November
23, 2008
The Reckoning
Citigroup Saw No Red Flags Even as It Made Bolder Bets
By ERIC DASH and JULIE CRESWELL
“Our
job is to set a tone at the top to incent people to do the right thing and
to set up safety nets to catch people who make mistakes or do the wrong
thing and correct those as quickly as possible. And it is working. It is
working.” -- Charles
O. Prince III, Citigroup’s chief executive, in 2006
In September
2007, with Wall Street confronting a crisis caused by too many souring mortgages,
Citigroup executives gathered in a wood-paneled library to assess their
own well-being.
There, Citigroup’s
chief executive, Charles O. Prince III, learned for the first time that
the bank owned about $43 billion in mortgage-related assets. He asked Thomas
G. Maheras, who oversaw trading at the bank, whether everything was O.K.
Mr. Maheras
told his boss that no big losses were looming, according to people briefed
on the meeting who would speak only on the condition that they not be named.
For months,
Mr. Maheras’s reassurances to others at Citigroup had quieted internal
concerns about the bank’s vulnerabilities. But this time, a risk-management
team was dispatched to more rigorously examine Citigroup’s huge mortgage-related
holdings. They were too late, however: within several weeks, Citigroup would
announce billions of dollars in losses.
Normally,
a big bank would never allow the word of just one executive to carry so
much weight. Instead, it would have its risk managers aggressively look
over any shoulder and guard against trading or lending excesses.
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.
Today, Citigroup,
once the nation’s largest and mightiest financial institution, has
been brought to its knees by more than $65 billion in losses, write-downs
for troubled assets and charges to account for future losses. More than
half of that amount stems from mortgage-related securities created by Mr.
Maheras’s team — the same products Mr. Prince was briefed on during
that 2007 meeting.
Citigroup’s
stock has plummeted to its lowest price in more than a decade, closing Friday
at $3.77. At that price the company is worth just $20.5 billion, down from
$244 billion two years ago. Waves of layoffs have accompanied that slide,
with about 75,000 jobs already gone or set to disappear from a work force
that numbered about 375,000 a year ago.
Burdened by
the losses and a crisis of confidence, Citigroup’s future is so uncertain
that regulators in New York and Washington held a series of emergency meetings
late last week to discuss ways to help the bank right itself.
And as the
credit crisis appears to be entering another treacherous phase despite a
$700 billion federal bailout, Citigroup’s woes are emblematic of the
haphazard management and rush to riches that enveloped all of Wall Street.
All across the banking business, easy profits and a booming housing market
led many prominent financiers to overlook the dangers they courted.
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. Mr. Prince and Mr. Rubin both declined to comment for this article.
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.
For a time,
Citigroup’s megabank model paid off handsomely, as it rang up billions
in earnings each quarter from credit cards, mortgages, merger advice and
trading.
But when Citigroup’s
trading machine began churning out billions of dollars in mortgage-related
securities, it courted disaster. As it built up that business, it used accounting
maneuvers to move billions of dollars of the troubled assets off its books,
freeing capital so the bank could grow even larger. Because of pending accounting
changes, Citigroup and other banks have been bringing those assets back
in-house, raising concerns about a new round of potential losses.
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.”
Questions
on Oversight
Though they
carry less prestige and are paid less than Wall Street traders and bankers,
risk managers can wield significant clout. Their job is to monitor trading
floors and inquire about how a bank’s money is being invested, so they
can head off potential problems before blow-ups occur. Though risk managers
and traders work side by side, they can have an uncomfortable coexistence
because the monitors can put a brake on trading.
That is the
way it works in theory. 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. Maheras supervised.
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.
After all,
traders’ livelihoods depended on finding new ways to make money, sometimes
using methods that might not be in the bank’s long-term interests.
But 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.
Risk management
“has to be independent, and it wasn’t independent at Citigroup,
at least when it came to fixed income,” said one former executive in
Mr. Barker’s group who, like many other people interviewed for this
article, insisted on anonymity because of pending litigation against the
bank or to retain close ties to their colleagues. “We used to say that
if we wanted to get a deal done, we needed to convince Randy first because
he could get it through.”
Others say
that Mr. Bushnell’s friendship with Mr. Maheras may have presented
a similar blind spot.
“Because
he has such trust and faith in these guys he has worked with for years,
he didn’t ask the right questions,” a former senior Citigroup
executive said, referring to Mr. Bushnell.
Mr. Bushnell
and Mr. Barker did not return repeated phone calls seeking comment. Mr.
Maheras declined to comment.
