The New York Times has a solid bit of reporting tonight by Eric Dash and Julie Creshwell, “Citigroup Pays for a Rush to Risk,” that seeks to explain why the giant bank got itself in so much trouble.
The piece points to the usual culprit, too much risk taking, but the particular Citi flavor was what appears to be a complete lack of normal risk controls. Yes, they had the procedures, the staff, and the formalities, but they were neutered by the firm’s culture and friendships between senior risk managers and top executives. And to pour gas on that fire, CEO Chuck Prince and board member Robert Rubin pushed for bank to take on more trading risk.
But Citi has always pushed the envelope. It got in serious trouble in the late 1970s by being a heavyweight in sovereign lending. In the 1980s, it broke quite a lot of regulatory ground (and the rest of the industry free rode on its efforts), and in the early 1990s nearly went under thanks to taking on lots of real estate risk in the wrong markets.
I think the end of the bank began with Sandy Weill’s assumption of leadership. Sandy loved doing deals and was not terribly interested in operational details. Had Dimon remained at Citi, or John Reed prevailed in the power struggle with Weill, the bank is unlikely to be on the verge of a meltdown as it is now.
Key excerpts from the New York Times:
But many Citigroup insiders say the bank’s risk managers never investigated deeply enough. Because of longstanding ties that clouded their judgment, the very people charged with overseeing deal makers eager to increase short-term earnings — and executives’ multimillion-dollar bonuses — failed to rein them in, these insiders say…..
While much of the damage inflicted on Citigroup and the broader economy was caused by errant, high-octane trading and lax oversight, critics say, blame also reaches into the highest levels at the bank. Earlier this year, the Federal Reserve took the bank to task for poor oversight and risk controls in a report it sent to Citigroup.
The bank’s downfall was years in the making and involved many in its hierarchy, particularly Mr. Prince and Robert E. Rubin, an influential director and senior adviser.
Citigroup insiders and analysts say that Mr. Prince and Mr. Rubin played pivotal roles in the bank’s current woes, by drafting and blessing a strategy that involved taking greater trading risks to expand its business and reap higher profits…
When he was Treasury secretary during the Clinton administration, Mr. Rubin helped loosen Depression-era banking regulations that made the creation of Citigroup possible by allowing banks to expand far beyond their traditional role as lenders and permitting them to profit from a variety of financial activities. During the same period he helped beat back tighter oversight of exotic financial products, a development he had previously said he was helpless to prevent.
And since joining Citigroup in 1999 as a trusted adviser to the bank’s senior executives, Mr. Rubin, who is an economic adviser on the transition team of President-elect Barack Obama, has sat atop a bank that has been roiled by one financial miscue after another. Citigroup was ensnared in murky financial dealings with the defunct energy company Enron, which drew the attention of federal investigators; it was criticized by law enforcement officials for the role one of its prominent research analysts played during the telecom bubble several years ago; and it found itself in the middle of regulatory violations in Britain and Japan….
To some, the misery at Citigroup is no surprise. Lynn Turner, a former chief accountant with the Securities and Exchange Commission, said the bank’s balkanized culture and pell-mell management made problems inevitable.
“If you’re an entity of this size,” he said, “if you don’t have controls, if you don’t have the right culture and you don’t have people accountable for the risks that they are taking, you’re Citigroup.”…
Though they carry less prestige and are paid less than Wall Street traders and bankers, risk managers can wield significant clout….Though risk managers and traders work side by side, they can have an uncomfortable coexistence because the monitors can put a brake on trading….But at Citigroup, many say, it was a bit different.
David C. Bushnell was the senior risk officer who, with help from his staff, was supposed to keep an eye on the bank’s bond trading business and its multibillion-dollar portfolio of mortgage-backed securities. Those activities were part of what the bank called its fixed-income business, which Mr. {Thomas] Maheras supervised [whose team created the instruments that led to more than half of Citi’s recent losses].
One of Mr.Maheras’s trusted deputies, Randolph H. Barker, helped oversee the huge build-up in mortgage-related securities at Citigroup. But Mr. Bushnell, Mr. Maheras and Mr. Barker were all old friends, having climbed the bank’s corporate ladder together.
It was common in the bank to see Mr. Bushnell waiting patiently — sometimes as long as 45 minutes — outside Mr. Barker’s office so he could drive him home to Short Hills, N.J., where both of their families lived. The two men took occasional fly-fishing trips together; one expedition left them stuck on a lake after their boat ran out of gas.
