Everyone said Meredith Whitney was wildly wrong when she predicted trouble for US banks. Guess who they’re listening to now?

YOU MAY NOT recognize the name. But the world’s biggest bankers do. So do clients of Oppenheimer & Co, the New York investment firm where Meredith Whitney was a managing director. And increasingly Washington is paying attention to what this 39-year-old financial analyst thinks. Named one of Fortune magazine’s 50 Most Powerful Women last year, she also made Institutional Investor magazine’s 2008 All-American Research Team. Her opinions are quoted in financial journals in the US and Europe and she is a frequent commentator on American television. What rocketed Whitney to such prominence was her publication of a report on October 31, 2007 that had the audacity to question whether Citigroup, one of the world’s largest banks, could continue paying its 54-cents-a-share quarterly dividend. The report, in which she also downgraded the stock, was dynamite. Not only did it destroy 7 percent of Citi’s value overnight, but it also blew 2.5 percent off the Standard & Poor’s 500 stock index. Four days later, the “Whitney Effect” cost Citi CEO Chuck Prince his job.

Like the child in the fairy tale who announced that the Emperor had no clothes, Whitney was the first analyst – and for a while the only one – to say that Citi’s financial performance was underwhelming. In the uproar that followed, most of her peers questioned her conclusions and sided with Citi. But now that Citigroup is struggling to survive, along with other banks inside and outside the US, Whitney’s fellow analysts have turned just as negative about the industry as she is.

For an expert in quantitative analysis, there is nothing geeky about Whitney. She talks in a friendly, straightforward manner and avoids jargon, believing that clear information “empowers” investors to make the best decisions. Whitney describes herself as a competitor. She even challenged billionaire Warren Buffett on the question of which of them earned more money delivering newspapers door-to-door as kids.

Competitive as she is, Whitney doesn’t gloat over being right about Citigroup. On the contrary, she feels that her consistent pessimism about the financial industry requires her to make suggestions to improve it. In her 90-minute interview with power’s Ann Morrison – one of the few she grants these days – Whitney also explains what she sees as the future for the banking industry, how her parents influenced her life and the parallels between financial analysis and wrestling.

She knows the wrestling world through her husband John “Bradshaw” Layfield, a World Wrestling Entertainment champion and author of Have More Money Now: A Common Sense Approach to Financial Management. The two met in 2003 when they were panelists on an investment TV show and they married two years later. Whitney, who is opening her own research firm this month, relaxes by doing the challenging New York Times crossword puzzle – in ink. She also relishes the fact that her new prominence allows her to hang around with super-smart people, especially the women in the Fortune 50 group. “I try out my ideas, and get smarter through the company I am exposed to. It is just my favorite way to spend time,” she says. “It’s the ultimate competitive sport.”

What information did you use to make your now-famous call that Citigroup was likely to cut its dividend?
I’ve approached my job the same way for 15 or 16 years in terms of looking at the numbers to tell me a story. In many ways you are almost an investigative journalist in this job, questioning whether the story makes sense. Even in October 2007, when we didn’t know what the exposure was to CDOs [collaterized debt obligations] and all the toxic assets that have resulted in billions of dollars of write-downs, what we did know was that Citi’s tangible equity was 2.8 percent [of tangible assets] while the average of its peers was 4.5 percent. So the bank was undercapitalized by at least US$30 billion. My estimates showed that they would not be able to earn their dividend. That meant Citi would either have to raise capital – and $30 billion is a big number – or sell assets or cut their dividend. Or do all three, which is eventually what they did. There was nothing different about the Citi call than any other call in my career, except that it attracted a lot more attention.

Why? Is there something special about Citicorp?
Citi had been off limits for many analysts. In the summer of 2007, I was at a meet-and-greet for the CFO, who was new from American Express. At the meeting, a highly regarded analyst said, “Citi is un-model-able, I’ve given up.” And I looked at this guy and thought, “But that’s your job.” There is nothing that is un-model-able. If you can’t model a company and you can’t understand a company, you’ve got no business covering that company. Nothing is too big to be analyzed. Does the company make money or doesn’t it? Is it adequately capitalized or isn’t it? Is it growing or isn’t it? It’s all pretty basic stuff. And if you look back at my report, it was so simple that people could understand it. I think that’s why it got so much attention. It was so simply presented that people went, “Oh my gosh, is that right? Holy smokes!”

