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F FINANCIAL CRISIS INQUIRY COMMISSION REPORTINANCIAL CRISIS INQUIRY COMMISSION REPORT
Thomas Maheras, co-CEO of the investment bank, had become a leader in the nas-
cent market for CDOs, creating more than billion in and —close to
one-fifth of the market in those years.
The eight guys had picked up on a novel structure pioneered by Goldman Sachs
and WestLB, a German bank. Instead of issuing the triple-A tranches of the CDOs as
long-term debt, Citigroup structured them as short-term asset-backed commercial
paper. Of course, using commercial paper introduced liquidity risk (not present
when the tranches were sold as long-term debt), because the CDO would have to
reissue the paper to investors regularly—usually within days or weeks—for the life of
the CDO. But asset-backed commercial paper was a cheap form of funding at the
time, and it had a large base of potential investors, particularly among money market
mutual funds. To mitigate the liquidity risk and to ensure that the rating agencies
would give it their top ratings, Citibank (Citigroup’s national bank subsidiary) pro-
vided assurances to investors, in the form of liquidity puts. In selling the liquidity
put, for an ongoing fee the bank would be on the hook to step in and buy the com-
mercial paper if there were no buyers when it matured or if the cost of funding rose
by a predetermined amount.
The CDO team at Citigroup had jumped into the market in July with a .
billion CDO named Grenadier Funding that included a . billion tranche backed by
a liquidity put from Citibank. Over the next three years, Citi would write liquidity
puts on billion of commercial paper issued by CDOs, more than any other com-
pany. BSAM’s three Klio CDOs, which Citigroup had underwritten, accounted for just
over billion of this total, a large number that would not bode well for the bank.
But initially, this “strategic initiative,” as Dominguez called it, was very profitable for
Citigroup. The CDO desk earned roughly of the total deal value in structuring fees
for Citigroup’s investment banking arm, or about million for a billion deal. In
addition, Citigroup would generally charge buyers . to . in premiums annu-
ally for the liquidity puts. In other words, for a typical billion deal, Citibank would
receive to million annually on the liquidity puts alone—practically free money, it
seemed, because the trading desk believed that these puts would never be triggered.
In effect, the liquidity put was yet another highly leveraged bet: a contingent lia-
bility that would be triggered in some circumstances. Prior to the change in the
capital rules regarding liquidity puts (discussed earlier), Citigroup did not have to
hold any capital against such contingencies. Rather, it was permitted to use its own
risk models to determine the appropriate capital charge. But Citigroup’s financial
models estimated only a remote possibility that the puts would be triggered. Follow-
ing the rule change, Citibank was required to hold . in capital against the
amount of commercial paper supported by the liquidity put, or . million for a
billion liquidity put. Given a to million annual fee for the put, the annual return
on that capital could still exceed . No doubt about it, Dominguez told the FCIC,
the triple-A or similar ratings, the multiple fees, and the low capital requirements
made the liquidity puts “a much better trade” for Citi’s balance sheet. The events of
would reveal the fallacy of those assumptions and catapult the entire billion
