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Prince Chokes on Wall Street's Dog Food

Here's a good way to get fired: Get your firm up to its armpits in junk subprime assets, then write them down by $8 billion to $11 billion dollars, only a couple of weeks after having written off a measly $1.6 billion in a disastrous -- but not disastrous enough --quarterly report.

That's what finally got Chuck Prince bounced from Citigroup (NYSE: C  ) . An emergency weekend board meeting put Robert Rubin in as chairman, and Sir Win Bischoff as acting CEO. (Citi, of course, put the typical Wall Street fib onto the announcement, saying Prince "elected to retire.")

What's the problem? Well, the immediate damage comes from rotting mortgage assets -- the very stuff that was making Wall Street so rich until earlier this year. So long as the prices of houses kept going up, borrowers' inability to repay was hidden by rolling refinancing. But the music stopped, and those unlucky enough to be stuck with the ground-up and optimistically graded mortgage meat are getting sickened, as the rot spreads into the prime cuts.

Consider the details of the Citi announcement. It's writing off that $8 billion to $11 billion of its $55 billion in "direct" exposure to subprime. (Bah, only 20%!) Of that $55 billion, Citi says that $11.7 billion is in loans, while the remainder is in "super senior" tranches of collateralized, asset-backed securities. That's the key here.

In chopping up and mixing mortgage meat to arrive at the grade-A dog food Wall Street's blue-chip firms craved, the financial butchers scraped the bad cuts together with the not-quite-as bad, then mixed them up. They served out different slices, shunting the earliest potential losses onto the lower-tranches -- which had higher yields, natch. The stuff on top was therefore declared grade-A. (If that sounds idiotic to you, then you're a Fool not a Wall Street financial genius.)

Citi's admission is further proof that those low tranches are decimated, and that the top slices are now going rancid at an alarming rate. Oh, and by the way, read the fine print. Those super-senior tranches "are not subject to valuation based on observable market transactions," meaning that Citi's valuation of these is based purely on ... umm ... what it figures they're worth.

This continuing disaster shouldn't surprise anyone who's been watching events at Countrywide Financial (NYSE: CFC  ) , Bear Stearns (NYSE: BSC  ) , Lehman Brothers (NYSE: LEH  ) , or Merrill Lynch (NYSE: MER  ) . These banks are all getting burned by a problem of their own making, and it's no secret that Citi is desperate for help, having enlisted the Treasury Department to try and help it dump distressed Structured Investment Vehicle (SIV) assets onto a bailout fund.

That's enough to tell us that this is just the beginning of the story, folks.

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