Because Mr. Bushnell had to monitor traders working for Mr. Barker’s bond desk, their friendship raised eyebrows inside the company among those concerned about its controls….insufficient boundaries were established in the bank’s fixed-income unit to limit potential conflicts of interest involving Mr. Bushnell and Mr. Barker, people inside the bank say.
Indeed, some at Citigroup say that if traders or bankers wanted to complete a potentially profitable deal, they could sometimes rely on Mr. Barker to convince Mr. Bushnell that it was a risk worth taking….Others say that Mr. Bushnell’s friendship with Mr. Maheras may have presented a similar blind spot….
According to a former Citigroup executive, Mr. Prince started putting pressure on Mr. Maheras and others to increase earnings in the bank’s trading operations, particularly in the creation of collateralized debt obligations, or C.D.O.’s — securities that packaged mortgages and other forms of debt into bundles for resale to investors.
Because C.D.O.’s included so many forms of bundled debt, gauging their risk was particularly tricky; some parts of the bundle could be sound, while others were vulnerable to default.
“Chuck Prince going down to the corporate investment bank in late 2002 was the start of that process,” a former Citigroup executive said of the bank’s big C.D.O. push. “Chuck was totally new to the job. He didn’t know a C.D.O. from a grocery list, so he looked for someone for advice and support. That person was Rubin. And Rubin had always been an advocate of being more aggressive in the capital markets arena. He would say, ‘You have to take more risk if you want to earn more.’ ”..
From 2003 to 2005, Citigroup more than tripled its issuing of C.D.O.’s,…Citigroup made up to $500 million in fees from the business in 2005 alone….
When Mr. Prince was put in charge in 2003, he presided over a mess of warring business units and operational holes, particularly in critical areas like risk-management and controls.
“He inherited a gobbledygook of companies that were never integrated….,” said Meredith A. Whitney, a banking analyst who was one of the company’s early critics. “The businesses didn’t communicate with each other. There were dozens of technology systems and dozens of financial ledgers.”…
In 2005…Mr. Prince and his board of directors decided to push even more aggressively into trading and other business that would allow Citigroup to continue expanding the bank internally.
One person who helped push Citigroup along this new path was Mr. Rubin.
As chairman of Citigroup’s executive committee, Mr. Rubin was the bank’s resident sage, advising top executives and serving on the board while, he insisted repeatedly, steering clear of daily management issues….
But while Mr. Rubin certainly did not have direct responsibility for a Citigroup unit, he was an architect of the bank’s strategy.
In 2005,…Mr. Rubin ….believed that Citigroup was falling behind rivals like Morgan Stanley and Goldman, and he pushed to bulk up the bank’s high-growth fixed-income trading, including the C.D.O. business.
Former colleagues said Mr. Rubin also encouraged Mr. Prince to broaden the bank’s appetite for risk, provided that it also upgraded oversight — though the Federal Reserve later would conclude that the bank’s oversight remained inadequate.
Once the strategy was outlined, Mr. Rubin helped Mr. Prince gain the board’s confidence that it would work….
Yet as the bank’s C.D.O. machine accelerated, its risk controls fell further behind, according to former Citigroup traders, and risk managers lacked clear lines of reporting. At one point, for instance, risk managers in the fixed-income division reported to both Mr. Maheras and Mr. Bushnell — setting up a potential conflict because that gave Mr. Maheras influence over employees who were supposed to keep an eye on his traders.
C.D.O.’s were complex, and even experienced managers like Mr. Maheras and Mr. Barker underestimated the risks they posed, according to people with direct knowledge of Citigroup’s business. Because of that, they put blind faith in the passing grades that major credit-rating agencies bestowed on the debt.
Yves here. Um, credit risk and marker risk are two different things. Even if the AAA ratings were solid, the CDOs still have market risk that needs to be allowed for. And CDOs were never very liquid. Many were described as “trades” because they were never intended to be re-sold.
Back to the article:
“I just think senior managers got addicted to the revenues and arrogant about the risks they were running,” said one person who worked in the C.D.O. group. “As long as you could grow revenues, you could keep your bonus growing.”
To make matters worse, Citigroup’s risk models never accounted for the possibility of a national housing downturn….
In fact, when examiners from the Securities and Exchange Commission began scrutinizing Citigroup’s subprime mortgage holdings after Bear Stearns’s problems surfaced, the bank told them that the probability of those mortgages defaulting was so tiny that they excluded them from their risk analysis, according to a person briefed on the discussion who would speak only without being named….
Earlier this year, Federal Reserve examiners quietly presented the bank with a scathing review of its risk-management practices, according to people briefed on the situation….
