Citigroup: KIA'd

Marla Singer's picture

By Marla Singer and Geoffrey Batt

In the wake of the crumbling of certain sandcastles in the sky, sovereign wealth funds in the middle east have baited our analytic gaze over the last month or so.  It takes very little, therefore, to prompt us to take careful notice now just about whenever one is mentioned.  Today, the Kuwait Investment Authority (hereinafter the "KIA") and its brutal body-blow to Citi demand our attention.

While pinning solid figures on any of the sovereign wealth funds in the middle east is a speculative effort at best, it is difficult to come up with figures much smaller than $150-200 billion for KIA's assets under management, at least assuming no major losses in the last 24 months- potentially a generous modeling gift.  Moreover, the KIA, residing as it does within the borders of a "close friend" of the United States, has often enjoyed direct and indirect encouragement therefrom.  Further, a demonstrated willingness to invest in Western European concerns (e.g., Daimler) and American enterprises (e.g. Citigroup), particularly in times of distress, has cemented bonds between the United States and these petrolpowers.  The honeymoon might be over.  To wit:

The Kuwait Investment Authority has held internal discussions about scaling back its banking relationship with Citigroup in a move that could include transferring funds currently deposited with the US bank, people familiar with the matter say.

 

A withdrawal of KIA funds from Citi would mark another setback for the bank as it seeks to recover from the financial crisis and pay back government bail-out funds.

Indeed.  In one fell swoop KIA might undo the Herculean YouTubeian pleadings by Federal Deposit Insurance Corporation Chairwoman Shelia Bair begging Americans to please, really, seriously, please just stop taking money out of absolutely, totally safe and solvent banks.  Oh, and paying off TARP is pretty much right out if Citi faces this kind of capital flight.

Well, how bad could it be exactly?  Again, the Financial Times:

According to KIA officials, most of Kuwait’s oil revenues are deposited at Citi – a decades-long relationship.

Ouch.  Well, that might not be all that much.  Right?

KIA manages a series of assets (not least for the Ministry of Finance), but, probably more significantly, also the Kuwait Future Generations Fund (hereinafter the "FGF") and the Kuwait General Reserve Fund (hereinafter the "GRF").  By law, the FGF slurps in 10% of the general revenue of... well... all of Kuwait... every year.

Article 1:

An amount of 10% (ten per cent) shall be allocated from the State’s General Revenues every year, as from the fiscal year 1976/1977 .

Article 2:

A special account shall be opened for creating a reserve which would be a substitute to the oil wealth “Future Generation Reserve” into which those amounts would be credited.

The Ministry of Finance shall employ these funds into investments, and the profits accruing therefrom shall go into this account.

And an amount of 50% (fifty percent) of the available State’s General Reserve Fund is to be added to this account, when this Law comes into force.

Article 3:

It is not permissible to reduce the rate stated in Article One of this Law, or to draw any amount from the Future Generations Reserve.

Unlike some other funds we know, these people are not screwing around.  (We are looking at you, Dubai).

Figures are difficult to come by (disclosure to the public of KIAs strategy or operations is subject to penalties by law), but FY 2004/2005 contributions to FGF were on the order of $3 billion.  Several years of that sort of accumulation adds up to a tidy sum, in theory.

Pointing out that a large bit of capital flight would be a blow to Citi is an act of profound understatement.  Pointing out that this sort of thing has rather serious strategic implications for the United States should cause colleagues to credit you with a mastery of the obvious.  In fact, the United States has worried about this sort of quasi economic warfare for some years in another context.  Consider, for example, this text from a declassified 1976 National Security Council memo to none other than Alan Greenspan from Robert Hormats discussing oil embargo contingencies.

In the event of a continued deterioration of the Arab/Israeli situation, Arab oil producing states would be increasingly motivated to use their control over oil resources, and possibly such economic power as might be available in the use of their finance assets, to place a range of pressures on the United States and the industrial world to achieve political ends in the Middle East.

[...]

II. Actions Involving Movement of Liquid Assets

The trend of Arab investment policy over the past half year has been toward the placement of increasing proportions of their new accumulations of funds in longer term instruments.  Their holdings of relatively liquid funds are substantial and are largely in dollar form.  Under the pressure of another Middle East conflict, however, efforts might be made to move some of these liquid assets either for economic or political reasons.  The latter motive is not entirely compatible with the former, however, since essentially arbitrary movement of funds could do considerably [sic] damage to the value of Arab portfolios in the process.

Action I: Shifting funds among sectors or institutions in a single country.