A lot of people held Citi stock, including your husband. Could you warn him?
According to the principles of my firm, my family can’t trade on the names I cover. So my husband held Citi and he couldn’t sell. Look, I lost a lot of money on Lehman because I couldn’t sell it.

Did you have any sense of the repercussions your Citigroup report would have?
I knew it was a big call because it hadn’t been done before. But I didn’t think it was going to completely sideswipe the market – some 360 points off the Dow [Jones Industrial Average]. I knew everything had to be perfect about that report. And it was pretty pristine.

How did your peers respond to the Citi downgrade?
Analysts across the board published reports saying that my concerns were overstated. Some even said that my math was wrong. For an analyst that is the lowest of all insults. For a woman, the last thing you want to be told is that you look heavy. As an analyst you never want to hear that your math is suspect. A lot of my peers, a lot of my clients and a lot of people I didn’t even know said I was wrong.

And there was even a death threat?
Uh-huh. There was some nasty stuff, coming from all over. You know, people were losing a lot of money and were scared by that.

Was Citi your toughest call?
No, it was the easiest because the numbers were so straightforward. It was an absolutely quantitative call, and I was using numbers the company had published themselves.

Then what was the toughest call? 
It came about two weeks later in November 2007, and the report was entitled Ring of Fire. In it, I explained the correlation, the incestuous relationship, between the ratings agencies and regulatory capital. As the ratings agencies were downgrading securities, the regulators were requiring companies to put up more regulatory capital against those securities. And the process kept continuing as assets became worth less and less, in a downward spiral. And so the title of the Johnny Cash song “Ring of Fire” just made sense. [“I fell into a burning ring of fire. I went down, down, down and the flames went higher.”] The conclusion of that report was that all financial institutions would have to raise capital. That was a big call.

One story about you begins: “It’s safe to say no one has fewer friends on Wall Street than Meredith Whitney.”
That’s not very nice. I have the same number of friends now as I had before. My personal relationships are the same. My professional relationships are built on respect, so those aren’t won or lost easily. There are some really neat people in this business.

How do you evaluate whether a CEO is doing a good job in this environment?
It’s tricky because there is so much government supervision. But at a minimum, the CEO has to run an efficient business and know where the bodies are. And you have to be a technology leader to do that. That means that from an information standpoint you can stay ahead of your problems, or at least keep up with them. Citi has none of those advantages: its credit card business doesn’t speak to its mortgage business, which doesn’t speak to its auto business. There are so many silos operating under the Citi umbrella that they don’t necessarily know what they have.

How would you rank other bank managements?
Jamie Dimon of JPMorgan Chase – technology leader, low-cost operator. He’s a simple businessman. The businesses should be simple: Do you make money or do you not make money? Ken Lewis of Bank of America is also a simple businessman. He has been a low-cost operator, took care of the businesses and created good shareholder value. His Merrill Lynch acquisition was just a very unfortunate deal at a very unfortunate time. Ken Chenault of American Express is the same, in addition to being a very inspiring leader.

You have great access to bank leadership. Are you ever concerned that your personal relationship with the CEOs might color your analysis?
No, my analysis has never been personal, it’s always quantitative. There are some managements that I think are fantastic even though I have had sell or hold ratings on them. I don’t have any buy ratings out right now. It’s not my job to tell people who is the funniest or the nicest CEO. It’s my job to make people money or to save them money.

You are terrific on TV. The only time I saw you stumble was when you were asked whether Lehman Brothers could survive.
That was a very sensitive situation because the writing was really on the wall for Lehman after their second quarter reported in June. I normally speak pretty freely. But I had the good sense not to in this case. It would have been irresponsible to say something negative on television about a company with its financials in such a fragile state. There are things I just won’t do in terms of taking out a company and shooting it. That would have been unnecessary and reckless. My mom did a good job. She raised me to be responsible.

