It appears that the pain of the recession is not deep enough to teach Citigroup Inc. (NYSE: C) what it needs to learn. The bank, which had to sell off non core assets and slim down in the wake of the financial crisis, is now readying a new unregulated insurance credit derivative, the CLX. Basically, the CLX is systemic risk insurance that will pay out in the event of a financial crisis. The basic premise is to allow investors to hedge against a spike in funding costs.The company is heading back into familiar territory where they’re putting taxholder money into play on another risky bet. Simply put the instrument will enable it to gamble on future events by issuing complex financial instruments which attempt to quantify risk. This is very similar to the original business that Citigroup was heavily involved with that precipitated their fall from glory.
Citi says regulators have been given CLX for consideration. So far, they haven't passed judgment.
As expected, the bank was quick to deny that it's putting taxpayers at risk. Rather, it might have the opposite effect: for example strengthening an insurer when borrowing costs soar.
However, it is difficult to buy Citigroup's claim. As Cambridge Professor Chris Rogers puts it, “This is basically a kind of insurance product. The main issue is: how good is the party issuing it? If it’s going to be paying out huge numbers in the event of a crisis, will it be able to meet obligations? Insurers can buy reinsurance for their liabilities, but the buck has to stop somewhere—there’s a limit to how much a private insurer can pay out. Only the government can cover unlimited losses.”
Undoubtedly, Citigroup's latest move seem to heavily depend on the perception that public memory is short.
All this talk about CLX raises the obvious question: Who stands to lose most if this unique yet complicated scheme crashes one fine morning? No prizes for guessing the right answer!
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