Felix Salmon

Citigroup’s earnings this morning could hardly have been worse: a $12.1 billion operating loss, which was reduced to a still-whopping $8.3 billion after counting in gains from selling Citibank Germany. But here’s a datapoint you might have missed: Citi’s book value per share fell 19% in the fourth quarter and 35% in 2008 as a whole to just $14.70. If you needed any further evidence that this is a solvency crisis and not a liquidity crisis, there you go.

Meanwhile, the deckchairs are being rearranged yet again: as if there haven’t been enough management reshuffles already during Vikram Pandit’s troubled tenure as CEO, he’s now "realigning" the company into two units, Citicorp (ah, the memories) and Citi Holdings. According to the press release,

Citi will manage the company consistent with this structure starting immediately, and management reporting will reflect this structure starting with the second quarter of this year.

It’s a wonder that anybody at Citigroup has any time for actual banking these days, between building org charts and mollifying regulators.

As for the question I had about overseas uninsured depositors panicking and pulling their money out, that turns out to have happened only to a relatively modest extent. Floyd Norris was on the conference call:

It looks like customers overseas are less sure of Citi than those at home. Domestic deposits ended 2008 at $290 billion, up 5 percent from the third quarter, But international deposits are falling. They fell by 4% to $484 billion, and are at the lowest level since the end of 2006.” Some of that is currency translation, but some is probably based on worries.

I don’t think a lot of it is currencies: international deposits have been falling steadily all year, from $561 billion in the first quarter. That drop of $77 billion in three quarters is a massive funding gap to fill in this environment, but it’s not a bank run by any means.

Both Citigroup and Bank of America are down more than 20% in early trade today, and I imagine that Hank Paulson and Tim Geithner are starting work on yet another weekend deal of some description, since at this rate it seems that neither institution is capable of surviving in its present form much longer. They should embrace the inevitable and just nationalize the two banks.

Any deal will be necessarily complicated by the fact that Paulson dragged his heels when it came to requesting the second tranche of TARP funds, even after he blew through the first $350 billion in no time. As a result, it’s far from clear what money Treasury can use to shore up two of America’s most systemically-important financial institutions.

On the other hand, this isn’t a bank run: Citi and BofA aren’t suffering from liquidity problems. They have all the liquidity they need, thanks to the Fed. The problem is one of solvency: the equity markets simply don’t believe that the banks’ assets are worth more than their liabilities.

I can’t see a solution to this problem short of nationalizing both Citi and BofA, and summarily firing the hapless Vikram Pandit along with the overambitious Ken Lewis. Lewis thought he could buy his way out of trouble, by acquiring Merrill Lynch; instead, he was simply tying his own already-troubled institution to an even more troubled institution. Pandit, it’s worth noting, tried the same hail-Mary technique, when he put together a deal to buy Wachovia, but that didn’t last long.

Citigroup, at $3.50 a share, simply doesn’t have the time to implement its new plan to get smaller slowly. And Bank of America, at $7.75 a share, doesn’t have the capital needed to absorb Merrill Lynch. Both are now trading at option value: on the hope, essentially, that somehow equity holders won’t be wiped out entirely. But they should indeed be wiped out, as part of a nationalization, along with preferred shareholders, including the government. TARP will show an immediate loss on its investments, which will serve as a salutary reminder for whoever’s in charge of disbursing the second tranche.

Nationalization is a messy solution, and one which will make no one happy. But it’s better than desperately trying to kick the ball down the field until the banks come back in a few weeks for even more money. If we’ve learned anything from the last Citi bailout, it’s that small interventions don’t work. What’s needed now is a complete revamp of both banks’ capital structures, and a brand-new owner.

Dear John Thain is getting into the weeds of the Morgan Stanley Smith Barney joint venture, and doesn’t like what he’s seeing.

The big problem here, according to DJT, is that Citigroup is intent on keeping its private bank — complete with the brokers the private bank uses. Up until now, lines have been very blurry between the Smith Barney brokerage and the private bank, which services clients with $10 million or more in assets. Suddenly, however, those two operations are going to be competitors.

This also means that Citi will essentially retain a lot of its brokerage costs without getting anything like the same revenues:

Citi retains brokers housed in their retail branches and its private bank, both direct competitors to the joint venture. Well, that hardly seems logical… To sell a business but still keep enough fragments of it to have to maintain the same infrastructure, support staff, and organizational complexity as if it wasn’t sold-things like stock trading, account processing, compliance, client account management, and relationship management software are all required no matter how many brokers you have.

