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1 1 2 THE FINANCIAL CRISIS INQUIRY COMMISSION 3 4 Official Transcript 5 6 Commission Hearing 7 Wednesday, April 7, 2010 8 Rayburn House Office Building, Room 2123 9 Washington, D.C. 10 9:00 A.M. 11 12 COMMISSIONERS 13 PHIL ANGELIDES, CHAIRMAN 14 BILL THOMAS, VICE CHAIRMAN 15 BROOKSLEY BORN 16 BYRON GEORGIOU 17 KEITH HENNESSEY 18 HEATHER MURREN 19 JOHN W. THOMPSON 20 PETER WALLISON 21 22 23 Reported by: 24 Pages 1 - 371 25 Cassandra E. Ellis, RPR 2 1 C O N T E N T S 2 SESSION 1: 3 THE FEDERAL RESERVE 4 EXAMINATION OF ALAN GREENSPAN 5 By Chairman Angelides 18 6 By Vice Chairman Thomas 30 7 By Commissioner Murren 42 8 By Commissioner Wallison 53 9 By Commissioner Georgiou 64 10 By Commissioner Hennessey 79 11 By Commissioner Born 86 12 By Commissioner Thompson 95 13 By Vice Chairman Thomas 105 PAGE 14 15 SESSION 2: 16 SUBPRIME ORIGINATION AND SECURITIZATION 17 EXAMINATION OF 18 RICHARD BITNER, RICHARD BOWEN, 19 PATRICIA LINDSAY and SUSAN MILLS 20 By Vice Chairman Thomas 137 21 By Commissioner Murren 144 22 By Commissioner Wallison 155 23 By Commissioner Georgiou 177 24 By Commissioner Thompson 196 25 By Commissioner Born 203 3 1 SESSION 2 CONTINUED: 2 SUBPRIME ORIGINATION AND SECURITIZATION 3 EXAMINATION OF RICHARD BITNER, RICHARD BOWEN, 4 PATRICIA LINDSAY and SUSAN MILLS 5 By Commissioner Wallison 210 6 By Commissioner Murren 218 7 By Commissioner Georgiou 220 8 By Vice Chairman Thomas 222 9 By Chairman Angelides 232 10 By Vice Chairman Thomas 250 11 By Chairman Angelides 251 12 By Commissioner Thompson 254 13 SESSION 3: 14 CITIGROUP SUBPRIME-RELATED STRUCTURED PRODUCTS 15 And RISK MANAGEMENT 16 MURRAY C. BARNES, DAVID C. BUSHNELL 17 NESTOR DOMINGUEZ and THOMAS G. MAHERAS PAGE 18 By Vice Chairman Thomas 278 19 By Commissioner Murren 288 20 By Commissioner Wallison 298 21 By Commissioner Thompson 330 22 By Commissioner Born 342 23 By Commissioner Murren 348 24 By Vice Chairman Thomas 350 25 By Chairman Angelides 355 4 1 P R O C E D I N G S 2 CHAIRMAN ANGELIDES: Good morning. The 3 meeting of the Financial Crisis Inquiry Commission 4 will come to order. 5 I want to welcome everyone on behalf of 6 Vice Chairman Thomas and the rest of the 7 Commissioners. 8 begin three days of public hearings focused on the 9 role of subprime lending and securitization in the 10 financial and economic crisis that has gripped our 11 nation. We're honored to welcome you as we 12 I want to thank Vice Chairman Thomas and 13 all my fellow Commissioners for all their hard work 14 and dedication as we strive to fulfill our mission on 15 behalf of the American people. 16 want to thank Commissioners Murren, Georgiou, and 17 Wallison, who are the lead Commissioners in 18 preparation for this hearing and for our investigation 19 into subprime lending practices. 20 And I particularly This hearing is one of a series that will 21 focus on key topics which this consider -- Commission 22 must consider as we examine the causes of the 23 financial crisis. 24 25 Over the next several months, we will look at the role that, among other things derivatives, 5 1 credit ratings agencies, the shadow banking system, 2 too-big-to-fail institutions, regulatory failure, and 3 speculation played in bringing our financial system to 4 its knees. 5 and investigation effort we are undertaking to 6 under -- to conduct a full and fair inquiry that this 7 nation deserves. 8 9 These hearings are just part of a research In each of these hearings, we will examine the larger forces, policies and events that may have 10 shaped the crisis. 11 series of case studies of companies and government 12 agencies so we can see what happened on Wall Street 13 and in Washington as the seeds of this crisis were 14 sown and as it developed and spread across the nation 15 and the globe. 16 And we will also undertake a As we meet today, the mortgage and housing 17 crisis is still very much with us over two million 18 American families have lost their homes to 19 foreclosure. 20 foreclosure process; and an additional 2.5 million 21 households are more than 90 days behind on their home 22 loans. 23 Another two million homes are in the One in four homeowners owe more on their 24 mortgages than the value of their homes. And American 25 households have lost almost 7 trillion dollars in 6 1 residential home value. 2 Over the next three days we will look at 3 how we got to where we are today. We'll examine the 4 role of the Federal Reserve in the mortgage crisis and 5 in subprime lending. 6 activities and losses related to subprime loans and 7 mortgage-related securities. 8 actions of the Office of the Comptroller of the 9 Currency as it oversaw Citigroup and other financial We'll explore Citigroup's We will probe the 10 institutions engaged in the subprime market. 11 will look at what happened at Fannie Mae and its 12 regulator as the crisis unfolded. 13 And we As we have noted before, this Commission is 14 a proxy for the American people, perhaps the only 15 opportunity to have their questions asked and 16 answered. 17 what happened so we can learn from it and restore 18 faith in our economic system. 19 On their behalf, we hope to take stock of As always, we welcome your thoughts and 20 input. 21 site, draft preliminary staff reports for review and 22 comment. 23 reports have not been adopted by the Commission and we 24 invite you to submit your comments by May 15th. 25 In that regard, we have posted, on our web Those can be found at FCIC.GOV. These Today's hearing is another step along the 7 1 road in our inquiry. 2 the public's understanding of what has happened. 3 need candor about the past so we can face the future. 4 We hope it will further our and I'd now like to ask Vice Chairman Thomas to 5 make some opening remarks, along with me, this 6 morning. 7 Thank you. VICE CHAIRMAN THOMAS: 8 Mr. Chairman. 9 participants in the hearing. Thank you, I, too, want to thank all of the I want to underscore the 10 fact that everyone we have worked with have been 11 extremely cooperative and, therefore, none of the 12 statutory tools that we have available, which will 13 allow us even with uncooperative folks to get the 14 story, have been necessary. 15 The people who are here before us today 16 have a story to tell, it isn't necessarily the 17 exclusive story of those who are telling it, 18 especially when we look at a corporation like 19 Citicorp. 20 We We're not singling out anyone, but as we 21 examine the fundamental, systemic crisis, we thought 22 it was useful and valuable, frankly, to have examples 23 so that we could, with the public, in these public 24 hearings, examine, in some depth, the questions that 25 we will be asking others: Other corporations, other 8 1 government agencies, other important players, a little 2 bit like just showing the tip of the iceberg with 3 seven-eighths behind the scenes in terms of what we're 4 doing. 5 As we did in the first hearing I'm going to 6 ask each witness if they would voluntarily allow us to 7 continue our communication with them, in writing, 8 since this is the journey of education for us as well 9 as the American people. 10 And at any one time the questions we may 11 think relevant, of the various witnesses, may very 12 well be, but not the kind of follow-up questions that 13 we would very much enjoy continuing to get answers to, 14 which are impossible only in the setting of a hearing. 15 So, Mr. Chairman, it's a pleasure to be 16 here. I thank the Chairman for kicking this off for 17 us, with the full understanding that we're ju- -- just 18 dealing with one-eighth of what it is that we're going 19 to be looking at, and seven-eighths will go on behind 20 the scenes, as it has for several months. 21 Thank you, Mr. Chairman. 22 CHAIRMAN ANGELIDES: 23 24 25 Thank you, Mr. Vice Chairman. Now, Chairman Greenspan, as we have done with all witnesses, and we will do with all witnesses 9 1 through the course of our hearings, I'm going to ask 2 you to stand so I can administer the oath to you. 3 Do you solemnly swear or affirm, under 4 penalty of perjury, that the testimony you are about 5 to provide the Commission will be the truth, the whole 6 truth and nothing but the truth, to the best of your 7 knowledge? 8 MR. GREENSPAN: 9 CHAIRMAN ANGELIDES: 10 I do. Thank you very much. So, Mr. Chairman, first of all, let me 11 start by saying thank for being here; thank you for 12 your extraordinary years of public service. 13 And, with that, I would -- I know you've 14 submitted written testimony to us, and I would ask if 15 you would like to make opening remarks of no greater 16 than ten minutes in terms of oral testimony to us, if 17 you would like to commence now. 18 19 MR. GREENSPAN: CHAIRMAN ANGELIDES: VICE CHAIRMAN THOMAS: Is there an on/off button, there? 24 25 Can you pull the microphone toward you? 22 23 Thank you very much. 20 21 Thank you very much. MR. GREENSPAN: missed it. I thought I had it, I Chairman Angelides? 10 1 CHAIRMAN ANGELIDES: Yeah, let's stop for a 2 minute, see if we can pull that a little closer. 3 it get -- 4 VICE CHAIRMAN THOMAS: 5 CHAIRMAN ANGELIDES: 6 MR. GREENSPAN: 7 10 13 And it's not on? What about this one over CHAIRMAN ANGELIDES: minute. All right, hang on a Is that -- here comes our technician and -- good morning, sir. 11 12 No, it's not on. here? 8 9 Can How are you doing? MR. GREENSPAN: I can talk loud, if necessary. CHAIRMAN ANGELIDES: 14 strain your voice. 15 should roll. We -- we don't want to We'll -- tell us, sir, when we All right. 16 VICE CHAIRMAN THOMAS: 17 CHAIRMAN ANGELIDES: 18 VICE CHAIRMAN THOMAS: Mr. Chairman? Yes, sir. In the interim, I do 19 want to thank Chairman Henry Waxman, Chairman of the 20 Energy and Commerce Committee, in whose meeting room 21 we're meeting today. 22 I noted to the Chairman that we've been in 23 this relationship a number of times but never in this 24 particular room. 25 I will not say that our first hearing in 11 1 the Ways and Means Committee had the microphones 2 working. 3 with the Chairman in terms of what it is that we get 4 when we get the room. So I'm going to read the contract you have 5 CHAIRMAN ANGELIDES: 6 VICE CHAIRMAN THOMAS: 7 the track. 8 over there, the reporters. 9 10 11 Here we go. No? We're on -- we're on I'm going to blame it on them scrambling CHAIRMAN ANGELIDES: Live television. All right. Good morning, this is -- welcome to the 12 meeting of the Financial Crisis Inquiry Commission. 13 All right, thank you very much. 14 15 16 And with that, Chairman Greenspan, of no more than ten minutes, an opening statement. MR. GREENSPAN: Thank you very much, 17 Mr. Chairman. 18 Thomas and members of the Commission. 19 Good morning to you, Vice Chairman I want to thank you for the opportunity to 20 share my views on important issues raised in the 21 Commission's invitation to appear today. 22 As I noted in my prepared remarks, while 23 the roots of the crisis were global it was securitized 24 U.S. subprime mortgages that served as the crises' 25 immediate trigger. 12 1 The rate of global housing appreciation was 2 particularly accelerated beginning in late 2003 by the 3 heavy securitization of American subprime and Alt-A 4 mortgages, bonds that found willing buyers at home and 5 abroad, many encouraged by grossly inflated credit 6 ratings. 7 The search and demand for mortgage-backed 8 securities was heavily driven by Fannie Mae and 9 Freddie Mac, which were pressed by the Department of 10 Housing and Urban Development and the Congress to 11 expand affordable housing commitments. 12 During 2003 and 2004 the firms purchased an 13 estimated 40 percent of all private label subprime 14 mortgage securities newly purchased and retained on 15 investors' balance sheets. 16 The enormity of these purchases was not 17 revealed until Fannie Mae in September 2009 18 reclassified a large part of its prime mortgages 19 securities portfolio as subprime. 20 And yet the effect of these GSE purchases 21 was to preempt 40 percent of the market up front, 22 leaving the remaining 60 percent to fill other 23 domestic and foreign investor demand. 24 25 As a consequence, mortgage yields fell relative to ten-year treasury notes, exacerbating the 13 1 house price rise, which in those years was driven by 2 interest rates on long-term mortgages. 3 I warned of the consequences of this 4 situation -- to testimony -- in testimony before the 5 Senate Banking Committee in 2004, and specifically 6 recommended that the GSEs need to limited in the 7 issuance of GSE debt and in the purchase of assets, 8 both mortgages and non-mortgages, that they hold. 9 still hold that view. 10 I The U.S. subprime market -- subprime market 11 grew rapidly in response to this demand, from global 12 investors, GSEs, and others. 13 mortgages in the United States had been a small but 14 successful appendage to the broader U.S. home mortgage 15 market, comprising less than 2 and a half percent of 16 total home mortgages serviced in the year 2000. 17 For years subprime At that time almost 70 percent of subprime 18 loans were fixed rate mortgages. 19 been securitized, and few, if any, were held in 20 portfolios outside the United States. 21 Fewer than half had By early 2007 virtually all subprime 22 originations were being securitized and subprime 23 mortgage securities, outstanding, totaled more than 24 900 billion dollars, a more than six fold rise since 25 the end of 2001. 14 1 The large imbalances of demand led mortgage 2 originations to reach deeper into the limited 3 potential subprime homeowner population by offering a 4 wide variety of exotic products, products that lowered 5 immediate monthly servicing requirements, thereby 6 enabling previously untapped, high-risk, marginal 7 borrow- -- borrowers to purchase a home. 8 9 Consequently, subprime loan underwriting standards rapidly deteriorated, and subprime mortgage 10 originations swelled in 2005 and 2006 to a bubbly 11 20 percent of all U.S. home mortgage originations, 12 almost triple their share in 2002. 13 The house price bubble was engendered by 14 lower interest rates but not the overnight rates of 15 central banks. 16 galvanized prices. 17 It was long-term mortgage rates that And by 2002 and 2003 it had become apparent 18 that individual country long-term rates were, in 19 effect, de-linked from the historical tie to central 20 bank overnight rates. 21 In 2002 I expressed concern to the Federal 22 Open Market Committee noting that our extraordinary 23 housing boom financed by very large increases in 24 mortgage debt cannot continue indefinitely. 25 Yet it did continue, despite the extensive 15 1 two-year-long tightening of monetary policy that began 2 in mid-2004. 3 In addition to tightening monetary policy 4 and warning of GSE risks, the Federal Reserve 5 exercised oversight of consumer protection risks under 6 the Home Ownership Equity Protection Act and its 7 general supervisory authority. 8 In 2000 the Board held hearings around the 9 country on implementing its HOEPA authority, focusing 10 on expanding the scope of mortgage loans covered by 11 HOEPA, on prohibiting specific practices, on improving 12 consumer disclosures, and of educating consumers. 13 Thereafter, we adopted rules that lowered 14 the trigger for HOEPA coverage and increased consumer 15 protections, including limitations on flipping, the 16 use of balloon payments, and the sale of 17 single-premium credit insurance. 18 More broadly, the Federal Reserve carefully 19 monitored, in the subprime market, and adjusted 20 supervisory policy to meet evolving marketplace 21 challenges. 22 its first inter-agency guidance on subprime lend- -- 23 lending, which addressed a variety of subprime 24 mortgage risks, including the importance of reliable 25 appraisals and the need for income and other In March 1999 the Federal Reserve issued 16 1 documents, documentation. 2 In October 1999, in 2001, and in 2004, the 3 Federal Reserve issued detailed guidance addressing 4 many of the loan features that have received recent 5 attention, including prepayment penalties, low 6 introductory rates and low down payment loans, among 7 others. 8 with my written testimony. 9 A summary of these initiatives is included The supervision of the federal banking 10 agencies, including the Federal Reserve, is an 11 important reason why banks and bank holding company 12 affiliates were not as significant originators of the 13 most controversial loan products as non- -- as 14 non-bank affiliated companies that operated outside 15 the jurisdiction of federal bank regulators. 16 The recent crisis reinforces some important 17 messages about what supervision and examination can 18 and cannot do. 19 woeful record of chronic failure. 20 regulators cannot identify the timing of a crisis or 21 anticipate exactly where it will be located or how 22 large the losses and spillovers will be. 23 cannot successfully use the bully pulpit to manage 24 asset prices, and they cannot calibrate regulation and 25 supervision in response to movements in asset prices. The forecasts of regulators have had a History tells us Regulators 17 1 Nor can regulators fully eliminate the possibility of 2 future crises. 3 What supervision and examination can do is 4 promulgate rates that are preventative and rules that 5 are preventative and that make the financial system 6 more resilient in the face of inherently unforeseeable 7 jobs. 8 relying on a fallible human regulator to predict the 9 coming crisis. 10 Such rules would protect automatically without Concretely, I argue that the primary 11 imperatives, going forward, have to be, one, increased 12 risk-based capital and liquidity requirements on banks 13 and, two, significant increases in collateral 14 requirements for globally traded financial products 15 irrespective of the financial institutions making the 16 trades. 17 of -- of misrepresentation and fraud than has been the 18 case for decades. 19 We will also need far greater enforcement If capital and collateral are adequate and 20 enforcement against misrepresentation and fraud is 21 enhanced, losses will be restricted to equity 22 shareholders who seek abnormal returns but in the 23 process expose themselves to abnormal losses. 24 25 CHAIRMAN ANGELIDES: Mr. Chairman, could you also -- could you try to wrap up, at least in 18 1 terms of -- 2 3 MR. GREENSPAN: I will in just a moment, one sentence. 4 Taxpayers will not be at risk, and 5 financial institutions will no longer be capable of 6 privatizing profit and socializing losses. 7 I thank the Commission for the opportunity 8 to submit these thoughts and look forward to answering 9 your questions. 10 11 CHAIRMAN ANGELIDES: Good. Thank you very much. 12 EXAMINATION BY CHAIRMAN ANGELIDES 13 CHAIRMAN ANGELIDES: So, Mr. Chairman, I 14 will start with a few questions and then the Vice 15 Chair and then we're going to go to the members, the 16 lead members, on this hearing. 17 So, let me pick up on some of your 18 testimony, both your written testimony as well as what 19 you have talked about today. 20 to focus on the area of subprime lending, which as you 21 know and you've indicated, that exploded across this 22 country from 2000 on, particularly in the later years. 23 And I specifically want And in your testimony, you pointed to the 24 fact that the securitization of toxic, subprime 25 mortgages was a key driver of the crisis. And, of 19 1 course, that securitization could not have occurred 2 without the origination of those products. 3 I want to focus very specifically on the 4 actions that the Federal Reserve could have taken, did 5 or did not take, with respect to reg- -- regulating 6 subprime mortgage products across this country. 7 And, specifically, I want to touch on 8 something you mentioned, the Home Ownership and Equity 9 Protection Act, and I have other questions about other 10 11 areas in which you could have acted. So let me lay this out for you. I mean, 12 first of all, there was a whole set of a pieces of 13 public action urging the Federal Reserve to act, as 14 well as public information, which would have urged you 15 to do the same. 16 And starting about 1999, a set of community 17 groups began to visit with the Federal Reserve, 18 warning about predatory lending practices. 19 of 2000, both HUD and Treasury urged the Federal 20 Reserve to use its authority, under HOEPA to curb 21 abusive lending. 22 Secretary of the Treasury, worked hard to try to put 23 in place best practices for mortgage -- subprime 24 mortgage lending. 25 was an epidemic of mortgage fraud that if unchecked, In January In 2002, Sheila Bair, then Assistant In 2004, the FBI warned that there 20 1 could lead to losses greater than the S&L crisis. 2 2005, the mortgage insurers wrote a letter to the 3 Federal Reserve as well as other federal agencies, 4 warning that it is, quote, deeply concerned about 5 increased mortgage market fragility, which combined 6 with growing bank portfolios and high-risk products 7 poses serious potential problems that occur without -- 8 with dramatic suddenness. 9 In In addition to that there were a number of 10 internal actions, some of which you referred to: A 11 staff memo in 1998 to the Community and Consumer 12 Affairs Committee, urging action in this area; a 13 report by the staff called The Problem of Predatory 14 Lending, in November 2000 in which the staff proposal 15 urged that loans be banned to people who did not have 16 the ability to pay and that there be broad 17 prohibitions on deceptive lending; Governor Gramlich, 18 of course, urged the promulgation of regulations. 19 You did note that you issued guidance, not 20 regulation, which showed an awareness of the subprime 21 problem. 22 And in our interview by our staff of you, 23 you noted yourself that “I sat through innumerable 24 meetings on HOEPA, the issues came up quite often”, and 25 you noted also, at another point recently that we at 21 1 the Federal Reserve were aware as early of 2000 of 2 incidence of some highly irregular, subprime mortgage 3 underwriting practices. 4 I mean very simply, Mr. Chairman, why, in 5 the face of all that, did you not act to contain 6 abusive, deceptive subprime lending? 7 allow it to become such an infection in the 8 marketplace? 9 MR. GREENSPAN: Why did you First of all, Mr. Chairman, 10 we did. There is a whole series of actions that we 11 take, which I've outlined in the appendix, which you 12 have and which I repeated summarily in my testimony. 13 But, you know, let's remember that in a 14 document that you sent to us, which is a Federal 15 Reserve document, it says, in July 1998, the Federal 16 Reserve board and HUD submitted a report to Congress 17 on mor- -- mortgage reform. 18 that improved disclosures alone were unlikely to 19 protect vulnerable consumers from unscrupulous 20 creditors. 21 That report concluded The report recommended that Congress 22 consider the need for additional legislation. And the 23 report made several recommendations to possible 24 amendments to HOEPA, such as further restricting 25 balloon notes, regulating the sale of single-premium 22 1 credit insurance, and minimum standards for 2 foreclosure. 3 Now, I sat through innumerable meetings on 4 the issue of HOEPA. And we had, for example, detailed 5 requests coming from a large group of representatives 6 in 2000, and I think it was seven senators, about a 7 month or so later, requesting that we do a series of 8 things, I mean, including taking the HOEPA trig- -- 9 trigger down from 10 percent to 8 percent, and a whole 10 list of things, which I won't outline here, but they 11 are in the appendix. 12 We did do almost all of the things that you 13 are raising. 14 think things were better than they would have been. 15 Were they enough to stop the surge in subprime 16 lending? 17 the extraordinary changes that were going in the 18 marketplace and, indeed, the actions of Fannie and 19 Freddie, which we didn't know about until September 20 2009, which altered the structure of that market from 21 what was in, say, prior to 2002, a small, 22 well-functioning group -- institution. 23 And the consequence of that is that I They were not. And the reason for that is CHAIRMAN ANGELIDES: But I want to -- I 24 want to press on this, because you didn't have the 25 ability to regulate Fannie and Freddie. And, by the 23 1 way, I've seen your numbers, and we're going to have a 2 whole day on them, and clearly things did not go well 3 at those institutions, given where they stand today 4 and over a hundred billion dollars of taxpayer 5 assistance to them. 6 But I just do want to note that you cited 7 the numbers from `03 and `04. 8 the private label security market in `05, and they 9 were negligible in `06. 10 They were 13 percent of But what I really want to say is you -- you 11 did have the ability to regulate the products 12 currently in the marketplace. 13 want to make sure we're not rewriting or forgetting 14 history here. 15 And so, you know, I do And so I want to focus on what the result 16 was of what the Federal Reserve did. 17 guidance and, in fact, I know you issued guidance in 18 1999, 2001, 2004, 2006, 2007, of course that was 19 guidance to examiners, not binding, and most 20 importantly couldn't apply to the whole marketplace 21 like HOEPA could. 22 institutions you regulated, not all the independent 23 mortgage lenders across the country. 24 25 You mention the It could only apply to those So it's good that you issued guidance, but I think that's more evidence that there isn't an 24 1 awareness of the problem and a failure to act. 2 But I want to specifically focus on the 3 2001 regulations which you cited. 4 think you said in your interview to our staff that, 5 quote, we developed a set of rulings that have held up 6 to this day. 7 And, in fact, I But here are the facts: The facts are you 8 adopted those rules in 2001. And at the time that 9 they were adopted, they were projected to cover 10 38 percent of the subprime lending activity in the 11 country. 12 When it was all said and done and an 13 evaluation was done of those rules in 2006, not 2009, 14 2010, what in fact had happened is the rules you 15 adopted covered just 1 percent of the market. 16 And so I return to you, again, was there 17 just a reluctance to regulate? 18 belief that regulation was not the right tool to kind 19 of constrain this level of abusive lending that ended 20 up leading to the origination of product and then the 21 mass securitizations you talked about? 22 Was there just a Because frankly, without the origination, 23 you couldn't have the securitization. But comment 24 specifically on that 1 percent. 25 that finding was that the rules only covered Are you aware that 25 1 1 percent? 2 MR. GREENSPAN: Well, look, Mr. Chairman, 3 I'll just go back to what I said in my opening 4 remarks. 5 We at the board in 1998 were obviously 6 aware of the nature of the problems. Remember that 7 the Federal Reserve board is a rule-making; it is not 8 an enforcement agency. 9 to implement to the types of enforcement that the FTC We did not have the capacity 10 has, HUD has, the Department of Justice, and 11 consequently that -- we were -- we were extending what 12 the rules should be and, indeed, we covered as much as 13 one -- anyone could conceive of. 14 CHAIRMAN ANGELIDES: But if you had adopted 15 those broader rules the FTC could have enforced 16 them -- 17 MR. GREENSPAN: 18 CHAIRMAN ANGELIDES: 19 20 21 22 No, but we did adopt --- and others could have enforced them. MR. GREENSPAN: No, we did adopt a whole series of rules. CHAIRMAN ANGELIDES: But as I said, they 23 only covered 1 percent of the activity. I mean, you 24 know, my view is, and I want to move on to another 25 issue, is you could have, you should have, and you 26 1 didn't. And I do think this is one area we have to 2 explore, how this contagion could have been 3 constrained. 4 Let me move on to a related issue, and it 5 does; it's the same issue but it's a different take. 6 There was the issue of examination of 7 non-bank subsidiaries. In January 1998, you 8 formalized a policy not to conduct routine consumer 9 compliance exams of the non-bank subsidiaries under 10 your purview. 11 November 1999. 12 should be examinations of consumer finance lenders, 13 which would have covered, depending on the 14 calculation, anywhere between another 12 to 18 percent 15 of the subprime originations. 16 covered everyone by any extent. 17 The GAO criticized that policy in Governor Gramlich proposed that there It wouldn't have There was an August 2000 memo from Delores 18 Smith and Glen Loney, I think, of your staff, called 19 compliance inspections of non-bank subsidiaries of 20 bank holding companies suggesting a pilot program. 21 2004 the GAO weighed in again, urging action given, 22 quote, the significant amount of subprime lending 23 among holding company subsidiaries. 24 action, no willingness to go in and examine a non-bank 25 subsidiaries. In But, again, no 27 1 Even though after your tenure, finally in 2 2007, the Federal Reserve with the FTC and the OTS and 3 state regulators did launch a pilot and then, in 2009, 4 began those examinations. 5 go in and at least examine these institutions? 6 MR. GREENSPAN. Why weren't you willing to Well, first of all, let me 7 just say, with respect to 2009, supervision and 8 regulation evolves over the years. 9 the actions the Fed took, in recent years, well after And I thought what 10 I left, were appropriate given the changing 11 conditions. 12 But let's -- let me take a second to give 13 you a sense in how the decision making operations at 14 the Fed took place. 15 We have, of course, this hundred large, 16 very sophisticated, professional group in the division 17 of consumer and community affairs, we have an outside 18 consumer advisory group, we had 12 community groups 19 within each of the Federal Reserve banks, and we 20 finally had the subcommittee of the board, which is a 21 committee on consumer and community affairs, which 22 essentially oversaw a whole operation. 23 operation, as it worked its way through, would come to 24 the board of governors with recommendations. 25 That Now, all I'm saying to you is that with 28 1 respect to a number of the issues that, for example, 2 Governor Gramlich, who is, frankly, one of the best 3 governors I think the board has ever had and a very 4 close friend of mine, he was the chair of that 5 committee and, indeed, we always looked to him to 6 decide which we should be doing and which we shouldn't 7 be doing because he had the most knowledge. 8 9 He chose not to bring those issues to the board. So I can't say, particularly, why, in 10 individual cases, but frankly I always thought his 11 grasp of the situation was as good as anybody I had 12 ever run into in the issue of consumer an affairs. 13 CHAIRMAN ANGELIDES: Well, he was one of -- 14 he was one person, but there were also others and 15 there were staff reports, I mean, would you -- let me 16 just ask you -- would you put this under the category 17 of, "Oops," should have done it? 18 MR. GREENSPAN: I'm sorry, of what? 19 CHAIRMAN ANGELIDES: Would you have put 20 this all under the category of, "Oops," we should have 21 done it? 22 MR. GREENSPAN: You know, I -- when you've 23 been in government for 21 years, as I have been, the 24 issue of retrospective and figuring out what you 25 should have done differently is a really futile 29 1 activity because you can't, in fact, in the real 2 world, do it. 3 I mean, I think, I mean, my experience has 4 been in the business I was in, I was right 70 percent 5 of the time, but I was wrong 30 percent of the time. 6 And there are an awful lot of mistakes in 21 years. 7 So I -- 8 CHAIRMAN ANGELIDES: 9 them? 10 MR. GREENSPAN: 11 sure what good it does -- 12 13 I'm not sure -- I'm not CHAIRMAN ANGELIDES: MR. GREENSPAN: 15 CHAIRMAN ANGELIDES: I'm sorry? MR. GREENSPAN: 18 CHAIRMAN ANGELIDES: 22 I don't know. All right, let's do this, then. 20 21 Would you put this in the 30? 17 19 Would you put this in the 30 percent category? 14 16 Would this be one of MR. GREENSPAN: Certainly part of it I would. CHAIRMAN ANGELIDES: Let's do this, then, 23 I'm going to stop at this moment. I'll have 24 additional questions, but what I would like to do is 25 now move to Commissioner Murren -- oh, I -- to my dear 30 1 2 3 4 5 friend, Bill Thomas. Bill Thomas? VICE CHAIRMAN THOMAS: Thanks, to my dear friend the Chairman. EXAMINATION BY VICE CHAIRMAN THOMAS VICE CHAIRMAN THOMAS: You are in 21, `87 6 to `06, I was in 28, from `78 to January of `07. 7 used to think timing was really important. 8 think timing's everything. 9 I Now I And so, from your perspective and my 10 perspective, looking back at it, and in this 11 particular instance, probably more so than anyone I 12 can think of, there are enormous number of would have, 13 could have, should haves from an enormous number of 14 institutions in government and in the private sector. 15 One of the things -- and you've written a 16 book, the recent paper in front of Brookings, the 17 crisis and your analysis here does a pretty good job 18 of pointing out problems in a number -- and you 19 focused, to a certain extent, on government and not -- 20 and not the private sector, but it's easy to do in 21 terms of risk management decisions that were made. 22 I want to try to focus in a slightly 23 different way on your role as the chairman of the 24 Federal Reserve. 25 shared in terms of an economy that in your attempts to During a period that you and I 31 1 stimulate you were beginning to run out of basis 2 points in the cupboard, and we were real close to 3 jawboning because that was all we were going to have 4 left, and always when you approach a crisis you 5 approach it from today looking at tomorrow. 6 It's unfair, as you said, but I would like 7 you, for just a little bit, to turn around, because 8 you've categorized concerns in the credit rating 9 structure, risk management structure, obviously the 10 GSEs, and I'm not going to ask you to assign a 11 weighting, but I do want to ask you, since we're not 12 going to be able to accomplish everything that we want 13 to accomplish in the timeframe, as I said in my 14 opening statements, would you be willing to respond to 15 written questions, in part based upon this hearing, 16 but in the other information that we might need, 17 moving forward, understanding consideration of time, 18 place, and manner. 19 20 MR. GREENSPAN: Most certainly, I would be delighted to do so. 21 VICE CHAIRMAN THOMAS: Thank you very much. 22 In your testimony you point to a lot of the 23 causes, none of them, not the subprime mortgage 24 origination, nor the housing bubble, nor the prudent 25 regulation of large entities, like Citi, that we'll 32 1 hear from, are really the narrow focus and even to a 2 certain extent the broader focus of the Fed. 3 So, in your words, what, exactly, is the 4 role and, therefore, the degree of fault that should 5 fall on the Federal Reserve -- 6 MR. GREENSPAN: 7 VICE CHAIRMAN THOMAS: 8 9 Well --- during that period? MR. GREENSPAN: Yeah, statutorily we have a 10 number of -- we had a number, and still do, have a 11 number of different authorities. 12 monetary policy, and that's what a central bank does. 13 We had supervision and regulation as secondary but 14 major issue. 15 some of our written documents, the third one was 16 systemic risk. 17 Fundamentally, it's And we even, as we specify in the -- So there's a very broad mandate that the 18 Federal Reserve has, and it's structured according to 19 meet those particular mandates. 20 We have an organization that is the best in 21 the business, as I'm concerned, in the issue of 22 monetary policy. 23 regulatory operation than exists within the total 24 Federal Reserve system. 25 with problems by its very nature which are insoluble that I know of no better supervision and And we are dealing basically 33 1 require us to make judgments about what the future is 2 going to hold. 3 And as I mentioned before, if we get it 4 right 70 percent of the time, that is exceptionally 5 good. 6 the best we could with the data that we had, and all I 7 can say is did we make mistakes? 8 mistakes. 9 that can be altered under the existing structure. And I think that we -- what we tried to do is 10 Of course we made I don't know of -- I know of no way that And I make a special point, as you know, of 11 trying to emphasize that the only type of regulation 12 that works and, in fact, works sufficiently and 13 adequately are those that do not require forecasts. 14 VICE CHAIRMAN THOMAS: Is it fair for me to 15 indicate that the thrust of your testimony was that 16 the crisis to a very great extent was caused by the 17 demand for subprime securities; is that a fair -- 18 MR. GREENSPAN: Well, the fundamental cause 19 of the crisis goes back to the end of the Cold War, 20 which is pretty obscure, but it's a global crisis. 21 You cannot think of the United States 22 crisis in any form without looking at the global 23 context. 24 25 VICE CHAIRMAN THOMAS: I'm going -- I'm going to get into that as we go forward, but the 34 1 narrow focus -- and I do want to thank you for citing 2 a book which I think is especially useful, Reinhart 3 and Rogoff, in getting the context and taking us down 4 memory lane on the history of bubbles. 5 But if you were focusing on subprime 6 securities, weren't they certainly predicated, to a 7 degree, on rising housing prices? 8 9 MR. GREENSPAN: First of all, let's remember that the subprime mortgage market was 10 actually a very effective market in its early years. 11 It served a limited population, homeowner, potential 12 homeowner population, which couldn't afford the 13 20 percent down payment that prime mortgages required. 14 VICE CHAIRMAN THOMAS: I agree with you in 15 the early history. I've looked at statements from 16 1999. 17 people wanted it, isn't that the story of all bubbles, 18 regardless of what it is, whether they all start out 19 with good intentions and somehow they go awry? As they were moving into this area, a number of 20 MR. GREENSPAN: Well, I'm just trying to -- 21 VICE CHAIRMAN THOMAS: And what we're 22 trying to focus on is, in this particular bubble, what 23 is it that went awry? 24 25 Would you feel comfortable saying that at least some of the concern with the housing bubble was 35 1 the FED's monetary policy or not at all? 2 MR. GREENSPAN: I'll try to explain, in 3 some detail. In the Brookings paper I go through a 4 lot of econometrics and the like, that certain 5 fundamental things changed in the world economy, which 6 made monetary policy, essentially, ineffective in 7 dealing with long-term asset prices. 8 So are you asking -- 9 VICE CHAIRMAN THOMAS: 10 understand the argument. 11 a line. I agree with you. I I'm just trying to move down 12 MR. GREENSPAN: I would say -- 13 VICE CHAIRMAN THOMAS: And clearly capital, 14 the savings rate, the change in the movement of money, 15 and that had you -- it wasn't monetary policy in terms 16 of your argument because, frankly, longer-term yields 17 would have been kept down by the inflow of capital and 18 long-term rates were kept below -- low by 19 international capital flows. 20 But isn't it a minimally fair statement to 21 at least say that if you had raised rates, wouldn't 22 longer rates, albeit suppressed somewhat, still would 23 have risen and slowed the growth of the housing 24 bubble? 25 MR. GREENSPAN: I'm afraid that's precisely 36 1 2 what we found didn't happen. We -- VICE CHAIRMAN THOMAS: And so even more 3 capital would be flowing in, and it would have left 4 basically long-term rates unchanged? 5 MR. GREENSPAN: 6 VICE CHAIRMAN THOMAS: 7 8 9 Well, you cannot explain -And that's your argument, isn't it? MR. GREENSPAN: What I'm saying is, basically, you cannot explain long-term rates in the 10 United States, other than what is being arbitraged in 11 the rest of the world, is the data I produced in the 12 Brookings paper demonstrates that between the years 13 2002 and 2005, the period when the bubble was 14 emerging, that short-term rates, that is, the federal 15 funds rate, over which we had full control, did not 16 affect long-term rates. 17 And that, as a consequence of that, even 18 though we tightened monetary policies, starting in 19 mid-2004, for a considerable period of time, we had 20 very little to negligible effect on inflations in the 21 home markets which, of course, is what the bubble is. 22 So the simple answer to your question is -- 23 VICE CHAIRMAN THOMAS: 24 25 Give myself an additional five minutes, Mr. Chairman. MR. GREENSPAN: Simple answer to your 37 1 question is that the evidence stipulates that we -- 2 our endeavor to tighten monetary policy did not affect 3 long-term rates as it always had at the beginning of 4 tightening cycle or earlier. 5 VICE CHAIRMAN THOMAS: Okay. If the 6 ten-year treasuries on which mortgages are based don't 7 react to short-term rates, what was the argument for 8 keeping the Fund's rate low? 9 MR. GREENSPAN: 10 11 The Fund's rate -- VICE CHAIRMAN THOMAS: difference? 12 MR. GREENSPAN: 13 VICE CHAIRMAN THOMAS: 14 15 Wouldn't make any Yeah, well -It was for another reason? MR. GREENSPAN: Yes. The Fund's rate was 16 kept low because even though monitoring policy 17 de-linked from long-term interest rates in that 18 period, it still had a significant impact on 19 short-term rates. 20 impact on the economy. And short-term rates do have an 21 The reason we pushed rates down was in 2003 22 there was a very considerable concern that the type of 23 deflationary processes which were underway looked very 24 much like those that were occurring in Japan and, 25 indeed, similar -- similar to what is going on today, 38 1 and we decided that we needed insurance against that, 2 in the short end of the market. 3 we kept rates down until mid-2004, that is. 4 VICE CHAIRMAN THOMAS: That was the reason As we're looking at 5 attempts, I mean, obviously we're dealing with a 6 situation in which a number of institutions failed, 7 both in and out of government, and we're asking 8 ourselves questions: 9 consolidate supervision to try to make sure that the Does it make sense to 10 left hand knows what the right hand is doing; is it 11 better to decentralize it; what about transparency, 12 the whole question of the rating structure, 13 third-party analysis. 14 In terms of looking at where people in 15 office and in positions of responsibility are going 16 now, monetary policy, bubbles, making sure that 17 certain things don't occur again, including, I think, 18 the Fed, in terms of recent statements that are made, 19 if they're moving toward regulatory instruments to 20 target the bubble and interest rates to target 21 economic activity, isn't that, to a degree, a -- maybe 22 repudiation is too strong a term -- but isn't that 23 different than the policy that you thought was 24 appropriate, or is it that they're looking at that 25 period of history that they went through and are 39 1 talking about where they need to go, and what's your 2 assessment of that? 3 MR. GREENSPAN: I think it's mainly the 4 latter. 5 was going on in meetings which I was not at, but the 6 markets are changing all the time. 7 It's difficult for me to know precisely what And it is critically important for the 8 Federal Reserve to keep up with those changes, and in 9 many instances, they change in directions and require 10 actions which previously would have been 11 inappropriate. 12 VICE CHAIRMAN THOMAS: And then, just let 13 me say, that in the last large paragraph of your 14 testimony, are you really that -- in my opinion, that 15 pessimistic about our ability to deal with the 16 conditions we find ourselves in. 17 it will always be something else, but to a certain 18 extent, I mean, when you've got a river that overflows 19 its banks, whether it's the Nile or the Kern River, 20 building a dam seems to help in terms of allowing a 21 more regulated release. 22 paragraph, the only possible solution is capital and 23 collateral at an adequate rate. 24 Citibank, and we'll be hearing from them recently, and 25 that every turn, they were, quote, unquote, adequately Because inevitably I got out of that last And I take a look at 40 1 2 capitalized in all the categories. So it's easy to say that, but what does 3 adequately capitalized mean? 4 human condition and, yes, I cited a book which kind of 5 puts us in a historical perspective of, this time it's 6 different but it isn't, but I cannot believe that we 7 can't get an understanding of how we can mitigate and, 8 to me, it's always transparency; it's always someone 9 who's disinterested slowing down the process and 10 11 And, yes, we're in the examining it, to a certain extent. MR. GREENSPAN: Well, Mr. Thomas, you're 12 raising exactly what the appropriate issue that should 13 confront regulators is, what is adequate capital. 14 And the reason I say that is, leaving aside 15 what that number is, and I might -- let me just say 16 parenthetically, that you're quite right; Citi and 17 everyone else was considered adequately capitalized. 18 The major mistake in the system, that adequate 19 capitalization issue is a function of what your risk 20 management system is, and as I mention in both the 21 Brookings paper and in the testimony, the written 22 testimony, what we discovered is that there was a 23 fatal flaw in that system. 24 until we saw the outcome of what happened to the 25 markets after Lehman, the Lehman bankruptcy. We did not recognize it 41 1 But the issue of adequate capital is 2 important because, just think for the minute, if we 3 knew what the actual number should be, and I have 4 views as to what that number ought to be, it's 5 higher -- 6 7 8 9 VICE CHAIRMAN THOMAS: There will be a follow-up question, in writing. MR. GREENSPAN: If we had adequate capital and liquidity, whatever else we do would be helpful 10 but not critical. 11 adequate capital and liquidity, the system will fail 12 to function. 13 If we have everything else, but not In short, I'm saying we can solve this 14 problem on the capital liquidity and collateral side 15 as well as doing it in other areas. 16 and misrepresentation, in my judgment, over the last 17 decades, has been inadequately enforced. 18 a critical question. 19 Like I said, fraud And that is But how you structure regulation is 20 interesting, important, but not critical to resolving 21 this crisis and preventing the next one. 22 VICE CHAIRMAN THOMAS: And I think we'll 23 hear from a number of folks offering testimony that 24 fraud or behavior should have consequences. 25 it's illegal or criminal, something should result from And if 42 1 it. And it has been, in my opinion, a failure from 2 Main Street to Wall Street and here in the nation's 3 capital. Thank you very much. 4 CHAIRMAN ANGELIDES: 5 Mr. Vice Chairman. 6 Ms. Murren. 7 Mr. Chairman. 9 your testimony. 10 Thank you, Now, we are going to go to COMMISSIONER MURREN: 8 All right. Thank you, And thank you, Chairman Greenspan, for I enjoyed reading it. EXAMINATION BY COMMISSIONER MURREN 11 COMMISSIONER MURREN: 12 specifically my line of questioning on the 13 responsibilities of the Federal Reserve as it relates 14 to insuring the safety and soundness of the financial 15 holding companies and the bank holding companies and 16 their supervisory role. 17 I'd like to focus And, in particular, go back to a time 18 period that you mentioned, 2005, which was the -- 19 arguably, the peak of the housing bubble, and talk a 20 little bit about the supervisory structure and 21 examination staff of the Federal Reserve system. 22 It's my understanding that there were 23 approximately 2600 people throughout the -- throughout 24 the Federal Reserve system engaged in supervision and 25 examination. And during that time, approximately 12 43 1 of those people were allocated to examining Citibank 2 specifically, and a similar number were allocated to 3 examining the other major banks, which, of course, 4 represent the major concentration of assets within the 5 banking system. 6 And I'm curious, in retrospect, as to 7 whether you would say that perhaps there could have 8 been better resource allocation within that framework 9 towards those larger banks, particularly in light of 10 the fact that the Federal Reserve is not constrained 11 by the appropriations process, as are some of the 12 other agencies. 13 MR. GREENSPAN: Let me go back to your 14 original remarks. You were asking about the 15 compensation issues that were involved recently and in 16 history. 17 I think it's important to -- 18 COMMISSIONER MURREN: Mr. Chairman, I'm 19 sorry, I actually didn't mean compensation, but just 20 the number of individuals that were assigned to each 21 enterprise. 22 23 MR. GREENSPAN: Yes, and I thought you were. 24 COMMISSIONER MURREN: 25 MR. GREENSPAN: Okay. And I'll go to that. 44 1 COMMISSIONER MURREN: 2 MR. GREENSPAN: Got it. The Federal Reserve and all 3 of the banking regulators have a fairly large cadre of 4 permanent on-site examiners in all of the big 5 institutions. 6 not only, obviously, from the Office of the 7 Comptroller of the Currency, which of course regulates 8 Citibank, which is by far the largest institution in 9 the Citi holding company system. 10 And there is a very large contingent, But we had -- the Federal Reserve had a number of people involved. 11 It's not an issue of resources. It's not 12 an issue of people. 13 inherently rather difficult job. 14 to get it done materially better by just reshuffling 15 the chairs. 16 understanding of the type of problems which arise and 17 most specifically, in my view, the necessity of -- the 18 reason I raise the capital so often is that, in a 19 sense, it solves every problem. 20 It's an issue that's an And you're not going I think it requires a better Now, banks don't like the issue of having 21 to put up more capital, but if they didn't and, 22 indeed, this last crisis exhibits this, they are 23 getting a subsidy unpaid for by the federal government 24 which has to bail out the banks at the tail end of a 25 crisis. 45 1 And I think what the point, the critical 2 question here is to focus on something we can do 3 something about, control, and generally have far 4 greater effect than any changes we could make in 5 supervision and regulation. 6 COMMISSIONER MURREN: Well, to the extent 7 that allocations of capital are similar in certain 8 respects to the management of an agency or a business 9 in terms of allocating resources that may be precious, 10 personnel, time, energy, intellect, when you think 11 about that, as an individual who's charged with 12 insuring safety and soundness for bank holding 13 companies, in this case, Citigroup, in concert with 14 other agencies, even when you -- if you look back at 15 some of the commentary from within the Federal Reserve 16 system, there is a review of the operations of the 17 Federal Reserve Bank of New York, as it relates to 18 their supervision of Citibank, which suggests that, it 19 was done in 2005, and I quote, that it had 20 insufficient resources to conduct supervisory 21 activities in a consistent manner. 22 And I understand this may not have been 23 brought to your attention in 2005, but that it is 24 ongoing and has not been remedied as of the tail-end 25 of 2009. 46 1 And I'm curious as to whether you think 2 part of the accountabilities of the Federal Reserve is 3 to insure that these resources are allocated in a 4 manner that would be consistent with insuring safety 5 and soundness? 6 MR. GREENSPAN: Well, I've heard those 7 statements. And I must say I do not recall a single 8 instance in which requests for funding for supervision 9 and regulation was turned down by the board. 10 More specifically, I cannot imagine that if 11 the Federal Reserve Bank of New York perceived that it 12 had inadequate resources to do the jobs that it's 13 required to do, that the president of the Federal 14 Reserve Bank would have been on the phone with me, 15 very quickly, and complained. 16 or any other communication ever existed. 17 No such telephone call So I find this notion of inadequacy not 18 verifiable. I do think there are always problems of 19 turnover, and I think the New York Bank had a 20 significant amount of turnover, which does create 21 managerial problems. 22 other words, it's not a lack of funds, as you 23 correctly point out, importantly, the Federal Reserve 24 is not subject to -- I should say -- the Federal 25 Reserve uses its own funds, and it does not require It's not a resource problem. In 47 1 2 funds appropriated by the Congress. So we're not limited, ourselves, even 3 though we try to restrict what we spend on, because we 4 don't have appropriated funds. 5 COMMISSIONER MURREN: May I continue on 6 this discussion of the supervisory responsibilities? 