For some time
after Sanford I. Weill, an architect of the merger that created Citigroup
a decade ago, took control of Citigroup, he toned down the bank’s bond
trading. But in late 2002, Mr. Prince, who had been Mr. Weill’s longtime
legal counsel, was put in charge of Citigroup’s corporate and investment
bank.
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.’ ”
It appeared
to be a good time for building up Citigroup’s C.D.O. business. As the
housing market around the country took flight, the C.D.O. market also grew
apace as more and more mortgages were pooled together into newfangled securities.
From 2003
to 2005, Citigroup more than tripled its issuing of C.D.O.’s, to more
than $20 billion from $6.28 billion, and Mr. Maheras, Mr. Barker and others
on the C.D.O. team helped transform Citigroup into one of the industry’s
biggest players. Firms issuing the C.D.O.’s generated fees of 0.4 percent
to 2.5 percent of the amount sold — meaning Citigroup made up to $500
million in fees from the business in 2005 alone.
Even as Citigroup’s
C.D.O. stake was expanding, its top executives wanted more profits from
that business. Yet they were not running a bank that was up to all the challenges
it faced, including properly overseeing billions of dollars’ worth
of exotic products, according to Citigroup insiders and regulators who later
criticized the bank.
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, and it was never
a priority of the company to invest,” 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.”
Problems with
trading and banking oversight at Citigroup became so dire that the Federal
Reserve took the unusual step of telling the bank it could make no more
acquisitions until it put its house in order.
In 2005, stung
by regulatory rebukes and unable to follow Mr. Weill’s penchant for
expanding Citigroup’s holdings through rapid-fire takeovers, 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.
Pushing
Growth
Robert Rubin
has moved seamlessly between Wall Street and Washington. After making his
millions as a trader and an executive at Goldman Sachs, he joined the Clinton
administration.
Mr. Weill,
as Citigroup’s chief, wooed Mr. Rubin to join the bank after Mr. Rubin
left Washington. Mr. Weill had been involved in the financial services industry’s
lobbying to persuade Washington to loosen its regulatory hold on Wall Street.
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.
“By the
time I finished at Treasury, I decided I never wanted operating responsibility
again,” he said in an interview in April. Asked then whether he had
made any mistakes during his tenure at Citigroup, he offered a tentative
response.
“I’ve
thought a lot about that,” he said. “I honestly don’t know.
In hindsight, there are a lot of things we’d do differently. But in
the context of the facts as I knew them and my role, I’m inclined to
think probably not.”
Besides, he
said, it was impossible to get a complete handle on Citigroup’s vulnerabilities
unless you dealt with the trades daily.
“There
is no way you would know what was going on with a risk book unless you’re
directly involved with the trading arena,” he said. “We had highly
experienced, highly qualified people running the operation.”
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, as
Citigroup began its effort to expand from within, Mr. Rubin peppered his
colleagues with questions as they formulated the plan. According to current
and former colleagues, he 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.
After that,
the bank moved even more aggressively into C.D.O.’s. It added to its
trading operations and snagged crucial people from competitors. Bonuses
doubled and tripled for C.D.O. traders. Mr. Barker drew pay totaling $15
million to $20 million a year, according to former colleagues, and Mr. Maheras
became one of Citigroup’s most highly compensated employees, earning
as much as $30 million at the peak — far more than top executives like
Mr. Bushnell in the risk-management department.
In December
2005, with Citigroup diving into the C.D.O. business, Mr. Prince assured
analysts that all was well at his bank.
“Anything
based on human endeavor and certainly any business that involves risk-taking,
you’re going to have problems from time to time,” he said. “We
will run our business in a way where our credibility and our reputation
as an institution with the public and with our regulators will be an asset
of the company and not a liability.”
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.
While the
sheer size of Citigroup’s C.D.O. position caused concern among some
around the trading desk, most say they kept their concerns to themselves.
“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, this person said, and the prospect that
millions of homeowners could default on their mortgages. Such a downturn
did come, of course, with disastrous consequences for Citigroup and its
rivals on Wall Street.
Even as the
first shock waves of the subprime mortgage crisis hit Bear Stearns in June
2007, Citigroup’s top executives expressed few concerns about their
bank’s exposure to mortgage-linked securities.
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.
Later that
summer, when the credit markets began seizing up and values of various C.D.O.’s
began to plummet, Mr. Maheras, Mr. Barker and Mr. Bushnell participated
in a meeting to review Citigroup’s exposure.
The slice
of mortgage-related securities held by Citigroup was “viewed by the
rating agencies to have an extremely low probability of default (less than
.01%),” according to Citigroup slides used at the meeting and reviewed
by The New York Times.
