Citigroup Consultants Urged CDO Drive, Maheras Says (Update3)
April 07, 2010, 12:37 PM EDT(Adds UBS consultants in 12th paragraph, lights in 21st.)
By Bradley Keoun
April 7 (Bloomberg) -- Citigroup Inc., the bank 27 percent owned by the U.S. government, began its foray into money-losing collateralized debt obligations on the recommendation of outside consultants and failed to see the risks, said the bank’s former trading chief, Thomas Maheras.
The consultants were hired by “our seniormost management” and in 2005 conducted a “careful study,” Maheras said in prepared testimony submitted in advance of a hearing today before the Financial Crisis Inquiry Commission, which is looking into the causes of the 2007 collapse of the subprime mortgage market and ensuing bank bailouts. The consultants weren’t named.
“Even in the summer and fall of 2007, I continued to believe, based upon what I understood from the experts in the business, that the bank’s super-senior CDO holdings were safe,” Maheras said.
The collateralized debt obligations, created by repackaging bonds that in turn were created from home loans, carried triple- A ratings and were deemed “super-safe,” Maheras said. The so- called super-senior holdings, the highest-rated of all CDO bonds, plunged as subprime-mortgage defaults surged and contributed to the bank’s record $28 billion net loss in 2008.
Citigroup had to get a $45 billion taxpayer bailout in late 2008. Last year, the U.S. Treasury Department converted $25 billion of the funds into 7.7 billion common shares in the bank, and Citigroup repaid the remaining $20 billion.
Bushnell, Dominguez
The bank’s shares rose 1.5 percent to $4.36 as of 9:45 a.m. in New York Stock Exchange composite trading, down about 90 percent since the end of 2006.
The commission, led by former California Treasurer Phil Angelides, also plans today to quiz former Citigroup Chief Risk Officer David Bushnell and Nestor Dominguez, who co-headed the bank’s CDO business.
The first to testify today was former Federal Reserve Chairman Alan Greenspan, who defended the central bank’s record on consumer protection in the years before the financial crisis and said regulators can reduce the chances of another meltdown by requiring banks to hold more capital.
A hearing tomorrow will feature former Citigroup Chief Executive Officer Charles O. “Chuck” Prince, who was ousted in November 2007, and Robert Rubin, the former Treasury secretary who headed Citigroup’s executive committee.
‘Alchemy’
One of the commissioners, Byron Georgiou, said during today’s hearing that Citigroup’s CDO business was akin to medieval “alchemy,” where mortgages made to borrowers with low credit scores were packaged into bonds with triple-A ratings.
Citigroup is at least the second bailed-out bank to acknowledge the use of consultants in formulating trading strategies that later failed.
UBS AG, Switzerland’s largest bank, said in an April 2008 report to shareholders that former investment-banking chief Huw Jenkins commissioned external consultants in the mid-2000s to evaluate growth areas. They found that the biggest gap was in fixed income, and UBS subsequently began accumulating mortgage- related assets as part of its CDO business, according to the report.
Bushnell, who was replaced as Citigroup’s chief risk officer in November 2007, said in a prepared statement that he communicated with Prince “almost daily” about the company’s risks and had a “regular, weekly one-on-one meeting” with the CEO. He also regularly provided reports to the board of directors, he said. Bushnell said he oversaw a team of 2,700 “highly qualified risk professionals.”
The depth of the housing crisis took them by surprise, he said.
“In this case, our method of analysis was not enough,” Bushnell said. “Risk models, which primarily use history as their guide, assumed that any annual decline in real-estate values would not exceed the worst-case historical precedent.”
‘Efficient Use of Capital’
Dominguez, who was co-head of Citigroup’s CDO business from 2006 to 2007, said in a prepared statement that his business produced $400 million in “total annual revenue in 2005 and 2006.” The revenue included fees from setting up the deals as well as profits from trading them, he said.
The bank’s executives believed that retaining the super- senior CDO bonds was an “efficient use of capital and Citi’s balance sheet,” Dominguez said.
Citigroup had almost $90 billion of revenue in 2006, and almost $2 trillion of assets.
The bank took a $14.3 billion writedown on CDOs in the fourth quarter of 2007 alone, according to Bushnell. Citigroup posted a $9.8 billion net loss that quarter, which stood as a record in its nearly 200-year history until a $17.3 billion loss was reported for the fourth quarter of 2008.
“I believed then, and still believe now, that Citi’s CDO business was performing an important function in the capital markets” by serving investor demand for the securities, Dominguez said. Shortly before noon, following a “pop,” the hearing room went completely dark as the lights failed. Technicians scrambled to open red-velvet curtains along the one outside-facing wall and Angelides resumed the session under natural light. Vice Chairman Bill Thomas told Greenspan he wasn’t sure if the recorder was still functioning, so responses to questions should be submitted in writing. The lights returned at 12:10 p.m.