7 And perhaps in this instance, working with other 8 agencies, some of the -- some of the safety and 9 soundness determinations for the holding companies 10 were the results of a dependence on the -- the 11 conclusions of other agencies; for example, the 12 securities dealers, the broker dealers for some of 13 these major institutions would be governed by the SEC. 14 And, if I'm not mistaken, in the 15 legislative language, it suggests that you -- the 16 Federal Reserve, should result -- rely on the results 17 of their supervisions, their examinations. 18 And I wonder, in some respects, if this 19 doesn't in some ways mirror a dependence, say, on a 20 rating agency? 21 on the work of others to determine the safety, 22 soundness, and security of an underlying asset? I mean, essentially you're depending 23 MR. GREENSPAN: Yeah, that -- that's a very 24 tough question to answer. 25 is that this gets to the issue of centralization and And the reason, basically, 48 1 the extent to which the pros and cons of having, for 2 example, as we do now, a number of different 3 regulatory operations within banking. 4 Since I came to the Federal Reserve, there 5 has been all sorts of discussions about should we have 6 a single consolidated regulator, including the SEC the 7 Fed, the OCC, et cetera. 8 9 And there are arguments, and I think effective arguments, on both sides of the argument. I 10 think the current system has worked as well as it can. 11 I'm not sure that centralization, per se, moving the 12 chairs around, will alter its effectiveness. 13 COMMISSIONER MURREN: Could you comment 14 briefly on the composition of the board of the New 15 York Federal Reserve Bank and your feeling about the 16 constitution. 17 themselves subject to the supervision of the entity, 18 itself, do you think that that influences in any way 19 the outcomes of their decision making? 20 If you have six of nine members who are And I would note that Lehman Brothers -- 21 Dick Fuld was one of the members of the board. 22 think it makes them too close to the companies that 23 they regulate? 24 25 MR. GREENSPAN: Do you Theoretically, I think that's an issue that has to be thought through. I 49 1 personally have seen no evidence that the members of 2 the board at the New York Bank had any influence on 3 policy, other than giving us advice. 4 They were an extraordinary valuable source 5 of information because of their scope. 6 that we in any way favored any of them or basically 7 were influenced with respect to policy by what they 8 said, other than facts they gave us, which we always 9 evaluated, I saw no evidence of that in my tenure. 10 COMMISSIONER MURREN: But the notion And just a final 11 question, on -- back to subprime origination that 12 occurred outside of entities that were supervised by 13 the Federal Reserve, is it your opinion that those 14 entities should be supervised by the Federal Reserve 15 now? 16 MR. GREENSPAN: Well, first of all, 17 remember, you have to distinguish between supervision 18 and enforcement. 19 A lot of the problems which we had in the 20 independent issuers of subprime and other such 21 mortgages, the -- the basic problem there is that if 22 you don't have enforcement, and a lot of that stuff 23 was just plain fraud, you're not coming to grips with 24 the issue. 25 The Federal Reserve, remember, is not an 50 1 enforcement agency. 2 types of personnel, which that the SEC, the Department 3 of Justice and HUD has, to do that, so I can't answer 4 that question, fully, because I can't say as fully 5 cognizant of all the possibilities I'd like to have. 6 We don't have or didn't have the COMMISSIONER MURREN: Do you think that, 7 then, you should have those types of enforcement 8 authorities? 9 MR. GREENSPAN: It would require a very 10 significant set of revisions with respect to how our 11 supervision and examination force would -- would be, 12 because remember that what the Federal Reserve 13 examiners are, are largely experts in examining 14 concentration of assets, the bookkeeping, a whole set 15 of issues which relate to how banks work and how banks 16 work in an effective manner. 17 It's not a group who can ferret out 18 embezzlement, fraud, misrepresentation. And, indeed, 19 when we get such examples, what we tend to do is to 20 recognize that we don't have the facilities, and we 21 refer it to the Department of Justice, which we did on 22 innumerable occasions on a lot of issues; in other 23 words, we were requesting other enforcement agencies 24 to rectify the problems that we, in our examinations, 25 were able to unearth. 51 1 COMMISSIONER MURREN: Do I have one more? 2 Thank you. 3 When you look forward, one of the comments 4 that you'd made in the past is that future supervision 5 will, of necessity, have to rely far more on a banks' 6 risk management information systems to protect against 7 loss and then, further, technology and innovation, the 8 development of sophisticated market structures and 9 responses. 10 Do you still feel that that is the 11 direction that supervision and regulation should go, 12 or do you think that there should be some balance 13 between that and what would perhaps be viewed as more 14 old-fashioned auditing of the various assets that lie 15 within an organization? 16 MR. GREENSPAN: Well, we are still working 17 with the supervision structure and philosophy that 18 existed a hundred years ago; that is, back, in say the 19 year 1900, the examiners for the Comptroller of the 20 Currency would go into a bank and be able to actually 21 see the individual loan documents and review them in 22 the usual manner. 23 The system has become so complex that 24 there's no longer the capacity, except in very small 25 community banks to still do it that way, which, 52 1 incidentally, is the ideal way to actually do 2 supervision and regulation. 3 So we are confronted with a problem that in 4 order to vet the individual counter-parties of various 5 banks which we supervise and oversee, we are reaching 6 far beyond our capacities so that you have to rely, 7 because there's no other real alternative to a sound 8 risk management system on the part of individual 9 institutions who, in my experience, know far more 10 about the people to whom they lend than we at the 11 Federal Reserve would know, so that they're -- they 12 have to be the first line of defense. 13 and they did in this instance, it's not a simple issue 14 of saying, Well, let's regulate better. 15 If they fail, The old-fashioned regulation to which you 16 refer was the best. 17 largely a victim of the degree of complexity that a 18 current complex division of labor society requires and 19 the financial institutions that are required to 20 support it. 21 It has been -- it has been So that you can't turn the clock back -- 22 this is all interrelated and we have -- it's a 23 different world. 24 higher, the complexity is awesome, and I wish I knew a 25 simple answer to this problem. The standards of living are much 53 1 But I do know that if you cannot depend on 2 the counterparty surveillance of the individual banks, 3 which we regulate, our ability as regulators 4 would be far less effective, to the extent that it is. 5 COMMISSIONER MURREN: 6 CHAIRMAN ANGELIDES: 7 Let's now go to Mr. Wallison. 8 minutes, Mr. Wallison. 9 10 Thank you. Thank you, Ms. Murren. And you have 15 COMMISSIONER WALLISON: Thank you, Mr. Chairman. 11 EXAMINATION BY COMMISSIONER WALLISON 12 COMMISSIONER WALLISON: 13 good to have you here. 14 opportunity to talk with you today. 15 Mr. Chairman, it's And I look forward to the As you know, we are in the business of 16 trying to find out what actually caused the financial 17 crisis. 18 and in your written statement, subprime and Alt-A 19 mortgages, and I wanted to follow up a little bit on 20 that. 21 And you mentioned in your opening statement It's not in the material that the 22 Commission has put out, but it appears that there were 23 as many as 27 million subprime and Alt-A, in other 24 words, weak loans, in the us financial system, of 25 which 12 million, according to the information that 54 1 Fannie itself put out, as you mentioned, in 2009, 12 2 million were held and guaranteed by Fannie Mae and 3 Freddie Mac, and about 5 million guaranteed by FHA, so 4 that would be maybe 17 million out of the total 27 5 million that were on the books of government agencies. 6 Now, what we've forgotten a little bit in 7 this is that we were very happy, during the late `90s 8 and the early 2000s, with the fact that these 9 mortgages were increasing home ownership in the United 10 States, something that is very important. 11 And we understood that these mortgages were 12 subprime and otherwise weak. But the whole objective 13 was to increase ownership among groups that had 14 previously been underserved. 15 ownership in the United States increased from about 16 64 percent in 1992, `93, to about 69 percent by the 17 2003, 2004. 18 significant thing in the minds of most people. And in fact the home And this was -- this was a very 19 Now these mortgages, however, as you 20 pointed out, drove a bubble, a very significant 21 bubble, and when that bubble deflated, they began to 22 deflate themselves, to default themselves, in 23 unprecedented numbers. 24 25 And in 19 -- in 2007, as you're aware, the entire asset-backed market for mortgage-backed 55 1 securities simply disappeared. 2 As far as I know, this is an unprecedented 3 event in financial history where a market simply 4 disappears. 5 of financial institutions were simply unable to market 6 or even value the assets they were holding. 7 And as a result of that, a large number Now, I would like to -- I would like to 8 give you a chance to expand on what might have -- on 9 what this whole series of events might have meant as a 10 cause for the financial crisis and particularly what 11 was the fatal flaw you spoke about after Lehman 12 Brothers failed. 13 And I would like you also to focus in your 14 remarks, perhaps, on the role of government policy in 15 creating or at least demanding the creation of all of 16 these weak and high-risk mortgages. 17 You've got a very broad experience in 18 markets, worldwide markets, exactly the kind of 19 problem that we've been looking at, the collapse of 20 the worldwide market and, in fact, a worldwide 21 financial crisis and, to me, your experience there 22 would be invaluable to us in understanding the 23 connections between government policy, on home 24 ownership, and that crisis. 25 MR. GREENSPAN: Well, Mr. Wallison, as I 56 1 mentioned in my prepared remarks, government policy, 2 as such, was very strongly related to the issue of 3 enhancing home ownership for lower and middle income 4 groups. 5 The way I put it, when Honda was a major 6 issue, early on, to the Federal Reserve, and we were 7 beginning to observe the extent of discrimination 8 that was involved in a lot of mortgage-making, the 9 thrust of policies were all acutely aware was very 10 strongly to move towards increasing home ownership, a 11 policy which I supported, because I think in a 12 market-oriented capitalist economy, the greater the 13 degree of ownership of property, the greater the 14 participation of all people in that -- that type of 15 economy. 16 The trouble, unfortunately, is that if you 17 now go back and track policy, we started off from a 18 point -- from the point where redlining was the real 19 concern. 20 there were a lot of banks which were leaving 21 potentially profitable loans on the table, so to 22 speak. 23 evaluate these loans in a more objective way and they 24 were doing that. 25 And, indeed, what that implied was that And so we at the Fed were pushing for them to The evolution of the subprime market goes 57 1 over the years and then begins to accelerate, because 2 it was the broad thrust of this government to expand 3 home ownership, especially amongst lower and middle 4 income groups. 5 which gave standards to Fannie and Freddie to 6 significantly increase their participation in those 7 types of loans. 8 9 It was the policy officially of HUD And we look back now at the numbers, as you will -- as you point out correctly, that is, as often 10 the case, we go from one extreme to the other. 11 you take the extent of Fannie and Freddie 12 participation in endeavoring to meet the HUD goals, 13 the numbers are extraordinarily large and very -- so 14 large, in fact, that they are preempting a major part 15 of the market, and that which we learned only in 16 retrospect, starting in September 2009, was a major 17 factor in producing the bubble. 18 COMMISSIONER WALLISON: And if Let me -- let me 19 follow up a little on that, and I'm delighted to have 20 the time to do that, because I've wondered for a 21 while. 22 flavor of what it was like to have sat in your seat 23 for many years during this period. 24 maybe even 2005, if the Federal Reserve had tried to 25 clamp down on subprime lending when home ownership was I wanted to get a little bit more of the In 2003, 2004, 58 1 increasing in the United States, what would you 2 imagine would have happened? 3 MR. GREENSPAN: Well, observe that at that 4 time foreclosures were low, home ownership was 5 expanding; the delinquencies in subprime markets were 6 remarkably small. 7 to thwart what everyone perceived in, I would say, a 8 fairly broad consensus, that the trend was in the 9 right direction, home ownership was rising, that was 10 an unmitigated good, the Congress would have clamped 11 down on us. 12 If the Fed, as a regulator, tried There's a presumption there that the 13 Federal Reserve is an independent agency, and it is up 14 to a point, but we are a creature of the Congress. 15 And if in that midst of period of expanding home 16 ownership no problems perceived in the subprime 17 markets had we said we were running into a bubble and 18 we would have to start to retrench, the Congress would 19 say we haven't a clue what you are talking about. 20 And I can virtually guarantee, indeed, if 21 you want to go back and look at what various members 22 of the House and the Senate said during these periods, 23 on the subject, I would suggest the staff do a little 24 run and you will be fascinated by how different it 25 sounded back then than the way the retrospective view 59 1 of history has evolved. 2 I mean, I sat through meeting after meeting 3 in which the pressures on the Federal Reserve and on, 4 I might add, all the other regulatory agencies to 5 enhance lending were remarkable -- the less -- right 6 now we have, as you point out, a nonexistent subprime 7 market. 8 well. 9 especially HOEPA, which are non-operative, at this 10 There's also a nonexistent Alt-A market, as And we have a lot of regulations for subprime, stage. There is no market. 11 I certainly trust it comes back, but the 12 private subprime market shows no signs of moving, and 13 it's not self-evident to me that it's coming back, so 14 we could argue what the rules should be. 15 over what? 16 The rules There's nothing left. And I -- I am merely saying that having 17 gone 18 and a half years before the Congress, there's 18 a lot of amnesia that is emerging currently. 19 COMMISSIONER WALLISON: Let me follow up a 20 little bit more, too, on one other part of this whole 21 process. 22 When the market collapsed, it was 23 impossible, as I said, for financial institutions that 24 were holding these instruments to value them or to 25 sell them; in other words, this had a major effect on 60 1 their liquidity but also on their financial 2 statements. 3 And I would like your views on the 4 significance of the elimination, the end of this 5 asset-backed market for mortgage-backed securities on 6 the accounting that financial institutions were 7 required to pursue, the rules of mark-to-market or 8 fair value accounting, and what effect those might 9 have had on the financial crisis. 10 MR. GREENSPAN: Yeah, this is a major 11 dispute within the accounting profession and in, 12 obviously, the banking industry, as well. 13 I've always held the view that on 14 fundamental straight loans, commercial loans or 15 personal loans, which you do not expect to sell prior 16 to maturity, that book valuation with amortization, as 17 is usually done, is the probably sensible thing to do. 18 But there are an awful lot of assets out 19 there which fluctuate in the value and you do sell. 20 And the accounting profession says that those, 21 definitely, have to be mark-to-market. 22 Now, this is a dispute which we could take 23 two hours on, and I don't want to get involved in it, 24 specifically, but there is no simple solution for -- 25 if you don't have a market value, as poor as it may 61 1 be, how else do you value these things? 2 have fundamentally either book or market. 3 nothing, really, in between. 4 COMMISSIONER WALLISON: So you really There's What about cash 5 flow valuation? 6 to use discounted cash flow because these -- many of 7 these assets, as I understand it, and we'll talk about 8 this later, when we get to Citi, were continuing to 9 flow cash. 10 Many -- many institutions attempted Is that not a valid way to do it? MR. GREENSPAN: Well, as I said, there are 11 pros and cons to all of this, and there is no general 12 agreement within the accounting professions or the 13 banking professions. 14 And I think it's a very important and 15 useful discussion because it points out the fact that 16 our books of account are not necessarily sacrosanct 17 merely because they're printed and published. 18 We do not know exactly what the 19 consequences of mark-to-market was, although, as you 20 remember, I guess, following the Lehman default, there 21 were very major arguments that the accounting process 22 of acquiring mark-to-market was a factor in 23 exacerbating the price declines. 24 25 That's a hard argument to make. It sounds plausible but the question is always, relative to 62 1 what? 2 position that I feel fully comfortable with on this 3 issue. 4 And so I'm not -- I -- I have not taken a I'm still learning. COMMISSIONER WALLISON: I have one more 5 question, my final question, and that is, the National 6 Community Reinvestment Coalition reported in its 7 annual report, in 2007, that banks had made over 2 -- 8 4 and a half trillion dollars in CRA loan commitments 9 in connection with obtaining approvals for mergers, 10 principally by the Federal Reserve, and that is 11 because the banks had to meet certain standards in 12 their CRA Community Reinvestment Act lending. 13 Do you recall these commitments, in 14 connection with approvals of mergers by the Fed, and 15 would you refer to that and describe that to us if you 16 do? 17 18 VICE CHAIRMAN THOMAS: Mr. Chairman, I yield Commissioner Wallison three minutes. 19 CHAIRMAN ANGELIDES: 20 COMMISSIONER WALLISON: 21 22 So done. I've got three more minutes so you have three more minutes. MR. GREENSPAN: All mergers and 23 acquisitions that are under the auspices of the 24 Federal -- that is, the Holding Company Act, require 25 us to evaluate CRA in conjunction with coming to a 63 1 decision. 2 other words, it cannot be made -- it cannot be done in 3 any other place in the Fed. 4 It can only be made by the full board, in So every merger that we authorized was 5 always accompanied with an evaluation of CRA and the 6 degree of meeting CRA requirements. 7 The law is pretty specific on that, and I 8 think that there were innumerable cases which we 9 turned down mergers and acquisitions that are far 10 greater, in which the staff initially said the board 11 would not, under its existing various procedures, is 12 not likely to agree with this merger unless you 13 altered your CRA commitments. 14 And so most of the mergers that occurred I 15 say probably had some CRA adjustment either directly, 16 in threatening to say no to the merger, or indirectly, 17 by anticipating that we would say no and therefore 18 change. 19 So in that regard, I think it was a fairly 20 heavy CRA commitment in the banking industry, and it 21 is working because you don't hear about it. 22 COMMISSIONER WALLISON: 23 CHAIRMAN ANGELIDES: 24 Mr. Wallison. 25 Fifteen minutes. Thank you. Thank you, Now we will go to Mr. Georgiou. 64 1 COMMISSIONER GEORGIOU: 2 Thank you. EXAMINATION BY COMMISSIONER GEORGIOU 3 COMMISSIONER GEORGIOU: Dr. Greenspan, let 4 me just follow up on one thing Commissioner Wallison 5 began on. 6 state that, in my judgment the origination of subprime 7 mortgages, as opposed to the rise in global demand for 8 securitized -- securitized subprime mortgage interest, 9 was not a significant cause of the financial crisis. 10 11 Could you elaborate on that, briefly, please? 12 13 At page 12 of your prepared testimony, you MR. GREENSPAN: I'm sorry, would you repeat that, again? 14 COMMISSIONER GEORGIOU: It says, you say, 15 let me respectfully reiterate that, in my judgment, 16 the origination of subprime mortgages was not a 17 significant cause of the financial crisis, as opposed 18 to the rise in global demand for securitized subprime 19 mortgage interest, the bottom of page 12? 20 MR. GREENSPAN: Yeah. The actual 21 originations of subprime mortgages, when the subprime 22 mortgages were evolving from the early 1990s through, 23 say, the year 2002, was a contained market, largely 24 fixed rate, and that mortgage -- that market worked 25 well. 65 1 It, in and of itself, was not the problem 2 and would not have been the problem, because it's only 3 when we went to adjustable rate subprime dipping deep 4 into the potential of home ownership that the problems 5 began to emerge because the defaults of foreclosures 6 were not a major problem early on. 7 So it's the securitization, which, in turn, 8 is a consequence of the demand coming largely from 9 Europe. I mean, there was a remarkably large demand 10 in collateralized debt obligations in Europe which 11 were funded by subprime mortgages. 12 And the reason the demand was so large is 13 the prices, I mean, the yields were high and the 14 credit rating agencies were giving the tranches of 15 these various CDOs Triple-A. 16 17 18 COMMISSIONER GEORGIOU: Well, you just turned me directly to where I wanted to move to. You know, one of the things that you said 19 at the end of your testimony, your prepared testimony, 20 again, is that you have a number of suggestions to 21 ensure that financial institutions will no longer be 22 capable of privatizing profit and socializing losses. 23 And those suggestions are largely in the 24 area of increased capital requirements and liquidity 25 requirements, which you suggest might have avoided 66 1 some of the most significant problems that we've had. 2 You know, you served the better part of two decades as 3 the most important banker in the world, which was 4 20 percent of the time the Federal Reserve has been in 5 existence, and ultimately the Federal Reserve is the 6 ultimate prudential regulator responsible for the 7 safety and soundness of all of our financial 8 institutions, all the principal bank holding companies 9 and financial holding companies in the United States, 10 which are some of the most important financial 11 institutions in the world. 12 I would ask you if your suggestions that 13 more capital and more -- more focus on liquidity could 14 have been implemented during your tenure in a way that 15 could have avoided the financial crisis? 16 MR. GREENSPAN: Not by the Federal Reserve, 17 by itself, because, remember, that where most of the 18 problems existed is in the so-called shadow banking 19 area, that is, investment banks and others not 20 directly supervised and regulated by the Federal 21 Reserve. 22 COMMISSIONER GEORGIOU: Well, except that 23 the capital requirements, frequently, were established 24 by the Federal Reserve. 25 MR. GREENSPAN: That's only -- 67 1 COMMISSIONER GEORGIOU: 2 MR. GREENSPAN: Let me just -- That's only for bank 3 holding companies and banks. 4 have capital requirements which we could enforce on 5 the investment banks. 6 We had -- we did not That's not -- it's an SEC -- COMMISSIONER GEORGIOU: Well, understood, 7 but the -- of course, in many instances, the banks 8 that you supervised were facilitating the creation of 9 securitized assets by the investments banks that were 10 11 within their -- their groups. For example, let me just give you an 12 example here. 13 which addressed early forms of capital arbitrage 14 through securitization, established risk weightings, 15 as you may recall, based on the credit ratings of each 16 tranche of a securitization. 17 The -- the securitization rule in 2001, And, soon after, regulators allowed 18 liquidity puts on asset-backed commercial paper 19 tranches to get 10 percent risk weighting resulting in 20 a capital charge of only eight-tenths of 1 percent in 21 liquidity puts. 22 And one of the Citi executives has told our 23 staff that Citi made a decision to support their 24 growing CDO business with its own capital because the 25 regulatory capital associated with holding the super 68 1 senior Triple-A tranches was close to zero. 2 How -- who how did your supervisors, if at 3 all, go about identifying and addressing the prob- -- 4 problems of capital arbitrage in the -- in the 5 marketplace? 6 MR. GREENSPAN: Remember that the so-called 7 basal accord, which was the consolidated international 8 system of determining, for example, what risk weights 9 to put on various assets and the various other issues 10 which determine risk-adjusted capital. 11 I -- it's not clear to me what that has got 12 to do with, for example, any of the large investment 13 banks, whether it be Bear Stearns, Lehman, others. 14 It's not clear to me how we could have regulated 15 specifically their capital. 16 Remember, their tangible capital got to 17 levels well below that requires -- as is required by 18 banks. 19 We had no capability -COMMISSIONER GEORGIOU: But some of the 20 activities of the -- of the -- the investment bankers 21 ho- -- affiliates, that were within the financial 22 holding companies and within the bank holding 23 companies have -- were impacted. 24 significantly impacted by the commitments that they 25 made. The bank itself was 69 1 Let me just give you an example, here, 2 again. 3 these credit default -- credit collateralized debt 4 obligations, where ultimately Citi, the bank itself 5 had to come up with 25 billion dollars on liquidity 6 puts that they had committed to bring these assets 7 back onto their balance sheet when the crisis hit and 8 they were basically illiquid and unable to deal with 9 them. 10 We found from our investigation of Citi that Now that had a significant impact; that was 11 roughly 30 percent or more of the capital that was 12 being held at that time by Citi and certainly that 13 eventuality is something that as a prudent safety and 14 soundness regulator at the Federal Reserve, somebody 15 ought to have known about and had some impact on. 16 MR. GREENSPAN: Well, I think you're 17 raising a legitimate question in the sense that, while 18 we didn't have any control over the capital of 19 investment banks, hedge funds, insurance companies, to 20 the extent that banks lend to those entities, 21 obviously that is an issue which does impact on the 22 overall financial markets. 23 But that is a question of supervision and 24 regulation on -- it's even, I would say, the 25 old-fashioned regulation. 70 1 2 Is -- are the loans that you're making sound and do they have the capacity of being repaid. 3 COMMISSIONER GEORGIOU: Well, but, again, 4 here, what we had is the bank, the ultimate bank 5 holding company backstopping and taking -- 6 undertaking, effectively, the risk of the 7 securitized -- the securitized, in this case, 8 collateralized debt obligations of the investment 9 bank. 10 Because the -- you know, and this is -- it 11 strikes me, frankly, as I study these things, you 12 know, I consider myself a reasonably intelligent 13 person. 14 trained economist, to understand these extraordinary 15 exotic financial structures. 16 It takes considerable study, I'm not a And you've pointed out in your testimony 17 that we run real risks in that frequently they're 18 misunderstood and exceedingly difficult to value. 19 And just to take this one example. It 20 seems to me that they were essentially engaged in 21 something akin to the medieval or the mythical 22 medieval alchemy in that they were able -- they were 23 claiming the ability to turn Triple-B mortgage-backed 24 securities into, effectively, Triple-A-plus senior 25 prime securities through the collateralized debt 71 1 2 obligations. And, in fact, as it turns out, they weren't 3 able to sell these to anybody. 4 their trading books. 5 told by people within the Fed and within the Citigroup 6 are that they held them on the trading book because on 7 the trading book, the capital requirements -- that the 8 leverage was essentially 700 or 800 to one because 9 there was, essentially, no capital requirement while 10 11 They held them on And part of the reason we're they were held on the trading book. And the liquidity puts themselves were only 12 rated at 10 percent. 13 effectively is going on, it seems to me, is a capital 14 arbitrage which puts the safety and soundness of the 15 ultimate bank in jeopardy in order to support -- in 16 order to support exotic financial instruments, which 17 we now know didn't deserve the ratings that they 18 ultimately received, and ought not to have been 19 regarded as so risk-free and should have been very 20 significantly greater capitalized. 21 So -- so -- so what -- what And I guess I'm just pointing out to you, 22 really, one of the consequences of your own testimony, 23 which is that I think that isn't it -- isn't it true 24 that the Fed could have and should have understood 25 these linkages better and required greater capital on 72 1 the part of all the bank and financial holding 2 companies in order to avoid the crisis that we -- we 3 face. 4 MR. GREENSPAN: Well, ultimately, I can't 5 speak in specific detail, but I do know what the 6 problem is. 7 and examiners would be looking at the Triple-A ratings 8 that they see in a lot of these securities. 9 The problem is that the bank supervisors And we have a fundamental problem that the 10 credit rating agencies gave Triple-A valuations to 11 certain tranches of collateralized debt obligations, 12 which in retrospect were nonsense, as you point out. 13 They couldn't sell them. 14 And my impression is, but I don't know 15 because I wasn't there, and I don't know what was 16 going on, specifically, in certain areas, that a bank 17 examiner would be looking at whether a loan was being 18 made which was backed up in some form or another by an 19 inappropriate credit rating agency, because when 20 you're dealing with the size and complexity of the 21 types of things that people have to evaluate, there is 22 a tendency, especially of an average pension fund 23 manager, to seek the -- 24 COMMISSIONER GEORGIOU: 25 MR. GREENSPAN: The safety. -- the safety -- 73 1 COMMISSIONER GEORGIOU: The safety of a 2 credit rating agency, understood. 3 `nother hearing that we'll be doing in the future with 4 regard to credit rating agencies, but the OCC 5 examiners that we talked to suggested to us that they 6 regarded these liquidity puts as essentially outside 7 of their purview because they were only supposed to be 8 looking at the -- you know, this was a principal 9 business that was existing within the investment bank, And we have a whole 10 and they regarded that as something that wasn't -- 11 wasn't their responsibility, essentially, to -- to -- 12 or not only wasn't their responsibility, they were 13 affectively precluded from examining it. 14 some of these linkages, as you look at the 15 fragmentation of the -- of the regulation, these 16 linkages between various units within the holding 17 companies put the banks' safety and soundness at 18 significant risk. So I think 19 And that, seems to me, to be an area where 20 the Federal Reserve could do a much better job in its 21 role as the ultimate prudential regulator and the 22 systemic risk regulator. 23 MR. GREENSPAN: Well, let me just say this. 24 Not knowing the details of the particular transactions 25 that you're working on, I mean, I certainly agree with 74 1 you, in principal, that there have been failures, 2 because you can't account for what happened without 3 supervision failure occurring as part of the problem. 4 But not knowing -- 5 COMMISSIONER GEORGIOU: Well, the specific 6 detail basically in Citi's case is that they had to 7 come up with 25 billion dollars, they came up with 25 8 billion dollars for the liquidity puts, to bring 9 back -- to buy back, essentially, these -- these 10 assets that were -- were -- were standing behind the 11 commercial paper. 12 Rather than having issued a strict bank 13 guarantee, which would be customary in a commercial 14 paper asset-backed transaction, which you would have 15 to -- 16 MR. GREENSPAN: Absolutely. 17 COMMISSIONER GEORGIOU: -- you would have 18 to provide capital to, in this instance they -- 19 they -- they honored these liquidity puts to the tune 20 of 25 billion dollars, and that was roughly 30 percent 21 of their capital at the time, the bank did. 22 23 MR. GREENSPAN: Actually, what year -- what year -- what year is this? 24 COMMISSIONER GEORGIOU: 25 MR. GREENSPAN: 2007. See, I -- I -- 75 1 COMMISSIONER GEORGIOU: I mean, it was 2 after you were gone, but it's just emblematic. 3 not trying to focus exclusively on Citi. 4 trying to say this is an emblematic structure of the 5 collateralized debt obligations which were these 6 exotic instruments that really didn't justify the 7 ratings that they had and -- and -- and caused 8 additional risk to the system which might have been 9 avoided by the capital. 10 11 12 CHAIRMAN ANGELIDES: I'm I'm just I'll yield another additional three minutes. COMMISSIONER GEORGIOU: Thank you. So I 13 guess my point really -- and, you know, I'm sorry that 14 I've run close to out of time. 15 CHAIRMAN ANGELIDES: 16 COMMISSIONER GEORGIOU: No. But my point is to 17 focus, again, on your fundamental obligation to 18 enforce an adequate safety and soundness of the 19 institutions. 20 And at the end of the day, really, I 21 understand your suggestion, and I think your 22 suggestion is a sound one that at this point we need 23 to have additional capital and liquidity requirements 24 on all of these financial intermediaries in order to 25 avoid a crisis in the future, because none of us can 76 1 predict precisely what exotic financial instrument 2 that's next devised will fail and not perform as 3 represented by the originators. 4 I note one thing, you testified in front of 5 the Waxman committee, back in October of `08, and one 6 thing I noticed that you said was that, as much as I 7 would prefer it otherwise, in this financial 8 environment I see no choice but to require that all 9 securitizers retain a meaningful part of the 10 securities they issue. This will offset, in part, 11 market deficiencies stemming from the failures of 12 counterparty surveillance. 13 I take it by that, you mean that that would 14 be a -- that would provide confidence to the market if 15 they were to retain a portion of those securities, 16 that those securities -- that they believed those 17 securities actually to be sound and worthy of 18 investment, is that -- was that your point? 19 MR. GREENSPAN: That's correct. 20 COMMISSIONER GEORGIOU: Right. And isn't 21 that the case, really, with regard to part of our 22 focus here is on securitization, and isn't it the case 23 that we -- we've created a situation in which a number 24 of the parties involved in the origination of these 25 securities are all paid in cash as the securities are 77 1 issued and retained no ultimate interest in the 2 ultimate -- in the ultimate success or failure of the 3 security, ranging all the way, if you count, you know, 4 the originators of the mortgages, the mortgage 5 brokers, the investment bankers, the lawyers who write 6 the prospectuses, the auditors who audit the books, 7 the credit rating agencies that rate the agents -- 8 that rate the securities, and at the end of the day, 9 they've left -- they've left all their -- they have no 10 skin in the game, they have no obligation to have a 11 financial consequence to their -- their creation. 12 13 14 And isn't that a problem that needs to be addressed? MR. GREENSPAN: Well, yeah, and I agree 15 with you in that the regard. 16 of that problem was that because of the complexity of 17 the types of products that were being issued, that 18 otherwise sensible people, in despair, relied on the 19 credit rating agencies issued by the -- issued. 20 The -- the major source And if they were otherwise, in other words, 21 of, instead of giving Triple-A designations to a lot 22 of these things, they gave them B or Triple-B, which 23 many of them were, people wouldn't have bought them. 24 The problem further is that you are raising wouldn't 25 have happened. 78 1 COMMISSIONER GEORGIOU: Well, of course, 2 and they wouldn't have bought them because many of 3 them were prohibited by either the statute or their 4 own requirements -- 5 MR. GREENSPAN: Precisely. 6 COMMISSIONER GEORGIOU: -- for not buying 7 them. 8 credit rating agencies frequently are only paid if 9 they -- if the securities were sold. 10 And of course the problem, further, is that the They were paid as a portion of the issue. 11 So they obviously had an incentive to 12 create a Triple-A rating which might not otherwise 13 have been justified. Thank you. 14 CHAIRMAN ANGELIDES: 15 Let's do this -- we're going to take a -- 16 VICE CHAIRMAN THOMAS: Thank you very much. Mr. Chairman, just 17 please let me, for the record, Mr. Chairman, I noticed 18 that you were nodding your head at the final statement 19 that the gentleman made. 20 Were you in agreement with his assessment 21 in terms of the behavior of the credit rating 22 agencies, to a certain degree? 23 MR. GREENSPAN: The credit rating agencies, 24 as such? All I will say is what I can say for myself 25 is that the rating -- the ratings that were developed 79 1 by the credit rating agencies were a major factor in 2 the cause of the problem. 3 VICE CHAIRMAN THOMAS: 4 CHAIRMAN ANGELIDES: Thank you. Thank you. We'll take 5 a five-minute break -- ten -- let's be back here in 6 five. Thank you. 7 (Recess.) 8 CHAIRMAN ANGELIDES: 9 10 depart the well, please, but do not disconnect the mics this time. 11 All right, let's start again, we are 12 starting with Mr. Hennessey. 13 Mr. Hennessey. 14 15 16 Reporters, please Your turn, COMMISSIONER HENNESSEY: Great. Thank you, Mr. Chairman. EXAMINATION BY COMMISSIONER HENNESSEY 17 COMMISSIONER HENNESSEY: Chairman 18 Greenspan, I want to focus on Fannie Mae and Freddie 19 Mac's role in creating or exacerbating the explosion 20 of bad subprime mortgages and specifically on their 21 portfolios. 22 Now, it's possible that not everyone 23 watching has read your written testimony, so I want 24 to, if I can, try to summarize how I understand that 25 part of your testimony, and then I want to ask about 80 1 specific House action, from 2007, which I think 2 contributes to this. 3 As I understand it, Fannie Mae and Freddie 4 Mac held huge portfolios of securities that they 5 issued, on the order of about 6- or 700 billion 6 dollars each. 7 and they ultimately led to Fannie and Freddie's 8 collapse. 9 These portfolios were undercapitalized In October of 2000 the Department of 10 Housing and Urban Development significantly raised the 11 affordable housing goals they set for Fannie and 12 Freddie. 13 Fannie and Freddie chose to meet those new 14 goals by dramatically increasing their purchase and 15 holding of securities backed by subprime, adjustable 16 rate mortgages. 17 Your testimony says that in 2003 and 2004 18 they bought about 40 percent of this market, five 19 times more than they did in 2002, and at the time 20 Fannie classified these mortgages as prime, in 21 September of `09 they reclassified much of that 22 portfolio to be subprime. 23 Now, as I understand it, this huge increase 24 in demand from Fannie and Freddie in 2003 and 2004 25 contributed to a decline in long-term mortgage rates 81 1 relative to treasuries. 2 mortgage rates helped fuel the rise in housing prices. 3 And then when that housing price bubble burst, it hurt 4 not just people who owned adjustable rate mortgages, 5 but also fixed rate mortgages, as well. 6 That decline in long-term Now, in February of 2004, and what we're 7 talking about here is we're both talking about the 8 GSEs' holding huge portfolios, this in effect 9 multi-hundred-billion-dollar hedge funds on top of 10 their guarantee and securitization business combined 11 with new affordable housing goals set in the fall of 12 2000. 13 Now, in February of 2004 you testified 14 that, quote, GSEs need to be limited in the issuance 15 of GSE debt and the purchase of assets, both mortgages 16 and non-mortgages that they hold. 17 2007, the Congress considered the Housing Finance 18 Reform Act. 19 Frank's committee gave the new housing finance 20 regulator certain authorities. 21 That was in 2004. And the bill that came out of Chairman And because it's important I want to read 22 the language. What that language said is that the 23 director shall consider any potential risks posed by 24 the nature of the portfolio holdings. 25 Okay. That's it. So the new regulator should consider the risk In 82 1 of these multi-hundred-billion-dollar portfolios when 2 he or she is evaluating Fannie Mae and Freddie Mac. 3 Now, there was an amendment; it was House 4 Amendment 207; it passed the House on May 22nd, 2007, 5 on a 383 to 36 vote. 6 bipartisan vote. 7 That is an overwhelming And what that amendment did is it limited 8 the new housing regulator's authorities. It said that 9 the new housing regulator can only consider the risk 10 that these portfolios place to the safety and 11 soundness of Fannie Mae and Freddie Mac, not to the 12 financial system as a whole. 13 What I want to do is I want to read to you 14 language from the sponsor of the amendment, 15 Mr. Neugebauer, he said, this legislation clarifies 16 that when a regulator looks at regulating this entity 17 that he looks at the safety and soundness of that 18 entity and not external factors. 19 He later says, we shouldn't put things out 20 there that the regulator is not able to quite honestly 21 articulate, because what is a systemic risk? 22 becomes a point of order that sometimes the regulator 23 cannot explain exactly the systemic risk is they 24 believe it is. 25 That It is a way to limit their portfolios. So, in effect, 221 House Democrats and 162 83 1 House Republicans voted to preclude the regulator from 2 being able to consider systemic risk with the GSE 3 portfolios, this is directly contradicting your 4 recommendation of February 2004. 5 Suppose it had gone the other way. Suppose 6 that Housing regulator had had the authority to limit 7 the GSE portfolios in 2007 and had exercised that 8 authority. 9 had on the crisis? 10 What effect do you think that might have MR. GREENSPAN: Well, let's -- let's go 11 back a number of years, because the original mandate 12 of Fannie and Freddie was read as securitization 13 solely and that the cumulation of portfolios of assets 14 was not in their business plan with the onset of, I 15 guess, a cynical view of the market that the 16 presumption that Fannie and Freddie were not backed by 17 the full faith and credit of the United States 18 government, and that cynicism basically led to a 20 to 19 40 basis points subsidy in their divestitures in 20 short-term debt, which, for a financial institution, 21 is huge. 22 And so the -- the procedures that were 23 involved with Fannie and Freddie were largely to build 24 up the asset side of the portfolios. 25 it almost didn't matter what they held just so long as It didn't al- -- 84 1 they harvested the subsidy. 2 profits, huge rates of return on equity, and set into 3 place a very large component of potentially toxic 4 assets. 5 That created huge And the failure of Fannie and Freddie was a 6 major factor in the crisis, remembering it occurs 7 prior to the Lehman default. 8 is that a combination of the system breaking down had 9 extraordinarily large effects, which are difficult to And the result of that 10 judge, because you only have a single incident. 11 can't say, well, what could have happened "if," but 12 there is no doubt in my mind that if Fannie and 13 Freddie had held only those mortgages in its portfolio 14 which were required to make securitization feasible -- 15 they have to hold a certain amount of inventory, which 16 is a very small fraction of what they actually held. 17 If that didn't happen, they would not have failed. 18 You And the lack -- that particular event, 19 which is a very important event in the evolution of 20 the crisis, may have headed it off. 21 know. 22 would have been far better off, in my judgment, is 23 unquestionable. 24 25 I don't frankly I don't know how one would know. COMMISSIONER HENNESSEY: But that Thank you. And a secondary point, as I understand your testimony, part 85 1 of what you're suggesting is that to meet the higher 2 affordable housing goals set in October of 2000, 3 Fannie and Freddie increased their purchase of 4 specifically subprime ARMs. 5 the time as ARM as weak -- sorry -- as prime. 6 reclassified them later. 7 They classified them at They We have the former head of Fannie Mae 8 coming in, and we have the former regulators coming 9 in. What would you recommend we ask them about the 10 interactions of these housing goals and the actions 11 that they took in 2003 and 2004? 12 MR. GREENSPAN: Well, I would ask them, 13 other than making profit for the corporation what was 14 the purpose of accumulating the assets in their 15 portfolio? 16 The reason I raise the issue is I never got 17 a straight answer in the early years that I was 18 involved with them. 19 unfortunate event, which as far as I'm concerned, had 20 it not occurred, namely the huge accumulation of 21 assets, for a lot of different reasons, including 22 potential distortions in the marketplace, we would 23 have not have had, incidentally, the big affordable 24 housing purchases by Fannie and Freddie because it's 25 based on volumes. And I think this is an And the amount of Fannie and 86 1 Freddie, as it turned out, ARMs that they bought would 2 have been very much less, and that would removed a 3 very substantial amount of weight on the -- on the 4 subprime market, because remember, that mandated 5 demand. 6 took out, effectively as the first tranche, 40 percent 7 of the market. 8 has extraordinary major impacts. It's mandated, remember that mandated demand And when you do that to any market, it 9 And I can't help but believe that even with 10 the affordable housing goals with a far smaller Fannie 11 and Freddie portfolio that we would have run into the 12 extent of the types of problems we were to run into in 13 2008, for example. 14 COMMISSIONER HENNESSEY: 15 CHAIRMAN ANGELIDES: 16 Thank you. Thank you very much. Ms. Born? 17 COMMISSIONER BORN: Thank you. 18 EXAMINATION BY COMMISSIONER BORN 19 COMMISSIONER BORN: Mr. Chairman, you long 20 championed the growth of the over-the-counter 21 derivatives market -- 22 23 MR. GREENSPAN: microphone closer? 24 25 Excuse me, can you put your CHAIRMAN ANGELIDES: Ms. Born? Is your mic on, 87 1 COMMISSIONER BORN: 2 CHAIRMAN ANGELIDES: 3 COMMISSIONER BORN: It is on, yes. Now we hear you. You've longed 4 championed the growth of the over-the-counter 5 derivative market because of the risk-shifting 6 opportunities that it provides. 7 position that the over-the-counter derivatives market 8 should not be regulated. 9 You've also taken the As chair of the Federal Reserve board, you 10 endorsed a President's Working Group report in 11 November 1999 calling on Congress to eliminate 12 regulation of the OTC derivatives market. 13 You then welcomed the adoption of the 14 Commodity Futures Modernization Act of 2000, which 15 eliminated virtually all federal government regulation 16 of the OTC derivatives market and also preempted 17 certain state laws relating to it. 18 derivatives have been trading with virtually no 19 regulation for a decade. 20 exceed 800 -- 680 trillion dollars in notional amount 21 by the summer of 2008. 22 So as a result OTC And the market grew to In your view, did credit default swaps, 23 which are a type of over-the-counter derivatives 24 contract, play any role in causing or exacerbating the 25 financial crisis? 88 1 MR. GREENSPAN: Well, first, let's remember 2 that in the early years, credit default swaps were an 3 extremely small part of the total notional value. 4 And, indeed, the arbiter or the collector of 5 international data, the bank for international 6 settlements, didn't find credit default swaps in 7 sufficient volume to show them as a separate category 8 until the end of 2004. 9 And if you separate credit default swaps 10 from the rest of the market and look at the rest of 11 the market essentially as interest rate derivatives 12 and foreign exchange derivatives, which it still is, 13 you have the remarkable phenomenon of these 14 unregulated derivatives having the most extraordinary 15 stress test in 2008, 2009 with no evidence of which I 16 am aware that they didn't work exactly as they were 17 going to. 18 default swaps did create problems, and indeed, the 19 Federal Reserve Bank of New York was probably the very 20 first group to really come to grips with the problems 21 in 2005. 22 It is certainly the case that credit So as you go back to the earlier periods, 23 credit default swaps were never discussed in 24 president's working group, to my knowledge. 25 talked about derivatives, we were talking about, When we 89 1 essentially, interest rate derivatives and foreign 2 exchange derivatives. 3 And they had been unregulated, to be sure, 4 and no problems have emerged as a consequence of that. 5 Credit default swaps are a more complex issue, but 6 they were not on the agenda in the early years when we 7 had these discussions at the president's working 8 group. 9 COMMISSIONER BORN: Well, they certainly 10 existed as of that time. 11 12, 1996, supervisory guidance for credit derivatives 12 that were issued, was issued, by the Federal Reserve 13 Board on the bank -- to the banking committee, the 14 community, about the use of credit default swaps and 15 other credit derivatives. 16 I think there is an August And certainly, if you've read Gillian 17 Tett's book called Fools' Gold, it talks about the 18 extensive activity in credit derivatives, including 19 some very creative things that J.P. Morgan did in 20 1997. 21 Are you aware that the collapse of AIG was 22 caused by its commitments under credit default swaps 23 that it had issued? 24 because of its exposure on credit default swaps to the 25 tune of more than 180 billion dollars. The taxpayers had to bail out AIG 90 1 2 MR. GREENSPAN: Well, first, let me respond to your 1997 reference. 3 I can't give you an exact number, but my 4 recollection was that there was credit default swaps 5 were something like 1 percent of the total notional 6 value of all derivatives. 7 it was being discussed is something which is to be 8 expected. 9 And that the mere fact that But if you're evaluating their impact on 10 the economy and on the financial system, a 1 percent 11 or less in notional value is not a big factor in 12 anything. 13 With respect to AIG, it is correct that 14 their offering and selling vast amounts of credit 15 default swaps was the proximate cause of their 16 problem. 17 But they were selling insurance. They 18 could just have easily have sold and gotten into the 19 same trouble by issuing insurance instruments rather 20 than credit default swaps. 21 My understanding is that it had -- the 22 reason that they did that was it was a capital -- 23 differential capital requirements. 24 an issue of the credit default swaps, per se. 25 But that was not The issue was the extraordinary behavior of 91 1 investment officers at AIG who took unbelievable risks 2 with essentially very little capital. 3 There is a difference between credit 4 default swaps and, for example, interest rate 5 derivatives in the sense that credit default swaps 6 insure the principal as well as the interest. 7 Interest rate derivatives, for example, only deal with 8 interest and are, therefore, far less subject to the 9 problems that exist when you're insuring the level of 10 principal as well as interest. 11 COMMISSIONER BORN: Mr. Chairman, the 12 market for credit default swaps had risen to 60 13 trillion dollars in notional amount equal to the gross 14 national -- the gross domestic product of all the 15 countries in the world by 2008. 16 Also, let me point out, that had these been 17 being sold as insurance products, they would have been 18 regulated by insurance regulators and supervisors. 19 There would have been a requirement of capital 20 reserves. 21 these contracts could only have been sold to entities 22 that had an insurable interest, that is, held the 23 bonds or securities that were being insured against. 24 25 There would have been a requirement that There was no such regulation in the OTC derivatives market thanks to the action of the 92 1 president's working group and Congress in 2000. 