The story begins:
Investors may do well by taking Citadel’s investment in E*Trade as a sign the worst of the mortgage market turmoil is behind us.
And while it goes on to tout Citadel’s incredible returns from buying up distressed assets as the big sign to jump on the bandwagon, there’s probably more reason to be cautious than to start accumulating the financials. There are two simple reasons for this.
Citadel invests in very specific asset classes (i.e. natural gas derivatives with Amaranth and credit spreads with Sowood) when doing these distressed buys. Second, the transactions are being consummated at enormous discounts. E*Trade has had specific trouble related to sub-prime assets on their books, and Citadel has done their due diligence – they know precisely what they are getting, including but not limited to what if any off-balance sheet items might be lurking around. And they have the capital to convince.
Many banks and broker/dealers still don’t know what their true exposure is to credit and rate derivatives and CDOs, what collateral they may be entitled to, or what lawsuits might be waiting in the wings. There are still a ton more sub-prime mortgages, as well as Alt-A and Jumbo classes, readying to reset just after the new year, and questions are begin to arise regarding the creditworthiness of derivative counterparties and commercial developers. All those issues will fall on…you guessed it…the banks and brokerages.
Unless you’re Citadel, you’d be wise to sit tight.
UPDATE 2: Discount on the troubled portfolio was around 75%. Try getting that in the everymans’ marketplace.