Saturday, February 21, 2009

Potential Government Missteps

As we progress through the various stages of financial deterioration, the Government is left with an increasingly weaker hand. An appropriate analogy may be that of a chess game, with the Government on one side of the table, and the Market on the other. As any chess player knows, the key to victory is the ability to see several moves ahead, and to assess your opponent's most likely reactions. We liken the Government's varied reactions to our current predicament to the actions of a novice chess player. A beginner tends to deploy his crucial pieces for attack, despite having only planned the assault one or two moves in advance. In addition, a novice chess player will generally fail to recognize a threat until it is too late. This current match against the Market has not gone favorably for the Government. Each attack has led to a more sophisticated counter-attack. Repeatedly, the Government has claimed victory over the capture of a pawn, only to realize that it has lost a rook in the process. We now stand in the latter stages of the game, and the Government's pieces are few.

It has become painstakingly clear that the end game will involve some form of nationalization of a number of major financial institutions. We feel that nationalization is, and has been, a necessary evil given the current predicament. However, we remain skeptical as to whether the Government is capable of crafting a strategy that will save the banks without triggering profound global repercussions. We focus specifically on Citigroup, as it is both the weakest and the most systemically significant institution. Citigroup operates in over 100 countries worldwide, and does so under numerous ownership structures. For example, Citi "controls" the second largest bank in Mexico by assets.

Obviously, the global reach of Citi obfuscates any Government nationalization scenario. We are concerned primarily due to the Government's inability to think or act with any degree of nuance. If the Government did not anticipate the consequences of the decision to allow Lehman Brothers to fail, we are gravely concerned about its ability to effectively nationalize an insitution such as Citi, whose tentacles reach to every corner of the globe.
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