WASHINGTON — Two leaders of disgraced financial titan Citigroup on Thursday told a special panel looking into the origins of the financial crisis that they were unaware of the huge potential for losses from bad mortgages and argued that federal regulators failed to see the very same threats.
Testifying before the bipartisan Financial Crisis Inquiry Commission, Robert Rubin, a former Clinton Treasury secretary and influential member of the Citigroup board of directors, acknowledged that he only learned in September 2007 in discussions with CEO Charles Prince that Citi owned about $43 billion in complex securities backed by U.S. mortgages.
Citi owned what was thought to be the safest level of complex financial instruments called collateralized debt obligations. These are comprised of pools of loans that are sold to investors in tranches, or layers of risk, depending on the investor's appetite for risk.
It wasn't necessary for senior management to take a closer look at the securities, Rubin said, because they carried top-grade ratings.
However, what Citi thought were safe bets turned out to be anything but.
Rubin and Prince said Citi and its regulators didn't foresee a massive decline in home prices that went beyond anything for which anyone on Wall Street had modeled.
"I think all of us bear — not just all of us at Citi — failed to see the potential for this serious crisis," Rubin said, on several occasions putting blame on the credit-rating agencies such as Moody's Investors Service and Standard & Poor's for falling down on the job.
While rating agencies are a huge part of the story of what went wrong, Rubin's suggestion that banks blindly followed their lead — an allegation made a day earlier by former Federal Reserve Chairman Alan Greenspan, too — is false.
Hearings in 2008 and 2009 by the House Committee on Oversight and Government Reform and a subsequent McClatchy investigation last year into Moody's revealed how the divisions in the ratings agencies that blessed the complex deals actually took their cues from Wall Street banks.
Ratings agencies helped package these complex securities that blew up the global financial system, working with investment banks to add more bad loans into a pool of loans — a process called credit enhancement — on the mistaken view that this would reduce the risk of losses through the broadening of loans.
Both the ratings agencies and Wall Street ignored clear evidence of eroding lending standards, doing little or no due diligence of their own. The additional loans amounted to pouring gasoline on fire.
Months after Rubin and then-CEO Prince learned of this exposure, credit-ratings agencies knocked down the coveted Triple-A rating on the complex securities and in October 2008 the financial giant posted losses estimated between $8 billion and $11 billion. Prince resigned soon afterward.
A contrite Prince, who began the hearing by apologizing to Americans for the economic suffering brought by Wall Street's folly, told the panel of six Democrats and four Republicans that future investor appetite is unlikely for the complex financial products — called structured finance — that brought Citi to its knees and triggered a $45 billion taxpayer rescue.
"In hindsight, it's very hard to see how these structured products could have been accepted in the way (that) they were accepted," Prince said.
During Wednesday's hearing, commission member Byron Georgiou, a securities lawyer by training, mused that the complex securities resembled the work of medieval alchemists. He amended that view Thursday, suggesting "hallucination" better described how they were put together.
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"It you look at the fundamentals, it belies logic," Georgiou said. "The fact that everybody believed this . . . nobody questioned this, is highly troubling because at the end of the day it was the most significant single matter" that nearly sunk the financial system.
Commission member Douglas Holtz-Eakin, a former director of the Congressional Budget Office and an adviser to Sen. John McCain's 2008 presidential campaign, read Rubin and Prince a series of reports from regulators that questioned Citi's ability to manage its risks. Prince, however, said that regulators failed to act.
"If they saw something that was inadequate, it probably would have been useful for them to raise it an earlier point in time," he said.
The documents being cited actually dated back to 2004.
On Wednesday, former Fed chief Greenspan vehemently denied any failure on the part of regulators. On Thursday, both Rubin and Prince apologized but denied any culpability.
This crisis, it seems, is an orphan.
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