanwhile, the SEC and Treasury Secretary Paulson, pictured above, continue to pander to hedge funds and private equity firms, even though these firms are completely unregulated, responsible for the current mess and have crept into public and private pensions in a big way.

Parish & Company strongly recommends that Congress immediately pass legislation requiring all hedge and private equity funds that have public and private pension assets, in addition to assets from tax other tax free organizations, to declare their complete ownership structure to the SEC, a summary of their top 50 investments and how they are valued and all significant debt agreements with FDIC insured financial institutions within 30 days. Given the tax exempt status of these organizations funding the hedge and private equity firms, clearly the Treasury Secretary has the necessary audit tool to make the requirement.

The obvious question now emerges, that being, what if investors at Etrade, Citigroup, Morgan Stanley and Merrill Lynch transferred their accounts to other institutions without mortgage based derivative risks? Remarkably, the Treasury Secretary is getting a free pass in terms of time given this hasn’t started already, let’s just hope he isn’t squandering this time on disingenious political fixes and will go instead to the source of the problem, not only for the nations benefit but also those involved.

article from bloomberg

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The following article in the WSJ makes no mention of Institutional Shareholder Services nor its parent, Riskmetrics, pending IPO.

“Cox, in denying access, puts his SEC legacy on the line,” Wall Street Journal, by Karen Scannell, November 29, 2007

This whole debate over prohibiting shareholders to separately forward director nominees is simply a ruse for hedge fund and private equity firms designed to takeover more and more publicly traded firms under the guise of good corporate governance. Cox did the right thing in rejecting this attempt. Far too many good companies, including Willamette Indusries of Portland, Oregon, have been destroyed by so called “shareholder initiatives” that change the composition of a companies board of directors in order to forward a merger.

Organizations cited in the article, including the Institutional Council of Investors, have a shameful record with respect to corporate governance and have no credibility. If they did, they would be agressively fighting the pending IPO of RiskMetrics.

Clearly, changes need to be made yet now is not the time given that hedge and private equity firms are not currently required to register with the Commission. As “The Investors Advocate” the SEC’s goal should always be increased transparency, not simply greasing the wheels for companies who disclose nothing to conduct predatory based mergers.

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Today it was announced that a Dubai firm will invest $7.5 billion in Citigroup notes and be paid 11 percent interest, on top of being able to convert the stake to equity in the future. Clearly, these terms indicate how desperate Citigroup has become and should be a wake up call to depositors with large uninsured money market balances at Solomon Smith Barney and other related subsidiaries.

The two primary architects of this debacle are Robert Rubin, Vice Chair of Citigroup, and former Secretary of the Treasury, known in the investment industry as the “Godfather of Hedge Funds” and Sandy Weill, former CEO of Citigroup who made a cool $1 billion in stock options in a single year. Weill, still a “senior advisor” to Citigroup, pictured below, and Rubin both wrote notable books. Rubin was also the primary architect of the deregulation of financial services in 1998, of which Citigroup was the biggest beneficiary. It would seem preposterous to make something this ridiculous up.

The following chart shows Citigroup’s stock trend, compared to Fannie Mae, over the last 6 months.

Few investors realize, however, the true nature of Citigroup’s travails. Here are a few thoughts:

1) Citigroup purchased Associated First Capital, what was known as the “icon of predatory lending” and then proceeded to slice and dice these portfolios of predatory loans into derivatives. Clearly, it just got too agressive and fleeced many of these vulnerable consumers right into default on their mortages. This is the same problem HSBC has, resulting from its purchase of another leading predatory lending firm, Household Finance.

2) The banking system is predicated upon each member having adequate capital, generally defined as 8 percent of assets. If you fall below this level the regulators come in, shut you down and allow other institutions to bid on your remaining assets. That’s how the system works. The formula is simple: take total loans and investments outstanding and multiply them by 8 percent.

3) The value of a banks loan and investment portfolio changes quarterly based upon a variety of factors, including credit risk and the maturity of the loans and deposits. These changes in value must be recognized quarterly per FASB 115 guidelines, guidelines put forth by George Bush Sr. to restore confidence during the S&L crisis, and therein lies the crux for Citigroup. What they had done is an Enron like shell game by creating derivatives and pushing them off their balance sheet, similar to how Enron did the same thing with debt and related interest payments. Now Citigroup is trying to create a market for these derivatives via a special SIV fund when to any honest banker this is nothing but a joke. Perhaps Greenspan put it best when saying it is better for the banks to take the losses now rather than create furthur problems.

