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1 1 2 THE FINANCIAL CRISIS INQUIRY COMMISSION 3 4 Official Transcript 5 6 Commission Hearing 7 Thursday, April 8, 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 DOUGLAS HOLTZ-EAKIN 18 HEATHER MURREN 19 JOHN W. THOMPSON 20 PETER WALLISON 21 22 23 24 25 Reported by: Pages 1 - 260 Cassandra E. Ellis, RPR 2 1 C O N T E N T S 2 SESSION 1: 3 CITIGROUP SENIOR MANAGEMENT 4 EXAMINATION OF CHUCK PRINCE and 5 ROBERT RUBIN PAGE 6 By Chairman Angelides 19 7 By Vice Chairman Thomas 36 8 By Commissioner Murren 50 9 By Commissioner Wallison 59 10 By Commissioner Georgiou 74 11 By Commissioner Holtz-Eakin 92 12 By Commissioner Born 106 13 By Commissioner Murren 113 14 By Commissioner Thompson 115 15 By Commissioner Wallison 121 16 By Vice Chairman Thomas 126 17 By Commissioner Angelides 129 18 By Vice Chairman Thomas 137 19 20 21 22 23 24 25 26 3 1 SESSION 2: 2 OFFICE OF THE COMPTROLLER OF THE CURRENCY 3 EXAMINATION OF 4 JOHN C. DUGAN, and 5 JOHN D. HAWKE, JR. PAGE 6 By Vice Chairman Thomas 152 7 By Commissioner Murren 156 8 By Commissioner Wallison 168 9 By Vice Chairman Thomas 183 10 By Commissioner Georgiou 185 11 By Commissioner Holtz-Eakin 202 12 By Vice Chairman Thomas 210 13 By Commissioner Holtz-Eakin 215 14 By Commissioner Thompson 216 15 By Commissioner Born 223 16 By Vice Chairman Thomas 231 17 By Commissioner Wallison 234 18 By Commissioner Georgiou 238 19 By Chairman Angelides 240 20 21 22 23 24 25 4 1 P R O C E D I N G S 2 CHAIRMAN ANGELIDES: Good morning. The meeting 3 of the Financial Crisis Inquiry Commission will come to 4 order. 5 the midst of three days of hearings on the issues of 6 subprime lending and securitization and how the subprime 7 origination phenomenon and securitization phenomenon may 8 have impacted our financial and economic crisis with which 9 we are dealing in this country today. As everyone who joined us yesterday knows, we are in 10 11 Yesterday we heard from Alan Greenspan, from the Federal Reserve, and from officials from Citigroup. 12 Today we are hearing, again, from officials from 13 Citigroup, both Mr. Rubin and Mr. Prince, and later today 14 from officials from the Office of the Comptroller of the 15 Currency. 16 this same cool, not really air-conditioned room, on Fannie 17 Mae and OFHEO. 18 And tomorrow we will continue our hearings in So, with that, I would like to begin our 19 hearing. We have two witnesses today, Mr. Chuck Prince, the 20 former chairman and CEO of Citigroup, and Mr. Robert Rubin, 21 the former treasury-secretary of the United States of 22 America as well as the chairman of the executive -- former 23 chairman of the executive committee of the board of 24 directors of Citigroup. 25 with us here this morning. Thank you, gentlemen, for being 5 1 What I would like to do, to start off, as we are 2 doing with all witnesses who appear before us in the course 3 of our hearings, both before you and after you, is we are 4 customarily swearing every witness in. 5 would like to ask each of you, both of you, to please stand 6 up so that I can swear you in front of the Commission. 7 Thank you. 8 9 So, with that, I Do you solemnly swear or affirm, under penalty of perjury, that the testimony you are about to provide the 10 Commission will be the truth, the whole truth and nothing 11 but the truth, to the best of your knowledge? 12 MR. PRINCE: Yes, sir. 13 MR. RUBIN: 14 CHAIRMAN ANGELIDES: 15 Gentlemen, you have provided us with written Yes. Thank you, very much. 16 testimony, which we have in hand. 17 of you, this morning, to provide us with oral testimony 18 of -- not to exceed ten minutes. 19 And I'm going to ask each And so, with really no further ado, Mr. Prince, 20 I will ask you to start this morning. 21 microphones and pull them as closely to you as you can and 22 let's commence. 23 Mr. Prince? 24 MR. PRINCE: 25 Thank you. Please turn on the Chairman Angelides, Vice Chairman Thomas, members of the Commission, let me 6 1 start by saying I'm sorry. 2 crisis has had such a devastating impact on our country. 3 I'm sorry for the millions of people, average Americans, who 4 have lost their homes. 5 team, starting with me, like so many others could not see 6 the unprecedented market collapse that lay before us. 7 I'm sorry that the financial And I'm sorry that our management I was the CEO of Citigroup from October 2003 8 until November 4, 2007. Before becoming CEO, I held various 9 positions in Citi's senior management. For nearly 30 years 10 until November 4, 2007, when I resigned, Citi and its 11 predecessors was my professional life. 12 I have given a great deal of thought to the 13 unique events that led to the financial crisis and which 14 brings us here today. 15 which I believe are important to set the context for the 16 problems that arose at Citi as well as many other financial 17 institutions and eventually led to Citi's receipt of 18 government assistance. 19 I wanted to share some of my views, The financial crisis resulted from a confluence 20 of several factors, the absence of any of which would likely 21 have caused the crisis to be averted or significantly 22 moderated. 23 First was the unusually long period of low 24 interest rates, stemming from a change in the pattern of 25 global funds flows following the 1998 emerging markets 7 1 financial crisis, as well as the stimulative actions of the 2 Federal Reserve Board, following the bursting of the tech 3 bubble and the terrorist attacks of 9/11. 4 As a result, investors were reaching for yield, 5 and many people from investors to traders to rating agencies 6 to regulators believed that a new era of generally lower 7 risk had begun. 8 9 During this period, securitized products, as an asset class, grew dramatically in an effort to satisfy 10 investor demand for products that had higher yields but were 11 still believed to have a high degree of safety. 12 The growth in securitized products also 13 reflected a growing belief in and reliance on financial 14 modeling by traders as a basis for risk decisions and a 15 growing reliance on rating agency determinations by 16 investors. 17 As a result of the rapid growth and demand for 18 assets to be securitized, together with longstanding and 19 bipartisan federal policies encouraging the expansion of 20 home ownership, the asset class of subprime mortgages grew 21 very quickly. 22 The patchwork nature of state regulation of the 23 origination of subprime, indeed of all mortgages, led in 24 hindsight to the origination of more and poorer-quality 25 subprime assets to be securitized. 8 1 Eventually the rating agencies dramatically 2 downgraded their ratings on the securitized products 3 collateralized by these subprime loans. 4 The precipitous nature of the actions by the 5 rating agencies, together with the widespread holdings of 6 these securities, caused a broad and generalized freezing of 7 the securities markets as investors could no longer be sure 8 what standards and models of risk and safety could be relied 9 upon and who held what levels of risk. 10 This general freezing of the credit markets then 11 precipitated a severe contraction of trade that led to the 12 general recession that still afflicts us. 13 It is against this backdrop that the events at 14 Citi and of many other banks and financial institutions took 15 place. 16 estimated 8 billion to 11 billion dollars in write-downs 17 related to subprime-related holdings. 18 resigned as CEO. 19 Specifically, on November 4, 2007, Citi announced an That same day, I After I left, Citi incurred even greater losses, 20 which eventually lead Citi to receive over 45 billion 21 dollars in Federal TARP funds. 22 doubt already aware, the largest losses at Citi emanated 23 from what were perceived at the time to be extremely safe, 24 super senior tranches of CDOs that carried the lowest 25 possible risk of default. As the Commissioners are no 9 1 It bears emphasis that Citi was by no means 2 alone in this view and that everyone, including our risk 3 managers, government regulators, other banks and CDO 4 structurers, all believed that these securities held 5 virtually no risk, a perception strongly reinforced by the 6 above Triple-A-rating bestowed by the rating agencies. 7 Citi's write-downs on these specific securities 8 totaled some 30 billion dollars over a period of six 9 quarters. And I believe it is fair to say that this factor 10 alone made a substantial part of the difference between 11 Citi's ultimate problems and those of other banks. 12 While I was not aware of the decisions being 13 made on the trading desks to retain these super senior 14 tranches, given the universal perception that these super 15 senior positions were extremely low risk, it is hard for me 16 to fault the traders who made the decisions to retain these 17 positions on Citi's books, having 40 billion dollars of 18 Triple-A-plus-rated paper on the balance sheet of a 19 2-trillion-dollar company would not raise a concern. 20 Moreover, it is important to appreciate that the 21 CDO business, which was a small part of a large and complex 22 financial organization, was being managed by highly 23 experienced traders and risk managers and was fully 24 transparent to our regulators who were embedded across the 25 company. 10 1 In retrospect it turned out that that risk 2 assessment, while widely held, was dramatically wrong given 3 the wholly unanticipated and significant collapse in 4 residential real estate values across the board in nearly 5 every community and geographic location nationwide and 6 across many parts of the world. 7 In that context, let me say something about 8 risk. I always believed that the risk function at Citi was 9 a critical part of our overall business. After becoming 10 CEO, one of the very first things I did was to name David 11 Bushnell as the chief risk officer of the company and to 12 change the reporting structure so that the risk function was 13 then completely independent of the businesses which it was 14 not before. 15 The risk professionals were not paid on profits, 16 were not paid on volumes or revenues of the business units, 17 and I believe that that was good governance, and I believe 18 that we were ahead of best practices at that time. 19 Mr. Bushnell was known as one of the most 20 sophisticated risk managers in the investment banking 21 community, with a strong hands-on trading background. 22 As serious issues unfolded in the late summer 23 and fall of 2007 relating to the subprime market and our 24 lower-rated CDO holdings as well as certain other 25 businesses, such as leveraged lending, our senior management 11 1 was fully focused on the unprecedented issues the company 2 faced. 3 to apprise the board members of the issues as they developed 4 in real time and to solicit their valuable advice and 5 counsel. 6 We had multiple special board and committee meetings Regrettably, we were not able to prevent the losses 7 that occurred, but it was not a result of management or 8 board inattention or a lack of proper reporting of 9 information. 10 The lessons learned from this experience are 11 many, but let me address two issues that seem to come up 12 repeatedly when discussing Citigroup. 13 fail? 14 15 16 Is Citi too big to And is it too big to manage? These are separate but related questions as you know. Let me start with the latter. I personally do not think Citi was too big to 17 manage, to be sure, it was a challenge, but we made enormous 18 strides during my tenure to improve the way in which the 19 various parts of Citi work together. 20 company as a whole was much better for it. And I think the 21 In any event, I do not think that the broad, 22 multifaceted and diversified nature of Citi's businesses 23 materially contributed to our losses or to the financial 24 crisis more generally. 25 focused firms suffered in similar ways. Indeed, smaller, more narrowly 12 1 To the contrary, I continue to believe that Citi 2 is a unique institution. 3 U.S.-based bank, a feature that gives it great advantages in 4 many of its businesses and around the globe. 5 It is the only truly international Now, too big to fail is a harder issue. My own 6 view is that we are past the days of exclusively small 7 local-based banks and financial institutions. 8 local institutions certainly have a place in the financial 9 landscape, the financial world we live in is complex, While these 10 interconnected, and global. 11 sophisticated, global, and diversified financial 12 institutions. 13 good for the United States to have a financial system with a 14 failure or threatened failure of key financial institutions 15 will impose the kind of dramatic and near catastrophic 16 damage on the entire financial system and the national world 17 economy that we saw when Lehman failed and when numerous 18 other financial institutions, including Citi, needed 19 extraordinary government assistance. 20 And I think this demands That said, I certainly do not believe it is We must find a solution to this problem, whether 21 through resolution authority, greater regulation, increased 22 capital requirements, or all of the other creative and 23 innovative measures that your Commission has been 24 discussing. 25 Thank you for your time and I'm happy to answer 13 1 your questions. 2 3 CHAIRMAN ANGELIDES: Mr. Prince. 4 Thank you very much, Mr. Rubin? MR. RUBIN: Thank you, Mr. Chairman. 5 Mr. Chairman, Mr. Vice Chairman, distinguished members of 6 the Commission, I, too, along with Chuck Prince appreciate 7 the opportunity to testify today. 8 9 The financial crisis, as we all know, has taken a terrible toll on millions of Americans who have lost their 10 homes, their jobs, their savings, and their confidence in 11 the future of our economy. 12 of the crisis is essential to protecting our nation's 13 economic future and to effective financial reform. 14 Better understanding the cause I hope that my experience at Goldman Sachs, the 15 National Economic Council, the Treasury Department, 16 Citigroup, and this chair of LISC, our nation’s largest 17 inner-city development organization can be helpful to this 18 inquiry. 19 Let me make two observations that I believe are 20 relevant to the Commission's work. 21 problems with the benefit of hindsight can be highly useful. 22 During my time at Treasury, we dealt with the Mexican 23 financial crisis and then later the Asian financial crisis. 24 25 First, examining And while, in both cases, our approaches on balance were successful, we still learned an enormous amount 14 1 from looking back at what happened. 2 Second, as policymakers address financial 3 reform, it is important to remember that our national 4 economic policies have enormous effect on all of us. 5 example, President Clinton undertook deficit reduction and 6 made critical public investments, and those policies, in my 7 view, contributed greatly to the longest economic expansion 8 in American history. 9 For Simply put, policy matters. With those thoughts in mind, let me turn to the 10 causes of the financial crisis. 11 some time, prior to the crisis, that markets including the 12 market for credit had gone to excess and that those excesses 13 would at some unpredictable point lead to a cyclical 14 downturn, this is not what happened. 15 While I had thought for Instead, we experienced the most severe 16 financial and economic crisis in 80 years. 17 crisis was not the product of a single cause but rather the 18 product of an extraordinary combination of powerful factors 19 operating at the same time and feeding on each other. 20 In my view, that Let me name just a few of those factors: Market 21 excesses; low interest rates most notably due to large 22 capital inflows from abroad, which contributed to excessive 23 risk taking by lenders and excessive borrowing by businesses 24 and consumers; a sharp rise in housing prices, which also 25 contributed to increased consumer leverage; a subsequent 15 1 precipitous drop in housing prices; vast increases in the 2 use and complexity of derivatives; misguided Triple-A 3 ratings of subprime mortgage-based instruments; lax and too 4 often abusive mortgage lending practices; shortfalls in 5 regulation; high levels of leverage in financial 6 institutions joined with deteriorating asset quality in 7 asset purchases and much else. 8 9 There were a few market participants or analysts who saw the broad picture and the potential for a 10 mega-crisis. 11 factors. 12 involved in the financial system, that is to say, financial 13 firms, regulators, rating agencies, analysts, and 14 commentators missed the powerful combination of factors that 15 led to this crisis and the serious possibility of a massive 16 crisis. 17 this, and I deeply regret that. 18 A larger number saw one or a few of these But almost all of us, including me, who were We all bear responsibility for not recognizing Let me now turn to Citigroup more specifically. 19 My role in Citi, defined at the outset, was to engage with 20 clients across the bank's businesses here and abroad, to 21 meet with foreign public officials for bank presence in 102 22 countries, and to serve as a resource to the bank's senior 23 management with respect to strategic and managerial matters. 24 25 Having spent my career in positions with significant operational responsibility, at Treasury and, 16 1 prior to that at Goldman Sachs, I no longer wanted such a 2 role at this stage in my life. 3 provided that I'd have no management of personnel or 4 operations. 5 And my agreement with Citi I remained with Citi until January of 2009, and 6 so wasn't present when Citi's problems occurred. 7 view, there were two primary causes of these problems. 8 First, Citi, like other financial institutions, suffered 9 large losses due to the financial crisis. 10 In my I am told that Citi has subsequently analyzed 11 the data made available in connection with the 2009 stress 12 tests and has estimated that the losses of Citi's businesses 13 other than CDOs were roughly comparable to peer firms. 14 Second, Citi suffered distinctively high losses 15 as a result of its retention of so-called super senior 16 tranches of CDOs. 17 I first recall learning of these super senior 18 positions in the fall of 2007 during discussions convened by 19 Chuck Prince with the most senior management of Citi to 20 discuss what by then was considerable turmoil in the 21 fixed-income markets. 22 In a presentation on the fixed-income business, 23 I learned that Citi's exposure included 43 billion dollars 24 of super senior CDO tranches. 25 The business and risk personnel involved advised 17 1 these CDO tranches, related to Triple-A-plus, and had 2 de minimus risk. 3 was that the CDO business was an arbitrage activity and that 4 I believed, perhaps because of my arbitrage background, that 5 these CDO transactions were not completed until the 6 distribution was fully executed. 7 My view, which I expressed at the time, Having said that, it is important to remember 8 that the view of the securities to be retained was developed 9 at a time when Triple-A securities had always been 10 considered "money good." 11 Moreover, these losses occurred in the context 12 of a massive decline in home sale prices or rather in home 13 real estate market prices that almost no financial models 14 contemplated, including the rating agencies, Citi's, or to 15 the best of my knowledge, the regulators. 16 The board required and received extensive 17 financial and risk reporting but I do not recall knowing 18 before September `07 that these super senior tranches were 19 on our books. 20 believed in good faith that more senior-level consideration 21 of these particular instruments was unnecessary, because as 22 I said a moment ago, the positions were rated Triple-A and 23 appeared to bear de minimus risk. 24 25 I feel confident that the relevant personnel In October the rating agencies substantially downgraded these securities and subsequently Citi estimated 18 1 that it would have a loss of 8 to 11 billion dollars. 2 When these losses or estimated losses were 3 announced, Chuck Prince decided to step down, Win Bischoff 4 became CEO, I stepped in as chairman of the board, and I 5 worked with employees, clients and others to stabilize the 6 bank, to assist in raising capital during a very difficult 7 period and served on the CEO search committee that led to 8 the selection of Vikram Pandit. 9 Ultimately, Citi took 30 billion dollars in 10 losses on its super senior CDO positions. 11 a substantial cause of the bank's financial problems and led 12 to the assistance of the United States government. 13 These losses were I believe that the overriding lesson of 14 financial crisis was that financial system is subject to far 15 more severe downside risk than almost anyone had foreseen. 16 I believe, too, that it is imperative in light of that 17 lesson that private institutions and the government act. 18 Citi, first under Chuck Prince and then under Vikram Pandit, 19 implemented major personnel changes, restructured and 20 improved risk management, and raised huge amounts of 21 capital. 22 The private solutions are only part of the 23 answer. Financial reform is imperative and should include, 24 one, substantially increased leverage constraints, with one 25 tier based on risk models and a second tier based on 19 1 simpler -- simpler metrics, because models cannot capture 2 all of reality. 3 Two, derivatives regulation - I reflected my strong 4 views from my time at Goldman Sachs, that derivatives can 5 create serious systemic risk and that appropriate regulation 6 is needed, a subject I also discussed in my 2003 book. 7 8 Three, resolution authority to avoid the moral hazard of too big to fail. 9 And four, consumer protection, primarily and 10 very importantly to protect American consumers but also to 11 protect the financial system. 12 With that, I appreciate the opportunity to share 13 my views and would be happy to respond to your questions. 14 Thank you. 15 CHAIRMAN ANGELIDES: Thank you, Mr. Rubin and 16 Mr. Prince. 17 you being here today; we appreciate your willingness to help 18 us in our endeavor. 19 you, thank you for your years of service to the country. 20 And let me just reiterate again, we appreciate And Mr. Rubin, let me also just say to So, with that, we are now going to begin a 21 period of questioning by Commissioners, and, as Chairman, I 22 will start off with some questions for both of you and each 23 of you. 24 25 So I want to pick up on your comment, Mr. Prince, about whether or not this institution was too 20 1 big to manage, too complex to understand, perhaps too big to 2 regulate. 3 Really, for the benefit of people watching 4 today, it appears as though that there are about 51 billion 5 dollars in write-offs related to subprime lending. 6 institution, as I understand it, is one that went from about 7 670 billion dollars in assets in about 1998 to 2.2 trillion 8 dollars on balance sheet, another 1.2 trillion dollars 9 off-balance-sheet by 2007. By 2008, the tangible common 10 equity-to-assets ratio we estimate at 61 to 1, with 11 off-balance-sheet 97 to 1. 12 The I really want to ask both of you some very 13 specific questions that get to the heart of the management, 14 the risk of the organization, particularly around subprime 15 lending. 16 Mr. Rubin, I'm going to start with you. On November 17th of 2007, there was a meeting 17 between executives of Citigroup, including yourself, and you 18 were there briefly, I believe, at the meeting, and then 19 Mr. Bushnell was at the balance of the meeting. 20 meeting with the senior supervisors from the Federal Reserve 21 Bank of New York, the Federal Reserve board, the OCC, the 22 SEC, the UK FSA. 23 This was a And at that meeting, there are notes about Mr. 24 Bushnell's assessment of what he thought had gone wrong. 25 And he mentioned, among other things, and I might add these 21 1 are notes, not his exact words, poor communication across 2 businesses, decentralized nature of firm, senior management 3 business line and risk management did not fully appreciate 4 the market risk of the leverage loan pipeline to the 5 retained super senior CDOs. 6 Corporate-wide stress testing scenario analysis 7 was insufficient. 8 consolidated understanding of its risk sensitivity factors. 9 The nature and origin and size of the CDO exposure was 10 11 The firm did not have adequate firm-wide surprising to many in senior management. So as you look at some of those comments, do you 12 think those are a fair reflection? 13 organization did become too big to manage, the internal 14 controls did break down, Mr. Rubin? 15 MR. RUBIN: Do you believe that the I think, Mr. Chairman, that if you 16 look at Citi prior to the crisis erupting, that David 17 Bushnell ran, at least my impression, ran a very effective, 18 independent risk management capability. 19 But what David did, as I understand it, and I do 20 remember being a part of that meeting; I don't think I was 21 there for the whole meeting. 22 it seems to me, is after the crisis emerged -- and when I 23 ran Goldman Sachs, we did this every time we had trouble -- 24 he looked back on what he could learn from the circumstances 25 that existed. What David did, and rightly, 22 1 And while I don't remember the specific comments 2 that you just made I do remember that there was a conclusion 3 that Citi could do a better job bringing together the risk 4 exposures across the various product areas and David's 5 obsessive function focused more on that. 6 Well, I guess my answer, Mr. Chairman, is I 7 don't believe that Citi is too big to manage. But I do 8 think that every time you go through, in this case it was a 9 crisis at Citi, but when I was running Goldman Sachs or 10 involved in co-managing Goldman Sachs, we had times we had 11 very, very difficult developments in the trading areas. 12 every time that happened, we would look back and we would 13 learn how to try to do things better. 14 what David was doing in the comments or, rather, was 15 reflecting in the comments that you just repeated. And And I think that was 16 CHAIRMAN ANGELIDES: All right. Let me ask you 17 a related question, Mr. Prince. 18 I'll try to move back and forth between the two of you. For the sake of efficiency, 19 On October 30th Mr. Bushnell made a 20 presentation, I believe to the board, of course I'll verify 21 that, but the essence of this is he had a timeline of key 22 events in the subprime market. 23 certainly senior management. 24 of 2007, that HSBC had announced major mortgage 25 delinquencies and losses related to that; on 6/12, June In fact, I believe it was to He noted that on February 27th 23 1 12th, my birthday, 2007, Bear Stearns' outside management, 2 it was announced that their funds were in significant 3 problems. 4 5 I knew you would want to know my birthday, Mr. Vice Chairman, so you could note it on your tickler. 6 7 On July 10th, S&P and Moody's announced significant CDO ratings changes and major downgrades. 8 9 10 On August 10th, BNP Paribas froze its funds, and for the first time Countrywide announced significant problems. 11 Mr. Prince, I would ask you, because both you 12 and Mr. Rubin have said you really became aware, and 13 Mr. Rubin did in September and I think you said the same 14 thing, of problems in the CDO desk. 15 happened, why didn't the potential of problems rise to the 16 top in the wake of these major announcements? 17 bubble up? 18 MR. PRINCE: When all these things Why didn't it Well, Mr. Chairman, I think you 19 have to go back to the time in question. So much has 20 happened since then that it's a little hard to put yourself 21 back in the timeframe of what just happened. 22 speak for what people must have been thinking, because I 23 obviously didn't know about the CDO positions and the 24 timeframes that you're talking about. 25 hindsight that people believed, and they believed with a And I can only But I believe in 24 1 level of certainty that it's hard to appreciate today, that 2 the super senior tranches would never be touched by these 3 problems. 4 were for the lower level, the not super senior tranches. 5 So the various rating changes you talked about Now again, sitting here today, that belief looks 6 pretty unwise, but I think at the time, Moody's was quoted 7 as saying that these problems would never reach the super 8 seniors. 9 process had gotten to a point where that top level would be And I think people believed that the structuring 10 immune from the problems that were being seen at the lower 11 levels. 12 And I'm not saying that's right; it obviously 13 turned out to be wrong, but I believe that's what they 14 believed at the time. 15 CHAIRMAN ANGELIDES: Well, let me probe that a 16 little, because Mr. Georgiou raised this yesterday. 17 very nature of the CDOs, which is they were a, essentially, 18 a collection of the lower tranches of the residential 19 mortgage-backed securities. 20 The And I -- I want to attribute this to 21 Mr. Georgiou that there was an element here of taking lead 22 and turning it into gold. 23 tranches that if you add a pile of stuff, and that's 24 probably a charitable description, you take the lower stuff, 25 now you put it at the top, and all of a sudden, that's You had a number of lower-rated 25 1 highly rated. 2 Interestingly enough, by the fourth quarter of `07, 3 housing prices had only fallen 5 percent. And just for 4 reflection, in `90, `91, on a cumulative basis in this 5 country, housing prices had fallen 3 percent, of course 6 particularly driven by places where I lived, California, 7 Florida, Texas. 8 written down 18 billion. 9 senior tranches were touched fairly quickly because, in But by that fourth quarter, you had already So clearly those super 10 essence, they weren't truly the Triple-A. 11 elevated in that structure. They were 12 So I guess the related question is, to what extent 13 did you ever do any at the board level, and I know you said 14 at one point, which I think reflects on the scale of the 15 institution, that putting on a 2-trillion-dollar balance 16 sheet 40 billion dollars of a Triple-A-rated zero risk paper 17 that that would not have in any way excited my attention. 18 At any point did either of you gentlemen look at 19 the nature of these instruments and say, I'm troubled about 20 the nature of taking this subpar stuff and rating it at the 21 top? 22 analysis of the underlying collateral? 23 Did you ever do the analysis, essentially, the hard MR. RUBIN: Mr. Rubin? Mr. Chairman, and I'll reflect back, 24 if I may, just in response to your question, for a moment, 25 on the days when I ran Goldman Sachs. 26 1 When you're running a large organization, or I'd 2 say even a medium-sized organization, what you can do is you 3 can look at the people you have in place, you can look at 4 the aggregations of risk, which the Citi had done very well 5 by David Bushnell, but there isn't a way in an institution 6 that has hundreds of thousands of transactions a day and 7 probably something over a trillion dollars a day running 8 through it, that you're going to know what's in those 9 position books. 10 And I didn't know it when I was running Goldman 11 Sachs, and you wouldn't know it sitting on the board of Citi 12 either. 13 there to bring you problems when they -- when they exist. 14 You really are depending on the people who are In this case you're talking about a level of 15 granularity that no board will ever have with respect to the 16 positions that are in -- that are in its books, which is why 17 a board has such a strong responsibility to make sure that 18 they have the right people in the right places. 19 CHAIRMAN ANGELIDES: Not to interrupt, you did 20 have weekly business meetings, which you both attended, of 21 the business heads. 22 23 24 25 MR. RUBIN: Yeah, but the business heads -- absolutely correct. CHAIRMAN ANGELIDES: And it does seem to me, I know that 40 billion dollars may sound like chump change in 27 1 this organization, but it seems to me like a fairly 2 significant initiative to have 40 billion dollars of 3 exposure. 4 I mean, it's not that it's so -- and I might 5 add, you know, in the RMBS arena, I think you guys were 6 doing about 90 billion dollars' worth of securitization, you 7 weren't light in this arena. 8 depth of strategic discussion around the positions and 9 mortgage-backed security and the underlying collateral. 10 11 MR. RUBIN: So I'm just curious about the Yeah, but if I may say something, Mr. Chairman? 12 CHAIRMAN ANGELIDES: 13 MR. RUBIN: Yeah. We had the strategic discussions 14 about, at the business heads meetings, about P&Ls and the 15 operation of the business one thing or another. 16 individual positions only came to that meeting when either 17 independent risk management or the people running the 18 businesses felt that there were problems. 19 But And in this case, they were dealing with, as we 20 now discussed many times, Triple-A securities that were 21 deemed to be de minimus in risk. 22 brought to that meeting. 