You write a lot about the consolidation in the US banking industry. Will there be more?
Do we need more than 7,000 banks in the US? I think you will see a re-regionalization of lending. We will go back to a period when banks knew their customers, and when your neighbor’s deposits funded your mortgage. You will have smaller banks, but that doesn’t necessarily mean small banks. Look, five major banks in the US control 70 percent of consumer lending products. To get smaller doesn’t mean little Mom-and-Pop savings and loans. It just means banks will become more regionalized. That makes sense. Old becomes new again.

So further consolidation is a good thing?
I am looking forward to further consolidation in the banking industry. I think you are going to see amazing combinations you have never seen before. Hopefully, the US government will take a pro-active approach and say, “Okay, what businesses make sense together? What business will grow and make money and attract capital? What do we want the world to look like in five years and how are we going to get there?” Certainly, we want a world where money is transferred and businesses are profitable and growing. So we have to change the concentration of lending and parse it up among many more players. The government cannot fund the American financial system in perpetuity.

In the massive consolidation that happened in the banking industry over the past 20 years, banks didn’t just take this piece or that piece. They took everything. So now you’ve got a lot of hopscotch combinations that don’t make any sense. Citi is a good example, because its businesses were never integrated. But look at the way that Citi’s Smith Barney and Morgan Stanley came together recently. If that brokerage joint venture were a stand-alone company, individuals would invest in it.

How is the US government going to instigate these business combinations?
If you create an agency to provide backstop financing to some of these combinations, you would start to see financial people tell government what they would want to buy – previously off-the-menu items. The idea is to provide a new government entity that would encourage private capital to come in and invest. There is no denying that credit was over-extended and put into the hands of individuals who couldn’t pay it back. But now credit is being taken away from consumers who can pay it back. So how do we put money back into the system? It’s done by creating businesses that can actually make money, survive on their own and grow. You can create those entities now, and now is the time to do it, with government help. There is not currently much support for this. But I have been writing about it, and I hope it will come. 

Will international players take part in this new re-organization?
Not ones like the Royal Bank of Scotland, which will probably be selling its Northeast bank and lending branches because it’s got to raise capital. HSBC? Probably. Look, 40 percent of global wealth is in the US. And the US probably has the most modern financial system, so there will be opportunities. I think the question will come down to how protectionist the US government will be in terms of its capitalism and American taxpayer dollars. The sooner we get to business combinations that make money, so that they can generate their own capital and make loans, the sooner we will see a stabilization of the economy.

When will that be?
When the trend of capital contraction reverses, this crisis will end. I don’t believe this will happen for another 12 months at least.

Late last year, you said we are now entering a “new era in the financial landscape” characterized by consumers paring down their debt and slowing their spending. That’s not likely to help the economy.
The first stage of credit contraction happened in the summer of 2007, when banks started to realize that the higher losses they were incurring on home equity loans, mortgages and credit cards were tied to home price depreciation. The states with the biggest home-price depreciation had the highest losses. And vice versa. So banks started cutting back on credit in the areas where home prices had lost the most value.

That trend has continued. But now a new law is going into effect that changes the way banks can price their risk. Though intended to protect the consumer from “unfair and deceptive lending practices,” it will have the unintended consequence of making it very difficult for banks to re-price their risk in the midst of a funding relationship. If banks cannot price their risk adequately [raise interest rates], they will just start to cut back on credit. We’ve written that they will pull at least $2 trillion from the credit card system. That’s out of $4.7 trillion in unused credit lines.

That will impact consumer spending, because US consumers use their credit cards as a cash-management vehicle. Some data points: 90 percent of US consumers revolve their credit card at least once a year, meaning that they won’t pay their full balance at least one time a year. So, they think “I’m using $1,000 of my credit line, but I have an extra $4,000. So my total credit line outstanding is $5,000. And I’ve only used $1,000. That unused $4,000 is my rainy day fund – if my dog gets sick or my kid needs braces or I lose one of my jobs.” With so many Americans relying on their credit cards as a source of liquidity, reduced credit lines would be like a major pay cut.