4) The biggest risk to Citigroup is rising interest rates than would require them to mark down the value of their loans and investments already on the books, as required by FASB 115. It is really simple math. If the 10 year treasury increases from 4 to 6 percent, the loss is 18 percent on comparable maturity loans and investments and a direct hit to capital. The formula is change in rate, in this case, 2 percent, times the remaining term. And this doesn’t even consider the notion that they have large investments in Fannie Mae and Freddie Mac that now have their own credit quality issues and could also require writedowns independent of those required due to the interest rate scenario.

Back in 2001 Bloomberg Markets did a cover story titled “A Tale of Two Cities.” In the article Sandy Weill looked rather smug, having just pocketed $1 billion in stock options, and highlighted its strengths. I was featured telling the other tale while playing a classical guitar while standing on a stone wall in Washington Park overlooking Portland. My tale was focused upon credit quality issues associated with predatory lending in addition to excessive derivatives and numerous other issues. I always thought it was rather gutsy of Loren Steffy to do that article for Bloomberg, once again highlighting why Bloomberg is such a premier source for financial information.

The good news is that there are many outstanding banks out there including Northern Trust, US Bank and many other regional and local banks. At this point, however, for the system to repair itself we’ll first need to rid it of the cespools of unproductive greed and corruption as exemplified by Citigroup. Or in more mundance terms, simply require Citigroup, a leader in structuring the most egregious Enron related partnerships, to follow the rules and take the required FASB 115 writedowns on its derivatives, loans and investments. Anything short of that will only harm the higher quality more important financial institutions we depend on.

*** Updating Note on January 17, 2008. The following link is a 9 minute podcast posted on youtube with more detailed observations on Citigroup and the federal reserves response to it and other related events.

http://youtube.com/profile?user=ParishInvestments

Disclosure: I do not own any financial interest in Citigroup although 3 clients do own a small amount of shares that were owned previous to engaging me as their advisor.

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Today a leading European financial publication based in the UK, Financial News, published a story regarding RiskMetrics IPO now being reviewed by the SEC. Riskmetrics primary clients are hedge and private equity firms, for which they construct math driven models resulting in many of the derivative based investments that are now destabilizing the financial industry. The article is titled “Corporate Governance: who is guarding the guardians.”

On October 24, 2007 I wrote a letter to SEC Chairman Christopher Cox, pictured above, search this blog for Cox to view related content, requesting that the RiskMetrics IPO be suspended due to RiskMetrics failure to conform to important proxy rules that require full disclosure of its ownership structure. Two weeks later I received a response from Cox, a form letter signed by a branch manager referring to the date of my letter with no mention of the subject. Failure to note the subject of course makes it difficult for oversight groups to see this request.

Harvey Pitt and Bill Donaldson, the two previous SEC Chairs, both sent thoughtful follow-up letters, hand signed, upon receving request of similar importance. Given the significance of this issue, I was simply stunned.

Meanwhile, the financial markets are sufferring from a growing crisis of confidence. It is no wonder, when the nations most important proxy firm is allowed to snub vitally important SEC proxy rules, and potentially gain the SEC’s approval for an initial public offerring.

Christopher Cox, a former Congressman and attorney, is the first elected politician to serve as SEC Chairman, and like the CEO of Etrade, another attorney without broad based financial experience whose stock has declined 80 percent in 2007, is too focused on making assumptions and needs to realize that vitally important rules, such as FASB 115 and proxy rules, were developed over a long period of time and are critically important to maintaining investor confidence. Failure to do so and the requisite heavy lifting to restore integrity, could cost the nation dearly.

In Cox defense, it is curious to note that while the NY Times roundly criticizes the state of corporate governance, as in today’s column by Paul Krugman, pictured below, it has provided almost no coverage regarding the RiskMetrics IPO, the most important IPO in at least 25 years and the heart and soul of any credible dialogue regarding corporate governance. Never before has a proxy firm been publically traded.

Krugman’s article is titled “Who will pay the price for Corporate failure?” Hopefully Gretchen Morgenson, Floyd Norris or someone else at the times business reporting deparment will cover this remarkable story prior to the release of the RiskMetrics IPO. Clearly, the WSJ will quickly do a series of stories given that the Financial News has broke the story in the UK. Both Morgenson and Norris were provided the same materials that were provided to Financial News.

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