2 Let me go onto another subject. In your 3 recent book, you described yourself as an outlier in 4 your libertarian opposition to most regulation. 5 ideology has essentially been that financial markets, 6 like the OTC derivatives market, are self-regulatory 7 and the government -- and the government regulation is 8 either unnecessary or harmful. 9 Your You've also stated that as a result of the 10 financial crisis, you have now found a flaw in that 11 ideology. 12 You served as chairman of the Federal 13 Reserve Board for more than 18 years, retiring in 14 2000, and became, during that period, the most 15 respected sage on the financial markets in the world. 16 I wonder if your belief in deregulation had 17 any impact on the level of regulation over the 18 financial markets in the United States and in the 19 world. 20 You said that the mandates of the Federal 21 Reserve were monetary policy, supervision and 22 regulation of banks and bank holding companies, and 23 systemic risk. 24 25 You appropriately argue that the role of regulation is preventative but the Fed utterly failed 93 1 2 to prevent the financial crisis. The Fed and the banking regulators failed 3 to prevent the housing bubble; they failed to prevent 4 the predatory lending scandal; they failed to prevent 5 our biggest banks and bank holding companies from 6 engaging in activities that would bring them to the 7 verge of collapse without massive taxpayer bailouts; 8 they failed to recognize the systemic risk posed by an 9 unregulated over-the-counter derivatives market; and 10 they permitted the financial system and the economy to 11 reach the brink of disaster. 12 You also failed to prevent many of our 13 banks from consolidating and growing into gigantic 14 institutions that are now too big and/or too 15 interconnected to fail. 16 17 18 Didn't the Federal Reserve system fail to meet its responsibilities, fail to carry its mandates? CHAIRMAN ANGELIDES: And by the way, on 19 this, I'm going to yield two minutes for the response. 20 We're over time. 21 MR. GREENSPAN: First of all, the flaw in 22 system that I acknowledged was an inability to fully 23 understand the state and extent of potential risks 24 that were as yet untested. 25 risks were until they unwound at the end of the Lehman We didn't see what those 94 1 Brothers' bankruptcy. 2 And I had always presumed, as did virtually 3 everyone in academia, regulatory areas, banks, 4 presumed that risk potential was, having failed there, 5 means that we were undercapitalizing the banking 6 system probably for 40 or 50 years. 7 be adjusted. 8 9 And that has to But the notion that somehow my views on regulation were predominant and effective as 10 influencing the Congress is something you may have 11 perceived. 12 view. 13 It didn't look that way from my point of First of all, I took an oath of office to 14 support the laws of the land. 15 discretion to use my own etiology to effect my 16 judgments as to what Congress is requiring the Federal 17 Reserve and others to do. 18 I don't have the As far as I'm concerned, if somebody asked 19 me my view on a particular subject, I would give it to 20 them, and I express them in the book you're referring 21 to, but that is not the way I ran my office. 22 I ran my office as required by law. And 23 there's an awful lot of laws that I would not have 24 constructed in the way that they were constructed. 25 But I enforced them, nevertheless, because that was my 95 1 job: That was built into my oath of office when I 2 took over the FED's chairmanship in 1987. 3 CHAIRMAN ANGELIDES: 4 MR. GREENSPAN: Thank you. So, I know my time has run 5 out, but I really fundamentally disagree with your 6 point of view. 7 8 CHAIRMAN ANGELIDES: Mr. Thompson? 9 10 COMMISSIONER THOMPSON: CHAIRMAN ANGELIDES: Microphone, Mr. Thompson? 13 14 Thank you, Mr. Chairman. 11 12 Thank you. COMMISSIONER THOMPSON: Thank you, Mr. Chairman. 15 EXAMINATION BY COMMISSIONER THOMPSON 16 COMMISSIONER THOMPSON: Dr. Greenspan, I 17 would like to go back to the line of questioning that 18 Mr. Georgiou raised regarding regulatory arbitrage, if 19 I might. 20 You said in the Brookings paper that 21 regulators can, and I quote, prohibit a complex 22 affiliate and subsidiary structure whose sole purpose 23 is tax avoidance and regulatory arbitrage. 24 25 It's clear from our view of Citi that that was, in fact, part of what drove some of their 96 1 decisions as they looked at opportunities. 2 So how should supervisors have prevented 3 this regulatory arbitrage from occurring prior to the 4 financial crisis? 5 MR. GREENSPAN: Well, it's -- to a large 6 extent, it's caused by the legal structure of these 7 organizations. 8 exists is that people are concerned about 9 off-balance-sheet accounting, that's not what bothers 10 11 You know, one of the problems that me. What bothers me is if you take something 12 off your balance sheet you should be prohibited from 13 bringing it back. 14 And I cannot believe that people 15 secondarily thought that reputation risk all of the 16 sudden emerged, that they didn't know about it, so I 17 think there's a bit of dubious bookkeeping going on at 18 that particular point. 19 But if you -- if the regulators can 20 determine what type of subsidiary structures you can 21 have in a large organization, you can eliminate a 22 fairly significant amount of the regulatory arbitrage. 23 And it's not an economic issue, it's 24 basically a means by looking at what the capital 25 requirements or other requirements are and figure out 97 1 how you would structure the various subsidiaries of 2 your organization to avoid that. 3 interest. 4 COMMISSIONER THOMPSON: That is in nobody's So financial 5 innovation has been an important component of what's 6 driven the contribution to GDP growth from the 7 financial services sector over the last 20 years or 8 so. 9 have significant societal impact, pharmaceuticals, If you were to think about other industries that 10 transportation, a range of others, they are required 11 to test their products and have those products 12 certified before they release them into the 13 marketplace. 14 So if we were to now think about the 15 societal impact of financial services and your views 16 around collateral and capital, should there be a 17 different scheme for new product introduction in this 18 industry that would mitigate, perhaps, the societal 19 impact that some of the risks that we are taking 20 really represent today? 21 MR. GREENSPAN: Well, that's a good 22 question. I think you first you have to start with 23 the question of what's the function of our financial 24 system. 25 services to the non-financial sector, Main Street, so And basically it's to supply financial 98 1 to speak, which facilitates the production and 2 standards of living that emerge as a consequence of 3 that. 4 When you -- for example, we have an 5 extraordinary rise in the share of national income 6 going to finance starting in 1947, year after year 7 after year, and so what we're dealing with is a major 8 problem in how to make judgments of what is innovation 9 that works and what is it that doesn't work but that 10 you need innovation to essentially keep up with the 11 complexity of the non-financial economy, it goes 12 without saying, all innovation, by its nature, is 13 unforecastable with respect to how it will come out. 14 So I think what we find in finance, as well 15 as in the non-financial area, is that a large number 16 of innovations fail, but fortunately what causes 17 progress and productivity is that more innovations are 18 positive than otherwise. 19 which is which, so my judgment is the only way to 20 solve that problem is to have enough capital that will 21 absorb X percent of innovations failing. 22 You cannot tell, in advance, We will never see SIVs or synthetic CDOs as 23 far in the future as I can imagine. They're gone. 24 The critical issue here is in investors who determine 25 what products fail and what succeeded, it's not the 99 1 banking system. 2 but if they don't buy them, there's no use. 3 4 The banking system can offer them, So the non-financial part of our economy is the arbiter of what products fail and not fail. 5 COMMISSIONER THOMPSON: So would you, 6 therefore, be an advocate of some form of incremental 7 capital being put in place ahead of the release of 8 these critical new innovations? 9 MR. GREENSPAN: As a general rule I'm not 10 comfortable with variable capital changes, you know, 11 whether it's for -- I mean, the main argument is 12 usually that there's cyclically adjusted capital 13 requirements. 14 where in the business cycle we were in real time. 15 That would be fine if we could forecast We're always very thoughtful on the issue 16 of where we were in the business cycle but it's 17 another -- it's a wholly different issue when you're 18 in real time and saying, are we in the beginning of 19 the cycle or are we closer to the end. 20 to -- 21 COMMISSIONER THOMPSON: And I think Well, for new 22 products we would clearly be at the beginning of the 23 cycle. 24 MR. GREENSPAN: I'm sorry? 25 COMMISSIONER THOMPSON: For a new product 100 1 innovation -- 2 MR. GREENSPAN: 3 COMMISSIONER THOMPSON: 4 be at the beginning of the cycle. 5 6 MR. GREENSPAN: Yes. No, no, I'm referring to the business cycle, generally. 7 COMMISSIONER THOMPSON: 8 MR. GREENSPAN: 9 -- we would clearly Oh, okay. But I agree with you. In other words, that every new -- every innovation always 10 starts at the beginning, and you don't really know 11 where it's going to come out, and the non-financial 12 system will tell you whether it's valuable to them. 13 And I would just as soon not try incremental. 14 nothing in principal against it; it's just that I feel 15 it's not easy to implement. 16 COMMISSIONER THOMPSON: I have Well you commented 17 this morning that the issue of consolidated regulatory 18 scheme had been discussed for years within the Fed 19 and, I guess, amongst the peer agencies. 20 And it's your opinion that the change 21 that -- there's no evidence that would suggest the 22 change to consolidating the regulatory scheme would, 23 in fact, help. 24 So, therefore, should I conclude from that 25 comment that you, as someone who sat over and was the 101 1 standard bearer, if you will, for our financial system 2 for almost 20 years, believes that no meaningful 3 change is necessary now. 4 MR. GREENSPAN: I don't know the answer to 5 that question because we've got so many overlapping 6 jurisdictions and the like that are frankly kept that 7 way for political, not economic or financial reasons. 8 And I have no doubt -- 9 COMMISSIONER THOMPSON: 10 MR. GREENSPAN: 11 COMMISSIONER THOMPSON: 12 MR. GREENSPAN: But politics aside. I have no -- I'm sorry? Politics aside. Politics aside, yeah, I 13 have always thought that there are differing things that 14 could be done. 15 But I wanted to emphasize that it's not the 16 particular agency which does these things, but more 17 importantly what is done than who does it. 18 COMMISSIONER THOMPSON: So you strongly 19 believe that incremental capital and incremental 20 collateral would help? 21 comments. 22 I interpret that from your MR. GREENSPAN: I would say I'd be more 23 inclined to just set absolute levels. There is a 24 problem with it changing capital requirements largely 25 because it creates an element of uncertainty in the 102 1 marketplace, which, probably, I have no idea how big 2 it would be, but it's certainly negative. 3 I think that you're far better off just 4 fixing capital requirements at levels and just holding 5 them there as permanent requirements. 6 would address, in my judgment, most of the problems I 7 see that are out there. 8 9 COMMISSIONER THOMPSON: I think that While I would tend to agree with that, it would also seem to me that 10 combining the notion of supervisory as well as 11 enforcement would also help, because you indicated 12 that in many instances, while the Federal Reserve had 13 supervisory responsibility, you really did not have 14 enforcement. 15 So I'm not sure how the system works and 16 improves without us making some changes not just in 17 capital and collateral, but in how we execute on the 18 rules and laws that we have in place. 19 MR. GREENSPAN: Well, I think in order to 20 do that, if the Federal Reserve were required to 21 enforce the rules and regulations that it promulgates, 22 I think the staff would have to be vastly larger. 23 24 25 COMMISSIONER THOMPSON: But some other part of government would also have to shrink? MR. GREENSPAN: Well, there's a -- right 103 1 now there's a great deal of discussion that's going on 2 with respect to who should be supervising what, and 3 the problems that -- I'm not sure that we solve any of 4 the problems that have been properly identified in 5 this crisis by moving the chairs around. 6 I do not deny that, and if you ask me, 7 starting from scratch, would I have a different type 8 of regulatory system focused on the areas where I 9 think they can be most effective, the answer is I -- 10 I -- I suggested that in the Brookings panel piece, 11 where I went through the reasons why, what regulations 12 can do and what they can't do. 13 what we can do, which can be very effective and, in my 14 judgment, determinative, what you tend to do is to 15 cause the losses to be concentrated in the common 16 shareholders of institutions. And if we emphasize 17 And if capital is large enough, all of the 18 losses accrue to them and not to the debt holders and 19 therefore they do not default. 20 don't have serial contagion which is caused by the 21 faults of senior debt mainly, but debt in general. And therefore you 22 CHAIRMAN ANGELIDES: Thank you very much. 23 COMMISSIONER THOMPSON: Unfortunately, we 24 don't have the luxury of being able to start over from 25 scratch. And so I think we're going to have to 104 1 implement incremental changes. 2 And your knowledge of the system and what 3 changes would be beneficial to the American public 4 would be very helpful. 5 CHAIRMAN ANGELIDES: Thank you. All right. 6 Now, Mr. Thomas, you and I have some remaining time. 7 Do you want to -- should I go ahead and take my just 8 cleanup items and then turn to you? 9 VICE CHAIRMAN THOMAS: I would advise you 10 that setting politics aside, as chairman you should 11 let me go first. 12 13 CHAIRMAN ANGELIDES: Chairman. 14 15 You go ahead, Mr. Vice VICE CHAIRMAN THOMAS: close. And then you get to Although I'm very tempted by that invitation. 16 CHAIRMAN ANGELIDES: 17 VICE CHAIRMAN THOMAS: Go ahead, Mr. Thomas. Thank you. I would 18 just tell my -- my friend that setting politics aside 19 is a sheer invitation for politicos to show you that 20 you can't. 21 22 COMMISSIONER THOMPSON: And it's hard to do. 23 VICE CHAIRMAN THOMAS: And we have seen 24 that over and over again, just the way the system 25 works. 105 1 And if you're going to start with a clean 2 sheet of paper, it means you have it turned over. 3 really need to turn it over because there is no such 4 thing as a clean sheet of paper. 5 EXAMINATION BY VICE CHAIRMAN THOMAS 6 VICE CHAIRMAN THOMAS: Mr. Chairman, this 7 is a question that I will ask you that I don't need 8 you to answer now. 9 to me. 10 11 You You might want to do it on paper If you don't and you can offer a reasonably short version, that's perfectly acceptable. And the reason I put it in that context is 12 that your mention of the book Reinhart and Rogoff, I 13 serve at AEI with a colleague, who was the husband of 14 Professor Reinhart, Vince Reinhart. 15 discussions that we've had, he's indicated in his 16 position -- I should give a bit of background -- he's 17 the head of monetary affairs at the Fed from `01 to 18 `09, and he's talked about the fact that he thinks, 19 based on his knowledge and experience, that the Fed 20 made a mistake signaling to the market that it was 21 going to slowly raise short-term rates. 22 And in And the argument goes that this created a 23 steep yield curve, because the market, as we saw over 24 and over again, quickly adjusted to where they knew 25 the rates would eventually go. 106 1 And the steep yield curve led to novel ways 2 for firms to take advantage of borrowing very 3 short-term and lending long-term. 4 Do you agree with that analysis? In 5 retrospect, was the Fed's strategy the right one to 6 take, or is it the usual argument at the time given 7 the information we had and under the circumstances? 8 9 10 MR. GREENSPAN: Well, Vincent Reinhart is a first-rate economist and whose judgment I, for many years, relied on. 11 Let me answer that question in writing 12 after I go over the particular details of the position 13 I know he's taking. 14 VICE CHAIRMAN THOMAS: And I wanted to 15 offer that to you because I am interested in -- in a 16 more fundamental answer, because it will lead to other 17 questions as we go forward, so thank you. 18 submit it to you in writing. 19 20 CHAIRMAN ANGELIDES: 23 Additional questions, Mr. Thomas? 21 22 And we'll VICE CHAIRMAN THOMAS: Not at this time, Mr. Chair. CHAIRMAN ANGELIDES: All right. All right, 24 couple of items just -- first of all, a couple of 25 clarifications, because I just want to make sure we 107 1 have the facts for the record. 2 Even by your own submission, and by the 3 way, let me stipulate that Fannie Mae and Freddie Mac 4 were disasters, but I just do want to point out, 5 because you keep referring to 40 percent of the 6 market, that if you'll look at that 2002 to 2005 7 period, the private market, Wall Street was anywhere 8 from 59 to 92 percent of that private label security 9 market. 10 11 12 That's just a fact. Secondly, I did want to just follow up on Ms. Murren's question of earlier. I just wanted to point out, because when 13 she referred to the review of the Federal Reserve 14 Bank, and I don't think there's any expectation you 15 would have seen this review from 2005, but this was 16 not some third-party wild-eyed critic. 17 review, which Ms. Murren referenced, was a peer review 18 by other Federal Reserve banks. This 2005 19 And I might say there was a second review 20 in December 2009 where again the peer, other Federal 21 Reserves, commented on the supervision of Citibank by 22 the Federal Reserve Bank in New York, and they said, 23 quote, the supervision program for Citigroup has been 24 less than effective although the dedicated supervisory 25 team is well qualified and generally has sound 108 1 knowledge organization, there have been significant 2 weaknesses in the execution of the supervisory 3 program. 4 internal reviews as to the inadequacy of supervision. 5 So I just want to point out that these were But I do want to return to just one line of 6 questioning that I asked you that I want to follow up 7 on, because you indicated that in many respects what 8 was important was to go after fraud, embezzlement, 9 illegal activities. And you've been very clear on 10 that. 11 2004; there was a sevenfold increase in the number of 12 suspicious activity reports related to mortgage fraud 13 by banks from 2003 to 2006; your own Federal Reserve 14 in 2005 put out a white paper on the detection, 15 investigation, deterrents of mortgage loan fraud. 16 So very quickly, there was the FBI warning in Just very quickly, what was the most 17 important thing you did to combat fraud, the single 18 most important thing that the Fed did in light of the 19 evidence that it was growing in mortgage. 20 MR. GREENSPAN: Well, first of all, the 21 enforcement against fraud and misrepresentation is one 22 of the key elements in any market society. 23 have an effective market society if counterparties 24 cannot trust individuals with whom they're dealing 25 with wholly independently of what that contractual You cannot 109 1 relationships and enforcement is. 2 The FBI, I believe they had 22,000 cases in 3 2005. 4 fraud is enough. 5 total mortgages outstanding, residential only, home 6 mortgages as well as a lot of commercial mortgages, 7 it's not a systemic problem. 8 9 That's important and critical. One issue of But 22,000, when you have 55 million CHAIRMAN ANGELIDES: you then make any actions? But what -- but did I mean, I could only count 10 two referrals under fair lending laws from 2000 to 11 2006 by the Fed to Justice, just two: 12 American Bank in Carpentersville, Illinois, and one 13 for Dessert Community Bank in Victorville. 14 pretty slim. 15 MR. GREENSPAN: One for First It seems Well, the issue was that 16 this staff, in evaluating what was going on, which -- 17 see, remember, a goodly part of supervision and 18 regulation is to get things solved so that if somebody 19 is in violation of something and you can get them to 20 adjust so that the regulators are satisfied, it never 21 gets to the point where it's a referral for 22 enforcement in some form or another. 23 I agree with you in the sense that the 24 number of actual referrals that were made to the 25 Department of Justice were small and I believe a good 110 1 reason for that is we were able to get compliance 2 without doing that. 3 CHAIRMAN ANGELIDES: All right. Well, I 4 want to -- here's my final observation. 5 follows up on Mr. Georgiou's questions and Ms. Born's. 6 And I'm going to ask you that in the remaining time 7 just to, I think, deal with something that's very 8 significant around which I think a lot of Americans 9 have questions. 10 11 Their -- (Power outage.) It really all right. That's what -- that's what God thinks about the questions. 12 CHAIRMAN ANGELIDES: Stay. Stay. 13 one second so we can get this back up. 14 let's do this, let's do this. 15 and see if there's any -- speak up a little and see if 16 there's any other questions. 17 All right, Let's just finish up So here is my final question, which is, it 18 does seem that there's a big issue here about this, 19 and there's something, as I read all these documents 20 which are coming through, something called the 21 Greenspan Doctrine. 22 was. 23 Doctrine, but there seemed to me with the Greenspan 24 Doctrine that even if you saw evident threats to the I knew what the Truman Doctrine We see the threat of communism. The Bush Hang on 111 1 financial system, you took no regulatory action. 2 I think the one thing I want to ask, 3 following up on Ms. Born, is looking back on the last 4 decade, do you feel that there's a failure of 5 regulation in our system? 6 MR. GREENSPAN: There was a -- there was a 7 failure of regulation in the critical part of it, 8 namely in the private counterparty risk management 9 system, this is the system which evolved over 50 10 years, spawned numerous Nobel Prize winners, was 11 accepted by academia, the regulatory agencies, and 12 especially the Federal Reserve. 13 a major mistake. 14 That turned out to be Is it an indictment of the total system? 15 By no means, because it's not the conceptual framework 16 of how to regulate, but the actual application of it. 17 We did not have enough capital in the system to 18 contain the type of crisis, which in my judgment, 19 happens once in a hundred years. 20 crisis is, best I can judge, is the most severe in 21 history. 22 the severest economic crisis. 23 Depression. 24 25 This financial It's not the same thing as saying that it's That was the Great But there is no example that I've been able to find of a breakdown in short-term financial 112 1 availability, which is the critical issue in a 2 financial crisis, in any history that I can see on -- 3 on our global scale that occurred within days 4 following the Lehman Brothers' bankruptcy. 5 6 CHAIRMAN ANGELIDES: All right. And Mr. Vice Chair? 7 VICE CHAIRMAN THOMAS: On that statement, 8 Mr. Chairman, I would ask you a follow-up question, 9 and that was quite a contextual position for your 10 statement that you do not, given your background, 11 understanding, history, see any comparable collapse. 12 In that regard I'd have to say, 13 notwithstanding the difficulties we're still in, the 14 experiences that we had previously, in my opinion I 15 want your reaction, allowed us to take some actions 16 which mitigated, notwithstanding all of the damage 17 that has been done, an even greater crisis; is that 18 accurate? 19 MR. GREENSPAN: I'm sorry, may I answer 20 that for the record, Mr. Thomas? 21 VICE CHAIRMAN THOMAS: We'll get that for 22 the record, because I think at some point the whole 23 concept of bubbles is, you didn't know, you didn't 24 anticipate, this time is different. 25 If this is to the magnitude that you 113 1 indicated different than in the past, notwithstanding 2 the damage, all of the understanding of what we need 3 to lead to, it could have been worse. 4 MR. GREENSPAN: Well, this is the critical 5 period that we're going to have to -- we're going to 6 have to look at how this thing ultimately evolves 7 before we fully understand what the consequences are. 8 But let me respond to your question in more detail on 9 the record. 10 VICE CHAIRMAN THOMAS: 11 Thank you. 12 Georgiou. 13 In writing, yes. Certainly yield a minute to Commissioner COMMISSIONER GEORGIOU: Just one question I 14 would ask you, and ask you to respond to it if you 15 could, in writing. 16 We, our capital, I think we've all come to 17 the conclusion that -- and your advice has been -- 18 that the capital and liquidity requirements 19 historically haven't really -- weren't adequate to 20 avoid the consequences of the financial crisis. 21 And I take it that means that we ought to 22 implement some more significant capital requirements 23 on a go-forward basis. 24 25 Would that be fair to say? VICE CHAIRMAN THOMAS: Mr. Chairman, these questions can be recorded but I think they ought to be 114 1 answered in writing -- 2 COMMISSIONER GEORGIOU: 3 VICE CHAIRMAN THOMAS: 4 COMMISSIONER GEORGIOU: thought he nodded his head yes. 7 8 Given the current circumstances. 5 6 Right. THE AUDIENCE: hear. 9 No. I understand, but I Is that correct? No, the witness can't We have to have a hard stop. VICE CHAIRMAN THOMAS: I believe 10 Mr. Wallison wants a question for the record and we'll 11 submit these in writing if you can phrase it. 12 COMMISSIONER WALLISON: 13 VICE CHAIRMAN THOMAS: 14 COMMISSIONER WALLISON: Quickly. Yes. And my question is 15 this: 16 situation is the total number, it seems to me, of 17 subprime and Alt-A mortgages in our economy, 26 18 million, which as I said at the outset, is about half 19 of all mortgages in our economy. 20 The unprecedented theme about our current When you are responding in writing to the 21 question of what caused this financial crisis I would 22 like you also to consider whether, in addition to less 23 capital than was required, what effect this 24 substantial number of bad mortgages might have had. 25 CHAIRMAN ANGELIDES: So those would be 115 1 submitted in writing to Mr. Greenspan. 2 What I just want to say, Mr. Greenspan, you 3 gave a lights-out performance today. 4 want to thank you very much for your time; thank you 5 very much for coming before us; thank you for your 6 service to the country. 7 I want to -- I And we are going to adjourn for 30 minutes, 8 and hopefully we'll have lights and power when we 9 return. Thank you all very much. 10 MR. GREENSPAN: Thank you very much. 11 (Session ended at 11:53 a.m.) 12 CHAIRMAN ANGELIDES: The meeting of the 13 financial crisis, lights power and all, will come to 14 order. 15 today. 16 Thank you very much, witnesses, for joining us What I'm going to ask you all to do at this 17 time is please rise, because as we do with all 18 witnesses, in the past and in the future, we'll swear 19 you in. 20 21 22 Mr. Bowen, can we swear you in along with everyone else? Thank you. Do you solemnly swear or affirm, under the 23 penalty of perjury, that the testimony you are about 24 to provide the Commission will be the truth, the whole 25 truth and nothing but the truth to the best of your 116 1 knowledge? 2 MR. BOWEN: I do. 3 MR. BITNER: 4 MS. LINDSAY: 5 MS. MILLS: 6 CHAIRMAN ANGELIDES: I do. I do. I do. Thank you very much. 7 This panel is about subprime origination and 8 securitization, and we are going to ask each of the 9 panelists -- you've submitted to us your written 10 testimony, and we are going to ask each panelist to 11 provide a five-minute opening statement. 12 repeat your written testimony and please do keep this 13 to five minutes. Please don't 14 There will be a light that comes on in 15 front of you that at one minute will indicate one 16 minute to go. 17 there. 18 And then red when the five minutes is So with that, we are going to start with 19 Mr. Bitner and then go left to right or right to left 20 depending on where you're sitting. 21 And just so for the audience, one of the 22 reasons we're doing that is certainly with respect to 23 Mr. Bitner and Ms. Lindsay, they were on the end of 24 selling mortgages to Citigroup, and so we thought we'd 25 take this in order. So, let's do that. Mr. Bitner. 117 1 MR. BITNER: 2 VICE CHAIRMAN THOMAS: 3 CHAIRMAN ANGELIDES: 4 Microphone, please. Yes, and then punch your microphone. 5 6 Thank you. VICE CHAIRMAN THOMAS: You have to turn it on at the base. 7 MR. BITNER: There we go. 8 CHAIRMAN ANGELIDES: 9 MR. BITNER: Is that okay? Yes. Good afternoon, members of the 10 Commission. 11 Bitner. 12 banking industry, who owned a subprime lending company 13 from the years 2000 to 2005. 14 For the record, my name is Richard I am a 15-year veteran of the mortgage Additionally, I am the author of 15 Confessions of a Subprime Lender: 16 of Greed, Fraud, and Ignorance, and I currently 17 publish several housing, finance, and real 18 estate-related periodicals, notably Housing Wire 19 Magazine. 20 An Insider's Tale Arguably, securitization could be the 21 single greatest innovation that has ever come into the 22 world of mortgage lending. 23 securitized, a consumer relied on a bank to supply the 24 money to fund a mortgage. 25 Before loans were And that entire process, from origination 118 1 to servicing, stayed with the same institution. 2 since banks owned every aspect of the loan and were 3 heavily regulated, they were motivated to manage risk 4 and to treat borrowers fairly. 5 Now, In addition to creating a renewable source 6 of capital, mortgage securitization also fragmented 7 the industry. 8 functioned in a true cradle-to-grave capacity, that 9 functionality of the industry became diversified. 10 So instead of one institution that This fragmentation gave each player a claim 11 of what I like to call plausible deniability. 12 Mortgage brokers simply maintained that they only 13 originated the loan, so any concern about the loan's 14 quality were the lender's responsibility. 15 The lender underwrote the deal using the 16 guidelines provided by the investment firms. 17 merely delivered the final products investors wanted 18 to buy. 19 So they The Wall Street firms who packaged the 20 securities and the investors who purchased them 21 claimed to be holders in due course, which protected 22 them from any liability when lenders and brokers acted 23 illegally. 24 25 And while the entire food chain contributed to the problems, fragmentation allowed each player to 119 1 point an accusatory finger at someone else, 2 effectively promoting what we now know is the 3 originate-to-distribute model of lending. 4 With minimal barriers to entry and 5 historically low-interest rates, loan originators 6 entered the business by droves. 7 the number of new -- the new -- excuse me -- new loan 8 originators working for mortgage brokers increased by 9 100,000 between the years of 2001 and 2006. 10 By some estimates, During the early years of subprime 11 lending -- subprime lending, very few states actually 12 had licensing requirements, which meant that the 13 barriers to entry were minimal. 14 began requiring licenses, the typical prerequisites 15 were disproportionately easy to meet, such as passing 16 multiple choice tests and not having any felony 17 convictions. And even when states 18 This ease of entry meant that the level of 19 fraud we experienced as a lender when reviewing files 20 originated by mortgage brokers was unprecedented. 21 my firm's experience, between the years of 2003 to 22 2005, more than 70 percent of all brokered loan files 23 that were submitted for initial review were somehow 24 deceptive, fraudulent, or misleading. 25 The issue is further complicated by the In 120 1 fact that little could be done to rid the system of 2 these violators. 3 broker was acting improperly, in fact committing 4 fraud, the options for enforcement were minimal. 5 states did not have licensing requirements, and those 6 that did have weak enforcement standards. 7 For example, if a lender found a Many Assuming there was a state licensing 8 authority, a lender could submit documentation in an 9 effort to rescind a broker's license. But in many 10 cases, however, the path of least resistance was 11 simply for the lender to place the broker on the "do 12 not do business with" list, which meant the broker was 13 effectively barred from doing business with that firm, 14 leaving them to go somewhere else to conduct business. 15 Determining a property's value posed a 16 number of challenges for firms like mine. 17 lenders usually conducted a second-party review for 18 most broker-ordered appraisals, because frankly, the 19 majority of appraisals were considered to be 20 unreliable. 21 company's history, nearly half of all the loans we 22 underwrote -- that we underwrote were originally 23 overvalued, in our opinion, by as much as 10 percent. 24 25 Subprime To put things in perspective, during my Interestingly, our experience also showed that 10 percent was the most an appraisal could be 121 1 overvalued and still be purchased by any one of our 2 four major investors. 3 Another quarter of the appraisals that we 4 reviewed were overvalued by anywhere from 11 to 5 20 percent. 6 appraisals that we initially underwrote were so 7 overvalued that they defied all logic. 8 dart at a board while blindfolded would have produced 9 more accurate results. 10 And the remaining 25 percent of Throwing a The implication of this trend becomes 11 evident once doing the math. If multiple properties 12 in an area are overvalued by 10 percent they, in turn, 13 become comparable sales for future appraisals. 14 the process repeats itself. 15 several occasions. Then And we saw this on 16 We would close a loan, for example, in 17 January and see the subject property show up as a 18 comparable sale in the same neighborhood six months 19 later. 20 being appraised for 10 percent more than the 21 comparable sale six months earlier. 22 believe it was the subprime industry's willingness to 23 consistently accept overvalued appraisals that 24 significantly contributed to the run-up in property 25 values that were experienced throughout the country. Except this time, the new subject property was In the end, I 122 1 To complicate matters further, the mortgage 2 industry experienced a gradual shift between what was 3 and what was not an acceptable form of risk. 4 credit score had been an excellent indicator of loan 5 performance, its reliability was predicated on holding 6 other credit factors constant, these included, but 7 were not limited to, a borrower's rental history, job 8 stability, and cash reserves. While 9 Unfortunately, the industry's inability to 10 apply logic when underwriting a loan file would serve 11 as its undoing. 12 illustrating this point than identifying how a 13 borrower's housing payment history was verified. 14 No other example is more prevalent to During this time period many lenders moved 15 from requiring a borrower to provide 12 months' 16 cancelled rent checks or verification or rental 17 history from a management company to simply allowing 18 for a private verification. 19 note from a borrower's mother became an acceptable 20 form of rental history, there should be no surprise 21 that loans defaulted at an alarming rate. 22 CHAIRMAN ANGELIDES: In other words, when a Thank you very much. 23 And there will be plenty of time for questions. 24 you. 25 Ms. Lindsay? Thank And if can pull those mics 123 1 towards you and put them on, thank you. 2 MS. LINDSAY: Okay. Good afternoon. Thank 3 you for inviting me to participate this afternoon. 4 hope for today's session is that I can bring a unique 5 perspective to the -- into subprime lending. 6 I have a unique background in that I grew 7 up in the subprime industry. 8 money lender. 9 was when I was six years old. 10 My father was a hard So I actually learned what Fannie Mae I don't want to tell you how old I am, but Freddie Mac wasn't around yet. 11 12 My VICE CHAIRMAN THOMAS: Just a minute, let me do the math. 13 MS. LINDSAY: So basically I grew up 14 with -- you know, my father would show me how to 15 evaluate a loan, what characteristics to look at, and 16 when I was 16 years old, 1979, okay, you can do the 17 math again, I learned how to service the loans and 18 learned how to look at loans, looked at properties. 19 And the biggest thing was with hard money 20 lending, these were borrowers who didn't have good 21 credit histories. 22 history, they would have a lot of equity in the 23 properties. 24 25 So to offset that poor credit We had three Cs that we looked at: the credit, collateral, and the capacity. The We had 124 1 borrowers clearly didn't have the credit, which later 2 on, in subprime, they didn't have the credit, but then 3 they didn't have the collateral either. 4 found out they didn't have the capacity. 5 And then we They would -- they switched to stated 6 income loans, and they would just state whatever would 7 qualify them for the loan, usually led by the brokers, 8 because the brokers were the professionals in the 9 industry who would know what they needed in order to 10 qualify for the loan. 11 Those loans were submitted to lenders, like 12 New Century Mortgage, who then sold them to investors 13 on Wall Street where they were packaged and resold 14 into securities. 15 I joined New Century as a wholesale 16 underwriter in 1997. 17 skeleton crew after we declared bankruptcy in April of 18 2007. 19 bankruptcy. 20 I was kept on as part of a I was kept there to help wind down part of the I found the lending standards at New 21 Century significantly different than what I had grown 22 up in the subprime lending industry. 23 worked at Beneficial Mortgage from December of 1996 24 until I was hired on at New Century in December of 25 1997. Also I had 125 1 Beneficial was one of the original subprime 2 lenders. 3 poor credit history, and they would offset it with the 4 protective equity. 5 borrowers were going to default, they would protect 6 their portfolio by having the equity. 7 could either get out by selling the property or they 8 could refinance or possibly do something else in order 9 to -- to get out of their loan. 10 They, too, would work with borrowers who had So in other words, if the So the borrower As Mr. Bitner mentioned, the -- the growth 11 and subprime industry grew because of the 12 securitizations on Wall Street. 13 like Beneficial, like some of the other local banks, 14 they kept their loans on portfolio or they would sell 15 them off to Fannie Mae or Freddie Mac if they 16 qualified for those loans. 17 Before the banks, With the advent of the securitizations, 18 loans were just sold in droves to Wall Street. 19 was a huge demand for the product because of the 20 returns. 21 they were based on a product that would, if anything 22 hiccupped, like the property values, they were going 23 to potentially default. 24 25 There The problem with the returns, though, is New Century was not able to originate loans without the use of warehouse lines of credit. We 126 1 didn't have our own funds to loan. 2 banking institution. 3 We were not a We didn't take deposits. So we got our money from warehouse lenders. 4 These warehouse lenders provided us the ability to 5 make these loans, and they were usually provided by 6 the same people who would purchase our loans on Wall 7 Street. 8 that our loans were forward-sold two and three months 9 ahead of time. 10 There was such a huge demand for our product We had approximately -- we were making, at 11 our peak, approximately 20,000-plus loans per month, 12 about 5 billion dollars in product every month that 13 was being sold, and those loans were forward-sold. 14 One of the other things that changed was 15 the originate-to-distribute model. 16 good loan used to be a loan that paid. 17 a definition of a loan that could be sold. 18 A definition of a It changed to We did track the performance of the loans 19 that we could, because we would always say that our 20 loans performed better than the others. 21 with that was we couldn't track all of the loans 22 because, like I said, most of the loans were sold and 23 we didn't know what happened to them unless we were 24 asked to repurchase. 25 The problem One of the other problems was the loose 127 1 guidelines. 2 didn't have credit. 3 they didn't have the collateral because they were at 4 100 percent financing. 5 We have layered risk. We had people who They didn't show the capacity and And then we added the interest-only loans, 6 and then there were the teaser rates that would 7 readjust after two years of being fixed. 8 And to finalize my opening statement, just 9 basically at the end of the day, we had a system that 10 went into a downward spiral because of layering risk 11 rather than mitigating the risk, and we just need to 12 go back to the core values of the three Cs. 13 you. 14 15 CHAIRMAN ANGELIDES: very much. 16 Thank you. Thank Thank you Ms. Mills? MS. MILLS: Chairman Angelides, Vice 17 Chairman Thomas, and members of the Commission, thank 18 you for inviting me to appear today. 19 Mills and I'm the head of the mortgage finance group 20 at Citigroup Global Markets, Inc. 21 My name is Susan My group is a part of the team responsible 22 for the securitization and underwriting of residential 23 mortgage-backed securities within Citi's investment 24 bank. 25 The Commission has asked me to address the 128 1 securitization activities of my group, including our 2 business model and our due diligence activities, with 3 an emphasis on the securitization of subprime and 4 Alt-A residential mortgages. 5 I have done so at greater length in a 6 written statement for the record. 7 few key points for you now. 8 9 Let me address a First, our mortgage trading and securitization activities were part of an 10 intermediation business; that is, we purchased 11 mortgage loans from originators and sold RMBS 12 securities to any sophisticated institutional 13 investors. 14 Simply stated, our objective in purchasing 15 mortgages was to securitize them and distribute the 16 resulting mortgage bonds to meet the demand from our 17 fixed-income investors. 18 Secondly, Citi's RMBS business was smaller 19 than the RMBS business at many other Wall Street 20 firms. 21 we ranked seventh in underwriting us mortgage-backed 22 securities in 2004; 10th in 2005; 11th in 2006; and 23 10th in 2007. 24 25 Publically available league tables showed that A significant reason for this was that unlike many other firms, in the period leading up to 129 1 the market dislocation in 2007, we did not operate 2 what is known as a mortgage conduit, which is an 3 entity used to acquire mortgages on an ongoing basis 4 through established relationships with originators. 5 In addition, Citi's investment bank did not have a 6 direct relationship with an affiliated mortgage 7 originator from which we had the ability to directly 8 source mortgages for our securitizations. 9 that instead of originating and servicing mortgages This meant 10 in-house for securitization business, as many of our 11 peers did, we exclusively purchased loans from 12 originators in the marketplace in arm's-length 13 transactions. 14 As a result, we underwrote our RMBS 15 according to the guidelines of the loan originators 16 and not our own set of guidelines. 17 Our due diligence had two principal 18 components. 19 a particular seller, we would evaluate the seller and 20 their operations, typically through an on-site review. 21 If we were not comfortable with a particular seller, 22 we would not do business with them. 23 First, before ever purchasing loans from Secondly, with respect to pools of loans 24 that we were purchasing, we would perform a due 25 diligence review focused on ensuring that the loans 130 1 met the originator's underwriting guidelines. 2 conduct this review we engaged third-party diligence 3 providers that we actively supervised. 4 To Once we had aggregated a pool of loans of 5 sufficient size, we would then securitize those loans. 6 As a part of this process, we submitted loan level 7 information to credit rating agencies to determine the 8 dollar amount of bonds in each rating category for the 9 RMBS. 10 We would market the RMBS bonds to 11 investors, solicit feedback from those investors 12 regarding the transaction, and finalize the structure 13 and pricing. 14 Our offering documents described the 15 underwriting standards of the originator or 16 originators of the loans in the pool and also provided 17 extensive narrative and stratifications concerning the 18 loans themselves. 19 I understand that the Commission is 20 particularly interested in our efforts to monitor the 21 mortgage market and detect fraud. 22 reviews served as the primary and, I believe, highly 23 effective means by which we evaluated the loans we had 24 purchased and securitized. 25 Our due diligence If we identified issues with the loans in a 131 1 pool of mortgages that we had agreed to purchase, 2 including concerns about potential fraud, we would 3 perform additional diligence until we were satisfied 4 that our level of diligence was appropriate. 5 We would not purchase loans that failed to 6 meet the applicable underwriting guidelines of the 7 originator or that violated any compliance regulations 8 or that appeared fraudulent. 9 We also monitored the performance of the 10 loans that we purchased, and we typically negotiated 11 the right to require the seller of loans that 12 experienced early payment defaults, an indication of 13 potential fraud, to repurchase those loans. 14 To assist us with these efforts, starting 15 in 2006, we established a unit within mortgage finance 16 to monitor the performance of the loans that we 17 securitized and to manage our repurchase requests. 18 Unfortunately, our diligence practices did 19 not detect what we now know to be the most significant 20 downturn in the us housing market for generations. 21 a result of the unprecedented housing collapse, which 22 led to the decline of the value of all mortgage loans, 23 many of our RMBSs have not performed as well as 24 expected. 25 However, we continue to believe, despite As 132 1 the financial crisis and the collapse of residential 2 home prices, that the securitization of non-agency 3 mortgages plays a vital role in making capital 4 available to institutions to enable individuals to 5 purchase homes. 6 And we are encouraged that we are slowly 7 starting to see the mortgage securitization market 8 return. 9 For our part, we at Citi are committed to 10 applying thorough diligent practices as we adapt our 11 businesses to the changing marketplace. 12 I appreciate the opportunity to discuss 13 some of those practices with the Commission today, and 14 I look forward to answering your questions. 15 16 CHAIRMAN ANGELIDES: Ms. Mills. Mr. Bowen? 17 MR. BOWEN: 18 very grateful to the Commission. 19 VICE CHAIRMAN THOMAS: 20 MR. BOWEN: 21 CHAIRMAN ANGELIDES: 22 23 Thank you very much, Thank you, Mr. Chairman. I am The mic, is it on? Is the light on? Pull it towards you. Thank you so much. MR. BOWEN: I'm very grateful to the 24 Commission to be able to give me testimony today. If 25 it wasn't for this commission, if it wasn't for you, 133 1 then my story could not have been told. 2 My name is Richard Bowen. I was promoted 3 to business chief underwriter for Citi in early 2006. 4 I had responsibility for underwriting for over 90 5 billion dollars annually of mortgage loans. 6 These mortgage loans were not made by Citi. 7 They were made by other mortgage companies and Citi 8 purchased them. 9 sure that these mortgages met Citi's credit policy 10 And it was my responsibility to make standards. 11 During 2006 and 2007, I witnessed business 12 risk practices which made a mockery of Citi credit 13 policy. 14 to substantial risk of loss. 15 unit management, repeatedly, during 2006 and 2007 16 about the risk -- risk issues I identified. 17 I believe that these practices exposed Citi And I warned my business I then felt like I had to warn Citi 18 executive management. 19 directors about these risks that I knew existed. 20 I had to warn the board of On November the 3rd, 2007, I sent an e-mail 21 to Mr. Robert Rubin, Mr. Dave Bushnell, the chief 22 financial officer and the chief auditor of Citigroup. 23 I outlined the business practices that I had witnessed 24 and had attempted to address. 25 I specifically warned Mr. Rubin about the 134 1 extreme risks and unrecognized financial losses that 2 existed within my business unit. 3 I also requested an investigation. And I 4 asked that this investigation be conducted by officers 5 of the company outside of my business unit. 6 warnings to Mr. Rubin involved two different areas 7 within my responsibility. 8 9 My The first one was called delegated flow. The delegated flow channel purchased 50 billion 10 dollars annually of prime mortgages. 11 were purchased one mortgage at a time. 12 mortgages were not underwritten by Citi before they 13 were purchased, but the underwriters reviewed a sample 14 of the files after they were purchased. 15 make sure that Citi's credit standards were 16 maintained. 17 These mortgages These This was to Most of the mortgages were sold to Fannie 18 Mae, Freddie Mac, or other investors. Even though 19 Citi did not underwrite these mortgages, Citi did 20 provide reps and warrants to the investors who 21 purchased them. 22 the investors that the mortgages were underwritten to 23 Citi credit guidelines. These reps and warrants guaranteed to 24 In June of 2006, I discovered that over 25 60 percent of the mortgages in delegated flow were 135 1 defective. And by defective, I mean the mortgages 2 were not underwritten to Citi policy guidelines. 3 Citi had given reps and warrants to the 4 investors that these mortgages were not defective. 5 And the investors could force Citi to repurchase many 6 billions of dollars of these defective mortgages. 7 This represented a large risk of loss to the 8 shareholders of Citi. 9 I attempted to get management to address 10 this critical risk issue. I started issuing warnings 11 in June of 2006. 12 e-mail, weekly reports, committee presentations and 13 discussions. 14 from the management that was in charge of internal 15 controls. 16 had very serious problems. 17 warnings through 2007. 18 and sell even more mortgages in 2007. 19 mortgages during 2007 increased to over 80 percent. 20 I told you that my warnings to Mr. Rubin These warnings were in the form of I even requested a special investigation And that investigation confirmed that we And I continued my But Citi continued to purchase And defective 21 involved two areas of the responsibility. 22 flow was the first area. 23 Wall Street subprime. 24 pools of subprime mortgages. 25 Delegated The second area involved was Wall Street subprime purchased CHAIRMAN ANGELIDES: Mr. Bowen, can you try 136 1 to also just wrap up just as quickly as you can just 2 because of time? 3 MR. BOWEN: Wall Street subprime purchased 4 pools of subprime mortgages from other mortgage 5 companies. 6 make sure that the mortgages in those pools met Citi 7 credit policy standards. 8 9 And the underwriters were responsible to Beginning in 2006, I witnessed many changes in the way the credit risk in these pools was 10 evaluated. 11 purchasing a pool of subprime mortgages was based upon 12 the numbers of approved decisions given by the 13 underwriters. 14 As an example, the credit decision on In some subprime pools, large numbers of 15 underwriter decisions were changed. 16 were changed from turndown to approved and the pools 17 were purchased. 18 Citi policy. 19 The decisions There were many other variances to Beginning in 2006, I issued many warnings 20 to management. And many identified pools were 21 purchased anyway over my specific objections. 22 Thank you Mr. Chairman. 23 CHAIRMAN ANGELIDES: Thank you very much. 24 And there will be lots of time for questions. And I 25 really appreciate the brevity of all the witnesses. 137 1 Let's do this now. I'm actually going to 2 start with Mr. Thomas to see if you have questions you 3 would like to lead with. 4 questions until the balance of the Commission members. 5 6 7 8 9 I would -- I'll defer my VICE CHAIRMAN THOMAS: Thank you, Mr. Chairman. EXAMINATION BY VICE CHAIRMAN THOMAS VICE CHAIRMAN THOMAS: First of all, thank you all for coming, and for anyone who grew up in 10 California through the `50s, the `60s, the `70s, the 11 `80s, the `90s, et cetera, a lot of this stuff is 12 pretty familiar to us now, especially following the 13 last several years. 