A Double Hit for the Economy

By Neil Irwin and Tomoeh Murakami Tse
Washington Post Staff Writers
Wednesday, January 16, 2008

Citigroup lost $9.83 billion in the final three months of the year, and retail sales fell in December. Together, the news shows how the slowing economy is punishing the financial position of the world's biggest banks and ordinary American consumers.

The stock market fell sharply yesterday, with the Dow Jones industrial average losing 277 points, or 2.2 percent. Investors fear that a self-reinforcing pattern will set in whereby the worsening condition of consumers will cause losses to financial institutions, making them less willing to lend money, making consumers that much less able to spend.

"The feedback loop goes in both directions," said Jan Hatzius, chief economist for Goldman Sachs. "Weakness in the financial sector is partly a reflection of a slower real economy, and the slower real economy is partly a result of weakness in the financial sector."

Citigroup's loss, the largest in the firm's nearly 200-year existence, was due to an $18.1 billion write-down of the value of mortgage loans Citi holds and a $4.1 billion hit from higher-than-expected losses on consumer loans. Executives said in a conference call that the credit weakness was most evident in five states -- California, Michigan, Florida, Arizona and Illinois -- that have been among the hardest hit by the housing slump and where loss rates on mortgages increased fourfold compared with the rest of country.

Retail sales, meanwhile, fell 0.4 percent in December, the Census Bureau reported. There was a particularly steep drop in sales by retailers of building materials, gasoline stations (because of lower fuel prices) and clothing stores, and sellers of books, music and sporting goods.

Part of the weak retail number was attributable to an early Thanksgiving, which pushed more holiday sales into November. Nonetheless, retail sales grew at the slowest pace since 2002, and economists said American consumers were clearly pulling back.

"It was not a good month in December," said Brian Bethune, an economist with the consulting firm Global Insight. "We're certainly losing momentum there, and early indications are that that continued in the first half of January."

The Citigroup results were the first in a round of major losses expected from some of the titans of U.S. finance. Most notably, Merrill Lynch will report what analysts expect to be a multibillion-dollar loss tomorrow.

"I don't think the Street is convinced it's over yet," said Sal Morreale, a trader at Cantor Fitzgerald. "Retail sales were not good. You have delinquencies; you have the subprime . . . add it all up and you've got real major problems."

Citigroup said it is taking aggressive action to gather more capital. It said it was raising $12.5 billion by selling stakes to big investors, including funds controlled by cash-rich foreign governments. The Government of Singapore Investment Corp. will make a $6.88 billion investment. The Kuwait Investment Authority will invest $3 billion. The investments follow a $7.5 billion stake sold in November to the Abu Dhabi Investment Authority.

Citigroup also plans to raise $2 billion more through a public offering of preferred shares.

The bank reduced its dividend by 41 percent, a move that could free about $4 billion a year. It also said it would cut 4,200 jobs in addition to the 17,200 already announced. Further reductions are expected.

While analysts welcomed the moves taken by the bank to improve its balance sheet, investors pummeled Citigroup shares, sending them down 7.3 percent.

"Citi's fourth-quarter results are unacceptable," said Vikram Pandit, recently named chief executive of the company, which is the largest U.S. bank by assets. "We need to do better, and we will do better," he said in a conference call with investors and analysts.

Citigroup wasn't the only institution to raise more money yesterday. Merrill Lynch said it is getting a $6.6 billion investment from the Kuwait Investment Authority, the Korean Investment Corp. and Mizuho Corporate Bank of Japan. Last month, Merrill said it would sell up to a $5 billion stake to Temasek Holdings, a government-run fund in Singapore.

The moves to raise more capital are particularly important if financial institutions are to play their normal role of cushioning the blow to the economy amid a slowdown. In a typical slowdown, banks stand ready to lend money to businesses and consumers, helping mitigate the damage. But in this financial crisis, banks are finding themselves with a shortage of capital. That, economists worry, may make them exaggerate the downturn rather than cushion it.

Treasury Secretary Henry M. Paulson Jr. has praised banks for raising capital, even though they must do so on unfavorable terms, because it makes it more likely that they will keep lending money through the slump.

"This has been a very difficult quarter, and there is no getting around that. . . . I am not going to make any promises," Pandit said in the conference call. "I am taking a clear-eyed view of our company."

Also yesterday, the Labor Department reported that wholesale prices fell 0.1 percent in December, reflecting lower fuel prices. Excluding volatile food and energy, prices paid by businesses rose 0.2 percent, which analysts said was not high enough to keep the Federal Reserve from lowering interest rates aggressively this month.

Bank of America said it would cut 12 percent of its corporate and investment banking staff, or 650 jobs, selling its equity prime brokerage business. That comes on top of the 500 jobs cut from the corporate and investment bank last year.

And IndyMac Bancorp, the nation's second-largest independent lender, said it will lay off 2,400 people, or about 24 percent of its workforce, to cut costs.

Staff writer Howard Schneider contributed to this report. Tse reported from New York.

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