Meanwhile, regulators have criticized the banking industry as a whole for relying on outsiders — in particular the ratings agencies — to help them gauge the risk of their investments.
“There is really no excuse for institutions that specialize in credit risk assessment, like large commercial banks, to rely solely on credit ratings in assessing credit risk,” John C. Dugan, the head of the Office of the Comptroller of the Currency, the chief federal bank regulator, said in a speech earlier this year.
But he noted that what caused the largest problem for some banks was that they retained dangerously big positions in certain securities — like C.D.O.’s — rather than selling them off to other investors.
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my guess is that Citi will be carved up sunday night, the tasty bits going to JPM and GS, with the level 2 and 3 garbage going to our US balance sheet.
Many were described as “trades” because they were never intended to be re-sold.
This was obviously a deliberate feature, not an unfortunate fact. I’m tired of reports glossing that.
While the ability to pass on garbage to others is usually held up, which is true, there is also the slightly less malevolent goal of being able to ride out any decline between here and Valhalla with leverage because, well, there is no market and there are no downgrades.
i’m not aware of any renewed spike in libor. how come citi’s creditors seem to be so much more relaxed than the equity market? maybe creditors all assume that citi would just get nationalised (which would wipe out equity holders but guarantee creditors)? or maybe citi really is just the victim of malicious rumour-mungering short-sellers? i guess things will become clear when markets reopen..
Rubin at the center of all this bubblicious activity.
Now an advisor to Obama and Geithner’s mentor.
Once again the foxes will be guarding the hen house.
What a marvelous country we live in.
The Federal Reserve wrote the report in 2008, when the damage was done. What were they doing in 05 (when half a billion in fees for arranging CDOs was booked)?
«I think the end of the bank began with Sandy Weill’s assumption of leadership. Sandy loved doing deals and was not terribly interested in operational details. Had Dimon remained at Citi, or John Reed prevailed in the power struggle with Weill, the bank is unlikely to be on the verge of a meltdown as it is now.»
Personalities often matter, but this is a bit less plausible than it appears. Look at the long term shape of the Citi stock price:
http://finance.yahoo.com/q/bc?t=my&l=off&z=l&q=l&s=C
and it is pretty clear that something in 1996-2007 caused a colossal deviation from trend, a gigantic asset pump-and-dump scheme.
What Weill and the rest at Citigroup did was to take run along with that scheme as much as possible; they took the ride, they did not create it. Perhaps more prudent management would have refused to participate, but it would have taken pretty saintly attitudes.
And if you look at similar graphs, they all have a gigantic 1995-2007 deviation from trend.
My impression is that this bubble (created in 1995, refuelled in 2001, ending in 2007) was engineered to fleece baby boomers saving to retire of their money and at the same time persuade them that they did not need any socialistic safety net.
hmmm, now everything is starting to make sense…
–> paulson changes the tax law so WF can hijack the citi/wachovia merger that will save citi.
–> citi goes down (with a little help from some *secret* naked shorters) with rubin's greasy fingerprints all over the collapse.
–> obama administration is handcuffed from digging too deeply into prosecutions, which would logically lead right to, guess who, rubin.
it's hard not to believe that cheney is behind this whole chicanery of how this is playing out.
here's a crystal ball reading:
–> the arab sheiks come in as white knights and scarf up citi at rock bottom prices.
–> all the off-balance sheet 'assets' get swept under the rug of the FED.
–> fuld/lehman gets served up as the fall guy (cuz everyone on both sides think he's a schmuck — easy target) to satisfy the masses' thirst for blood.
–> the buck STOPS there…until it starts to fall that is, just like everything else has fallen recently…in a controlled demolition.
trying real hard not to be cynical about all this, but hope seems to be blinded the more the details are revealed.
Yves,
Amusing story. I’m idly curious about one thing. Does the extreme concentration of Harvard and Yale alumni at all these accident scenes ever trouble you in the dark watches of the night?
The FAA now has mechanisms in place to track the performance of entry level flight instructors and flight schools through the demonstrated performance of their students. What would an analogous tracking mechanism say about the Harvard and Yale b-school programs and professors?
Can it be seriously argued the top 10% of graduates from the average cow paddy community college, and with five years’ experience as a local bank branch manager, would have done worse than this non-stop parade of bozos?
To put it another way, it’s the average performance of the men that make the Green Beret and the Ranger tab “elite”, not vice versa.
«What would an analogous tracking mechanism say about the Harvard and Yale b-school programs and professors?
Can it be seriously argued the top 10% of graduates from the average cow paddy community college, and with five years’ experience as a local bank branch manager, would have done worse than this non-stop parade of bozos?»