Around the
same time, Mr. Maheras continued to assure his colleagues that the bank
“would never lose a penny,” according to an executive who spoke
to him.
In mid-September
2007, Mr. Prince convened the meeting in the small library outside his office
to gauge Citigroup’s exposure.
Mr. Maheras
assured the group, which included Mr. Rubin and Mr. Bushnell, that Citigroup’s
C.D.O. position was safe. Mr. Prince had never questioned the ballooning
portfolio before this because no one, including Mr. Maheras and Mr. Bushnell,
had warned him.
But as the
subprime market plunged further, Citigroup’s position became more dire
— even though the firm held onto the belief that its C.D.O.’s
were safe.
On Oct. 1,
it warned investors that it would write off $1.3 billion in subprime mortgage-related
assets. But of the $43 billion in C.D.O.’s it had on its books, it
wrote off only about $95 million, according to a person briefed on the situation.
Soon, however,
C.D.O. prices began to collapse. Credit-rating agencies downgraded C.D.O.’s,
threatening Citigroup’s stockpile. A week later, Merrill Lynch aggressively
marked down similar securities, forcing other banks to face reality.
By early November,
Citigroup’s anticipated write-downs ballooned to $8 billion to $11
billion. Mr. Barker and Mr. Maheras lost their jobs, as Mr. Bushnell did
later on. And on Nov. 4, Mr. Prince told the board that he, too, would resign.
Although Mr.
Prince received no severance, he walked away with Citigroup stock valued
then at $68 million — along with a cash bonus of about $12.5 million
for 2007.
Putting
Out Fires
Mr. Prince
was replaced last December by Vikram S. Pandit, a former money manager and
investment banker whom Mr. Rubin had earlier recruited in a senior role.
Since becoming chief executive, Mr. Pandit has been scrambling to put out
fires and repair Citigroup’s deficient risk-management systems.
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.
Citigroup
executives responded with a 25-page single-spaced memo outlining a sweeping
overhaul of the bank’s risk management.
In May, Brian
Leach, Citigroup’s new chief risk officer, told analysts that his bank
had greatly improved oversight and installed several new risk managers.
He said he wanted to ensure “that Citi takes the lessons learned from
recent events and makes critical enhancements to its risk management frameworks.
A change in culture is required at Citi.”
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.
“What
most differentiated the companies sustaining the biggest losses from the
rest was their willingness to hold exceptionally large positions on their
balance sheets which, in turn, led to exceptionally large losses,”
he said.
Mr. Dugan
did not mention any specific bank by name, but Citigroup is the largest
player in the C.D.O. business of any bank the comptroller regulates.
For his part,
Mr. Pandit faces the twin challenge of rebuilding investor confidence while
trying to fix the company’s myriad problems.
Citigroup
has suffered four consecutive quarters of multibillion-dollar losses as
it has written down billions of dollars of the mortgage-related assets it
held on its books.
But investors
worry there is still more to come, and some board members have raised doubts
about Mr. Pandit’s leadership, according to people briefed on the situation.
Citigroup
still holds $20 billion of mortgage-linked securities on its books, the
bulk of which have been marked down to between 21 cents and 41 cents on
the dollar. It has billions of dollars of giant buyout and corporate loans.
And it also faces a potential flood of losses on auto, mortgage and credit
card loans as the global economy plunges into a recession.
Also, hundreds
of billions of dollars in dubious assets that Citigroup held off its balance
sheet is now starting to be moved back onto its books, setting off yet another
potential problem.
The bank has
already put more than $55 billion in assets back on its balance sheet. It
now says an added $122 billion of assets related to credit cards and possibly
billions of dollars of other assets will probably come back on the books.
Even though
Citigroup executives insist that the bank can ride out its current difficulties,
and that the repatriated assets pose no threat, investors have their doubts.
Because analysts do not have a complete grip on the quality of those assets,
they are warning that Citigroup may have to set aside billions of dollars
to guard against losses.
In fact, some
analysts say they believe that the $25 billion that the federal government
invested in Citigroup this fall might not be enough to stabilize it.
Others say
the fact that such huge amounts have yet to steady the bank is a reflection
of the severe damage caused by Citigroup’s appetites.
“They
pushed to get earnings, but in doing so, they took on more risk than they
probably should have if they are going to be, in the end, a bank subject
to regulatory controls,” said Roy Smith, a professor at the Stern School
of Business at New York University. “Safe and soundness has to be no
less important than growth and profits but that was subordinated by these
guys.”
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