23 And these simply were not If I had to make a guess, and I do not know, my 24 guess is that the people who structured these did a 25 probabilistic analysis and determined that even though as 28 1 you correctly say, the individual securities within them 2 were not of the quality of the totality if you will, that 3 with the structures that they had, that the risk became 4 de minimus. 5 I seem to remember, because they not only depend 6 on the Triple-A as you know, they did a lot of their own 7 independent work. 8 much more recently, that they calculated the risk for 9 something like one in 10,000. 10 11 12 13 14 And I seem to remember seeing someplace, CHAIRMAN ANGELIDES: models showed. Well, that's what their Yeah. MR. RUBIN: Yeah, what their models shows, and it's sort of -CHAIRMAN ANGELIDES: But I really question the 15 models if you only have a 5 percent price drop, you write 16 off 18 billion. 17 MR. RUBIN: Look, there's no question, 18 Mr. Chairman, that once developments became or started to 19 become adverse the -- these securities got -- incurred 20 considerable difficulty. 21 there were real problems. 22 as of the time that these positions were taken and as they 23 were seen at that time. 24 25 And, in hindsight, obviously, But I was trying to speak of them CHAIRMAN ANGELIDES: Let me ask you a couple of quick yes-or-no questions to move along here. 29 1 You had, Mr. Prince, you -- you indicated you 2 had about 11 billion dollars' worth of warehouse lines out 3 to subprime originators. 4 MR. PRINCE: I'm sorry? 5 CHAIRMAN ANGELIDES: Eleven, you had about 6 11 billion dollars, you've acknowledged in your interview 7 with us that you became aware fairly late in the game, you 8 said, I found out at the end of my tenure -- this is about 9 the 11 billion dollars in warehouse lines that supported 10 some very aggressive subprime lenders, about 26 of them, and 11 you said, I did not know before, I think getting that close 12 to the origination function, being that involved in the 13 deracination of some of these products is something I wasn't 14 comfortable with. 15 Mr. Rubin, did you know that the bank had a very 16 significant 11-billion-dollar extension of credit to very 17 aggressive subprime lenders? 18 had awareness? Is that something of which you 19 MR. RUBIN: 20 whether I knew at the time or not. 21 don't, Mr. Chairman. 22 I certainly don't remember today CHAIRMAN ANGELIDES: I honest -- I truly Let me ask you, Mr. Rubin, 23 one more question specifically, and I want to go to one 24 final issue before I, at least at this point, turn to the 25 other members. 30 1 Yesterday we had before us Mr. Bowen, who was, I 2 believe, chief risk officer, his title, he was in the 3 business underwriting unit in the risk function. 4 He had -- had tried unsuccessfully to get his 5 superiors to move on some concerns he had, and then on 6 November 3rd, `07, sent you an e-mail. 7 about the inaccurate adequacy of the sampling size for loans 8 that Citi was buying and then selling to Fannie and Freddie. 9 He was concerned The sample size, according to your policy, 10 should have been 5 percent. 11 2 percent. 12 percent of the sample files failed to meet the minimum 13 contractual underwriting criteria of the originator or had 14 information missing and a fail rate that was not accurately 15 being reported. 16 to 80 percent. 17 It was consistently less than But in addition to that, he found that 40 to 60 He also found that that failure rate rose Did you ever act -- that was sent to you, 18 Mr. Bushnell, and I believe some other individuals. 19 ever -- it was sent to, yes, you, by Mr. Bushnell, 20 Mr. Crittendon, and Ms. Howard. 21 MR. RUBIN: Did you Did you ever act on that? Mr. Chairman, I do recollect this 22 and that either I or somebody else, and I truly do not 23 remember who, but either I or somebody else sent it to the 24 appropriate people, and I do know factually that that was 25 acted on promptly and actions were taken in response to it. 31 1 CHAIRMAN ANGELIDES: All right. Could you 2 please get us, back to us, perhaps, you know, you and/or the 3 people existing at the company today, back to the Commission 4 exactly how Citi responded and when it responded and what it 5 did? 6 MR. RUBIN: I would be very happy to, and I 7 believe legal counsel at Citi has -- in fact, I know they 8 do, has that information. 9 CHAIRMAN ANGELIDES: All right, last set of 10 questions for you before I yield the right to go on to other 11 members, and I will come back at the very tail end, but I 12 want to ask you about sequence of events, and here they are. 13 Both of you have said that you didn't become 14 aware of the CDO exposures until September, I believe. 15 as I understand by looking at documents, by looking at the 16 interviews you did with our staff, that you learned in early 17 September, which point you started, Mr. Prince, a series of 18 meetings and, later, nightly calls that became known as the 19 Defcon calls. 20 And I think the first meeting was on September 9th. 21 Mr. Rubin was in Korea, but he was in touch by e-mail. 22 then, Mr. Rubin, you joined these I guess very extensive 23 calls that happened over time. 24 25 And And And I think you said, Mr. Rubin, on September 12th, when the CD -- CDOs really become a focus of your 32 1 discussions, but here's -- I want to just ask you about a 2 sequence here. 3 On October 1st, Citigroup preannounces its 4 third-quarter earnings, and I believe indicates a 5 13-billion-dollar exposure to subprime, including a 6 billion-dollar write-down related to subprime-related CDOs. 7 On October 11th, there's some rating agency downgrades. 8 MR. RUBIN: What was that date, Mr. Chairman? 9 CHAIRMAN ANGELIDES: I believe October 11th, the 10 second date. 11 Apparently you became aware mid-September; October 1st, you 12 announce that you are announcing your exposure's 13 billion, 13 but here's what happens, at least according to records I've 14 seen, and I certainly will give an opportunity for you and 15 your folks to review these to make sure we have the 16 chronology right, and maybe I should ask the question. 17 But then here's what I want to ask you about. It appears that on October 15th, two things 18 happened. 19 in which Mr. Crittendon tells analysts and the public that 20 Citigroup has a 13-billion-dollar subprime exposure. 21 The first is that there is a call with analysts However, on the same day, a presentation is made 22 to the corporate audit and risk management committee and 23 then to the board of directors, and as part of that there's 24 a presentation on risk management, and it says, quote, the 25 total subprime exposure in markets and banking was 33 1 13 billion dollars, with an additional 16 billion dollars in 2 direct super senior, and 27 billion dollars in liquidity and 3 par puts. 4 So on the same day that the public's being 5 informed it's 13 billion, the board and the audit committee 6 are being told that this adds up to, frankly, more than 50 7 billion, I believe 55 is the total math here roughly, at 8 which point, on November 3rd, you have an emergency board of 9 directors, and on November 4th you announce the 55 billion 10 dollar exposure, and Mr. Prince, I believe that's the day in 11 which you announce your resignation. 12 I guess what I want to ask is, why is there an 13 announcement made to the public that it's 13 billion at the 14 same time that that board and the audit, risk and audit 15 committee, are being told that it's substantially more? 16 I think, Mr. Prince, I'll ask you and then Mr. Rubin. 17 MR. PRINCE: And Well, Mr. Chairman, I think that 18 you've asked a very detailed factual question referring to 19 documents and presentations and so forth, and I would have 20 to look at those and compare them pretty carefully to answer 21 it in the level of detail in which you've asked it. 22 think that at the time, the financial people were working 23 very intensely with the fixed-income people to try to 24 determine exposures in this area. 25 But I This was an unprecedented time in which markets 34 1 were crashing and rating agencies were pulling supports out 2 of longstanding structures. 3 their view of what the exposure was to subprime changed 4 during that period of time as these events happened. 5 And I think that the -- that Now, you just quoted from a presentation. And 6 it sounds to me as if, just listening to what you read, that 7 the presentation was structured in a way to say that our 8 subprime exposure was X, but don't forget we have these 9 other things. 10 And perhaps that reflects their thinking at the time. 11 But, again, I would have to look very carefully 12 at the comparisons you're making to be able to answer the 13 question in as detailed a way as you've asked it. 14 CHAIRMAN ANGELIDES: All right. Well, we will 15 provide this to you. Actually, let me just say it's on 16 page 1. 17 the corporate audit and risk committee, and it says the 18 total subprime exposure in markets and banking was 19 13 billion dollars. 20 It's right at the top, under the heading Subprime. This is called Risk Management Review, an update to 21 It's right in the executive summary. It says, the total subprime exposure markets and 22 banking was 13 billion with an additional 16 billion in 23 direct super senior and 27 billion in liquidity and power 24 puts. 25 members. All right, Mr. Rubin, and then we'll move on to other 35 1 MR. RUBIN: Yeah. Mr. Chairman, I don't 2 remember the presentation, but I could give you what I 3 suspect was the case, if I may, and you can confirm this for 4 yourself. 5 I might, as I say, I don't remember the 6 presentation, but it strikes me as understandable in the 7 context of how those positions were then being seen, which 8 is to say that the 13 billion, I would guess, was subprime 9 exposure below the Triple-A super seniors that we've now 10 discussed a number of times. 11 And if that was viewed as subprime exposure, 12 that the 43 billion, which is exactly the number that we 13 referred to as the super senior number, wasn't viewed as a 14 subprime exposure, it was viewed as a Triple-A security. 15 CHAIRMAN ANGELIDES: I will just note, you can 16 look, I don't want to surprise you, I will have you look at 17 the document. 18 It's right up top. MR. RUBIN: It's under subprime. Oh, it may have been listed under 19 subprime, but I don't think, and, again, I don't remember 20 the meeting and the discussion and I certainly was not part of 21 the formulation of these documents. 22 out other ways exactly what these people were thinking. 23 I think you can find But my guess would be that they reviewed as two 24 different classes of exposure: One being subprime exposure 25 and the other being because of all of the structuring 36 1 Triple-A super seniors. 2 CHAIRMAN ANGELIDES: All right, let me do this, 3 I may have one or two other questions, but I want to stop 4 now and move on to the vice chair. 5 your answers to these questions. 6 Mr. Thomas. 7 VICE CHAIRMAN THOMAS: 8 Thank you very much for Thank you, Mr. Chairman. EXAMINATION BY VICE CHAIRMAN THOMAS 9 VICE CHAIRMAN THOMAS: 10 coming. 11 trying to understand what happened so that we can convey to 12 the American people what happened is an exceedingly 13 difficult and complex job in which we have a very short 14 period of time. 15 We appreciate it. Thank both of you for As you know, given our charge of I want to ask you, we obviously know more today 16 than we did yesterday in this very narrow area, and we're 17 going to know more tomorrow. 18 designed to be exhaustive. 19 questions, not only relating to the topic that we have 20 before us but other concerns based upon your position and 21 experiences, some very in-depth, others very broad, would 22 you be willing to respond in a timely way to written 23 questions that we might submit to you between now and the 24 end of our statutory journey? 25 you have a -- These hearings are not And if I ask you, if we had Is that an appropriate -- do 37 1 2 MR. PRINCE: Well, I'm not sure how we could say no, Vice Chairman, so I guess the answer is yes. 3 CHAIRMAN ANGELIDES: 4 VICE CHAIRMAN THOMAS: Well -Well, I don't understand 5 how you can explain what you did and how you did it, but 6 it's really easy, because all you do is say yes. 7 MR. RUBIN: The answer, Mr. Chairman, I agree, 8 Chuck, the answer is yes, we would be delighted to, and that 9 is -- and I'll interpret Mr. -- 10 VICE CHAIRMAN THOMAS: Is that "we" as part of 11 your responsibility at Citi to advise senior or former 12 senior management? 13 14 MR. RUBIN: interpreting Mr. Prince's view. 15 16 17 18 19 I was expressing my view and VICE CHAIRMAN THOMAS: Could I have your view, Mr. Prince? MR. PRINCE: Indeed, yes, I would be greatly pleased to do that. VICE CHAIRMAN THOMAS: Thank you very much. 20 Yesterday's panel, and we spent some time with Mr. Murray 21 Barnes, former managing director, independent risk officer 22 of Citigroup, David Bushnell, as you mentioned, chief risk 23 officer, Nestor Dominguez, former co-head of the Global 24 Collateralization Debt Obligations, Citi Markets & Banking, 25 and Thomas Maheras, who is the former chairman and co-chief 38 1 executive officer, Citi Markets & Banking. 2 I woke up this morning, my alarm was set at 3 5:00, and I have my radio on CSPAN. 4 voice of Brooksley Born, the Commissioner who was inquiring 5 about, as we began our journey yesterday into this garden of 6 good and evil, about synthetic CDOs and what were they. 7 And I woke up to the And, of course, if you listen to that 8 discussion, it led into Commissioner Byron Georgiou's trying 9 to comprehend how you take a bunch of Triple Bs, slice them 10 and dice them and turn them into Triple-A and Triple-A-plus, 11 the super senior tranches that somehow were never supposed 12 to go bad. 13 And then I listened to Commissioner Wallison's 14 excellent questioning of the panel leading us to a better 15 understanding of these products that were created to be 16 sold, which meant -- generated millions of dollars, in some 17 years tens of millions of dollars, to then-Citi management, 18 on the way up, but never resulted at any time even in a 19 dollar of clawback on the way down. 20 So that I finally woke up realizing that, if I 21 had a chance to start my life over, I may very well choose a 22 different path because apparently you get to the top without 23 ever having experienced any of these things that people 24 underneath you do; you don't have a comprehension; you're 25 not informed, but you get to make all this money on the 39 1 upside and there's no downside. 2 You folks had an opportunity to submit written 3 testimony, which you did. I don't believe, correct me, 4 Mr. Chairman, there's no limit on the pages of written 5 testimony. 6 CHAIRMAN ANGELIDES: 7 VICE CHAIRMAN THOMAS: Not that I'm aware of. There's a limit on the 8 verbal which you can express as you see fit. So what we 9 have in front of us is your written test- -- testimony, that 10 started with a blank sheet of paper and that you were 11 willing to inform us, more or less. 12 Now, Mr. Prince, I'm looking on page 2 and you 13 say, in the middle of page 2, the patchwork -- quote, the 14 patchwork nature of state regulation of the origination of 15 subprime, indeed, of all mortgages, led in hindsight, to the 16 origination of more and poorer quality subprime assets to be 17 securitized. 18 19 20 Was there a requirement that they be securitized? MR. PRINCE: Well, I'm not sure I understand 21 your question, Mr. Vice Chairman. 22 VICE CHAIRMAN THOMAS: Well, there was a demand, 23 as you say a sentence above it, in dealing with this growth 24 of securitized products that you obviously, given your 25 business, wanted to produce securitized assets that had low 40 1 risk and high yield. 2 create so-called synthetic products. 3 Who wouldn't? To the point that you But it sounds like you're saying the fault was 4 the state regulation of the origination of subprime because 5 they -- they gave us poor quality subprime assets to be 6 securitized. 7 You didn't have to do that but you did. And -- 8 and, please, we heard enough yesterday about you starting 9 along a line of argument that others, third parties, gave 10 you assurance that they were okay, rating agencies, others. 11 Again, how do you get to the top if you don't 12 have any experiential experience, whatsoever, or your 13 argument is, at that point, and you don't pay any attention 14 to it? 15 What do you get paid for if it isn't having some 16 intuition, understanding, knowledge, or do you just do what 17 everybody else is doing because everybody else is doing it, 18 and if you don't do it, then you won't make money? 19 I do think it's all about money. 20 the way up. 21 down. 22 Because And it was big money on But never at any point is it on the way back What I'm saying is that when we get this -- when 23 I get, and I'll speak for myself, this kind of an argument 24 as to what happened, in hindsight, it's listening to someone 25 blame the inferior quality of leather in a pair of shoes 41 1 based on the feed that some person supplied to a FINRA 2 feeding the cattle that produced the leather. 3 I have to tell you, listening to the radio this 4 morning explain what it was that you did with products makes 5 it very, very difficult, notwithstanding a beginning 6 paragraph or two in which I do believe was sincere in terms 7 of your concern about what happened, but in this entire 8 process, not one dollar of clawback. 9 Mr. Rubin? 10 MR. RUBIN: 11 VICE CHAIRMAN THOMAS: 12 Well, there were a lot of pieces -- question. 13 MR. RUBIN: 14 VICE CHAIRMAN THOMAS: 15 I -- I -- I have a Oh, I'm sorry. I apologize. That was a statement but if anybody wants to turn it into a question, they can. 16 MR. RUBIN: Okay. 17 VICE CHAIRMAN THOMAS: You have -- you started 18 with a blank sheet of paper as well. 19 pages where you go into that analysis of some things that we 20 need to work on. 21 think we're all talking about. 22 I do like the latter I think you've got some core stuff that I And you know as well as I do that when you talk 23 about financial services legislation moving through the 24 Congress that committee jurisdictions limit what they can 25 look at and it's going to be a long and difficult process. 42 1 What I want to focus on is that for the first 2 time in these hearings, someone has introduced of their own 3 volition, in the comments that they've offered to the 4 Commission, some partisan comments. 5 In one, two, three, in the fourth paragraph, you 6 state, it's important to remember, quote, it's important to 7 remember that our national economic policies enormously 8 affect all of us. 9 deficit reduction and made critical public investments. For example, President Clinton undertook And 10 those policies contributed to the longest economic expansion 11 in American history, simply put, policy matters. 12 Well, so does the truth. I -- you came in at 13 the beginning of the Clinton Administration and actually 14 before the President was sworn in, in December of `92, and 15 the President was sworn in, in January of `93, and he became 16 President with a democratic Congress and a democratic 17 majority in the House of Representatives. 18 The House of Representatives is that branch of 19 the legislature, the national legislature, which in 20 Article 1, Section 8, has sole responsibility for the 21 generation of revenue legislation. 22 controls the nation's purse strings. It is the place that 23 Just before you were sworn in as Secretary of 24 the Treasury, January 11th, 1995, for your three years of 25 experience as Treasurer, on January 3rd I was sworn in for 43 1 the ninth time into the House of Representatives and for the 2 first time in four decades as part of a Republican majority 3 in the House of Representatives. 4 And so I guess I'm a -- I'm a little -- I'm a 5 little personally concerned that if anybody looks at the 6 election of November of 1944 it was over the tax and spend 7 policies of the Democratic administration and the Democratic 8 majority, principally, those who controlled the purse 9 strings in the House of Representatives. 10 And the American voters in that election, just 11 prior to your becoming Treasurer, rejected those policies 12 and voted out as a majority those members of the Democratic 13 party. 14 So if there was deficit reduction, as a policy, and 15 critical public investments for six of the eight years of 16 the Clinton Administration, three-quarters of that 17 administration's policymaking, it was with a Republican 18 majority in the House of Representatives that controls the 19 purse strings. 20 And you know the punch line. I was on the 21 committee that controls the purse strings, and so I guess 22 I'm a little concerned that the continued representation of 23 what I would call a half truth doesn't serve our needs 24 today. 25 And I -- and I -- I know this is a partisan 44 1 statement surprisingly, that the fact that it became 2 bipartisan to have to make public policy, I believe worked 3 to the benefit of the American people. 4 There's been great criticism by the current 5 majority, both in the administration and the Congress, about 6 the unilateral control of the Presidency and the Congress 7 for a period of time by the Republicans. 8 about the current return of structure of the current 9 non-bipartisan arrangement. And I'm concerned 10 So if you would, just as you were writing there, 11 uncharacteristically, given a little bit of credit to the 12 fact that just prior to your signing in, you knew you were 13 going to have to work with a House of Representatives 14 controlled by another party, which I think ultimately, in 15 the American political tradition of accommodation and 16 compromise, moved some pretty good policy. 17 And, yes, the President signed it, but he would 18 have had nothing to sign if it hadn't been advanced by a 19 Congress with a House of Representatives controlling the 20 purse strings run by a Republican majority. 21 22 MR. RUBIN: Is it possible for me to respond to that? 23 VICE CHAIRMAN THOMAS: 24 MR. RUBIN: 25 VICE CHAIRMAN THOMAS: Okay. You sure can. Let me first assure you -You can -- you can add an 45 1 addendum to your opening statement, if you want to. 2 3 MR. RUBIN: No. Let me -- let me just very briefly respond to pieces of that, if I may. 4 I certainly didn't mean it to be a partisan 5 comment. 6 But I'll give you my view of the secrets if you say I'll 7 just take one moment since it doesn't relate to the crisis, 8 but in `93 we did have a deficit reduction program, and it 9 was powerful, and it set the stage, in my opinion, for eight 10 I was trying to make a point about public policy. years of fiscal discipline. 11 The `94 election just came out exactly as you 12 said. 13 decision. 14 that's a political issue. 15 I don't personally think it was about the `93 I think it was about a lot of other matters, but And you were absolutely correct in saying that 16 in 1997, the Republicans and Democrats worked together in a 17 bipartisan fashion, beginning, as you correctly say, in the 18 House of Representatives, for the reasons that you describe, 19 to arrive at a balanced budget agreement, which carried 20 forward the work that at least in my judgment, began in 21 1993. So that would be my summary of that, that period. 22 VICE CHAIRMAN THOMAS: I appreciate that. 23 Mr. Prince, so I want you to comment, if you 24 would, because I don't know you personally and I only knew 25 you from, to a certain extent, a comment that's obviously 46 1 gotten far more coverage than it should have if, in fact, 2 you made it, and I assume, knowing the press only reports 3 those things that occur, that you made it at some point 4 about the business of if they're playing the music you have 5 to dance. 6 No, you don't. Now, I understand there probably would have been 7 consequences. Maybe somebody would have not continued to 8 make tens of millions. 9 commend everyone that the audio, not the video, the audio of But when you listen I just have to 10 the dialogue between the questioning of the Commissioners 11 and the answer from those people in Citibank who were in a 12 position to make up all these things and have a knowledge, I 13 understand that you're at the top, but these were the people 14 who were not. 15 And the creations that you made, arguably driven 16 by the desire of markets, and your job is to make markets, 17 and your argument is we didn't know, you didn't understand, 18 had we known then. 19 At -- at some point, is it necessary, in your 20 opinion, to create a structure which stops you from doing 21 things? 22 kind of a structure, requires you to what you're doing -- I 23 believe sunshine's a great disinfectant, that there's 24 complete transparency, that you need third parties to -- to 25 have an understanding of whether or not they would buy it? Because I don't think any of us want to create that 47 1 More importantly, should you have to have money, 2 notwithstanding that you were adequately capitalized under 3 some regulations that were created prior to the environment 4 that we were in, what, probably, looking back, because you 5 now have hindsight, would you have preferred that was 6 comfortable to allow you to carry on your business, but 7 nevertheless, I don't believe in simply imposing structures 8 for the sake of controlling. 9 I don't want to kill the goose that mostly laid 10 golden eggs. 11 golden. 12 about national and international, we can't go back. 13 You laid other eggs but some of them were And I think it's absolutely necessary. Your point I'm very concerned that we address problems in 14 the United States and we don't get a successful and 15 negotiated agreement internationally, which doesn't advance 16 our need to control. 17 Given the nature of your company in terms of its 18 significant international involvement, what could have been 19 done that would have made it possible for you to carry on 20 aspects of business that makes sense but would have limited, 21 controlled, mitigated, but you wound up doing? 22 23 24 25 MR. PRINCE: There's a lot there, if I may. me just respond to the quote that you mentioned. VICE CHAIRMAN THOMAS: No, it's the alleged quote that I read in the media, because I never heard it. Let 48 1 MR. PRINCE: Well, you were in Japan, so that's 2 why you didn't hear it directly. And I would appreciate the 3 courtesy of quoting the entire quote. 4 started with the statement that when the liquidity dried up, 5 the financial environment would become very complicated, but 6 that as long as the music was playing, you had to get up and 7 dance. The entire quote 8 Now, I think that reflects -- 9 VICE CHAIRMAN THOMAS: 10 Just let me say, Mr. Prince -- 11 MR. PRINCE: Can I finish my answer, please? 12 VICE CHAIRMAN THOMAS: -- I'm not surprised that 13 the entire quote was not printed, given my background and 14 experience. 15 16 MR. PRINCE: many places. 17 Well, it actually was printed in If I can just finish my answer? I think I've been quoted in Secretary Paulson's 18 book, at about the same time as asking the regulators to 19 impose limitations on the companies so that they would not 20 be engaging in some of these activities. 21 I want to emphasize that this was about 22 leveraged lending; it had nothing to do with the mortgage 23 business. 24 had nothing to do with the issues that we've been talking 25 about here. It had nothing to do with the CDO business, it 49 1 But in terms of the quote itself. The quote 2 itself related to the leveraged lending business, and I 3 specifically asked the regulators if they would take action 4 in regard to that. 5 VICE CHAIRMAN THOMAS: You started off your 6 statement in using the term you wanted the regulators to 7 impose? 8 9 So you wanted them to stop you from dancing? Can't -- can't you set up structures inside, or is it that you would feel then you had a -- you -- if you 10 limited yourself, others would not? 11 origination of imposed. 12 because none of you can regulate yourself in terms of 13 creating these triple synthetic, Triple-B, the Triple-A 14 senior tranches that are never, ever going to go down? 15 16 17 MR. PRINCE: me. And that's the So it was imposed on everyone Sir, you must have misunderstood I apologize. As I said, this had nothing to do with the 18 mortgage business. 19 lending business. 20 lending business, banks lending to private equity firms, was 21 a matter of great topic, a matter of great discussion. 22 This had to do with the leveraged In the summer of 2007, the leveraged And at that point in time, because interest 23 rates had been so low for so long, the private equity firms 24 were driving very hard bargains with the banks. 25 point in time the banks individually had no credibility to And at that 50 1 stop participating in this lending business. 2 It was not credible for one institution to 3 unilaterally back away from this leveraged lending business. 4 It was in that context that I suggested that all of us, we 5 were all regulated entities, that the regulators had an 6 interest in tightening up lending standards in the leveraged 7 lending area. 8 9 10 11 But again, I want to say, for the third or fourth time, it had nothing at all to do with the mortgage business. VICE CHAIRMAN THOMAS: Thanks. In other words, 12 you weren't going to be the lemming that stopped and said 13 that I don't know if I want to keep walking. 14 CHAIRMAN ANGELIDES: 15 COMMISSIONER MURREN: 16 17 18 19 All right. Thanks. Ms. Murren? Thank you. EXAMINATION BY COMMISSIONER MURREN COMMISSIONER MURREN: Thanks to you both for being here today. I want to follow on the thread of that 20 conversation, because you and many of the people that were 21 here to testify yesterday have alluded to the fact that they 22 were not rewarded for growth, that they weren't rewarded for 23 revenue growth or for earnings growth, that that was 24 secondary in the way they were compensated; am I wrong? 25 I misunderstand that? Did 51 1 2 MR. PRINCE: I'm not sure who you're quoting. I apologize. 3 COMMISSIONER MURREN: Did you not say earlier in 4 your testimony that part of your major driving force in your 5 compensation was not revenue growth? 6 MR. PRINCE: In my statement, Commissioner, what 7 I said was that the risk function, the risk function, was 8 not compensated on -- on revenue growth or profit growth. 9 The risk function as an independent control function was not 10 compensated based on business volumes. 11 COMMISSIONER MURREN: Okay. Thank you for that 12 clarification, that's -- that is logical. 13 that would be how do you then try to factor in risk into the 14 way that you compensate all of your executives? 15 The follow on to And because what I hear in a little bit of this 16 notion of if people are dancing, you need to dance too, is 17 when you think about compensation, oftentimes people are 18 rewarded because of the way they're compared to their 19 industry. 20 So then it's very difficult for any manager in 21 any position to be able to say, no, we don't want to grow in 22 this business because inevitably, at the end of the year, 23 you will be compared to entities perhaps that are growing, 24 perhaps unwisely. 25 And I would like your comments, perhaps, on if 52 1 there is a way that things might have been structured 2 differently so that those decisions would have been easier 3 for people to make. 4 MR. PRINCE: That's a very thoughtful question. 5 The compensation structure on Wall Street is -- is one that 6 many people have criticized over the years. 7 for traders, for bankers and so forth, a compensation model 8 that is based on revenue growth, not even profit growth. 9 It is for -- And a number of people over the years, Warren 10 Buffet among them, has tried to change that compensation 11 model on Wall Street. 12 Let me tell you, if I may, how compensation 13 worked for me. 14 predecessors, and over that period of time, certainly when I 15 was an executive of the company, we were paid in fair amount 16 in stock of the company. 17 common stock of the company. 18 were required to hold 75 percent of the stock we received; 19 in other words, we couldn't cash it out. 20 100 percent of the stock, not the 75 percent. 21 I spent nearly 30 years with Citi and its More than half of our pay was in And for a period of time we In my case, I held Our rules also provided that you had to hold the 22 stock as long as you were with the company. 23 it when you left. 24 time. 25 You could sell In my case, I held the stock the entire As I sit here today, I hold virtually every 53 1 share of stock I acquired over a nearly 30-year career. 2 I watched it go from $50 a share to $30 a share to less than 3 a dollar a share. 4 And So in my case, I think my interests were aligned a 5 hundred percent with stockholders. 6 majority of my personal net worth built up over 30 years 7 disappear, because my company suffered from these problems. 8 9 I watched a great Now, I can't speak for others. for whether other people cashed out. I can't speak But I think a model 10 that requires you to have that kind of alignment with the 11 stockholders is a good one. 12 COMMISSIONER MURREN: It is good, in certain 13 respects, but I would guess that you would agree that 14 there's certain elements of that that would also themselves 15 encourage risk-taking. 