Application: To selected countries, specifically including the US.

Effect: Large-scale shifts of funds out of individual banks could post short-term liquidity difficulties for those particular banks, although failures would be unlikely since only the large financial institutions are involved.  Individual bank liquidity problems could be mitigated by resort to discount-window emergency borrowing at the Federal Reserve.  Moreover, financial markets in the United States as a whole would be readily able to cope with rechanneling flows between sectors and institutions.  There might be some initial confusion and uncertainty in capital markets, but in general this type of action poses no threat to the US financial system as a whole.

Action II:  Specify oil prices and demand payment for oil in currency other than dollars.

[...]

Sounds sort of familiar, no?

Part II of the document goes on to describe potential countermeasures and is a must read, not necessarily because it reflects the present day situation (which is probably more about dollar confidence and liquidity pressure at home for the Kuwaitis), but because many of the countermeasures contemplated as part of a United States response would be difficult or impossible to implement in the country's current and enfeebled state.

A related declassified and heavily redacted CIA document from 1978 discusses similar possibilities, and similar responses.  In general, the documents dismiss the possibility of economic warfare of this kind, reasoning that:

The composition of the Saudi portfolio at this time limits its use as a political weapon.  Since Saudi surplus funds are heavily concentrated in a few countries and in US dollar assets, any politically-motivated shift out of the US dollar could involved heavy financial losses for the Saudis.

Even though the names have changed, that doesn't seem to be the case any longer.

As one reviews the mindset of a then-alerted and highly nervous apparatus of national security it is difficult not to read between the lines of analysis and realize something very stark and, in the present environment, worrying.  Almost every single response available to policy makers in the event of economic warfare of this kind depended on the dollar's status as the reserve currency of choice, its strength, and the absence of other options.  (The Swiss Franc and the German Mark were generally expected to see the petrodollar inflows).  Since this buffer is now gone it doesn't take much creativity to notice that, today, the United States is in an intensely vulnerable position to actions of this kind.

To get a sense of just how powerless policymakers were, consider these comments about the impractability of the free market itself under econmic pressures (in this case oil embargos):

The Free Market.  Complete reliance on price to bring supply and demand into balance would create short-term and mid-term economic problems of sufficent severity that it would be unacceptable as an option.  However, price increases would add to the effectiveness of a rationing scheme or allocation program.

Reflect for a moment on the fact that this is a memo from a Goldmanite.

There isn't any reason to think that Kuwait is engaging in overt economic warfare against the United States, of course.  However, if economic conditions, a lack of confidence in the dollar, or a pessimistic view of the fiscal black hole that is the United States Congress and the present administration cause pullouts like these, what's the difference in effect?  There isn't one.

It seems hard to believe the current party line that Pandit has somehow insulted the Kuwaitis by not visiting often enough or sending flowers to apologize.  Too much is at stake for these sorts of pleasantries to dictate policy, and there is likely plenty of reason to consider de-Americaing one's portfolio just now.

Is it also possible that, contrary to popularly entertained illusion, middle eastern petrol dollar wealth simply does not back up quite as much as everyone thinks?  If so, is Dubai a hint of what lurks behind the opacity of sovereign wealth funds and other middle eastern enterprises?  Opacity works for the likes of Dubai precisely because of investors' willingness to imagine vast sums of crude wealth behind the curtain.  Certainly, Dubai shamelessly exploited this economic blind spot.  Who else is taking advantage of this bit of investor cognitive bias?  With this level of opacity, how responsible is it to assume that we know anything about the solvency or liquidity position of entities like these?

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ShankyS's picture

Financial terrorism after we saved their ass from Sadam? OK, take your money and see how long you last in the real world big boy. It is a horrifying thought for those in the administration,  FDIC and CITI, but I myself would find it a glorious thing. That would not be the first domino, but more like the first redwood tree guaranteeing the total collapse that will be required to ever get this problem solved. Yes, that would be to take everything to zero and start over. They are just sabre rattling I'm guessing, but then again who else in the room wants dollars these days? Not me.

 

Well done Marla and Geoffrey. This is really good stuff. +1000

delacroix's picture

we used kuwait to bait saddam, into a well planned trap. of course up until then saddam was an ally, who was well supplied with american war hardware. talk about asset destruction, lots of $$s worth, went up in smoke, quick-time. betrayal, is a common feature, in the big leagues.

Anonymous's picture

I guess they're done paying us back for 1991.

Anonymous's picture

I prefer to think of it as "helping us deal with our domestic financial terrorists."

