I was flummoxed, bowled over and plain stupefied as I read the article by Eric Dash and Jack Healy on the front page of the business section of the New York Times this past Saturday. On the surface, the story simply defies belief.
Beleaguered Citigroup has been forced to execute a fire sale of its prize-winning entity, Phibro, because the Federal Government’s ‘pay czar’, Kenneth Feinberg, has ruled that the compensation contract with top level employees at Phibro “promoted excessive risk-taking and ran counter to the public interest”. (A quote from the article.)
Okay, I accept the fact that the Federal Government, as the largest shareholder of Citigroup with a 34% equity ownership, can use its muscle. But why use its muscle in a way that only harms its own very large equity investment?
I could understand Czar Feinberg’s edict if Phibro were some ordinary subsidiary, making ordinary money and paying out extraordinary bonuses to a vast array of minions regardless of their contribution of Phibro to Citigroup’s profits. But Phibro has been anything but ordinary. In fact it has been a beacon of success in an otherwise sea of disaster for Citigroup, and the enormous compensation of the rainmakers at Phibro has been tied directly to the profits they have reaped for shareholders.
The success of Phibro has not been a ‘one off’ event. Since its acquisition by Citigroup in 1997, Phibro has been profitable each year, and (according to the article) generated an average of $371 million in pretax earnings for each of the last five years. That is a total of $1.855 billion of profit for shareholders!! Contrast that with the $27.7 billion loss that Citigroup recorded in 2008.
Somehow if I were a 34% shareholder of Citigroup, I would have done everything in my power to hold on to a subsidiary that made real, solid income year after year. Given the still desperate shape of the mortgage industry and consumer finances, Citigroup can ill afford to lose money making businesses. And it can even less afford to essentially give away highly profitable assets. Occidental Petroleum Corp. paid just $250 million (according to its own spokesperson) for an entity that has generated $1.855 billion of income before taxes over the last five years. I would have loved to have had a chance to bid on Phibro (except that I don’t have the $250 million to spend).
I never thought Government was particularly good at understanding how the private sector works. But I did think that at least it had learned basic fourth grade arithmetic. That’s why I was so flummoxed on Saturday.
I have to wonder how Citigroup will be a serious competitor in the dog-eat-dog world of finance in the years ahead. How can it feel to be the chief executive officer at Citigroup, when your executive powers are usurped by a Federal Government employee? With powerhouses like Goldman Sachs raking in the profits during this time of chaos, I simply don’t know how Citigroup can be a player in the long run.
But what is of even greater concern is the idea that if the Federal Government can determine what level of income is too high and what degree of risk taking is too great in one industry, it can do so in another.
It seems evident that despite a major equity investment with our taxes into a major company, the Federal Government does not grasp the essence of return on investment. This is a problem for Citigroup today and it could turn into a problem for the entire U.S. economy in the future.
Patricia W. Chadwick has had more than 35 years of investment experience. She is the founder and president of Ravengate Partners LLC, a consulting firm that provides advice on financial markets and global economics.