16 For example, when you look at the expectations 17 and how Wall Street expectations play out in the prices of 18 equity, in particular, they typically are related very 19 directly to revenue and profit growth returns on equity 20 which, by definition, mean you're going to want to lever up. 21 So, then, is there -- and even -- perhaps this 22 isn't the time to discuss it, but my point simply is risk, 23 itself, and the assumption of liability was not necessarily 24 the norm in how people's compensation was determined. 25 were people that cashed out. There There were people actually 54 1 whose cash pay was substantial enough to accommodate any 2 declines in the stock price should they occur. 3 So I think that it would be fair to say that there 4 is, in my view perhaps, some greater emphasis on growth than 5 perhaps is healthy, at the corporate level; would you not 6 agree? 7 MR. PRINCE: Well, clearly you can't overstate 8 the need for risk assessments in running your business. But 9 I want to emphasize, if I may, that the CDO positions that 10 we're talking about were not put on the books by people who 11 were trying to take on more risk. 12 mistaken, but they thought they were taking on little or no 13 risk. 14 They thought, they were So very clearly, from the Commission's standpoint, 15 the notion of making sure that risk considerations are 16 embedded in the operation of a business is absolutely a high 17 criteria, I grant you that. 18 complicated issue in this case, because the folks involved 19 did not think they were reaching in a risk standpoint, so 20 risk parameters weren't violated. 21 But I think it is a more Now, in hindsight, it's been horrible, I accept 22 that, but at the time, on a prescriptive basis, going 23 forward, as the Commission needs to struggle with, the 24 notion of having stronger risk parameters, as such, 25 wouldn't, by itself, go to the essence, I believe, of what 55 1 2 happened here. COMMISSIONER MURREN: The financial services 3 sector, though, is uniquely complex and has a regulatory 4 structure that is designed to help companies, in this 5 instance, because of risk-focused regulation manage their 6 own systems of risk. 7 And I'm interested in your comment, Mr. Rubin, 8 about the notion that you were in a position, both of you, I 9 guess, but perhaps just you, to have people surface problems 10 11 to you as they occurred. But wouldn't it also be true to say that you and 12 the regulators that oversee your business, to ensure safety 13 and soundness, should have been asking the right questions. 14 And, from your perspective, I would be interested in your 15 description of your interaction with the various regulatory 16 agencies, and also to what extent you felt that they were 17 asking the right questions at the right time. 18 MR. RUBIN: Yeah, Commissioner, I think I may 19 have slightly misstated what I -- I may have slightly 20 misspoken or there may have been a misunderstanding. 21 No, I didn't say that I was in a particular 22 position to have issues raised. 23 board cannot know what's in the position books of a 24 financial services firm. 25 What I said was that a -- a I've been on three public boards. Two were not 56 1 in the financial sector, and that was true there too. 2 You're not going to know what, on a granular level, what's 3 happening in a business. 4 So what you need to do, what a board needs to do 5 and I believe Citigroup did do, is to put strong people in 6 the relevant positions. 7 is both those people and a whole set of checks and balances, 8 an internal auditor, a CFO, legal counsel and the rest, to 9 surface problems when they exist. 10 And that was what I had alluded to. 11 12 And then what you're depending on COMMISSIONER MURREN: And in the instance of Citigroup -- 13 MR. RUBIN: Right. 14 COMMISSIONER MURREN: -- observers would say 15 that that was not present, that the internal communications 16 necessary for that to work effectively weren't there, the 17 infrastructure wasn't there, properly allocated and properly 18 executed for risk management. 19 But you have said that this isn't true. Given 20 the outcome, do you think that there was a way for you to 21 have done that better and do you think that the regulators 22 should have noted that more strongly in what they did? 23 MR. RUBIN: I don't agree with the -- with 24 the -- I don't think that's right, Commissioner, in terms of 25 the -- the processes as not being there. 57 1 We had the board meetings, I guess, roughly 2 speaking, once every month or thereabouts, and the 3 independent risk management people reported both to the 4 audit committee and to the board, certainly in writing and 5 very often verbally, and I think we actually had very robust 6 processes around reporting risk. 7 As Mr. Prince said, in the instance that we're 8 talking about, you had a particular set of instruments, 9 these Triple-A instruments, that simply weren't viewed, and 10 I think understandably, given the way Triple-A had been 11 viewed in the entire time, in the many decades I was in the 12 industry -- 13 COMMISSIONER MURREN: 14 MR. RUBIN: 15 COMMISSIONER MURREN: 16 MR. RUBIN: But we're talking about -- They weren't viewed -- Yeah. -- processes. No, I think the processes 17 were very strong. 18 can I say, Commissioner, you had a very well-regarded head 19 of risk management. 20 I think you had a -- you had a -- well, You had, I think, something like 2500 people or 21 thereabouts that worked in this area, and he presented to 22 both the audit committee and to the board at every meeting. 23 24 25 COMMISSIONER MURREN: So let's talk about the regulators for a second. MR. RUBIN: Yes, ma'am. 58 1 COMMISSIONER MURREN: Your interactions with 2 them, do you feel that they asked the right questions at the 3 right times? 4 were the kinds of things that would support every agency 5 feeding back to the Federal Reserve about the safety and 6 soundness of your enterprise? 7 effectively? 8 9 Do you feel like your interactions with them MR. RUBIN: Do you think that that worked Commissioner, I was not personally involved -- given my role in the institutions, which I 10 described in my statement, I was not involved in the 11 interactions between the company and the regulators, so I 12 can't answer that. 13 COMMISSIONER MURREN: 14 MR. PRINCE: And you, Mr. Prince? Well, I was, and I -- I -- 15 Commissioner, I would describe it as follows: 16 regulators were embedded in the organization; that is to 17 say, they were representatives of the regulators, the 18 various regulators, who had offices in our building and who 19 worked there on a daily basis. 20 The In addition to that are various staff functions, 21 the risk function, the audit function, the legal function 22 would meet with the regulators on a periodic basis. 23 without knowing every meeting, my guess is it was at least 24 once a month. 25 And I would personally meet with regulators on a 59 1 frequent basis, at least once a quarter, sometimes on a 2 private basis. 3 regulators also mistook the ultimate safety of the CDO 4 positions. 5 regulators weren't active. 6 the company's standpoint. 7 I think that what happened here is that the I don't think it was a situation where the It certainly felt active from I don't think it was a situation where the 8 regulators didn't know what was going on. 9 lived with us day by day by day. As I said, they I think that the mistake 10 that was made by everyone about the value of these 11 instruments was fundamentally also made by the regulators. 12 And I think that's basically what happened. 13 14 I don't think it was a failure of regulatory involvement with the company. 15 16 COMMISSIONER MURREN: Concede my time. 17 18 Thank you. CHAIRMAN ANGELIDES: Thank you very much, Ms. Murren. 19 Mr. Wallison? 20 COMMISSIONER WALLISON: 21 EXAMINATION BY COMMISSIONER WALLISON 22 COMMISSIONER WALLISON: 23 Mr. Prince. 24 and answering our questions. 25 Thank you, Mr. Chairman. Let me start with you, I want to thank both of you for coming to this Let me start with you, though, Mr. Prince. You 60 1 2 talked about -CHAIRMAN ANGELIDES: Mr. Wallison, pull the mic 3 a little closer to you, I think for everyone, so we can hear 4 your mellifluous -- 5 COMMISSIONER WALLISON: 6 CHAIRMAN ANGELIDES: 7 COMMISSIONER WALLISON: 8 CHAIRMAN ANGELIDES: 9 COMMISSIONER WALLISON: Mellifluous. Sorry about that. Okay. Easy for me to say. Mr. Prince, you talked 10 about a 30 percent decline in housing prices, completely 11 unprecedented event, and you talked about it as though it 12 was kind of in the common talk today; like a black swan, it 13 just sort of happened. 14 Have you considered why it happened? Have you 15 given any thought to that, and if you have, would you 16 describe to us what your thinking is? 17 MR. PRINCE: Well, I have given that some 18 thought, as you would imagine. 19 time before the financial crisis, David Bushnell would say, 20 you know, our stress testing is X or Y, and we would have to 21 have a decline of X or Y, and we haven't had that since the 22 Great Depression. 23 I know that for a period of And I thought about why in this time period we 24 had such a huge decline. How could that be the case? I'm 25 certainly not an in-depth expert on the mortgage market. 61 1 But my guess is that the period of time before the crisis in 2 which home prices appreciated so much and in which so much 3 expansion of lending occurred could be seen as a bubble 4 period in housing as well as other things. 5 So that if you were to draw a trend line that 6 would go up at a certain number of degrees, that because of 7 the easy money and other factors, that trend line in housing 8 would have accelerated very quickly. 9 So instead of going up at a steady incline, it -- 10 it went up at a rapid incline. And I think that coming back 11 down, on the other side of that, is the 30 percent kind of 12 number that we see. 13 COMMISSIONER WALLISON: 14 MR. PRINCE: 15 Well, we've -- So that the decline is in some way a function -- 16 COMMISSIONER WALLISON: 17 MR. PRINCE: 18 COMMISSIONER WALLISON: Sure. -- of the increase. Well, we've had bubbles 19 before. 20 this was a very large bubble, but we've had them before. 21 We've had, perhaps not quite as large as this one; But when they deflated, the mortgage failures, 22 as probably Mr. Bushnell told you, were not substantial. 23 They certainly were not 30 percent; it was certainly not a 24 30 percent decline in housing values. 25 Were you aware, for example, that in this 62 1 particular bubble, 26 million, 27 million really, of 2 mortgages were subprime or Alt-A; that is to say, they were 3 ready to fail as soon as the bubble deflated? 4 Now, when I asked Mr. Bushnell that yesterday, 5 he was not aware of it. 6 the table yesterday whether they were aware of it, and they 7 were not aware of it. 8 I asked some of the other people at This is -- when Alan Greenspan testified, 9 however, he mentioned that there were 12 million mortgages 10 that were made by Fannie Mae and Freddie Mac that were not 11 reported as Alt-A or subprime by them. 12 aware that a very substantial number -- almost half of all 13 of the bad mortgages in the economy at that time were made 14 by Fannie and Freddie and were either guaranteed by them or 15 on their books. 16 So people were not Now, would it have -- would it make it somewhat 17 clearer to you why this happened, why we had a 30 percent 18 decline in housing prices if you understood or knew, at the 19 time, that so many of the mortgages, half of all mortgages 20 in our financial system were of poor quality? 21 MR. PRINCE: Well, Commissioner, it's hard to 22 put yourself back, mentally, at that timeframe, after all 23 that's happened. 24 25 The events over the last couple of years color one's thinking. It's hard, now, to -- to think of a 63 1 subprime loan as not being a, quote, bad loan. 2 I'm not sure that was the case at the time. 3 that from a policy standpoint, from a lending standpoint, 4 subprime loans were necessarily equated to bad loans. 5 COMMISSIONER WALLISON: But -- but I'm not sure I'm -- I'm really very 6 happy that you said that, because that is exactly right, and 7 that's the point I think I would like everyone to 8 understand. 9 Most people were very proud of the fact, 10 especially here in this building, and elsewhere in 11 Washington were very proud of the fact that subprime loans 12 were being made and the -- and the home ownership rate in 13 this country was going up during this period. 14 Now, when it turns out that these mortgages 15 failed and caused, I believe, at least there are indications 16 that they caused the financial crisis, everyone is running 17 away from it and trying to point fingers at who made these 18 loans. 19 But we have to remember that 64 percent, there 20 was a 64 percent home ownership rate in 19 -- in 1994, but 21 by 2005, and I'm talking about two administrations here, the 22 Clinton Administration and the Bush Administration, it had 23 gone up to 69 percent. 24 25 And everyone was very proud of this. So I think we have to look at this as a question of government policy and not a question of casting blame on 64 1 2 people who happen to be involved at the time. Let me go to one other subject: The National 3 Community Reinvestment Coalition says in their annual report 4 in 2007 that over 4 and a half trillion dollars in CRA, that 5 is, Community Reinvestment Act commitments, were made by 6 banks in connection with efforts to get approvals from 7 regulators for mergers. 8 9 You were much involved, I think, in this, as the general counsel of Citi, for a while. And Citi's 10 commitments, if I recall the number correctly, was something 11 like 400, 500 billion dollars, somewhere between 400 and 500 12 billion dollars. 13 Are you familiar with the fact that these 14 commitments were made in connection with applications to the 15 Fed or to another regulator for approval of a merger? 16 MR. PRINCE: Well, that's a long time ago, but I 17 would say in a general sense, yes. 18 COMMISSIONER WALLISON: And while you were at 19 Citi there were announcements that these commitments were 20 being met; that is to say, that they were made and now these 21 loans that actually been made in order to provide financing 22 for people to buy homes. 23 MR. PRINCE: Were they, in fact, made? Well, Commissioner, I'm -- I'm -- 24 I'm confident that the commitments that the company made in 25 the CRA -- CRA area were -- were fulfilled, yes. I don't 65 1 know the details, but I'm absolutely confident. 2 COMMISSIONER WALLISON: 3 MR. PRINCE: 4 Understood. Understood. We committed we would make these loans and we did. 5 COMMISSIONER WALLISON: You made them, and the 6 announcement were valid, they, the loans, were actually 7 made. Okay. 8 I just have one more question for you, and that 9 has to do with the fact that you talked about the downgrade 10 by the rating agencies as being precipitous and causing 11 tremendous turmoil in the markets. 12 But the downgrade really had one effect and that 13 is it was an accounting effect, wasn't it? I mean, that is 14 to say, once the downgrade occurred then it became necessary 15 for financial institutions that held these mortgages to 16 write them down in some way or take losses on their balance 17 sheets. 18 I'd just like your views on this whole question of 19 fair value accounting and mark-to-market accounting and the 20 way the -- the accounting rules operated to have an effect 21 on the financial crisis. 22 MR. PRINCE: Well, that's a -- that's a very 23 broad topic, and I'm sure you could have days of hearings 24 just on mark-to-market accounting. 25 COMMISSIONER WALLISON: I hope we will. 66 1 MR. PRINCE: I wish you well on that. 2 COMMISSIONER GEORGIOU: 3 MR. PRINCE: Roll call. And I -- and I hope I'm not here 4 for it, but my basic view on that is that the debate on 5 mark-to-market accounting I think is a false debate. 6 debate on mark-to-market accounting is either attributed to 7 all mark-to-market accounting or it should be no 8 mark-to-market accounting. 9 way, it becomes a very artificial discussion. 10 The And by defining the debate that In almost every area that we live in, there are 11 moderating factors. 12 it has stock limits in it. 13 underfunded, you could fund it over a number of years, et 14 cetera, et cetera, et cetera. 15 If the stock market has a big down day, If a company's pension plan is There are very few areas where -- where the 16 absolute nature of today's mark-to-market accounting 17 obtains. 18 accounting is not associated with the cash flow of these 19 instruments. There's no question that the mark-to-market There's no -- there's no question of that. 20 COMMISSIONER WALLISON: 21 MR. PRINCE: Right. And it's entirely possible that at 22 some point in the future, people will make a lot of money 23 from these instruments because they will pay out. 24 again, the debate now isn't about those kind of issues. 25 debate is about we have to have mark-to-market accounting as But, The 67 1 a theoretical purity -- 2 COMMISSIONER WALLISON: 3 MR. PRINCE: 4 -- or we don't. And I think that's a false debate. 5 6 Right. COMMISSIONER WALLISON: Thank you for that answer. 7 Mr. Rubin, almost everyone who has come before 8 our Commission has testified that the high levels of 9 delinquency and defaults on subprime and Alt-A loans, after 10 the bursting of the bubble in 2007, was one of the 11 preliminary -- was one of the primary causes of the 12 financial crisis. 13 It was the deterioration, indeed, of these 14 subprime loans that caused the CDO problem that you're so 15 well aware of, so I was a bit surprised that when you 16 listed, oh, almost a dozen items in your testimony as the 17 causes of the financial crisis, the delinquency and defaults 18 on subprime loans was not among them. 19 MR. RUBIN: Why -- why was that? Well, to some extent, 20 Mr. Commissioner, there was a question of how much I was 21 going to list. 22 23 24 25 COMMISSIONER WALLISON: You listed a dozen items. MR. RUBIN: I listed a dozen and said much else at the end, you're right. 68 1 But I guess what I was thinking -- what you said 2 was factually correct. 3 that led to the subprime foreclosure rates rather than list 4 the subprime foreclosure rates themselves. 5 What I did was to list the factors I referred to over leveraging consumers, I 6 referred to excess lending by -- by lenders, I referred, if 7 I remember correctly, to regulatory problems, and I referred 8 to excesses and abuses in mortgage extension. 9 It was that combination of factors that led or at 10 least contributed greatly to the problems in subprime. 11 were absolutely correct. 12 led to problems of subprime. 13 You I could have said, and all of that And I instead referred to the factors that led 14 to the problem rather than to that particular consequence of 15 the problem. 16 COMMISSIONER WALLISON: When you were Secretary 17 of the Treasury, do you recall the housing policies of the 18 Clinton Administration and the strong effort to increase 19 home ownership by increasing the credit available to 20 moderate- and low-income borrowers? 21 MR. RUBIN: 22 COMMISSIONER WALLISON: 23 Yes, I do. And those, I assume, you thought were successful, at the time? 24 MR. RUBIN: I did, indeed. 25 COMMISSIONER WALLISON: And so you supported 69 1 those policies? 2 MR. RUBIN: I did. 3 COMMISSIONER WALLISON: Between 1994 and 2005, 4 as I mentioned before, the home ownership rate in the United 5 States increased substantially. 6 Would -- at the time, everyone was very pleased 7 about this, as I mentioned. Would you have gone to 8 Congress, at that point, understanding what you know now, 9 and said to Congress, we have to stop this subprime and 10 Alt-A lending, because sometime in the future it is going to 11 cause us tremendous problems. 12 Secretary of the Treasury, and done that? 13 MR. RUBIN: No. Would you have gone there, as Let me, if I may give you my 14 view of that, because I think you're raising a very, very 15 important question. 16 I believe that CRA served very valuable purposes 17 in making credit available to those who would otherwise not 18 have had access to credit, particularly inner-cities. 19 one reason I mentioned my chairmanship of LISC, as the 20 nation's largest inner-city development organization, is 21 because it relates -- it's that experience that I think has 22 given me some sense of this issue. And 23 What I think we do need and need very badly, I 24 don't think the problem lies in CRA, and I think it's very 25 important to have subprime credit available. 70 1 I think where our problem lies is that it's 2 clear, now that we've had this experience, that there were 3 excesses and abuses and substantial excesses and abuses. 4 I think what we need is to continue with CRA. 5 continue to need, and I think it's very important, to make 6 credit available in inner-cities and corresponding the 7 distressed rural areas. 8 consumer protection, because then you can get at the 9 excesses and the abuses without a problem. 10 I think at least in two respects, if I may, Commissioner. COMMISSIONER WALLISON: 12 MR. RUBIN: 13 COMMISSIONER WALLISON: 15 I think we But I do think we need very strong 11 14 Yes. I think that we need -If I can get more time. Go ahead. MR. RUBIN: I apologize. I think we need 16 effective disclosure, but I also think there are some 17 instruments that are inherently susceptible to abuse. 18 think serious consideration ought to be given to barring 19 those instruments. 20 So COMMISSIONER WALLISON: All right. And I I don't 21 think, as I'm agreeing with you in this sense, CRA is not 22 the problem, but Fannie Mae and Freddie Mac have on their 23 balance sheet, had on their balance sheet in 2008, have on 24 their balance sheet probably today, about 12 million 25 subprime and Alt-A loans that we really didn't even 71 1 understand were on their balance sheet before they disclosed 2 it in 2009. 3 problem. That is one of the reasons we have this 4 Did you ever attempt when you were Secretary of 5 the Treasury to rein in the kinds of things that Fannie and 6 Freddie were doing at that time? 7 MR. RUBIN: Commissioner, at the time, let me 8 give you two responses to that, if I may. If you -- if 9 you -- if we have serious consumer protection put in place, 10 then the kinds of loans that you're referring to, if in fact 11 they are the consequence of excesses and abuses, were no 12 longer -- hopefully no longer exist in the subprime loans or 13 mortgages view up on the books of Fannie and Freddie will be 14 sound, at least probabilistically, sound loans. 15 When I was at -- 16 VICE CHAIRMAN THOMAS: 17 18 Mr. Chairman, I yield the Commissioner an additional five minutes. MR. RUBIN: Okay. When I was at Treasury, there 19 were -- we had concerns about Fannie and Freddie. And we 20 particularly had concerns about these very large 21 organizations operating with the implicit guarantee of the 22 federal government. 23 And the Deputy Treasury-Secretary at the time, 24 Larry Summers, and my successor as Secretary, actually got 25 quite involved in that issue. I was not personally that 72 1 involved but he was very involved in focusing on those 2 issues. 3 COMMISSIONER WALLISON: What would be your idea 4 of a loan that would enhance the ability of low and middle 5 income people to buy homes, an affordable housing loan, as 6 it was req- -- as Fannie and Freddie were required to make 7 it that would be a sound loan? 8 9 I mean, if you -- if you were going to require organizations as Fannie and Freddie were required to make 10 certain kinds of loans, how can you then say at the same 11 time that if we regulated these loans they would be sound 12 loans rather than the kinds of loans that they seem to have 13 made? 14 MR. RUBIN: Well, I'm not an expert on mortgage 15 extension, but I -- I -- I think what I would -- this is a 16 first-flash response, and if I had more time to think about 17 it I could probably give you a more comprehensive response, 18 but I think what I would do as part of consumer protection, 19 more generally, not just with respect to Fannie and Freddie, 20 is I would have suitability requirements so that loans could 21 only be extended to people who had -- who were -- who were 22 thought to have the means there but because of their 23 employment assets, whatever else might be, to constitute 24 sound borrowers. 25 there are probably certain instruments that I would And then, as I said a moment ago, I think 73 1 prohibit. 2 If it were practical, and I think it may not be 3 financially practical to do this, I do think it would be 4 very important to have some kind of counseling available to 5 low-income borrowers because I think too often borrowers in 6 that position, and as I said, I've seen a lot of this world 7 through the eyes of LISC, which I think handles all this 8 very soundly, I might add. 9 I think very often, low-income borrowers really 10 are not adequately equipped to make the decisions they need 11 to make. 12 have suitability requirements, I would probably bar certain 13 instruments, and I would have disclosure that was done in 14 such a way that it was readily accessible to people who were 15 not sophisticated. 16 17 But that may just not be practical. COMMISSIONER WALLISON: MR. RUBIN: 19 COMMISSIONER WALLISON: 21 22 And I assume down payments? 18 20 So I would And what? Down payments? Down payments? MR. RUBIN: Oh, absolutely. I absolutely would have adequate, adequate down payments. 23 COMMISSIONER WALLISON: 24 CHAIRMAN ANGELIDES: 25 VICE CHAIRMAN THOMAS: Thank you very much. That's it? Mr. Chairman? 74 1 CHAIRMAN ANGELIDES: 2 VICE CHAIRMAN THOMAS: Yes? Might I briefly correct 3 the record? Staff has indicated to me in my opening remarks 4 that I said that Republicans gained the majority in the 5 House of Representatives in 1944. 6 might be wished, it isn't true; it was 1994. 7 record to reflect that. No matter how much that 8 CHAIRMAN ANGELIDES: 9 COMMISSIONER GEORGIOU: I want the Mr. Georgiou? Thank you, Mr. Chairman. 10 EXAMINATION BY COMMISSIONER GEORGIOU 11 COMMISSIONER GEORGIOU: As they say, imitation's 12 the sincerest form of flattery, and recognizing that the 13 Chair and the Vice Chair have stolen some of my thunder 14 regarding the collateralized debt obligation problem, I 15 still feel compelled to return to it briefly, with both of 16 you, if I can, for two -- for at least two reasons. 17 One is that Citi wrote off more than 30 billion 18 of the 43 billion that you had on the books, which was 19 roughly a third of the capital that the whole bank had at 20 the time. 21 And second, because I think it's emblematic of 22 something that went seriously wrong in our system that 23 everybody believed was impossible. 24 25 I mean, yesterday, we had a panel of your underlings, if you will, who were very serious, high-ranking 75 1 people within the bank, who sat there, four of them, 2 Messieurs Maheras, Dominguez, Bushnell, and Barnes, and they 3 all made a lot of money, in one instance almost 100 million 4 dollars in the course of the three years before all the 5 troubles hit at Citi. 6 And notwithstanding that and notwithstanding 7 their respective responsibilities for originating these 8 CDOs, supervising the risk associated with them and all the 9 other aspects of their responsibilities, all of them 10 essentially said that this was inconceivable, unknowable, 11 couldn't have happened, everybody thought it didn't happen, 12 every other institution who was dealing with them had the 13 same view, and so we were hit with this calamity which 14 nobody could have anticipated. 15 And it seems to me that yesterday I likened it 16 to the medieval alchemy. 17 beginning to believe that maybe it was hallucinatory. 18 mean, and this is something that I think really deserves 19 exploration, because if you look at the fundamentals, it 20 belies logic. 21 people who believed it, but I just want to -- I want to 22 focus -- focus your attention on it yet one more time, if I 23 can. 24 25 And today, as I study it more, I'm I That's not to say that there weren't a lot of These RMBS securitizations that occurred resulted -- and this is out of a Goldman Sachs analysis, you 76 1 know, a post hoc analysis, basically, that 75 percent of the 2 tranches were Triple-A; 10 percent, Double-A; 8 percent, A; 3 5 percent, Triple-B; and 2 percent equity and the underlying 4 RMBS. 5 of the tranches in the underlying securities. So the Triple-B tranches were at the bottom 7 percent 6 Now, they take all the Triple-B tranches out of 7 all these underlying RMBS and slice and dice them, and what 8 you get in the collateralized debt obligation is 60 percent 9 of something that's characterized to be Triple-A super 10 senior tranches; 20 percent Triple-A, 6 percent Double-A, 11 5 percent A, and only 2 percent Triple-B, 2 percent 12 Double-B, and 5 percent equity. 13 So suddenly you've taken what was the bottom 14 7 percent of the underlying security and made it, you know, 15 90 percent of it, more than 90 percent of it above A rated, 16 and it strikes me that the fact that everybody believed 17 this, regulators, Mr. Prince, you mentioned in your 18 testimony, nobody questioned this, is highly troubling, 19 because at the end of the day, this was the most significant 20 single matter that impacted your books and it certainly 21 impacted whole -- the books of a lot of other financial 22 institutions. 23 So -- so -- and I guess there's a comment that 24 was given to us by a former senior staff member from the 25 Federal Reserve who warned us that the, quote, specious 77 1 accuracy of complicated financial models should not be 2 trusted. 3 And basically these models, presumably somebody 4 was modelling this and somebody believed in a modelling that 5 resulted in these analyses, that is, the underwriting people 6 at your shops, the credit rating agencies, the regulators to 7 the extent that they evaluated this, but we now know that 8 everybody was horribly wrong to the tune of over a third of 9 your capital. 10 So how do we address these kinds of dilemmas I 11 guess is -- is what I put to you? 12 you could respond to that briefly? 13 MR. PRINCE: And maybe, Mr. Prince, Well, I think you've -- you've 14 stated it quite well. In hindsight it's very hard to see 15 how these structured products could have been accepted in 16 the way they were accepted. 17 I think that on a going-forward basis, if I can 18 say so, the Commission needs to think about the next issue. 19 In other words, it's very unlikely that structured products 20 are going to be a problem for anyone in our lifetimes. 21 Those are not likely to be accepted in the same way. 22 COMMISSIONER GEORGIOU: 23 MR. PRINCE: Thankfully. And the question really is, how 24 could an industry, how could the control processes for an 25 industry have missed something so universally, and how do 78 1 you protect the next one. 2 And I don't know what the answer is to that, I 3 don't know whether the next one will be sovereign debt or I 4 don't know the answer to that but there -- there, hopefully, 5 a part of the Commission's effort will be to try to examine 6 why and how people as smart and with as much experience as a 7 Tom Maheras and a David Bushnell and the rating agencies and 8 our various regulators, how all of them could have had what 9 turned out to be a false belief about these instruments. 10 COMMISSIONER GEORGIOU: 11 VICE CHAIRMAN THOMAS: 12 Thank you. Mr. Rubin? Would you yield, just briefly? 13 COMMISSIONER GEORGIOU: 14 VICE CHAIRMAN THOMAS: Certainly. In terms of your comment 15 about being accepted -- and it's on my time -- about your 16 belief as you made with these products was accepted, my 17 assumption is that wasn't meant in the context of something 18 being offered and then something being accepted. 19 surprised that people bought them in terms of the accepted 20 aspect or that they were accepted as a product that would be 21 worthwhile. 22 it's offered. 23 24 25 You were Because obviously, you can't accept it unless MR. PRINCE: I -- I was referring to the latter in the question. VICE CHAIRMAN THOMAS: Okay. Thank you. 79 1 MR. PRINCE: Yes. 2 COMMISSIONER GEORGIOU: 3 MR. RUBIN: Thank you. Mr. Rubin? Commissioner, I -- I would respond 4 to that very thoughtful question the following way: 5 been involved with financial markets for about 40-some 6 years, and I can remember when the Black and Scholes models 7 first came into prominence as a way of measuring option 8 volatility. 9 I've And we actually hired Fisher Black, who, had he 10 lived, would have won a Nobel prize because his 11 co-developers of that did, and had long conversations with 12 Fisher about how do you think about models. 