14 15 16 And I'll address my initial questions to Mr. Bitner and Ms. Lindsay. Just what was the last straw? What made 17 you walk away? 18 where they start with the cold water in the pot, and 19 then it started getting a little hotter, and then 20 eventually you realized circumstances you were in? 21 22 Was it kind of like the cannibals, MR. BITNER: I think, for me, it was a combination of a couple -- 23 VICE CHAIRMAN THOMAS: 24 MR. BITNER: 25 VICE CHAIRMAN THOMAS: Is your mic on? I believe so. Okay, close, then. 138 1 MR. BITNER: For me it was a combination of 2 a couple of things, starting as early as 2003. 3 forget about the fact that we have a subprime business 4 model. 5 know, and every month you're making more of them and 6 you're making less. 7 is that the quality of the widget that you're 8 producing is of a decreased quality. 9 watching this trend, and of course -- 10 11 Let's We had a model which makes widgets and, you And yet what you're also noticing VICE CHAIRMAN THOMAS: And you're Hey, can you sell them? 12 MR. BITNER: What's that? 13 VICE CHAIRMAN THOMAS: 14 MR. BITNER: 15 VICE CHAIRMAN THOMAS: 16 about the decreased quality of the widgets? Can you sell them? Well, yeah, we can sell them. 17 MR. BITNER: 18 VICE CHAIRMAN THOMAS: So you feel guilty You know, there's -If people stopped 19 buying them, that would be a signal to you, wouldn't 20 it? 21 MR. BITNER: 22 a couple of things going on here. 23 that -- well, all right, let me get out of the widget 24 example. 25 No. There's a combination of One is the fact Let's go back to the mortgage example. We're producing mortgages that clearly are 139 1 assuming greater levels of risk, because we're being 2 told by someone that we're selling them to that this 3 is now an acceptable form of risk, whereas maybe a 4 year or two ago, that wasn't the case. 5 2005, several things actually happened to me, one of 6 which was -- 7 VICE CHAIRMAN THOMAS: In October of If I interrupt you, 8 I apologize, but I do want to nail down some points as 9 we go forward. 10 They were an acceptable level of risk 11 because you were running out of the other mortgages 12 that were more familiar to you and better quality? 13 could you still do those but not at the volume that 14 you could do these? 15 MR. BITNER: No. What I refer to as an 16 acceptable level of risk could simply be by referred 17 to by looking at a matrix that was put out by an 18 investor, whether it was the Citi Financial or 19 whichever group, saying, you know, in order to get a 20 95 percent loan-to-value loan or hundred percent 21 loan-to-value loan, the loan must now meet this 22 criteria. 23 Or So it wasn't a case of whether I had more 24 or less of those that were available to me; it's just 25 that the decision making capabilities were being 140 1 pushed -- 2 3 VICE CHAIRMAN THOMAS: changed? 4 5 6 Your targets MR. BITNER: Your targets changed, absolutely. So what ultimately happened, by the time I 7 hit October of 2005, is a couple things occurred. 8 One, we had a record-setting month in terms of volume, 9 in terms of the number of loans that we had closed. 10 Number two, we also found ourselves in the 11 situation where, as we were looking at it from a 12 risk -- risk perspective and analyzing the volume of 13 loans that we did, we noticed that we had also hit 14 record level numbers of stated income loans, record 15 level number of hundred percent finance loans, which 16 was very different from when we started. 17 When we started in 2000, much as Chairman 18 Greenspan alluded to, I think we had a business model 19 that was more of a minor part of the business sector 20 of mortgage lending, where the average down payment 21 was 10 to 15 percent, you know, stated income loans 22 only made 15 -- 23 24 25 VICE CHAIRMAN THOMAS: Okay, Mr. Bitner, I have a time limit as well as you. What I want to focus on is that those of 141 1 us, again, who grew up in Southern California were 2 well aware that the first thing you tried to do is to 3 get enough money up, borrow from your parents, do 4 whatever you can, to get into a home, because the home 5 would appreciate. 6 forms of saving. 7 get equity out of that house and buy another one. 8 9 And that was one of your principal And that over time, you could then These events were occurring because that was just the climate we were in. Do you feel you got 10 to a point -- and I noticed you're from Texas, and it 11 was savings and loans problems in Southern California 12 and savings and loans problems in Texas, and there was 13 a way to apparently make the machine work faster. 14 you see a level of what I guess we could call fraud at 15 some point get the appreciation higher by virtue of 16 the relationship between the appraiser and the real 17 estate agent in terms of buying and selling homes or 18 flipping them, is a term? 19 MR. BITNER: It was one of the greatest 20 problems that we had, but I don't know if 21 necessarily -- and I talk about this at somewhat in 22 great depth in the book -- that there's really an 23 issue of the relationship between the appraiser and 24 the agent. 25 Did What we're really talking about here is the 142 1 fact that the appraisal is ordered directly from the 2 broker, the mortgage broker in this particular case, 3 not the real estate agent. 4 And one of the things that I concluded and 5 my belief is that -- and hear me through for a second, 6 let me finish this -- is that the broker did not need 7 to apply any direct pressure to an appraiser. 8 9 The way the industry worked was pretty simple. You placed an order in front of the appraiser 10 and you said, I need $235,000. 11 if that appraiser was not able to hit that level, then 12 ultimately they went to somebody else. 13 VICE CHAIRMAN THOMAS: So that appraiser -- I understand. And 14 so you didn't sell your product and that's how you 15 make money. 16 practice to make sure they could sell their product? 17 Was there a degree of uniformity on how you began to 18 produce these mortgages? 19 20 So people conformed to a certain business MR. BITNER: Could you be a little bit more specific? 21 VICE CHAIRMAN THOMAS: There's a slow way, 22 there's an old-fashioned way, there's a 3C way, or 23 there's the quickest way to get it done under the new 24 rules. 25 Was there a general understanding that your 143 1 job was to produce these so you could make money, and 2 therefore you do it in the fast, most -- fastest, most 3 convenient way possible? 4 5 MR. BITNER: answer that question -- 6 7 VICE CHAIRMAN THOMAS: MR. BITNER: Why did I get out of the business? 10 VICE CHAIRMAN THOMAS: 11 MR. BITNER: 12 fire. 13 do with the other. 14 Why did you get out of the business? 8 9 Well, see, the easiest way to Mm-hmm. Because my house caught on Now, you're going to go, what does one have to And I can tell you when you have moments 15 and changes in your life, when things like that happen 16 and you look and you start watching the house -- in 17 this case, interestingly, the house that the profits 18 from the subprime built begin to burn, you start 19 questioning the validity of the work that you've been 20 doing over time and whether or not it's providing the 21 value that it provided five years ago when you started 22 the business, and the answer, to me, was pretty clear 23 that it wasn't. 24 25 VICE CHAIRMAN THOMAS: Do you think much of that self-examination and, frankly, what we used to 144 1 call guilt was evident on Wall Street in terms of the 2 continued desire to purchase whatever it was you're 3 producing? 4 others who filled your shoes fairly quickly. 5 Because when you stepped aside, there were MR. BITNER: That's correct. And I can't 6 speak for all of Wall Street but what I know is when I 7 left, it certainly meant sleep -- it certainly meant 8 that it was a little easier to sleep at night. 9 VICE CHAIRMAN THOMAS: Okay. Let me 10 reserve my time and I'll come back on a second round 11 so that everybody gets a chance to get into the 12 questions, Mr. Chairman. 13 CHAIRMAN ANGELIDES: 14 COMMISSIONER MURREN: 15 16 17 18 Terrific. Ms. Murren? Thank you. EXAMINATION BY COMMISSIONER MURREN COMMISSIONER MURREN: My first question is for Mr. Bitner and for Ms. Lindsay. You had referenced the fact that some of 19 the requests from your customers for the types of 20 products that they had wanted had evolved over time. 21 And I was curious as to whether you could 22 comment on whether their due diligence practices also 23 evolved over time? 24 25 MS. LINDSAY: For New Century Mortgage I was primarily in charge of the fraud detection and 145 1 prevention. 2 with -- with that piece of it, one of the problems 3 that I had specific to fraud prevention was the advent 4 of stated income loans. 5 And I will say I did try to keep up So in other words, if you couldn't prove 6 the fraud, it became a business decision. 7 time we had any teeth, risk management on the back 8 end, was when we could prove the fraud, when we had 9 something in writing, when we could hand-production 10 11 The only something and show them. Otherwise, they would say, well, prove 12 it -- it -- show me it's a bad loan. 13 couldn't, and therefore it was a business decision and 14 we would move on. 15 your question at least somewhat? So, I don't know, did that answer 16 COMMISSIONER MURREN: 17 MR. BITNER: 18 Ms. Lindsay said. 19 add to that point. And then you It did. It does. I very much agree with what There are several things I would 20 We -- and let me use the example of the 21 stated income loan, because I don't think that our 22 processes and procedures changed any; it just became 23 very much sort of that same challenge. 24 25 You know, you get a -- you get a particular documentation or a file that comes in with a person 146 1 who claims to be -- to make an income that appears to 2 be relatively reasonable for that particular 3 occupation in that particular -- in that particular 4 market. 5 And the way I say "appears to be 6 reasonable" is that there were ways that we could 7 check that. 8 that you could at least try to make sure that you 9 didn't have, as we've all come to know, the strawberry 10 11 We could go to salary.com and other ways picker who is making, you know, $450,000 a year. COMMISSIONER MURREN: Did the person that 12 was purchasing the loans from you though, their due 13 diligence when they came in to look at the products 14 that you generated, did they change their due 15 diligence practices over time, the Citibanks of the 16 world, who would -- 17 MR. BITNER: No, I don't think so. I think 18 it was fairly -- I mean, for what it's worth, I mean, 19 I thought we had fairly strong due diligent practices. 20 They didn't change relative to those types of loans in 21 terms of what we were looking for, because again, we 22 still felt, and one of the reasons why, for those of 23 us who have been lifelong in this mortgage industry, 24 and I came from the side of having worked for the 25 investor before, was that at the end of the day, the 147 1 one thing that always drove our opinion was our 2 belief: 3 person make this payment, at the very basic level. 4 Can this person make this loan, can this And if the answer is no then we probably 5 don't have a reason to be doing this loan. 6 COMMISSIONER MURREN: One short question, 7 when you look back on this do you think that there 8 should have been some sort of regulatory supervision 9 of your business activities and that of your industry, 10 specifically that segment that was not necessarily 11 monitored by the Federal Reserve, as a -- as a bank 12 would be? 13 MS. LINDSAY: I think the person who's 14 investing the money should know what they're investing 15 in. 16 my personal funds, and I grew up in the industry. 17 need to know the risk that I'm taking and -- and know 18 what it involves. 19 As a hard money lender myself, I actually loaned I I don't think the people who ultimately 20 invested their money in this knew any -- had any idea 21 what the risks were involved. 22 So I think that there should be some 23 regulation to the effect of showing the investors who 24 are at the end of the day the ones who are purchasing 25 the loans, the bonfires or the retirees who are 148 1 investing; I think everybody needs to understand what 2 the risk is so they can make an informed decision, so 3 in that respect, yes, definitely. 4 COMMISSIONER MURREN: There is a little bit 5 of a conflict in that, in that you both just stated 6 that you felt that due -- that the due diligence 7 practices that were exercised by people that 8 ultimately were either passing through these loans or 9 they were end-use investors were adequate. 10 But yet, clearly, as we've seen, they 11 didn't fully understand the risks that they were 12 taking. 13 And I guess that's -- is that correct? MS. LINDSAY: That is correct. They had -- 14 they had a set of underwriting guidelines, so they 15 were kind of following the guidelines, but they didn't 16 understand what the underlying risk was. 17 I think they kept -- we would run out of 18 product; we would run out of customers with a certain 19 product; they could no longer qualify because the 20 property values had gone up so much. 21 the interest-only loans. 22 risks. So here comes It just kept layering the 23 And the people who -- it wasn't the Wall 24 Street investors who were purchasing these who were 25 taking the losses. They were passing them along, who 149 1 were passing them along, passing them down the line, 2 five or six levels, and that's where the money was 3 coming from. 4 So I just think the person who is 5 ultimately investing in these needs to be aware of 6 what the risk is, I think there are too many levels 7 that it went through. 8 COMMISSIONER MURREN: 9 MS. LINDSAY: 10 Thank you. You're welcome. COMMISSIONER MURREN: To follow up really, 11 on that topic, which is risk and the assessment of 12 risk, both, I guess, from Ms. Mills and Mr. Bowen, if 13 perhaps, Ms. Mills, you could talk a little bit about, 14 first, within your unit, what contribution or what 15 importance did risk have in the way you ran your 16 business? 17 18 19 MS. MILLS: Risk meaning the department risk or just the evaluation of risk? COMMISSIONER MURREN: The evaluation of 20 risk and then, in particular, where I'm headed with 21 this is to try to determine to what extent your 22 ability to understand the underlying risk of your 23 business was related to your performance in your 24 duties within your unit. 25 review based in part on your ability to determine So was your performance 150 1 risk? 2 MS. MILLS: When we bid on pools of loans 3 from originators, so people who were aggregating 4 loans, we purchased or we agreed to bid on pools of 5 closed loans. 6 There was a, on average, a 30-day time 7 period from when we were awarded the transaction to 8 when we actually had to pay for the loans. 9 that 30-day period is when we conducted our due 10 And in diligence. 11 And our due diligence was -- had two 12 components when it came to loan file diligence or 13 three components. 14 looked to the property; we looked at credit, so we 15 made sure that the loan was originated to the 16 originator's guidelines; and then we looked at 17 compliance to make sure the loan didn't violate any 18 state or local lending laws. 19 We looked at valuations, so we And we -- sometimes we do a hundred percent 20 diligence. 21 sampling methodology where we would select both random 22 and -- randomly selected and adversely selected loans. 23 More often than not, we would use a The randomly selected loans were to just 24 get a snapshot of is the pool as described on the loan 25 level data file that you got from the seller. 151 1 The adverse selection was to try to 2 identify the riskier loans in the pool and to spend a 3 little bit more time focusing on the riskier loans to 4 make sure that, in fact, that they were as described. 5 COMMISSIONER MURREN: But then when you get 6 to the end of the year, when we determine, or when 7 compensation is determined -- 8 MS. MILLS: 9 COMMISSIONER MURREN: 10 MS. MILLS: My own personal compensation? Yes. I don't know exactly what 11 factors go into my own personal compensation. 12 that the people who worked for me, their compensation 13 was based on the way that they did their job, whether 14 or not they were performing adequately and up to the 15 standards that I maintained; it was based on the 16 profitability of the business, and it was based on the 17 profitability of the firm. 18 19 20 21 22 COMMISSIONER MURREN: I know Was there a revenue component to it? MS. MILLS: That's, yes, that's what profitability is. COMMISSIONER MURREN: Well, arguably, 23 profitability is after you take losses or any kind of 24 expenses related to the revenue stream. 25 MS. MILLS: Yes, well, the way that the 152 1 firm keeps the books and records, it's a calendar 2 year. 3 money the business made at the end of the year, and 4 there's a bonus pool allocation amongst the various 5 businesses. 6 So there was a cutoff, and we knew how much And, you know, my management decides the 7 final word on who got paid what, I didn't have the 8 final word, I just made recommendations. 9 COMMISSIONER MURREN: But your -- was risk 10 discussed with you during the time of your performance 11 evaluation, risk to the firm, risk to your unit? 12 MS. MILLS: I can't remember specifically. 13 It's -- it's -- because our business model is one of, 14 you know, intermediation, in that we buy loans and we 15 distribute bonds, and we think that we disclose the 16 risk to our investors in the offering documents, which 17 we believe are compliant with all required securities 18 laws, and we sold bonds that had ratings, there was 19 risk that was monitored and maintained on the trading 20 desk itself. 21 I'm not a trader though, so that was -- it 22 was not my responsibility to manage the risk of the 23 firm. 24 25 COMMISSIONER MURREN: When you interact -- you've had some interactions, I believe, with the SEC 153 1 and with FINRA related to your business unit, as part 2 of the fact that the regulatory body that governs the 3 investment bank would be the SEC, primarily, not so 4 much the Federal Reserve; is that right? 5 6 7 MS. MILLS: I've only had interaction with FINRA. COMMISSIONER MURREN: Okay. And could you 8 talk a little bit about your interactions with the 9 regulators just in terms of the kinds of interest that 10 they might have had when they were evaluating your 11 business and its importance to the parent company? 12 MS. MILLS: My interaction with FINRA was 13 related to some inquiries that they made, 14 transaction-specific. 15 some securities that we had issued off of our shelf. 16 So they had some questions on And I had some meetings with our counsel 17 and then I had one in-face meeting with FINRA, where 18 they asked me questions about the deals that they had 19 questions about, that they were specifically related 20 to issues with the reporting of delinquencies and was 21 I aware of situations where delinquencies may have 22 been misreported on remittance reports. 23 COMMISSIONER MURREN: When you think about 24 the regulatory regime that governs the investment 25 bank, is there any discussion within the firm about 154 1 how that relates to the overall safety and soundness 2 of the parent company? 3 MS. MILLS: 4 would be involved in. 5 Was that discussed? Those are not discussions I COMMISSIONER MURREN: Thank you. And 6 Mr. Bowen, if I may, you had stated in your testimony 7 that there were a number of practices that you had 8 raised with regard to the quality of the loans that 9 were being generated in your unit. If you could talk 10 a little bit, you know, similar line, which is, to 11 what extent was there any kind of regulatory oversight 12 of this particular issue, to your knowledge, and to 13 what extent, again, did you feed back to management or 14 did management relate to you the importance of that to 15 the parent company in total? 16 MR. BOWEN: I did not interface with any 17 regulators. Underwriting was considered to be a part 18 of risk. 19 through the risk structure, as my manager did. And I escalated all of my concerns up 20 As it relates to the quality of the loans, 21 again, as I indicated when I took over this 22 responsibility in early 2006, I was charged with 23 ensuring that the mortgage loans that came through my 24 area were underwritten according to Citi policy 25 guidelines. 155 1 And I attempted to follow through on that 2 and identified those that came through my area that 3 did not meet that criteria. 4 5 COMMISSIONER MURREN: And do both of you report up to the same risk management unit? 6 MR. BOWEN: I reported up through -- I'm 7 sure, ultimately, they met at the chief risk officer 8 at the Citigroup level. 9 different part of the organization. 10 I was in a completely COMMISSIONER MURREN: So the concerns might 11 not have been shared within your two divisions, then, 12 if there were any concerns about the quality of the 13 underlying assets; is that correct? 14 MR. BOWEN: I do not know. 15 MS. MILLS: I don't know, either, where 16 risk intersected from the two businesses. 17 18 19 20 21 22 23 24 25 COMMISSIONER MURREN: Okay. Thank you. I'm done. CHAIRMAN ANGELIDES: Thank you, Ms. Murren. Mr. Wallison? COMMISSIONER WALLISON: Thanks, Mr. Chairman. EXAMINATION BY COMMISSIONER WALLISON COMMISSIONER WALLISON: I have so many -- I have a lot of questions for all of you, and I would 156 1 like you to be as concise as you can be. 2 to make these questions that don't require a lot of 3 expansion. 4 5 I will try Let me start with you, Mr. Bitner, and then I'll try to go along the line. 6 What you described in your testimony was an 7 industry engaged in what might be called mortgage 8 fraud, defrauding lenders and possibly investors with 9 a quality of the things that you -- that the industry 10 was selling, not you personally -- did you ever come 11 across predatory lending? 12 MR. BITNER: Well, I would say, I mean, 13 yes. 14 loans that I knew that we denied, which I thought was 15 a blatant effort on the top -- on the part of a broker 16 to act in a predatory manner that were then 17 subsequently taken to somewhere else and eventually 18 hearing that it was closed with another lender, yes. 19 I think we experienced it in terms of watching COMMISSIONER WALLISON: So, but in terms of 20 the percentage of what I would call making -- taking 21 an advantage of the naiveté, perhaps, or the greed of 22 the lender or the investor, as compared to predatory 23 lending, that is, taking advantage of the borrower, 24 what do -- what relative percentage would you see 25 there? 157 1 MR. BITNER: I don't know that given the 2 microcosm of the world that I lived in that I would be 3 accurate. 4 best guess, 10 to 20 percent. I can give you -- I may be giving you my 5 COMMISSIONER WALLISON: 6 MR. BITNER: 7 COMMISSIONER WALLISON: 8 MR. BITNER: 15 Absolutely. COMMISSIONER WALLISON: That was contract And did loans ever get returned to you? 13 14 When you sold a with every -- every contract that I had with my -- 11 12 My Very best guess. loan did you make reps and warranties? 9 10 Okay. MR. BITNER: Yes, and I was required for repurchase. COMMISSIONER WALLISON: What kind of 16 percentage of loans were actually returned to you, and 17 can you generalize for me between the kind of 18 institution that did return them? 19 MR. BITNER: Yeah, absolutely. The 20 repurchase requests were fairly small. They were 21 pretty consistent, meaning in terms of guidelines, 22 either usually first payment default, borrower did not 23 make their first payment. 24 they were a little bit different, had guidelines that 25 said if a borrower went as late as 90 days in their In the case of Countrywide, 158 1 first one year the loan was on the books. 2 But in most cases it was because of some 3 sort of a case of fraud. 4 behind on their loan that loan would go through a very 5 strict quality control process by the part of the 6 investor we sold it to, and it was usually the next 7 level of investor, so specifically, for me, that was 8 GMAC, HSBC, formerly Household Finance, Citi 9 Financial, and Countrywide. 10 Typically if a borrower came COMMISSIONER WALLISON: 11 return those loans to you? 12 returned? And they would And what percentage were 13 MR. BITNER: Small, maybe 2 to 4 percent. 14 COMMISSIONER WALLISON: So despite the fact 15 that they were very poorly underwritten, as far as you 16 could tell -- 17 18 MR. BITNER: talking about my underwriting qualities. 19 20 Oh, no, no, no, no, now you're COMMISSIONER WALLISON: Ah, your underwriting was better? 21 MR. BITNER: Right. Because when you said 22 that they were poorly underwritten, remember I was the 23 one -- 24 25 COMMISSIONER WALLISON: I accept your correction. Okay. I accept -- 159 1 MR. BITNER: 2 COMMISSIONER WALLISON: 3 6 7 But these were risky loans? 4 5 Yeah. MR. BITNER: They were subprime loans, of course. COMMISSIONER WALLISON: And nevertheless, the returns were relatively small? 8 MR. BITNER: The repurchase requests -- 9 COMMISSIONER WALLISON: 10 MR. BITNER: 11 COMMISSIONER WALLISON: Yes. -- were relatively small. So they probably 12 weren't as risky from the point of view of the 13 underwritten qualities of the loans? 14 MR. BITNER: I don't know that they were 15 necessarily any more or less risky. 16 we had a very strict diligence process. 17 else, I had separate people who were, much like in 18 your department, checking facts for fraud, trying to 19 make sure that they were vetted out for that. 20 COMMISSIONER WALLISON: I mean, I believe Like anything You talked a lot 21 about loans to Wall Street. A lot of the loans, I 22 think you said, went to Wall Street. 23 that Fannie and Freddie were buying loans? 24 ever -- were you aware of where your loans ultimately 25 went when you sold them? Were you aware Did you 160 1 MR. BITNER: Yeah. Actually, I don't know 2 that I would say my loans directly went to Wall 3 Street. 4 I mean, I guess, you can call Citi, yes, I mean, a 5 conduit, you could call that technically a Wall 6 Street -- a Wall Street firm. 7 8 The four institutions that I mentioned, well, So, I apologize, what was the second part of that question. 9 COMMISSIONER WALLISON: Were you aware 10 that -- if any of your loans went to Fannie Mae and 11 Freddie Mac? 12 13 MR. BITNER: No, I was not aware, once they got sold to the end investor. 14 COMMISSIONER WALLISON: Were you aware that 15 Fannie Mae and Freddie Mac plus FHA actually held more 16 or guaranteed more subprime and Alt-A loans, in 2008; 17 that is to say, on their books in 2008 than Wall 18 Street? 19 20 21 22 23 MR. BITNER: I was very familiar with that, yes. COMMISSIONER WALLISON: How did you become familiar with that? MR. BITNER: Well, I run what I think is a 24 somewhat respected media outlet, and we report on that 25 information. By then I was already -- 161 1 COMMISSIONER WALLISON: Oh, but you were -- 2 were you aware of it at the time that you were making 3 these loans? 4 5 MR. BITNER: This is -- you're talking about 2007? 6 COMMISSIONER WALLISON: 7 MR. BITNER: 8 COMMISSIONER WALLISON: 9 MR. BITNER: 10 11 Yes. 2008? Yes. Yes, I had already exited the industry at that point. COMMISSIONER WALLISON: Right. When you 12 were in the industry, were you aware that Fannie and 13 Freddie were buying these loans? 14 MR. BITNER: About -- about 2006 it really 15 came to my attention, when I left my organization, 16 joined a different firm, and really started noticing 17 things like the Community Home Buyer program, which, 18 incidentally, if you looked at it from Fannie Mae's 19 underwriting guidelines, very much resembled the 20 hundred percent financing program we underwrote to our 21 major investors. 22 23 COMMISSIONER WALLISON: Okay, good. Thanks very much for your time on this. 24 Ms. Lindsay, may I ask you a few questions? 25 Were you aware of what companies were 162 1 buying New Century loans? 2 MS. LINDSAY: Yes. 3 COMMISSIONER WALLISON: And do you know 4 whether the loans ultimately went to Wall Street or 5 went to the GSEs? 6 MS. LINDSAY: We did have some that went to 7 the GSEs. 8 representatives from Fannie Mae to show them what we 9 were doing in order to prevent fraud, showed them all 10 of our detection and prevention measures. 11 12 I actually met with some of the But, yeah, we had pretty much every Wall Street investor who was securitizing buying our loans. 13 COMMISSIONER WALLISON: Did -- did -- did 14 you actually sell loans directly to Fannie and 15 Freddie, or was it to a conduit that eventually went 16 to Fannie and Freddie? 17 MS. LINDSAY: 18 directly. 19 specific to our loans. 20 21 I believe they bought them I believe they put them in a security That was my understanding. COMMISSIONER WALLISON: That is to say, your -- your loans were -- 22 MS. LINDSAY: New Century, yes, subprime. 23 COMMISSIONER WALLISON: 24 MS. LINDSAY: 25 COMMISSIONER WALLISON: -- in a pool? New Century, yes. New Century put 163 1 them in a pool and they eventually got to Fannie and 2 Freddie? 3 MS. LINDSAY: 4 COMMISSIONER WALLISON: 5 6 Yes. Through some intermediary or directly? MS. LINDSAY: I believe it was directly. 7 read in one of our SEC filings that we completed a 8 securitization to Freddie Mac. 9 2002 or 2003. 10 I I believe that was in And then I met with Fannie Mae probably 11 around 2003. 12 they were buying our loans, and I don't believe it was 13 through a conduit. 14 And I'm not sure when, but I know that COMMISSIONER WALLISON: Now you spoke 15 during your earlier testimony about the fact that as 16 prices increased, it became much more difficult to 17 make loans to people who are at least subprime 18 borrowers and maybe even prime borrowers. 19 20 Are you -- you are, I suppose, aware of the expression "affordability gap"? 21 MS. LINDSAY: 22 COMMISSIONER WALLISON: 23 Yes. And is that what you think you were encountering at that point? 24 MS. LINDSAY: Yes. 25 COMMISSIONER WALLISON: In other words, 164 1 would you explain the affordability gap, then, to -- 2 to us? 3 MS. LINDSAY: Basically the housing prices 4 soared so much that they exceeded the normal income. 5 I'm not sure what it's called, the income allocations 6 for specific areas. 7 what it's called but -- 8 9 10 They have -- and I can't remember COMMISSIONER WALLISON: about Fannie and Freddie, though, here; right? They had a certain loan limit? 11 MS. LINDSAY: 12 COMMISSIONER WALLISON: 13 You're talking Oh, I'm sorry, no. Okay. I'm talking about something different. 14 MS. LINDSAY: Okay. 15 COMMISSIONER WALLISON: I'm talking about 16 the affordability gap; that is to say, prices got so 17 high for loans that many people could no longer 18 qualify for a 30-year loan that amortized over the 19 30-year period. 20 or -- 21 They wanted an interest-only loan MS. LINDSAY: Yes, exactly, and so, yes, 22 then -- then that was the advent of the interest-only 23 and just kept expanding the limits. 24 25 We also started doing a 40-year loan to stretch it out a little bit more. So, yes, we kind of 165 1 accommodated -- you know, the snowball started going 2 down the hill and it got bigger and bigger. 3 COMMISSIONER WALLISON: Let me ask you the 4 same kind of question I asked Mr. Bitner, and that is, 5 most of what you are describing in your testimony and 6 in your prepared testimony and so forth is, something 7 close to misleading investors or -- or possibly the 8 buyers of these loans or the lenders that were buying 9 the loans. 10 Did you encounter any predatory lending? MS. LINDSAY: It was my understanding that 11 the people who were buying the loans were the ones who 12 approved the guidelines. 13 said, we'll take that risk, we'll buy that hundred 14 percent interest-only loan, for whatever reason. 15 16 And they're the ones who I have no idea why somebody would want to do that but apparently they did. 17 COMMISSIONER WALLISON: But did you 18 encounter any loans in which the -- there was 19 advantage taken of the borrower rather than the lender 20 or the investor? 21 22 MS. LINDSAY: occasionally. 23 24 25 We ran across that COMMISSIONER WALLISON: How often would that be? MS. LINDSAY: It was pretty rare, as 166 1 Mr. Bitner mentioned. 2 decline it. 3 somebody from one of the local law enforcement 4 agencies contact us regarding predatory lending, or we 5 would contact them if we knew of it. 6 7 Every once in a while we would have COMMISSIONER WALLISON: Were those high-interest? 8 9 If we ever saw it, we would MS. LINDSAY: But it was a very small amount. 10 COMMISSIONER WALLISON: Were these loans 11 high-interest loans or were they normal-interest 12 loans? 13 14 15 16 17 18 19 MS. LINDSAY: They were all subprime so they were higher than a traditional bank loan, yes. COMMISSIONER WALLISON: How much higher, would you -- do you recall how much higher they were? MS. LINDSAY: It depended on the product. At least 2 or 3 percent, depending on the product. There was actually one time in our history 20 that the subprime interest rates were lower than the 21 prime interests rates for about two months. 22 So we had a lot of people coming to us for 23 loans because we can get them done quicker than the 24 traditional bank could and the interest rate was -- 25 COMMISSIONER WALLISON: And there was a lot 167 1 2 3 4 5 of competition for those loans, wasn't there? MS. LINDSAY: And there was absolutely a lot of competition. COMMISSIONER WALLISON: Tremendous amount of competition, that's right. 6 MS. LINDSAY: Yes. 7 COMMISSIONER WALLISON: Okay. I'm sorry 8 that I can't take more time with you, Ms. Lindsay. 9 Maybe there will be additionals to the question 10 period, later, but I would like to talk to Ms. Mills 11 for a while. 12 13 You and Mr. Bowen were at the same institution? 14 MS. MILLS: Correct. 15 COMMISSIONER WALLISON: But your 16 descriptions of the risk management in that 17 institution are wildly different. 18 that in any way? 19 MS. MILLS: Can you explain I can only explain it in the 20 context that we worked in businesses that had 21 different business models. 22 investment bank and being -- and working for a 23 broker-dealer and working in the fixed-income 24 division, our job was to meet demand from our 25 fixed-income investors. And being a part of the 168 1 And there was tremendous demand from our 2 investors to buy mortgage-backed securities, prime or 3 Alt-A or subprime. 4 So in -- in the context of us being a 5 market maker and an underwriter of securities, which 6 is our primary business, we either underwrote 7 securities or we bought whole loans and issued and 8 underwrote securities. 9 10 11 COMMISSIONER WALLISON: Okay. Your investors were? MS. MILLS: Our investors were 12 institutional investors, sophisticated institutional 13 investors, typically pension funds, money managers, 14 insurance companies. 15 16 COMMISSIONER WALLISON: directly from you? 17 MS. MILLS: 18 COMMISSIONER WALLISON: 19 They bought, yes. MS. MILLS: 21 COMMISSIONER WALLISON: Yes. What percentage to Fannie Mae and Freddie Mac? 23 MS. MILLS: 24 COMMISSIONER WALLISON: 25 Fannie Mae and Freddie Mac? 20 22 They bought I don't know. Can you give us kind of a ballpark, 50 percent, 30 percent, 169 1 60 percent? 2 3 MS. MILLS: that. 4 5 I would have to follow up on COMMISSIONER WALLISON: that later? 6 MS. MILLS: 7 COMMISSIONER WALLISON: 8 Can you provide Yes. I'd appreciate that very much. 9 You said in your testimony that you 10 underwrite -- you underwrote to originator standards, 11 not Citi's standards? 12 MS. MILLS: 13 COMMISSIONER WALLISON: Right. Now, this is quite 14 interesting, because Mr. Bowen's group underwrote to 15 Citi's standards. 16 Why was there this different business 17 model? 18 to the originator's standard instead of Citi's 19 standards? 20 Why would a customer want loans underwritten MS. MILLS: We mostly bought from large, 21 well-capitalized originators, who were known in 22 market. 23 Century's guidelines, for example, or Ameriquest's 24 guidelines, or Wells Fargo's guidelines. 25 And so there was an acceptance of New And so in the offering document for the 170 1 prospectus, we would be technically the issuer but we 2 would describe the originator's guidelines. 3 COMMISSIONER WALLISON: You mentioned three 4 companies that were largely subprime lenders, is 5 that -- is that what you're talking -- 6 7 MS. MILLS: of ours. 8 9 They were large counterparties We bought -COMMISSIONER WALLISON: them? 10 MS. MILLS: 11 COMMISSIONER WALLISON: 12 You bought from Yes. They were the originators? 13 MS. MILLS: Yes. 14 COMMISSIONER WALLISON: But they were 15 largely subprime originators, at least they were 16 during that period. 17 18 MS. MILLS: The pools that we bought were subprime pools. 19 COMMISSIONER WALLISON: 20 MS. MILLS: They were subprime? Wells Fargo originates many 21 different types of loans, so I -- we don't want to say 22 that they're just a subprime originator. 23 COMMISSIONER WALLISON: So your buyers were 24 actually perfectly happy with the originator's 25 standards of underwriting? 171 1 2 MS. MILLS: the word happy. 3 I don't know that I would use I think that they were -- COMMISSIONER WALLISON: 4 they went to you for. 5 MS. MILLS: Well, that's what They were accepting of it 6 and -- and -- but what they bought were rated 7 securities. 8 to Triple-B and then there was -- 9 COMMISSIONER WALLISON: 10 So they bought, you know, Triple-A down ratings. 11 MS. MILLS: 12 COMMISSIONER WALLISON: 13 Yes. MS. MILLS: 15 COMMISSIONER WALLISON: Yes. 16 well-known subprime originators. 17 MS. MILLS: 21 22 23 Bought from these Yes, as did the rating agencies. 19 20 But the underlying loans they understood to be subprime loans. 14 18 You had gotten the COMMISSIONER WALLISON: Okay. Thank you very much. May I go on now to Mr. Bowen. I have a few questions for you. What percentage, Mr. Bowen, of the 24 mortgages that were improperly underwritten were prime 25 mortgages, and what percentage were subprime, or could 172 1 you make a distinction between them? 2 MR. BOWEN: The -- there were different 3 channels that originated each. 4 were on the prime side. 5 The largest volumes COMMISSIONER WALLISON: And so it -- did -- 6 let me ask this -- when the mis-underwriting, like 7 mis-underestimating, when the mis-underwriting occurred, 8 did it occur more frequently with the subprime or with 9 the prime, or did it not matter; it just happened 10 generally? 11 MR. BOWEN: By virtue of the larger volume 12 in the prime side the absolute numbers were certainly 13 greater. 14 COMMISSIONER WALLISON: Okay. So the 15 percentages would have been about the same. 16 but the numbers were greater because there were more 17 prime loans? 18 19 20 21 22 MR. BOWEN: The -- I -- I cannot make the comparison. COMMISSIONER WALLISON: Okay, understood. That's perfectly good. Do you know of any difference between the 23 reactions of the GSEs, Fannie and Freddie, and the 24 reactions of the Wall Street firms to improperly 25 underwritten the loans? 173 1 2 MR. BOWEN: I did not interface with any of that area. 3 COMMISSIONER WALLISON: So you wouldn't 4 know if investors forced Citi to repurchase or whether 5 the GSEs forced Citi to repurchase some of these 6 loans? 7 You were aware of the risks that Citi was 8 taking because of the possibility of repurchase, but 9 you don't know whether it actually happened. 10 11 MR. BOWEN: No. That was a different area of the organization. 12 COMMISSIONER WALLISON: Okay. And do you 13 know of the actual delinquency rates on these loans 14 that were improperly underwritten? 15 MR. BOWEN: On the prime side, there was 16 reporting that was developed at the end of 2007 that 17 did indicate -- and this was the first reporting, to 18 my knowledge, that had been developed -- that did 19 indicate a significantly higher delinquency rate among 20 those. 21 22 23 COMMISSIONER WALLISON: That was the first time in 2007 when that seemed to be occurring? MR. BOWEN: This was as of 2007, but it 24 looked at all of the loans that were underwritten from 25 2006 to 2007. 174 1 2 COMMISSIONER WALLISON: MR. BOWEN: COMMISSIONER WALLISON: you. and that is, your memo to Robert Rubin. CHAIRMAN ANGELIDES: COMMISSIONER WALLISON: I just need a minute. 13 14 Let me yield additional -- 11 12 Thank Mr. Chairman, I only have one questions, 9 10 Thank you. That's interesting. 7 8 That was -- that was solely on the prime side, Commissioner. 5 6 And then I have one more -- 3 4 Okay. CHAIRMAN ANGELIDES: Well, I'll give you two. 15 COMMISSIONER WALLISON: Thanks. Your memo 16 to Robert Rubin, extraordinary document that we have 17 been privileged to see and that in fact was -- it was 18 quite candid. 19 anyone? Did you ever receive a response from 20 MR. BOWEN: 21 COMMISSIONER WALLISON: 22 question. 23 institution? 24 25 At what point, Commissioner? Well, that's a good From that time until the time you left the MR. BOWEN: From the point -- I'm attempting to clarify -- from the point at which I 175 1 sent the e-mail to Mr. Rubin? 2 COMMISSIONER WALLISON: 3 MR. BOWEN: Right, that e-mail. I was -- I sent the e-mail on 4 November the 3rd, I received a very brief phone call 5 on Tuesday, November the 6th, I guess, from a general 6 counsel within the company. 7 He said that they had received my e-mail, 8 they took it seriously, they were doing some 9 background investigation, and they really didn't need 10 to talk to me at that point in time. 11 I sent two follow-up e-mails to the general 12 counsel: 13 I explained that there were details that he needed to 14 know in this background investigation that posed 15 extreme risk to Citi shareholders and to please 16 contact me. 17 18 19 20 21 One in November and one in December of 2007. I was not contacted until January the 7th of 2008. COMMISSIONER WALLISON: And when you were contacted in 2008, what were you told? MR. BOWEN: We initiated a series of 22 conference calls. I spent over five hours in 23 conference calls with the general counsel, and he 24 involved another general counsel over internal 25 investigations, going into the details underlying my 176 1 e-mail to Mr. Rubin. 2 COMMISSIONER WALLISON: 3 could tell, was any action taken? 4 contacting you, was any action taken with respect to 5 people who were involved in the underwriting process. 6 MR. BOWEN: 7 COMMISSIONER WALLISON: 8 MR. BOWEN: 13 14 15 I do not know. When did you leave Physically or from their employ? 11 12 Other than the bank? 9 10 And as far as you COMMISSIONER WALLISON: lawyer? Wow. Are you a I would say their employ. MR. BOWEN: I left the organization officially January the 23rd of 2009. COMMISSIONER WALLISON: So you were there 16 about a year after the point where you had had that 17 conversation with the general counsel's office. 18 MR. BOWEN: 19 COMMISSIONER WALLISON: 20 you enlarge upon this a little bit so we can 21 understand what you mean by this? 22 somewhere else? 23 I was not there physically. Oh, please, would Were you sent Were you in prison? CHAIRMAN ANGELIDES: Well, can I make an 24 observation? I do not believe that -- that a subject 25 that we should be discussing are specific employment 177 1 matters, Mr. Wallison. 2 3 COMMISSIONER WALLISON: All right. I won't ask any further questions. 4 Thank you all for your indulgence in 5 answering my questions so quickly and with such 6 concision. 7 CHAIRMAN ANGELIDES: 8 COMMISSIONER GEORGIOU: 9 Mr. Georgiou? Thank you. EXAMINATION BY COMMISSIONER GEORGIOU 10 COMMISSIONER GEORGIOU: I guess to 11 initially to Mr. Bitner and Ms. Lindsay, what 12 incentives were there on the part of the originating 13 brokers and others involved in the originations to 14 do -- to deliver higher interest rate loans, if any? 15 MR. BITNER: There was standard operating 16 procedure that broker could be compensated in one of 17 two ways: 18 origination fee and/or they could sell it above market 19 interest rate. They could either charge the borrower an 20 And by doing that they would be paid a 21 yield spread premium typically up to a maximum of 22 2 percent of the loan amount. 23 maximum upside for them, so significant financial 24 gain. 25 In most cases there's a COMMISSIONER GEORGIOU: Right. Now, when 178 1 you say yield spread premium, that's above the amount 2 that they would otherwise receive as a brokerage fee 3 for originating the loan? 4 MR. BITNER: That's correct. And a very 5 quick example, today's rate may be 7 percent; if the 6 sell 7.5 percent on a subprime loan, they may be 7 paying an additional 1 percent. 8 may get paid 2 percent on top of that. 9 10 At 8 percent, they COMMISSIONER GEORGIOU: And who pays that additional amount? 11 MR. BITNER: That comes directly from the 12 lender, in this case, companies like myself and New 13 Century who were doing business directly with the 14 broker. 15 COMMISSIONER GEORGIOU: And would you then 16 pass that additional cost on to the ultimate purchaser 17 of the loan? 18 MR. BITNER: Well, that would have been 19 factored in, yes, to the ultimate fee that I would 20 have been able to or any lender would have been able 21 to obtain by selling the loans then in bulk to the 22 larger investors in the food chain. 23 COMMISSIONER GEORGIOU: Okay. Now if -- 24 let's assume for the sake that the broker gets a 25 higher fee for originating a higher interest rate 179 1 loan, say at the high end, where they're getting 2 2 percent. 3 circumstances under which the broker -- anybody would 4 go back to the broker in the event that that person 5 who signed onto that loan weren't able to perform 6 under it? 7 Would there be any -- ever be any MR. BITNER: Well, boy, I wish we really 8 could have, and that's really where the rubber meets 9 the road here, because the average broker typically 10 may have had a net worth in the organization of 11 somewhere between 5- to 25,000 dollars. 12 getting blood out of a turnip. 13 14 And good luck So the answer is we would have loved to but the practicality of it was it couldn't be done. 15 COMMISSIONER GEORGIOU: 16 if -- and did you charge a differential fee? 17 the chain, basically, from your company to whomever it 18 is that you were selling them to, did you charge a 19 differential fee for having originated a loan that 20 charged higher interest? 21 22 MR. BITNER: And -- and now Going up I'm not sure if I understand what you mean by a differential fee. 23 COMMISSIONER GEORGIOU: Well, I mean, did 24 you -- you paid -- you bought the loan; you sold the 25 loan. Did you get an additional amount for having 180 1 originated a higher interest rate loan? 2 MR. BITNER: Well certainly at the end of 3 the day, if I put pools of loans together that had 4 higher interest rates on them, they would be of 5 greater value to myself or any lender that -- that was 6 trying to sell them in the open market, yes. 7 COMMISSIONER GEORGIOU: Okay. And did -- 8 and, now, there's been discussion that some of the 9 acquirers had recourse back to you in the event that 10 there was an early payment default. 11 MR. BITNER: Or fraud. 12 COMMISSIONER GEORGIOU: Or fraud. And was 13 it your testimony that 2 -- 2 percent of the loans 14 were repurchased or in that range? 15 16 MR. BITNER: range, yes. 17 I would say roughly in that Less than 5 percent. COMMISSIONER GEORGIOU: Okay. Turning to 18 you, Ms. Lindsay, did you -- did you incentivize 19 mortgage brokers to provide loans at a higher interest 20 rate? 21 MS. LINDSAY: Yes. We had a rate sheet. 22 So we -- the brokers could basically pick their rates 23 that they were doing. 24 with their clients, the borrowers, and they would have 25 what's called par, meaning the broker doesn't pay -- They're supposed to discuss it 181 1 or the borrower doesn't pay, and the lender doesn't 2 pay the broker. 3 And then in the same token the borrower can 4 also buy down their rate at a discount. 5 either way: 6 pay for that; if it was a high rate, the lender would 7 pay the broker for that. 8 9 So it can go If it's a lower rate, the borrower would COMMISSIONER GEORGIOU: The lender, in your case, being New Century -- 10 MS. LINDSAY: Correct, yes. 11 COMMISSIONER GEORGIOU: 12 MS. LINDSAY: 13 COMMISSIONER GEORGIOU: -- would pay that? Yes. And then would you, 14 in turn, of course, obtain a higher price from 15 whomever you sold it to? 16 MS. LINDSAY: Yes. We -- how we sold our 17 loans were in bulk sale. 18 million dollars at 1 or 2 percent, depending on what 19 the market would -- would bear. 20 21 22 23 So we would sell a hundred COMMISSIONER GEORGIOU: I'm sorry, at 1 or 2 percent? MS. LINDSAY: Of -- of the whole package, so we would package them in one big bulk. 24 COMMISSIONER GEORGIOU: 25 MS. LINDSAY: Right. So a hundred million dollars, 182 1 and some investors would pay us 1 or 2 percent, in the 2 early days we would get as much as six or 7 percent, 3 but later on it was one to 2 percent. 4 5 COMMISSIONER GEORGIOU: And you'd get that as a -- as an upfront fee when you sold the loan? 6 MS. LINDSAY: Yes. So -- so if we have a 7 hundred million dollars, the investor would wire us a 8 check for 2 percent over the hundred million dollars, 9 and we would send them all the loans. 10 COMMISSIONER GEORGIOU: 11 able to sell the higher interest rate loans? 12 13 MS. LINDSAY: Yes. And you would be And -- and the pricing -- 14 COMMISSIONER GEORGIOU: 15 MS. LINDSAY: Yes. At a higher price? And the investors would 16 look at that, and they would evaluate what price they 17 were willing to pay us. 18 difference between the 1 and 2 percent that they were 19 going to pay on the whole package. 20 And that was probably the COMMISSIONER GEORGIOU: Right. Now, 21 Commissioner Wallison asked you about whether there 22 were predatory lending practices, which would be 23 practices that were intended to take advantage 24 effectively of the borrower, as opposed to mortgage 25 fraud, which was by the borrower against the lender or 183 1 the investor at the end of the day. 2 MS. LINDSAY: Right. 3 COMMISSIONER GEORGIOU: Were there 4 practices that could be characterized as predatory in 5 that they attempted to steer borrowers to higher 6 interest rate loans who might otherwise qualify for 7 lower ones? 8 9 MS. LINDSAY: Not that I'm aware of. sure it probably happened. We had about 7500 10 employees in our organization at one time. 11 sure that some people did. 12 I'm So I'm It was discouraged though. We had our policies and procedures, we had 13 our fair lending group, we had a compliance group, and 14 we would talk about predatory lending. 15 example, we would -- we would look at somebody's 16 income potential. 17 age, for example, we would not put them in an 18 interest-only loan or in some sort of an 19 adjustable-rate mortgage. So if somebody was of retirement 20 COMMISSIONER GEORGIOU: 21 MS. LINDSAY: 22 23 24 25 And for Right. So we did do things to discourage anything that would appear to be predatory. COMMISSIONER GEORGIOU: Okay. Mr. Bitner, can you respond to that particular point? MR. BITNER: That's actually a very good 184 1 question. 2 perhaps the best example might come where we would 3 have seen a loan file come in that to use something 4 specific might have had a 620 or 640 credit score, and 5 it was a loan that we clearly were able to do with our 6 guidelines. 7 I can give you an example of that. I think And we would question to ourselves, why did 8 the broker not take this loan and perhaps run it 9 through Fannie Mae's or Freddie Mac's automated 10 underwriting system, because it appeared that it's 11 very possible they could have gotten a slightly better 12 rate and a better deal for the borrower in doing that. 13 What we saw, I think, was such a large influx of new 14 originators who came in, who were so heavily called 15 upon by firms like mine and others, that I think the 16 path of least resistance for people who were not 17 seasoned in the industry was simply to say, I'm going 18 to send a loan to Kallmer, to New Century, to Citi, or 19 whoever I am, and they're going to take it, turn 20 quickly for it -- turn the loan quickly around, we're 21 going to close it, going to make our money and go down 22 the road. 23 So I think we started seeing a lot of that 24 type of a thing, where a borrower may very well have 25 gotten an interest rate that could have been 185 1 three-quarters of a point or a point, or maybe even a 2 little better, with a little bit greater diligence on the part of 3 the broker. 4 COMMISSIONER GEORGIOU: And how is it that 5 you capitalized your company to be buying all this 6 huge volume of loans? 7 lines from anyone? 8 9 MR. BITNER: Did you have any warehouse I did have warehouse lines. When I entered the industry, the -- the -- and I spent 10 a fair amount of time talking about this in the book, 11 the dollar amounts that were needed to fund a company 12 like mine were substantially less than they were maybe 13 by the time I exited the industry in 2005. 