Back in 2006, when the housing bubble was entering its truly (and obviously) manic phase, mega-bank Citigroup was being pressured by Wall Street to grow faster. And rather than pushing back against what were clearly ill-timed demands from desperately-short-sighted analysts, Citigroup CEO Chuck Prince uttered some words -- and adopted a strategy -- that live on in the annals of banker cluelessness:

"As long as the music is playing, you've got to get up and dance."

Here's how Businessweek covered the story at the time:

"The concerns are perfectly legitimate," says [CEO Charles "Chuck"] Prince. "People are saying 'Do something!' They want to know how long is this guy going to take?" Not to worry: "Investors will be happy to hear that Prince is dropping hints that he's revving up the deal engine again. He laments that for the past three years he had to stay out of the market and focus exclusively on making existing operations more profitable. 'We're getting ourselves back on the playing field,' he said, noting that most of the acquisitions will be in foreign markets. There's already chatter in London that he's eyeing Lloyds Bank or BNP Paribas.

Here in the U.S., consumers are Prince's target. "If we don't grow consumer, the whole place has modest growth," he says. Prince is planning big branch expansions in locations where many customers of the company's Smith Barney brokerage business live, hoping to sell them bank products. In Boston, for instance, Citi is planning to build 30 branches next year as a service to 30,000 Smith Barney clients. If it's successful, Citi will roll out new branches in Philadelphia and a half-dozen other cities.

And some, at least, in the financial community think this is a good idea. "We are impressed by [Citi's] organic growth efforts, including 785 new branches year-to-date," said one analyst.

This, it should be noted, was one short year before the US housing market and consumer spending in general imploded. For more on Citi's housing bubble tragi-comedy, see Banks and Bubbles III: "We're getting ourselves back on the playing field"

Now fast forward to the present as an even bigger global financial bubble enters its terminal phase, and Citigroup is back on the dance floor, stomping around to even more dangerous music. From today's Bloomberg:

Citigroup Embraces Derivatives as Deals Soar After Crisis

In the past five years, the firm that took the largest U.S. bank bailout of the financial crisis increased the total amount of derivatives on its books by 69 percent, surpassing most U.S. peers and closing the gap with the market leader, JPMorgan Chase & Co. (JPM). At the end of June, Citigroup had $62 trillion of open contracts, up from $37 trillion in June 2009, company filings show. JPMorgan trimmed its holdings 14 percent to $68 trillion.

Citigroup is expanding as regulators try to rein in instruments that helped fuel the 2008 credit contraction. The third-largest U.S. lender has amassed the largest stockpile of interest-rate swaps, a type of derivative that can swing in value when central banks raise rates. More than 92 percent of the bank's derivatives don't trade on exchanges, making it harder for regulators to spot dangers in the market.

"Risk-taking is in their DNA," said Arthur Wilmarth, a law professor at George Washington University, who wrote a 2013 paper describing failures that led New York-based Citigroup to seek a $45 billion bailout and more than $300 billion in asset guarantees during the crisis. Even taking the winning side of a derivative carries a risk the other party can't pay, he said. It's "basically a speculative trading business."

Derivatives typically require parties to make payments to each other based on the value of underlying stocks, bonds, commodities or interest rates. Airlines and farmers use the contracts to offset price swings for fuel, vegetables and meat. Bond buyers rely on them to insure against defaults, and some investors use them to speculate.

Client Demand
Regulators are demanding banks keep more capital for derivatives after credit-default swaps insuring mortgage bonds amplified losses from the U.S. housing bust. The government bailed out American International Group Inc. (AIG), which sold many of the contracts, to prevent the system from collapsing.

Citigroup, led by Chief Executive Officer Michael Corbat, 54, expanded the business from a low base to meet the needs of customers, said Danielle Romero-Apsilos, a company spokeswoman.

"We have seen gradual, risk-managed increases in interest-rate derivative activity over the last five years as a result of client demand, which has brought us in line with our competitors," she said in a statement.

The increase in the value of Citigroup's derivatives restores the bank to a second-place position it hasn't held since the first quarter of 2008.

The bank doesn't disclose how much it earns from derivatives. During the first half of the year, it brought in $6.85 billion from fixed-income markets, including currencies and commodities, and $1.54 billion from equities. The figures include revenue from trading derivatives as well as cash instruments such as Treasuries and corporate bonds.

Gross Notional
Citigroup's $62 trillion of derivatives is what's known as a gross notional figure, a raw tally of all contracts without adjusting for risk-reduction efforts. The amounts don't represent money that changed hands and are used to calculate payments between parties. Banks prefer to focus on net figures, which are much smaller, in part because they can use offsetting positions to cancel each other.

That math relies on every party paying -- something AIG couldn't do -- and on the trades moving in opposite directions, a relationship that can break down. In 2012, offsetting trades at a JPMorgan subsidiary in the U.K. led to more than $6.2 billion in losses when they moved in the same direction.

Citigroup reported $44.5 billion of derivatives assets at the end of June after backing out netting arrangements and collateral, according to filings with the Securities and Exchange Commission. JPMorgan reported $49.1 billion.

The tendency of banks to rely on each other to net positions means one firm's failure can cascade through the system. The danger that one party can't hold up its end of the deal is known as counterparty risk. It means even if positions are netted, every trade adds risk unless it's fully backed by collateral, said Marti Subrahmanyam, a finance professor at New York University's Stern School of Business.

"Always the concern with gross numbers is that netting could break down," Craig Pirrong, a finance professor at the University of Houston, said in an interview.

Rising Rates
About 55 percent of Citigroup's portfolio is interest-rate swaps, which typically involve exchanging a floating-rate payment for one that's fixed. Less than half of the bank's interest-rate contracts are cleared, and while those in which the firm receives a fixed payment look safe in a low-rate environment, they can lose value when rates rise.

Some thoughts

The Bloomberg article does a good job of pointing out the absurdity of reporting a net risk position of only 1/1,000th of gross derivatives exposure. With this kind of leverage it will take just a few relatively minor hedge funds to fail to bring down the whole house of cards.

And note that Citi's big recent bet is on interest rate derivatives, which are, as the name implies, bets on the direction of interest rates. For every up bet there's a corresponding down bet, which means the only environment in which this market doesn't blow up is one characterized by extreme stability. Let there be a rate spike in either direction and half the counterparties on tens of trillions of dollars of bets are under water. The higher the volatility the deeper the losers are buried. Let a few of them be unable to make good on their obligations and Citi's minimal "net" exposure becomes "gross" in both meanings of the word. Since rising volatility is the only certainty in the decade ahead, some form of derivatives crisis is highly probable, leaving Citi in its accustomed spot at the center of the storm.