13 And the problem with all models, and it's one 14 reason I make the suggestion I do with respect to leverage 15 constraints, is that they're no better than the information 16 that you feed into them. 17 And in this case, the information that was fed 18 into them and is one reason why Commissioner Born is right 19 about derivative regulation, though I would add, margin 20 capital requirements to be substantially increased as part, 21 the information that's fed into them is usually 10 or 20 22 years of history, whatever it may be and in this instance, 23 and I think it was the great lesson of this crisis is that 24 the downside of the financial markets turned out not to be 25 reflected in the experience of the last 10, 20, 30, or even 80 1 40 years, but rather to be far greater than that and far 2 greater than anybody had thought. 3 And I think the one thing that could have made 4 an enormous difference here is if there had been a 5 recognition, although there was virtually no recognition of 6 this, very much including by myself, that the real potential 7 downside of our system under stress conditions was not 8 reflected in the experience of the last some decades, but 9 rather it was far worse. 10 And I think as you all go forward it seems to me 11 that what we need to do, in both the private sector and the 12 public sector, is to have changes and reforms that reflect 13 what is now a new understanding of the downside risk of our 14 system. 15 COMMISSIONER GEORGIOU: Okay. But -- and let me 16 try to keep the focus on you folks, for just a minute here, 17 because, you know, some people saw this, and I'm not saying 18 that you needed to be as prescient as they were but, you 19 know, there's a famous December of `06 meeting that David 20 Viniar, the CFO of Goldman Sachs, called when they had lost 21 money for 10 days in a row. 22 They had apparently a trigger, which you may 23 know about, when you lose money in a particular trade for 10 24 days in a row, you at least call a meeting. 25 and they analyzed this, and they basically shifted their And they did, 81 1 position to sort of offload some of their exposure to the 2 mortgage markets. 3 And of course, people like Paulson, you know, 4 made 15 billion dollars betting against the subprime market 5 on the hedge fund side. 6 trying to focus on you, you had a whole history at Goldman 7 Sachs and yet careening into `07, if you will, Citi made a 8 number of other bets that seems to me to have been, in 9 retrospect, further putting you in jeopardy in this regard. 10 But you folks -- but Mr. Rubin, I'm I mean, you bought the Argent, the Ameriquest 11 platform from Roland Arnall in February of `07, and -- 12 and -- and we're continuing essentially to advance your 13 exposure in this regard. 14 And let me just point out one other: 15 `07, you actually started to buy back in exercise, having to 16 exercise these liquidity puts to bring the CDOs back onto 17 your balance sheet where they had been off-balance-sheet, 18 and both of you testified that it wasn't until something 19 like October of `07 that it came to your attention. 20 Well, that seems awfully late. In July of And maybe had you 21 been in a position to know earlier, you might have taken 22 some ameliorative action to protect the balance sheet of 23 Citi in the meantime. 24 So, Mr. Rubin, could you respond to that? 25 MR. RUBIN: Yeah, let me respond to that, if I 82 1 may. 2 You are correct, Commissioner. There were some 3 people. 4 one. 5 see this complete picture. 6 Viniar saw or didn't see, but I don't think that any major 7 firm really saw -- and if you look at the various activities 8 that are engaged in the LBL area as well as in these areas, 9 I think it bears this out, really saw the potential for the 10 There were some hedge fund managers. Paulson was I think there actually are some others who really did I can't speak to what David kind of crisis that we had. 11 In terms of the purchase back at the puts, I 12 mean, at that point I wasn't aware of it and I think I 13 testified, I know I said this in my statement, I wasn't 14 aware of this 43-billion-dollar exposure until I think it 15 was September or thereabouts. 16 taking place within the business at a level that you just 17 wouldn't see if you were on a board. 18 So that was activity that was And those put -- those positions were taken back 19 pursuant to the puts because the market had basically, at 20 least is my understanding, had basically frozen. 21 22 COMMISSIONER GEORGIOU: them. I mean that -- 23 MR. RUBIN: 24 COMMISSIONER GEORGIOU: 25 Well, you couldn't sell Yeah, they had no choice. so you took the puts back. They couldn't sell them 83 1 But -- but wouldn't that -- wasn't that a signal 2 to somebody? Shouldn't that have been a signal to somebody 3 that your exposure was dramatically increasing by having to 4 take these back? 5 MR. RUBIN: Well, let me just, if I may. 6 COMMISSIONER GEORGIOU: 7 MR. RUBIN: Right. You're correct. They -- they 8 were -- they, at least as I understand it, though I wasn't 9 aware of it at the time, they had to buy back those tranches 10 because the markets had fundamentally become frozen. 11 COMMISSIONER GEORGIOU: 12 MR. RUBIN: 13 COMMISSIONER GEORGIOU: Right. But still -But that's -- this is 14 way earlier, you know, this is almost a year; it's more than 15 a year before Lehman fails; it's nine months before Bear 16 Stearns fails. 17 18 MR. RUBIN: It was -- it was, as I remember correctly, what you said, July of '07. 19 COMMISSIONER GEORGIOU: 20 MR. RUBIN: 21 July of `07. July, `07, about three months before we became aware of these Triple-A positions. 22 COMMISSIONER GEORGIOU: 23 MR. RUBIN: Right. But they still believed, as I 24 understand it, and I think in good faith, as did the 25 universe in general, almost, with some very few exceptions, 84 1 as you correctly say, that these were Triple-A securities, 2 that the risks were de minimus, and that this market would 3 clarify in time, and they would begin to function again. 4 COMMISSIONER GEORGIOU: Right. Okay. Well, 5 yesterday we heard from -- from -- well, let me -- let me -- 6 let me actually ask you about one other question. 7 I recall, if my memory serves, that you had to 8 either miss your Thanksgiving dinner or get up from your 9 Thanksgiving dinner in November of `07, to fly to Abu Dhabi 10 to raise seven and a half billion dollars in capital from 11 the Abu Dhabi investment authority. 12 mean, obviously you needed that capital at that time. 13 And I guess I -- I Would it have been possible for you to have raised 14 more capital for Citi, either then or prior to then, that 15 might have avoided the taxpayers having to bail out Citi at 16 the time? 17 Now, I recognize it was expensive capital. It 18 was, I get points plus 11 percent. 19 money loan in certain characterizations, but could you speak 20 to the capital requirements? 21 It was really a hard Because Dr. Greenspan yesterday said that one of 22 the things that he would now recommend, even though he 23 basically didn't take much responsibility for this, but he 24 did suggest that on a go-forward basis, there ought to be a 25 whole lot more capital and a whole lot more liquidity 85 1 required of these large financial institutions in order to 2 avoid the risk that the taxpayers will have to bail them out 3 in the future. 4 5 MR. RUBIN: And as you know from my statement, I agree with Dr. Greenspan's positions. 6 COMMISSIONER GEORGIOU: 7 MR. RUBIN: Right. I think the average constraint 8 should be very substantially increased, which means you 9 would have more capital in these organizations. 10 My recollection, Commissioner, is that at that 11 time, which was shortly after our new CDO -- no, that was, 12 I'm sorry, that was when I was chairman, which is we were in 13 the search process, one thing or another, that was we tried 14 to raise -- I think I'm right in this, but you better ask 15 others to confirm this -- but my recollection is that we 16 raised as much capital as we could in that period of time. 17 COMMISSIONER GEORGIOU: Right. 18 MR. RUBIN: 19 opportunity to raise more capital. 20 there are others who will remember that better than I. I don't think that there was the 21 COMMISSIONER GEORGIOU: 22 MR. RUBIN: Although, as I say, Right. The -- We have, because your point is 23 extremely well taken. From that point forward, we had a 24 highly proactive focus on raising private capital and 25 ultimately raised some numbers of tens of billions, I don't 86 1 remember the exact amount, through this period of difficulty 2 for Citi. 3 COMMISSIONER GEORGIOU: Right. But of course, 4 by that time the capital was harder to raise and more 5 expensive to raise, right? 6 MR. RUBIN: Yeah. But I don't think we ever, 7 and again, there are others, Commissioner, who have a better 8 recollection of this than I do, but I don't think we ever 9 held back from raising capital at that point because of 10 price, at least not as far as I can recollect. 11 COMMISSIONER GEORGIOU: 12 could, please. 13 Mr. Prince, yes, if I Yeah, thank you. Mr. Prince, from `06 to `07, this is referring 14 back to the dance metaphor there. 15 leveraged loan exposure limit from 35 billion to 100 16 billion. 17 Citi increased its If you were at all concerned about this 18 business, how come you allowed the limits to be tripled 19 during that period? 20 MR. PRINCE: Leveraged lending, Commissioner, is 21 a business of lending money to private equity firms and so 22 forth for them to conduct their activities. 23 It was widely reported in the press at the time 24 that the private equity firms were driving very hard 25 bargains with the banks. They were insisting on no mat 87 1 clauses and payment in kind interest and so forth and so on. 2 My belief then and my belief now is that one 3 firm in this business cannot unilaterally withdraw from the 4 business and maintain its ability to conduct business in the 5 future. 6 Running a securities business is a lot like 7 running a baseball team where none of the players have 8 contracts, and people can leave any day and go to another 9 team. 10 And if you are not engaged in business, people 11 leave the institution. 12 in the leveraged lending business, for you to say to your 13 bankers, we're just not going to participate in the business 14 for the next year or so until things become a little more 15 rational. 16 any people left to conduct business in the future. 17 18 19 And so it's impossible, in my view, 0you can't do that and expect that you'll have COMMISSIONER GEORGIOU: Okay. I think if I -- if I could, just one more minute. The -- there are several issues. It seems to me 20 that if we -- I'm going to ask, and if we don't get a chance 21 to answer them, I would ask you to try to respond in writing 22 too, because there's been a lot of discussion about a whole 23 variety of forms of arbitrage, which were engaged in by the 24 principal financial institutions that are coming before us. 25 Regulatory arbitrage, to the extent that smart 88 1 lawyers try to structure things in a way to -- to yield the 2 least restrictive regulatory process. 3 Capital arbitrage, very important in that people 4 move things off-balance-sheet so that you don't have to hold 5 capital against them or you hold them in your trading desk 6 where one of the Fed employees that we interviewed said that 7 if you hold the trading assets, the capital requirements are 8 so low on those that you're basically holding 750 or 800 to 9 1 leverage on them. 10 So there's a lot of different ways that very smart 11 people who work for these institutions are able to avoid 12 what, it seems to me, was one of the glaring failures of our 13 system in that insufficient capital, insufficient money, was 14 being put where their mouth was by these institutions and 15 being held to cushion yourselves against the risk. 16 17 18 Could you speak briefly to that? I know we don't have a lot of time, but, Mr. Prince? MR. PRINCE: I think, Commissioner, with respect 19 that question is important enough and detailed enough that I 20 would prefer to respond -- 21 22 COMMISSIONER GEORGIOU: That would be -- that would be fine. 23 MR. PRINCE: -- supplementally. 24 COMMISSIONER GEORGIOU: 25 MR. RUBIN: Mr. Rubin? Yeah, I'd -- I agree with Chuck that 89 1 a written response would be appropriate. 2 general comment, if I may. 3 COMMISSIONER GEORGIOU: 4 MR. RUBIN: I would make one Sure. I think one of the challenges of 5 those, who are engaged in this financial reform effort are 6 faced, is the very technical -- the technicality of the 7 problem. 8 9 And I think that the kinds of loopholes, loopholes may be the wrong word, the kinds of issues that 10 you've identified do need to be addressed in terms of 11 increasing constraints on leverage. 12 hopefully will be part of this process. 13 COMMISSIONER GEORGIOU: 14 MR. RUBIN: And I think that should Right. But however you do it, I've been 15 around this for a long time, but however you do it, there 16 will always be people seeking to find ways around that. 17 18 COMMISSIONER GEORGIOU: question about that. 19 20 21 22 MR. RUBIN: I think this will always be a work in process. COMMISSIONER GEORGIOU: Right. But there could be some things done. 23 MR. RUBIN: 24 COMMISSIONER GEORGIOU: 25 Well, there's no I agree. And, you know, one thought is maybe there should be a principle of the total 90 1 amount of capital required for a pool of assets should be 2 the same after a securitization as before, you know, that 3 you ought not to be able to transfer assets 4 off-balance-sheet and end up with a circumstance where you 5 don't have to hold any capital against them, particularly in 6 circumstances where they may have to come back. 7 And, you know, it's been pointed out to me that 8 50 percent of the mortgages that you held were 9 off-balance-sheet in 2007 and 58 percent in 2008. 10 Now, I know there's some new cap -- new balance 11 sheet requirements that have come in as of 1/1 of '10 that 12 may require you to bring some of them back on, but there's a 13 reason why you had over a trillion dollars of assets off 14 balance sheets. 15 interest for the organization in some capacity, I don't know 16 what capacity, less capital, less visibility, who knows, but 17 you moved a lot of assets off-balance-sheet, and so did a 18 lot of other people; you're not alone in this regard. 19 it seems to me that for transparency and clarity, that needs 20 to be addressed. Somebody believed that it was in the 21 MR. RUBIN: 22 CHAIRMAN ANGELIDES: 23 24 25 And Can I make a one-second response? Sure, very quickly, because we have to move on. MR. RUBIN: I'll just take one second. identified a very important problem. You've On the other hand, 91 1 it's -- it's that securitization, as long as it's done under 2 sound basis, that is very central to the functioning of our 3 economic systems. 4 It seems to me that you're exactly right except 5 that you've got to find some way to enable institutions to 6 engage in securitization that doesn't at the same time lead 7 to problems. 8 9 COMMISSIONER GEORGIOU: Right. And one thing, I know I'm passed my time, but let me just -- 10 CHAIRMAN ANGELIDES: Way past. 11 COMMISSIONER GEORGIOU: -- say one thing. One 12 idea that has been floated about is to have you take some 13 risk in connection with these securities. 14 hold them. 15 Maybe you need to Greenspan said it yesterday, I mean, said it in 16 his prior testimony, maybe you need to hold them and be long 17 and align with the investors some portion of it so that 18 your -- your diligence is appropriately incented to be sound 19 because you know you're going to have -- thank you very 20 much. 21 22 23 CHAIRMAN ANGELIDES: All right. I yield you a couple of minutes out of my time. Just one note for the Commission members, 24 according to our staff, this is an estimate, just an 25 estimate, but of the 51 billion dollars in losses related to 92 1 subprime exposure, 10 -- close to 11 billion dollars appear 2 to have been in the bank and some 40-plus were in the 3 non-bank, just for the numbers. 4 COMMISSIONER HOLTZ-EAKIN: 5 CHAIRMAN ANGELIDES: 6 COMMISSIONER HOLTZ-EAKIN: 7 All right. Mr. Holtz-Eakin? Thank you, Mr. Chairman. 8 EXAMINATION BY COMMISSIONER HOLTZ-EAKIN 9 COMMISSIONER HOLTZ-EAKIN: Let me begin with 10 apologies, first of all, that due to the vagaries of travel, 11 I was late and missed your testimony and came in the middle 12 of yours. 13 And I do apologize, it was not my intention. And that, also, because of a prior commitment, I 14 was unable to hear the testimony yesterday of the other 15 representatives of Citi. 16 than perfectly informed, I apologize in advance. 17 And so to the extent that I'm less Mr. Rubin, I did want to pick up on something you 18 just said, because it really did catch my attention. You 19 said no one could have foreseen this kind of crisis. And 20 that was a universally sort of held belief. 21 I think the important thing to recognize is that 22 the question is not whether you could have foreseen the 23 whole crisis. 24 spark that lit the crisis, which is the poor standards in 25 underwriting, the poor assessments of risks associated with The question is, could you have foreseen the 93 1 mortgages, the inadequate hedging and capital provisioning 2 against that. 3 If that's done, there is no crisis. And in light of the fact that we've had housing 4 crisis, the savings and loan crisis, that you are familiar 5 and many are with the activities of Fannie Mae and Freddie 6 Mac and identified them as a risk, and that, in your 7 experience, you've seen crises in Mexico and in Thailand and 8 in the Far East, wouldn't there be grounds to be at least a 9 little suspicious at some point? 10 MR. RUBIN: It's a good question. 11 that no one could have foreseen. 12 people did foresee. 13 foresaw the full combination and clearly -- 14 Actually, I think some What I said was that very few people COMMISSIONER HOLTZ-EAKIN: 15 the point is they didn't need to. 16 the mortgage piece. 17 I didn't say MR. RUBIN: They didn't need to; They just needed to see Well, you know, I'm not so sure 18 about that. 19 in my opening statement, was you had a large combination of 20 forces that had come together. 21 It seems to me that what you had, and I said it I at least think, and it's interesting 22 discussions that one could have, I think that a few of those 23 that occurred you would have had a very different experience 24 than we had. 25 I think it was an extraordinary combination of 94 1 many factors that came together. 2 you could see some of these, why didn't that suggest to you 3 that this could be a problem. 4 And you could say, well, As I said in my opening statement, I actually did 5 worry about excesses back in 2005 and 2006, and talked 6 about it in speeches, one thing and another. 7 But what I didn't see and virtually nobody saw 8 was that it wasn't really those excesses, but it was so many 9 other factors coming together at the same time and I think 10 it was that extraordinary combination that lead to this 11 crisis. 12 And, you know, it's interesting, and I know 13 you've been around for a long time too. 14 had capital markets we've had crises. 15 look back, you always look back and you look back and you 16 say, well, these were -- these were obvious warning signs. 17 As long as we've And then when you But they're not obvious at the time. They're 18 only obvious in hindsight. 19 personally think unfortunately that market-based systems, 20 which I believe in strongly, will have periodic down cycles, 21 hopefully not like we've just experienced, and that's why I 22 think this financial reform effort is so extremely 23 important. 24 25 And I think we all -- I COMMISSIONER HOLTZ-EAKIN: In your testimony, you did talk about low rates causing markets to reach for 95 1 yield. 2 many people, Citi included, were increasingly borrowing at 3 very short term and lending longer to take advantage of a 4 very steep yield curve. 5 And one way to interpret that is that, you know, And I guess my question is, did Citi create a 6 structure which was, in light of the way the yield curve 7 ultimately shifted, too dependent on a steep yield curve to 8 survive the change in rates? 9 MR. RUBIN: Well, I actually was referring to 10 something slightly different, but it certainly, and I'm not 11 sure I totally understand the question, but it's certainly 12 true that across the financial world, not just in this 13 country, but around the globe, there was a so-called carry 14 trade, which is what you're referring to, I think. 15 COMMISSIONER HOLTZ-EAKIN: Well, in particular, 16 just your off-balance-sheet activities, funding things at 17 very short maturities and at the very low rates there to 18 make money at the -- at the longer maturities and reach 19 yield. 20 of the business model? 21 MR. RUBIN: Is that something that across Citi became too much Well, that's a good question that I 22 don't know that -- I would say, in retrospect, not just at 23 Citi, but I guess I'm just repeating myself, and I 24 apologize, but across -- across the entire financial system, 25 there was a dependence -- or I shouldn't say a dependence, 96 1 but there was a great deal of this kind of a carry trade 2 going on. 3 slightly different though. 4 I actually meant in my statements something I was referring to this massive influx of 5 capital from abroad that caused the bond market yields to be 6 lower than they otherwise would have, and I think that was 7 very centrally involved, because as you know very well 8 because I know your background, mortgage -- mortgage yields 9 tend to be a function of the tenure, and that's really what 10 11 my reference was to. COMMISSIONER HOLTZ-EAKIN: One of the risks that 12 you're exposed to, then, is interest rate risks. 13 think the question becomes risk management. 14 And so I And, Mr. Prince, you said, very clearly, you 15 cannot overstate the need for a risk assessment in running 16 your business. 17 capacities was managerial advice and this strikes me as 18 central to both of your portfolios. 19 And, as I understand it, one of your And I just want to review some of the things 20 that at least the preparation of this hearing reveals, which 21 is that on March 29, 2004, OCC examiners concluded an 22 examination of fixed-income derivatives business at 23 Citibank, which included the business group working on CDOs, 24 and included that, quote, the quality of risk management is 25 less than satisfactory. And that report was transmitted to 97 1 Citibanks -- some six banks -- six months later. 2 The OCC also concluded that certain CDO tranches 3 super senior positions continue to pose risk management 4 challenges. 5 Obviously, Citi had the chance to respond to 6 that, but as we've heard, you seem to place a lot of 7 reliance on credit rating agencies in assessing the risk 8 associated with those senior CDO positions. 9 10 How much reliance was placed on the rating agencies from each of you? 11 MR. PRINCE: Well, Commissioner, with respect, 12 the -- the positions that are involved weren't known to me, 13 and I think to Bob, until September, October -- so -- of 14 `07, so -- 15 16 COMMISSIONER HOLTZ-EAKIN: much the rating agencies placed as the risk? 17 18 So you don't know how MR. PRINCE: So you asked how much did we place from the rating agencies? 19 COMMISSIONER HOLTZ-EAKIN: 20 MR. PRINCE: Okay. How much did Citi? I apologize. I 21 misunderstood the question. I don't know the answer to 22 that. 23 he would have been the proper one to answer that question. David was here yesterday, David Bushnell, and I think 24 COMMISSIONER HOLTZ-EAKIN: 25 MR. RUBIN: Mr. Rubin? Yeah, I'll -- I'll identify with 98 1 something that Chuck said and then I'll just add one 2 comment, if I may. 3 Both of us learned about -- well, I'll speak for 4 myself, but I think it was also true of Chuck -- learned 5 about this in the fall of `07, and clearly -- and I remember 6 that initial -- when I initially heard about it, and I had a 7 reaction, which is in my statement, you'll see it there, to 8 the effect that if you're engaged in an arbitrage kind of a 9 business, and admittedly I had an arbitrage background and 10 it probably caused me to think this way, then the other side 11 of that transaction is to completely dispose of the risk. 12 But the people who were running the businesses 13 replied, and I think their reply was totally understandable, 14 that these were Triple-A securities and had de minimus risk 15 and that certainly was how Triple-A securities had always 16 been seen in all the time that I've been in the business. 17 So I would say from their response that they 18 were very much relying on those Triple-A ratings. 19 also understand, and I don't recollect where I know this 20 from, but that David Bushnell's people did an enormous 21 amount of independent analysis, as well. 22 that's where I saw the number, now that I think about it, 23 that they had calculated that it was something like a 1 in 24 10,000 probability of a default on these instruments. 25 COMMISSIONER HOLTZ-EAKIN: Though I And I believe So you're both 99 1 comfortable, it's fair to say, that Citi had adequate 2 supplemental internal risk assessment to -- 3 MR. PRINCE: Had what? I'm sorry. 4 COMMISSIONER HOLTZ-EAKIN: Adequate supplemental 5 risk assessment internally on top of the credit rating 6 agencies? 7 MR. RUBIN: Well, I think you need to go back to 8 David Bushnell was here yesterday but -- and I was -- I 9 didn't hear -- 10 COMMISSIONER HOLTZ-EAKIN: 11 superiors. 12 your organization? 13 You were his Were you satisfied with the risk assessment in MR. RUBIN: I think David, who I knew reasonably 14 well, was very knowledgeable and very capable. 15 impression was that they did a -- 16 COMMISSIONER HOLTZ-EAKIN: 17 MR. RUBIN: 18 And my Is that a yes? -- a very good -- that is -- that is a yes. 19 COMMISSIONER HOLTZ-EAKIN: 20 MR. PRINCE: Mr. Prince? I had great confidence in David 21 Bushnell before this and I have great confidence in him now. 22 I would trust his judgment on how this should best have been 23 run. 24 25 COMMISSIONER HOLTZ-EAKIN: So you felt that both that the internal processes, while you weren't aware of the 100 1 details of the assessment of the risk, the internal 2 processes surfaced things appropriately? 3 MR. PRINCE: Correct. 4 COMMISSIONER HOLTZ-EAKIN: In the OCC's 5 examination report for Citibank that ended the year 6 September 31st, 2007, has stated that traditionally the 7 board has been provided limited information on the material 8 risks impacting this legal entity. 9 have been unable to become quite familiar with the risk 10 And consequently they assumed within the bank. 11 In light of that assessment by a key regulator, 12 are you still happy with the fact that the company is proud 13 of its -- this is your response, the company is proud of its 14 board processes, both at the parent level and the bank 15 level. 16 for Citibank to be proud of those processes prior to 2008? 17 18 19 20 Do you still feel that there is a reasonable basis MR. PRINCE: I'm sorry, Commissioner, what's the date of that report? VICE CHAIRMAN THOMAS: Prior to the answer, I yield the gentlemen an additional five minutes. 21 COMMISSIONER HOLTZ-EAKIN: 22 MR. PRINCE: 23 Thank you. I'm sorry, Commissioner, what's the date of that report? 24 COMMISSIONER HOLTZ-EAKIN: That report is 25 December 31st, 2007, for the year ending in 2007. 101 1 MR. PRINCE: Well, that was after I left, so I 2 haven't seen that, and I haven't seen the company's response 3 to it, but I think it's -- I think it's worth noting that 4 the regulators, including the Fed, who are involved in the 5 company throughout this entire period, the Fed saw 6 everything that went to the board of directors at every 7 meeting, and if they felt that the processes relating to the 8 board were inadequate, it probably would have been useful 9 for them to raise it at an earlier point in time. 10 COMMISSIONER HOLTZ-EAKIN: 11 MR. RUBIN: Mr. Rubin? I think that, and I'm repeating what 12 I said earlier, that David Bushnell was extremely well 13 qualified for his job. 14 they acted in good faith in deciding what needed to be 15 brought to the board. 16 processes. 17 And I -- I don't have any doubt that And I think that they had good I think that after the fact -- well, let me add 18 one more thing, if I may, Commissioner, because I think it's 19 important. 20 those positions were taken, that they were evaluating them 21 and making the decision to retain them rather than dispose 22 of them, they sought Triple-A securities and sought 23 de minimus risks. 24 25 I think in terms of the facts at the time that Obviously, in retrospect, after the enormous developments that took place and the tremendous costs that 102 1 they -- that those developments led to, these securities had 2 a very different look. 3 whether they did what they needed to do, in terms of 4 bringing issues to the board's attention, you have to 5 evaluate them in terms of the facts at the time and what was 6 reasonable for them to do at the time. 7 would be that they acted in good faith and did what they 8 felt was appropriate. 9 But I think that in evaluating COMMISSIONER HOLTZ-EAKIN: And my judgment The Fed, at the same 10 time, this is the report of the senior supervisors' meeting, 11 which had participants from the Federal Reserve Bank, the 12 Federal Reserve Board, the Office of the Comptroller of the 13 Currency, the SEC, the UKs FSA, and the Japan's FSA felt 14 that poor communication across all business lines 15 decentralized nature of the firm created silos, that senior 16 management did not fully appreciate the market risk of the 17 leveraged loan pipeline or of the retained super senior CDO 18 positions, and that management found that the balance sheet 19 in risk loans were not adequately enforced. 20 risk metrics for leveraged loans to CDOs did not fully 21 represent risks. 22 And traditional So in both the measurement of risk and the 23 conveyance of risks, the same regulators who you place such 24 strength in, found that the activities appeared to be 25 inadequate. Are you still satisfied with both the metrics 103 1 used to assess risk and the conveyance of the -- 2 3 MR. RUBIN: Commissioner, is dated when? 4 5 That report you just read, COMMISSIONER HOLTZ-EAKIN: This is dated November 19th, 2007. 6 Speaking simultaneously 7 CHAIRMAN ANGELIDES: And can I just add, because 8 Mr. Holtz-Eakin was flying in, I did reference it earlier, 9 just so you know, this is the November 19th meeting, which 10 Mr. Rubin attended; part of the meeting Mr. Bushnell was 11 there. This is the one I referred to earlier. 12 COMMISSIONER HOLTZ-EAKIN: 13 MR. RUBIN: Thank you. I think the -- I think the problem 14 with a report like that, Mr. Commissioner, is that you have 15 to distinguish -- it's actually a very important point, so I 16 would like to spend a moment on it, if I may. 17 COMMISSIONER HOLTZ-EAKIN: 18 MR. RUBIN: Please. I spent a career evaluating trading 19 operations at Goldman Sachs when I was running it or 20 co-running it and so forth. 21 try to figure out whether people had acted reasonably and 22 sensibly in light of the facts that they knew at the time as 23 opposed to when you look back at them after you knew what 24 had happened. 25 And the challenge always was to And I think the report you need to read is not 104 1 the one you just read, because at that point they knew what 2 had happened. 3 reports that they issued before that, before they knew what 4 was happening, so that you would know what they felt -- 5 6 I think what you've got to do is find the COMMISSIONER HOLTZ-EAKIN: My apologies. 7 MR. RUBIN: 8 COMMISSIONER HOLTZ-EAKIN: 9 Please, continue. Excuse me? Please continue. Our apologies. 10 VICE CHAIRMAN THOMAS: 11 MR. RUBIN: 12 COMMISSIONER HOLTZ-EAKIN: 13 nothing wrong; we did. 14 MR. RUBIN: I apologize. I'm -- I'm a little -- all right. Go ahead. You did So I think what one needs to do is 15 look back at the reports that were issued before the crisis 16 developed. 17 know if those reports stated these sorts of problems or not, 18 but if there were problems, I presume the regulators would 19 have brought them to the attention of the company, and the 20 company would have addressed them. 21 And then if there were problems, and I don't It is very -- and I can tell you from my own 22 experience, because I lived this for years, it is very, very 23 difficult after the fact to try to make a judgment as to 24 what was reasonable at the time because you get so 25 influenced by knowing what had happened. 105 1 COMMISSIONER HOLTZ-EAKIN: It's a fair point. 2 Are you aware of any reports from supervisors prior to the 3 crisis, 2004, 2005, 2006, which suggests this same 4 characterization of Citibank's internal risk assessment and 5 communication of risk? 6 MR. RUBIN: If there -- if there were such 7 reports, Commissioner, I'm not aware of them. And if there 8 were such reports, I assume that the company would have 9 addressed to them -- addressed them in response to those 10 reports and that the regulators would have insisted they be 11 addressed. 12 COMMISSIONER HOLTZ-EAKIN: Well, if there were 13 such reports, they're still writing the same thing later. 14 So we can pursue the existence of the reports, and I'd ask 15 the liberty to come back to you with additional questions on 16 that front. 