Bolweevil's picture

Articles such as this (and others of similar caliber here at ZH [TD!] ) could save print media. Or at least turn a profit before eReaders take hold...

carbonmutant's picture

How much trouble would the Kuwait Investment Authority be in if Citi suspended withdrawal requests?

rapier's picture

It's a partnership till the end for the US and the robed ones. I have no idea what an end would look like but neither side will knowing screw the pooch and the Gulf money flowing through the US financial system is the pooch.

Squid-puppets a-go-go's picture

so if your a fractionally reserved bank leveraged at 30 to 1

and your major depositing client withdraws their deposits which are, say , 50% of your cash holdings

yer suddenly leveraged 60 to 1

(figures are nominal - who knows what the current stats are for Citi's leverage and KIA's deposits with them - anyone? )

Hephasteus's picture

If you wanted realistic numbers. They go to withdraw and you give them 1/4 their money and the tanks empty and you are at well infinity leverage.

http://shhac.info/x/b/divide_by_zero.jpg

Tic tock's picture

First BAC pays back TARP virtually overnight, to get out from under the thumb, and the next day Citi is poised to lose a fair portion of working credit!! anyway..where else would KWiqi park, please don't tell me Dubai

The Rock's picture

Citi deserves all negative Karma coming to them... especially for raising the APR on thousands if not millions of unsuspecting credit card account holders to 30%!!!  Fuckem!

delacroix's picture

maybe they're gonna take it outta citi, and put it in bac,  ha ha.      this isn't kuwait gettin scared. they are told what to do. just like here. a terrorist attack, could eliminate that specific clan, in a heartbeat, conveniently blamed, on target of choice. and they know it. only a big friend, keeps them from getting beat up, and  losing their lunch money. besides, investments, can be destroyed, anywhere nowadays, so where is the safety. they only get to keep, what the big bankers, let them keep.  after all to the bankers, all the money is really, theirs, they only loan it to us, until they want it back, then they take it.

Anonymous's picture

Fat finger on the comma key?

Anonymous's picture

I heard some banks are putting the maximum allowable hold on all deposits of checks drawn on Citi accounts. No joke.

Apocalypse Now's picture

The 1976 National Security Council background to this story is part of the narrative for establishing the PPT.  As you can see, markets are a national security issue and you now know why the markets have been up to stimulate confidence for Christmas shopping and going into mid-term elections. 

The world reserve currency must be backed up by a dominant military to protect oil routes.  In addition, the oil funds invested in the US act as protection money for those in power in the middle east - unless Kuwait has worked a deal with Russia/China they will remain invested in dollars.  Part of the deal with these leaders is that they have TSHTF mansions in the US in case there is an uprising in their countries, so they would want access to safe money where they would want to flee (US, possibly EU). 

Until the dollar was taken off of gold, international capital flows were rather controlled.  Now, we are completely blind sided because market reporting focuses on actions within each individual securities market by region and exchange rate markets separately.  In reality, investing is about understanding where the carry trade will be and where the international capital flows will concentrate.  An excellent piece by Martin Armstrong just came out on this very issue:

http://economicedge.blogspot.com/2009/12/martin-armstrong-dow-and-future...

tip e. canoe's picture

they don't call it fiat currency for nothin...
thanks for the heads up on marty's latest colonel.

Anonymous's picture

Maybe this should be added into the U.A.E. equation...

http://online.wsj.com/article/SB126031187195082573.html

"The next question: What would be the test case? Boeing executives and the bankers wanted a plane buyer willing to take risks on the new investment vehicle, but one established enough to comfort Mr. Morin and potential investors. On March 7, Mr. Lee pitched the idea to officials from a large carrier due to take several Boeing planes -- Dubai's state-owned Emirates Airline."

So that's Dubai debt guaranteed by the US Treasury?

And more to Abu Dhabi's Etihad airline too?

http://www.theaustralian.com.au/business/aviation/export-credit-agencies...

1984's picture

Wasn't there a movie made about this?

"Rollover (1981)"

http://www.imdb.com/title/tt0083006/

 

Anonymous's picture

C'mon... its clear no one here understands banking and you're just fear mongering.

Assume you're right and the KIA has $200B (2x GDP.. unlikely). Then it is still at most 25% in cash, so thats $50B (the rest is in stocks, bonds, real-estate, etc). Citi's balance sheet is probably $2T. (~2.5% to KIA deposits).