14 So it was -- it was loans from parents and 15 a variety of other things to capitalize the company 16 with several hundred thousand dollars that got me into 17 the business. 18 COMMISSIONER GEORGIOU: Right. But then 19 you had -- you had a line of credit available to you 20 from somebody to actually provide the loans? 21 22 23 24 25 MR. BITNER: Correct. Actually through Citi's warehouse division and through GMACs, correct. COMMISSIONER GEORGIOU: Okay. And what did they charge you for that privilege? MR. BITNER: I'd have to go back and remind 186 1 myself but I think it was -- one was Libor baseline 2 Libor plus a couple of points and, you know, typically 3 50 -- 25- to 50-dollar transaction fee per -- per -- 4 per loan, so, you know -- 5 COMMISSIONER GEORGIOU: And would they -- 6 would they then buy -- would the party that provided 7 the warehouse line of credit customarily buy all the 8 loans that you originated pursuant to it? 9 MR. BITNER: Well, it depended. I mean, 10 they were -- in this case, for example, GMAC, which 11 was our largest investor, they were also our largest 12 warehouse line. 13 with GMAC that, yes, did one and the same and actually 14 offered us better terms if we were able to use both 15 their warehouse line and send -- sell the loan to 16 them. So there were two separate divisions 17 COMMISSIONER GEORGIOU: 18 turning to Ms. Mills, if I could. 19 require parties from whom you bought the loans to 20 purchase the loan back because of early payment 21 default or any other provision that you had in the 22 agreement? 23 MS. MILLS: Okay. I guess, How often did you Initially, when we first 24 started to purchase large blocks of loans in 2005, we 25 saw about 2 percent of the loans be early -- early pay 187 1 defaults. 2 is about 5 or 6 percent early pay defaults. 3 And the last number that I remember in 2007 COMMISSIONER GEORGIOU: Uh-huh. And so 4 now, and then you would go back to an institution like 5 Bitner's and -- 6 MS. MILLS: No. We dealt with larger 7 institutions. 8 directly from a firm like Mr. Bitner's. 9 not buy loans from Mr. Bitner's firm. 10 11 So we wouldn't have bought loans And we did So for the -- in the example of Wells Fargo, just because they're still around -- 12 COMMISSIONER GEORGIOU: 13 MS. MILLS: Right. -- if we bought loans from 14 them, and we had early pay defaults, we had a system 15 that tracked them. 16 my department that worked with all of the firms that 17 we bought loans from, and we pursued these repurchase 18 requests. 19 And then we had a unit inside of And it was a -- it was somewhat of an 20 iterative process. 21 notice that said, you sold us these loans and they 22 didn't make their payment and you need to buy them 23 back. 24 25 You know, we would send them a COMMISSIONER GEORGIOU: happy. And they weren't They weren't happy with that. 188 1 2 3 MS. MILLS: It was a fair amount of back-and-forth. COMMISSIONER GEORGIOU: Well, I -- I know 4 this is going to be difficult to answer, and maybe you 5 can't, but how often were you able to actually enforce 6 these buy-back provisions? 7 MS. MILLS: 8 COMMISSIONER GEORGIOU: 9 Fairly often. And I take it you could only enforce it from people who were liquid and 10 adequately capitalized down the chain from whom you 11 had bought these loans? 12 MS. MILLS: It was very purposeful in our 13 business model that we only dealt with 14 well-capitalized institutions for a lot of the reasons 15 that we're talking about today. 16 We placed a lot of value on the reps and 17 warrants that we got from the sellers when we bought 18 the loans, but we also felt it was important that they 19 had capital to back up those reps and warrants. 20 And so we were fairly successful in getting 21 firms to repurchase early pay defaults until those 22 firms went out of business. 23 24 25 COMMISSIONER GEORGIOU: you were stuck. Right. Somebody was stuck anyway. MS. MILLS: We were stuck. And then 189 1 COMMISSIONER WALLISON: Tell me, were you 2 involved in the securitization, thereafter? 3 after collecting all these loans, were you involved in 4 the process of structuring them and selling them as 5 RMBS? 6 MS. MILLS: I mean My group was involved in 7 preparing the offering documents. So not only did we 8 perform the diligence on the whole loans when we 9 purchased the pools, then once we actually owned the 10 loans, we worked with our trading desk in deciding 11 what loans would be securitized. 12 COMMISSIONER GEORGIOU: 13 MS. MILLS: Right. And it was my group that worked 14 with the rating agencies and the lawyers and the 15 accountants to put together the prospectuses that were 16 used to sell the securities to our investors. 17 COMMISSIONER GEORGIOU: So you're the 18 perfect witness to answer the question I'm about to 19 ask. 20 At the last hearing when we had some of the 21 heads of these organizations before us, and recently 22 I've been sort of reflecting that perhaps the system 23 might have worked better if a variety of people along 24 the way had additional skin in the game, if you will, 25 or had to eat their own cooking was the term that I 190 1 used, where maybe rather than take all their fees in 2 cash at every step of the process, including the 3 mortgage brokers, the intermediate purchasers, the 4 purchasers, yourselves, you know, the lawyers who 5 wrote the prospectuses, the investment bankers who did 6 the -- got paid on the underwriting, the credit rating 7 agencies, that maybe they ought to take them in the 8 actual securities, themselves, some portion of their 9 fee, so that they are actually long in the security 10 and that maybe, under those circumstances, they would 11 have a greater incentive to do appropriate diligence 12 and to be certain, more certain that they would 13 perform in accordance with the representations that 14 they made to the investors. 15 Have you given any thought to that question 16 or anything similar? 17 operate your securitization of these mortgages if you 18 got paid, at least in significant part, in the 19 security itself? 20 MS. MILLS: Do you think that Citi could In the context of when we 21 purchased loans as principal and then securitized 22 those loans, there is always a risk that we would wind 23 up not being able to sell all of the bonds and we 24 would have some of the bonds left in our position. 25 COMMISSIONER GEORGIOU: Right. 191 1 MS. MILLS: Also, when we did subprime 2 securitizations, there's a component of the 3 securitization where it’s an equity piece that there 4 was no market for that we wound up owning in almost 5 all of the transactions where we bought whole loans. 6 7 COMMISSIONER GEORGIOU: CDOs or is that -- 8 MS. MILLS: 9 COMMISSIONER GEORGIOU: 10 of securitizations? 11 of those? 12 13 MS. MILLS: No. There's a piece, it's called the equity off of the NIM. COMMISSIONER GEORGIOU: 15 MS. MILLS: 17 -- the first round You still couldn't sell a portion 14 16 Well, would that be Right. NIM is net interest margin security. COMMISSIONER GEORGIOU: But that's pretty 18 marginal, isn't that like 2 percent of the offering or 19 thereabouts? 20 21 22 MS. MILLS: It is. It varies depending on the loans that are in the particular securitization. COMMISSIONER GEORGIOU: Right. But you 23 would charge maybe a 7 percent underwriting fee off 24 the -- just say you issued a billion-dollar RMBS, I 25 mean, you -- you'd customarily get a 70-million-dollar 192 1 fee. 2 MS. MILLS: I'm not sure where those 3 numbers are coming from. 4 whole loans and selling bonds, the only way that the 5 business makes money is if you sell the bonds for more 6 than you paid for the loans. 7 In the context of us buying COMMISSIONER GEORGIOU: Okay. All right. 8 So you're saying that your pricing so that 9 ultimately -- but I thought that the impression that I 10 got was that you had pretty ready and willing buyers 11 for these bonds; is that not fair? 12 MS. MILLS: We did, but depending on market 13 circumstances or, you know, investor appetite, it is 14 possible that we would have bonds left in our 15 position. 16 in our position all the time. But we're a market maker and we have bonds 17 COMMISSIONER GEORGIOU: 18 MS. MILLS: 19 20 Right, of course. And bonds that we buy in the secondary market. COMMISSIONER GEORGIOU: Right. And you 21 wouldn't be acquiring them without the intention 22 ultimately of selling them. 23 24 25 MS. MILLS: No, it was always our intention to distribute. COMMISSIONER GEORGIOU: Okay. And I 193 1 guess -- 2 3 CHAIRMAN ANGELIDES: additional time? 4 5 COMMISSIONER GEORGIOU: CHAIRMAN ANGELIDES: I'll yield you two minutes. 8 COMMISSIONER GEORGIOU: 9 CHAIRMAN ANGELIDES: 10 Just a minute or two, if I could. 6 7 Would you like some Thank you. Three minutes, take your time. 11 COMMISSIONER GEORGIOU: And I take it your 12 compensation or your group's compensation -- I guess 13 somebody touched upon this already, probably 14 Heather -- but depended, to some extent, on the amount 15 of revenue that you generated through the 16 securitization process for your group; is that right? 17 18 MS. MILLS: I believe that is a component, yes. 19 COMMISSIONER GEORGIOU: Right. Now, did 20 you ever -- did any of these securities ultimately 21 fail in the hands of the investors, if you know? 22 23 MS. MILLS: because it's not a pass-fail scenario. 24 25 Fail is a difficult word to use COMMISSIONER GEORGIOU: value? How about lose 194 1 2 MS. MILLS: I can tell you that they lost value and they performed worse than we expected. 3 COMMISSIONER GEORGIOU: 4 time, did they come back to Citi? 5 MS. MILLS: Okay. Now, at any As a market maker, you always 6 have the possibility that someone that you sold bonds 7 to comes back to you and says, I don't like this bond; 8 I want you to buy it back from me. 9 10 COMMISSIONER GEORGIOU: did that happen? 11 12 Right, but how often MS. MILLS: I'm not on the trading desk. I couldn't really answer that appropriately. 13 COMMISSIONER GEORGIOU: Okay. Let me ask you 14 this: If you're on the incentive-based, compensation 15 of your group was -- was dependent on the origination 16 fees of creating those securities, were you -- do you 17 ever have an occasion when they didn't perform as well 18 as expected of any clawback of compensation that went 19 to the group? 20 21 22 MS. MILLS: That's not a Citi policy as far as I know. COMMISSIONER GEORGIOU: Okay. Okay. I 23 guess, Mr. Bowen, I guess I'm not entirely certain I 24 understand -- thank you very much, Ms. Mills -- I'm 25 not certain I understand the -- the different area 195 1 that you had. 2 3 You had an area that was reviewing the acquisition of loans, and for what purpose at Citi? 4 MR. BOWEN: I was business chief 5 underwriter of the correspondent area. 6 purchased loans. 7 did not originate mortgages. 8 originated those loans and they were purchased by 9 Citi. 10 11 We actually The -- that part of the organization Other mortgage companies COMMISSIONER GEORGIOU: Right. For what purpose? 12 MR. BOWEN: Again, the -- it was my 13 understanding on the prime side most of them were 14 sold off to investors. 15 16 COMMISSIONER GEORGIOU: securitized? 17 18 And were they I guess they were. MR. BOWEN: I was -- I was not on that side of the business. 19 COMMISSIONER GEORGIOU: Okay. All right. 20 Well, then -- then, I think, thank you very much, all 21 of you. 22 23 24 25 I think I've exhausted my questions here. CHAIRMAN ANGELIDES: Thank you very much. Mr. Thompson? COMMISSIONER THOMPSON: Mr. Chairman. Thank you, 196 1 2 3 EXAMINATION BY COMMISSIONER THOMPSON COMMISSIONER THOMPSON: And good afternoon ladies and gentlemen. 4 Mr. Bitner, it's not often that someone 5 would have an epiphany quite like yours that would 6 cause you to change your career. 7 applaud you, not so much for the disaster that you 8 had, but the fact that you chose to take some action 9 as a result of that. And so I -- I 10 I'm struck, however, by the fact that there 11 would appear to be no state regulations over this part 12 of the business. 13 participate in this could see where there were obvious 14 flaws, that actions should have been taken. But you yourself and many others who 15 So, in your opinion, were there obvious 16 steps that state or federal regulators should have 17 taken that would have reigned in this crisis long 18 before it got out of hand? 19 MR. BITNER: I always felt, you know, it's 20 very interesting when you look at people in the 21 financial world who are responsible for managing money 22 for individuals, a series of people have to get 23 Series 7 licences, things of that nature, I think most 24 financial professionals, CFBs, go through some pretty 25 strenuous testing. 197 1 It always amazed me that to become a lender 2 or a broker, which arguably is the greatest investment 3 as most of us as humans will ever make in the course 4 of our lives, oftentimes requires nothing more than a 5 fingerprint check and a multiple-choice test. 6 I always use the state of Texas as an 7 example, which has probably the most stringent 8 standards, and is truly just a pass-fail, 70 percent, 9 multiple-choice test, not exactly what I would 10 consider to be rocket science for the purposes of 11 entry. 12 So, yes, I would have liked to have seen -- 13 frankly, I would have liked to have seen stricter 14 standards just to get into the business as a baseline, 15 both for lenders and brokers. 16 COMMISSIONER THOMPSON: So you obviously 17 saw up the food chain as well, and that is, the people 18 who were buying the bundles of loans from you. 19 would you say about regulations in that sector? 20 MR. BITNER: What Well, I'm a very big believer, 21 and I realize this panel is not focusing on the rating 22 agencies. 23 24 25 I have a very strong belief -VICE CHAIRMAN THOMAS: Au contraire, we will. MR. BITNER: No, I'm sorry, for purposes 198 1 of -- 2 CHAIRMAN ANGELIDES: 3 4 MR. BITNER: The purposes of this discussion, excuse me, I know you will but -- 5 6 VICE CHAIRMAN THOMAS: MR. BITNER: 8 VICE CHAIRMAN THOMAS: 12 I'm sorry? You're in line ahead of them; that's the only difference. 10 11 You're in line ahead of them; that's the only difference. 7 9 Oh, today. MR. BITNER: And I feel fortunate for that, thank you. The reality is this, we talked about the 13 originate-to-distribute model, we talked about a 14 situation where one institution used to hold all of 15 the responsibility. 16 Securitization broke that up where, again, 17 no one truly had skin in the game. 18 group, really, that was supposed to act in here were 19 the rating agencies. 20 The only impartial And it just -- it still continues, to this 21 day, to boggle my mind that three years later there 22 has been literally nothing that has been done, and 23 this is not a sign of this commission, because I 24 realize that's not what this commission is tasked 25 with, to do anything to either get back to the days 199 1 where we could create an arm's-length distance between 2 the investment banks and the rating agencies or find 3 some other ways for which they are compensated that 4 has nothing to do with the volume of work that they 5 do. 6 COMMISSIONER GEORGIOU: We are going to try 7 to do a little bit about that at some point down the 8 road here. 9 COMMISSIONER THOMPSON: Well, that's 10 certainly an area, as Mr. Georgiou says, has come to 11 our attention, and we'll look into it a little bit 12 later. 13 14 Ms. Lindsay, can I move to you in just a moment, please? 15 MS. LINDSAY: Yes. 16 COMMISSIONER THOMPSON: Don't take this 17 question the wrong way, but given the collapse of New 18 Century, I mean, it literally imploded. 19 MS. LINDSAY: Yes. 20 COMMISSIONER THOMPSON: Would it be fair to 21 say that the risk management function, as it existed 22 within the organization, was more window dressing by 23 senior management to get this fraud perpetrated on as 24 many people as they possibly could? 25 MS. LINDSAY: With respect to my 200 1 department, I strictly was in charge of fraud 2 detection and prevention. 3 we did a pretty good job. 4 So I'd like to think that As far as the rest of the business unit 5 goes, as far as producing loans that borrowers 6 couldn't afford, the guidelines that were created, 7 yeah, I think -- I think it was a mess. 8 One of the problems was, since values kept 9 going up, one of the questions -- for example, I dealt 10 with repurchase requests as part of my job, and when I 11 started seeing some of the repurchase requests come 12 in, specifically the 80/20s, the hundred percent 13 financing, I would bring that to the attention of 14 senior management, and they would say, well, that's 15 just one loan or two loans. 16 month, you know. 17 We made 20,000 loans last So there were no significant numbers 18 because the values kept going up. 19 the fraud was masked. 20 see the numbers. 21 we're taking a loss. 22 couldn't show anybody that we were taking a loss 23 because we were in such an upswing. 24 25 And the -- all of And production always wanted to Show me the numbers; show me where That was the big thing. We And then by the time we figured out that there was a problem, it was too late and New Century 201 1 exploded or imploded, both. 2 COMMISSIONER THOMPSON: So it would -- 3 would it be fair to say that you were pressured by 4 senior management to ignore those things that your 5 normal barometer would have said are problematic? 6 MS. LINDSAY: We were basically told to 7 stick to the fraud. 8 we had risk managers that were put throughout the 9 country to review loans. 10 If we had concerns about a loan, And some of their requests were ignored, 11 some of the production teams would override their 12 decisions, and other groups were really good and would 13 sit down with them and figure out why they were making 14 the recommendations they were. 15 Part of the problem was the lack of -- lack 16 of depth or knowledge in the industry. 17 sales people -- since it was such a new industry, we 18 had so many new employees throughout the country in 19 subprime that had never been in mortgage lending 20 before. 21 inability to understand what the problems were to make 22 informed decisions. 23 And so the So I think part of it was just their And so they did ignore the more seasoned 24 professionals who may have had a better insight into 25 it. 202 1 COMMISSIONER THOMPSON: So how much did the 2 competitive pressure, particularly between New Century 3 and Countrywide, contribute to the level of risk that 4 the organization was willing to take? 5 MS. LINDSAY: Oh, it was huge. That was -- 6 I mean, the account executives would come in and say, 7 well, if we don't do this loan, if we don't give this 8 pricing or make this particular loan, Argent, 9 Countrywide, and they would name off ten of our other 10 competitors, who will do it right now, can we do it 11 faster, better, quicker, you know, at a better price. 12 So, yes, it was huge. 13 COMMISSIONER THOMPSON: Okay. 14 Ms. Mills, the vernacular of league tables 15 is all about a proxy for market share in your 16 business. 17 And in my experience with Wall Street, 18 that's everything. 19 corporate loan officer, everybody who looks at 20 themselves wants to compare themselves favorably 21 against industry league tables. 22 Every investment bank, every Yet you were proud of the fact that you 23 were sliding, that seems counterintuitive to me to the 24 culture of Wall Street. 25 MS. MILLS: What am I missing? I won't tell you that league 203 1 tables were not something that people talked about, 2 but I can tell you that there was never pressure to do 3 business just to gain league table position in -- in 4 my business. 5 So my management was focused on being 6 profitable and being a presence in the market. But 7 there was never any pressure to be one, two, or -- or 8 three. 9 buy loans where you think you can make money and It is, you know, do business that makes sense, 10 distribute the bonds, and I -- I -- I'm not aware of 11 any pressure to just do business to be higher in the 12 league tables. 13 COMMISSIONER THOMPSON: So you were an 14 island in the sea of Wall Street or an island in the 15 sea of Citi, because other parts of Citi certainly had 16 pressure on league tables. 17 18 MS. MILLS: business and my interactions with my management. 19 20 COMMISSIONER THOMPSON: very much. 21 22 I can only speak about my Okay. Thank you I yield, Mr. Chairman. CHAIRMAN ANGELIDES: Thank you very much. Ms. Born? 23 COMMISSIONER BORN: Thank you very much. 24 EXAMINATION BY COMMISSIONER BORN 25 COMMISSIONER BORN: Mr. Bitner, you've just 204 1 spoken about the inadequacy of state regulation or 2 oversight of mortgage lenders and brokers. 3 say in your written testimony that there were two 4 statutes in the early 1980s that you think laid -- 5 laid the groundwork for subprime lending. 6 You also And I wondered if you would comment on 7 those. They're the depository institutions 8 Deregulation and Money Control Act of 1980 and the 9 Alternative Mortgage Transaction Parity Act of 1982. 10 11 What role did they play in laying the groundwork for subprime lending. 12 MR. BITNER: Well, I would be remiss if I 13 said or inadequate if I said that I was truly expert 14 on these. 15 attempting to find where sort of a foundational point 16 for the industry began, several different scholars had 17 pointed me to these particular acts as sort of 18 starting points where we begin to say we actually saw 19 foundations for that. 20 When I was researching my book and -- and The depository, the monitory -- the 21 money -- Money Control Act, excuse me, was by and 22 large allowed businesses to, and lenders, to charge 23 higher rates and fees to borrowers that had not been 24 in place at times. 25 was put in and around that. So there was some structure that 205 1 The Alternative Mortgage Transaction Parity 2 Act in `82 also really gave rise to the use of 3 variable interest rates or what we really now refer to 4 now as ARMs or adjustable rate mortgages. 5 Those two, in and of themselves, were 6 certainly a starting point. 7 started to kick the industry into gear, although those 8 were fairly minor, the third really sort of occurred 9 in the early `90s, when we came out of a refinance 10 I think what really wave in `93. 11 And subsequently, like with most 12 originators, when you find yourself -- this time I was 13 actually not originating in the industry -- when 14 interest rates go higher and there's no other ways to 15 do loans because people stop refinancing, you look for 16 alternative forms of opportunities. 17 And that's really when subprime lending 18 began to enter the market. 19 few years later that we began to see the 20 securitization of these products. 21 just more portfolio lending at that time. 22 It really wasn't until a COMMISSIONER BORN: Initially that was So basically the role 23 that those two statutes played was to give the 24 flexibility to design new kinds of mortgage products? 25 MR. BITNER: Correct. And, again, at that 206 1 time we really just saw people dipping their toes in 2 the water; it was not any sort of a major entry point. 3 COMMISSIONER BORN: 4 MR. BITNER: 5 COMMISSIONER BORN: 6 Yeah. Ms. Lindsay, may I ask you about New Century? 7 MS. LINDSAY: 8 COMMISSIONER BORN: 9 Thank you. Yes. It was, we have heard, the third largest subprime lender in the country from 10 2005 to 2007, and I wondered what, in your view, 11 caused it to go bankrupt? 12 MS. LINDSAY: That's a good question. We 13 just -- we just grew too fast. 14 competitive. 15 repurchase requests starting to come in as the market 16 kind of flattened out as the values stopped going up, 17 to mask any fraud or any problems, it -- we started 18 seeing repurchase requests. 19 It got really And then that, coupled with the We had reps and warrants with all of our 20 investors as well, and the primary reason to 21 repurchase loans were fraud or first payment defaults. 22 We also had compliance issues and missing 23 documentation. But the first payment default started 24 growing exponentially. 25 The middle of `06 we created a specific repurchase It was pretty -- pretty busy. 207 1 desk to handle all of the repurchases. 2 think we couldn't keep up with them. 3 COMMISSIONER BORN: And I just So in other words, you 4 just -- because a larger number of your -- the loans 5 that you were selling were slow in payment or not 6 paying, you had a lot of liability with respect to 7 them? 8 MS. LINDSAY: That's correct, yes. 9 COMMISSIONER BORN: And was it also because 10 the mortgage market itself was slowing down, the 11 originations were slowing down? 12 MS. LINDSAY: Originations were slowing 13 down. I think we had pretty much exhausted all of the 14 products. 15 were no new borrowers out there. 16 part of it as well. We got out as far as we could, and there I think that was 17 COMMISSIONER BORN: Thank you. 18 Ms. Mills, you describe in your testimony 19 how diligently your operation has been doing due 20 diligence on the underlying loans for your 21 mortgage-backed securities and also how you cut back 22 on purchases when you saw problems in the housing 23 market. 24 25 Did your operation incur any losses relating to the implosion of the housing markets and, 208 1 if so, what were they caused by and how great were 2 they? 3 MS. MILLS: I can't give you the specific 4 loss numbers. 5 started to drop because of the dislocation that was 6 occurring in the market. 7 I will tell you that whole loan prices We had loans in our position that we owned 8 that suddenly were worth less just by virtue of the 9 fact as to what was happening in the market. We had 10 loans on our books that were supposed to be 11 repurchased by companies that had gone out of 12 business, and there was nobody to go to to repurchase 13 those loans. 14 We also had a large book of whole loans 15 that we bought at distressed values. 16 also lost value. 17 And those loans So the business lost a lot of money. We 18 can follow up on the exact dollar amount but as the 19 securitization market went away, there was no venue 20 for us to sell the loans and securitize them. 21 And because our business is not running a 22 portfolio, you know, we spent a lot of time in the 23 last couple years managing the whole loans that we 24 owned. 25 COMMISSIONER BORN: So has that been a 209 1 primary focus of your group in the last couple years? 2 MS. MILLS: 3 COMMISSIONER BORN: 4 Yes. if you could provide the information on the losses -- 5 MS. MILLS: 6 COMMISSIONER BORN: 7 MS. MILLS: 8 COMMISSIONER BORN: 9 I would appreciate it Okay. -- to the Commission. Okay. Mr. Bowen, you described the significant problems with Citi's 10 implementation of its -- and its -- of its 11 underwriting standards for mortgages. 12 And you said that you saw a significant 13 number of defective products being purchased in 2006 14 and 2007 and that you tried to alert people and that 15 the purchases, nonetheless, went forward. 16 What do you think the motivation of the 17 impetus for going forward with these noncomplying loan 18 purchases were? 19 20 MR. BOWEN: on speculation from my part and I -- I don't know. 21 22 COMMISSIONER BORN: 25 Thank you. I'll yield the rest of my time. 23 24 Again, that -- that would call CHAIRMAN ANGELIDES: very much. All right. Mr. Thomas. VICE CHAIRMAN THOMAS: Thank you. Thank you 210 1 Commissioners, need any additional time for any 2 follow-ups? 3 COMMISSIONER WALLISON: 4 VICE CHAIRMAN THOMAS: 5 CHAIRMAN ANGELIDES: How much time do you VICE CHAIRMAN THOMAS: I'll give you four and a half. 10 COMMISSIONER WALLISON: 11 VICE CHAIRMAN THOMAS: 12 13 14 15 16 17 18 Go ahead, need, Mr. Wallison? 8 9 How long? Mr. Wallison. 6 7 I want -- five. Oh, okay. We'll negotiate to Go ahead. CHAIRMAN ANGELIDES: Microphone, Mr. Wallison. EXAMINATION BY COMMISSIONER WALLISON COMMISSIONER WALLISON: That's right. I have some questions for Ms. Lindsay. You refer to buyers of securitized subprime 19 mortgages as unsophisticated. And that's quite 20 interesting, to me. 21 They're people who are in this business all the time. 22 Why do you regard them as unsophisticated? 23 MS. LINDSAY: These are buyers after all. They were sophisticated in 24 putting financial deals together. The reason I used 25 the word unsophisticated is because they didn't know 211 1 the risk of the underlying product. 2 very high-risk loans. 3 COMMISSIONER WALLISON: These were all And they didn't 4 know that. You thought of them as putting together 5 the pools very well and negotiating, I suppose, about 6 how these pools would be eventually marketed? 7 MS. LINDSAY: 8 COMMISSIONER WALLISON: 9 But you didn't think they understood the underlying loans? 10 why would that be true? 11 is what I mean. 12 Right. MS. LINDSAY: Why -- I mean, why do you think that Well, my personal opinion is, 13 because of what I had learned growing up and working 14 in finance and working for hard money lenders and 15 other subprime lenders who actually had a stake in the 16 game, who had an interest in whether the loan 17 performed or not, these were extremely risky loan. 18 And so if they would look back at a 19 Beneficial mortgage, for example, the highest 20 loan-to-value Beneficial mortgage would have loaned somebody 21 with a poor credit score, and if they had spots on 22 their credit or on their employment history, they 23 wouldn't loan them any more than 65 percent 24 loan-to-value. 25 that other 35 percent. So they would have to come up with 212 1 So the default -- so, basically, if anybody 2 defaulted on these loans, the lender was going to take 3 a loss immediately. 4 protective equity. There was no -- there was no 5 COMMISSIONER WALLISON: 6 MS. LINDSAY: 7 COMMISSIONER WALLISON: 8 9 10 11 No cushion. You sold loans to Fannie Mae and Freddie Mac? MS. LINDSAY: Yes. COMMISSIONER WALLISON: Were they unsophisticated, in your view? 12 MS. LINDSAY: 13 COMMISSIONER WALLISON: 14 Right. I don't know what -Well, was there any difference -- 15 MS. LINDSAY: -- what they were thinking. 16 COMMISSIONER WALLISON: Was there any 17 difference -- of course not, but you don't know about 18 the others, either. 19 I mean, the point is, did you think from 20 looking at what they were buying that they might also 21 be unsophisticated? 22 MS. LINDSAY: Yeah, I didn't see the actual 23 products that they were buying other than they were 24 buying the higher -- the subprime loans that had the 25 higher credit risk or the lower credit scores. 213 1 I'm not sure what loan-to-values they were 2 using. So I'm not sure which packages. 3 been buying a particular pool of loans that had a 4 lower loan-to-value. 5 question. 6 They may have I don't know the answer to that COMMISSIONER WALLISON: Okay. Ms. Mills, 7 in February of 2007 you started reducing your subprime 8 exposure. 9 that February of 2007 was early. 10 Why? What signaled you to do that? MS. MILLS: And We had started to see a 11 deterioration in the quality of the loans that were 12 being originated and a deterioration -- deterioration 13 in the whole loan prices that -- where loans could be 14 sold. 15 And so because we lent money to a lot of 16 the people that we also bought from, we had access to 17 their financial statements. 18 required to do was to send us quarterly financial 19 statements. 20 Part of what they were And there were all sorts of financial 21 covenants related to their profitability. 22 very sort of micro level we started to see that the 23 types of loans that were originating, these companies 24 were not making money. 25 So on a And that, in combination with the fact that 214 1 whole loan prices continued to drop, we had already 2 started to step away a little bit from the business in 3 the middle of 2006. 4 activity; we stipulated our bids; we tried to buy the 5 -- if there is such a term -- sort of like the core, 6 subprime products, nothing that was really like an 7 outlier as far as risks because the credit -- the 8 rating agencies were increasing their credit 9 enhancement levels, which was reducing the amount of 10 We slowed down our purchase proceeds that you could raise by selling bonds. 11 So we had to pay less for loans. And 12 because everything we bought was competitive bid, we 13 also weren’t winning pools. 14 15 COMMISSIONER WALLISON: bidding against? 16 17 18 Who were you MS. MILLS: Primarily other Wall Street firms. COMMISSIONER WALLISON: And did they do the 19 same thing that you were doing, or you were selling on 20 to others, it seemed to me, from what you were saying, 21 they were selling directly to investors? 22 MS. MILLS: In very general terms, most of 23 the firms that were in our space I believe bought 24 loans and securitized them, but I'm not -- I can't 25 speak, you know, definitively, that that's all they 215 1 did. 2 3 COMMISSIONER WALLISON: But the bidding was still strong? 4 5 Okay. MS. MILLS: There was still a lot of activity, yes. 6 COMMISSIONER WALLISON: One more question. 7 You described the process of working with investors 8 and a credit rating agency. 9 get a dollar amount and a rating for the RMBS; then 10 you would market to investors and solicit feedback. 11 This sounds like a very iterative process, and I think 12 all of us would like to understand a little bit more 13 how this really -- how this really worked. You said that you would 14 MS. MILLS: Okay. 15 COMMISSIONER WALLISON: 16 MS. MILLS: Please. Once we owned a pool of loans, 17 we would send a data file to the rating agencies. 18 primarily dealt with Moody's, S&P and Fitch. 19 rating agency had their own data requirements, so what 20 data they wanted to see and what format they wanted to 21 see it in. 22 rating agencies have models that they sort of run the 23 cash flows of the underlying mortgage loans through 24 this model. 25 We Each We would send them the information. The And they would come back to us and tell us 216 1 how many bonds we could issue that were rated 2 Triple-A, Double-A, Single-A, Triple-B, and then what 3 the over collateralization amounts underneath the 4 Triple-B needed -- needed to be. 5 And then, based on -- that was sort of how 6 we sized the bonds in the offering process. 7 we went out to investors and you went out with 8 pricing. 9 Libor plus a spread. 10 And then So you might try to sell the Triple-A at And you either had investor interest or you 11 didn't. 12 able to tighten the spread; if you didn't have 13 investor interest, you would have to widen the spread. 14 If you had investor interest you might be COMMISSIONER WALLISON: Tighten the spread, 15 widen the spread, did the rating agency have any role 16 in the interest -- 17 CHAIRMAN ANGELIDES: I'm going to yield 18 additional, by the way, an additional, we're over, so 19 I'll just an additional -- 20 COMMISSIONER WALLISON: Sure, this is 21 important, Mr. Chairman, I appreciate the additional 22 time. 23 CHAIRMAN ANGELIDES: 24 COMMISSIONER WALLISON: 25 Three minutes, total. Did the rating agency have any role after you got the initial 217 1 2 structure from the rating agency? MS. MILLS: You don't technically get the 3 structure from the rating agency. 4 sizes and other features of the deal that are related 5 to credit enhancement. 6 You just get bond They're involved up until the actual day 7 that the deal closes. It is an iterative process, and 8 the pool could change during the marketing time. The 9 loans could drop out; loans could go delinquent. So 10 there's always this sort of final true-up that goes 11 on, and on the day that the deal closes you get a 12 letter from the rating agency that says I -- I, rating 13 agency, you know, in relation to this security, will 14 let you issue this many Triple-A's and so on. 15 COMMISSIONER WALLISON: Did you ever go 16 back to the rating agency during the time you were in 17 the middle of talking to the investors and say, we 18 need a change here in this structure or that part of 19 the rating or the number of bonds involved and that 20 kind of thing so that they changed their assessment 21 and responded to your request? 22 MS. MILLS: I don't have any specific 23 recollection of that happening in the subprime space. 24 I do remember, and I know that we're not focused on 25 prime, but in the prime securitization market, I do 218 1 remember instances where investors wanted more credit 2 enhancement levels than the rating agencies were 3 requiring. 4 CHAIRMAN ANGELIDES: All right, 5 Mr. Wallison, we'll move on, thank you. 6 you have a couple minutes, if you like, and then 7 Mr. Georgiou, two minutes each. 8 COMMISSIONER MURREN: 9 Ms. Murren, Thank you. EXAMINATION BY COMMISSIONER MURREN 10 COMMISSIONER MURREN: I have a question, 11 actually, for all of you, but it may be a simple yes 12 or no answer. 13 In listening to your commentary, it appears 14 that we've talked about declining underwriting 15 standards and the fact that this is a business where 16 there were fairly low barriers to entry and that the 17 price of loans declined over the course of the boom. 18 So when you think about, in your own minds, 19 weighing the factors that drove the boom, was it 20 demand-driven or was it supply-driven when you think 21 about the relative importance of these two things? 22 And then, in consideration of that, do you 23 think that had we had better oversight and reasonable 24 barriers to entry, that things might have been 25 different? 219 1 MR. BITNER: I guess I'll take that first. 2 I think it's a combination of both. I 3 don't think one happens without the other. 4 I very much believe that had there been some barriers 5 to or some -- I'm sorry, not barriers to -- greater 6 levels of oversight that we could have prevented this 7 mess from happening or at least minimized it to a 8 certain degree. 9 MS. LINDSAY: Yeah, I agree. And, yes, As far as the 10 loan originators go there needs to be more oversight 11 with that, definitely, there, as Mr. Bitner pointed 12 out there were several states that didn't even require 13 licensing. 14 And that was part of the problem. 15 And they were allowed to originate loans. MS. MILLS: From my perspective, I think it 16 was both supply- and demand-driven. 17 I can't really speak that well about the impact of 18 regulation just because the people that we bought from 19 we believed were regulated or well run or well 20 capitalized. 21 I don't really -- So I didn't have the same sort of negative 22 experience in dealing with smaller unregulated 23 counterparties. 24 MR. BOWEN: I was not involved in the 25 actual origination of the loans. These had already 220 1 been originated by the time that I reviewed them, so I 2 really can't opine on that. 3 CHAIRMAN ANGELIDES: 4 COMMISSIONER MURREN: 5 CHAIRMAN ANGELIDES: 6 COMMISSIONER GEORGIOU: 7 8 9 All right. Thank you. Mr. Georgiou? Thank you, Mr. Chairman. EXAMINATION BY COMMISSIONER GEORGIOU COMMISSIONER GEORGIOU: Ms. Mills, could 10 you tell us, in the typical structure that you had 11 when you did these bonds, how were the credit rating 12 agencies paid? 13 14 MS. MILLS: They were paid a fee that was driven by the transaction size. 15 COMMISSIONER GEORGIOU: 16 MS. MILLS: So it was -- Typically they got a certain 17 number of basis points up to a maximum cap dollar 18 amount, and then they were sort of capped out at the 19 dollar amount. 20 21 22 23 24 25 COMMISSIONER GEORGIOU: Right. But they got basis points based on the size of the issue. MS. MILLS: The dollar amount of the transaction, yes. COMMISSIONER GEORGIOU: All right. And that didn't matter how they rated it. Okay. 221 1 MS. MILLS: No. 2 COMMISSIONER GEORGIOU: 3 How many times did you take to market or They got paid. 4 attempt to take to market a pool of loans that didn't 5 receive ratings that you thought were necessary to 6 sell them? 7 8 MS. MILLS: I'm not sure I understand the question. 9 COMMISSIONER GEORGIOU: Did you ever -- did 10 the rating agencies ever provide a rating that was too 11 low for you to be able to market effectively the -- 12 the pool of loans that you securitized. 13 MS. MILLS: What the rating agencies gave 14 us was the dollar amount of bonds in each rating 15 category. So you've always had bonds in each rating 16 category. And there was typically appetite for bonds 17 with various ratings. 18 19 20 21 22 COMMISSIONER GEORGIOU: All right. Differential -- differential returns? MS. MILLS: Different risk appetites and yield requirements. COMMISSIONER GEORGIOU: Okay. You provided 23 warehouse lines to Argent to the tune of about three 24 and a half billion dollars; is that right? 25 MS. MILLS: It was the Argent, slash, 222 1 Ameriquest platform. I think most of our warehouse 2 lines were technically with Ameriquest. 3 COMMISSIONER GEORGIOU: 4 MS. MILLS: 5 Right. I think we might have had one smaller warehouse line with Argent. 6 COMMISSIONER GEORGIOU: But then you -- you 7 bought -- later in the process, you folks ended up 8 buying Argent; is that right? 9 MS. MILLS: 10 11 Yes. COMMISSIONER GEORGIOU: out for you? 12 MS. MILLS: 13 COMMISSIONER GEORGIOU: 14 How did that work I think. 15 Could have been better. Thank you. CHAIRMAN ANGELIDES: 16 That's good enough, Mr. Thomas? EXAMINATION BY VICE CHAIRMAN THOMAS 17 VICE CHAIRMAN THOMAS: Couple of quick 18 follow-ups along that line and then moving in another 19 direction. 20 In terms of the rating agencies and you're 21 sending your materials to them and getting them back, 22 was there ever something that could be described as 23 negotiations; that is, you got something back from 24 them, you argued back, they reexamined or looked at 25 it, was there anything that could be fairly 223 1 characterized as negotiating with the rating agencies 2 in coming up with the final package and agreement? 3 MS. MILLS: What you could do is you could 4 change the composition of the pool. 5 words, if you got back credit enhancement levels where 6 there weren't a sufficient enough number of Triple-A 7 bonds, you could remove some of the riskier loans from 8 the pool and resubmit it to the rating agencies. 9 VICE CHAIRMAN THOMAS: So in other When it was 10 submitted to you in that regard, was there any 11 guidance or a clear understanding of what you could do 12 to make it work? 13 MS. MILLS: What do you mean? 14 VICE CHAIRMAN THOMAS: Were there any 15 negotiations with the rating agencies? 16 a package and I send it back to you -- 17 MS. MILLS: 18 VICE CHAIRMAN THOMAS: If you send me Right. -- I can give it to 19 you cold and you've got to figure out what to do or I 20 can give you a couple of hints in terms of moving it 21 in a particular direction, but of course it would be 22 up to you to make that decision? 23 MS. MILLS: I don't believe so. I think 24 that we knew if you pulled out riskier loans you could 25 have less credit enhancement. 224 1 VICE CHAIRMAN THOMAS: I could even 2 probably handle that level of understanding. 3 mixed it up and sent it back. 4 So you Were there situations where you had to send 5 it back two or three times to get what you were 6 looking for? 7 8 MS. MILLS: answer that. 9 VICE CHAIRMAN THOMAS: 10 11 12 13 I'm not sure that I know how to MS. MILLS: Do you recall? I don't know that I can answer that. VICE CHAIRMAN THOMAS: yes or no or I don't know. Well, the answer is So you don't know? 14 MS. MILLS: I don't know. 15 VICE CHAIRMAN THOMAS: Okay. And I want to 16 say this, I appreciate your willingness, because 17 unlike others, you are in a current position, and 18 we're asking you questions about your employer. 19 so I'm very sensitive to that, and having said that, 20 I'm going to ask both of you a series of questions. 21 22 COMMISSIONER THOMPSON: Can I make a follow-up to the last question? 23 VICE CHAIRMAN THOMAS: 24 COMMISSIONER THOMPSON: 25 And Go. Were there ever instances where you might have given the same bundle 225 1 of loans to two different rating agencies to 2 essentially shop for the best rating? 3 MS. MILLS: There was a requirement from 4 investors, primarily on the Triple-A side, that bonds 5 have two ratings. 6 S&P. 7 But the demand for rating agencies was driven by the 8 investors so that we could sell bonds. Most of our deals had Moody's, S&P, and Fitch. 9 10 COMMISSIONER THOMPSON: MS. MILLS: Typically, well, I don't like the word shop, because that wasn't really the process. 13 14 The process was that in order to sell bonds, you needed to have more than one rating agency. 15 COMMISSIONER THOMPSON: 16 VICE CHAIRMAN THOMAS: 17 the worst one? 18 19 So the answer is yes? 11 12 And there was typically Moody's and Thank you. Did you ever choose No. We currently have what's called a new party or an emerging party; it's called the Tea Party. 20 In the history there was a political party 21 called the Know-Nothing Party. 22 response that people would give when questions were 23 answered. 24 25 And that was the What I heard from both of you, one formerly employed, one currently employed, is I think one of 226 1 the reasons I was interested in looking at Citibank 2 was in terms of its structure. 3 And basically the answer that we have 4 gotten back from you whenever we wanted to inquire 5 about what I think most of us would think would be an 6 aspect of the work you were in or a partnership in 7 some way, the answer was, I don't know because they 8 were somewhere else. 9 I know it's an enormous operation, and I 10 know that the history was more of a kind of a 11 conglomerate than a synthesizing integrating 12 structure. 13 company was built or did you feel that there might 14 have been a design to the separation in terms of the 15 information? 16 17 18 Was this done just because of the way the And, Ms. Mills, if you want to, you can take a pass on that question. MR. BOWEN: Mr. Bowen? Mr. Vice Chairman, I cannot 19 render an opinion as to why the organization structure 20 was why it was. I -- it was very heavily segmented. 21 VICE CHAIRMAN THOMAS: 22 MR. BOWEN: 23 24 25 Yeah. And I was responsible for my piece, and other people were responsible for theirs. VICE CHAIRMAN THOMAS: And let's revisit your e-mail, once again, very briefly. Was that the 227 1 first e-mail you ever sent? 2 MR. BOWEN: 3 VICE CHAIRMAN THOMAS: 4 MR. BOWEN: 5 VICE CHAIRMAN THOMAS: 6 To Mr. Rubin? Yes. Did you send them to others? 7 MR. BOWEN: 8 VICE CHAIRMAN THOMAS: 9 Yes. At corporate management. I'm just asking you, were you an e-mailer in terms of communicating with 10 folk higher up the chain about what you saw as 11 problems? 12 13 14 MR. BOWEN: There are in excess of hundreds of pages of documents that I submitted. VICE CHAIRMAN THOMAS: I'm looking at 15 something that could be characterized as sending an 16 e-mail to higher-ups in this segmented operation to 17 try to explain something that concerned you. 18 MR. BOWEN: I know that the warnings went 19 to the highest levels within my business unit, which 20 was called the consumer lending group. 21 VICE CHAIRMAN THOMAS: I mean, your 22 analysis of what was going on was akin to the fellow 23 in the field who calls an air strike on his location 24 because his position is being overrun, and that was 25 about the only way that you could resolve the problem 228 1 that you were in. 2 found yourself in those predicaments more than once? 3 So I was just wondering if you had MR. BOWEN: You're talking about prior to 4 Citi or are you -- I -- I don't understand the 5 question. 6 VICE CHAIRMAN THOMAS: No. Let me ask you, 7 it was segmented and you wanted to send an e-mail, and 8 you have, I assume, a book with people who are in your 9 company, and you have a choice of selecting who it is 10 you want to send it to. 11 you pick Rubin and not Prince. 12 MR. BOWEN: My question would be, why did There was speculation in the 13 press leading up to that weekend that Mr. Prince would 14 no longer be with the company. 15 that there was going to be a special board meeting. 16 VICE CHAIRMAN THOMAS: There was announced There's no water 17 cooler where folks in the company had this info? 18 had to go find out about it in the press rather than 19 the scuttlebutt in the company? 20 21 22 MR. BOWEN: You I don't understand your question, Mr. Vice Chairman, I'm sorry. VICE CHAIRMAN THOMAS: Then we'll just 23 leave it at that. But you decided, based upon what 24 you read in the press, there may be a structural 25 change in your company, and that prompted you to send 229 1 the e-mail to Rubin. 2 speculated as being removed? 3 MR. BOWEN: Was that because he wasn't I was -- I knew that there were 4 issues that were being considered by executive 5 management and the board of directors. 6 like I needed to get these in front of them because, 7 to my knowledge, they had no -- they had no knowledge 8 of my issue. 9 VICE CHAIRMAN THOMAS: And I felt And if you were 10 getting it to the board of directors, it made sense 11 that it could have been Rubin, given his structure 12 within the board of directions. 13 get it to Rubin? 14 MR. BOWEN: Was that a motive to It was, again, speculated in 15 the press going up to that weekend that Mr. Rubin was 16 taking over for Mr. Prince. 17 VICE CHAIRMAN THOMAS: Thanks. I'm 18 interested, because I don't know anything about it, 19 how you operated in terms of rela- -- I would say 20 relatively small amounts of money. 21 talked about how you got your company up and going. 22 Mr. Bitner, you And would it be correct to say that there 23 was no chance of growing that company, save for the 24 warehouse concept where you could use these other 25 folks' money to do what you would otherwise do, 230 1 because you couldn't bootstrap yourself; is that 2 accurate? 3 MR. BITNER: Well, I think, if I understand 4 your question, we did grow the company. 5 is warehouse lenders are based on an amount of 6 leverage, you know, typically a 10 or 15 to one 7 leverage off of a net worth. 8 9 10 11 So you're correct. The reality The amount of loans that I could fund was, I think, initially limited to maybe 10 or 15 million dollars on a monthly basis. But, you know, the route my company chose 12 and other companies that I knew also, we took most of 13 our money, put it back into the company, grew our net 14 worth to continue to make ourselves more competitive, 15 to grow the size of our warehouse lines, to try to be 16 able to fund more business. 17 VICE CHAIRMAN THOMAS: And, Ms. Lindsay, at 18 least in terms of New Century, you were involved in 19 that as well? 20 MS. LINDSAY: Yes. 21 VICE CHAIRMAN THOMAS: I guess I'm trying 22 to figure out how you find out about this stuff. 23 discussed earlier state regulation and, perhaps, 24 problems that weren't there? 25 We You have professional organizations, don't 231 1 you? Where there are newsletters that were going out? 2 Did you -- you talked a lot -- were you as silo'd as 3 Citigroup in terms of talking -- 4 MS. LINDSAY: With respect -- 5 VICE CHAIRMAN THOMAS: -- to others who 6 were in the business and you were looking at what you 7 were doing and how were you doing it? 8 MS. LINDSAY: 9 VICE CHAIRMAN THOMAS: 10 No, we all talked. Were you members of the Know-Nothing Party as well? 11 MS. LINDSAY: No, we all knew everything. 12 No, we all talked. 13 would talk about fraud. 14 seminars. 15 specific area was fraud detection and prevention. 16 I mean, my niche was fraud, so we I spoke at several different I worked with the MBA. You know, my How can we, with our changing guidelines, 17 how do we prevent fraud. And, you know, we did talk 18 about that. 19 groups did talk about the increasing risk with the 20 interest-only loans and when they readjust. 21 was more of our compliance department and fair lending 22 group who would talk about stuff like that. 23 VICE CHAIRMAN THOMAS: Nobody ever talked about -- well, some And that And was there a 24 discussion, as you got into the whole business of 25 warehouse lines and the rest, about the risk 232 1 associated with that? 2 MS. LINDSAY: The risk with borrowing the 3 money to make the loans? 4 Then that would probably pose the biggest risk to us. 5 6 VICE CHAIRMAN THOMAS: MS. LINDSAY: There was plenty of opportunity for a long time, yes. 9 10 But there was plenty of opportunity? 7 8 If we didn't sell the loans. VICE CHAIRMAN THOMAS: Long time is what in your business? 11 MS. LINDSAY: Well, we were founded in -- 12 we made our first loan in January of 1996, and then we 13 declared bankruptcy in April of 2007. 14 VICE CHAIRMAN THOMAS: 15 MS. LINDSAY: 16 VICE CHAIRMAN THOMAS: 17 For subprime, sadly, yes. You were in at the beginning and collapsed when everyone else did? 18 MS. LINDSAY: 19 VICE CHAIRMAN THOMAS: 20 That was a long run? Yeah. Thank you, Mr. Chairman. 21 EXAMINATION BY CHAIRMAN ANGELIDES 22 CHAIRMAN ANGELIDES: Thank you, Mr. Thomas. 23 Terrific. Let me -- I have questions, first, for 24 Mr. Bowen and Ms. Mills, and then for Mr. Bitner and 25 Ms. Lindsay. And Mr. Bowen, I'm going to start with 233 1 you. 2 One of the things I want to try to get a 3 good understanding of is that when I do look at the 4 data on Citigroup, it appears that in the various 5 lines of the business where Citi was buying, selling, 6 securitizing or holding mortgages, it looks as though 7 the write-downs may have been across all business 8 lines in the order of about 20 billion dollars. 9 this would exclude what happened in the collateralized 10 And debt obligation business. 