17 MR. RUBIN: 18 COMMISSIONER HOLTZ-EAKIN: 19 20 Thank you. Thank you. I yield back my time. CHAIRMAN ANGELIDES: Yes. And I just might add, 21 Mr. Holtz-Eakin, and I think you did point out, I just want 22 to point out that Mr. Holtz-Eakin did reference reports that 23 were pre-crisis, very specifically. 24 referenced the `04 and the `05 reports that are very clear 25 on this subject. And I think you So I -- we will -- we will direct the 106 1 Commission staff to provide that information to you. 2 I also just want to correct something, for the 3 record. When I asked the question to the staff of on 4 balance sheet, off-balance-sheet losses, it was -- there was 5 a miscommunication. 6 number do not use, folks. 7 Except I will say that the losses in the non-bank were very 8 substantial. 9 10 We will get you the right number. All right, let's go now to Ms. Born and then we'll go to Mr. Thompson. 11 12 So the 10 billion and 40 billion dollar COMMISSIONER BORN: Thank you very much, Mr. Chair. 13 EXAMINATION BY COMMISSIONER BORN 14 COMMISSIONER BORN: And I also want to sincerely 15 thank both Mr. Prince and Mr. Rubin for being willing to 16 appear before us today and help us with this important 17 inquiry. 18 Mr. Rubin, you said in your book, several years 19 before the financial crisis erupted that unregulated OTC 20 derivatives can cause problems, in your view, when the 21 markets become stressed. 22 23 24 25 Do you believe that they did, in fact, contribute to the financial crisis? MR. RUBIN: I believe that the -- at the very least, the credit default swaps seemed to have played a role 107 1 in the financial -- and maybe even a meaningful role in the 2 financial crisis. 3 or not, I do not know, Commissioner. 4 Whether any derivatives beyond that did My reference, by the way, in the book, which I 5 appreciate that you obviously read, is -- was derivatives 6 more broadly, not just over-the-counter derivatives. 7 COMMISSIONER BORN: Do you now think that 8 there's a need for any regulation of the OTC derivatives 9 market? 10 MR. RUBIN: I think that there should be, and I 11 thought this when I was at Goldman Sachs. 12 there should be regulations of over-the-counter derivatives, 13 but I also think that the regulation of listed derivatives 14 should be enhanced, particularly through increased capital and 15 margin requirements. 16 COMMISSIONER BORN: I think that You say in your testimony 17 that you feel that standardized derivatives should be 18 exchange-traded and that customized contracts should be at 19 least cleared, if possible, and if not, there should be 20 disclosure of information about them. 21 on what benefits you think that would provide? 22 MR. RUBIN: Could you elaborate At the very least -- well, if you 23 standardize them, to the extent that you can get, and I know 24 you're an expert in this field, Commissioner, but to the 25 extent that you can standardize these instruments, not only 108 1 do you have disclosure and transparency to the regulators 2 and to the markets, but you also have potentials for netting 3 within organizations that I think could considerably reduce 4 the risk in times of stress. 5 The over-the-counter derivatives obviously 6 present a more difficult problem, but it does seem to me, 7 and I understand that technically this is very difficult, 8 but it does seem to me that if it is possible to put these 9 over-the-counter derivatives through a clearing system, you 10 then go with reduced counterparty risks and you increase 11 transparency. 12 If that is technically not possible, and I 13 understand there are a lot of technical problems, then it 14 seems to me at the very least, there ought to be some means 15 found for creating transparencies so that the regulators at 16 the very least, I'm not sure what I think about the markets, 17 but the regulators at the very least know what the exposures 18 are. 19 COMMISSIONER BORN: You said in the past that 20 there was no political will to regulate over-the-counter 21 derivatives. 22 Do you -- in your view was the lack of political 23 will related to pressure by the financial services industry? 24 25 MR. RUBIN: In the -- I think they were very strongly held views in the financial services industry in 109 1 opposition to regulation. 2 overcomable, it's probably not a word, overcomable, but not 3 surmountable at that point. 4 And I think that they were not Can I just do one brief anecdote? When I was at 5 Goldman Sachs, in my last year or two, my co-partner, senior 6 partner and I, felt a very serious concern about this, and I 7 went to see Dick Fisher, who at that time was the senior 8 partner at Morgan Stanley and really a distinguished leader 9 of our industry, and he agreed. 10 And so I started an effort to see if we could do 11 something. 12 Commissioner. 13 proposals. 14 And our focus then was on margin requirements, It didn't have the breadth of the later And it very quickly became apparent that there 15 was simply no possibility of moving forward. 16 for the very reason you said, and that is, the industry had 17 very strong views on this and it wasn't going to be 18 something that we could do. 19 COMMISSIONER BORN: And that was Do you think that the lack 20 of political will may also have been affected by a pervasive 21 view that the market was appropriately self-regulatory and 22 that there wasn't a need for regulation? 23 MR. RUBIN: I don't -- that's a level of 24 sophistication, it's a terrifically interesting and 25 important question, but I don't think when you got into the 110 1 political arena that that really was what this was about. 2 think this was more about the interests of those who were 3 involved and their ability to effect those interests, 4 effect, e-f-f, yeah, effect those interests, rather than the 5 much more sophisticated question that you're raising. 6 COMMISSIONER BORN: You said that you think that 7 at the least credit default swaps played a role in the 8 financial crisis. 9 Looking at the bigger over-the-counter 10 derivatives market, there is a lot of inner-connectivity 11 that's created through the contracts. 12 of transparency. 13 plus the lack of effective price discovery played a role in 14 some of the financial panic that struck in 2007 and 2008. 15 There's also a lack And I wonder whether or not those problems MR. RUBIN: Oh, listen, that point is extremely 16 well taken, and it's too big to fail idea, but the other 17 area is too interconnected to fail. 18 the point that you're raising. 19 your question is yes. 20 COMMISSIONER BORN: And that's precisely So I think the answer to Do you think that your 21 proposals for exchange-trading, if possible, clearing, if 22 possible, disclosure of information, at least to the 23 regulators, would address some of that problem? 24 25 I MR. RUBIN: In part, Commissioner, but I felt back when I was at Goldman Sachs and I felt ever since and I 111 1 still feel now that you do need one more piece. 2 think that you need substantially increased capital to 3 margin requirements because that will give you greater 4 cushion in the event that problems occur. 5 And I do And I think I said in my book, as long as you 6 have normal conditions, I don't think any of this is 7 particularly a problem. 8 conditions, you can get very serious issues very quickly. 9 And so I think you need a bigger cushion. 10 But the trouble is under stress COMMISSIONER BORN: In that connection, you 11 know, there are margin requirements on exchanges. They can 12 be raised and probably should be raised. 13 over-the-counter derivatives market, the instruments 14 themselves have lent themselves to high levels of leverage. The -- in the 15 There are a number of instruments which have 16 seemingly been designed just to build in a great deal of 17 leverage. 18 require margin or collateral on that; is that correct? And there aren't currently any mechanisms to 19 MR. RUBIN: Yes, that is correct. 20 COMMISSIONER BORN: Do you think -- I'm 21 concerned that some of the complexity that's entered into 22 the market, some of the highly complex instruments may not 23 really be fully understood by the parties, either by the 24 over-the-counter derivatives dealers themselves, their 25 management and board, boards, or by the entities that are 112 1 purchasing them. 2 And I think particularly of the problems we've 3 heard in municipalities, like Jefferson County, Alabama, the 4 grease problems that were evidently somewhat designed to 5 disguise the amount of greases, exposures, and debt, I would 6 like your views on the need for this degree of complexity. 7 I'm not sure regulators have the capability of understanding 8 these instruments. 9 I don't know if anybody else does fully. MR. RUBIN: Oh, it's a very good question, 10 Commissioner. 11 discuss this in my book. 12 recollection, but I think I did. 13 And I think I -- my recollection is I did I may be wrong about that I think the complexity -- I think the complexity 14 is understandable and actually useful -- well, not 15 complexity, per se, is never useful, I suppose -- but 16 is a product of the purposes that are trying to be 17 accomplished. 18 On the other hand, I think your point is 19 correct, and I lived this for a long time, so I actually 20 knew a fair amount about it. 21 that I think users of these instruments very often don't 22 understand that the complexities and the risks embedded in 23 them, not under normal circumstances, but under stress 24 conditions. 25 I think your point is correct And that's exactly why I think, or it's one 113 1 reason why I think, capital margin requirements could be 2 greatly increased. 3 greater cushion. 4 capital margin requirements, it would cause people to focus 5 more on trying to understand the risks they were taking and 6 probably result in less use of these instruments. 7 think on balance, that would be a desirable outcome. Number one, at least you would have And I also think that if you have greater 8 COMMISSIONER BORN: 9 CHAIRMAN ANGELIDES: Thank you. Okay, fine. 10 COMMISSIONER THOMPSON: 11 CHAIRMAN ANGELIDES: 12 COMMISSIONER MURREN: Yes? Ms. Murren, do you have a Just a follow-up on your comment about your perspective that you think capital -- 15 16 Mr. Thompson? question, before I go to Mr. Thompson, on this point? 13 14 And I VICE CHAIRMAN THOMAS: I yield the Commissioner two minutes. 17 CHAIRMAN ANGELIDES: 18 COMMISSIONER MURREN: 19 Fine. It will be short. EXAMINATION BY COMMISSIONER MURREN 20 COMMISSIONER MURREN: 21 requirements are very important. 22 products that were specifically designed to avoid capital 23 requirements? 24 MR. RUBIN: 25 COMMISSIONER MURREN: You mentioned capital Did Citigroup ever create I don't know the answer to that. And you, Mr. Prince, would 114 1 you create a product simply to -- or at least one of the 2 principal reasons for designing the product was to avoid 3 capital requirements? 4 MR. PRINCE: I -- I think the answer is no 5 because the product would have to be designed as something 6 that a client would want. 7 you wouldn't create a product that was internally focused. 8 9 In other words, you wouldn't -- If your question is, would the -- would the team create products -- and in the course of creating the 10 products, try to minimize capital burdens, my guess is the 11 answer is yes, but I don't know for sure. 12 COMMISSIONER MURREN: So then it wouldn't 13 surprise you to know that in the minutes of one of your 14 meetings that specifically relate to the creation of new 15 products, in this instance, it would be liquidity puts, that 16 there was a notation that specifically referenced the fact 17 that this type of structure would avoid capital 18 requirements? 19 20 MR. PRINCE: seeing the document and understanding the context of it. 21 CHAIRMAN ANGELIDES: 22 the document. 23 Ms. Murren? 24 25 I have no way of responding without We will -- we will provide What is the document, so we can reference it, COMMISSIONER MURREN: It's the minutes of a meeting that took place in 2002 of a CMAC. 115 1 CHAIRMAN ANGELIDES: CMAP, which is the 2 committee that approved new products for your institution, 3 correct? 4 COMMISSIONER MURREN: 5 CHAIRMAN ANGELIDES: Yes. All right. We'll provide 6 that document so you can review it, and if the staff would 7 make sure we follow up. 8 COMMISSIONER MURREN: 9 CHAIRMAN ANGELIDES: 10 this. Thank you. Can we go -- let's go do Mr. Thompson -- is it -- 11 COMMISSIONER WALLISON: Can you -- 12 CHAIRMAN ANGELIDES: 13 COMMISSIONER THOMPSON: 14 EXAMINATION BY COMMISSIONER THOMPSON 15 COMMISSIONER THOMPSON: Absolutely, Mr. Wallison. Thank you, Mr. Chairman. The topic you're on is 16 actually something that is important to me and it's all 17 around financial innovation. 18 And, Mr. Rubin, you've had a long, long career 19 in both the private sector and the public sector. 20 seen innovation in this industry for a long time, and you 21 understand the public policy role for making sure that we 22 protect the public's interest when there are innovations 23 that hit a marketplace regardless of industry. 24 25 26 27 You've So I guess my question of you is, what steps should be taken to ensure that products that have a societal 116 1 effect, like some of the structured products that were 2 brought to market by this industry, are well tested before 3 they get there, before we create in the process another 4 calamity like the one we're experiencing? 5 MR. RUBIN: That's an interesting question. I 6 think that probably as desirable as it would be to 7 accomplish the purpose that you just outlined, that may not 8 be doable because the problem is -- well, let me put it 9 differently -- when problems develop with these kinds of 10 instruments, it's usually because of some set of 11 circumstances that hadn't been anticipated. 12 So what you can do internally and what all of 13 the institutions do is they test their instruments 14 against, I think I said this before actually, some past 15 history of 10 years or 20 years or whatever it may be, and 16 they look at what was the worst reasonable case, and then 17 they make a judgment, okay, what are the risks of loss, and 18 it's one thing or another. 19 And then what happens when you have very great 20 difficulty is something else happens, something you didn't 21 anticipate. 22 a very good question. 23 me that the answer comes back to where I was before. 24 25 And because of that problem -- that's actually Because of that problem, it seems to I think you've got to create a system that can deal with the unanticipatable or at least unanticipated. 117 1 And that's why I think leverage constraints have to be 2 substantially increased and why I would increase margin 3 capital requirements on all these innovative products. 4 I might add, and I think this is important, 5 well, I'd like might add one more thing if I may. 6 financial innovation actually does play an important role in 7 our economy and a constructive role. 8 an appropriate, if you will, regulatory framework for it. 9 COMMISSIONER THOMPSON: I think I just think you need Well, some would argue 10 that financial innovation is nothing more than regulatory 11 arbitrage of one sort or another. 12 with that? 13 MR. RUBIN: No. Would you agree or not I actually don't think so. 14 think an awful lot of innovation has nothing to do with 15 regulatory arbitrage. 16 I I remember a case of a country, for example, 17 that had a very large exposure in the oil business, and they 18 basically needed -- well, they didn't need, but they decided 19 they wanted some way to hedge themselves against future oil 20 price movement so they continued to fund their social 21 programs. 22 need to create an innovative structure to do that, and I 23 think we should have a system that allows us to do that, but 24 on the other hand, I think we have to recognize that there 25 is systemic risk that can be created in doing that, and Nothing to do with regulatory arbitrage, but they did 118 1 that's why we need the kind of framework that Commissioner 2 Born and I were discussing a bit ago. 3 COMMISSIONER THOMPSON: Mr. Prince, can the risk 4 management systems of an organization like Citi keep up with 5 the rate and pace of innovation that goes on within the 6 organization of Citi? 7 MR. PRINCE: Well, that's a -- that's a very 8 important question. 9 at Citi was extremely robust. 10 I think that the risk function we had As I said, David was thought of as the best risk manager on Wall Street. 11 We had a couple thousand people in the risk 12 organization independent of the businesses able to say no 13 any time they wanted to. 14 constraints, risk limits and so forth. 15 The businesses operated under the A different question, and perhaps the one you're 16 getting to, is whether or not the intellectual capacity, 17 the -- the -- the smartness of the people can keep up with 18 the innovation of the traders and so forth. 19 the key there, and what I took very seriously as my job, was 20 to make sure we had the best people involved. 21 I think that When I became CEO, the first thing I did was to 22 put David in charge, because he understood the securities 23 business. 24 the risk function independent of the businesses. 25 great comfort over the years from the frequent comments from He had been a trader in his past life. I made I took 119 1 the regulatory authorities commenting on David's strength as 2 an individual and on the strength of the function, 3 notwithstanding the after-the-fact document, apparently. 4 And I think that's, in some level, the best you can do. 5 We never had a situation where a product went 6 out the door that hadn't been looked at by risk. 7 whether, at times, they didn't do as good a job as they 8 could have, I'm sure, human nature being what it is. 9 set up a structure and to put the right people in that 10 If I can, just one point. 15 I think the regulatory situation ought to be changed. 13 14 But to structure is I think the best you can do. 11 12 And COMMISSIONER THOMPSON: That's where I'm going next. MR. PRINCE: I think all of the different 16 regulators and the different schematics I think is crazy. 17 And I think, to the extent your earlier question went to 18 that, I just wanted to make sure I commented on that. 19 COMMISSIONER THOMPSON: Yeah, I -- I -- 20 innovators and by their sheer nature are passionate about 21 what they do, and so it's -- my personal opinion is it's not 22 clear to me that a risk management function can keep up with 23 the passion and the creativity that a very aggressive, 24 innovative team brings to bear. 25 And I think that poses a systemic risk, quite 120 1 frankly, to the industry, because of the pace of innovation 2 that has occurred. 3 add. 4 But that's just my opinion, if I might On the regulatory front, yesterday Mr. Bushnell 5 said that he thought that some consolidation of the 6 regulatory oversight was, in fact, warranted because there 7 were way too many regulators, if you will, that they would 8 have to deal with. 9 If I look at what happened in Canada or if I 10 look at what happened in the UK, would you comment, given 11 that you are a global bank, on the differences that you 12 observed in the regulatory scheme of their -- and the 13 recovery process perhaps, because all those economies were 14 hit just like we were, but the recovery process and the 15 rigor of their oversight versus what we have here. 16 MR. PRINCE: I think that's, with respect, too 17 broad a question for me to cover in any depth. 18 let me give you the best answer I can under the 19 circumstances. 20 If I can, I think that the regulatory structures in the 21 various jurisdictions you talked about compare with the 22 United States in some ways more favorably. 23 The regulatory structure in the U.S., being 24 historically based from the time after the Depression, has 25 great inefficiencies in it, great overlaps, great 121 1 redundancies. 2 more efficient regulatory structure would lend itself to 3 greater probity for the -- for the industry. 4 And I think that a more streamlined and a I think the way that the various economies have 5 reacted to the crisis may be due in part to that, but I 6 think it's also due in part to the nature of the closed or 7 open nature of the financial services industry. 8 9 In Canada, for example, it is a more closed industry. In the U.S. and the UK, it is more open to the 10 market of this institute in respects. 11 regulatory environment. 12 COMMISSIONER THOMPSON: 13 very much. 14 Thank you. So it's not just the All right. Thank you I yield the rest of my time, Mr. Chairman. 15 CHAIRMAN ANGELIDES: Thank you, Mr. Thompson. 16 Now, Mr. Wallison, you had an item and then 17 Mr. Georgiou and then we'll go to the Vice Chair, and I have 18 just a few remaining questions. Yes, Mister -- 19 COMMISSIONER WALLISON: Thank you very much. 20 EXAMINATION BY COMMISSIONER WALLISON 21 COMMISSIONER WALLISON: 22 I was -- and I could have misunderstood this, This is for Mr. Rubin. 23 but I thought you said that when you were at Goldman Sachs, 24 you were concerned about something in the derivatives 25 market, and I thought it might have been credit default 122 1 swaps. What was that? 2 MR. RUBIN: Oh, no, it wasn't, in fact, I don't 3 think credit default swaps. 4 credit default swaps -- 5 6 COMMISSIONER WALLISON: MR. RUBIN: Oh, no, no, they didn't exist until much, much later. 9 10 They were not important, then? 7 8 To the best of my knowledge COMMISSIONER WALLISON: What was it that you went to see Mr. Fisher about? 11 MR. RUBIN: Oh, I was -- I'll tell you what I 12 was concerned about. October 19th, 1987, as you remember, 13 we had a 22 percent drop in the stock market. 14 COMMISSIONER WALLISON: 15 MR. RUBIN: Right. Some of the traders who were 16 involved at that time said to me they thought that portfolio 17 insurance had a real effect on that it's an issue we haven't 18 discussed here actually it's not a credit issue; it's an 19 ability of the lower trust or rather a potential for the 20 derivatives to feed back into and exacerbate cash market 21 movements. 22 And so what I thought was that we should have 23 higher margin requirements on derivatives because of that 24 potential for -- under stress conditions, for derivative to 25 feed back into cash markets. And that was the framework for 123 1 that discussion. 2 COMMISSIONER WALLISON: I see. Now, when you 3 were Secretary of the Treasury, however, you -- you opposed 4 any regulation of derivatives, so why -- 5 MR. RUBIN: 6 COMMISSIONER WALLISON: 7 MR. RUBIN: 8 COMMISSIONER WALLISON: 9 No. No, I -- I -- let me -- MR. RUBIN: 11 COMMISSIONER WALLISON: I don't know. MR. RUBIN: I'm aware of that. Let me, if I could, respond. 15 COMMISSIONER WALLISON: 16 MR. RUBIN: 17 So maybe you want to clear that up. 13 14 At least that's the story we have in the newspapers. 10 12 -- did you oppose it? Sure. It will take a moment or two to respond to it. 18 I think there really were two issues. 19 opposed to regulation of derivatives, let me say. 20 and derivatives were the dues I set out, you know, a bit 21 ago. 22 I was not My dues But there were two issues, and Commissioner Born 23 very rightly raised the question of risks and 24 over-the-counter derivatives. 25 because and as I already expressed about these risks. I agreed with her view, There 124 1 was a second issue, and the second issue, which I had been 2 advised about upon by counsel for Treasury, was that 3 approaches within the existing regulatory framework that 4 were being considered could create legal uncertainty in the 5 over-the-counter market, that it could take years to resolve 6 that in court, and that that could lead to chaotic 7 conditions. 8 COMMISSIONER WALLISON: 9 MR. RUBIN: That's right. My concern was avoiding that legal 10 uncertainty. I was not opposed to regulation derivatives. 11 Quite the contrary, I was actually tried to accomplish 12 something to that, in that regard, when I was with Goldman 13 Sachs. And my views have not changed since then. 14 COMMISSIONER WALLISON: 15 CHAIRMAN ANGELIDES: 16 COMMISSIONER WALLISON: 17 CHAIRMAN ANGELIDES: 18 COMMISSIONER WALLISON: 19 CHAIRMAN ANGELIDES: 20 record? 21 written response? 24 25 Now, Peter, we -- go ahead. Well, there's one more. Well, we're out of time. Real quick. Can you submit it for the Can you say what the question is and we'll get a 22 23 Okay. COMMISSIONER WALLISON: the record. Sure, I'll submit it for Thank you. CHAIRMAN ANGELIDES: Do you want to state what it is so we can get it on the record? State it -- state it 125 1 2 very quickly. COMMISSIONER WALLISON: Let me just state it, 3 you were talking about stress in the CDS market, that it 4 becomes very dangerous when there is a lot of stress. 5 But my understanding is that throughout the 6 financial crisis, even after Lehman, the CDS market has 7 continued to function. 8 understand, and don't answer it now please, because we don't 9 have the time, but I would like -- I would like you to And so I -- I just want to 10 respond in writing to the question of why it is that the CDS 11 market was not disrupted and continued to function during 12 this entire -- 13 14 MR. RUBIN: I think it actually functioned with enormous volatility, but I'd be delighted to respond. 15 COMMISSIONER WALLISON: 16 CHAIRMAN ANGELIDES: 17 COMMISSIONER GEORGIOU: It was risk, of course. Mr. Georgiou? I just wanted to state 18 something for the record. 19 was raised by Commissioner Murren on the capital arbitrage 20 question with regard to the liquidity puts, you know, 21 that -- those were to be distinguished from an unconditional 22 line of credit that might otherwise be necessary to backstop 23 the commercial paper that you were selling. 24 course, you would have to show on your books and capitalize. 25 As you respond to the issue that And that, of Whereas, the liquidity put was, you know, was 126 1 off-balance-sheet and not -- not appropriately capitalized 2 or not required to be capitalized under the rules or at a 3 very, very significantly less margin. 4 5 I just leave you with that as you -- as you respond to that in writing. Thank you. 6 CHAIRMAN ANGELIDES: 7 VICE CHAIRMAN THOMAS: 8 Mr. Thomas? Thank you, Mr. Chairman. EXAMINATION BY VICE CHAIRMAN THOMAS 9 VICE CHAIRMAN THOMAS: I want to thank both of 10 you. 11 it in writing, what I'm a little confused in terms of 12 talking about managing the company and stress test the rest, 13 it's my understanding based upon the documents that we 14 looked at that -- that Citi really didn't have the technical 15 capacity to assess the RMBS models until `07. 16 Just one specific question, again, if you want to do So I'm wondering what was going on, prior to `07 17 in terms of management tests, questions being offered. 18 I'll give you documents and we can fit it together and you 19 can give me a timeline. 20 So I started out talking about the garden of good 21 and evil, and I meant that. Because unfortunately and 22 frustratingly, we can agree that all models, all ratings, 23 all stress tests are useful. 24 models, all ratings, all stress tests may not be useful in 25 terms of a model you look at or a model that you don't look And then you can say all 127 1 at. 2 It -- it -- it means, then, that you've got to 3 go to some timeless kind of approaches to a certain degree. 4 I will tell you, I wouldn't be here if the function of this 5 Commission was to examine policy that would be offered by 6 the Commission for Congress to create legislation to deal 7 with this problem, because I've been down that road too many 8 times before. 9 I like things that are twofers and threefers. 10 So one of the reasons I like capital is that it does give 11 you the cushion. 12 you just create -- we've seen folk, partly in the .com 13 bubble, create synthetic capital. 14 synthetic. 15 operations of companies; you get cash on the barrel; that's 16 good. 17 But it also slows everything down because It's hard to create That's why I like dividends in terms of There's just something about -- now, if you 18 create devices that produce that, then you're getting away 19 from reality. 20 The other problem is if we talk about 21 derivatives, sure, let's classify them as standardized and 22 customized, and it's going to be, what, three weeks that the 23 market comes up with a rack of B. Spoke suits that are going 24 to fit, and they're all customized, they're not standard, 25 and you simply shift if those are the standards. 128 1 So I said I'm glad we're not doing this but I do 2 think the capital, a lot of transparency, and especially 3 responsibility tied to behavior. 4 I will tell you, it is impossible for me to go back 5 home, which I'm going to do shortly, and tell people that we 6 had a panel of four people who over three to five years 7 earned, based upon the creativity that they supervised, 8 which apparently they didn't understand and couldn't 9 measure, almost 150 million dollars on the way up. But that 10 same team, on the way down, didn't have a nickel clawed 11 back. 12 And I don't like government telling people what 13 they can make, but if there isn't some attempt by this 14 industry to equate value in some way with effect, across the 15 corporate model, with what ordinary people perceive as 16 value. 17 I can't comprehend a baseball player making a 18 quarter of a trillion dollars over ten years. 19 tell you I can measure him. 20 average, I can look at his errors, I can look at his RBIs; 21 there's all kinds of ways to measure. 22 But I can I can look at his batting We sat through a panel, and again, I want to 23 thank you, because Citibank's an example. It's not pulled 24 out for a certain extraordinary aspect except for maybe the 25 management in your organization, because I'm interested in 129 1 2 the national/international. But basically, we've been given no opportunity 3 or understanding and plenty of declaration about how we used 4 all the tests available, and nobody knew. 5 something happened. 6 made, and behavior has to have consequences. 7 sorry -- and you can make your -- your stock argument, 8 Mr. Prince, most of these guys that were in front of us 9 yesterday got something other than that as well. 10 Yes, but Something was created, assumptions were To say you're And to make the argument that somehow a simple 11 apology still allows you to maintain a profile of income 12 based upon what devastated everyone else doesn't fit the 13 scale test, no matter how often you feel really, really sad 14 about what happened. 15 16 Thank you, Mr. Chairman. EXAMINATION BY CHAIRMAN ANGELIDES CHAIRMAN ANGELIDES: All right. Mr. Prince and 17 Mr. Rubin, let me just make a couple of conclusive 18 comments here having now heard a day and a half of testimony 19 from folks within your organization. 20 now having read along with many commissioners very extensive 21 documentation and interviews. 22 The two of you today Let me preface this by saying that if I die 51 23 percent right and 49 percent wrong I'll be a happy man. 24 don't aspire to reach what Mr. Greenspan thinks he's 25 reached, which is 70/30. I 130 1 2 And let me also preface this by saying that I believe you're men of good faith. 3 But I want to bring us back to why we're here 4 today, which is, we have been trying to examine how this 5 substantial far-flung financial empire failed to the point 6 where the United States government had to provide 45 billion 7 dollars in assistance as well as 301 billion dollars in 8 guarantees of assets. 9 I also want to kind of key off something 10 Mr. Holtz-Eakin said, which is that in one particular area, 11 subprime lending, there was a massive failure, approximately 12 50 billion dollars in losses. 13 And what I've been struck by in the 14 documentation and in the testimony is I've been struck by, 15 frankly, how much folks in the organization did not know 16 about how -- what was going on, and I'm particularly struck 17 by how much the two of you did not know about how much 18 was -- what was going on within your organization. 19 And at the end of the day you were the head 20 guys. You were the chairman and the CEO. 21 chairman of the executive committee. 22 Mr. Rubin, a garden-variety board member. 23 suite of executive offices. You were the And not, I might add, You were in the 24 And if you look at the record, Mr. Holtz-Eakin 25 did point out there were a number of regulatory reports on 131 1 the table. 2 information up, not, by the way, about a piddling business, 3 but a 50-billion-dollar-a-year business in which mortgages 4 were being bought and then sold, in which there appeared to 5 be very substantial compliance issues. 6 Mr. Bowen, who was here yesterday, had sent We've discussed the fact that Citigroup had 7 11 billion dollars of warehouse lines out to subprime 8 originators, which you, as management, were not aware of. 9 Mr. Holtz-Eakin referenced the senior supervisors' report, 10 which did catalogue a number of significant issues, and even 11 today, I think it's clear from the record that even after 12 HSBC had its problems, and Bear Stearns, there were -- there 13 were not the highest level of decisions about -- about how 14 to handle subprime. 15 October. That didn't come until September and 16 And it just seems to me that at the end of the 17 day, the two of you in charge of this organization did not 18 seem to have a grip on what was happening. 