Furthermore... funds flow around the world via LIBOR lending. So Citi is currently paying 15-25 bps on floating funds to the KIA. IF the withdrew, Citi could just go borrow that amount in the inter-bank market.

Its funny how many people - pundits, congressman, online personalities -- want to pretend they understand banking, economics, finance without doing the first bit of work to LEARN anything.

Anonymous's picture

Your scenario is not scary. I like scary movies better. Time for a re-write, and add some scary.

Anonymous's picture

Your scenario is not scary. I like scary movies better. Time for a re-write, and add some scary so when I read it I walk away saying Ohme, Ohmy what am I going to do!

Anonymous's picture

'+100' (which i assume to be the vernacular)

Goodness, I had to read through all of those posts to get to one that actually was grounded more in reality than assumption or fantasy.

Anonymous's picture

Thanks for your post brother. Adding strength to the Anonymous community.

Commander Cody's picture

The question in my mind is a matter of trust.  Do you trust the holder of your money to preserve and grow it, or do you think they will gamble it away on high-risk ventures (derivatives and such) so that it is not safe.  If you aren't backed up by the full faith and credit of the US government, then you are gambling, presuming the US doesn't default.  That's where the valuable printing presses at the Fed come in handy.

Anonymous's picture

So I'm guessing Citi's plan here is to dilute massively in order to pay back the TARP, pay huge bonuses, then demand more TARP because this unforeseen event places them in systemic danger and thus might threaten the nascent recovery.

So crazy, it just might work...

trav777's picture

If anyone seriously runs the bank, the US will institute capital controls.  Currency wars are a precursor to the real action.

Everybody needs a devaluation at this point, just too much debt.  But the exporters don't want to see their importers buy less - too many colliding interests when you get overproduction of debt along with overproduction of capacity.

This is like the 90s fiber build-out except in every other manufactured good.  Too much capacity for cars, toys, steel, concrete, planes, computers, everything, and it was all borrowed to build.

ATG's picture

Maybe you could explain in learned detail exactly

why everyone needs a devaluation at this point,

after the dollar has already devalued 86%

relative to gold since 2001?  If devaluation were

the answer, would not everyone devalue to zero

immediately?

Anonymous's picture

i can attest to the long relationship of kuwait with citi.
in 1977 i was a eurocurrency trader for citibank, nassau. it was a 13 billion book of business. $11 billion of it was the x account--which was actually kuwait.

SWRichmond's picture

Marla, excellent.

"....economic warfare of this kind, reasoning that:

The composition of the Saudi portfolio at this time limits its use as a political weapon. Since Saudi surplus funds are heavily concentrated in a few countries and in US dollar assets, any politically-motivated shift out of the US dollar could involved heavy financial losses for the Saudis."

This is, of course, the exact same reasoning that is being used vis-a-vis China.  Our banksters are nothing if not clever.

Second, all war is economic.  Please do not distinguish between "economic warfare" and other kinds, there are no other kinds.  All war is strategic; all war requires and uses money.  A would-be belligerent that cannot afford to field an opposing force is not a belligerent.  Wars are won not by killing the opponents soldiers but by making it impossible for him to have soldiers there to oppose you in the first place.

The oldest war (other than the war between men and women), the one that is constantly being fought, and IMO will constantly be fought, is the war between old money and new money.  And old money has the upper hand, having more experience and deeper resources, so it almost always wins.  Old money uses the greed of new money to maneuver it into a position where it can be neutralized.

This means the banksters are predictable, which is IMO their major weakness.  No matter what individual strategies they might employ at any given time, it's all about controlling the money.  Money, therefore, is our weapon of choice to use against them.  Of course, they control our money.

Isn't that interesting?

ATG's picture

Rothschild vs Rockefeller

max2205's picture

Too bad bowing doesn't pay off like it used to.  Maybe POTUS can deep throat?

Anonymous's picture

If the KIA had $200 billion and pulled it out of Citi that would definitely squash them. The FDIC would not just sit on its hands as that much money flies out of Citi's deposit base. There's a reason they got $500 billion on that credit line from the Treasury.

Even if Citi could survive such an outflow it would destroy any confidence people have in the bank and cause numerous other investors and high-level depositors to pull out. The government can do little about a bank run, especially now that it can be done electronically.

Should this story hold true and the KIA pulls out its considerable amount of money, it most likely means Citi will fail.

Sun Tsu's picture

-Marla, insightful post on Kuwait, however Dubai has little gas or oil wealth. The Emir's great vision is for Dubai to be the Middle East's  banking and trade center.

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