"Sorry" May Not Cut It This Time

Owing up to something bad is never easy, which is why Citigroup is looking for other ways out. The Wall Street Journal reports that Citigroup is facing off a "reconsideration" event over $41 billion in off-balance sheet Collateralized Debt Obligations (CDOs).

If you are a bank dabbling in dicey assets, it makes sense to keep them off the balance sheet (OBS). The important thing is to draw the line between a potential liability and an actual liability.

One way of keeping things OBS is to stash them in a Structured Investment Vehicle (SIV).

The WSJ explains that Citigroup, like its competitors, used SIVs for exactly this purpose.

"Like other banks, Citigroup structured these vehicles so they wouldn't be included on its books. The vehicles are created as corporate zombies that ostensibly aren't owned or controlled by anyone. In that case, accounting rules say consolidation of such vehicles is determined by who holds the majority of risks and rewards connected to them."

You can read the article here.

According to the Journal, Citi's actions in buying up CDO related SIV debt may have changed the playing field. If the relationship between Citi and the core documentation governing the CDOs has changed, accounting rules indicate that a reconsideration event may be in order.

"Over the summer, the bank was forced to buy $25 billion in commercial paper issued by its CDO vehicles because investors were no longer interested in the paper. Citigroup already had an $18 billion exposure to these vehicles through other funding it had provided.

This combined $43 billion exposure means that if CDO losses climb high enough, the bank could be exposed to more than half the losses, according to Bernstein's Mr. Mason. That would seem to argue for Citigroup's consolidating all $84 billion of its CDO assets originally held in off-balance-sheet vehicles."

Basically, as the subprime credit crunch drained liquidity and investor interest out of the debt markets Citi's SIVs struggled to roll over their short term issues.

Citigroup faced a choice: it could either accept the responsibility for the entire basket held by the affected SIVs, or it could try to ride out the storm.

In this instant, "riding it out" meant a cash infusion to keep the SIVs afloat. Buying up up the short term debt issued by its SIVs meant Citi could avoid taking on a larger responsibility.

The problem the Journal article points out, however, is that this move fundamentally changed the relationship between Citigroup and the affected SIVs. If this necessitates a "reconsideration event" Citigroup may be in for even more write downs.

This is why Citi is looking for other ways out and argues that a reconsideration is not necessary.

A reconsideration would be too much like owning up to something bad, and Citigroup is still hoping to wing it.