19 Now, Mr. Prince, I will say that on November 4th, 20 you took responsibility and you resigned. Mr. Rubin, I want 21 to ask you very clearly, because you've gone out of your 22 way, in my opinion, in the interviews I've read and in 23 public statements, to make a very fine point or a very large 24 point about how you are not involved in operations. 25 said how you made speeches warning about potential risks. You've 132 1 But of course you have very direct duties. 2 chairman of the executive committee of the board of 3 directors; you attended weekly business meetings, your 4 compensation, according at least to your own testimony, was 5 a one-million-dollar salary plus a 14-million-dollar 6 guaranteed bonus. 7 You were Mr. Prince, in your interview you indicated that 8 the level of interaction between you and Mr. Rubin was 9 frequent, that you would talk three or four times a day. 10 one of you was out of town, you would talk by phone every 11 other day. 12 investment banking business. 13 Mr. Rubin, just very clearly, do you bear central 14 responsibility for the near collapse but for the U.S. 15 government of Citigroup? 16 17 Mr. Rubin, you were very involved in the MR. RUBIN: And I guess I would ask you, I think, Mr. Chairman, let me respond to that in a number of parts, if I may, okay? 18 CHAIRMAN ANGELIDES: 19 MR. RUBIN: 20 21 If Sure. Because I think you posed, obviously, an important question. Number one, the executive committee of the 22 board, which you just referred to my being chairman of, was 23 an administrative body; it didn't have a decision. 24 did was it met between board meetings. 25 very infrequent. What it Those meetings were And it wasn't a substantive part of the 133 1 decision making process of the institution. 2 to deal with -- it was designed to be conveyed by the 3 chairman, which was me, so that the COO or whoever else could 4 get formal approval, if necessary, between board meetings. 5 It was not a, as I say, a substantive part of the -- of the 6 decision making process of the institution. 7 It was designed I think that all of us bear, but not just all of 8 us at Citi, I think all of us, and I said this in my 9 comment, I think all of us in the industry who failed to see 10 the potential for this serious crisis and failed to see the 11 function of the multiple factors at work bear 12 responsibility. 13 regret in that respect. 14 And I think we all have a great deal to the I was not involved, as you correctly say, in the 15 management of the people or the personnel. 16 of the board. 17 interaction on other issues was on a strategic and 18 managerial level. 19 that the Triple-A securities that were at the heart of this 20 problem were understandably viewed by those who had 21 conducted the business, were involved in the business, as 22 being essentially of de minimus risk. 23 not -- this did not come to us until September of `07. 24 25 I was a member I worked extensively with clients. My And I think, as I said in my statement, CHAIRMAN ANGELIDES: And this really did But it went terribly wrong, Mr. Rubin, and even at the end, investors are being informed 134 1 that you have a 13-billion-dollar exposure when, in fact, 2 the audit risk community and the board, of which you're a 3 member, is being told 55 billion on the same day. 4 And I guess -- I don't know that you can have it 5 two ways. You either were pulling the levers or asleep at 6 the switch. 7 to recover from this calamity, I'm not so sure apologies are 8 important as assessment of responsibility, because that's 9 the way in which you begin to move forward. 10 And I -- and I think this is about, as we try And perhaps, instead of asking you what -- what 11 did you know and when did you know it, maybe I should be 12 asking you what didn't you know and why didn't you know it. 13 MR. RUBIN: I think that the board, of which I 14 was a part, and me and the other activities that I was 15 involved in had a very serious commitment to oversight and 16 to assuring, as best we could, that the institution 17 conducted its business appropriately. 18 But, Mr. Chairman, a board cannot know what is 19 going on in the positions of an institution, of a training 20 institution. 21 the number, but I would guess it was a trillion dollars-plus 22 of transactions that went through Citi every day. 23 There probably was some number, I don't know And what you can do and what Citi, in my 24 judgment, absolutely did and that I was part of doing as 25 both a member of the board and also some other activities 135 1 was making sure that you have the proper people in place, 2 running trading, running independent risk management, and 3 the large -- and the checks and balances functions that we 4 had, which included, obviously, our internal auditor, our 5 legal counsel, CFO, and the rest, and you can also be sure 6 that you have robust processes at the board level, which I 7 don't think there's any questions that we had. 8 think I mentioned earlier, reports of the board at every 9 meeting about the risks in the institution. 10 We had, as I And you're depending on those processes, 11 depending on having the right people in those jobs, which I 12 think we did, and depending on those processes being robust 13 and highly proactive, which we did. 14 CHAIRMAN ANGELIDES: All right, I'm going to 15 make -- I'm going to make one last comment on this, and that 16 is the following: 17 member. 18 can characterize it, but to someone, I think to most people, 19 chairman of the executive committee of the board of 20 directors implies leadership, certainly 15 million dollars a 21 year guaranteed implies leadership and responsibility. 22 Mr. Rubin assumed responsibility, said it was the honorable 23 thing, and I just think, Mr. Prince -- excuse me, 24 Mr. Prince, when he resigned, said it was the honorable 25 thing to do, and I just, my point is I think that leadership You were not a garden-variety board You were chairman the executive committee, and you 136 1 and responsibility matters. 2 MR. RUBIN: I agree with that, but if I may say 3 so, Mr. Chairman, the executive committee is really 4 misconstrued in that comment. 5 formal administrative apparatus; the institution had nothing 6 to do with one's role in the function of the institution. 7 The executive committee was a I did feel, in `07, because of all the problems, 8 well, actually, it wasn't because of all the problems that 9 had developed. I did feel in `07 that I should not get a 10 bonus. But the reasons was not the reason that you're 11 alluding to. 12 career, one thing and another, that money could be better 13 used by the rest of the institution, by the institution for 14 other purpose. 15 The reason was I felt that in my stage of my So I went to the compensation committee, went to 16 the management and suggested that I not get a bonus in `07, 17 which I did not get, and I did exactly the same thing in 18 `08. 19 CHAIRMAN ANGELIDES: Well, this is you'll be the 20 only one in the end who can make an assessment of your 21 responsibility. 22 upside and downside. 23 were failures, but acknowledging and understanding are 24 important. 25 A risk business always implies that there's It's not about the fact that there But that's up to you and for people to judge. MR. RUBIN: Mr. Chairman, I totally agree with 137 1 that, but I think it's also very important to understand how 2 one of these institutions works, what roles people can play, 3 and what they cannot possibly play. 4 5 CHAIRMAN ANGELIDES: And that's why -- Well, you make your case. Mr. Vice Chair? 6 MR. PRINCE: Mr. Chairman, before you leave the 7 point, before you leave the point, you didn't ask me my 8 opinion. 9 10 VICE CHAIRMAN THOMAS: point. 11 CHAIRMAN ANGELIDES: 12 MR. PRINCE: 13 We're not leaving the Oh, excuse me? You didn't ask me my opinion on this, but I would like to state, if I may. 14 CHAIRMAN ANGELIDES: 15 MR. PRINCE: On Mr. Rubin? That I think it is absolutely 16 incorrect to suggest that Mr. Rubin had central 17 responsibility or any central responsibility for what 18 happened to Citigroup. 19 20 CHAIRMAN ANGELIDES: acceptance of your role. 21 22 23 I appreciate you -- your VICE CHAIRMAN THOMAS: Okay, and I appreciate that. EXAMINATION BY VICE CHAIRMAN THOMAS 24 VICE CHAIRMAN THOMAS: 25 MR. PRINCE: Yes. Mr. Prince, you were CEO? 138 1 VICE CHAIRMAN THOMAS: 2 MR. PRINCE: 3 VICE CHAIRMAN THOMAS: 4 Yes, sir. MR. PRINCE: 6 VICE CHAIRMAN THOMAS: 7 MR. PRINCE: I don't understand. I -- is this a rhetorical question, VICE CHAIRMAN THOMAS: 10 MR. PRINCE: 11 VICE CHAIRMAN THOMAS: 14 VICE CHAIRMAN THOMAS: 15 MR. PRINCE: 16 VICE CHAIRMAN THOMAS: Sir Win Bischoff became the CEO -When? -- of Citigroup the day I resigned. Okay. And then what happened in terms of the office of CEO? 18 MR. PRINCE: At that point a search was conducted, and sometime thereafter Vikram Pandit became CEO. 20 21 Who assumed the position of CEO? MR. PRINCE: 19 No. I don't understand the question. 13 17 After you left. Mr. Vice Chairman? 9 12 What happened at Citi, then, at Citicorp? 5 8 And you resigned? VICE CHAIRMAN THOMAS: And there was obviously a search? 22 MR. PRINCE: Yes, sir. 23 VICE CHAIRMAN THOMAS: Mr. Rubin, as chairman of 24 the board, notwithstanding all of the discounting, it's 25 really hard to believe that in a time of stress, based upon 139 1 your background, your experience, your involvement, not only 2 at Goldman Sachs, but as Secretary of the Treasury, and the 3 role that you played getting up from your Thanksgiving 4 dinner to -- to do the kinds of things that you obviously 5 had to have fairly significant knowledge of in the 6 corporation, to then back away from any kind of critical 7 decision, I'll accept it because you've said that's the 8 case, but it just brings into question any number of items 9 we've been asking, which have been dismissed because you've 10 had such an overall structure, you were so coordinated, you 11 trusted all those people under you. 12 And yet, when we go back, and I understand I'm 13 getting older, my memory isn't as good, I just made a 14 mistake on a date, but we have the record open. 15 written questions, you said would you respond to them, and I 16 just want to give you a heads-up as we finish this that in 17 our attempt to understand at least in some depth one 18 corporate model, there are going to be additional questions 19 trying to understand how with middle management and upper 20 management panels and CEO and chairman of the board panels, 21 that we're comfortable with the assurance that you know what 22 was going on but that everybody denied any responsibility 23 involved in it. 24 25 MR. RUBIN: In terms of Could I just make one factual correction, Mr. Vice Chairman? 140 1 2 VICE CHAIRMAN THOMAS: factual corrections, obviously. 3 MR. RUBIN: 4 chairman of the board. 5 6 I need No, no, I wasn't -- okay -- I wasn't VICE CHAIRMAN THOMAS: You were not chairman of the board? 7 MR. RUBIN: I only became chairman of the board 8 after Mr. Prince stepped down. 9 board for the four or five weeks of the search process. 10 the search process then resulted in Vikram Pandit being 11 selected. 12 I remained chairman of the VICE CHAIRMAN THOMAS: And Why would they make you 13 chairman of the board if you had no knowledge of the 14 structure, the information, the operation of the company in 15 any meaningful way, was what I got out of your -- 16 17 MR. RUBIN: I had a lot of understanding of the structure and function of the company. 18 VICE CHAIRMAN THOMAS: Right. And when you're 19 looking for a CEO, you're going to look for somebody who 20 hopefully has and understands the knowledge of some of the 21 problems. 22 is I've got this problem with -- We don't need to carry this out. 23 MR. RUBIN: 24 VICE CHAIRMAN THOMAS: 25 All I'm saying Just to respond to your --- multiple denials and then, boom, you're in a position that's very significant. 141 1 MR. RUBIN: I don't think there are multiple 2 denials, Mr. Vice Chairman. 3 explanation of the affirmative role that the board played in 4 terms of the structure and function of the institution when 5 Mr. Prince stepped down. 6 I think what there was, was an I was then asked to be chairman of the board, 7 which I did, and we had, I think, a four- or five-week 8 search committee, and wound up with I think an outstanding 9 selection of new CEO. 10 VICE CHAIRMAN THOMAS: And I understand all that 11 but, Mr. Rubin, I guess what we're saying is that we can 12 talk about boards of directors, we can talk about structure 13 function, all we want in terms of corporate models. 14 Frankly, there are people in those positions, 15 and you have a higher confidence in some people than others. 16 Mr. Prince mentioned who he thought was outstanding. 17 interviewed some of them. 18 We've At some point you can't understand an 19 institution by simply following the lines of a structure 20 function model or even the dotted lines. 21 trying to say is it's really hard for us to believe, 22 especially on my personal knowledge of you, an involvement 23 in any institution that I'm aware you've been involved in, 24 of this ability to fall back to a structure -- structure 25 function model and argue about the box you were in. And what we're I have 142 1 never, ever seen you accept the outline, the frame or the 2 structure of a box. 3 MR. RUBIN: Well -- 4 VICE CHAIRMAN THOMAS: Well, if you wanted to 5 accomplish something that you felt fairly strongly about, 6 and it's difficult for me to say we're finished, but I 7 wanted to end on a compliment. 8 9 MR. RUBIN: because I think it's sort of a -- 10 11 CHAIRMAN ANGELIDES: MR. RUBIN: Okay. It's a rather mixed compliment. 14 15 We'll make -- we'll make this your response to the compliment will be the last word. 12 13 Let me respond to the compliment VICE CHAIRMAN THOMAS: I reserve the right to amend the compliment based upon his answer. 16 MR. RUBIN: No, I said in my -- in my opening 17 statement, Mr. Vice Chairman, that I had decided when I left 18 Treasurer I was never going to have an operating role again. 19 And that's precisely what I -- what we developed at 20 Citigroup. 21 compliment. 22 And that's the answer to your -- your -- your Thank you. CHAIRMAN ANGELIDES: And the record of today's 23 Commission and discussion is what it is, and I want to 24 thank, on behalf of the Commission, both of you for taking 25 the time, for your time with us today, your answers to the 143 1 questions. 2 much. We appreciate it very, very much. 3 MR. RUBIN: 4 CHAIRMAN ANGELIDES: 5 12:30, members. Thank you so Thank you. We will re-adjourn at We will recommence at 12:30. 6 -------(Session ended.)----- 7 CHAIRMAN ANGELIDES: The meeting of the 8 Financial Crisis Inquiry Commission will come back into 9 order. This afternoon session will be devoted to looking at 10 the Office of the Comptroller of the Currency with respect 11 to that office's oversight of Citigroup and, in a larger 12 sense, its oversight of financial markets particularly as it 13 relates to subprime lending and securitization. 14 We have two witnesses with us here today, Mr. John 15 Hawke, who is the former Comptroller of the Currency and 16 Mr. John Dugan, who is the current Comptroller of the 17 Currency. 18 And gentlemen, I'd like to start by doing what 19 we customarily do, both for witnesses who have come before 20 and will come after you, and that is to administer the oath 21 to both of you, if you'll please stand. 22 Do you solemnly swear or affirm, under penalty of 23 perjury, that the testimony you are about to provide the 24 Commission will be the truth, the whole truth and nothing 25 but the truth to the best of your knowledge. 144 1 MR. HAWKE: I do. 2 MR. DUGAN: I do. 3 CHAIRMAN ANGELIDES: 4 Thank you so much. So gentlemen, just one moment here. 5 Gentlemen, I'd like to -- I know that you've 6 submitted written testimony to us, and I think Mr. Dugan 7 you've get the record for the amount of information, even 8 though you did have a main statement. 9 each of you to start today by providing some brief oral 10 11 testimony, five -- up to five minutes each. Mr. Hawke, I'm going to ask you to go first, as the 12 former comptroller, and then Mr. Dugan. 13 would you begin your testimony? 14 15 But I'd like to ask So, Mr. Hawke, if And if you could move that, not only turn it on, but move the mic toward you, sir. 16 MR. HAWKE: Thank you, Mr. Chairman. 17 CHAIRMAN ANGELIDES: 18 MR. HAWKE: Thank you. And Mr. Vice Chairman and members of 19 the Commission, I am pleased to be able to participate in 20 the work of the Commission, and I hope I can say something 21 useful today. 22 I wanted to start by making two points. I 23 touched on it in my -- in my opening statement, but I think 24 they are very important. 25 creature of the accounting rules. One, securitizations were really a We -- we had seen 145 1 securitizations for many years. 2 were sort of one-off transactions, an entity that wanted to 3 increase its liquidity; to meet loan demand or credit card 4 demand would securitize a bunch of receivables and other 5 assets and go to market maybe once a year, twice a year, 6 something like that. 7 There was a time when they Securitizations evolved into a constant, everyday 8 method of raising the liquidity. And that process was 9 facilitated by the accounting rules, which allowed 10 institutions to treat assets sold as securitizations as off 11 their books, provided that certain accounting criteria 12 were -- were satisfied, basically that there were no 13 contractual indemnifications or liabilities. 14 And if those rules were met the institution could 15 treat the assets for financial accounting purposes as not on 16 their books and the regulators would do the same thing. 17 regulators would not treat those assets as subject to 18 capital requirements. 19 The That -- that might be okay if there were no 20 risks that resided with the institution after the 21 securitization. 22 way, particularly in more recent years, is that once the 23 bank securitizes assets, there are several different kinds 24 of risks that they retain. 25 But what we have come to learn in a painful On a simple level, they retain a liquidity risk, 146 1 because if their securitizations start to go bad, they may 2 have a harder time raising new liquidity in the marketplace. 3 But, more recently, what we've seen is that as 4 they were wholesale defaults on the mortgages that were 5 securitized, the trustees of the securitizations pools were 6 very aggressive in putting loans back to the banks that had 7 sold the loans, on the ground that representations and 8 warranties that had been given at the time of the 9 securitization had been breached, generally for some kind of 10 11 fraud. And -- and there were tens if not hundreds of 12 thousands of loans that had been put back to banks, and that 13 has precipitated in enormous amount of litigation and 14 controversy at a time when banks themselves were under 15 tremendous pressures. 16 I don't think any of us anticipated that -- that 17 kind of risk in the process of securitization. 18 raises the question about whether we should not have some 19 capital requirements against assets that have been 20 securitized and that are treated by the accountants and by 21 the regulators as off the books to deal with those risks. 22 And I think that's a subject that is worthy of 23 investigation. 24 25 And it The other -- the other point is with respect to the way we measure capital. We have -- there was an old head of 147 1 supervision at the Fed many years ago who, when asked how 2 many capital a bank needs, said, I can't tell you but I know 3 it when I see it. 4 And -- and we have evolved from that into a very 5 highly technical set of rules for allocating capital. 6 Basel -- the Basel, as I sat on the Basel committee for six 7 years and the Basel committee rules are mind boggling in 8 their -- in their complexity. 9 The And the -- the -- the one thing that we don't do 10 with -- with respect to these increasingly complex capital 11 rules is to measure capital, measure the value of capital 12 accurately. 13 We -- we treat assets for the most part based on 14 historical book values. 15 result of an examination. 16 the -- what the true value, the true market value of the 17 assets on the books of the bank are, I realize that fair 18 value accounting is a very controversial topic, and I don't 19 think we need to go all the way to fair value accounting 20 to -- to satisfy the point that I'm making, but we have a 21 system of bank supervision that's built on the concept -- 22 Assets may get written down as a But we don't really look at what CHAIRMAN ANGELIDES: Could you wrap -- see if 23 you can wrap up in the next minute? 24 you and I -- but is that yellow means one minute to go. 25 MR. HAWKE: Okay. I should have warned 148 1 2 CHAIRMAN ANGELIDES: If you could wrap up in one minute. 3 MR. HAWKE: I'll finish this very quickly. We 4 have a system of supervision that's based on the concept of 5 prompt corrective action, and that is that as capital levels 6 fall, it should be increasingly vigorous supervisory action. 7 But that whole concept fails if we're not measuring capital 8 accurately. 9 10 CHAIRMAN ANGELIDES: All right. Terrific. Thank you very, very much. 11 Mr. Dugan, and let me just say, to start here, 12 because the Vice Chair always has a favorite phrase that 13 behavior has consequences, I actually want to thank you and 14 the OCC. 15 been extraordinarily prompt in providing documents to us and 16 making available witnesses, and we appreciate it. 17 understand you've done very well in that respect, so thank 18 you. 19 Of all the entities we've dealt with, you have MR. DUGAN: Thank you. We Chairman Angelides, Vice 20 Chairman Thomas, and members of the Commission, thank you 21 for this opportunity to address your questions regarding 22 national banks, subprime lending, federal preemption, and 23 the supervision of Citigroup, all of which focus on the 24 problems caused by deep losses on residential mortgages. 25 By the lack of adequate consumer protection 149 1 contributed to the record levels of these losses, there was 2 a more fundamental problem: 3 that made credit too easy, especially by unregulated 4 mortgage lenders and brokers. 5 loans, the lack of meaningful cash down payments, payment 6 option loans, and teaser rate adjustable mortgages. 7 Poor underwriting practices These included stated income In addition, without any skin in the game, brokers 8 and originators had every incentive to apply the weakest 9 underwriting standards that would produce the most mortgages 10 11 that could be sold to mortgage securitizers. And, unlike banks, most mortgage brokers in the 12 United States were virtually unregulated. So there was no 13 supervisory check on imprudent underwriting practices. 14 The rapid increase in market share by these 15 unregulated brokers and originators pressured regulated 16 banks to lower their underwriting standards, which they did, 17 though not as much as unregulated mortgage lenders. 18 The OCC took a number of steps to keep national 19 banks from engaging in the same risky underwriting practices 20 as their non-banking competitors. 21 but not enough for the whole mortgage system. 22 That made a difference, All these factors produced the worst under -- 23 underwritten mortgages in our history. When house prices 24 sharply declined, it led to record levels of delinquency, 25 default, foreclosures, and loss. 150 1 However, the weak lending standards that caused the 2 crisis were not the result of federal preemption of state 3 mortgage lending laws. 4 subprime lending and Alt-A lending would have been done in 5 national banks and federal thrifts, but just the opposite 6 was true. 7 If it had been, the vast majority of As described in my written statement, national 8 banks and their subsidiaries made only 10 percent of 9 subprime mortgages and only 12 percent of all non-prime 10 mortgages from 2005 through 2007. 11 Conversely, 72 percent of all non-prime 12 mortgages were made by lenders that were subject to state 13 law. 14 exclusively subject to state law. 15 recognized that these were the worst underwritten loans with 16 the highest levels of foreclosure. Well over half were made by mortgage lenders that were 17 And it is widely Now, I'm not suggesting that national banks 18 played no role in the subprime lending crisis. 19 Some national banks originated poor quality, non-prime 20 mortgage loans, some purchased badly underwritten subprime 21 mortgage-backed securities, and some had significant 22 exposure to subprime mortgage risk that they did not 23 understand or anticipate, all of which produced very large 24 losses. 25 They did. But the relatively smaller share of non-prime 151 1 mortgages made by national banks and their relatively better 2 performance belie the argument that national banks' federal 3 preemption caused the mortgage crisis. 4 Let me turn briefly to Citigroup: The critical -- 5 rule -- role that subprime mortgage losses played in its 6 problems and the OCC's supervision of its national bank 7 subsidiary, Citibank. 8 Citigroup's mortgage problems did not arise from mortgages 9 originated by Citibank, and indeed the bank's financial The overwhelming majority of 10 performance throughout the crisis was consistently better 11 than it was for Citigroup as a whole. 12 Instead, the huge mortgage losses arose primarily 13 from the collateralized debt obligations structured by 14 Citigroup's securities broker-dealer with mortgages 15 purchased from third parties. 16 By far the largest exposure of Citibank to the 17 CDOs came from its liquidity puts that supported the CDO's 18 super senior tranches. 19 25-billion-dollar exposure to the bank, from these liquidity 20 puts, came as a surprise to the senior management of 21 Citigroup and to the OCC. 22 In the summer and fall of 2007, the Subsequent review and investigation showed this to 23 be both a risk management and an internal reporting 24 breakdown by the company. 25 supervisory problems caused by the legally segregated It also revealed some of the 152 1 responsibilities of different regulators and the undue 2 reliance on high credit ratings. 3 Citigroup, Citibank, the OCC, and other 4 regulators have since taken a number of steps to address 5 these issues. 6 In closing, there are many lessons to be learned 7 from the mortgage problems that precipitated the crisis, but 8 the one I would like to leave you with is this: 9 the government should establish minimum common sense I believe 10 underwriting standards for mortgages that can be effectively 11 applied and enforced for all mortgage lenders, whether they 12 are regulated banks or unregulated mortgage companies. 13 If we had had such basic across-the-board rules 14 in place ten years ago on income verification, down 15 payments, and teaser rate mortgages, I believe the financial 16 crisis would have been much less severe than it was. 17 Thank you very much. 18 CHAIRMAN ANGELIDES: Thank you very much. We 19 will now go to Commissioner questions. 20 will defer mine till the tail end, and we'll start with the 21 Vice Chairman. 22 VICE CHAIRMAN THOMAS: We will start -- I Mr. Chairman, I will 23 probably defer most of mine to the tail end. 24 respond briefly to a couple points. 25 But I want to EXAMINATION BY VICE CHAIRMAN THOMAS 153 1 VICE CHAIRMAN THOMAS: First of all, thank both 2 of you very much. In the business of regulation a lot of 3 folks come and go, and I'm pleased to see with just two 4 people we've got a broad scope of history during a period 5 when a lot of this was evolving. 6 a little bit based upon the perspectives that you present. And that -- and that helps 7 Over the last couple of days, one conclusion that I 8 have now locked down pretty firmly is that simplicity is not 9 conducive to maximizing income if you're involved in any way 10 on Wall Street. 11 professions. 12 because you're fascinated with what they do until they show 13 you what you're doing, and then you say, that's just because 14 you practice it, but it ain't that big a deal. 15 That's true to a certain extent in other I think magicians learned it a long time ago, I happen to think -- who was it, Therfer 16 (phonetic), I think said -- For every complex problem, 17 there's a simple answer, and it's wrong. 18 this world today, I understand and accept complexity. 19 So especially in But having something complex and something 20 convoluted for the purpose of having it be perceived what it 21 isn't are -- are two different things. 22 worries is -- and we're not responsible for setting up a 23 structure which allows us to advocate to Congress what it is 24 that ought to be the solution, thank goodness. 25 the things that concerns me, and just a quick reaction, And one of my But one of 154 1 because it's outside your area of expertise, but it came to 2 me in the comments that you just made at the end, and that 3 is I had been concerned for some time about the influence 4 or -- my impression is of the influence, others may or may 5 not agree, of the tax code, on the way in which people begin 6 dealing with their homes; homes rather than houses. 7 You get into the flipping business and the rest 8 I'm not concerned about that, but that the tax code really 9 encouraged people, arguably, to pursue the American dream 10 and wind up owning a home, but not the way it used to be 11 where you owned the home, it was better than rent because 12 you could get equity, and eventually you would have a 13 mortgage-burning party and you accumulated wealth in your 14 home. 15 In fact, there was some discussions that this was 16 one of the American ways of saving not available to other 17 societies to a certain extent, because they didn't own homes 18 nor did the government assist in owning homes to the degree 19 that the U.S. did and other societies. 20 But in 1986, on the tax committee, Ways and 21 Means Committee, behind closed doors, we fought a pretty 22 hard, tough battle because there was a desire and we, in 23 fact, agreed to remove consumer interest as a deductible 24 item on the tax form thereby damping down the consumer 25 enthusiasm, because the government would cover a piece of 155 1 the action in terms of the write-off on interest. 2 Wanted to do the same thing on mortgage 3 interest, not tied very directly and specifically to 4 improvement involvement with the house, and obviously it 5 turned out that you created an environment in which the very 6 creative folk in marketplaces would send you a check every 7 month which represented the accrued equity in your home for 8 that month so that you could spend it ostensibly on 9 something about the house. But, of course, it went right 10 back into consumer -- into consumption, totally negating, 11 and more so, the argument about not wanting to have interest 12 deducted on consumer demand and I think spiking it, and then 13 you had the cheaper money. 14 Do you folks feel, at all, in any way, that that 15 partially contributed to, assisted the environment in terms 16 of the problem that we now face? 17 MR. DUGAN: Well, I'm certainly no expert on the 18 tax policy, but I think there were a cluster of things that 19 encouraged homeownership that fed on each other to stimulate 20 demand -- 21 VICE CHAIRMAN THOMAS: I haven't even discussed 22 the societal and the government desire for everyone to own 23 their own home, just like going to college, so you do 24 everything you can to allow access to that, notwithstanding 25 the fact not everybody ought to be able to participate in -- 156 1 MR. DUGAN: But I think it's all part of that 2 pattern that created the intense desire and demand for 3 bigger, more mortgages and the -- also, as you said, the 4 easy access to home equity through home equity lines of 5 credit. 6 equity extraction to be used for consumption and that had 7 very significant effects. 8 9 Now there was a change. And it allowed much more But it sort of fed on itself. So I am no expert, but I think it did feed the whole notion of greater and greater demand for mortgages, 10 mortgage credit that fed the securitization and the desire 11 as well. 12 VICE CHAIRMAN THOMAS: 13 CHAIRMAN ANGELIDES: 14 COMMISSIONER MURREN: 15 16 Thank you. Ms. Murren? Thank you. EXAMINATION BY COMMISSIONER MURREN COMMISSIONER MURREN: Thank you both for your 17 very detailed and thoughtful testimony. 18 it and I, though, wanted to go back to some of the witnesses 19 that we've heard today and yesterday. 20 have an opportunity to hear the previous witnesses? 21 MR. DUGAN: I enjoyed reading I don't know, did you Some of it but my staff heard it and 22 I have been briefed on various aspects of what they say, so 23 some of it, but not every bit. 24 25 COMMISSIONER MURREN: Well, my general impression was, from every single individual that we heard 157 1 from, was that in their view, as a company, as managers, and 2 as participants in their company and also in the financial 3 crisis, that during the course of performing their duties 4 and also the course of conducting business, that they felt 5 very strongly that their risk management systems and the way 6 that they dealt with risk and, you know, to use some of the 7 words was excellent, very good, best in class, almost to the 8 person, in fact, I think it was to the person, that they 9 really validated their own opinion of their risk management 10 policies and methodologies. 