But the Yale/Hardvard “bozos” are WINNERS who MADE A LOT OF MONEY for themselves and their friends. Winners do whatever it takes…
This is fully legal money, so it must be that they have deserved to earn every dollar of their immense fortunes by creating real value, that’s what their market value was.
Consider instead the top 10% of the community college: many of them probably are going to lose their jobs and end up as minimum wage workers, if they are lucky. That means that they are LOSERS.
This is fully legal money, so it must be that they have deserved to earn every dollar of their immense fortunes by creating real value, that’s what their market value was.
Spoken like a true sophisticate. By any chance, did you have a past life as a courtier at Versailles circa 1788?
Beware news stories blaming people who are gone, and members of the Clinton admin. Beware newspaper stories mixing a sudden influx of fact in support of an obviously politically motivated and thoroughly business as usual agenda.
Just remember: it’s always someone elses fault, and you will do fine in corporate america.
I love déjà vu and Jamais vu:
When the world financial system was shuddering in 1997 — in a climate of global fear similar to today, though less intense — Messrs. Geithner and Summers spoke over Thanksgiving weekend that year to hash out a way to craft a rescue package for South Korea. Their boss, Mr. Rubin, was wary of intervening, afraid the country’s financial problems were so big that an intervention might not make sense. Messrs. Geithner and Summers disagreed, seeing intervention as a key to stabilizing the country. That night, they crafted a proposal they thought would pass muster with Mr. Rubin, who ultimately agreed to the plan.
Why aren’t guys such as Rubin, Greenspan and Summers in jail?
The guys at Enron went to jail for similar and lesser crimes.
seems to me the world will be a safer place without Citibank
Robert Reich’s Blog (http://robertreich.blogspot.com/2008/11/why-citigroup-is-about-to-be-bailed-out.html) makes a case for bailing out GM rather than Citi. That would mirror the thinking of the incoming administration. Who is more powerful at the moment: current or the incoming administration?
“Nonetheless, Citi is about to be bailed out while GM is allowed to languish. That’s because Wall Street’s self-serving view of the unique role of financial institutions is mirrored in the two agencies that run the American economy — the Treasury and the Fed. Their job, as they see it, is to keep the financial economy “sound,” by which they mean keeping Wall Street’s own investors and creditors happy.
Because the public doesn’t understand the intricacies of finance, it’s easily persuaded that this is the same thing as keeping credit flowing to Main Street. That’s why the public and its representatives have committed $700 billion of taxpayer money to Wall Street and another $500 to $600 billion of subsidized loans to the Street from the Fed — bailing out the investors and creditors of every major bank, including , momentarily, Citi — only to discover, at the end of this frantic and unbelievably expensive exercise, that American jobs and communities are more endangered than they were at the start.”
1) Yves: “Um, credit risk and marker risk are two different things.”
Respectfully, sir, this is plain wrong. In fact it was the mistaken notion that ‘market risk’ and ‘credit risk’ are wholly divisible that mightily contributed to this disaster.
As we just witnessed on a colossal scale, credit risk and market risk get more and more tightly bound as things go wrong.
2) Blissex: Your comments suggest you view yourself as Ivy League material, but they also suggest you would be eliminated by any company adhering to the No A**hole rule. Presume for a moment, painful as it may be, that both are true — what does that alone say about the ‘guaranteed value’ of a being a real winner with a Yale/Harvard education?
3) Yves: Your point about the end beginning with Sandy Weil’s assumption of leadership is dead on. And it should be remembered that it was — no surprise — Bob Rubin who sat atop Citi and arbitrated the removal of John Reed in favor of his buddy Weil.
As to the long-term value of Weil’s ‘roll-up and ignore operations’ scheme, funnily enough his daughter Jessica Bibliowicz is now scraping her knees with that same strategy. But all sorts of buildings now have Sandy’s name etched onto them, so for the family it was a big win.
4) The fact that the NY Times would dare pound a little on Bob Rubin is a remarkable turnabout — they lionized him regularly until today, including featuring him on their Sunday magazine during the Clinton era. As we usually say in happier times with respect to a job promotion: overdue and well-deserved! Now, NY Times, how about Walter Durant?…
you mean walter duranty. anyway, rubin’s role in facilitating this mess is finally becoming known.
When the world financial system was shuddering in 1997 — in a climate of global fear similar to today, though less intense — Messrs. Geithner and Summers spoke over Thanksgiving weekend that year to hash out a way to craft a rescue package for South Korea.
I still find it terribly interesting that lending is flowing at all, and further, that it would be had the existing lines of credit not been available..