To make matters worse, says DJT, Smith Barney itself has a significant number of teams of brokers who are private bankers in all but name and who use the private bank’s platform rather than Smith Barney’s. It’s unclear where those brokers will end up, but it’s crystal clear that their VIP clients are going to require a seamless transition. And the chances of that happening seem slim.

When Citigroup realized it was going to lose much more money in the fourth quarter than the market expected, it decided to leak the news to the press. Deutsche Bank is more grown-up about such things, releasing a "preliminary and unaudited" set of results showing a

gruesome €4.8 billion loss for the quarter.

Deutsche’s share price has fallen 10% as a result; the more worrying news, especially for Tim Geithner and the rest of the Obama economic team, is that Citigroup’s share price is down another 15%, at just $5 — that’s a fall of 26% from Friday’s closing level. Is there a clean causal relationship here, as my headline implies? One can never know for sure, but at the very least there’s a lot of bad news coming out in the banking industry right now.

In light of Deutsche’s results, Citigroup’s decision to severely scale back its prop-trading business makes more sense. Citi says that the group was using too much capital, which surely true, but one also suspects that the risks have begun to outpace the rewards: much of Deutsche’s quarterly loss came from the debt and equity prop desks.

I’ll be fascinated to see, when Deutsche releases full results, what proportion of this $6.3 billion loss is attributable to its US operations and assets. There has been no safe haven from the current financial meltdown, the US is still ground zero when it comes to the source of losses, probably because US borrowers, especially in the housing market, levered themselves up so much during the boom years. Of course, none of that will come as any consolation in Frankfurt.

How rich are Morgan Stanley Smith Barney’s clients? Consider this:

• According to the official press release announcing the formation of Morgan Stanley Smith Barney, the new joint venture will have "6.8 million client households globally – with a strong presence in the critically important high-net-worth client segment".
• Morgan Stanley co-president James Gorman, who will chair the joint venture, says that

  “most financial advisers are hoping to serve clients who have $1 million in investable assets”.

• Citigroup’s Mike Corbat is at pains to point out that Citi’s "bank-branched advisors" — the brokers who work out of Citibank branches and deal with smaller customers — are not part of the deal.

Given all that, you might be forgiven for thinking that the median client would have at least half a million dollars in assets, and the mean client might be well into seven figures. But you’d be wrong.

According to that official press release, the joint venture will oversee just $1.7 trillion in client assets — which works out at exactly $250,000 per client.

OK, it’s unfair for me to talk about "just $1.7 trillion" — $1.7 trillion is one hell of a lot of money in anyone’s book. But clearly "the critically important high-net-worth client segment" doesn’t make up that much of Morgan Stanley Smith Barney’s client base. This is a decidedly middle-class shop, as befits its Dean Witter and Smith Barney heritage: all the talk about "wealth management" is basically window dressing, and/or client flattery.

Of course, if the average Morgan Stanley Smith Barney client has $250,000 now, there’s a good chance that they had $400,000 at the height of the market in 2007. If the average client was down by 30% in 2008, that would mean that Morgan Stanley Smith Barney’s clients collectively saw more than $700 billion of wealth evaporate last year. That’s an entire TARP right there.

David Enrich says that the new big idea over at Citigroup is "to focus on wholesale banking for large corporate clients and retail banking for customers in selected markets around the world". If that ever happens, I have the perfect name for the new entity: Citicorp. It could even do a lot worse than to re-hire John Reed as its CEO; at least he has a proven ability to run such a thing.

The problem, of course, is how on earth to get there from here. No one has any particular interest in buying the other disparate elements of Citigroup, from Primerica to the credit-card operations and the investment bank, and it might be easier, quicker, and more elegant to simply spin them off to shareholders as standalone operations unburdened with much if any debt.

But that would imply that rump Citi — Citicorp — would be the "bad bank", rather than everything else, which seems to be the present idea.

If you are going to create a bad bank, though, putting the dodgy assets in Citicorp seems to me to be much more sensible than trying to attach them to anything else. After all, Citicorp was insolvent once before, during the debt crisis of the 1980s, and it managed to emerge from that crisis, thanks partly to Reed’s leadership. Maybe he could manage the the same feat again.