11 Does the fact that they all so strongly advance 12 it or believe it surprise you in light of your reports and 13 in light of what's happened? 14 MR. DUGAN: It doesn't change our view of what 15 we thought their risk management was at the time or how it 16 played out, I guess I would say. 17 that they well understood about the risks they took, others 18 less so. 19 I think there were things We, on various occasions, pointed out problems. I will say that when we pointed out problems to 20 them, they were by and large quite responsive to them. 21 I also think that when the crisis hit, it revealed some 22 problems that were of significant concern to us, which we 23 did communicate to the company. 24 25 COMMISSIONER MURREN: But There were a couple of instances prior to the crisis too, where you had noted some 158 1 deficiencies in their risk management practices. 2 comment? 3 remedying those things. 4 complete? 5 Could you You said that they were very responsive in MR. DUGAN: Is that accurate or was it I think that is accurate. I think 6 what I was thinking about when I said that was we did a 7 review of their credit derivatives, trading business in the 8 bank in 2005, where we found a number of problems and 9 concerns. 10 And we downgraded our rating of the management 11 of that business and told them that they needed to fix 12 things if they wanted to get that assessment of them 13 improved. 14 They did curtail the risks that they were taking 15 and they did take a number of steps to fix that particular 16 problem. 17 to work. 18 And we thought that is how the process is suppose COMMISSIONER MURREN: One of the things that you 19 mentioned is that there are a number of different regulatory 20 bodies that govern the overall enterprise. 21 you mentioned that it was really not inside of the bank 22 company itself which you monitored, where the problems 23 arose, but rather other areas. 24 25 And specifically Could you maybe describe to us your interactions with some of the other regulators? Because if I'm not 159 1 mistaken, and maybe you could comment on this, there was 2 some interest in utilizing the information that was produced 3 by the other regulators to be able to determine the safety 4 and soundness of the bank. 5 So to what extent did you or did others that you 6 interacted with make sure that information was validated and 7 also that the right questions were being asked? 8 9 MR. DUGAN: So of course, in the way the bank holding company structure works, as I think you know, we 10 were responsible as the primary supervisor for the bank and 11 its subsidiaries. 12 supervisor for the consolidated company and the non-banking 13 subsidiaries of the holding company. 14 And the Federal Reserve was the umbrella And in some cases, those non-banking 15 subsidiaries were themselves broker-dealers, for example, 16 that were regulated by the SEC. 17 So that was a mixture of different regulators. 18 And also we had futures Commission merchants that were 19 regulated by the Commodity Futures Trading Commission. 20 We have, by long historical practice, a very 21 close working relationship with the Federal Reserve as the 22 holding company regulator. 23 have access to everything we do; it's quite transparent. 24 25 They see everything we do; they I believe what happens in the bank, and there is tremendous amount of focus on what's going on in the bank, 160 1 it's a little murkier when we go outside the bank to deal 2 with issues that could effect the bank. 3 We rely on the Federal Reserve with respect to 4 the affiliates for which it has primary supervisory 5 responsibility. 6 we're constantly sharing information. 7 And as I said, we have a relationship where When you get to the securities broker-dealer, by 8 statute in the Gramm-Leach-Bliley Act, there are 9 restrictions on our ability to get information from those 10 companies and restrictions on when we could examine those 11 companies. 12 And I do think that did and has created some 13 issues in the process about not having as efficient and 14 integrated supervisory model as we should have, and that 15 showed up, in some ways, in the supervision of Citibank and 16 Citigroup. 17 COMMISSIONER MURREN: One of the notations that 18 we had made in the earlier conversation with witnesses was 19 regarding some of the creation of new products which they 20 would, of course, I believe, bring to the OCC to determine 21 if they were able to sell them; correct? 22 MR. DUGAN: Not necessarily. There's not a 23 prior approval requirement for new products with the OCC. 24 However, particularly in the wake of the Enron situation, 25 there was a tremendous focus put on making sure that 161 1 institutions had new product committees and the right 2 processes and the right due diligence and the right controls 3 to examine those new products. 4 And then we would periodically go and examine 5 those processes to make sure that on a test basis that they 6 were appropriately looking at them. 7 process worked. 8 9 COMMISSIONER MURREN: So that's the way the Okay. With that in mind, when you think about -- and one of the reasons that we chose 10 Citibank to look at was the ability to shed light on 11 practices that might have been common throughout the 12 financial services industry. 13 MR. DUGAN: Right. 14 COMMISSIONER MURREN: In your opinion, with your 15 perspective, do you think that it was common for companies 16 to look at these products and to determine whether or not 17 they needed to meet regulatory capital standards? 18 one of the ways they determined whether a particular new 19 product was attractive to them? 20 MR. DUGAN: Was that I'm quite sure that that factored 21 into every decision. Much in the way that companies decide 22 on the profitability of a particular type of product is a 23 risk adjusted return based on the capital requirements that 24 are allocated to that, so absolutely, that is a factor that 25 people look at. 162 1 COMMISSIONER MURREN: Again, on a comparative 2 basis, when you look at across the financial services 3 industry, looking at a variety of different companies, when 4 you look at them, are there certain commonalities that they 5 all share in terms of their failures as we look back now, 6 things that they might have done differently? 7 MR. DUGAN: There are some, yep. 8 COMMISSIONER MURREN: 9 MR. DUGAN: And what would those be? So, for example, obviously in the 10 area that you're -- that this Committee is looking hard at, 11 in the area of complex structured financial products in the 12 CDOs, it was a surprise in the process, not just to the 13 management of Citi, but to the management of several other 14 companies, about the significant, sudden, and deep losses 15 created on these instruments. 16 And I think there was not a full appreciation, a 17 full examination of the -- of course, these were 18 extraordinary events. 19 But of the -- in many cases, situations where 20 companies have thought they had limited exposure to subprime 21 risk from their direct lending activities only to find out 22 that they had much more significant exposure than they 23 thought coming from the securities side and, particularly, 24 from the CDO side, we saw that in several instances. 25 I think the difference with Citi and with 163 1 several other institutions that we do not supervise is they 2 have so much more of it; it was so much bigger a 3 concentration, which caused a much more significant problem 4 when it hit. 5 COMMISSIONER MURREN: To the extent that the 6 regulators are also responsible to some degree for examining 7 that very issue, which is the concentration of risk, you 8 know, particularly as it relates to the holding company, in 9 a practical sense, how would that have been discovered based 10 on what you described as being a little bit murky in certain 11 areas? 12 MR. DUGAN: Well, I think in the case of the 13 structured products, I think it is fair to say that 14 Citigroup and its management, and I would say also the 15 regulators, derived a false sense of security by the very 16 high credit ratings on the super senior tranches, which 17 ended up causing the big losses, not the tranches below it, 18 which were riskier but which had been sold off, and 19 interestingly, they did not cause as much loss even to where 20 they were sold, because people used them and hedged them in 21 different ways. 22 And so I think that was something that people did 23 not adjust to or see as well as they should. I think the 24 thing that surprised us, as I mentioned in my opening 25 remarks here, was on the liquidity put. That was never 164 1 treated even as an exposure to subprime losses by Citigroup. 2 Even after problems started hitting and we began asking 3 questions, we weren't told about the magnitude that was 4 viewed as something that was an exposure of the bank. 5 that was unique to that institution. 6 7 COMMISSIONER MURREN: And what do you think explains that? 8 9 And MR. DUGAN: I think that liquidity put is a kind of liquidity support facility that is not unusual in the 10 sense that there were similar kinds of facilities provided 11 for asset-backed commercial paper conduits that had been 12 around for many years, that have worked well, and the actual 13 liquidity facility was viewed as so unlikely to be exercised 14 that it was not a significant risk. 15 And the fact was we did have an extraordinary 16 situation. 17 for credit protection; it was only supposed to be there for 18 liquidity protection. 19 assets, you couldn't exercise this liquidity put, or if you 20 had a downgrade, you couldn't exercise it. 21 And, by the way, it was not supposed to be there So if you had losses in a pool of But what happened in this circumstances was the 22 market started sensing things before the credit rating 23 agencies did, there was a run on the commercial paper, and 24 this seemingly liquidity only temporary facility ended up 25 being something that was permanent and ended up taking on 165 1 all the credit risks. 2 So it was partly an extraordinary event, partly 3 because it was similar to things that they had done before, 4 and partly was only tied to what was supposed to be the 5 safest asset in that particular securitization pool that 6 they never treated it as that kind of risk or -- and 7 calculated even the magnitude of it when they talked about 8 it. 9 COMMISSIONER MURREN: Would you also agree that 10 one more component might be that it's difficult to evaluate 11 the concentration of risk when you do have so many people 12 that are involved with analyzing the underlying assets and 13 liabilities of a variety of organizations, all of whom feed 14 back up into an umbrella holding company? 15 MR. DUGAN: It can be, but a good risk system, 16 of course, and you're exactly right in the sense that, you 17 know, they were analyzing their subprime exposure from 18 various other things and putting them together, and this one 19 they didn't put with it, and it turned out to be huge. 20 so it was a breakdown. And 21 COMMISSIONER MURREN: Thank you. 22 Mr. Hawke, I don't want to leave you out of my 23 questioning, so I wanted to ask you, from your perspective, 24 having been an observer of the financial services industry 25 for some time, what changes in the regulatory environment do 166 1 you think have influenced where we are today versus perhaps 2 a very early part of your tenure? 3 MR. HAWKE: I'm not sure that changes in the 4 regulatory environment, per se, were a major contributing 5 factor to -- to the crisis. 6 7 I'm one who believes, and a lot of people disagree with me, that the regulatory structure -- 8 9 VICE CHAIRMAN THOMAS: Mr. Hawke, can you pull the microphone just a little bit closer? 10 MR. HAWKE: Thank you. -- that the regulatory structure 11 was -- was not a major -- major contributing cause. 12 clearly nobody would have invented this structure if you 13 were developing a financial regulatory structure from 14 scratch. 15 Nobody, But in my experience, it has worked -- it has 16 worked quite well. 17 a high degree of coordination among the agencies. 18 there are occasionally differences, today the system, I 19 think, works, it generally works quite, quite well. 20 Not perfectly, by any means, but there's And while There -- a lot of people attribute today's 21 problems to what they generally call deregulation, and they 22 focus on the Gramm-Leach-Bliley Act of 1999. 23 believe that Gramm-Leach-Bliley was a contributing factor to 24 the crisis. 25 turning out to be pretty much of a dead letter. I don't The -- I think Gramm-Leach-Bliley ended up 167 1 Once Citigroup's acquisition of Travelers was 2 validated by Gramm-Leach-Bliley there was very little 3 activity in the way of cross-industry acquisitions between 4 insurance and securities and banking, banking firms. 5 Paradox -- paradoxically, it wasn't until the crisis in over 6 the last year or so that -- that Gramm-Leach-Bliley became 7 an important factor in allowing companies like Morgan 8 Stanley and Goldman Sachs to become bank holding companies 9 where they couldn't have before that, but I don't think that 10 if you characterize Gramm-Leach-Bliley as a deregulatory 11 statute that it was a principal contributing factor to the 12 problem. 13 COMMISSIONER MURREN: Would it be fair to say 14 that it would make transparency better if though you were to 15 be able to perhaps regulate more strongly or at least to 16 reveal more about what the non-bank entities are doing in 17 the financial services sector? 18 19 CHAIRMAN ANGELIDES: minutes. 20 COMMISSIONER MURREN: 21 CHAIRMAN ANGELIDES: 22 MR. HAWKE: 23 24 25 Let me yield another five Sure. Five minutes. Oh, I think without question that's -- that's right. COMMISSIONER MURREN: Thank you. Just one final question, really, on the -- the OCC reports on Citibank. 168 1 There were a couple of notations about their failures of the 2 regulatory structure there and I wonder how strongly you 3 took action in the face of those things. 4 Do you feel that as an enterprise that you have 5 what you need to be able to put the kinds of muscle behind 6 your recommendations or your observations that you need? 7 And you had commented earlier that you felt like they were 8 listened to when they were made by management -- when you 9 made them to management. 10 Is that an accurate characterization? 11 MR. DUGAN: Yes, it is an accurate 12 characterization. The fact is when we do have a cause -- a 13 course -- a cause to take action, we can do it quite 14 effectively. 15 exercise, do exercise, have exercised, in this circumstance, 16 to get the kind of change and action that we want. We have very strong tools that we can 17 COMMISSIONER MURREN: 18 CHAIRMAN ANGELIDES: 19 Okay. Thank you. Thank you, Ms. Murren. Mr. Wallison? 20 COMMISSIONER WALLISON: 21 EXAMINATION BY COMMISSIONER WALLISON 22 COMMISSIONER WALLISON: 23 24 25 Thank you, Mr. Chairman. Let me start with you, Mr. Hawke, if I may. You were the Comptroller during the Clinton Administration, latter part of the Clinton Administration, 169 1 and then through a portion of the Bush Administration. 2 I think I'm following up a bit on Commissioner Murren's 3 question because I saw this somewhat broader. 4 And Did you see any change in the way that 5 regulation was viewed in the Clinton Administration or the 6 Bush Administration? 7 MR. HAWKE: No, I did not, Commissioner 8 Wallison. As a matter of fact, I found that in both the 9 Clinton and Bush Administrations, the Treasury Department 10 was exceedingly sensitive about the independence, statutory 11 independence of the OCC. 12 And while we were obviously part of the Treasury 13 Department and found strength in being part of the Treasury 14 Department, I can't think of any instance where in either 15 administration we had intercession on the part of the 16 administration that was aimed at the way we conducted our 17 supervisory and regulatory activities. 18 COMMISSIONER WALLISON: So these concerns that 19 there was some kind of environment which did not favor 20 regulation during the Bush Administration, at least, that's 21 been one of the complaints, is it was not something that you 22 noticed when you were a regulator? 23 MR. HAWKE: As I said, I -- I don't think that 24 deregulation was a -- was a contributing factor, whether it 25 was Gramm-Leach-Bliley or anything earlier than that. 170 1 COMMISSIONER WALLISON: I'm sorry to just follow 2 this up again. 3 the zeitgeist, if you will, about regulation, because we 4 read a lot, hear a lot about some notion that regulators 5 were not regulating during the Bush Administration. 6 notice anything like that? 7 And I want to talk about the environment, MR. HAWKE: Did you No, as I say, we -- we kept a steady 8 course in our supervisory and regulatory activities. 9 extensive interagency discussions, but that is among the 10 We had banking, the financial regulatory agencies. 11 But I can't think of single instance where the 12 administration that happened to be in power at a particular 13 time attempted to influence our supervisory or regulatory 14 policy. 15 COMMISSIONER WALLISON: Thank you. Let me go 16 on to another subject. 17 literally tens of thousands, if not hundreds of thousands, 18 of loans have been put back to banks in the securitization 19 process. 20 people act as though this originating-to-distribute idea 21 means that no one has any liability after the loan is sold. 22 You noted in your testimony that That's really an important point, because many In fact, the banks or anyone else who has sold a 23 loan does have liability. And you were concerned about 24 that. 25 of the things that a regulator ought to look at when a bank The question I have, however, is wouldn't it be one 171 1 is holding loans that it is going to securitize to make sure 2 that the loan is a good-enough loan to pass a securitization 3 test? 4 MR. HAWKE: Well, I can -- I can't disagree that 5 that would, in an ideal world, have been something that 6 regulators might have done. 7 pass through the books of banks during the heyday of 8 securitization quite rapidly. 9 Although my sense is that loans They -- they -- they were not sitting around 10 for -- waiting for examiners to come in and look at them. 11 And I don't think anybody predicted this kind of response 12 from the securitization trustees when they started trying to 13 find ways to salvage the loans that were going bad in their 14 pools by putting them back to banks on the ground that there 15 had been some sort of fraud in the initiation of the 16 transaction and that the representations and warranties that 17 the bank had given at the time of the sale of the loan had 18 been breached. 19 COMMISSIONER WALLISON: Let me turn, then, to 20 the question that you mentioned, in fact, in your testimony, 21 and that is, fair value or mark-to-market accounting. 22 Would you favor us with your views on how that 23 affected the view of the condition of financial 24 institutions, particularly banks. 25 MR. HAWKE: Well, this is a highly controversial 172 1 subject, and I should say that I'm not an accountant, and I 2 probably should not delve into this but -- 3 COMMISSIONER WALLISON: If we leave this to the 4 accountants, we'll never have a debate about this issue, so 5 please. 6 MR. HAWKE: My basic point, my experience in 7 this regard, is affected by my service as a director to the 8 FDIC, a statutory role for the comptroller. 9 every time that a bank failed, and as we look back at the It seemed that 10 last examination report before the failure, the bank showed 11 positive capital, but immediately after the failure it 12 showed negative capital. 13 And -- and one had to conclude that things 14 didn't change in a period of months so quickly. 15 conclusion from that was that the real value of the bank's 16 capital was not being adequately assessed, whether by the 17 regulators or by the rating agencies or the marketplace or 18 whatever. 19 And my And now, moving to full-blown fair value 20 accounting is, as I say, a controversial issue, people talk 21 about the volatility that that would create. 22 the regulators who are implementing a system of prompt 23 corrective action have to -- which is what our system of 24 supervision is based on, have to know what the real value of 25 capital is. But I think Otherwise prompt corrective action becomes a 173 1 fool's paradise. 2 By the time you're really ready to act capital, 3 real capital, may have already eroded. 4 have to know what the real value of capital is. 5 COMMISSIONER WALLISON: So the regulators True. Do you suppose 6 that the regulators or the market has a better idea of what 7 the real value of capital is when there is no market? 8 9 MR. HAWKE: Well, and that is a good question. When there is no market I don't know that the market has 10 any -- any better way of looking at it than the regulators 11 do. 12 assets for which there is no -- There are ways, there are techniques for evaluating 13 14 COMMISSIONER WALLISON: Discounted cash flow, for example. 15 MR. HAWKE: Yeah, discounted cash flow is one of 16 them. 17 with precision. 18 important. 19 situation in the savings and loan industry in the late `80s 20 and early `90s. 21 And not every asset can be valued on a bank's books But looking at real values is -- is And my favorite example of this is the -- is the Everybody knew that when market rates were up 22 around 20 percent, and S&Ls had average yields on their 23 portfolios of 6 percent, that they were underwater, that -- 24 that -- that it -- and there was no way you could earn your 25 way out of that. We had an insolvent industry. 174 1 Had the regulators -- and I think the regulators 2 were fully aware of that. 3 basis of what real market values were and had they done it 4 incrementally, as interest rates started to go up, instead 5 of waiting till the end, when it was just a cliff that you 6 had to dive off, the -- some of the impact of the savings 7 and loan debacle could have been avoided. 8 9 10 Had the regulators acted on the COMMISSIONER WALLISON: Thanks very much. Let me go on to Comptroller Dugan. You have, uniquely, served in both the Bush 11 Administration; you were appointed by George W. Bush; and in 12 the Obama Administration. 13 I'm going to ask you the same question I asked 14 Mr. Hawke, and that is, have you seen any significant 15 difference between the regulatory environment? 16 the zeitgeist, that sense of whether regulation is important 17 or not important, in the Obama Administration than you saw 18 in the Bush Administration? 19 MR. DUGAN: No. I call it I think -- I do think it's 20 fair, however, to say that the world changed when we hit the 21 crisis in how everybody was looking at this. 22 Treasury Department ended up playing a much more significant 23 role because of the money it was distributing, so it became 24 much more active than would otherwise be the case. 25 true in the Bush Administration, under Secretary Paulson, I think the That was 175 1 carried over to the new administration. 2 But in terms of, as Mr. Hawke said, about 3 interference, directing, we have very strict rules, 4 statutory firewalls that prevent interference with the 5 regulator, with the -- with the comptroller, even though 6 we're a Bureau of Treasury on regulatory matters, and that 7 has been observed in every case in both administrations. 8 9 10 COMMISSIONER WALLISON: You describe the financial crisis as the result of the worst underwritten mortgages in our history. 11 We've had a lot of focus on Citi here, and I'm 12 going to ignore Citi for the moment, because there have been 13 a lot of questions about that and there will probably be 14 more. 15 smaller than Citi, that are now failing. 16 or have failed, already. 17 the list of the FDIC as possible failures -- I don't suppose 18 that all of these are -- are not national banks, that some 19 of these are national banks? But there are about 200 banks, small banks, at least I don't suppose -- There are 700 or so that are on 20 MR. DUGAN: Sadly, yes. 21 COMMISSIONER WALLISON: 22 Now, it seems to me that if there's one thing Sadly, yes. 23 that a regulator ought to be able to do is to make sure that 24 a bank has complete files on loans and that it is only 25 making prudent mortgage loans. 176 1 But we hear, at least, that most of these banks 2 are failing because the loans that they had made, and most 3 of these banks make mortgage loans, either commercial or 4 residential, but principally residential, and hold them on 5 their balance sheets. 6 these banks made loans that are now seeming to be imprudent? 7 And what role could the regulators, particularly your 8 office, have played in preventing that from happening? 9 What is the reason that so many of MR. DUGAN: Well, I want to be careful here, 10 because I was speaking about residential mortgage 11 underwriting, not commercial mortgage underwriting. 12 COMMISSIONER WALLISON: 13 MR. DUGAN: Right. When it comes to the banks that have 14 failed, there have been a number of thrift institutions that 15 that have failed because of residential mortgage problems. 16 But I think all of the national banks that have 17 failed, and certainly the overwhelming majority of 18 commercial banks that have failed, small banks, have failed 19 because of commercial real estate problems, not residential 20 real estate things. 21 been in some cases a decline in underwriting standards, it's 22 as true if not more true that the problem is a concentration 23 problem. 24 these loans on their book, too many eggs in one basket, if 25 you like. In those circumstances, while there has It's a situation where they just have too many of 177 1 And we did try to address this in regulatory 2 guidance that started -- it was a long interagency process, 3 that dated back actually to Mr. Hawke's era, and proceeded 4 very controversial. 5 We did finally come out with guidance that set 6 some benchmarks that were not hard caps on the amount of 7 concentrations that commercial banks could have in 8 commercial real estate lending. 9 parts of the industry as being too prescriptive and we Very bitterly opposed by 10 nevertheless finalized the rules. 11 I think I worry that it wasn't actually strong enough and we 12 should have done more. 13 And, looking back on it, And to your more general point, I do think there 14 is a notion, and honestly this was a little bit surprising 15 to me when I came from the private sector into the 16 government, that regulators don't set underwriting 17 standards. 18 And historically, that's not how things work. 19 It's more been a notion of if you have a willing lender and 20 a willing borrower, then they should be allowed to make a 21 transaction provided that it's done in a forthright manner 22 where people can -- consumers can understand the risk in a 23 consumer transaction and the lender understands, 24 appropriately measures, monitors, controls and manages the 25 risk of the transaction. 178 1 What I suggest in -- is that, given the 2 experience that we've gone through, that that paradigm 3 didn't work very well -- 4 COMMISSIONER WALLISON: 5 MR. DUGAN: Mm-hmm. -- in the residential mortgage 6 space. 7 a market failure that does require more prescriptive minimum 8 government requirements. 9 across the board. 10 And it's a place where there has been, if you like, But critically they have to apply If any one significant part can end-run the others you can have problems. 11 COMMISSIONER WALLISON: One of your 12 prescriptions, I've read the material you've been writing, 13 and in your -- in your prepared statement is higher -- 14 higher down payments, for example, for mortgages. 15 you were talking about a 20 percent possible down payment. 16 17 MR. DUGAN: I think I haven't actually thrown out a number and it could vary in certain circumstances. 18 COMMISSIONER WALLISON: That's a very sensible 19 approach. 20 how do we bring that idea into an idea where we are 21 expecting our banks and other financial institutions, but 22 particularly the banks, to increase home ownership by 23 offering mortgages to people who cannot make a down payment? 24 25 I guess the question I'm going to ask you now, is MR. DUGAN: tradeoff. There is a tradeoff, undeniably a If you put in we had a crisis in which credit was 179 1 too easy and too many people got loans because of weak 2 underwriting standards, if you strengthen those standards, 3 fewer people will get loans, that is the tradeoff. 4 But I think what the crisis showed us was that 5 people got loans that they couldn't handle. 6 help anybody. 7 And that didn't And what I would suggest is that's something 8 that the notice and comment process, how you do it is very 9 important to sort out, number one. 10 And, number two, I think there are different 11 kinds of programs that one could do in a very open and 12 transparent way with people of more moderate means, whether 13 it's through the Federal Housing Administration or through 14 the VA. 15 Which, by the way, has had more success by 16 holding to stronger underwriting standards, even of the 17 lower down payments. 18 So there is not a one-size-fits-all thought here. 19 It's just that we have to bring back some discipline to the 20 system and some common sense minimum underwriting standards. 21 22 VICE CHAIRMAN THOMAS: additional minutes. 23 24 25 Yield the gentleman five COMMISSIONER WALLISON: Wonderful. Thank you very much. I'm glad you mentioned an open and transparent 180 1 way, because that, of course, is a really significant issue. 2 If we want to improve home ownership in this country then 3 there is an open and transparent way to do it, and that is 4 to provide some sort of government subsidy for, we'll say, 5 just to imagine it, down payments. 6 But what we did before, was we took institutions 7 that the government controlled in some way but didn't 8 actually fund, and said, and I'm talking here about Fannie 9 Mae and Freddie Mac, and we said to them, you distort your 10 underwriting systems and you produce these mortgages for us. 11 Hands off, we don't have to put anything in the budget 12 that -- that provides that benefit for the people we are 13 expecting you to help. 14 So open and transparent I think is a really 15 important issue here. 16 I have one other question, I think, because there was 17 something in your testimony that really struck -- struck my 18 eye when I read it. 19 loans, non-prime loans originated by national banks and 20 their subsidiaries subsequently entered the foreclosure 21 process, 22 percent, compared to a market average of 25.7 22 percent. 23 And I'm grateful that you raised it. You note that 22 percent of non-prime Now, I don't know, but I was fairly shocked by 24 the idea that 22 percent of non-prime mortgages in any group 25 of financial institutions would be in the foreclosure 181 1 process right now. 2 In terms of your knowledge of the industry, what's the 3 multiple over the usual number of -- of -- of mortgages that 4 are, or homes that are in the foreclosure process at this 5 stage of a -- of a -- a deflation of a bubble, we'll say. 6 That's -- that's quite extraordinary. And I would like, actually, Mr. Hawke, after -- 7 after you've answered too -- because he has also a very long 8 experience in this business, to respond to that. 9 MR. DUGAN: Well, what I would say is we've 10 never experienced something like this before. 11 experienced this kind of decline in house prices, including 12 the Great Depression. 13 I'm betting that you would have seen an actual more 14 significant decline. 15 We've never If we had had numbers at that time, And I'm, I guess, a little numb to the numbers. 16 We've been collecting the most significant loan-level data 17 on mortgages through a mortgage metrics report that we 18 publish every quarter about this, and the trends for 19 subprime lending, less so for Alt-A, Alt-A lending, but 20 certainly there has been shocking and it's reached into the 21 prime space, as well. 22 I'd have to get back to you for the record about 23 historically what the multiples were, but it's an 24 eye-popping number. 25 payment option mortgages, which in many cases were not And it's even, in some ways, higher for 182 1 subprime mortgages, they're more in the Alt-A thing, but 2 some of the numbers in some of the states are just shocking 3 how much -- how much of them have gone to foreclosure. 4 there are multiples of historical averages. 5 COMMISSIONER WALLISON: 6 MR. HAWKE: Thank you. Mr. Hawke? Commissioner, I don't have a 7 statistic. 8 that is that what -- what this reflects is faulty 9 underwriting, faulty underwriting, not just faulty But I do have what may pass for an insight, and 10 underwriting, but a basic corruption of the underwriting 11 process. 12 But Underwriting a loan is not a mystical science. 