Like the cat in Erwin Schroedinger’s celebrated thought-experiment, Citigroup is in a superposed state of being alive or dead. A stock price of $1.60  makes no sense at all for an institution with a $2 trillion balance sheet. Either the stock price should be zero, or somewhere north of $5 (equivalent to a price of around $10 before dilution, depending on how you reckon the dilution effect of converting privately-held preferred to common). If it is not a going concern, it is zero; if it is a going concern it can throw huge amounts of cash off its portfolio. Today’s price simply is the price of a bet on Citigroup’s future.

In the relative short term, say, the next two quarters, Citigroup’s profits are whatever the government says they are. Vikram Pandit estimates that the bank earned $20 billion in the first two months before writedowns; why should there be any writedowns at all? The government merely has to pronounce the magic words, “Regulatory forbearance,” and like other magic words of fable (”Open Sesame,” or Tischlein deck dich, come to mind), losses turn into profits. As I’ve mentioned in the past, I know what sort of “toxic assets” Citigroup owns, because the hedge fund for which I was strategist sold Citigroup a representative sampling of such AAA’s. They are still paying. They may trade at 30 cents on the dollar, but their cash flows are not (yet) impaired. By the end of the business cycle, when every LBO undertaken by the likes of Bain Capital has turned to dust, the cash flows might well be impaired — but that hasn’t happened yet.

If Citigroup wishes, it could report substantial earnings for the first quarter, that is, if the regulators want it to report substantial earnings. Guess what: Timothy Geithner owns 36% of the bank. He has an axe. Which way does he want it to break? Remember the old joke about the accountant’s solution to the question, what is the sum of 2 + 2 (”What do you want it to be?”).

In fact, Citigroup could lever up gigantic amounts of AAA’s now offered at 28 cents on the dollar and manufacture arbitrarily large income streams. This may not last forever. The deteriorating economy well may impair such cash flows some time in 2010, or more likely in 2011. But the income stream is reasonably safe for 2009.

You’re Tim Geithner. You’ve got an insurance industry that’s about to collapse and might require a multi-hundred-billion-dollar bailout. You have a global credit crisis that will generate national bankruptcies and you just asked Congress for another 12-figure sum for the International Monetary Fund. And you just bought 36% of Citigroup. Do you want to show a loss, or a profit? Or am I getting ahead of myself? Do you want to keep your job and be a hero, or be fired in disgrace, get plastic surgery, change your name and move to the Central African Republic? Different people like different things. There’s no telling about taste.

The point of this line of argument is that a case can be made for a continued run in Citigroup stock through the next couple of quarters. The market will come to believe that the cat is alive and price it within the range of live felines. Of course, it well might drop dead in a year, but that’s then, and this is now.

This entry was posted on Thursday, March 12th, 2009 at 2:20 pm and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.