Page 225 - untitled

 FINANCIAL CRISIS INQUIRY COMMISSION REPORT

But after writing  billion in liquidity puts—protecting investors who bought
commercial paper issued by Citigroup’s CDOs—the bank’s treasury department had
put a stop to the practice. To keep doing deals, the CDO desk had to find another
market for the super-senior tranches of the CDOs it was underwriting—or it had to
find a way to get the company to support the CDO production line. The CDO desk
accumulated another  billion in super-senior exposures, most between early 
and August , which it otherwise would have been able to sell into the market

only for a loss. It was also increasingly financing securities that it was holding in its
CDO warehouse—that is, securities that were waiting to be put into new CDOs.
Historically, owning securities was not what securities firms did. The adage “We
are in the moving business, not the storage business” suggests that they were struc-
turing and selling securities, not buying or retaining them.
However, as the biggest commercial banks and investment banks competed in the
securities business in the late s and on into the new century, they often touted
the “balance sheet” that they could make available to support the sale of new securi-
ties. In this regard, Citigroup broke new ground in the CDO market. Citigroup re-
tained significant exposure to potential losses on its CDO business, particularly
within Citibank, the  trillion commercial bank whose deposits were insured by the
FDIC. While its competitors did the same, few did so as aggressively or, ultimately,
with such losses.
In , Citigroup retained the super-senior and triple-A tranches of most of the
CDOs it created. In many cases Citigroup would hedge the associated credit risk
from these tranches by obtaining credit protection from a monoline insurance com-
pany such as Ambac. Because these hedges were in place, Citigroup presumed that
the risk associated with the retained tranches had been neutralized.
Citigroup reported these tranches at values for which they could not be sold, rais-
ing questions about their accuracy and, therefore, the accuracy of reported earnings.
“As everybody in any business knows, if inventory is growing, that means you’re not
pricing it correctly,” Richard Bookstaber, who had been head of risk management at
Citigroup in the late s, told the FCIC. But keeping the tranches on the books at
these prices improved the finances for creating the deal. “It was a hidden subsidy of

the CDO business by mispricing,” Bookstaber said. The company would not begin
writing the securities down toward the market’s real valuations until the fall of .
Part of the reason for retaining exposures to super-senior positions in CDOs was
their favorable capital treatment. As we saw in an earlier chapter, under the  Re-
course Rule, one of the attractions of triple-A-rated securities was that banks were re-
quired to hold relatively less capital against them than against lower-rated securities.
And if the bank held those assets in their trading account (as opposed to holding
them as a long-term investment), it could get even better capital treatment under the
 Market Risk Amendment. That rule allowed banks to use their own models to
determine how much capital to hold, an amount that varied according to how much
market prices moved. Citigroup judged that the capital requirement for the super-se-
nior tranches of synthetic CDOs it held for trading purposes was effectively zero, be-