Michael Klein: The bigger picture

The Global Credit Crisis: How Bad Will it Get? April 14, 2008

Michael Klein - Chairman and Co-Chief Executive Officer, Citi Markets and Banking

We have certainly entered this period of difficulty in the most healthy possible manner that we could have. And just so you have a sense-the earnings of companies are literally twice as much today as they were in 2000, 2001, 2002. The margins are extraordinary, despite big increases in raw materials. The productivity in global companies, U.S. companies, large and small, has been extraordinary in terms of the impact on both health and profitability. So we've entered this cycle with a corporate universe that's actually very, very flush. We've entered this as well, with consumers also, in certain ways, acting differently. How many of you know individuals that kept cash in the bank and had mortgages; cash in the bank and leased cars. There was a sense that money didn't cost a lot. And as a result, keeping a little cash and some debt was not a bad thing in that sense. Well, money still doesn't cost a lot. If you can get it, and most of the participants who own real assets have the ability to get real money.

So there is liquidity in the marketplace. Finding and attaching that liquidity from where it is to where it needs is the challenge today; it's the jigsaw puzzle that we're working on. In a funny way, these big sovereign wealth funds are actually one of the greatest things that you can imagine, not just because they have a lot of money, but they are very big saving machines. In Abu Dhabi, there's only two and a half million people, and there's a rumored fund of $1 trillion. They must invest that in other locales, so that forced savings that comes into market, there is greater liquidity. So we enter this with far greater health, arguably, far greater in liquidity, and we enter with a far more diversified growth than we've ever seen before. Remember, 2007, the fourth year in a row of record growth, sixth year out of eight, and eighth year out of ten of record global growth. One hundred countries growing over 4%. This is an unbelievably healthy period with which to enter this. Now of course, when you're going very fast and you try to stop, that stopping process in hard. But the underlying element of what's happening is, I would argue, why we can be 28 months into a real estate, 10 months into a financial turmoil, and not feel the real economy because globally, the economy continues to be very strong. And what none of us really addressed is there are historic lag patterns. I remember when the Euro was first adopted and actually put in place, and the U.S. hit its recession, and Europe was growing strong, and the arguments were, "This is the first time when the U.S. sneezes, Europe's not going to catch a cold, we have our own currency." And then nine months later, boom, the recession came. Now lags occur.

But this is an extraordinary lag that's occurring between the real and financial economy and that may portend that there is greater degree of comfort in the system. And again, I think what we may find-and I'm hopeful, I'm actually optimistic-that we'll find is that as Asia pulls the growth, U.S. has the ability to consolidate its recovery for longer and then not actually pull the rest of the world. And by the time it rolls-and I think it will, roll into Europe and into other markets-the U.S. will have consolidated much of its losses. Now, despite some of the comments that have been made about future losses that could take place, these are extraordinary losses, extraordinary losses that have already been taken. Extraordinary reductions of values already. We've not ever had 10 years, 5 years, 20 years, 30 years, of negative housing value.

And with inflation, if there is inflation, one has to consider inflation as a netting factor. The concept that we'll have 10 years during the life of these mortgages where housing will go down 30% and despite inflation will never go up again, is implausible, in my opinion. And as a result of that, there are timing issues, and there are lag issues. And the question which, I think, very strong efforts put in place by the Fed, the ECB, Congress and others, to create this degree of timing, are, I think are very good positives.

Last point I'd make. Citi is, at this moment in time, better capitalized than we've been in all of this decade. In all of this decade, the capital that we raise proactively and assets we've sold, we have the highest capital ratios we've had literally in the entire decade. Why? Because Citi and other banks have taken the point of view, "We have to be in the business of supporting our clients and our customers. We have to be in that business." It's a client confidence business so you move ahead. And I think it is clear, unlike the Japanese crisis of ten years, the financial system has taken aggressive early actions on purpose for this reason. Our deposit base, and this is purely a just practical fact, we are viewed by most of the consumers and companies of the world as the safe haven, despite the financial market turbulence, deposits are coming into our company at a rate of increase of 30% per month, as people put money to say, "This is a safe house." So I think there are much in the way of hyperbole that can drive us. Yes, those corporate loans traded down to 80 cents a few moments ago and they're back at 91 cents. Yes, when Carlyle Capital and Bear Stearns were at their bottom and some of those government securities went to 93, 94, they're back up to 100, since we've had volatile periods. August 7, August 9, March 17. Two extraordinary, extraordinary periods of volatility. Incredible depth to volatility. A waiting, a market event to take place, and yes, we've had substantial recovery since each of those, whether they're relief rallies or absolute rallies or important questions. But I would say tone, because of how we've come into this and the actions, is actually much more akin to where Adam is in the banking system, and I think today the ability for the banking system to be helpful much more in that regard. That doesn't mean it won't go, where you say the real economy, I don't want to make those guesses.

The last comment I'd make is on the so-called anti-Americanism. I think, at the end of all this, we're going to recognize, financial history doesn't get written, no history gets written in the midst of actions. We'll learn that consumers around the globe began to learn to live with no cost of money and changed their behavioral patterns in every respect. I think, by the way, investors learn to live with the concept of a reach for yield. Now, the German banks that have had difficulty unfortunately, put five times their equity base into some of these assets categories that failed. Five times their equity base. It has nothing to do with who created subprime; it has nothing to do with who creates securitization technology. Putting five times your equity base into a single-asset category when you are that time of institutions, that's probably not a great fiduciary move, to put it. And that's a big, big, big issue and a big problem. So I think when history is written, we'll see consumption behavior; we'll see intermediary; we'll see rating agencies; we'll see regulators; we'll see investors all across the board having missed certain elements. But it will be up and down the spectrum, and it's deep in the heart and soul of humans to want to live better. And if presented with the opportunity to do so with a better house, at the same amount of your paycheck, that occurs. And that's part and partial of the psychology that's taken place that we'll live through. But I would say this is a very constructive period where the underlying health entering it is far better, which gives us a far better time period to digest this consolidation and move forward.