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Commission Focuses on Subprime and Citi's Troubles

Source: NY Times


Posted on 07 Apr 2010

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The committee examining the causes of the financial crisis was poised Wednesday to focus on the subprime mortgage troubles that contributed to Citigroup's near-collapse, with testimony from Alan Greenspan, the former Federal Reserve chairman, and several former senior Citi officials.

In prepared statements, a former Citi mortgage lending officer and whistle-blower, Richard M. Bowen III, testified before the Financial Crisis Inquiry Commission that he had alerted his bosses about problems in the bank’s mortgage portfolio, and Mr. Greenspan, the former Federal Reserve chairman, warned that preventing future crises would be nearly impossible.

In his testimony, Mr. Greenspan again defended the Federal Reserve against criticism that it failed to crack down on subprime mortgages during his lengthy tenure, pointing out that the Fed warned about subprime lending and low-down-payment mortgages in 1999, and again in 2001. He also said the Fed warned about unfair or deceptive practices by state-chartered banks in 2004.

The only meaningful way to lessen the impact of future crises, Mr. Greenspan testified, was to require banks to hold more capital, and all financial traders to hold more collateral.

His prepared statement included a warning about the effectiveness of intensified regulation.

“What supervision and examination can do is to promulgate rules that are preventative and that make the financial system more resilient in the face of inherently unforeseeable shocks,” Mr. Greenspan said. “Such rules would kick in automatically, without relying on the ability of a fallible human regulator to predict a coming crisis.”

He also warned that the problem of financial institutions being perceived as “too big to fail” has become prevalent, despite proposals in Congress that seek to permanently end taxpayer bailouts of large financial institutions.

“The next pending crisis will no doubt exhibit a plethora of new assets which have unintended toxic characteristics, which no one has heard of before, and which no one can forecast today,” he warned.

“But if capital and collateral are adequate, and enforcement against misrepresentation and fraud is enhanced, losses will be restricted to equity shareholders who seek abnormal returns, but in the process expose themselves to abnormal losses. Taxpayers will not be at risk. Financial institutions will no longer be capable of privatizing profit and socializing losses.”

Mr. Greenspan reiterated some of the arguments he made in a recent paper delivered at the Brookings Institution regarding the causes of the crisis. He said the housing bubble was ultimately caused by a glut of excess savings in East Asia and other emerging economies that helped drive down long-term interest rates — and not by the Fed’s decision to keep short-term rates low from 2002 to 2005.

Mr. Greenspan also said that while Congress gave the Fed the authority in 1994 to prohibit unfair, deceptive and abusive lending practices, lawmakers left those definitions murky. There was no “prevailing sentiment within the Federal Reserve — and it was certainly not my view — that entire categories of loan products should be prohibited as ‘unfair’ or ‘abusive,’ ” he said.

Following Mr. Greenspan, several executives from Citigroup, the troubled financial giant, were expected to testify. The bank eventually received $45 billion in assistance from the government.

Phil Angelides, the commission’s chairman, said the panel chose Citigroup as its first case study because it touched on every aspect of the subprime mortgage crisis. Citigroup originated subprime mortgages, made loans to independent subprime mortgage companies, and bought a huge number of subprime mortgages that it packaged into complex securities known as collateralized debt obligations.

“You have an organization that was active in all areas of the business — and we bailed them out with $45 billion,” he said in an interview late last week. Mr. Angelides added that he hoped to “pull the veil” back on the bank’s regulators at the Fed and Office of the Comptroller of the Currency.

The commissioners were expected to hear from a whistle-blower on the sharp deterioration of lending standards driven by the need to keep Wall Street’s loan-packaging machine humming.

Mr. Bowen planned to tell the panel that he alerted top officers that as many as 80 percent of the loans the bank sold to Fannie Mae, Ginnie Mae and other investors were defective.

“Since mid-2006, I have continually identified these breakdowns in processes and internal controls,” Mr. Bowen writes in a detailed November 2007 e-mail memorandum sent to Robert E. Rubin, an influential Citi executive and board member, as well as the bank’s risk and finance chiefs. “I know this will prompt an investigation into the above circumstances, which will hopefully be conducted by the officers outside the consumer lending group.”

It was unclear from Mr. Bowen’s prepared statement whether Citi’s board or executives followed up on his warnings.

In a later session, the commission planned to call four other Citigroup executives to discuss how it managed to write off some $45 billion of complex mortgage bonds it had deemed supersafe. The massive losses forced the government to step in with bailouts to prevent the bank’s collapse.

In their testimony, the four executives insisted that they vastly underestimated the magnitude of the financial storm and failed to appreciate the risks of holding such a large portfolio of mortgage-related investments. So-called “super-senior C.D.O.’s” were held out to be supersafe, they asserted.

Those beliefs were reinforced by credit rating agencies and the bank’s own stress tests and risk models, which failed to capture a severe nationwide decline in housing.

“No one, including myself, ever conceived we would see real estate prices plunge 30 to 40 percent, with homeowners walking away from homes en masse for the first time ever,” Thomas Maheras, the former co-head of Citi’s investment bank who oversaw its mortgage activities, said in a prepared statement.

He expressed “regret” that he nor his colleagues did not see the housing crisis coming.

David C. Bushnell, Citigroup’s former chief risk officer, was less contrite in his prepared remarks, which stopped short well short of a personal apology. In his testimony, Mr. Bushnell pointed out that other market participants and regulators made similar errors and he called it a “rational, but in retrospect, mistaken business judgment” to keep such a big position.

Three other former Citigroup executives were also expected to address the commission: Nestor Dominguez , the former head of Citi’s C.D.O. group; Murray Barnes , the risk officer directly responsible for the C.D.O. unit; and Susan Mills , the head of the mortgage finance group in Citi’s investment bank.

None of the Citigroup executives addressed in their prepared statements how compensation influenced their judgment. Nor do they acknowledge that around the same time, a handful of investment banks, like Goldman Sachs, and several savvy investors ratcheted down their mortgage exposures.

Two additional Citigroup officials are scheduled to testify on Thursday. Charles O. Prince III, the former chief executive who presided over the losses, will be questioned alongside Mr. Rubin, an influential adviser and a former Treasury secretary.


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