March 22, 2011

Citigroup on Liquidity

Would you shrink your share base by 90%? What if it cleared noise out of your trading?

NOTE: See the update on the Issuer Data Initiative at bottom.

Citigroup, market cap $129 billion, plans to trim its 29 billion shares with a 1-for-10 reverse split. Citi float mushroomed from 5.5 billion shares when the U.S. government injected cash through warrants that converted to shares, which the Treasury then unloaded through Morgan Stanley while the Fed quantitatively eased the markets to solid gains.

Resisting the gravitational pull to ask rhetorically why government has power to print monopoly money, pump up its own outcomes, and put paper into one bank but not another, let’s make this Part Two of “lessons in liquidity.”

Last week we discussed the very antimatter to Citigroup, Berkshire Hathaway. BRK.A trades about 500 shares per day, mostly on the NYSE, without high-frequency trading (HFT), for about $127,000 each. There are 1.6 million shares out. Its beta coefficient, a measure of volatility, is lower than every Dow Jones Industrial component save Wal-Mart.

Meanwhile, Citigroup became the mother of all trading securities, averaging over 450 million shares daily – easily the most active stock of all. It’s five times more volatile than BRK.A. On January 18 this year when Citigroup (NYSE:C) reported results, its stock traded about 1.9 billion shares, some 35% of total NYSE volume that day.

Justin Schack, who heads market structure matters for the smart folks at agency trader Rosenblatt Securities, told the Securities Technology Monitor that Citi’s reverse split could reduce total volume in US trading markets by 5%. And since C is a major force behind options contracts, those markets could take a hit too.

Why? Because much of the volume in Citigroup comes from “furnishing liquidity.” That’s HFT. Without disparaging the architects behind paying traders to trade (similar to inflating your currency because prices are falling), this volume is not real. Exchanges pay liquidity providers to attract and keep the best bid or offer so they can earn revenue from the consolidated tape (see Issuer Data Initiative, again).

Suppose 80% of trading in Citigroup is HFT. These shares just move from Citigroup’s Designated Market Maker Barclays, at Post 8 Panel U, through Supplemental Liquidity Providers like Getco, Goldman Sachs and Knight, and around to proprietary traders executing at BATS and Direct Edge, to mix with the retail volume at Penson, Citadel and others.

This behavior literally distorts itself. If the shortest distance between two points is a straight line, this trading market looks like a skein of yarn meeting a basketful of kittens.

Citigroup is a broker-dealer. They know trading. And they’ve decided to reduce liquidity by 90% when conventional wisdom says preserve liquidity, like gold.

What if we just pressed pause? I’ve personally argued that more liquidity is better. But maybe a small amount is best. In real estate, it is. Suburbs have high beta. Beaver Creek does not. If gold is your medium of supply fitted to demand, a Ford Taurus and a two-piece men’s suit today cost exactly what a suit and a Model T cost 100 years ago.

Maybe all public companies should trade for $100,000 per share. Would that kill the Citigroup effect?

Speaking of data, thanks for your growing support for the Issuer Data Initiative. But “thank you” isn’t correct. It’s your data. Information about your shares has gone missing in gobs and bunches via the consolidated tape. Let’s drag it back into the light.

If you haven’t yet committed support, do so today.

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