11 So I'm trying to get to the identification 12 of risk, an identification of how those losses 13 occurred, how they might have been avoided. 14 opening statement today, you talked about how your 15 review, I guess, of the underwriting standards and the 16 business lines you were in, which was the buying of 17 mortgages to hold in portfolio and the buying of 18 mortgages for sale; correct? 19 20 MR. BOWEN: selling side. 21 22 25 I was not involved on the I was involved -- CHAIRMAN ANGELIDES: Just on the purchase side? 23 24 In your MR. BOWEN: -- on the purchase side, yes, sir. CHAIRMAN ANGELIDES: All right. You made 234 1 the comment that what was happening made a mockery of 2 Citi's business practices. 3 your e-mail, again, on November 3rd. 4 So I do want to just go to And I guess, apropos of the Vice Chair's 5 comments, I believe Mr. Prince stepped down, what, on 6 the 5th? 7 looking at your memo and having looked at the 8 transcripts of the interview of our staff with you, it 9 appeared that with respect to the purchasing from So he stepped down a couple days later. But 10 mortgage companies and the sale to third parties, you 11 indicate that that's about a 50-billion-dollar-a-year 12 business, and that you underwrite a small sample of 13 those to see to what extent -- I want to get clear to 14 what extent they met your policy criteria. 15 Now, as I understand it there were two 16 issues here: You were concerned that the sample size 17 was too small, that the policy called for a 5 percent 18 sample, is that correct, and that you believe there 19 was under sampling? 20 MR. BOWEN: Yes, that is correct. 21 CHAIRMAN ANGELIDES: Okay. And then, 22 secondly, I understand -- I want to understand if 23 46 percent of the files are either outside of the 24 policy criteria or have documentation missing from the 25 files and then it rose to 80 percent, tell me really 235 1 specifically what that means? 2 They -- these were standards that Citi was 3 setting for what it would buy, or was it verification 4 that the loans were what the sellers represented they 5 were? 6 you sampling these things to see if they actually meet 7 the standards that the sellers say they meet? 8 9 10 11 12 13 In other words, is it a standard you set or are MR. BOWEN: The sellers represented that they sold to Citi according to our standards. was our standards I measured those loans against. So, again, I'm trying to understand your question, Mr. Chairman. CHAIRMAN ANGELIDES: Well, I guess what I'm 14 understanding is you had standards then. 15 meet X standard. 16 deficient in meeting X standard. 17 were happy, notwithstanding that; correct? 18 19 And it They had to And you're saying they were MR. BOWEN: But the purchasers The purchasing of the mortgages was against our standards. 20 CHAIRMAN ANGELIDES: 21 MR. BOWEN: Yeah. But the recommend -- we did not 22 underwrite all of the -- in fact, we did not 23 underwrite any of the mortgages there prior to their 24 being purchased. 25 CHAIRMAN ANGELIDES: Correct. So what are 236 1 you judging? 2 were deficient, just tell me how they were deficient. 3 What I'm saying is, when you say these MR. BOWEN: They were deficient in one of 4 two ways: 5 express guidelines by Citi, or they were underwritten 6 and then they purported to be against the underwriting 7 guidelines by Citi. 8 9 One, they were not underwritten against the But they did not have documents that were required by Citi policy to support the assumptions 10 that were put into or made in the underwriting 11 decision by the originating lender. 12 CHAIRMAN ANGELIDES: Okay. And what were 13 the risks that flowed from that, that you would be 14 getting loans obviously that were suboptimal, that 15 weren't underwritten properly, that had risks and risk 16 layering that would be inappropriate, you believe, for 17 mortgages you would hold and potentially resell; 18 correct? 19 MR. BOWEN: The risks, from my standpoint, 20 as I outlined in my memo to Mr. Rubin, was that we, in 21 turn, being Citi, represented to the investors that 22 these mortgages were made according to our guidelines. 23 CHAIRMAN ANGELIDES: 24 MR. BOWEN: 25 CHAIRMAN ANGELIDES: And they were not? And they were not. All right. And is 237 1 that also -- does that also apply to the corresponding 2 fundings to Wall Street bulk purchases, same essential 3 problem? 4 5 6 7 8 9 10 MR. BOWEN: We did do underwriting in the Wall Street subprime channel. CHAIRMAN ANGELIDES: But you were overwritten; is that a fair statement? MR. BOWEN: In many instances, that is correct, sir. CHAIRMAN ANGELIDES: You said, I'm 11 underwriting this, I don't believe it's something we 12 ought to hold, you believe the risks are too great, 13 and you're being overridden? 14 MR. BOWEN: There were many instances where 15 my underwriters' decisions were reversed. 16 CHAIRMAN ANGELIDES: And was this -- did 17 this accelerate? 18 risk management business? 19 business; there's always someone I can think of, you 20 know, Mr. Thompson the same, you know, you're running 21 a business, there's always people who recommend for 22 and against certain transactions, but did you see a 23 market change? 24 25 I mean, how long have you been in MR. BOWEN: I mean, having run a I'm sorry, Mr. Chairman, I'm having a hard time following what -- 238 1 2 CHAIRMAN ANGELIDES: I guess what I'm saying is did you see more overrides? 3 MR. BOWEN: 4 CHAIRMAN ANGELIDES: 5 okay, that's fine. 6 All right. 7 Absolutely. In other words -- So you saw accelerating overrides? Let me talk to you about another matter. 8 The Argent purchase to which Mr. Georgiou referenced, 9 and Ms. Mills, the one you said could have turned out 10 better, this was the acquisition of Ameriquest, which 11 was one of the biggest, most aggressive subprime 12 lenders located in the State of California. 13 And as I understand it, from looking at 14 documents that our staff's put together, there was -- 15 and interviews -- there was a desire to captive -- to 16 buy -- to acquire a captive subprime originator to 17 give you a flow of loans. 18 You reviewed that transaction, didn't you, 19 Mr. Bowen? 20 supervisor? 21 22 MR. BOWEN: 25 I was involved, as Mr. Davis was, in the due diligence of that acquisition. 23 24 Were you involved with Mr. Davis, your CHAIRMAN ANGELIDES: against it? MR. BOWEN: Yes. And you recommended 239 1 CHAIRMAN ANGELIDES: 2 MR. BOWEN: And on the basis of? We sampled the loans that were 3 originated by Argent, and we found large numbers that 4 did not -- that were not underwritten according to the 5 representations that were there. 6 CHAIRMAN ANGELIDES: 7 what kind of percentage? 8 Vice Chair and me. 9 MR. BOWEN: 10 11 14 15 16 Large numbers, That's a question from the I do not recall, Mr. Chairman. CHAIRMAN ANGELIDES: Could you check, perhaps, for us? 12 13 Okay. MR. BOWEN: I have no access to that document. CHAIRMAN ANGELIDES: Okay. You don't have access to that document? VICE CHAIRMAN THOMAS: It was enough to 17 cause you some concerns, because obviously you state 18 that as the reason for your decision. 19 MR. BOWEN: Yes. 20 VICE CHAIRMAN THOMAS: 21 MR. BOWEN: 22 VICE CHAIRMAN THOMAS: 23 MR. BOWEN: 24 VICE CHAIRMAN THOMAS: 25 CHAIRMAN ANGELIDES: Among other items. Yes. So it was a lot. Yes, sir. Whatever that means. Terrific, let me move 240 1 2 on, now, to Ms. Mills. You mentioned that there were certain 3 underwriters that you just wouldn't feel comfortable 4 doing business with, but as a predicate, were you 5 involved in the warehouse lending business? 6 MS. MILLS: Yes. 7 CHAIRMAN ANGELIDES: All right. So just by 8 way of reference for the public and the Commission, my 9 understanding is that Citi extended about 11 billion 10 dollars of warehouse lines, credit facilities to 11 subprime originators. 12 So in a sense, and I'm sure there were many 13 other institutions who provided these, so that you 14 were providing fairly significant credit support to 15 subprime originators. 16 are about 26 of them across the country. 17 And I guess, by my count, there Let me start by actually picking up and 18 saying, when you said, there was some people we 19 wouldn't feel comfortable with, give me an example or 20 two of entities you didn't feel comfortable with 21 supporting, either purchasing their loans or providing 22 a warehouse line. 23 MS. MILLS: Sometimes when we would go to 24 visit a company that perhaps was not a startup but 25 hadn't been in business for that long, we would go out 241 1 and conduct an on-site review and meet with senior 2 management. 3 And having done this for many, many years 4 and having people on my team that had done it for 5 many, many years to a certain extent there is an 6 instinctual reaction as to whether or not the company 7 knows what they're doing, and whether that's the 8 management team that they've put together, the state 9 of their office, the state of their files, whether or 10 not they're making money, what the business plan is. 11 So there are concrete examples that you can look at, 12 such as profitability. 13 But there is also the sense that, you know, 14 maybe they're just not ready to do business with us, 15 and maybe they need to have a little bit more time 16 under their belt before we would be comfortable that 17 they had worked out the kinks; for instance, if it was 18 a new platform. 19 CHAIRMAN ANGELIDES: Would you normally, in 20 the course of extending your warehouse line, also get 21 a commitment of having them funnel product to you? 22 Were they linked agreements? 23 MS. MILLS: 24 CHAIRMAN ANGELIDES: 25 was a relationship. No. But, of course, there 242 1 MS. MILLS: Part of the reason that we lent 2 was to establish relationships with these originators. 3 But there was no direct linkage. 4 CHAIRMAN ANGELIDES: There were 26 5 different companies to which you extended warehouse 6 lines, I believe, Jim and you, which I believe is -- 7 excuse me, sir? 8 9 VICE CHAIRMAN THOMAS: just briefly? 10 11 Would you yield for CHAIRMAN ANGELIDES: Yeah, and then I want to -- 12 VICE CHAIRMAN THOMAS: 13 many you instinctually rejected. 14 MS. MILLS: My concern is how I mean, I can't remember. Like 15 I said, I've been doing this for a long time. 16 that there were companies we went to see that we did 17 not lend money to. 18 that we had warehouse lines with that we did not 19 renew, because we were uncomfortable with the 20 operation. 21 22 23 I know that there are companies VICE CHAIRMAN THOMAS: batting average? I know Did you have a Was it lots? MS. MILLS: Our minimum capital 24 requirements were fairly high. So in the subprime 25 space, it's not like there were hundreds of companies 243 1 to choose from. 2 I wouldn't want to speculate. 3 4 5 You know, I really would not want -- VICE CHAIRMAN THOMAS: You round up with 26 so it was like a 1200 batting average? MS. MILLS: Well, I think the list that you 6 have right now of 26 is every warehouse line that 7 we've ever done. 8 9 And some of the warehouse lines that are on that sheet are -- have nothing to do with subprime. 10 They are current lines where we are financing Fannie, 11 Freddie, and FHA loans. 12 13 14 15 VICE CHAIRMAN THOMAS: Thank you, Mr. Chairman. CHAIRMAN ANGELIDES: Yeah, there's some agency and there's non-agency on this list; correct? 16 MS. MILLS: Right. 17 CHAIRMAN ANGELIDES: And then it's one of 18 the documents which I'm sure the staff can classify. 19 All right, let me proceed on this. 20 One thing that Mr. Prince -- and we'll have 21 a chance to talk to him tomorrow morning. 22 things he said -- he actually said two things. 23 to see if you share his views on these matters. 24 25 One of the I want He said, I believe, in hindsight, the lack of adequate regulation of the origination or mortgages 244 1 created a situation where the demand side, the pull 2 side of that equation, found a place where more raw 3 material could be created and could be created safely. 4 So there was more and more and more of 5 these subprime mortgages created as raw material -- 6 raw material for the securitization process. 7 surprisingly, in hindsight, more and more of it was 8 lower and lower in quality. 9 Not And at the end of that process the raw 10 material going into it was actually bad quality, it 11 was toxic quality, and that is what ended up coming 12 out of the other end of the pipeline. 13 obviously participated in that flow of activity. 14 Wall Street The second thing he said is, I found out at 15 the end of my tenure -- this is about the warehouse 16 lines -- so he said he found out that they had been 17 extended is how I interpret this. 18 before, so it's 11 billion dollars of warehouse loans. 19 I think that getting that close to the origination 20 function, being that involved in the origination of 21 some of these products, is something that I wasn't 22 comfortable with. 23 I did not know it On reflection, do you share his view about 24 the toxicity of products flowing into the system and 25 do you share his view that it was a business mistake 245 1 to be that close to originators, to mix the business 2 lines between what you did, as a kind of a third-party 3 buyer, and the sellers of those loans, the originators 4 and sellers? 5 MS. MILLS: I'm not sure what Mr. Prince 6 was referring to when he talked about the types of 7 loans that he referenced. 8 9 I don't think it was a mistake for us to lend money to originators. I think it was a way to 10 facilitate the business that we were in, and that is 11 to create mortgage-backed securities to be sold to 12 sophisticated institutional investors. 13 We specifically were not that close to the 14 origination side of the business, because we bought 15 loans that closed in other entities' names; we never 16 sent money directly to an originator; we set up our 17 warehouse lines so that there were mechanisms where we 18 could never be deemed to be the originator. 19 So we really were in a different -- 20 different position than an originator of loans, 21 themselves. 22 bought and what we were willing to finance. 23 And we had complete control over what we Our warehouse lines had restrictions as to 24 the types of loans that we would finance. We would 25 not finance every type of loan that originated, would 246 1 originate. 2 We had limits as far as types of loans, 3 geographics, LTVs, seasoning of the loans, how long 4 the loan could stay on the line. 5 wasn't a blank check to an originator that we would 6 just finance anything that they originated. 7 CHAIRMAN ANGELIDES: 8 VICE CHAIRMAN THOMAS: 9 CHAIRMAN ANGELIDES: Let me -- John would like one Okay. John, do you want to ask one more. 12 13 All right. more? 10 11 It wasn't -- it COMMISSIONER THOMPSON: I'll let you finish. 14 CHAIRMAN ANGELIDES: Yeah, okay, it will be 15 hopefully surgical here, but this is an important 16 point. 17 may return to ask all of you this question. 18 And after Mr. Thompson asks his question, I I want to go to the responsibility of a 19 market maker. You know, everyone here at some level 20 has their business model. 21 they're securitizing. 22 others have said, you're not alone in this; look, 23 we're market makers; whatever people wanted to sell 24 us, whatever people want to buy, we'll be market 25 makers. They're originating; And you've said today, and 247 1 What's the responsibility of a market maker 2 to ensure that the product that they are moving into 3 the marketplace is a good and sound product? 4 words, to undertake the reasonable level of due 5 diligence that you would feel absolutely comfortable 6 warranting that this is the kind of product you want 7 to move, akin to a manufacturer who makes a technology 8 product or a, you know, a toy manufacturer 9 understanding whether or not that toy manufacturer, In other 10 perhaps in another country, had lead in it, what's the 11 responsibility of market makers in the financial 12 system essentially to warrant the products they're 13 moving? 14 15 MS. MILLS: To -- what was the last part of what you said? 16 CHAIRMAN ANGELIDES: To warrant, to stand 17 behind the quality of the products they're moving 18 through the system and just -- you know, it's a large 19 question, to the extent that everyone's saying, I'm 20 just passing this along, where is the responsibility 21 along the chain for ensuring the quality of the 22 products that are moved into the system? 23 understand that, can I ask you a question, just so I'm 24 clear? 25 standards? Because I You did not have your own underwriting 248 1 MS. MILLS: Correct. 2 CHAIRMAN ANGELIDES: 3 underwriting of others; correct? 4 MS. MILLS: You relied on the Correct. We believed that we 5 conducted the appropriate diligence so that when we 6 created offering documents, prospectuses, which is the 7 document that you deliver to investors, that we had 8 high confidence that what we were telling investors 9 about the loans was accurate. 10 There were pages and pages of 11 stratifications with information about the loans. 12 There were pages of risk factors where we told 13 investors every possible scenario that could describe 14 something that would go wrong with these securities. 15 There were pages that described the origination 16 guidelines of whoever the originator was for that 17 particular pool. 18 agencies on these bonds. There were ratings from rating 19 And our job, as an underwriter, is to, you 20 know, comply with securities laws and, you know, this 21 business is regulated by the SEC. 22 amounts of outside counsel to make sure that Citi, as 23 a firm and as an underwriter, was -- was protected, 24 and that we were also telling investors what they 25 needed to know. We used extensive And it's the investor's decision to 249 1 buy the bond. 2 CHAIRMAN ANGELIDES: All right. Well, you 3 did have different standards for the loans you were 4 buying to hold; correct? 5 standards. 6 securitization, you just accepted whatever was given 7 to you subject to your verification that it met those 8 other folks' standards; correct? 9 MS. MILLS: 10 Ostensibly different In other words, in the business of I believe so, yes. CHAIRMAN ANGELIDES: Okay. And then on the 11 other side of the business where Citi was originating 12 to hold, they had a higher standard, is my 13 understanding. 14 MS. MILLS: 15 their standards were. 16 17 18 19 20 I'm not that familiar with what CHAIRMAN ANGELIDES: Are you familiar with the differential standards, Mr. Bowen? MR. BOWEN: I was not involved in the origination channels, Mr. Chairman. CHAIRMAN ANGELIDES: Do you agree with 21 Ms. Mills' characterization of the responsibility of 22 the market makers? 23 24 25 MR. BOWEN: I -- I can't express an opinion on that, sir. VICE CHAIRMAN THOMAS: Last question? 250 1 2 CHAIRMAN ANGELIDES: question here. 3 All right, last Yes, Mr. Thomas, do you have a -- EXAMINATION BY VICE CHAIRMAN THOMAS 4 VICE CHAIRMAN THOMAS: The phrase market 5 maker, I guess, in your analogy, which I would like to 6 follow through on, that you have people who make 7 products. 8 had to make sure that the product wasn't toxic, or if 9 you sell a baby blanket, you're supposed to make sure 10 11 And you were talking about what motive they that it doesn't burn easily. The problem is you have a whole tort system 12 to back you up on that, and you do it, and there are 13 actionable -- plus you got other folks looking at it. 14 Ms. Lindsay, you started off your testimony indicating 15 that it was really the responsibility of the people 16 who were buying the product to understand. 17 I mean, the good old-fashioned caveat 18 emptor, you know, we're putting it out there, but it 19 doesn't have anything to do with us. 20 direction that apparently almost everything was going, 21 Ms. Mills, I was hearing a little bit of that out of 22 you as well. 23 If it goes the Commissioner Georgiou said maybe if you had 24 some skin in the game. Do you think if you were 25 actually on the line -- well, obviously you wound up 251 1 with a lot of losses -- in terms of each and every 2 product you put out there, it would have been sobering 3 in terms of decision making, or there was just so much 4 to make that, you know, 20,000 out of 2 million isn't 5 that big of a number so keep shoving product, which 6 was one of the things we heard? 7 MS. LINDSAY: Yeah, I think that if you 8 have skin in the game, obviously you're going to 9 protect it more. 10 I think it got so overwhelming, at the end, 11 to try to get product to the -- to sale that the 12 product did go downhill. 13 skin in the game is very important. 14 15 But, yeah, the having the VICE CHAIRMAN THOMAS: Yeah, and everyone uses skin in the game as a euphemism. 16 MS. LINDSAY: Right. 17 VICE CHAIRMAN THOMAS: I'm beginning to 18 think more and more if it wasn't a euphemism, it would 19 be even better. 20 21 22 23 EXAMINATION BY CHAIRMAN ANGELIDES CHAIRMAN ANGELIDES: Just to very quickly, then wrap up. Mr. Bowen, I did have one question for you. 24 You, when you referred to the Wall Street bulk 25 purchases, was that Ms. Mills' shop? 252 1 MR. BOWEN: No. 2 CHAIRMAN ANGELIDES: 3 So when you're talking about the exceptions It was not? Okay. 4 and the overrides, that doesn't refer to Ms. Mills' 5 shop? 6 MR. BOWEN: No, sir. 7 CHAIRMAN ANGELIDES: Okay, thank you. My 8 final question, Ms. Mills, is for you, and that is, 9 from what we've learned, you began to slow down. 10 You're privileged, you're lucky that you're getting 11 the questions. 12 No, you, it looked like, from what we see, 13 is you began to slow down because of the risks you saw 14 in the market. 15 I actually have two questions: One is I'm 16 looking at a March 28th, 2007, non-agency strategy 17 memo. 18 it was not yours? I don't know if this was yours and I don't -- 19 Okay. Because -- would you know whose it was, 20 just because it speaks about even as late as March 28, 21 2007, it talks about gaining additional access to 22 mortgage origination, both flow and bulk, to enable 23 Citi to grow its whole loan purchase business. 24 know from whence this would have emanated and where it 25 ended up? Do you 253 1 MS. MILLS: I believe that that 2 presentation was put together by the business 3 management unit of global securitized markets. 4 5 CHAIRMAN ANGELIDES: above you or -- 6 7 MS. MILLS: Business management is sort of -- 8 CHAIRMAN ANGELIDES: 9 MS. MILLS: 10 11 Which would have been All right. They manage the business. CHAIRMAN ANGELIDES: But it was not your document? 12 MS. MILLS: No. 13 CHAIRMAN ANGELIDES: Okay. So I'll put 14 that aside, and we'll find out whose document it is, 15 and we'll ask them about that document. 16 But I do understand that you slowed down 17 your purchases, but at the same time, and they'll be 18 here later today, the collateralized debt obligation 19 desk in the investment bank was ramping up. 20 raising its limits from about 30 billion dollars to 35 21 billion dollars, and this was a unit that ultimately 22 had, I think, about 30 billion dollars in write-downs. It was 23 Was there any communication between you, 24 directly, as someone who's buying, seeing things in 25 the markets and securitizing, and the folks on the 254 1 other desk, who are ramping up, buying their 2 residence, you know, their mortgage-backed 3 collateralized debt obligations, in the sense they 4 need to ramp up their profile, their risk profile, at 5 the same time you're pulling down? 6 MS. MILLS: 7 CHAIRMAN ANGELIDES: 8 EXAMINATION BY COMMISSIONER THOMPSON 10 COMMISSIONER THOMPSON: So, Ms. Mills, pardon me for my preoccupation with league tables. 12 13 All right, thank you. Mr. Thompson? 9 11 No. So if they didn't matter, why buy Argent? And were you involved in that transaction at all? 14 MS. MILLS: I was involved in the diligence 15 that went on for the Argent platform because they were 16 a client of ours that I had done business with over 17 the years. 18 Wall Street firms were buying originators, and 19 their -- we didn't -- we didn't think that the end was 20 there. 21 think that it was the end of subprime. We didn't think that it was over. 22 23 24 25 At that time in the market, a lot of other COMMISSIONER THOMPSON: We didn't So league tables did matter? MS. MILLS: league tables. This -- this is not about This is about having access -- 255 1 2 COMMISSIONER THOMPSON: Market share did matter? 3 MS. MILLS: This is -- I didn't say that. 4 This is about having access to originations so that we 5 could supply bonds to our fixed-income investors. 6 And so with all of the other originators, 7 independent originators in the market being bought by 8 other Wall Street firms, for our business and our 9 business of creating mortgage-backed securities, we 10 were concerned about having access to supply of 11 mortgages, and so Argent was a platform that was 12 available, and it was someone that we knew, and it was 13 a very long, you know, months and months of diligence 14 process. 15 And in that time, call it the summer of 16 2007, the subprime market and securitization 17 essentially dried up, was our view. 18 thought of it as akin to a fall of `98 sort of 19 situation, where the capital markets sort of froze for 20 a couple of months, but then they became unfrozen. 21 I think we And Argent had essentially stopped 22 originating loans, because our purchase was pending, 23 and our thought was, until subprime came back, we 24 would use the platform, which was just an origination 25 platform that didn't have any loans in it, and we 256 1 would originate agency-eligible loans and FHA-type 2 loans until subprime came back. 3 And because it was our platform, we could 4 control the types of loans that were originated. 5 we all know how that worked out. 6 COMMISSIONER THOMPSON: 7 MS. MILLS: 8 VICE CHAIRMAN THOMAS: And Okay, thank you. Sure. On that -- on that 9 question, at some point somebody decided it would be 10 better to have them in-house than the business model 11 you were following. 12 MS. MILLS: 13 VICE CHAIRMAN THOMAS: 14 MS. MILLS: 15 To buy the platform? Yeah. In the context that there weren't that many independent originators left. 16 VICE CHAIRMAN THOMAS: And it was easier 17 not to do that because you didn't have that, another 18 silo, to attach to Citibank? 19 decision came from? 20 discussed moving in that direction? Do you know where that Where were the groups that 21 MS. MILLS: 22 VICE CHAIRMAN THOMAS: 23 24 25 Moving in the direction of? Of purchasing Argent? MS. MILLS: I know that I discussed it with -- with my management. And I know that there 257 1 were -- I was involved in some discussions with the 2 two gentlemen or the one -- one of the two gentlemen 3 who ran fixed income. 4 in any direct discussions. After that, I was not involved 5 VICE CHAIRMAN THOMAS: 6 you were, rightfully so, kind of one of the 7 originators of the idea? 8 MS. MILLS: 9 VICE CHAIRMAN THOMAS: 10 No. No? Do you know where it was originated? 11 MS. MILLS: 12 VICE CHAIRMAN THOMAS: 13 Would you say that No. Okay. Consistent. Thanks. 14 CHAIRMAN ANGELIDES: All right. Members, 15 we are close to on time, considering our lights-out 16 problem earlier in the day. 17 I want to thank all of you for the time 18 you've given us and for your answers to our questions; 19 appreciate it very, very much. 20 We are going to take a ten-minute break, 21 ladies and gentlemen, and we'll be back here in ten 22 minutes. Thank you very, very much. 23 (Session ended at 2:56 p.m.) 24 CHAIRMAN ANGELIDES: 25 The meeting of the Financial Crisis Inquiry Commission will come back 258 1 into order. 2 We are now in our final session of the day. 3 We will be hearing from our panelists in our third 4 session, which is called Citigroup CDOs, 5 collateralized debt obligations, and Risk Management. 6 Let me ask each of you or all of you if you 7 would please stand to be sworn in and, again, let me 8 say, as I say to everyone, this is a customary 9 swearing in, that we have done for all witnesses and 10 will in the future. 11 Do you solemnly swear or affirm, under the 12 penalty of perjury, that the testimony you are about 13 to provide the Commission will be the truth, the whole 14 truth and nothing but the truth, to the best of your 15 knowledge? 16 MR. BARNES: Yes, I do. 17 MR. BUSHNELL: 18 MR. DOMINGUEZ: 19 MR. MAHERAS: 20 CHAIRMAN ANGELIDES: 21 VICE CHAIRMAN THOMAS: I do. I do. Yes, I do. Thank you very much. Mr. Chairman, prior 22 to your moving forward, can I ask all of you, would 23 you be more than willing to respond in writing to 24 questions sent to you, in writing, as we move forward 25 in this investigation? 259 1 2 Each one of you need to say yes to the microphone. 3 MR. BUSHNELL: 4 MR. MAHERAS: 5 MR. DOMINGUEZ: 6 MR. BARNES: 7 VICE CHAIRMAN THOMAS: 8 9 Yes. Yes. Yes. Yes. Thank you very much. Thank you, Mr. Chairman. CHAIRMAN ANGELIDES: Thank you. So, 10 gentlemen, thank you very much. 11 written testimony, and we're going to ask each of you 12 to provide up to five minutes, you can be briefer if 13 you choose, but no more than five minutes of oral 14 testimony to commence this session. 15 You've all submitted We're going to start with you, 16 Mr. Dominguez and move across the table, from my 17 vantage point left to right. 18 when you first introduce yourselves, while we know who 19 you are, for the folks watching, if you could just 20 also briefly describe your position in the 21 institution, it would be very helpful. And I would appreciate 22 So, Mr. Dominguez, if you would start off? 23 And, by the way, at one minute, you'll see the little 24 timer in front of you, the light. 25 from green to yellow and then to red when the five The light will go 260 1 minutes is up, all right? 2 Mr. Dominguez. 3 MR. DOMINGUEZ: Thank you very much, Chairman Angelides, Vice 4 Chairman Thomas, and members of the Commission, thank 5 you very much for inviting me to appear before you. 6 My name is Nestor Dominguez. I hope that 7 my experience with Citigroup can shed light, with the 8 benefit of hindsight, on the important issues before 9 the Commission. 10 I understand that the Commission is 11 interested in Citi's business activities with respect 12 to collateralized debt obligations or CDOs. 13 I was involved in Citi's CDO activities 14 from 1999 until I left Citi on November 1st of 2007. 15 From 2006 to 2007, I served as co-head of Citi's 16 global CDO business that focused on cash CDOs. 17 I was responsible for overseeing the 18 structuring, distribution, and trading units of that 19 business. 20 Citi's CDO business was performing an important 21 function in the capital markets in creating 22 securitized products to meet investor demand for 23 exposures to specific asset classes and to specific 24 cash flow profiles. 25 I believe then and still believe now that Citi completed many successful and 261 1 productive transactions in numerous asset classes 2 during a time of dramatic global expansion of the CDO 3 industry as a whole. 4 Citi expanded its involvement in the 5 structuring of ABS CDOs from 2001 to 2007. 6 number of years, up to the fall of 2007, Citi rose to 7 become one of the leading global originators and 8 traders of all types of CDOs, including those backed 9 by RMBS securities, corporate credits, and several 10 Over a other categories of collateral. 11 The cash CDO business that I co-headed 12 generated approximately 400 million in total annual 13 revenues in 2005 and in 2006. 14 one-time structuring fees of between one half a 15 percent to 2 percent of the assets in each CDO deal we 16 structured and from secondary trading and warehousing 17 activities. 18 This revenue came from Our CDO business model called for 19 distributing all the securities that resulted from our 20 CDO structuring activities except the most senior 21 tranches of specific transactions that were structured 22 to be held on Citi's balance sheet. 23 These retained positions were referred to 24 in the market as super senior because they -- because 25 they were structurally senior in the cash flow 262 1 waterfall to tranches that themselves had virtually 2 zero expected loss based on analytical modeling. 3 This tranche, this other tranche was 4 subordinate to the super senior tranche, was rated 5 Triple-A by the rating agencies. 6 The view that super senior tranches carried 7 virtually no risk was widely held at Citi, based on, 8 among other things, the level of structural 9 subordination beneath these retained securities and 10 11 our modeling and stress analysis. We, at Citi, believed that the retained 12 super senior tranches were an efficient use of capital 13 and Citi's balance sheet with an extremely remote risk 14 of impairment of interest or principal repayment. 15 Citi retained certain super senior tranches 16 in two forms. 17 liquidity puts. 18 between 2003 and 2006, the senior-most level of the 19 capital structure was funded by the issuance of 20 short-term asset-backed commercial paper, which at 21 that time was a large and deep market with a long 22 history of stability during previous times of stress. 23 First, in a product referred to as For certain cash CDO transactions, To facilitate the issuance of this 24 commercial paper, Citi issued a renewable 364-day 25 liquidity facility to the CDO as a backstop source of 263 1 funding in case of either a significant widening in 2 credit spread or a temporary inability to issue 3 commercial paper. 4 Second, Citi also retained portions from 5 both cash and synthetic form of super senior notes of 6 certain CDOs issued in 2006 and 2007 by both the CDO 7 desk based in New York and as a result of synthetic 8 CDO structuring activities in London. 9 In both super senior programs, the risk of 10 loss on the retained super senior exposure and the 11 liquidity puts was examined extensively, and based on 12 those stress tests and models, the likelihood of 13 losses was considered extremely remote. 14 Ultimately, Citi recognized significant 15 mark-to-market losses on its CDO exposures. 16 losses occurred as a result of cataclysmic and 17 unprecedented market events: 18 and mortgage defaults not seen since the Great 19 Depression, and anticipated by virtually no one, 20 including those of us who dedicated ourselves to 21 building a business we believed was good for our 22 clients and for the shareholders of our company. 23 These Housing price declined I hope I can be of some help to the 24 Commission in putting into perspective the nature of 25 Citi's CDO business. I look forward to answering your 264 1 questions. 2 3 CHAIRMAN ANGELIDES: Thank you. 4 Impeccable timing. Mr. Barnes? MR. BARNES: Chairman Angelides, Vice 5 Chairman Thomas, and members of the Commission, thank 6 you for the opportunity to appear today. 7 My name is Murray Barnes and I served as a 8 managing director in the independent market risk 9 management group of Citi's investment bank with the 10 responsibility for overseeing Citi's global credit 11 markets trading businesses from 2005 until early this 12 year. 13 The Commission has asked me to address risk 14 management issues related to CDOs backed primarily by 15 subprime RMBS, including the setting of risk limits 16 for these products and valuation and pricing issues. 17 Generally speaking, the role of independent 18 market risk is to work with the business to limit and 19 manage market risks that trading businesses are 20 exposed to in a manner that is consistent with the 21 company's risk appetite. 22 In my role, I reported directly to the head 23 of market risk management for the investment bank who, 24 in turn, reported directly and exclusively to Citi's 25 chief risk officer. 265 1 This reporting line was fully independent 2 of the business. This meant that, among other things, 3 compensation for independent risk managers was not 4 determined by the business, nor was it tied to the 5 performance of the businesses that we covered. 6 One of the primary risk management tools 7 that we employed with respect to CDO activities and 8 all other trading functions involved the setting of 9 risk limits. 10 Market risks set risk limits on overall 11 trading activity. 12 there were several applicable limits, including limits 13 that applied to assets the desk warehoused for future 14 securitizations and limits that applied to any 15 positions the desk retained from past securitizations, 16 including the super seniors. 17 In the case of the CDO business, Market risk independently monitored 18 compliance of risk limits and reviewed risk limits in 19 light of market developments. 20 During my tenure, market risk assessed 21 potential exposures in a variety of ways, including 22 through the use of stress tests, which employed 23 assumptions using historical data to stress for 24 potential loss. 25 Stress tests were performed at the division 266 1 level, desk level, and for individual market factors 2 in an effort to dimension risk in as many ways as 3 possible. 4 engaged in a dialogue with the business concerning the 5 proper stress levels to employ, although the levels 6 ultimately applied were the responsibility of market 7 risk management. 8 9 As part of this process, we routinely In accordance -- in accordance with Citigroup's pricing policies, responsibility for 10 marketing trading positions resided with each 11 business, including the CDO desk. 12 Prior to the market events in late 2007, 13 Citigroup relied on using comparable analysis to value 14 its CDO super senior exposures. 15 comparing the spreads on similarly Triple-A-rated 16 first-pay tranches that it recently priced. 17 resulted in such exposures generally being carried at 18 par through June 30th, 2007. 19 It did this by This These marks reflected the widely held 20 belief, both within the company and throughout the 21 market, that the super senior positions bore almost no 22 risk of loss. 23 As the unprecedented market events unfolded 24 in 2007 and new issuances of CDOs froze, the business 25 developed a model to price its super senior positions 267 1 based in part on an intrinsic cash flow methodology of 2 the CDOs underlying RMBS collateral. 3 I understand, with the benefit of 4 hindsight, why one might conclude that Citi's 5 independent market risk management function failed to 6 set appropriate limits on the CDO business. 7 The issues, however, are significantly more 8 complex. 9 super senior positions posed only an extremely remote 10 risk of loss prior to the events of 2007, it is still 11 difficult to imagine how the severity of the decline 12 in house prices and its effect on the CDO market could 13 have been predicted, let alone modeled. 14 Indeed, given the widely held view that Throughout the challenging market 15 conditions of late 2007 and beyond I believe that 16 Citi's independent risk management function was fully 17 engaged for the business and had access to and 18 utilized the risk management tools that were then 19 available. 20 Our downside risk assessments included what 21 we then understood to be extreme loss scenarios, and 22 market risk set limits for the business on the basis 23 of that analysis. 24 25 With the benefit of hindsight, we realize that certain stressful assumptions were not adequate. 268 1 Ultimately, I believe that the rapid growth of complex 2 structured credit products presented unique challenges 3 that in some respects outpaced the market's ability to 4 develop the necessary tools to fully evaluate the 5 risks of those products. 6 The impact of this increasing complexity 7 was exacerbated by the commonly held belief that house 8 prices could not fall by anything like the 30 9 percent-plus decline that we have seen. 10 I appreciate the difficulty of the task 11 facing this Commission and look forward to answering 12 your questions. 13 14 CHAIRMAN ANGELIDES: impeccable timing. 15 Another piece of Thank you very much. MR. MAHERAS: Mr. Maheras? Tough act to follow. 16 Chairman Angelides, Vice Chairman Thomas, and members 17 of the Commission, I also thank you for the 18 opportunity to appear here today. 19 My name is Tom Maheras and I served as 20 Citi's co-head of the investment bank from January 21 2007 until I left the bank in the early part of 22 October 2007. 23 Let me begin by placing Citi's CDO business 24 in context. When I was co-head of the investment 25 bank, we provided a very broad range of products and 269 1 services in more than 80 countries around the globe, 2 and we employed more than 40,000 people. 3 The CDO business was at all times a very 4 small part of the investment bank's overall business. 5 To give you some perspective, in the fiscal year 2006, 6 the investment bank had a balance sheet of about or a 7 little over 1.3 trillion dollars and revenue -- and 8 revenues in excess of over 27 billion dollars. 9 The entire CDO business in that year, its 10 best year ever, comprised 1 and change to under 11 2 percent of those revenues. 12 I believe that the business was 13 appropriately supervised by experienced and highly 14 competent managers and by an independent risk group 15 and that I was properly apprised of the general nature 16 of our work in this area and its attendant risks. 17 I also strongly believe that our board of 18 directors and our most senior management were provided 19 with the appropriate information and guidance about 20 Citi's investment banking business activities. 21 When issues arose in early 2007 regarding 22 the more junior CDO tranches we held and when issues 23 regarding our safest super senior CDO holdings arose 24 later that year, senior management and the board took 25 reasonable steps to evaluate and address the 270 1 unprecedent- -- unprecedented events that rapidly 2 unfolded. 3 How then did our investment bank end up 4 incurring such large losses on its CDO positions? 5 What went wrong? 6 The losses that Citi incurred that related 7 to the CDO business principally arose from the 8 extremely high-rated CDO tranches, the so-called super 9 seniors that everyone at the bank and most in the 10 industry believed were among the safest instruments in 11 the capital markets. 12 These super seniors were rated above 13 Triple-A. 14 same structures that were rated Triple-A, which meant 15 that their chances of default were deemed to be 16 extremely low. 17 They were senior to those securities in the It is difficult now to put ourselves back 18 to the time before the financial crisis. But it is 19 important to understand the following critical point: 20 Citi's losses from its CDO business did not result 21 from its fixed-income group placing high risk bets in 22 its proprietary trading business on esoteric 23 cutting-edge trades in a reach for outsized profits. 24 To the contrary, our primary CDO losses stemmed from 25 client-driven activities resulting in the holding by 271 1 Citi of very low-interest yielding, very low-interest 2 yielding, and what were understood to have been super 3 safe securities that later unexpectedly depreciated in 4 value. 5 My focus on the CDO business increased when 6 we began to see deterioration in the subprime market 7 and related financial fallout in early 2007. 8 when the lower-rated, the lower-rated CDO securities 9 started to decline in value, when we took significant This is 10 steps to reduce our exposure to these riskier CDO 11 positions. 12 But even in the summer and fall of 2007, I 13 continued to believe, based on what I understood and 14 had gathered from the experts in the business, that 15 the bank's super senior CDO holdings were safe. 16 was only later in the fall of `07 that the banks 17 started to see mark-to-market losses on these 18 positions. It 19 And it was only after I left the bank and, 20 thereafter, when the rating agencies downgraded these 21 securities in a sweeping and unprecedented series of 22 moves that these positions were significantly marked 23 down. 24 25 What could have been done to prevent these losses? I have asked myself this question so many 272 1 times. 2 eventually imposed on the company shareholders, I 3 understand that it would be somehow more reassuring to 4 concluded that we made an ill-conceived trading bet or 5 that we invested in a business that was overly risky 6 or even that we lacked proper controls, but I do not 7 believe any of these to be the case, any of those to 8 be the case. 9 Given the extraordinary losses that were Knowing what we knew at the time and 10 looking back on this part of our business, I cannot 11 fault the fact that the business and most everyone in 12 the industry, including our own regulators, regarded 13 these super senior CDO securities to be extremely 14 safe. 15 What I can tell you with the benefit of 16 hindsight is that we, like many other experienced 17 members of the industry, failed to recognize that 18 there was a real possibility of the kind of 19 catastrophic residential real estate crash that our 20 country has experienced over the past several years. 21 We were certainly not alone in failing to 22 predict that real estate prices would plunge 30 to 40 23 percent, with homeowners walking away from their homes 24 en masse for the first time ever. 25 I regret that I and my colleagues did not 273 1 see that coming, but we did not. 2 Going forward, we must recognize the 3 ever-present vulnerability of our financial system to 4 serious and unanticipated widespread shocks and 5 continue to evolve risk measurement and risk 6 management practices accordingly. 7 8 I thank you and would be pleased to answer the questions you might have. 9 10 CHAIRMAN ANGELIDES: Mr. Bushnell? 11 12 Thank you very much. MR. BUSHNELL: Chairman Angelides, Vice Chair -- 13 CHAIRMAN ANGELIDES: 14 MR. BUSHNELL: Sorry. Microphone, please. Chairman Angelides, 15 Vice Chairman Thomas, and members of the Commission, I 16 am pleased to participate in today's hearing and to 17 assist in your important and challenging inquiry. 18 My name is David Bushnell and I was the 19 chief risk officer of Citigroup from 2003 to 2007 and 20 the chief administrative officer of Citigroup in the 21 latter part of 2007. 22 I've submitted a longer statement for the 23 record, and I would like to begin my testimony today 24 by addressing what is, in my view, the single-most 25 contributing factor to Citi's significant write-downs 274 1 and losses. 2 As you know, beginning in 2007, an 3 unprecedented collapse in the United States' 4 residential real estate market was the primary 5 instigator of a global crisis in the world's financial 6 system. 7 was severely impacted by this sudden downturn. 8 9 As with many other market participants, Citi In particular, Citi suffered massive unanticipated losses in connection with its 10 approximately 43-billion-dollar position in a specific 11 asset class exposed to the subprime residential real 12 estate. 13 These were the so-called super senior 14 tranches of collateralized debt obligations. 15 fourth quarter of 2007 alone, Citi took a 16 14.3-billion-dollar write-down on this single asset 17 class. 18 In the These super senior CDO tranches have come 19 under tremendous scrutiny, and rightfully so. 20 understand their contribution to Citi losses however, 21 it is important to understand how these investments 22 were perceived at the time. 23 To First, in 2007 this 43-billion-dollar 24 position represented less than 2 percent of Citi's 25 2.3-trillion-dollar balance sheet. 275 1 Second, prior to late 2007, these 2 securities were rated above Triple-A, an extremely 3 high credit rating. 4 Citi and the rest of the market shared the 5 view that super seniors were safe and presented an 6 extremely low risk of default or depreciation in 7 value. 8 9 Thirdly, the views of the credit rating agencies were reinforced, in part, by risk models 10 employed by Citi. 11 most other financial institutions, tested for what 12 were believed to be extreme-loss scenarios for 13 residential real estate. 14 These risk models, like those of We now know that even the most pessimistic 15 assumptions in these models did not foresee the 16 severity of the downturn. 17 As the chief risk officer during this 18 relevant period, I've given a great deal of thought to 19 the lessons to be learned from these events. 20 First, the write-downs associated with 21 CD -- with our CDO positions far exceeded anything 22 predicted in our stress tests and were materially 23 greater than was anticipated using a statistical 24 approach. 25 Second, the complexity and sophistication 276 1 of these structured products obscured the importance 2 of understanding the risk characteristics of the 3 ultimate underlying collateral, that is, residential 4 mortgages. 5 Third, at the most sophisticated level, 6 none of us fully appreciated the consequences of such 7 a collapse would have for even the senior most 8 tranches of these structured products. 9 In short, we did not anticipate these 10 extraordinary developments or comprehend their 11 interactions. 12 mistaken business judgment to retain the super senior 13 tranches of CDOs. We made a rational but, in retrospect, 14 As chief risk officer, I was responsible 15 for communicating risk and compliance issues to the 16 executive management, to the board of directors, and 17 to external regulators. 18 on an ad hoc basis with the CEO, Chuck Prince, and had 19 a regular, weekly one-on-one meeting with him. 20 I communicated almost daily I was also a member of Citi's business 21 group heads. This group met weekly and included all 22 of Citi's senior-most executives from the firm's 23 business and administrative and control functions. 24 provided regular risk reports to the full board of 25 directors and participated in its audit and risk I 277 1 management committee and subcommittee meetings. 2 Citi's independent risk organization was 3 organized across business lines with a geographic 4 overlay. 5 a chain of increasingly senior risk managers in order 6 to assure their independence. 7 risk organization of approximately 2,700 8 highly-qualified risk professionals. 9 All of these reported up through me through In all, I oversaw a Citi's risk discipline framework included 10 risk policies, limits, the value at risk and stress 11 testing for what we then considered extreme-loss 12 scenarios. 13 All of these procedures were well known to 14 our regulators and were conducted in accordance with 15 the then-global capital regulatory standards. 16 All extensions of credit required the 17 approval of risk management. 18 disagreement between our risk group and the business 19 as to an appropriate limit, independent risk had the 20 final say. 21 If there was a I would like to conclude by noting that 22 Citi's risk managers were dedicated well-trained 23 professionals with the independence, authority, tools, 24 and technology to deliver best in class risk 25 oversight. That does not change the fact that in this 278 1 case, our method of analysis was not good enough. 2 I hope that my participation in this 3 hearing will help contribute in some small way to the 4 important work of the Commission to better protect the 5 financial system in the future. 6 to answer questions that you have. 7 CHAIRMAN ANGELIDES: And I will be happy Thank you very much, 8 Mr. Bushnell. We will now go to -- I will do what I 9 did in the last session, members, which is reserve my 10 questionings till the end. 11 Chairman. 12 We'll start with the Vice VICE CHAIRMAN THOMAS: Thank you, 13 Mr. Chairman. 14 reserve time, as we did previously. 15 16 I'll ask some questions and in the end, EXAMINATION BY VICE CHAIRMAN THOMAS VICE CHAIRMAN THOMAS: Mr. Bushnell, I 17 didn't come back out of retirement to sit back on a 18 thing I've done for 28 years to try to protect the 19 financial system. 20 A consequence of what we try to do in our 21 job of trying to explain to Americans what happened, I 22 can assure you, probably won't contain one word of 23 what you folks just told us. 24 Did any of you, and I'll just ask a show of 25 hands, and I assume you'll be honest in your response, 279 1 lose one night of sleep over what happened? 2 hands. 3 you. No You didn't lose one -- oh, no, I didn't prompt I said, did you lose one night of sleep? 4 MR. MAHERAS: 5 VICE CHAIRMAN THOMAS: 6 supposed to be yes. 7 hand. I lost a lot of sleep. The answer is You're supposed to raise your Once you got it, you raised your hand. 8 You lost a lot of sleep? 9 MR. MAHERAS: 10 No? Yes. VICE CHAIRMAN THOMAS: Well, for someone 11 who earned as much money as the most highly-paid 12 player on the New York Yankees -- at least he can show 13 a World Series win for what he got. 14 And if they do various things that are 15 against the rules, they got to pay fines and do other 16 stuff. 17 I'm not going to dwell on the money. I 18 can't comprehend it. 19 supervised by competent people or what happened 20 wouldn't have happened. 21 happened to everybody else, then no one is competent. 22 Obviously, you weren't And the argument is what The argument that none of you ever heard 23 the phrase, "what goes up must come down," you thought 24 somehow housing was unique? 25 other areas that never go down? Or are you familiar with Or why in the world 280 1 would you pay anybody for risk management in the area 2 of dealing with these securities when housing never 3 goes down? 4 I mean, you would think that's not an area 5 where you would invest money. 