Didn’t something similar happen in Japan?
Yes, when Japan changed the Grey Zone laws in December 2006. It is not exactly a parallel situation, though what is parallel is a resulting contraction in consumer credit. You could argue that led the Japanese economy to flip back into recession.

You have a reputation for working very long days. Would you call yourself as a workaholic?
Even if I don’t get into the office until 9am, I am usually working from home at 5am. And I often work until 8:30pm. But I love it. If you love what you do, you don’t define yourself as a workaholic. There is nothing more interesting right now than finance. I also appreciate that I have a lot of people’s ears right now, and I want to make the most of it.

Including people in Washington?
Uh-huh. No position is set in stone, so I keep trying to come up with valuable, insightful research. Most of the reason I work so late is that’s when I do my writing. Writing helps me think.

You were a history major at Brown University, so how did you end up in finance?
I was a German history major at Brown and that was pretty entrepreneurial. I have always been attracted to the most competitive field. And I thought that to graduate with honors from Brown was competitive, the history department was incredibly competitive, and it was a fascinating time to be studying German history – it was when the Berlin Wall fell. I wrote my senior thesis on the economic roots of the dissemination of the Bauhaus movement to the US. It was quasi-finance, I guess, mixed with culture – the juxtaposition of Walter Gropius and Frank Lloyd Wright. America is a really neat place, a country of individuals, and that’s why the Bauhaus never really caught on. Also, my dad said to me growing up, “From New York, you can go anywhere, but you can’t go from anywhere to New York.” Finance is the most competitive industry in New York, and so here I am.

Did your entrepreneurial spirit start with your newspaper delivery route?
When I was about eight or nine, I told my mother that I had to have my own money. And that led to the newspaper route. It was just run-around money. In fact, the first real thing I bought was a watch for my mom, which she still has. I was very good at delivering papers and was able to buy up other paper routes. At the Fortune women’s summit in October, I didn’t want to bug Warren Buffett, who was there. But I needed to talk to Carol Loomis [Fortunesenior editor-at-large], who was with him. I couldn’t help myself and said to him, “Thank you for providing such comfort at a time when most Americans are scared to death.” And he said, “Tell me about your paper route.”

If you had a real paper route, not just a casual hobby, you will talk about it all day long. And I said, “Well, I’ll tell you about my paper route, but I need to know a few things. Was yours a bike route or on foot?” And he said, “Bike.” And I said, “That is such a different experience because my paper route was on foot, so I don’t know if we can compare ourselves.” I would go up to the front door, put the paper behind the screen door and get better tips. And so I asked Warren Buffett, “What was your best tip?’ And he said, “$1.” I asked him what that would be adjusted for inflation. And he said, “$10.” I got $20.

Are there any parallels between your job and your husband’s as a professional wrestler?
Yes, to the extent that the guys I meet through John, by and large, have been fascinating, smart, polite, incredible. Because they go out in a theater setting every night, they can never underestimate their audience. They bring their game up over and over again, and that’s why the crowd responds to them. If you ever underestimate your audience, you’ll make a whole lot of enemies. I don’t know whether this has changed me, but it certainly reinforced my belief that if you can’t explain something to someone in simple terms, you don’t know what the heck you are talking about. The power of communication is that I give you information to empower you. And a lot of people in finance don’t do that. They want things to appear complicated so that they can have power. It comes down to respect for your audience. The wrestlers work really hard, I work really hard. They travel a lot, I travel a lot. The jobs are never-ending. But I do not go into a meeting and get a huge round of applause.

No, but you can move markets, you have unparalleled access to industry leaders, you have influence in Washington and you are one of the 50 most powerful women in America. 
The acknowledgment is neat. But getting an opportunity to meet really smart people has been the big bonus, especially being included in that Fortune group of powerful women. With them cool is defined by your attitude, not by how much money you make. It’s more about what are you doing, how helpful are you to other people, how are you giving back? I work in an industry so obviously dominated by men I just take it for what it is. But what a luxury to be able to get such smart people together who just happen to be women. Being around smart people is the ultimate luxury. It’s the ultimate competitive sport. But it’s a collective competitive sport, if that makes any sense. I am not competing with anyone other than myself.