6 into the products that don't go down. 7 You would stick more I just have to tell you that I'm frankly 8 more concerned about you than some of the guys at the 9 top, because I'm always familiar about guys at the 10 top, and they make a lot of money, and I don't -- this 11 has nothing to do with you, Mr. Thompson, because I 12 now know you as a person. 13 You guys were at a level, paid handsomely. 14 And what I heard was we took somebody's word who rates 15 them and we pay them to get the rating but we took 16 their word for it. 17 model what happened. 18 It did. We had models, and nobody could So you didn't know what you were 19 doing or, yes, you did, you knew what you were doing 20 until you didn't. 21 know that you didn't know? 22 Mr. Dominguez at what point did you MR. DOMINGUEZ: We became concerned late -- 23 mid to late summer of 2007 as the markets froze, the 24 CDO markets froze. 25 VICE CHAIRMAN THOMAS: That was across the 281 1 board in terms of your company, or were some other 2 folks not getting it? 3 themselves in a way that they thought this was going 4 to continue, that their models were right, the rating 5 agencies were correct, or did you all pretty much 6 realize it about the same time throughout the silos of 7 your company? 8 9 Were they still conducting MR. DOMINGUEZ: Well, in August of 2007, we began -- we began extensive discussions about the 10 implications of the decline, the dramatic decline of 11 the underlying subprime markets, and how that would 12 feed into the super senior positions. 13 We had already seen it feed through into 14 the lower-rated tranches, you know, earlier that 15 summer and late that spring. 16 dialogue began -- began in earnest. 17 So that's when the VICE CHAIRMAN THOMAS: When no one wanted 18 to purchase is that, in a general sense, the 19 low-interest yielding super senior tranches, they were 20 low interest, why? 21 like treasury notes? 22 purchase something as secure as that? 23 24 25 Because they was as good as gold, How come no one wanted to MR. DOMINGUEZ: Well, the -- the -- there was several types of super seniors, by and large -VICE CHAIRMAN THOMAS: I'm trying to stay 282 1 above the details you want to go down. 2 point I'm more than willing to descend with you. 3 MR. DOMINGUEZ: To make a By and large we distributed 4 the most senior tranches on almost all our CDOs except 5 for a program liquidity puts which was specifically 6 intended to be held on balance sheets. 7 So, there was a market. It was -- it was 8 all institutional. 9 commercial paper conduits, with protections from the 10 11 mono-line. It traded between banks with So there was a market and by and large -VICE CHAIRMAN THOMAS: On the whole, did 12 you keep them because you thought they were really 13 good and you wanted to keep them, or that you couldn't 14 really move them or figure out a way to package them 15 to move them? 16 I mean, is there a -- MR. DOMINGUEZ: The -- the -- the only 17 program specifically designed to be kept on the 18 balance sheet was the liquidity put program. 19 VICE CHAIRMAN THOMAS: 20 MR. DOMINGUEZ: Mm-hmm. The rest of the super 21 seniors that we got caught with in the fall, late 22 summer, fall of 2007, was really as a result of the 23 freezing up of the markets. 24 25 And the market had been through -- I've been involved in the market since `99, as I mentioned. 283 1 The market had been through a number of very stressful 2 situations: 3 war, and spreads widen and narrow, participant's 4 capital comes in and -- and goes out of the markets. September -- September 11th, the Iraqi 5 So we've been through stressful times 6 before, and of course those -- those senior most 7 tranches are specifically designed to take a lot of 8 stress, and so people viewed them as very robust. 9 so we expected the market to come back. And But, of 10 course, what happened in -- in October and November is 11 the market -- the underlying market for RMBS, as 12 represented by the ABS Index, for example, declined 13 even more dramatically. 14 VICE CHAIRMAN THOMAS: Things go down, but 15 not according to somebody's model, not according to 16 somebody's rating agency, so it's someone else. 17 Mr. Maheras, you made a lot of money. Do 18 you believe now, looking back on that situation, that 19 you earned all of it? 20 21 22 MR. MAHERAS: I appreciate the topic of Wall Street compensation. It -- it is very -- VICE CHAIRMAN THOMAS: 23 of Wall Street compensation. 24 people in front of me. 25 I'm no longer in Congress. It's not the topic I've got a group of I'm looking at these numbers. I don't have a 284 1 constituency, but I moved back to my home. 2 And they've asked me questions, and I'm 3 basically conveying to you the questions they're 4 asking me. 5 Do you think you earned that money? 6 MR. MAHERAS: I was paid very handsomely. 7 I was paid in a manner consistent with the market at 8 the time. 9 VICE CHAIRMAN THOMAS: Kind of like the 10 rating agencies and the models, it wasn't associated 11 with what you did before or after; it was some model 12 that you put yourselves up against. 13 My question was a bit more personal than 14 that. 15 in terms of what happened? 16 Do you personally believe you earned that money MR. MAHERAS: Well, in -- in the year of 17 2007, when things came to pass that ended up costing 18 the firm, I didn't get paid any money. 19 20 VICE CHAIRMAN THOMAS: whatsoever, you worked for nothing? 21 MR. MAHERAS: 22 sorry, I did not get paid a bonus. 23 bonus. 24 No money, I'm sorry, I'm I got paid a zero In the prior years -VICE CHAIRMAN THOMAS: Well you got paid 285 1 something. 2 MR. MAHERAS: I was paid a salary that 3 year. 4 paid, it was at a time when Citigroup was paid, at a 5 time when Citigroup did very well, performed very well 6 economically, and my pay was part cash and nearly half 7 the shares of the company, which aligned our interest. 8 9 In the prior years, when I was very handsomely VICE CHAIRMAN THOMAS: your base salary? 10 MR. MAHERAS: 11 VICE CHAIRMAN THOMAS: 12 bonus. 13 14 15 16 Yes. MR. MAHERAS: I left in early October of `07. VICE CHAIRMAN THOMAS: Of `07? Did you get anything in `08? MR. MAHERAS: 18 VICE CHAIRMAN THOMAS: 20 You didn't get a In `08 -- when did you leave the company? 17 19 `07, you only got No. So you left when you, in fact, only had your salary? MR. MAHERAS: I left at a time when I had 21 only earned a salary to that point, and I was not 22 given a bonus for that year. 23 VICE CHAIRMAN THOMAS: And you had 24 remuneration that would continue to go on, it wasn't 25 just cash, that you got? 286 1 MR. MAHERAS: I had shares in the company, 2 granted in prior years, which had three or four years of 3 vesting requirement. 4 shares. 5 was at much, much lower levels. 6 7 So at the time when I received the stock, it VICE CHAIRMAN THOMAS: So you lost at least one night's sleep. 8 9 And it had -- it was a number of At any time during that night or however many nights it was, did you ever consider perhaps 10 voluntarily not taking the total package that you knew 11 you were walking away from based upon what was left of 12 the company that paid you handsomely? 13 them anything? 14 the decisions that you were responsible for? 15 Did you owe Did you owe somebody anything about MR. MAHERAS: Per the standards of the 16 compensation system, I would have happily played by 17 those rules if that was the way the packages worked, 18 sir, but, no, I didn't. 19 VICE CHAIRMAN THOMAS: Well, I'm talking 20 about an internal rule that would make you feel better 21 based upon what happened, not some company model, 22 because I know full well in terms of clawback, which 23 changed in `08, I'm aware of the changes that were 24 made. 25 don't know you. I'm just trying to talk to you as a person. I 287 1 MR. MAHERAS: Well, as I said before, I did 2 lose a lot of sleep. 3 fact that a company I cared a lot about and had worked 4 at for 23-plus years and many, many people I cared a 5 lot were going -- about a lot were going through a 6 very difficult period after I left the firm. 7 It wasn't -- it was about the The losses that have been well detailed 8 occurred well after I left the firm. 9 terrible that I was not there to be part of the 10 And I felt solution. 11 Had I -- had I known what was going to 12 come, I would never -- I would not have left the firm, 13 Mister -- 14 VICE CHAIRMAN THOMAS: 15 as part of the problem. 16 MR. MAHERAS: I was. But you were there I was there when 17 those securities were put on the balance sheet and I 18 was there -- 19 VICE CHAIRMAN THOMAS: And you didn't know 20 it then, of course, because you were relying on 21 ratings services and all the other things that let you 22 sleep at night. 23 MR. MAHERAS: 24 VICE CHAIRMAN THOMAS: 25 I barely -And so when you walked away, when you walked away, it hadn't fallen. 288 1 So if someone builds a building and it 2 didn't fall down when they walked away but it did 3 after they left, with more than two decades of 4 dedication to that structure? 5 obviously, I'll -- I'll better appreciate it as we go 6 along, and I've got a lot of specific questions, 7 Mr. Chairman, but at this point I'll reserve my time. 8 9 10 11 12 13 14 CHAIRMAN ANGELIDES: Mr. Vice Chairman. I don't -- I mean, All right. Thank you, Ms. Murren? COMMISSIONER MURREN: Thank you. EXAMINATION BY COMMISSIONER MURREN COMMISSIONER MURREN: I have maybe two observations and then some questions. Number one is Citigroup has a very large 15 and a number of extremely talented fundamental 16 analysts, both in the equity research department and 17 in fixed income. 18 were unable to determine the value of underlying 19 securities because you relied completely on a 20 financial model is somewhat disingenuous. 21 So the notion that the four of you The bottom line is there is fundamental 22 ability to determine whether assets are risky or not. 23 So I think that, you know, the notion that somehow 24 it's all about the model is a little bit disingenuous. 25 And then, to follow on to that, you know, 289 1 the other thing that's a little disingenuous is the 2 notion that you didn't get paid in 2007. 3 I mean, let's face it, those things that 4 were -- those decisions that were made in the earlier 5 years are ultimately what led to what happened, so to 6 some degree you do bear responsibility for that. 7 The line of questioning that I'd like to 8 pursue, though, is one that I'm very focused on, and 9 that is regulation, and then secondarily, 10 compensation, but not so much the amount of 11 compensation; to me that's almost secondary; it's 12 really how you got paid, which relates to the amount 13 of risk that you're willing to take and the way in 14 which you approach it; what are your timetables. 15 guess is they were annual. 16 My But, to begin with, I'm interested in each 17 of you commenting on your interactions with the 18 regulators. 19 number one, your understanding of risk-focused 20 regulation and what that meant to you personally in 21 managing your areas? 22 Could you please talk a little bit about, Mr. Maheras, if you could start? MR. MAHERAS: Sure. My interaction with 23 the regulators was most frequently with the OCC. 24 then, I would say, the Fed would follow that. 25 regulators, the frequency was much, much lower. And Other 290 1 And the interaction with the regulators was 2 around business conditions, business strategies, 3 planning, risk-management-type topics. 4 appropriately focused, consistent with the independent 5 risk management group of the firm and the management 6 of the firm; appropriately focused on ensuring 7 alignment of independent risk with business products; 8 they were particularly focused on these meetings, 9 particularly focused on new products; ensuring that They were 10 new products enjoyed internally an infrastructure, 11 systems technology, risk management, financial 12 accounting and all that was on par with or could keep 13 up with fast business growth, again, particular in the 14 new areas. 15 the regulators. 16 That's my recollection of interaction with COMMISSIONER MURREN: How often did you 17 interact with them, and to what extent was part of 18 your responsibility an awareness that the regulatory 19 division that supervised the investment bank also had 20 a responsibility to convey information to the Federal 21 Reserve that related to the safety and soundness of 22 the bank holding company? 23 How keenly did you think about that on a 24 regular basis, and to what extent was it factored into 25 your business decisions, either in terms of those 291 1 things you chose to approach, or when we get to the 2 next question, how did that factor into your 3 compensation? 4 MR. MAHERAS: I -- I can -- I can answer 5 part of that. 6 also, to members of the panel here who would have had 7 much more interaction with the regulators. 8 9 10 I -- I -- I would say that I can defer, The -- to my eyes, there was -- I'm sorry, can you repeat the first part of your question, Commissioner? 11 COMMISSIONER MURREN: If you look back at 12 your interactions with the regulators, to what extent 13 were you personally aware of the fact that your 14 division needed to represent information to the 15 holding company regulators that would affirm or not 16 the safety and soundness of the overall enterprise? 17 MR. MAHERAS: We were keenly aware of that 18 as a topic. 19 and soundness of the institution. 20 were built around ensuring that we met safety and 21 soundness standards and certainly rating standards as 22 well. 23 The framework was built around the safety Capital measures So we were keenly aware of that imperative. COMMISSIONER MURREN: And did you feel that 24 the regulators did an adequate job of supervising your 25 activities and evaluating the risks that you were 292 1 2 exposed to? MR. MAHERAS: Well, I think we in the 3 industry and the regulators, missed this particular 4 aspect of risk management. 5 negative on subprime, as a matter. 6 very earliest part of `07 and the end of `06, we were, 7 in most of our business areas, reducing our risk 8 around subprime. We were -- we were We were, from the 9 What we're trying to convey here is that we 10 were not focused on those areas, logically not focused 11 on those areas where we all believed the system-wide, 12 that these -- these securities were safe enough to 13 withstand very significant pressure. 14 We weren't sitting there twiddling our 15 thumbs and assuming that housing could never go down. 16 We had in our base case that housing was going down 17 during `07 and would likely continue. 18 But what it took to lose money in these 19 securities where we took the most pain, what it took 20 was a very significant step function down in housing 21 prices, which was, unfortunately, well outside our 22 sights and our frame of reference. 23 COMMISSIONER MURREN: I'm sorry. Do you think that you 24 would have been more focused on that aspect of it if 25 the formula or at least the basis for how everyone 293 1 gets compensated at your firm were less related to 2 revenue growth, return on equity, which by definition 3 means that you would want to be levered, and earnings 4 per share growth, which, of course, is what will 5 likely drive the stock price; if there were more of an 6 orientation internally, towards evaluating risk and 7 being able to handicap that as opposed to growth? 8 9 MR. MAHERAS: Well, I -- I can't accept the premise of the question that there was not more. 10 There was a very, very significant internal focus on 11 risk. 12 compensation constructs were generally, you know, 13 significantly correlated to the performance, the 14 bottom line performance, of the business. I -- I -- you correctly point out that 15 But I don't believe that there was a lack 16 of focus on risk. I think that to the contrary, I 17 think Citigroup probably had the largest risk 18 management infrastructure in the business. 19 COMMISSIONER MURREN: 20 MR. MAHERAS: Bigger isn't better. We missed -- we missed 21 something. We missed something. And the senior-most 22 securities, after having appropriately recognized that 23 the housing as an asset class was coming down some, 24 appropriately recognized and acted accordingly by 25 reducing our risk in the junior areas, the risky 294 1 areas, those areas that were perceived to be risky or 2 that could have some risk. 3 We were actively engaged and successful at 4 reducing risks all over the firm. 5 place, and it was that place that was furthest from 6 our focus, unfortunately, with the benefit of 7 hindsight, where we took a loss. 8 9 10 There was one But risk management was at all times incredibly prioritized and consumed a lot of our time and focus. 11 COMMISSIONER MURREN: You each actually 12 observed in your testimony that you thought your risk 13 management practices were excellent. 14 been necessarily the opinion of outside observers. 15 16 That has not Perhaps, if you could comment on that, Mr. Bushnell? 17 MR. BUSHNELL: I would be happy to weigh 18 in, and I might also follow on with a question that 19 you asked about the regulatory interface because 20 they're sort of combined. 21 I'm confident that amongst the panel 22 members, I had the most interaction with regulators 23 around the world. 24 daily. 25 scheduled briefings on a periodic basis, weekly, My interactions with them were And that was a combination of regularly 295 1 monthly, quarterly, to ad hoc calls. 2 And they were worth, if you will, the 3 alphabet soup, everywhere from the OCC to the Fed to 4 the FSA in London to the FSA in Japan to the Hong Kong 5 monetary authority, all of the regulatory authorities 6 that we dealt with, so I would be happy to follow up 7 on that. 8 9 The linkage in the question is we had feedback from the regulators themselves. I didn't 10 have any indication during my tenure in 2003, 2004, at 11 these periodic meetings or in their annual reports to 12 the board of directors about risk management that 13 there were inadequacies and that we were second-rate 14 in our risk management in comparison to their peers. 15 16 17 Indeed, we had other instances, in certain areas, that felt that we were ahead of our peers. COMMISSIONER MURREN: Could you talk a 18 little bit about those meetings? 19 expressing it is risk-focus -- risk-focused 20 regulation, which really is an evaluation of your 21 internal controls and internal communication with 22 regard to risk. 23 24 25 And their way of In your opinion, was that an effective way to measure the risk at your firm? MR. BUSHNELL: I think that based upon the 296 1 base fundamental, and I know we don't like to keep going back to 2 these model, I think the framework of risk, everything 3 from its independence, its structure, the usage of 4 limits and policies, is the right way to go. 5 The fundamental area that we missed and I 6 think the regulators missed etcetera, Tom said we 7 stressed real estate losses. 8 had been not seen, you know, in history, but we still 9 didn't stress them enough. 10 We stressed them to what And that was at the baseline of all of 11 this. 12 tried to indicate that our method of analysis was 13 wanting. 14 So I think that that's why, in my testimony, I And, indeed, the -- if I could, I'd like to 15 get one thing across to the Commission, the usage of 16 statistical models, without stress tests and thinking 17 of things that have never happened before as part of 18 those stress tests is important. 19 COMMISSIONER MURREN: And in that -- those 20 conversations with the regulators, were they asking 21 questions about the underlying asset classes, or were 22 they simply asking questions about the methodology of 23 your modeling? 24 MR. BUSHNELL: Both. 25 COMMISSIONER MURREN: And did they look at 297 1 the CDO business? 2 MR. BUSHNELL: They did. They looked at 3 the structured finance business, of which the CDO 4 business was a part. 5 COMMISSIONER MURREN: And at any point were 6 the underlying assets tested as part of that or, 7 again, was it really just an evaluation of your risk 8 modeling? 9 MR. BUSHNELL: I don't know what their 10 internal -- we saw reports off that, but I don't know 11 if they did any of their own stress testing, if you 12 will, of those positions. 13 COMMISSIONER MURREN: But that wouldn't be 14 stress testing. It would actually be going into the 15 portfolio and looking at the assets as opposed to 16 determining if there's an event that's cataclysmic 17 that would affect the whole asset class; is that not 18 right? 19 MR. BUSHNELL: 20 COMMISSIONER MURREN: 21 22 Yes. So there was none of that type of thing? MR. BUSHNELL: I -- I -- I don't know what, 23 in their work papers and in their examinations, what 24 they looked at specifically. 25 report, if you will, of these areas, but I don't know I saw the -- a final 298 1 what -- what detail they went into in coming up with the 2 summarizing report. 3 4 COMMISSIONER MURREN: In those final reports, what was the conclusion? 5 COMMISSIONER HENNESSEY: My recollection 6 was that there were no major findings in the credit 7 structuring business. 8 instances, though, of what I would call minor issues, 9 but nothing major off of that. There may have been certain 10 COMMISSIONER MURREN: 11 CHAIRMAN ANGELIDES: 12 That's it? All right. Mr. Wallison? 13 14 Thank you. COMMISSIONER WALLISON: Thank you, Mr. Chairman. 15 EXAMINATION BY COMMISSIONER WALLISON 16 COMMISSIONER WALLISON: Let me make a 17 couple of prefatory remarks. Everyone knew that the 18 bubble was going to deflate. Many bubbles had 19 occurred in the past, and then they deflated, but no 20 bubble's deflation ever caused a worldwide financial 21 crisis. 22 Even assuming that the Great Depression 23 wasn't a deflation of a bubble. So I'm not going to 24 cast blame when something completely unprecedented 25 happens that is not only -- not only not within the 299 1 experience of the people who confronted it and were 2 involved in it, but was not within the experience of 3 anyone alive today. 4 So I want to just, with that prefatory 5 remark, I would like to just talk about what was known 6 at the time. 7 then move across. 8 9 I'll start with you, Mr. Dominguez, and You referred to what happened as a cataclysmic and unprecedented event. And I don't 10 think anyone can doubt that. 11 subprime and Alt-A mortgages were outstanding at the 12 time in 2007 when you were creating CDOs and marketing 13 them? 14 15 16 17 MR. DOMINGUEZ: Did you know how many Were outstanding in the market? COMMISSIONER WALLISON: market, exactly. 18 MR. DOMINGUEZ: 19 COMMISSIONER WALLISON: 20 21 22 23 Outstanding in the No. Do you have a guess of how many were outstanding? MR. DOMINGUEZ: I'd say 200 billion subprime and another -COMMISSIONER WALLISON: Okay. Would it 24 have made any difference to you, in terms of knowing 25 what the risks were, if you knew that half of all 300 1 mortgages outstanding in 2007 were subprime and Alt-A? 2 When I say half of all mortgages 3 outstanding, we're talking about over 4 trillion 4 dollars in mortgages, almost 5 trillion dollars in 5 mortgages, would that have made a difference in terms 6 of what you could imagine would happen? 7 Now, it might not have been your business 8 to understand that, but I think what it does is 9 suggest that a cataclysmic and unprecedented event is 10 not so far off the radar screen in a situation like 11 that. 12 just want to go back to Mr. Dominguez with a couple of 13 other questions and details about CDOs, if you don't 14 mind. 15 16 17 18 I'll address this question to all of you, but I Why was it necessary to have a super senior tranche in a CDO? MR. DOMINGUEZ: Well, the super senior tranche is the most senior tranche. 19 COMMISSIONER WALLISON: 20 MR. DOMINGUEZ: Right. It's called super senior 21 simply because there's another tranche below it, and 22 it is senior to that tranche, and that happens to be 23 rated Triple-A. 24 25 COMMISSIONER WALLISON: rephrase it, then. Right. Let me There are a whole series of 301 1 tranches. 2 MR. DOMINGUEZ: Yes. 3 COMMISSIONER WALLISON: And the ones that 4 were generally sold to the public were Triple-A and 5 then Double-B and so on down? 6 MR. DOMINGUEZ: Yes. 7 COMMISSIONER WALLISON: And then there was 8 an equity piece at the very bottom, which, in fact, 9 was the riskiest piece of all, and someone even bought 10 that because there was a lot of profit associated with 11 it if everything worked out. 12 I don't understand the economics, the 13 financial economics yet of why it was necessary, and 14 it seems to have been necessary, to have created a 15 piece at the top that was super senior that were 16 superior to the ones that were actually marketed to 17 investors. 18 business. 19 I'm talking about the economics of the Why -- why was that necessary? MR. DOMINGUEZ: It wasn't necessary. 20 Some -- some -- some transactions had senior pieces, 21 super senior pieces, that were marketed to conduits 22 and other -- other investor categories. 23 mentioned before, there's a specific program called 24 the liquidity put program that was specifically 25 designed -- As I 302 1 COMMISSIONER WALLISON: Let me stop you 2 there. My time, of course, is limited. 3 done because this was something from Citi's business 4 that it wanted to do; it wanted to hold those super 5 seniors; is that right? 6 MR. DOMINGUEZ: 7 COMMISSIONER WALLISON: So it was On that program, yes. Okay. As you 8 described it, the CDO consisted of more than just 9 mortgages; am I correct about that? 10 Other assets were included in some of these CDOs? 11 And what were those assets, and why were 12 they included, and were those the sorts of things that 13 were demanded by investors? 14 MR. DOMINGUEZ: Well, in my statement, what 15 I said was that there's -- there's several kinds of 16 CDOs, RMBS pools. 17 type. Securitized RMBS pools are but one 18 COMMISSIONER WALLISON: 19 MR. DOMINGUEZ: Right. So there's collateralized 20 loan obligations, there's CDOs made up of Tier 1 21 capital securities from middle market banks; there's 22 middle market loans. 23 investor types that tend to gravitate towards specific 24 types of CDOs. 25 RMBS CDOs, and there are investors who only buy And so there are various There are those investors who only buy 303 1 collateralized -- 2 COMMISSIONER WALLISON: Were there mixed 3 CDOs, that is, consisting of residential 4 mortgage-backed securities plus other kinds of 5 asset-backed securities? 6 MR. DOMINGUEZ: Were they mixed in any way? The -- the -- the 7 percentage limitations, which defined in the 8 transactions, which defined the eligible collateral 9 securities, allowed for several asset classes. And 10 the asset classes that were allowed was determined in 11 negotiations with the investors. 12 COMMISSIONER WALLISON: 13 MR. DOMINGUEZ: 14 COMMISSIONER WALLISON: Okay. Who indicated to us -I understand. So 15 this was marketing -- marketing, and the investors 16 wanted certain kinds of assets on their balance 17 sheets, and you accommodated them by creating those 18 pools -- 19 MR. DOMINGUEZ: 20 COMMISSIONER WALLISON: 21 22 23 24 25 wanted. That's right. -- that they Okay. Did your potential customers care whether a CDO they purchased was synthetic or not? MR. DOMINGUEZ: Some investors didn't. What -- what -- what happened in the marketplace, the 304 1 synthetic ABS CDO and the cash ABS CDO developed 2 somewhat independently, but by 2005, 2006, those 3 markets were converging as investors -- many investors 4 were reasonably agnostic to how they got that 5 exposure. 6 What they were interested in and the 7 investors we dealt with -- the institutional investors 8 we dealt with wanted to take certain exposures to the 9 asset class. And many of them, whether it was 10 synthetic or cash form, were agnostic to that; some 11 weren't. 12 13 COMMISSIONER WALLISON: Okay. Mr. Barnes, I have questions for you. 14 How many subprime and Alt-A mortgages did 15 you think were outstanding before what you call the 16 unprecedented -- unprecedented events in 2007? 17 you know? 18 MR. BARNES: Did On a relative basis, I thought 19 it represented around 15 percent of the total 20 residential mortgage -- residential real estate 21 market. 22 COMMISSIONER WALLISON: There was obviously 23 a widely held view that there could not be a 24 disastrous fall in house prices, such as occurred in 25 2007 and subsequently. 305 1 Would there have been such a view if people 2 had known, at least in your view, if people had known 3 that almost half of all mortgages in the financial 4 system were subprime and Alt-A? 5 MR. BARNES: I think clearly the fact that 6 an increasing amount of mortgages were 7 subprime-related. 8 retrospect, was the underwriting standard associated 9 with those was definitely substandard. 10 And what became clear, in But at the same time, even given a decline 11 in house prices, given the various levels of 12 subordination provided by the underlying mortgages, 13 the RMBS that was actually backed by those mortgages, 14 and the CDOs that were backed by the RMBS, certainly 15 the -- the consensus within the firm as well as across 16 the industry of the market participants was that 17 the -- the likelihood of losses hitting the super 18 senior was extremely remote. 19 COMMISSIONER WALLISON: Okay. You said 20 that after the events of 2007, it was necessary to 21 change the methodology for valuing super senior CDOs. 22 And you called -- you used something you 23 called an intrinsic cash flow method evaluating CDOs 24 and the underlying collateral. 25 Please explain how this was done as 306 1 2 concisely as you can? MR. BARNES: Basically the I -- the -- 3 the -- the methodology was to look at the underlying 4 residential mortgage-backed securities that backed the 5 CDO and look at common loan characteristics within 6 each of those RMBS. 7 And we effectively used some kind of 8 historical regression model. But based on certain 9 input assumptions, which were judgmental, tried to 10 predict what the timing and level of defaults were, as 11 well as the severity of losses. 12 And this is a very iterative process and 13 one challenged by the fact that 2007 was still 14 extremely out of sample with what we had experienced 15 historically. 16 And so even developing this much more 17 sophisticated model that looked through the CDO 18 through to the underlying collateral, and even through 19 the RMBS to various -- the various loan pools and 20 allocating them into -- into buckets that had similar 21 features, that was -- it still was not a very good 22 predictor of future defaults, delinquencies, defaults. 23 COMMISSIONER WALLISON: Right, I understand 24 that part, but what is an intrinsic cash flow system 25 of methodology for -- 307 1 MR. BARNES: What it -- what it really did 2 was by looking through to the loans and looking at the 3 RMBS and the priority of payments that exist within 4 the RMBS structure, according to the performance of 5 the underlying loans, the forecasted performance, the 6 model then looked at how those cash flows, whether 7 they were a hundred percent of the -- 8 9 10 COMMISSIONER WALLISON: discounted -- you knew what the cash flows were, and then you discounted them in some way? 11 12 MR. BARNES: Well, first, we had to actually wash them through the RMBS waterfall -- 13 COMMISSIONER WALLISON: 14 MR. BARNES: 15 And then you Yes. -- in terms of the various tranches. 16 COMMISSIONER WALLISON: 17 MR. BARNES: Right. -- and then, to the extent 18 that there was CDO, which was referencing those RMBS, 19 we then went through that process again, and then that 20 effectively came up with what -- what in -- what, in 21 the firm's opinion, was a sort of an expected future 22 value of those cash flows. 23 discount them using some discount. 24 25 And then we had to COMMISSIONER WALLISON: auditors approve that? And -- and did your 308 1 MR. BARNES: We went through a rigorous 2 process, including a review of the assumptions, a 3 review of the -- a review of the model itself and that 4 process was, frankly, a challenge because of us being 5 so out of sample and relying on input switch couldn't 6 really be properly validated or verified in the 7 marketplace. 8 9 But the decision was made that in the absence of an observable market to actually assess the 10 fair value of these securities, that was a decision 11 that was made by senior management, by finance and 12 risk. 13 COMMISSIONER WALLISON: With the auditors? 14 MR. BARNES: I wasn't involved I'm sure. 15 in the discussions with the external auditors, but 16 certainly that model or an early version of it was 17 included in the initial substantial losses that were 18 taken and that were included in eight phase in the 19 fourth quarter of `07. 20 21 22 COMMISSIONER WALLISON: All right, thank you very much. Mr. Maheras, the losses on the CDOs were 23 large, as we know, but as you point out, the whole CDO 24 business was only 2 percent of the revenue of the 25 investment bank that you were running. 309 1 Incidentally, investment bank was a 2 mythical idea, was it not? 3 actual entity? 4 among a commercial bank, an investment bank, and a 5 consumer bank, as I recall. 6 I mean, there wasn't an All of Citi's operations were divided So you had a whole lot of different 7 entities under the investment bank no matter where 8 they were in the unit. 9 that. 10 Correct me if I'm wrong about But then the question I want to ask is, the investment bank, did it have a profit? 11 And although there was severe losses in 12 case -- in the case of the CDOs if you include over a 13 trillion dollars in assets that were in the investment 14 bank, was that a profitable investment for the bank? 15 16 17 MR. MAHERAS: I'm sorry, you're asking if the CDOs -COMMISSIONER WALLISON: The entire -- the 18 entire operation under your control, 1.X trillion 19 dollars in Citigroup assets, was that ultimately 20 profitable despite the losses on the 2 percent of 21 revenue that the super senior CDOs represented? 22 MR. MAHERAS: Let me clarify, the under 23 2 percent number is the number that would represent 24 revenues from the CDO business in 2006. 25 COMMISSIONER WALLISON: Mm-hmm. 310 1 MR. MAHERAS: It was an under 2 percent 2 number. In 2006, the investment bank, for which I was 3 co-head of, had a 7 -- a little over 7 billion dollars 4 of after-tax net income performance, so it was very 5 profitable. 6 In 2007, by the end of the year, I don't 7 know exactly what -- what the performance was. 8 time I left, we were -- we were profitable on a 9 year-to-date basis through the end of the third At the 10 quarter at around 4 to 5, around 5 billion dollars 11 after-tax net income. 12 COMMISSIONER WALLISON: 13 MR. MAHERAS: Okay. The losses that were 14 suffered, which were substantial, were in the fourth 15 quarter. 16 VICE CHAIRMAN THOMAS: 17 COMMISSIONER WALLISON: 18 VICE CHAIRMAN THOMAS: COMMISSIONER WALLISON: 22 much. 23 but I appreciate it. 25 Mr. Chairman, I yield Commissioner Wallison another five minutes. 21 24 Thank you very much. 19 20 Mr. Chairman? Oh, thank you very I actually don't think I'll need all of that, CHAIRMAN ANGELIDES: leave on the table. We'll pick up what you 311 1 COMMISSIONER WALLISON: Mr. Bushnell, what 2 would have been included in the stress tests that you 3 said should probably have been done? 4 would have been reasonable to include in those stress 5 tests a decline in housing values of 30 or 40 percent? 6 Was that within anyone's idea of what would have been 7 a reasonable stress test? 8 9 MR. BUSHNELL: Do you think it I don't think so, I think that that, again, based on what we had seen in history 10 and even taking the worst case that we had ever seen 11 in history and doubling it, if we had come up with 12 that in risk management, we could have run the models 13 using that and come up with the number. 14 that one would have put in the results of that would 15 have been questioned, I'm sure. 16 COMMISSIONER WALLISON: The credence I'm going to ask 17 you the same question that I've asked to your 18 colleagues, and that is, if you had known as the 19 risk -- the chief risk manager in the bank, if you had 20 known that in 2007 half of all mortgages in the U.S. 21 financial system were subprime or Alt-A, would that 22 have caused you to think that the dangers of a 23 deflating bubble would be greater than they have ever 24 been? 25 This is, I might say, an unprecedentedly 312 1 large number, that we've never had anything remotely 2 like that. 3 MR. BUSHNELL: I think that we knew in our 4 research areas and in outside services, such as Case 5 Schiller, that we employed in risk management, that 6 the proportion of mortgages that were both being 7 originated and in the totality of the mortgage market 8 was -- was favoring subprime, you know, it was 9 increasing in that. 10 What -- what we still didn't appreciate, 11 and none of those outside experts appreciated, was the 12 risk that that provided, again, how much of a -- back 13 to the -- back to the loss scenarios that would have 14 said that means you should not double historical 15 losses but triple historical losses. 16 that pitch was made, Commissioner. 17 18 19 20 21 COMMISSIONER WALLISON: I don't think Thank you very much and thank all of you. CHAIRMAN ANGELIDES: Mr. Wallison. Thank you very much, And Mr. Georgiou? COMMISSIONER GEORGIOU: 22 so little time. 23 just about the CD -- CDOs. So many questions, Let me -- let me start, if I can, 24 Mr. Maheras, I think that maybe there was a 25 misunderstanding with regard to this 2 percent number. 313 1 The way I saw it is you were, at one point, you said 2 that the 43 billion dollars was only 2 percent of 3 Citi's two-trillion-dollar balance sheet. 4 mention that or did somebody -- 5 MR. MAHERAS: 6 MR. BUSHNELL: 7 COMMISSIONER GEORGIOU: 8 Did you Actually, that -That was in my -That was Mr. Bushnell? 9 MR. BUSHNELL: 10 Yes. COMMISSIONER GEORGIOU: Right. Okay. 11 And -- but of course that would be just the balance 12 sheet that was reported on the balance sheet; that 13 wouldn't be taking in any of the other assets that 14 were off? 15 MR. BUSHNELL: Right. It would have been a 16 less even a smaller component of what we would have 17 thought of as our risk balance sheet, our exposure 18 balance sheet. 19 COMMISSIONER GEORGIOU: 20 MR. BUSHNELL: 21 Right. Not just our gap balance sheet. 22 COMMISSIONER GEORGIOU: And these CDOs, you 23 know, I -- we're all here; we're not experts in this 24 area; we're learning. 25 it. You know, I try to understand You've got -- basically you take, as I understand 314 1 it, you take in an RMBS CDO you take a whole bunch of 2 Triple-B-rated mezzanine tranches from RMBS bonds and 3 then you slice up the cash flow streams to create the 4 CDO. 5 And in the model that we have here, you end 6 up with 60 percent of the resultant CDO tranches being 7 rated Triple-A-plus super senior, 20 percent Triple-A, 8 6 percent Double-A, 5 percent A, 2 percent Triple-B, 9 2 percent Double-B, and 5 percent equity. 10 So, 91 percent of the result is rated at A 11 or above and 80 percent of it is rated Triple-A or 12 Triple-A-plus. 13 Now, I guess I would just ask that I know 14 that all of you have said that the financial crisis 15 con- -- the occurrence of the drop in all the housing 16 prices, which ended up impacting mortgages which 17 underlie the RMBS and then effectively also the CDOs, 18 wasn't -- wasn't comprehensive, wasn't really 19 contemplatable at the time or wasn't within your risk 20 models. 21 But doesn't anyone question whether you can 22 effectively do what I would liken to sort of the 23 medieval alchemy, where you're taking base metals, 24 lead, Triple-B-rated tranches of mezza- -- of RMBS, 25 and slicing and dicing them and ending up with 315 1 products that are essentially senior and super senior, 2 Triple-A and Triple-A-plus, turning them into gold. 3 I mean, doesn't anyone wonder whether 4 that's possible and whether that the -- there ought to 5 be some question as to the legitimacy of the ratings 6 that resulted in those tranches? 7 to you, Mr. Barnes, for example? 8 MR. BARNES: Did that ever occur I mean, certainly looking at 9 the -- the level of subordination, you know, the way 10 you described it, you know, intuitively, if it's new 11 to you, it does seem quite extreme. 12 Having said that, you know, our assumption 13 was that these securities were being packaged by loans 14 which were diversified across the country. 15 country -- not all of the country had the degree of 16 price appreciation and the subsequent correction that 17 the likes of California and Las Vegas and some of the 18 other parts of the states have, you know, has been 19 well -- well publicized. 20 The -- the And we looked to the -- the -- the credit 21 enhancement provided on the actual mortgage itself the 22 5 percent first loss protection, which is provided by 23 the residual piece on the RMBS, will be the equity, as 24 you just described it. 25 COMMISSIONER WALLISON: Right. 316 1 MR. BUSHNELL: And then the additional 30 2 to 50 percent, well, let's say 40 percent, that was 3 effectively provided -- provided a further degree of 4 credit enhancement from the tranches beneath the super 5 senior. 6 Now, in retrospect, you know if -COMMISSIONER GEORGIOU: Well, but -- but 7 wait a second. 8 the Triple-A was 20 percent. 9 security had 93 percent that was rated either Triple-B 10 or above; that is, the constituent securities you were 11 working with, Triple-B tranches of mezzanine, 12 mezzanine securities, as I understand it, and then you 13 were -- you were change -- taking the cash flows and 14 assigning them to other tranches that were rated 15 differently, in the resultant CDO. 16 No, the super senior was 60 percent, I mean, the resultant Not -- setting aside, for the moment, the 17 synthetic CDOs. But I guess all I'm trying to say, 18 and, again, I don't want to spend all of our time 19 analyzing how it is that the CDOs were constructed, 20 but it's not so implausible, is it, that a structure 21 like this, which becomes ever more complex, which is a 22 security-structured from a pool of other securities 23 that have already been structured and which you're, of 24 course, making a structuring fee, presumably 50 basis 25 points or 200 basis points, depending on the deal, so 317 1 you're taking that off the top, that the resultant 2 product might not perform as well as characterized, 3 that is, 60 percent of it being Triple-A-plus, so 4 essentially risk-free. 5 And -- and I want to focus on the capital 6 behind it, because one of the questions that I asked 7 Dr. Greenspan this morning, and which I would -- which 8 I also reiterate to you, is that -- and I'm not trying 9 to pick just on Citi, because a lot of people did 10 this. I mean this is not -- it just happens that 11 you're here today talking about Citi, but this has 12 happened throughout the industry. 13 why this was done, as we understand it, is that the -- 14 the liquidity puts per the super senior tranches you 15 essentially had to hold no capital for. 16 Part of the reason The -- the -- there's -- we had an 17 interview with a senior person from the -- our staff 18 did -- from the -- the deputy director of the Division 19 of Banking Supervision and Regulation at the Federal 20 Reserve Board who said that the trade, if these were 21 held in trading assets, as I understand some of them 22 were, that you effectively had to hold almost no 23 capital. 24 to one. 25 The leverage ratio was as much as 750 to 800 And that -- and the liquidity puts, as 318 1 opposed, for example, to a stand -- an actual direct 2 letter line of credit that would stand behind 3 commercial paper customarily, you would have to have 4 capital for on your balance sheet of the bank. 5 Whereas, if you did it with the liquidity puts, there 6 was essentially no capital required. 7 Can anybody speak to that, or was that a 8 factor in your decision making in moving into the CDO 9 market so aggressively? 10 MR. DOMINGUEZ: No. There was not a 11 factor. 12 program or other programs used within kind of broad 13 ranges was not a determining factor. 14 15 The amount of capital that the liquidity put We weren't out to minimize number -- the amount of capital or anything of that nature. 16 COMMISSIONER GEORGIOU: 17 the capital really wasn't the capital of the 18 investment bank, right, because the liquidity puts 19 were provided by the bank. 20 MR. DOMINGUEZ: 21 COMMISSIONER GEORGIOU: Well, of course, The bank. So, the losses that 22 were suffered, were suffered on the bank's P&L when 23 they had to honor the liquidity puts; isn't that 24 correct? 25 MR. DOMINGUEZ: No. I don't believe that's 319 1 the case. When -- when the program -- when commercial 2 paper stopped rolling, when the A and B commercial 3 paper markets actually disappeared -- 4 COMMISSIONER GEORGIOU: 5 MR. DOMINGUEZ: Right. -- the features of that 6 program were that you would automatically create a -- 7 I believe it was a ten-year note of Libor plus 40, and 8 that went into the broker-dealer. 9 COMMISSIONER GEORGIOU: So you had to 10 write -- so you had to take losses in the 11 broker-dealer? 12 MR. DOMINGUEZ: Yes. 13 COMMISSIONER GEORGIOU: 14 MR. DOMINGUEZ: 15 COMMISSIONER GEORGIOU: On that note? Yes. And I guess that 16 goes back to a question that was raised earlier. 17 mean, I don't know where, within the bank, the bank 18 and the broker-dealer, where the losses, ultimately, 19 from all of this write-down went. 20 But of course your compensation was based 21 on the production of these among other -- other 22 securities that produced during those years. 23 I And, of course, when they were written 24 down, there were no clawbacks that were -- were 25 enforced against anyone taking back any of the money 320 1 that was made based on the revenues that came from 2 these CDOs that were written down; isn't that correct? 3 MR. DOMINGUEZ: That's correct. 4 COMMISSIONER GEORGIOU: Okay. And do you 5 think that there might have been -- I guess I'm 6 trying -- you know, Alan Greenspan told us today that 7 he felt that one of the major problems was that there 8 was inadequate capital and inadequate liquidity in the 9 system at essentially all of the bank holding 10 companies and financial holding companies throughout 11 the system, that all of which either -- most of which 12 either failed or would have failed but for the 13 infusion of extraordinary taxpayer capital, which is, 14 after all, our charge here is supposed to be to 15 investigate all of those institutions. 16 So could you -- do you think that an 17 increased capital requirement at the investment bank 18 would be a significant deterrent to doing any of these 19 activities that got you into trouble? 20 Mr. Maheras, maybe you could address that? 21 MR. MAHERAS: Maybe, There's certainly a 22 connection between capital requirements and the amount 23 of business a business entity's going to conduct. 24 with or without a specified amount of capital required 25 at the actual underlying security level, the bank is But 321 1 still operating within constraints, overall leverage 2 ratios, Tier 1 ratios, or a whole mix of myriad of 3 different capital ratios. 4 But to be fair to your point, if you had 5 higher capital requirements across the board, across 6 all the activities, you would have had a lesser 7 overall balance sheet in the industry and you would 8 have probably seen less of the -- the ebullience that 9 built up over a couple of years. 10 You know, one thing that probably hasn't 11 come across is people weren't creating these 12 securities and just trying to find a way to sell them. 13 This wasn't, you know, the perception of Wall Street 14 of old, you'd create products and you'd find a way to 15 sell them. 16 The businesses evolved over the last five 17 to ten years to one where the investor classes have 18 grown so large, and their demand for yield and their 19 demand for securities with specific yield 20 characteristics drove a lot of this activity. 21 They -- they -- they drove Nestor's 22 business to create products, because they had a bid 23 for some of those underlying tranches, leaving Nestor 24 with a piece or two to then sell on the aftermarket. 25 But the -- the -- the -- 322 1 COMMISSIONER GEORGIOU: 2 MR. MAHERAS: But the -- The availability of liquidity 3 and financing to purchase those things with investors 4 coupled with the fact that regulatory capital 5 requirements in some asset classes, with the benefit 6 of hindsight, were a little low -- 7 COMMISSIONER GEORGIOU: 8 MR. MAHERAS: 9 10 Right. -- you know, conspired to -- to probably exacerbate the problem. COMMISSIONER GEORGIOU: But weren't they -- 11 weren't the investors buying principally the ones that 12 had nice yield, the more -- the lower-rated tranches, 13 really, within the CDOs? 14 MR. MAHERAS: Well, you had all different 15 types of investors. Insurers were focused on, and 16 some of these conduits Nestor talked about, and 17 re-insurers were focused on the senior-most, the 18 super senior and Triple-A's. 19 COMMISSIONER GEORGIOU: 20 MR. MAHERAS: Right. You had asset managers 21 focused on the Double-A's, and Triple-A's, and 22 Single-A's, and Triple-B's. 23 focused on Triple-B's and -- You had hedge funds 24 COMMISSIONER GEORGIOU: 25 MR. MAHERAS: And equity. -- and equity. So you had 323 1 the full array of investor types across the ratings 2 spectrum of these various structures. 3 COMMISSIONER GEORGIOU: Right. But when 4 you talk about the 25-billion-dollar liquidity put 5 program, that was -- those were securities that were 6 super senior that you didn't sell to anybody that you 7 effectively moved off your balance sheet because, you 8 know, they were off in a -- in a -- in a special 9 investment vehicle, with special purpose vehicle 10 11 off-balance-sheet, right? And basically no risk was attributed to 12 them because the risk, the liquidity put risk, the 25 13 billion dollars that was ultimately paid was paid by 14 the bank itself. 15 MR. DOMINGUEZ: Well, yes, there -- 16 there -- there was risk attributed to them, and you 17 can see in the documents provided to the staff where 18 the -- the notional amount of the super senior related 19 to the liquidity put is itemized. 20 So we've always looked at the risk as if 21 they were on balance sheet even though the liquidity 22 facility, we call the continued credit facility, 23 didn't -- didn't have to be exercised for it to show 24 up on our balance sheet for -- 25 COMMISSIONER GEORGIOU: So what was the 324 1 risk that you attributed to the 25 billion dollars 2 that was ultimately paid for those, to bring those 3 assets back on the balance sheet? 4 MR. DOMINGUEZ: What was the capital? 5 COMMISSIONER GEORGIOU: What you say -- 6 what -- you did evaluate the risk -- 7 MR. DOMINGUEZ: 8 COMMISSIONER GEORGIOU: 9 MR. DOMINGUEZ: Well those -- we quantify them in very similar ways. 12 13 COMMISSIONER GEORGIOU: Do you know the amount, by any chance? 14 MR. DOMINGUEZ: 15 COMMISSIONER GEORGIOU: 16 How did you quantify the risk. 10 11 Well, those -- I'm sorry? Do you know the amount that you calculated. 17 MR. DOMINGUEZ: Those positions were 18 generally held at par, and there was -- until -- until 19 late 2007. 20 positions and both with respect to looking through the 21 underlying assets and with respect to comparables such 22 as they existed in the market, and they were marketed, 23 I believe, to 10 basis points running. There was a lot of analysis done on those 24 COMMISSIONER GEORGIOU: 25 MR. DOMINGUEZ: 10 basis points? Per annum, yeah. 325 1 COMMISSIONER GEORGIOU: Okay. Well, I 2 mean, I guess the other -- the other thing, I guess 3 there is an issue about regulatory -- capital 4 regulatory arbitrage because, as I understand it -- 5 I'm sorry, could I have a minute or two more? 6 7 CHAIRMAN ANGELIDES: Why don't you take two minutes. 8 9 You can have a minute. COMMISSIONER GEORGIOU: The -- the securitization rule was changed in 2001which addressed 10 some portions of the capital arbitrage system, the 11 rule established risk ratings -- risk weightings based 12 on the credit ratings of each tranche of 13 securitization. 14 And they allowed liquidity puts on 15 asset-backed commercial paper tranches to get a 16 10 percent risk rating resulting in a capital charge 17 of eight-tenths of a percent basically on liquidity 18 puts. 19 And one of the Citi executives to whom we 20 spoke said that Citi made the decision to support the 21 growing CDO business with its own capital because the 22 regulatory capital associated with holding the super 23 senior Triple-A tranches was close to zero. 24 25 And I wonder, I guess I'm trying to get to what we can do on a go-forward basis in the future 326 1 here to avoid another meltdown. 2 mistakes were made. 3 that you wouldn't have done -- you wouldn't have 4 invested in those -- created those securities, had you 5 known what was going to happen to them. 6 recognize that. 7 go-forward basis, to avoid future catastrophes, 8 similar catastrophe, we probably have to change 9 something. 10 You know, obviously You now, all of you, are -- agree We all The question, I guess, is, on a So what is it that we're going to change? 11 One -- one -- again, Dr. Greenspan suggested 12 greater -- significantly greater capital and 13 significantly greater liquidity requirements. 14 a -- an end to this capital arbitrage where, by simply 15 moving assets from one legal structure within your 16 organization to another, from one unit to another or 17 moving it off-balance-sheet, that you could 18 essentially create an opportunity to create a product 19 that doesn't require you to hold any capital against 20 it. 21 And So some people have suggested that there 22 should be a principle that the total amount of capital 23 required for a pool of assets should be the same after 24 a securitization as before, and it reduces. 25 reduces from the point of view of a mortgage down into It 327 1 an RMBS and from an RMBS to a CDO. 2 any thoughts? 3 you can respond to that? 4 Do any of you have Mr. Bushnell is shaking his head. CHAIRMAN ANGELIDES: If By the way, I will 5 yield two additional of my minutes. 6 to keep it within Mr. Georgiou's time or he'll be in 7 the penalty box. 8 9 VICE CHAIRMAN THOMAS: So therefore try I'll take a minute of that time. 10 CHAIRMAN ANGELIDES: 11 MR. BUSHNELL: There you go. I do have some thoughts on 12 that. 13 and I think the problem is really twofold. 14 I overheard your questioning of Mr. Greenspan, One, there needs to be more capital in the 15 system, and you need to end the opportunities for 16 regulatory arbitrage. 17 I would make a comment that says, as 18 opposed to the reason there is an arbitrage that 19 exists, is because there are multiple regulators. 20 there were not multiple regulators you could not 21 arbitrage regulatory capital requirements. 22 COMMISSIONER GEORGIOU: 23 MR. BUSHNELL: If Right. And that more emphasis needs 24 to be placed on, if not having a single purveyor of 25 regulatory capital, at least a complete agreement 328 1 amongst the various agencies, both in the U.S. and 2 worldwide because some of the -- 3 COMMISSIONER GEORGIOU: Because you said -- 4 you said you dealt a lot with the OCC. 5 from one of the OCC people who said the following to 6 our staff: 7 bank; it changed from an agency business to a 8 principal business, We didn't know that; that's 9 outside of our jurisdiction. 10 And we heard The CDO business was managed outside the Gramm-Leach-Bliley wouldn't let us look 11 into that, yet the bank had these liquidity puts that 12 were not reported in any risk system that we had. 13 14 15 Now, that's the OCC examiner talking about this circumstance. So obviously they regarded themselves as 16 constrained by the law from asking you about anything 17 other than, you know, other than what asking the 18 banker, banking people, about your business, really, 19 and so forth, and which is obviously a major problem. 20 And I suspect that really the only issue 21 regarding compensation, which I would toss out just as 22 something to reflect upon, is that if you all had a 23 longer timetable for you to earn your bonuses so that 24 you could track through the process, the creations 25 that you had, to ensure that they didn't crater and 329 1 ultimately have a clawback that resulted from that 2 cratering, wouldn't that enhance your diligence in the 3 timing and in the -- in the -- in the effectiveness of 4 your -- of your issuance of these securities? 5 6 CHAIRMAN ANGELIDES: Mr. Georgiou. 7 8 Two final minutes for COMMISSIONER GEORGIOU: Yeah. Mr. Maheras, could you speak to that? 9 MR. MAHERAS: I -- I don't know that 10 anything would have been different if there were a 11 clawback. 12 positions on, you know, arbitraging some compensation 13 scheme. 14 I don't think that people put these I think -- I don't think there's any issue 15 with, and I think it could be a healthy variant of the 16 compensation construct to possibly use clawbacks more. 17 But I don't know that there would be any 18 difference as it relates to the events of the last 19 couple of years. 20 COMMISSIONER GEORGIOU: Right. I mean, one 21 of the great frustrations to the public, I think, is 22 that you made significant compensation. 23 begrudges you that compensation if it ultimately 24 produces value for your organization or for anybody 25 else, but what ended up happening is significant Nobody 330 1 losses were suffered and the taxpayers got stuck 2 holding the bag and having to backstop all these 3 institutions. 4 And nobody really, at your level, above 5 your level, below your level, ever had to come out of 6 pocket with any money of their own to backstop the 7 institution for the failures that resulted. 8 9 And this is what -- if there's one thing that I hear about all the time that angers the 10 taxpayer more than anything else is that there was no 11 consequence to people at your level and in your 12 position for the failures that resulted on your watch. 13 And I just leave you with that reflection 14 and yield the balance of my time. 15 Mr. Chairman. 16 CHAIRMAN ANGELIDES: Thank you so much. 17 Let's move on now to Mr. Thompson. 18 this in the right order. 19 20 21 22 Thank you, COMMISSIONER THOMPSON: I think I'm doing Thank you, Mr. Chairman. EXAMINATION BY COMMISSIONER THOMPSON COMMISSIONER THOMPSON: I guess, if I were 23 to think about this industry, much has been said about 24 the rate and pace of innovation and the inability in 25 many respects to really characterize the risk 331 1 associated with some of that innovation. 2 One might also argue, however, that 3 innovation in this industry is as much about 4 regulatory arbitrage as it is some unique new product, 5 because it's still, when it's all said and done, a 6 dead instrument that underpins what you're doing in 7 the marketplace. 8 9 And so my question is, in light of Dr. Greenspan's comments this morning and the current 10 state of the industry, should we be doing more to test 11 new products in some controlled way in this industry, 12 given the systemic and societal risks that are 13 associated with them, just like we do in other 14 industries, where there's huge societal risk with new 15 product introduction, pharma, airlines, I mean, you 16 pick it, so I'll start with you, Tom. 17 MR. MAHERAS: Me? 18 COMMISSIONER THOMPSON: 19 MR. MAHERAS: Yes. Well, to my eyes, there was a 20 lot of testing of new products from the regulators. 21 You know, clearly certain things went wrong. 22 could -- I'm not sure what form it would take. 23 And it I would point out, though, that a lot of 24 things have been done. If you think about the impact 25 of FAS 166 and 167, it forces consolidation back on 332 1 the balance sheets for a lot of financial 2 intermediaries who may have taken advantage of balance 3 sheet arbitrage or the regulatory capital arbitrage 4 you cited. 5 6 FAS 166 and 167 recently instituted go a long way towards helping that situation. 7 Increased capital requirements, I can't 8 think, as I sit here, but I would be happy if I have 9 any other thoughts to share them with you in writing 10 at a later point. 11 motion that are of substance. 12 13 But I think certain things are in COMMISSIONER THOMPSON: Mr. Bushnell, would you comment? 14 MR. BUSHNELL: I think if -- if one wanted 15 to have some sort of further control around a new 16 products process, there are several ways to accomplish 17 that. 18 again, observe that they didn't seem to work. 19 Most of the institutions, and we can argue, But in their own boundaries have a new 20 capital, a new product screening committee, that -- 21 that -- and I think Tom mentioned it, that would 22 address a bunch of issues in terms of everything from 23 internal, can we settle it, can we account for it, 24 what's the customer reaction going to be, what's -- 25 what are the taxation concerns that our customers 333 1 might have all sorts of things. 2 MR. MAHERAS: 3 MR. BUSHNELL: Suitability. Suitability for customers. 4 You could conceptually expand that to have, you know, 5 in essence, an agency of the government that would 6 look with those types of disciplines as part of it. 7 Another methodology would simply be to put 8 the tax of extra capital on a new product. 9 necessarily have to have an agency that just says, 10 until this, somebody would have to make a decision 11 that says -- until this product is tried and tested in 12 a time of stress, we're gonna have to acquire an 13 extra -- an excess amount, however you want to define 14 that, of capital for all those who originate it. 15 You don't So I think my comment is I think there are 16 several different ways that if that's thought to be 17 unnecessary adjunct to the regulatory framework, there 18 are several ways to accomplish that. 19 COMMISSIONER THOMPSON: Well, you had a 20 pretty unique view because you were not just chief 21 risk officer, but you were the chief administrative 22 officer. 23 looked across not just risk but how the organization 24 itself functioned, how does information flow, how does 25 the IT systems infrastructure work, on and on and on And that would suggest that your purview 334 1 and on. 2 is an amalgamation of companies that were brought 3 together over the course of the last 15 years or so, 4 that perhaps we didn't anticipate the stability of the 5 organization and its ability to absorb the combination 6 of market risk and all of the turmoil and stress that 7 might have been going on as you tried to integrate 8 many, many, many entities that you bought over the 9 last 15 or 20 years. 10 And that might suggest that given that Citi In your judgment at this point, should the 11 company have looked for greater organizational 12 stability before it pressed into some of these new 13 markets where the risk was really unknown? 14 MR. BUSHNELL: I -- I -- I don't think so, 15 in that, in the integration process, one of our first 16 things that we required, sort of all new members of 17 the Citigroup family that we acquired or merged with 18 and came involved with, was integrations of risk 19 systems and risk policies that said, you know, whether 20 it was an overseas institution or a domestic 21 institution, I don't care how you were dealing with 22 your risk policies, here's how you will do it on a 23 going-forward basis. 24 25 So at least from a risk perspective it was one of our primary areas of focus to get integrated as 335 1 fast as we could. 2 administrative officer, areas like technology is a 3 tough one, it -- it takes, I'm sure you're aware, in 4 the business, a long time to get legacy systems and 5 get a consistent methodology for that. 6 Clearly other areas, as chief But I think we tried to prioritize, 7 therefore, our integration process with special 8 attention to compliance issues, policy issues, risk 9 issues as being the ones that were the most important 10 to get consolidated first, if you will. 11 COMMISSIONER THOMPSON: So let me turn my 12 attention to Mr. Dominguez and Mr. Barnes, for a 13 moment. 14 If you think about risk and you have very 15 scientific models that give you a sense of whether or 16 not a given market or a given product is, in fact, 17 risky to a certain level, I guess the question is, at 18 what point did you or might you have talked to people 19 who were really on the ground, the traders, the 20 analysts, the people who really had a sense of what 21 was going on in the market around these products as 22 you were making your call as to whether or not the 23 business was sound or not? 24 25 Oftentimes traders will have a much closer insight into what's going on than perhaps someone 336 1 who's sitting, you know, in your role. 2 part of your process or not? 3 incorporated in a model that you yourselves have said 4 was more statistically driven as opposed to human 5 judgment core unit? 6 MR. DOMINGUEZ: So were they a And how was that So in the process of 7 warehousing and creating an ABS CDO transaction for 8 each piece of collateral, that is, each security that 9 ultimately went into the collateral pool, and there 10 may be 50 to 75 different pieces of collateral or 11 secure -- individual securities in there, we conferred 12 with the secondary trading desk. 13 And because they not only were in the 14 market to see if there was -- they were hearing 15 anything about that underwriter or -- or even that 16 particular transaction, but they could make a judgment 17 on where that piece of collateral was trading relative 18 to the market. 19 So clearly, if it was trading much wider 20 than the rest of the market or much tighter, that 21 always raised bells and whistles. 22 The second part, which you know we haven't 23 talked about here yet, is for each of these CDO 24 transactions there is a third-party collateral manger. 25 And there's two types of CDOs, the static CDOs and the 337 1 so-called arbitrage CDOs, which was -- is largely 2 Citi's business. 3 And a third-party collateral manager was 4 hired for every transaction. 5 transactions, so we did some static transactions. 6 that manager typically was -- had an expertise and 7 track record in the particular asset class of the CDO 8 we were -- we were creating. 9 we did talk to other people, we talked to other 10 I should say most And So -- so as a multi- -- markets, we had -- 11 COMMISSIONER THOMPSON: How about the guys 12 that were actually writing the mortgages? 13 Citi's a conglomerate. 14 everything. 15 of what is coming into the hopper if you talk to the 16 guys who were actually originating the paper. 17 I mean, It does a little bit of And so you'd have a sense of the quality MR. DOMINGUEZ: Well, that's true, but our 18 belief was that -- that would be reflected in the 19 market prices. 20 important. 21 And so that's why that factor was very And also the diligence done by the 22 third-party asset managers. And I really need to 23 emphasize that these were very well known, in many 24 cases had longstanding reputations in that particular 25 asset class and managed other portfolios in that asset 338 1 class, so -- so that was the process. 2 3 CHAIRMAN ANGELIDES: Mr. Thompson, do you would like some additional time? 4 COMMISSIONER THOMPSON: 5 CHAIRMAN ANGELIDES: 6 Yeah, I'm just -- I yield a couple minutes. 7 COMMISSIONER THOMPSON: I'm just struck by 8 the fact that for a lack of a better term, we can hide 9 behind statistical models, and leadership by and large 10 is about intuitive sense and judgment. 11 And at some point somebody had to make a 12 call, independent of what the model produced, and so 13 it just seems odd to me that we'd say, well, our 14 models told us this and therefore this is the way we 15 behave. 16 17 18 Where was the intuitive leadership judgment that says something may not be right in this market? MR. BARNES: If I can just comment? And I 19 think on the risk management side, I think working 20 closely with the business, and I think we already 21 viewed ourselves as partners with the business, and we 22 were on the desk interacting with them to a dialogue 23 on a daily basis, I interacted with my counterpart who 24 covered the global securitized markets. 25 market making in -- in -- in subprime RMBS, made sure This is the 339 1 that we were consistent in terms of our methodologies. 2 As Mr. Dominguez mentioned, while assets were in the 3 warehouse as they were being ramped up ahead of a 4 planned CDO, they were being mark-to-market daily, 5 even though if the securitization went ahead, 6 effectively Citi would recover its cost. 7 But we reflected that mark-to-market 8 volatility through P&L on a daily basis. We relied on 9 market surveillance, everything from our own internal 10 RMBS research or mortgage research department as CDO 11 and CLO research group. 12 And then we also looked at other market 13 indicators, the fact that CDOs were pricey. 14 priced deals were still commanding extremely tight -- 15 extremely tight spreads, whether it was from major 16 insurers, the bond insurer's model lines, or other 17 banks not only in the us but also in Europe, who 18 continued to view it as, you know, as extremely safe 19 risk. 20 Recently And then the final thing is that the -- the 21 other thing is while we saw the market deteriorate, 22 the business was actually very proactive at reducing 23 some of the low order risks, some of the first order 24 risks. 25 So in terms of getting rid of more junior 340 1 tranches accelerating the warehousing process 2 throughout the summer of 2007. 3 know, the error, and I know this is starting to become 4 a bit of a broken record, but it was -- the focus was 5 not on the super senior position. 6 And in retrospect, you And even the super senior positions of the 7 liquidity puts were really only intended to be held 8 temporarily. 9 always be there for that, so that was -- that was my And the assumption was the market would 10 sort of assessment of how we were looking at risk 11 what was admittedly a very fluid situation with the 12 a lot of, you know, significant market volatility. 13 we -- we -- that was part of our job to rely on that 14 type of market surveillance. 15 COMMISSIONER THOMPSON: All right. So, 16 Mr. Maheras, can you answer that from the business 17 perspective as opposed to the risk management 18 perspective? 19 MR. MAHERAS: 20 CHAIRMAN ANGELIDES: But I think so. Let's take -- if we 21 can just take about a minute and a half, at most, I'm 22 only concerned because there's a time we have to get 23 out of here. 24 25 But, John, I want you to -- I want you to get that. No, Mr. Maheras, please respond. 341 1 MR. MAHERAS: Okay. I think it's a very 2 good question. You started with the point about the 3 intuitive leadership. 4 probably hard to imagine that existed here given the 5 story we’re telling, but I can assure you that the 6 managers of the structured credit business to whom 7 Dr. Nestor Dominguez reported were actively focused on 8 subprime risks and actively focused on risk reduction 9 in the area and were effectively -- effectuating that, And, you know, again, it's 10 again, and the -- and where they saw the risk, and 11 that was happening actively. 12 The mortgage people, who were a different 13 business unit within fixed income, you heard from 14 Ms. Mills earlier today, she was in that unit, their 15 supervisors were actively managing down exposures with 16 a negative and quite concerned view. 17 They were -- these units were getting 18 intuitive leadership. 19 that I think, as a general matter, in companies like 20 ours, it's very important to make sure that silos of 21 expertise are communicating with each other and, to 22 the maximum extent possible that it was encouraged; it 23 was a best practice. 24 25 We were all very focused on And to varying degrees it was done extremely well. And certain places, where 342 1 communications should be had, and other places it was 2 suboptimal, but it was a best practice, it was an 3 important one, and I think you made that point. 4 5 COMMISSIONER THOMPSON: much, gentlemen. 6 7 Thank you very CHAIRMAN ANGELIDES: Mr. Thompson. Thank you, Ms. Born? 8 COMMISSIONER BORN: 9 EXAMINATION BY COMMISSIONER BORN 10 COMMISSIONER BORN: Thank you. I would like to 11 understand a little bit better what synthetic 12 collateralized debt obligations are. 13 beginning to understand cash CDOs, but I would 14 appreciate it, Mr. Dominguez, if you could indicate 15 for us what the difference between a cash CDO and a 16 synthetic CDO is. 17 in a synthetic CDO, rather than containing actual 18 RMBS's, for example, it would include credit default 19 swaps or other kinds of derivatives on asset-backed 20 securities; is that correct? 21 I think I'm My understanding right now is that MR. DOMINGUEZ: That's the essential 22 difference. 23 differences, but that's the key difference. 24 25 There were some other technical COMMISSIONER BORN: And how much of the issuance of CDOs by Citi were synthetic and how much 343 1 were cash in terms of the proportion? 2 MR. DOMINGUEZ: It was primarily cash. The 3 synthetic ABS CDO market, which was run out of London, 4 our London operation, which did not report to me, was 5 a new and growing market, and I don't have the exact 6 numbers. 7 of about a third, a third to a quarter of our 8 positions. 9 10 11 There's a proportion, but it's on the order COMMISSIONER BORN: Perhaps we can ask Citi to provide exact statistics on that. Why was it growing at that point of time? 12 Was it because it was more difficult to get the assets 13 for the cash CDOs? 14 MR. DOMINGUEZ: I think that's part of it. 15 When you're warehousing collateral, you're effectively 16 limit -- limited to what's out there in the market and 17 trading, so that's part of it. 18 The other part of it is that the managers, 19 the third-party managers, who were often hired to -- 20 to select a collateral liked or -- in fact, investors 21 liked the ability to reference any asset of any 22 vintage if -- if there was a willing counterparty to 23 play among the dealer community willing to write the 24 other side of the contract. 25 So it allowed more flexibility. And, as I 344 1 mentioned before, a number of investors, an increasing 2 number of investors, were -- were agnostic to whether 3 they got the exposure synthetically or in cash. 4 COMMISSIONER BORN: So essentially, by 5 synthetic, we mean that there are aren't any actual 6 assets, just the derivatives obligations? 7 8 MR. DOMINGUEZ: synthetic CDO. 9 10 COMMISSIONER BORN: MR. DOMINGUEZ: And that's what they were called. 13 14 Although I assume there were some hybrids with actual RMBS. 11 12 That's the pure -- pure COMMISSIONER BORN: assets? And some synthetic They were called hybrids. 15 MR. DOMINGUEZ: Yes. 16 COMMISSIONER BORN: Do you think, and let 17 me maybe ask Mr. Barnes this. I understand that you 18 suggested to the staff that the synthetic CDOs being 19 built on the credit default swaps essentially allowed 20 deals to be created faster than if you had to actually 21 accumulate all the assets. 22 MR. BARNES: 23 COMMISSIONER BORN: 24 MR. BARNES: 25 That was -Is that correct? That was my observation, yes. One of the challenges is that in actually building a 345 1 portfolio of RMBS or other types of securities to go 2 into the CDO, typically the market is more of a buy 3 and hold market. 4 issuance of the underlying securities such as the ones 5 that Ms. Mills described earlier. 6 And so you had to wait for the new Whereas, as long -- to -- to 7 Mr. Dominguez's point -- as long as you can actually 8 find a willing buyer of the CDS protection on a 9 particular RMBS you could effectively build this 10 portfolio significantly more quickly. 11 COMMISSIONER BORN: So did the use of 12 synthetic CDOs allow, in effect, more securitization 13 to occur than if you had to wait for the RMBS to be 14 actually issued and available? 15 MR. MAHERAS: Probably at the margin, but it's 16 important to remember that it was really the 17 investors, was the limiting factor. 18 investors, it didn't matter how quickly you can create 19 the deal. 20 right. 21 22 If there are no So, at the margin, I would say that's COMMISSIONER BORN: But you suggested that investors were, in fact, interested? 23 MR. MAHERAS: They are. 24 COMMISSIONER BORN: 25 MR. MAHERAS: They are. In the -- But so -- so it's -- it's a 346 1 question of -- what I'm trying to suggest is that 2 there wasn't an infinite capacity to do this because 3 your ultimate limitation would be the investors, 4 whether they wanted that risk at all. 5 But, as I said, at the margin it allowed 6 for an easier and cleaner execution of the 7 transaction. 8 9 MR. BARNES: And while the investors were there the -- from a risk standpoint, the fact that 10 shortened the horizon period or the hold, 11 holding period for the warehousing, that was actually 12 viewed as a sort of a risk mitigate. 13 and it was actually the underlying market that was 14 more concerting for us in 2007. 15 COMMISSIONER BORN: And -- and -- Well, as the underlying 16 market began to close down, did the synthetic CDOs 17 allow you to continue securitization longer than you 18 otherwise would have been able to? 19 MR. MAHERAS: 20 21 22 No, no. pretty much shut down around the same time. COMMISSIONER BORN: So investors were scared off -- 23 MR. MAHERAS: 24 COMMISSIONER BORN: 25 They -- they -- they Exactly. mortgage market essentially? -- by the freeze in the 347 1 MR. MAHERAS: That's right. 2 COMMISSIONER BORN: So you don't think that 3 the synthetic CDOs in any way contributed to extending 4 the period of securitization or the appear -- 5 appearance of the housing bubble? 6 MR. MAHERAS: 7 MR. BARNES: Well -From my standpoint, I would 8 say that to the extent it allowed more deals to print, 9 then probably it resulted in losses being larger in 10 aggregate than had those deals not occurred. 11 COMMISSIONER BORN: Well, that was my next 12 question, whether, you know, Citi experienced greater 13 losses because of the securitization of synthetic CDOs 14 than it otherwise would have. 15 losses on the synthetic CDOs -- I assumed there were 16 MR. MAHERAS: 17 MR. BARNES: 18 COMMISSIONER BORN: -- as well as the cash MR. MAHERAS: But in answer to your 19 20 Yes. Yes. CDOs? Yes. 21 question, I don't think it extended the housing bubble 22 because it didn't require any origination. 23 24 25 COMMISSIONER BORN: All right. I yield back the rest of my time. CHAIRMAN ANGELIDES: Terrific. Ms. Murren. 348 1 EXAMINATION BY COMMISSIONER MURREN 2 COMMISSIONER MURREN: Just a follow-up 3 question on our conversation earlier about the 4 regulators. 5 You had mentioned that both you, 6 Mr. Maheras, and you, Mr. Bushnell, that you were 7 sensitive to the fact that your regulators needed to 8 convey information to the Fed about the safety and 9 soundness of the parent company. 10 And you had talked about your interactions 11 with the OCC and a little bit with the Fed, but you 12 didn't mention the SEC. 13 mistaken, that the SEC is the functional regulator for 14 the investment bank; is that right? 15 MR. BUSHNELL: 16 And I think, if I'm not For the us portion of the investment bank. 17 MR. MAHERAS: And I would say the 18 investment bank, I think it may have -- Commissioner 19 Georgiou may have mentioned this -- the investment 20 bank conducted activities in a number of different 21 legal entities. 22 It conducted activities on the bank balance 23 sheet and it conducted activities at the holding 24 company, conducted activities at Citigroup global 25 markets. Global markets was the broker-dealer entity 349 1 which was regulated by the SEC. 2 COMMISSIONER MURREN: 3 And did you have interactions with the SEC. 4 MR. MAHERAS: My earlier reference to 5 having less interaction there was a personal one. 6 interaction with the SEC was lower than that of my interaction with OCC 7 and the Fed. 8 interaction in other parts of the firm with the SEC. 9 I can't speak to the frequency of COMMISSIONER MURREN: And could you talk a 10 little bit about their approach to supervising that 11 entity, the investment bank? 12 13 MR. BUSHNELL: Would you like me to address that? 14 15 COMMISSIONER MURREN: Either one or both of you, which -- whoever. 16 MR. BUSHNELL: I think that I, too, saw 17 relatively less of the SEC amongst my regulatory 18 contacts. 19 regulators did try to share information. 20 send each other their exam reports of different 21 trading desks or different divisions throughout the 22 world. 23 My They were there and a lot of times the They would And this included not only the OCC and the 24 Fed, and the Fed of the OCC, but as you say, foreign 25 regulators, certain of the large regulators would get 350 1 a piece of that. 2 pieces of that but I -- I -- not as frequently. 3 The SEC in some instances would get I would say, when I saw groups of 4 regulators, the Fed was always there. 5 always there. 6 of our legal entities was always there. 7 occasionally be there, in part because sometimes the 8 issues being discussed weren't relevant to the U.S. 9 broker-dealer, but that was my experience. I mentioned the FSA in London for all 10 COMMISSIONER MURREN: 11 CHAIRMAN ANGELIDES: 12 13 14 15 16 The OCC was The SEC would Thank you. Mr. Thomas? A burst of energy as we come around the turn. VICE CHAIRMAN THOMAS: Thank you, Mr. Chairman. EXAMINATION BY VICE CHAIRMAN THOMAS VICE CHAIRMAN THOMAS: I asked if you would 17 be willing to respond to us in writing over a period 18 of time about issues that we're dealing with. 19 didn't talk about it today, but I am, based upon my 20 background in Ways and Means and the particular 21 profile of your company, with such a significant 22 presence outside of the United States, what are you, 23 50/50, 60/40? 24 MR. BUSHNELL: 25 VICE CHAIRMAN THOMAS: We I think 50/50 -Internal versus 351 1 external -- 2 MR. BUSHNELL: -- I think for assets or 3 income is a reasonable estimate. 4 time. 5 VICE CHAIRMAN THOMAS: It has varied over I mean, this was 6 worldwide. 7 and we're working on our problem, focused on our 8 needs, and repairing our problems. 9 You folks deal in markets around the world But if we don't do this on a broad 10 international basis, we're not going to accomplish a 11 whole lot. 12 greater reaction to people who are supposed to know 13 what they're doing, not doing it on that basis. 14 And -- and there's going to be an even Now, obviously we have tried to move some 15 things internationally, but I would very much like to 16 pick your brains, if that's a word that I can use, 17 on -- based on what you do with one foot in the world, 18 especially Europe, and one foot here, what would make 19 more sense? 20 I'm more than willing to talk about a 21 structure which is fair, but I also would like to talk 22 about a structure that gives us a modest advantage in 23 terms of not being dumb about changes that we're going 24 to make. 25 I mean, when you look at an international 352 1 situation, we somehow don't want to have product and 2 financing linked in a way that you can make a sale on 3 a one-stop shop when most of the rest of the world 4 operates that way in dealing with folks. 5 6 7 So if you're willing to do that, that would be very helpful to me. I just want to make a couple of comments, 8 in part, Mr. Maheras, about your statement in terms of 9 constant contact notwithstanding the silo structure in 10 communications. 11 the question, were you aware that Citi global 12 securitized markets, which I believe are under the 13 direction of Susan Mills who was here before us 14 earlier, they were decreasing their purchases in 15 securitization of subprime mortgages due to concerns 16 with the mortgage market, in a real time situation 17 were you aware that that division or department was 18 doing what it was doing at the time it was doing it? 19 In the interview, Mr. Bushnell, on MR. BUSHNELL: Commissioner, at that point 20 in time, for that specific area, I was not. I knew 21 that we had several different areas where, both in 22 risk management and the business of their own volition 23 if you will, were looking at subprime exposures and 24 increasing loan loss reserves, tightening underwriting 25 standards on the consumer side, et cetera, but as the 353 1 specifics of Ms. Mills' business, I was not aware of 2 that at that time. 3 VICE CHAIRMAN THOMAS: And again, in 4 reference to notes from meeting between Citigroup and 5 regulators in late November of `07, quote, effective 6 communication across business was lacking, management 7 acknowledged that in looking back, it should have made 8 the mortgage deterioration known earlier throughout 9 the firm, the global consumer groups saw signs of 10 subprime issues and avoided losses as did 11 mortgage-backed securities traders, but CDO structures 12 business did so belatedly, no dialogue across 13 businesses. 14 So we're looking, based upon all the data 15 we put together, with a slightly different profile, in 16 reacting to what you said. 17 Mr. Bushnell, when Mr. Thompson asked you a 18 question about structures, and I was going to go 19 through a whole series of questions about capital 20 requirements, because throughout this entire period 21 you were, according to the standards, adequately 22 capitalized, the rating agencies, stress tests, but I 23 don't think it will be useful in any kind of a 24 dialogue right now. 25 In your response to him, Mr. Bushnell, I 354 1 didn't get a feel for what you believe. I mean, I 2 heard, should you want to conceptually expand that, I 3 always love ephemeral, non-committed, general 4 philosophical discussions. 5 impassioned plea that you were worth what you got. 6 I want to get something back in terms of after what 7 you went through -- and I'm really looking at all of 8 you, notwithstanding the fact that I'm looking at 9 Mr. Bushnell -- I want to know, from your experience, You guys made an 10 and I understand that it was an extraordinary 11 circumstance, but then there should be a willingness 12 to be extraordinary about your openness and 13 frankness about what would help. 14 So I understand additional capital, but once 15 again, the standards that we had. 16 ask you now what you think of the financial regulation 17 moving through Congress, because there's going to be a 18 whole series of legislation moving through Congress, 19 but I do want to enter into a discussion, we'll 20 structure it, give you plenty of time if you will be 21 willing to respond back. 22 I'm not going to And I know, Mr. Maheras, you took umbrage 23 with my talk about you not thinking things go down. 24 believe you said that you didn't anticipate so many 25 people walking away from their houses. That was a I 355 1 statement you made. 2 Most of them wouldn't call them houses. 3 They call them homes. 4 them. 5 circumstances they believe that were beyond their 6 control, but somebody other than themselves was at 7 fault. They were dragged away from them, through 8 9 And they didn't walk away from So if you put the context of what we're looking at in trying to explain it to people, when you 10 get these kinds of responses, it makes it very, very 11 difficult to fairly talk about you in the 12 circumstances you were in, regardless of remuneration 13 and structure of financial reward, that you get it. 14 That's all. It's tough. 15 Thank you, Mr. Chairman. 16 CHAIRMAN ANGELIDES: Thank you, Mr. Thomas. 17 All right. Commissioners and witnesses, this is the 18 stretch run, here. 19 I'll try to see if we can't get yes, no's, pretty 20 quick answers to these. I have a number of questions. 21 EXAMINATION BY CHAIRMAN ANGELIDES 22 CHAIRMAN ANGELIDES: 23 24 25 I want to get a sense of your view on a couple big matters. So the first is just the size and complexity of Citigroup, an institution that had 356 1 assets, I think, that were about 690 billion or so in 2 1998, grew to -- by 2007 to 2.188 trillion on balance, 3 another 1.26 trillion off-balance-sheet, so 3.4 4 trillion. 5 Leverage, I think, by 2008, of tangible, 6 common equity assets were 61 to 1. When you take the 7 off-balance-sheet, 97 to 1, I'm going to ask you, 8 Mr. Maheras, and particularly because you said you 9 spent -- I think in one of your interviews -- you 10 spent about 1 percent of your time thinking about CDOs 11 which ultimately produced a 30-plus-billion-dollar 12 write-off. 13 manage, too big to regulate, too complex? 14 Is this institution just too big to MR. MAHERAS: It's an important question. 15 I -- by the way, I was given different points in time, 16 and 1 percent referred to an earlier time when it 17 was -- it warranted less focus. 18 much more than that. 19 Later in `07, it was But in terms of Citigroup being too large 20 of a -- too complex to manage? I don't -- I don't 21 necessarily subscribe to that, I think it's more 22 complicated to manage a company with the breadth and 23 range of activities of a Citigroup than that of a 24 mono-line investment bank, but I don't think it's too 25 big. 357 1 I think you have examples out there of 2 firms that are just as large that are perceived to be 3 well managed. 4 definition, Citigroup is too big to manage. 5 And so I don't think that, by CHAIRMAN ANGELIDES: All right. 6 Mr. Bushnell, Mr. Thomas referred you to, I believe, a 7 meeting you attended with Mr. Rubin, but albeit, I 8 guess he attended it briefly. 9 17th, 2007, meeting with the senior supervisors from This was the November 10 the Federal Reserve of New York, Federal Reserve 11 Board, the OCC, the SEC, the UK FSA. 12 He referred -- and in that, and I don't 13 expect you to have these notes in front of you, but 14 you did make a number of comments about poor 15 communication across businesses. 16 firm did not have adequate firm-wide consolidated 17 understanding of its risk factor sensitivities. 18 Senior management business and risk management did not 19 fully appreciate the market risk of the leverage loan 20 pipeline, the routine super senior CDOs. 21 You said that the These are actually notes, these aren't 22 verbatim, these are notes of your comments. You left 23 the institution, too big to manage, too complex, 24 because your comments here indicate a significant 25 level of concern about the ability to manage this well. 358 1 MR. BUSHNELL: I think that there was very 2 definitely I had lessons learned and was trying to -- 3 I set those forth to our board of directors during the 4 crisis, as they come into my mind, and at that meeting 5 with the regulators, I said, here's areas that we 6 could improve upon given what's happened, et cetera. 7 As to that relation to complexity, Chairman 8 Angelides, I'd answer it slightly differently, and it 9 has to do with the nature of our global economy, et 10 cetera. 11 think of customers in a broad sense, the inevitability 12 of an institution that can service global capital 13 flows will be a reality, whether it's going to be in 14 the United States or somebody else is going to take us 15 over from that, that by nature, will mean that there's 16 multiproduct, multi-types of customers, corporate 17 customers, consumer customers, institutions, et 18 cetera. 19 I think that from customer's side, when you So I think we have to sort of face the 20 reality that we will have these huge global financial 21 institutions and, therefore, concentrate on their 22 governance and regulations rather than saying, no, 23 that we're going to somehow make them smaller. 24 25 CHAIRMAN ANGELIDES: All right. Let me move on, I want to talk about these super senior CDOs, 359 1 that the various tranches, but I want to see if I can 2 simplify them. 3 Georgiou I think made a good point. 4 pile of blank and taking stuff in the middle or the 5 bottom of that, and all of the sudden shoving it to 6 the top, and the lead becomes gold. 7 I mean, in the end, Commissioner You are taking a And I want to pick up on something that 8 Mr. Thompson said, just about intuitive. 9 clear you didn't really underwrite the underlying 10 collateral. 11 reported up to you or vice versa? 12 MR. BARNES: 13 CHAIRMAN ANGELIDES: 14 It is very I think it was -- was it Ms. Duke who Vice versa. You reported to Ms. Duke? 15 MR. BARNES: Right. 16 CHAIRMAN ANGELIDES: She said her comment 17 in an interview with us, we were seduced by 18 structuring and failed to look at the underlying 19 collateral. 20 So just reflecting on these CDOs, these -- 21 you know, you take an original loan with original 22 collateral, and just by way of background, I'm a real 23 estate person, so sticks and bricks is what I relate 24 to real value, real assets. 25 You take it through the next stage; it 360 1 securitizes as an RMBS. Now you take it to the next CDO, 2 and then you can have synthetic CDOs. 3 want to talk about the underlying value of these, 4 because the fact is, I don't know what kind of stress 5 test you did but here's just some basic facts. 6 `90 to `91, real home prices did drop nationwide in 7 this country by a cumulative 3 percent. 8 quarter of 2007, at which point these CDO super -- 9 super senior tranches are in free fall and market And I guess I From By the fourth 10 value, you write off 18 billion, but home prices have 11 only fallen 5 percent. 12 So I guess what I'm saying is, what was the 13 stress test? 14 from `90 to `91 at 3 percent, and I know I lived it. 15 I was in California and in the land development 16 business. 17 Was it never going down? They'd fallen So the question is how -- how stressful was 18 the stress test? 19 all the prices had dropped by the time you guys had 20 taken an 18-billion-dollar write-off. 21 Doesn't seem like much, 5 percent is MR. BARNES: Let me -- let me comment on 22 that, because I think, you know, one of the things, 23 and I referred to the Commissioner earlier about the 24 intrinsic cash flow model, and that was really the 25 first quarter was actually it was in October, I 361 1 believe, that -- that the initial loss, the 8- to 2 10-billion-dollar estimate of the fourth quarter was 3 disclosed. 4 And based on this model, based on an 5 assumed further decline in home prices, which was 6 produced out of our economics and market analysis 7 group, the bulk of the super seniors, I believe, all 8 of the liquidity puts which were backed by older 9 vintage collateral, did not break, in other words, 10 they -- they recovered a future value of par. 11 because we were required to mark to fair value under 12 the accounting standards and there really was no 13 market, it was really the -- the use of a very large 14 discount factor applied to those future cash flows 15 that contributed to that large write-down. 16 CHAIRMAN ANGELIDES: But Well, so here's the 17 problem with models, again having been in real estate, 18 you know, sometimes you can use your Argus models, but 19 at some point the lease either renews or it doesn't. 20 They either buy your lots or they don't. 21 doesn't sound like this was very binary and calculated 22 in this possibility. 23 did not calculate this in, correct? 24 25 MR. BARNES: And it I mean, that's obviously -- it And the bine- -- the binary reference is critical because this really is an 362 1 out-of-the-money option, which suddenly has -- has 2 zero intrinsic value to then suddenly has a 3 substantial loss associated with it. 4 5 CHAIRMAN ANGELIDES: But that happens in markets. 6 MR. BARNES: Yeah, and based on the market 7 surveillance that we got, the market was commanding a 8 very, very small premium across not just banks, like 9 ourselves, but other market participants, including 10 insurers and the mono lines. 11 In hindsight, we didn't -- we didn't 12 develop the models. 13 to the RMBS, but looked through to the underlying 14 rentals. 15 16 We didn't look through not only CHAIRMAN ANGELIDES: assets. 17 MR. BARNES: 18 CHAIRMAN ANGELIDES: 19 20 Right, the real The real factors -Both the real assets and the real borrowers. MR. BARNES: And the real factor that 21 actually drove the losses, which is something which is 22 extremely difficult to model, was the fact that it was 23 actually massive ratings downgrades, which because of 24 the underlying characteristics of the RMBS and 25 specifically the CDOs that were backed by RMBS, 363 1 altered the allocation of cash flows associated with 2 those downgraded securities. 3 effectively, these CDOs got starved of cash because 4 they were actually backed by these mezzanine tranches 5 of RMBS. 6 And, as a result, CHAIRMAN ANGELIDES: Right, right, which 7 were subordinate to the senior, which goes back to the 8 very nature of the product. 9 MR. BARNES: And that was something which 10 the industry didn't model well. 11 it's to some degree given the challenges that the 12 rating agencies have had, is rather behavioral. 13 they elected to downgrade securities by multiple 14 notches -- 15 CHAIRMAN ANGELIDES: 16 MR. BARNES: 17 CHAIRMAN ANGELIDES: And -- and -- and But lead does melt. I'm sorry? That's the point, lead 18 melts where gold doesn't, and so the underlying 19 collateral is a huge flaw in this. 20 When All right, let me ask this next question 21 about how things were booked. So here's a basic 22 question I have, and it really goes to how you booked 23 these assets, because it goes to how Citigroup was 24 able to report profits and executives were able to 25 take compensation. 364 1 I think we understand the fact that you 2 really couldn't sell these super senior tranches; 3 correct? 4 much. 5 No, you really -- and, well, you didn't sell MR. BARNES: I think in the case of the 6 liquidity puts, most of which predated my time and the 7 risk management group covering the business, but my 8 understanding was that it wasn't an intention to sell 9 the liquidity puts. But there were other deals where 10 the super seniors were sold to European banks, U.S. 11 banks, as well as bond -- 12 CHAIRMAN ANGELIDES: 13 MR. DOMINGUEZ: 14 MR. BARNES: 15 CHAIRMAN ANGELIDES: 16 17 trading volumes? At par? Yes. Yes. But what kind of Because here's my -- MR. DOMINGUEZ: The typical trade would be 18 very chunky. 19 buy 500 million in one transaction or a billion. 20 was -- it was common to do billion-dollar. 21 So, in other words, a -- a conduit would CHAIRMAN ANGELIDES: It Well, this is 22 something I think we can explore in a written 23 interrogatory, but here's my question: 24 these assets, and I guess in the spring of `07 for the 25 first time under that new FASB rules you did have to If you had 365 1 lay out your Level 1, your Level 2, your Level 3 2 assets, and these were Level 3 assets, correct, for 3 which there was no discernible market activity in 4 pricing? 5 But you booked them at a hundred percent, 6 which then of course allowed Citi until you did write 7 them down, to book profits, which then resulted in 8 compensation. 9 booking profits on these values. 10 So the organization in a sense is I have a basic question. I'll make it 11 simple for everyone watching this. 12 think is worth 200,000 but there's no market for it 13 and no one would pay me 200, it's not going to be 14 worth 200. 15 If I have a home I So I guess I would ask, and maybe if you 16 have a quick answer, how the heck did you book these 17 at par and keep them there so long? 18 MR. BARNES: I'm not an accountant but in 19 terms -- I have been involved in the -- in the 20 discussions around that, and from my standpoint, we 21 looked, as I said in my opening statement, we looked 22 at comparable analysis, and other deals were pricing 23 at similar levels. 24 We were able to -- we were able to buy 25 protection from bond insurers at very, very tight 366 1 spread levels, ten basis point spread levels. 2 And in the absence of an observable market 3 I think it is acceptable to use the most comparable 4 analysis that you can in what was always a very 5 illiquid and non-traded market. 6 CHAIRMAN ANGELIDES: All right. I think I 7 want to probe this, because I want to understand 8 whether across the industry, these things were booked 9 at levels that just weren't reflective of reality, 10 they were illiquid assets, they were put in Level 3, 11 and I -- and in -- and so I -- I -- I think we would 12 like to explore that, a couple -- 13 MR. MAHERAS: 14 CHAIRMAN ANGELIDES: 15 I think -Yes, go ahead, Mr. Maheras. 16 MR. MAHERAS: I think -- I think you said 17 that they were booked at par. 18 at par, my recollection is it's when these things were 19 trading at par, when there were observable quotes. 20 When they were booked I think what these gentlemen are referring 21 to is when the market stopped and there were no longer 22 observable, quote, trading activity. 23 began -- 24 25 CHAIRMAN ANGELIDES: that's what I would like to see. That's when they All right. Well, 367 1 MR. MAHERAS: There were other 2 methodologies to mark them which resulted in them 3 taking current markdowns. 4 CHAIRMAN ANGELIDES: Because the ABX does 5 start moving down slightly, but I would like to at 6 least look at where the ABX was. 7 Yes. Let me see if I can move quickly through 8 these. I want to just talk about risk, for a minute, 9 and then I have one final set of questions, members, 10 and that is, Mr. Bushnell or Mr. Dominguez, let me see 11 if I can get the right document here. 12 2006, your financial control group wrote a memo that's 13 addressed to you about liquidity puts, and they say, 14 the liquidity risk and the liquidity puts is the risk 15 that Citigroup must purchase the ABCP, the 16 asset-backed commercial paper, long-term notes that 17 cannot quickly be sold enough to prevent or minimize a 18 loss. 19 In October of Part of liquidity risk and liquidity puts 20 is the risk of a Citi downgrade, which can lead to 26 21 billion dollars in liquidity put exercises hitting our 22 balance sheet simultaneously, in this scenario 23 Citigroup is faced with severe concentration risk. 24 25 Did you do anything about that or look at that or -- 368 1 MR. DOMINGUEZ: 2 CHAIRMAN ANGELIDES: 3 Yes. Or at that point were you stuck? 4 MR. DOMINGUEZ: No, no, that -- that 5 working paper engendered a lot of discussion, 6 reexamination of how we were treating it. 7 many more people involved that were on that 8 distribution list. 9 There were And, again, it was decided that the -- the 10 product was priced appropriately, it was marked 11 appropriately, because we were seeing products that 12 had as many comparable elements, sufficient comparable 13 elements, at tighter levels than that. 14 And again, as I said before, the credit 15 risk component was marked as if it was already on the 16 books. 17 CHAIRMAN ANGELIDES: All right. Here's the 18 final set of questions. 19 Mr. Bushnell, I am going to submit some questions to 20 you. 21 on October 30th, `07, internally, and it was a 22 presentation to the board of directors. 23 And I just want to tell you, You made a presentation, just to let you know, And so I am going to ask some questions for 24 you about that presentation, which was basically 25 review of the current environment, and I do want to 369 1 ask you, so you might begin preparing. 2 a bunch of significant events, like HSBC announcing 3 losses associated with mortgage delinquencies, the 4 Bear Stearns asset management funds having their 5 problems, and I really would like to get a picture 6 as these things happened in `07 what you did to react 7 to those, so I'll get that to you. 8 9 You had noted But here's my final question, and I would like to see if anyone would like to comment on it. 10 want to understand the timeline, and these are 11 questions I will pose to Mr. Prince and Mr. Rubin 12 tomorrow. 13 14 I June 30th, as I understand it, you still have everything marked, correct, at par? 15 MR. BARNES: Par. 16 CHAIRMAN ANGELIDES: All right. On July 17 20th, in an earnings call, your CFO, Mr. Crittedon, 18 basically tells the world you have 13 million dollars 19 in subprime exposure. 20 On October 15th, on an earnings call, it's 21 announced, and I believe it's -- I can't remember who 22 made the announcement -- but, again, Citigroup has 13 23 billion dollars of exposure and then, of course, on 24 November 4th, it's, whoops, we've got 55 billion. 25 At what point did senior management know 370 1 that 13 had become 55? 2 senior, but when did someone else above CEO level/board -- 3 know that 13 had become 55. 4 MR. BUSHNELL: No one? I mean, you are If my recollection goes into 5 that, it comes into the definition of exposure and 6 what we thought was possibly a loss. 7 presentations to senior management, certainly the 8 super senior numbers was not included in the July 9 number that you've referenced there. 10 So I think that And we started to have discussions with 11 that in early September in terms of a senior 12 management standpoint. 13 tutorials and updates that struck me as late 14 September, maybe the first week in October. 15 And we had some board CHAIRMAN ANGELIDES: Is it fair to say that 16 the CEO and the board did not know about the liquidity 17 puts and the direct senior exposure, senior -- super 18 senior exposure prior to that September time period? 19 MR. BUSHNELL: 20 CHAIRMAN ANGELIDES: 21 different recollection? 22 MR. MAHERAS: I think that's fair. Anyone have a My recollection is pretty 23 close to David's, except I -- I think I recall hearing 24 about the exposure sometime in August and immediately 25 elevated it. I can't tell you if it's August or late 371 1 August or early September, but it would be around that 2 month, you know, within a month of David's 3 recollection. 4 5 CHAIRMAN ANGELIDES: MR. DOMINGUEZ: 10 I'm not involved in those discussions. 8 9 I assume you have nothing to add? 6 7 Okay. CHAIRMAN ANGELIDES: Those are all my questions. Okay. All right. Any other Commissioners have anything that they want to put on the table? 11 Gentlemen, thank you very much for coming 12 today. We do appreciate your time and your answers 13 and we will have additional questions. 14 appreciate it all very much. 15 And we Thank you to the public, who has joined us 16 today, and thank you, the Commissioners, for all their 17 hard work. 18 until tomorrow morning at 9:00 A.M. 19 20 21 22 23 24 25 This meeting is recessed or adjourned (FCIC Hearing adjourned at 5:30 P.M.)
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