13 The objective is to determine whether the borrower has a 14 sufficient income to pay interest and principal on a loan 15 without recourse to the collateral. 16 we made over and over again in the various advisories that 17 the OCC put out in probably half a dozen occasions in recent 18 years where we have made that point. 19 And that's a point that And the -- the -- the loans that were made on 20 the basis of stated income or -- or data that turned out to 21 be fraudulent or faulty don't -- don't reflect flaws in the 22 underwriting as such -- as much as they do a corruption in 23 the process, because those lenders that were -- that were 24 doing that really didn't care what the borrower's ability to 25 pay current interest and principal on the loan was, because 183 1 they were looking to the collateral. 2 And that was certainly true with the Alt-A and 3 other kinds of alternative mortgage instruments, as I 4 mentioned in my prepared statement. 5 Banks were not looking at the borrower's 6 ability to handle the fully amortized market rate of 7 interest-type obligations when the reset point came in those 8 transactions and -- because they were relying on the 9 immutable fact that housing prices only go up. 10 And it was that reliance on the value of the 11 collateral rather than the conventional type of loan 12 underwriting that -- that contributed to this high level of 13 foreclosures. 14 COMMISSIONER WALLISON: Thank you. 15 Mr. Chairman, I might have some questions at the end if we 16 still have time. 17 18 19 20 CHAIRMAN ANGELIDES: certainly. Thank you. All right, Mr. Thomas has a quick question on this item. EXAMINATION BY VICE CHAIRMAN THOMAS VICE CHAIRMAN THOMAS: Just very briefly, I 21 understand you're focused on national, but in the discussion 22 with Mr. Wallison, there's community banks. 23 want you to do is either confirm or deny my thinking, and 24 that is, with the growth of credit unions in terms of the 25 degrading of what banks could do on a somewhat of an I guess what I 184 1 exclusive basis, savings and loans were really packaged on 2 originate-to-hold, as you got into this business as 3 originate-to-distribute on residential loans and then the 4 warehousing structure, about all that was left of some 5 community banks, as a business focus, was some of the 6 commercial lending. 7 they should have, but is -- I mean, that's kind of where 8 they wound up, wasn't it? 9 And they stretched that farther than MR. DUGAN: There is that issue; that is to say, 10 many of the retail loan products became more commodity-like 11 and scale businesses. 12 community banks to compete. 13 And it was harder and harder for A shrinking menu of things, and many, 14 particularly in places in the country which had high housing 15 development, in the sunbelt and the like, it became a very 16 principled source of business. 17 And that's the conundrum, of course. 18 VICE CHAIRMAN THOMAS: 19 MR. DUGAN: Sure. Is that if you start moving in 20 concentrations in that area, it's the basic bread and butter 21 of what they do, and so how you do that is a very difficult 22 problem. 23 VICE CHAIRMAN THOMAS: And at the same time, 24 commercial establishments looking for loans, the others who 25 were moving into the other products didn't have that much of 185 1 an interest, and so they found themselves, unfortunately, to 2 a certain extent, for a lot of community banks. 3 MR. DUGAN: 4 VICE CHAIRMAN THOMAS: 5 CHAIRMAN ANGELIDES: 6 COMMISSIONER GEORGIOU: 7 EXAMINATION BY COMMISSIONER GEORGIOU 8 COMMISSIONER GEORGIOU: 9 That's right. Thank you. Thank you. Mr. Georgiou? Thank you, Mr. Chairman. Just want to follow up on something that Commissioner Wallison began, Mr. Dugan, 10 and that is that back in 2007, you stated a number of times 11 that subprime loans made by national banks in 2006 were 12 becoming delinquent at about half the rate of the industry 13 average; do you recall that? 14 MR. DUGAN: 15 specific. 16 don't know. 17 I -- I -- I -- I don't recall that I remember saying they performed better. But I I don't recall that. COMMISSIONER GEORGIOU: Well, because in your 18 testimony on page 9, you now quote statistics showing that 19 the default rate for national banks for non-prime loans, 20 originated between `05 and `07 was about 86 percent of the 21 market average. 22 Does that mean that they -- the national banks' 23 relative performances -- has deteriorated, has worsened over 24 the last few years, in your view? 25 MR. DUGAN: I'd have to go -- I'd have to go 186 1 back and look at the original statement and compare the same 2 data set of the subprime, not just subprime and Alt-A. 3 be happy to. 4 5 COMMISSIONER GEORGIOU: I'd Would you mind doing that? 6 MR. DUGAN: I'd be happy to do it. 7 COMMISSIONER GEORGIOU: For us, and follow up in 8 writing so we can clarify that? The -- you know, there are 9 statutory protections administered by the Federal Reserve 10 under Section 23 of the Federal Reserve Act which limit the 11 amount of transaction between a commercial bank and its 12 affiliates in order to protect the commercial bank from 13 non-bank risks. 14 And while the Fed administers this Act, bank 15 supervisors have an interest, you know, obviously have an 16 interest in this subject, and I wonder whether the liquidity 17 puts that we've been discussing at Citigroup were 18 considered a possible 23A concern, in your view? 19 MR. DUGAN: I don't know that specifically, but 20 to be a 23A violation, it would have to kind of loan to one 21 borrower kind of concept, the amount of credit to an 22 affiliate that exceeded 10 to 20, 10 percent of your 23 capital, and that would be a big number with Citibank. 24 I'm not sure that would be in addition -- 25 COMMISSIONER GEORGIOU: So Well, the capital was 187 1 less than 100 billion dollars, I think, at any relevant 2 time. 3 MR. DUGAN: Right. 4 COMMISSIONER GEORGIOU: And as it turns out, 5 they took 25 billion dollars of losses on liquidity puts and 6 a total of 30, slightly over 30 billion dollars on the 43 7 billion dollars' worth of collateralized debt obligations. 8 So it ended up being about a third, more or less, of their 9 capital. 10 So it would meet that test, I would say, as being significant. 11 MR. DUGAN: Let -- let me get back to you on 12 this, because A, I'm not sure whether we've looked at it in 13 those lights, but B, it also may be the case that when you 14 have a contingent liability like that, it's treated 15 differently than something that ended up being that kind of 16 loss to the bank. 17 I just don't know the -- COMMISSIONER GEORGIOU: Right. And then what 18 about the warehouse lines of credit that were provided by 19 Citi to customers of the investment banks, such as New 20 Century, that we heard from yesterday? 21 MR. DUGAN: Those would be subject to 23A and 22 23B. 23 subject to the lending limits, that's -- because New Century 24 wouldn't have been an affiliate, so it's not 23A and 23B. 25 Well, are you saying to New Century? COMMISSIONER GEORGIOU: Right. That would be Right. No, that 188 1 would be with the lending limits and the concentration, 2 presumably, into this particular area. 3 MR. DUGAN: Right. 4 COMMISSIONER GEORGIOU: I guess one of the 5 things that we were told, and if I can find it, by -- one of 6 your examiners told our staff that the CDO business at Citi 7 was managed outside the bank; it changed from an agency 8 business to a principal business. 9 It's outside of our jurisdiction. 10 And we don't know that. Gramm-Leach-Bliley would not let us really look 11 into that, yet the bank had these liquidity puts that were 12 not reported in any risk system that we had. 13 the case, how serious -- I mean, obviously it was a 14 serious problem, how do we remedy that? 15 structure preventing us from -- preventing you, really, and 16 others responsible for getting it all the information you 17 need to assess the stability, the safety and soundness of 18 these institutions? 19 MR. DUGAN: If that was I mean, is the I do think there's an issue here, 20 and there is language that is in the Gramm-Leach-Bliley Act 21 that makes it harder to get information from a functional 22 regulator, which is what the SEC is, with respect to a 23 broker-dealer. 24 25 And I say that not because the SEC was resistant to providing things, but it creates asylum and talent. And 189 1 things that are done outside of the back are not as 2 routinely in the purview of examiners to see and touch and 3 feel and ask questions about and stir up. 4 And I think that we do need to have a better way 5 to get at that information on a consolidated integrated 6 basis. 7 financial reform legislation and I think is a good thing. 8 9 That is one of the things that was -- is in the COMMISSIONER GEORGIOU: Okay. And it's in the financial reform legislation, that's what, moving to -- 10 MR. DUGAN: To remove that provision in the 11 Gramm-Leach-Bliley Act that put those kinds of restraints on 12 the functional regulator. 13 entity is now more easily subject to examination and 14 supervision, particularly by the Federal Reserve, as the 15 consolidated regulator. 16 17 And for functionally regulated VICE CHAIRMAN THOMAS: point, briefly? 18 COMMISSIONER GEORGIOU: 19 VICE CHAIRMAN THOMAS: 20 21 22 23 24 25 Gentlemen, yield on that I'm sorry? Yes. In the House, past version? MR. DUGAN: I believe it's in the House passed version and a version and in the Senate. VICE CHAIRMAN THOMAS: And in the Senate. So it's in both. MR. DUGAN: I think, I think so, but we'll get 190 1 back to you on that. 2 3 VICE CHAIRMAN THOMAS: Yeah, thanks, well, I can check it, I just want to -- I think it's in both. 4 COMMISSIONER GEORGIOU: How much, if at all, I 5 mean, I guess I'll direct this to both of you gentlemen, if 6 at all did you understand that the collateralized debt 7 obligation exposure of Citibank when you were examining it? 8 9 MR. DUGAN: Well, my understanding is this: certainly knew that the broker-dealer was -- had a 10 structuring business, and that structuring business had 11 CDOs. 12 We knew early on that at times they were going 13 to use liquidity puts, but at the time when they first 14 started doing CDOs, the underlying collateral was not 15 subprime collateral. 16 COMMISSIONER GEORGIOU: 17 MR. DUGAN: 18 COMMISSIONER GEORGIOU: 19 MR. DUGAN: 20 COMMISSIONER GEORGIOU: 21 MR. DUGAN: 22 23 We Was not, sorry, what? Was not subprime collateral. What were they using? Regular mortgages, prime mortgages. Right. And that was our understanding. Later, we began to -COMMISSIONER GEORGIOU: But they were still 24 using low-level tranches of the -- of the subprime mortgage 25 securities, were they not? 191 1 2 MR. DUGAN: That was not my understanding of what we knew initially about the business. 3 COMMISSIONER GEORGIOU: 4 MR. DUGAN: 5 COMMISSIONER GEORGIOU: 6 MR. DUGAN: Okay. -- Before. All right. And later they began to use 7 derivatives in a synthetic way to create CDO exposure. 8 that business began to put some of the super senior 9 synthetic exposures in the bank. 10 COMMISSIONER GEORGIOU: 11 MR. DUGAN: And Right. We did learn about that; we did go 12 do an examination of our London branch office, our London 13 office of the OCC examined their London branch office, and 14 we did get a sense of the exposure there in the early months 15 of 2007. 16 Although, I will say that the exposure that we 17 ultimately got at the end of 2007 was quite a bit larger 18 than what we thought it was at the beginning of 2007. 19 What we didn't know, though, was that there was 20 a specific liquidity put on these CDOs. 21 didn't know the magnitude of the exposure. 22 magnitude was never really reported. 23 And we certainly And that And, you know, there -- there were liquidity 24 facilities, as I said before, that were with other kinds of 25 conduits, which were in the bank, which we would examine and 192 1 which we would know about. We wouldn't necessarily know 2 about every liquidity facility that was done. 3 But what I will say is during 2007 when problems 4 started to emerge and we began pushing and kicking the tires 5 harder, we weren't getting the answers that this was an 6 exposure, and it didn't show up until the crisis hit. 7 that was a problem. 8 COMMISSIONER GEORGIOU: Right. And And, you know, I 9 don't want to belabor this, because I'm sort of tiring of 10 saying it again myself, but -- but -- and -- and I'm sure 11 everyone else is, but at some point this exposure -- well, 12 first of all, there is been a contention, and I think it was 13 from some people in the Fed, and the staff of the Fed have 14 suggested this to us and others, that really there was a 15 real regulatory and capital arbitrage game being played, 16 here with regard to these liquidity puts. 17 when -- in the commercial paper market basically most people 18 won't buy commercial paper unless it's backed up with a line 19 of credit that's unconditional so that they can roll it over 20 at the time and sell it. 21 Because in -- And so if you -- if they gave you a 25 billion, 22 if they put a 25-billion-dollar line of credit, 23 unconditional line of credit on the bank books, then you 24 would see it, you would know it, people would have to hold 25 capital on it, and you would be looking at what their 193 1 exposure presumably was for having to honor that line of 2 credit. Would that be fair to say? 3 4 MR. DUGAN: Yes. But we'll go -- we'll go ahead with your term. 5 COMMISSIONER GEORGIOU: Okay. My point then 6 being, is that by putting on -- putting the liquidity puts, 7 using liquidity puts instead of a customary line of credit 8 to backstop this commercial paper, several things happen. 9 One is it's off-balance-sheet, more -- less 10 transparent to you, less clear to you that there is any 11 particular risk to the bank. 12 understand, the capital is -- at least no more than 13 one-tenth of the capital is required that would have been 14 required had -- had the line of credit been -- And the capital, as I 15 MR. DUGAN: So here's how this works. 16 COMMISSIONER GEORGIOU: 17 MR. DUGAN: -- flat out? That's right. When you have 18 liquidities facilities, and if -- and if it's a liquidity 19 facility that's less than one year in duration, the capital 20 rules say, and if it's truly a liquidity facility was the 21 argument -- 22 COMMISSIONER GEORGIOU: 23 MR. DUGAN: Right. -- that it was only there in case of 24 a temporary liquidity problem, not to back up credit losses, 25 then the current capital rules said 10 percent capital 194 1 charge, 10 percent credit conversion factor. 2 COMMISSIONER GEORGIOU: 3 MR. DUGAN: Correct. If you had a full guarantee at a 4 hundred percent, then you have a hundred percent credit 5 conversion factor. 6 balance sheet. It would be as if it were on your 7 COMMISSIONER GEORGIOU: 8 MR. DUGAN: 9 Right. And, as I said, the argument was that if you didn't actually have a credit guarantee but you 10 were only guaranteeing on a temporary liquidity basis, it 11 should only be 10 percent. 12 You are quite right that what the crisis showed 13 us was what was what was supposed to be a temporary 14 liquidity facility, once it got exercised, ended up 15 resulting in it being full credit support, and all of the 16 assets came back onto the balance sheet. 17 As a result, the Basal committee, with the full 18 support of the U.S. regulators has said that its credit 19 facilities can't be at 10 percent. 20 percent. 21 COMMISSIONER GEORGIOU: 22 MR. DUGAN: They've got to be at 50 Uh-huh. So it's not quite the same. 23 that process is working its way through the America 24 regulatory process. 25 And so But, in addition, this accounting change from 195 1 FAS 166, 167 is making it much harder as a general matter, 2 in the first instance, to take those conduits and get them 3 off-balance-sheet, at all. 4 5 COMMISSIONER GEORGIOU: Right. Which is another positive development. 6 MR. DUGAN: That's right. 7 COMMISSIONER GEORGIOU: But I guess, to go back 8 to it, because I know Chairman Angelides has made this 9 point, is that it really only took a 5 percent drop in the 10 housing prices to trigger effectively a full recognition of 11 that 25 -- those 25 billion dollars of liquidity puts. 12 And, really, that was because the underlying 13 collateralized debt obligation was composed of all Triple-B 14 tranches of the underlying residential mortgage-backed 15 securities. 16 So those tranches were at the 7 percent and 17 below level of the originating security; that is, 93 percent 18 of the tranches were higher-rated, so obviously everything 19 within the collateralized debt obligation, even the ones 20 that were regarded as prime-plus or Triple-A-plus. 21 really got an A-plus. 22 is. 23 security tranche no longer was getting any cash flow because 24 of the relatively modest diminution of housing prices and 25 the resultant defaults, then all of the upper-level I never I don't know, really, quite what that So when the underlying 7 percent-and-below-rated 196 1 collateralized debt obligation failed and had to be brought 2 back onto the books essentially and written off, really, in 3 a very rapid succession there at Citi. 4 So -- and everybody who's testified here has 5 said that neither the regulators nor the risk assessors nor 6 the originators nor anybody else really regarded this -- 7 this particular product as having essentially any risk of 8 default, anything more than a 10,000 to 1 chance of default. 9 And is that -- I mean, obviously, in retrospect, 10 we know that was not the case. 11 did any -- I guess let me ask it in a different way, because 12 I'm not being very articulate. 13 But wouldn't it have been -- Did you or any of your people ever look into 14 these credit default obligations, I mean these 15 collateralized debt obligations and have any suspicion that 16 maybe they really weren't as solid as they were represented 17 to be? 18 MR. DUGAN: I think that we did think that there 19 was some pricing risk in one of our exams that we noted with 20 the CDOs in 2005. 21 question of the kind you're suggesting that the super senior 22 exposure didn't have quite a remote level of risk. 23 But I don't think there was a fundamental The other thing I'll mention to you, though, is 24 the further thing they would say is, if there were a 25 downgrade, a credit downgrade as a result of the 5 percent 197 1 drop, the liquidity put could not be exercised; it wasn't 2 there to take into account. 3 What happened was confidence got lost before 4 there was a downgrade, investors started to run, that was a 5 true liquidity event, not a credit event, the liquidity put 6 got exercised, and it was supposed to be on a temporary 7 basis, and once the, you know, the liquidity squeeze went 8 by, they would be able to resell and roll -- 9 10 COMMISSIONER GEORGIOU: never -- 11 MR. DUGAN: 12 COMMISSIONER GEORGIOU: 13 14 15 -- them over. MR. DUGAN: So the point is -- 17 MR. DUGAN: 20 21 Of course it never Of course it never happened, right. COMMISSIONER GEORGIOU: 19 It never happened. happened. 16 18 Right, of course, they Right. -- that what was styled and put forward as an extra protection proved to be illusory. COMMISSIONER GEORGIOU: Right. So in -- so what are we -- what's to be done about that? MR. DUGAN: Well, I think what I said was, 22 number one, there's much greater -- much more suspicion 23 about credit facil- -- liquidity facilities, in general. 24 25 We -- the U.S. had -- used to be under the original Basal rules, it got a zero risk rating -- 198 1 COMMISSIONER GEORGIOU: 2 MR. DUGAN: Right. -- and we were the ones who put it 3 at 10 percent. 4 mentioned, the accounting rules have changed to make a bunch 5 of these securitizations not possible. 6 7 COMMISSIONER GEORGIOU: Right. One more question. 8 9 Basal's bumped it up to 50 percent, and as I CHAIRMAN ANGELIDES: Yes, I'll yield two minutes. 10 COMMISSIONER GEORGIOU: Thank you. 11 I don't want to go too far into the accounting 12 rules, but can we all agree with regard to mark-to-market 13 that whether you believe in it or don't believe in it, one 14 thing we can all agree on is that you're not permitted to do 15 it on the upside and not on the downside? 16 MR. DUGAN: I guess that's right. Although, I 17 must say I disagree with Jerry on the mark -- the fair value 18 accounting point, but yes. 19 COMMISSIONER GEORGIOU: But I mean but we saw 20 historically at several companies, not in the financial 21 business, at Enron, for example, where they -- 22 mark-to-market, a number of assets that they characterized 23 as having increased in value quarter by quarter, this was a 24 significant element of their recognition of income, so 25 you're not -- I mean, you certainly ought not to be 199 1 permitted, as a financial institution, to mark it up but 2 never to have to mark it down. 3 MR. DUGAN: And I don't think that was the case 4 in this instance. Once it was in the trading book, it was 5 being marked and going up and down, and that's why you had 6 the very sudden, precipitous losses -- 7 COMMISSIONER GEORGIOU: 8 MR. DUGAN: 9 COMMISSIONER GEORGIOU: Right. -- in the fourth quarter of 2000 -And to follow up just on 10 the capital issue there, isn't it also the case that if it's 11 in your trading book, there's very little capital required 12 to sustain it? 13 14 MR. DUGAN: not if you sell it. 15 16 So if -- so if you hold the piece, COMMISSIONER GEORGIOU: But if you hold the piece, right? 17 MR. DUGAN: If you hold the piece and it's on 18 your books, it's treated as a securitization exposure. 19 the way super senior exposures were treated, actually, was 20 the same, whether it was in the trading book or the banking 21 book. 22 And You are right, however, that in many cases, the 23 trading book valuations were way lower than what the banking 24 book was, and that was true for a number of securitizations. 25 It's one of the things we pushed very hard to change, 200 1 already, at the basal committee, because to prevent that 2 kind of arbitrage, that also is making its way back into the 3 U.S. capital. 4 COMMISSIONER GEORGIOU: Right. I mean, we've 5 got somebody from the Fed who told us that if it was kept on 6 the trading book, the capital requirement was something like 7 70 -- the regulator -- the leverage was 750 or 800 to 1. 8 MR. DUGAN: 9 COMMISSIONER GEORGIOU: 10 MR. DUGAN: That's true. That's how little -- But you also have to remember there 11 was a leverage ratio that applied on top of that, so it's a 12 matter of risk-based capital, that's true, but there was a 13 much higher piece -- 14 COMMISSIONER GEORGIOU: 15 MR. DUGAN: 16 17 18 Right. -- that applied, just as a straight on balance sheet. COMMISSIONER GEORGIOU: Okay, thank you, Mr. Hawke wanted to respond to that and then I'm done. 19 CHAIRMAN ANGELIDES: 20 MR. HAWKE: Go ahead and respond. Just very briefly I want to clarify 21 my position, and that is, I'm not an advocate of going to 22 full market value accounting for all purposes. 23 I look at this in the context of the process of 24 prompt corrective action. But what the regulators are 25 supposed to be doing is taking increasingly stringent 201 1 supervisory action. 2 zero. As a bank's real capital approaches It's a protection against insolvencies. 3 And from a supervisory point of view, I think 4 it's important to know what the real value of capital is on 5 the downside. 6 the upside. 7 assets deteriorate in value the -- their liabilities 8 increase in value, which is an anomaly, but that -- that's 9 not completely relevant for prompt corrective action 10 The -- I've heard arguments about -- about I've also heard arguments that as a bank's purposes. 11 COMMISSIONER GEORGIOU: Okay. And -- and I take 12 it you would agree with Dr. Greenspan's suggestion yesterday 13 that it, particularly for institutions as complex as Citi -- 14 15 CHAIRMAN ANGELIDES: I will yield you another minute. 16 COMMISSIONER GEORGIOU: I'm sorry. As complex 17 as Citi that we need much more capital and higher capital 18 and liquidity requirements; is that fair to say? 19 MR. DUGAN: I have testified, generally, that 20 systemically important institutions, particularly 21 institutions with trading requirements, need higher capital, 22 generally. 23 COMMISSIONER GEORGIOU: 24 MR. HAWKE: 25 COMMISSIONER GEORGIOU: Mr. Hawke? I would agree with that. Okay. Thank you. Thank 202 1 you, Mr. Chairman. 2 CHAIRMAN ANGELIDES: 3 COMMISSIONER HOLTZ-EAKIN: 4 Mr. Holtz-Eakin? Thank you, Mr. Chairman. 5 EXAMINATION BY COMMISSIONER HOLTZ-EAKIN 6 COMMISSIONER HOLTZ-EAKIN: Thank you, gentlemen, 7 for taking the time to come today. 8 some well-trod ground, and I apologize for that, but I 9 wanted to ask you in particular, Mr. Dugan, some questions 10 I'm going to begin with that I asked the Citi grant -- Citibank panel this morning. 11 And so, Mr. Dugan, the OCC's current examiner in 12 charge of Citibank said that when he first came into 13 Citibank in October 2007, he quickly determined that 14 Citibank's entire risk management structure needed to be 15 revamped, and he embarked on a course of action to require 16 Citibank to change its entire risk management structure. 17 it reasonable to infer from that judgment that the prior 18 risk management structure of Citibank was deficient in some 19 respect? 20 MR. DUGAN: I think what I would say is that 21 when we had the crisis, it revealed things that were not 22 apparent when we didn't have the crisis. 23 Is And, in particular, we were quite concerned that 24 the risk management was not sufficiently independent from 25 the line of business, and that in a couple of very 203 1 significant cases, it had agreed to increase limits and ramp 2 up risks in ways that we did not think was appropriate, 3 particularly with the problems that were apparent on the 4 trading side as opposed to the loan side, that that was a 5 serious, significant thing that needed to be addressed. 6 COMMISSIONER HOLTZ-EAKIN: Had there been 7 previous OCC reports that suggested deficiencies in the risk 8 management structures at Citibank? 9 MR. DUGAN: There were, as I mentioned earlier, 10 earlier reports where we did raise significant objections on 11 risk management, downgraded them with respect to particular 12 businesses, as we did with the credit default swap business, 13 and which they then responded and took steps to address. 14 But it was not a situation where we had 15 criticized the whole structure and believed it should be, as 16 I said, that was more a thought that came out of the 17 deficiencies that were revealed in the crisis. 18 COMMISSIONER HOLTZ-EAKIN: Okay. Just so I 19 understand the details, you did, in fact, issue a downgrade 20 to the risk management rating in the past? 21 22 MR. DUGAN: business that we -- 23 24 25 With respect to the particular COMMISSIONER HOLTZ-EAKIN: business? MR. DUGAN: Yes. With this particular 204 1 2 COMMISSIONER HOLTZ-EAKIN: And you were satisfied with the Citibank response in this instance? 3 MR. DUGAN: Yes. 4 COMMISSIONER HOLTZ-EAKIN: The 2007 report does 5 say, regarding the role of the boards in particular, that 6 traditionally the board has been provided limited 7 information on the material risks impacting this legal 8 entity. 9 familiar with the risks assumed within the bank. 10 Consequently they have been unable to become fully Isn't that a serious charge against the bank's board of directors? 11 MR. DUGAN: It is, but you have to understand 12 this in context. 13 bank, the board of directors of the bank. 14 like some other companies, was running the whole 15 organization by line of business and not paying as much 16 attention, as we would like, to the legal entity of the bank 17 and separately having it have the right risk reporting that 18 is particular to that bank. 19 it. 20 focused, has continued to be particularly focused on that, 21 and the company has moved in that direction. 22 What we were talking about now is the And I think Citi, And it gotten too far away from The new EIC, when they came in, was particularly COMMISSIONER HOLTZ-EAKIN: In fact, their 23 response was to say the company is proud of its board 24 processes both at the parent and the bank level. 25 What's your personal opinion of the 205 1 effectiveness of the board both prior to and after your 2 review? 3 MR. DUGAN: I think we believe that the board, 4 at the bank level, and we had believed this for quite some 5 time, needed to be more independent and operate as a more of 6 an independent rather than them being staffed with too many 7 insiders on the bank board. 8 9 And so we did believe that that was some step that absolutely needed to be taken, particularly, as I said 10 before, when we became aware of this breakdown that occurred 11 in the internal reporting in connection with the liquidity 12 put and the huge liability that came back onto the bank's 13 balance sheet as a result of what happened. 14 COMMISSIONER HOLTZ-EAKIN: Thank you. I know 15 you've answered a lot of that before, but they were asked 16 the same questions. 17 MR. DUGAN: Yes. 18 COMMISSIONER HOLTZ-EAKIN: This morning's 19 discussion about Citi was intended to talk about the 20 industry as a whole, and so I guess what I would ask you is 21 was Citibank unusual in any of these regards or was this 22 typical of the risk management challenges and internal 23 reporting and monitoring facilities that are in the industry 24 and for national banks as a whole? 25 MR. DUGAN: Citi was unusual in our large bank 206 1 experience because the bank was a smaller proportion of the 2 overall company than is typical, even for our very largest 3 banks. 4 So it was less than half of the assets of the 5 overall company, until recently, when they began downsizing. 6 So they had a huge non-bank piece of it, and that affected 7 the culture and the way things were done in ways that were 8 different, historically, than some of the other institutions 9 that we supervised. 10 COMMISSIONER HOLTZ-EAKIN: So is it a fair 11 characterization to say that on net, they were below the 12 industry standard for management of these risks? 13 MR. DUGAN: It was different. As I said before, 14 I think we felt they had a firm grasp of risks that they 15 were -- understood a bunch of things, but that their 16 appetite got bigger, and that appetite to take more risks 17 spilled on risks that they thought they understood well, 18 turned into some very big bets on things that created quite 19 large liabilities, not just for the company as a whole, but 20 for the bank, and that was different. 21 COMMISSIONER HOLTZ-EAKIN: Thank you. I wanted 22 to turn to another oversight issue, which is, we understand 23 that the OCC came in at the request of OFHEO, now FHFA, in 24 the summer of 2008 to review Fannie Mae. 25 What can you tell us about the risk management 207 1 system and capital levels of Fannie Mae compared to national 2 banks of similar size? 3 MR. DUGAN: So we were asked by the Fed to go 4 into both Freddie and Fannie. 5 examination, this is important, and we did not review what 6 they would be like under their legal structure and their 7 legal capital requirements. 8 And to -- we didn't do an We were asked to say if this were a bank what 9 would its capital requirements be; how would they look? 10 we had our expert retail examiners work on that review. 11 And And where we came out, and just by some very 12 simple arithmetic bolstered by the results of what we did, I 13 think it's fair to say that they would have been treated as 14 significantly undercapitalized at that point. 15 Fannie Mae and Freddie Mac, all their mortgage-backed 16 securities get a hundred percent credit guarantee, and in a 17 bank world, all of that stays on the balance sheet. Based on 18 If you have us back to your point that was 19 raised earlier by Commissioner Georgiou, if you have a 20 hundred percent credit guarantee, it's on your balance 21 sheet. 22 And by statute, the rules for Fannie and Freddie 23 and their risk-based capital rule had a credit conversion 24 factor that was far reduced on that, presumably under the 25 theory that mortgages just weren't as risky, but that's just 208 1 not the way we would do it. And had that come on the 2 balance sheet in the denominator, in the numerator they were 3 allowed to count more of deferred tax assets as an asseting 4 capital than a lot more than we would allow. 5 Now you put the two of those together, plus the 6 fact that the way they did their reserving practices, their 7 credit reserving mortgages was considerably less rigorous 8 than what we would do on the bank's side; it was a 9 significant effect on their capital position. 10 11 COMMISSIONER HOLTZ-EAKIN: surprise you in any way? 12 CHAIRMAN ANGELIDES: 13 what you said? 14 that question? 15 16 Did these findings I'm sorry, could you repeat I somehow didn't hear it, could you repeat COMMISSIONER HOLTZ-EAKIN: Did these findings surprise you in any way? 17 MR. DUGAN: I don't know that we were surprised 18 in the sense that, you know, it was a company that was 19 totally and a hundred percent in the mortgages business, and 20 mortgages were having trouble, and we knew statutorily they 21 had a regime that had a lower regular capital ratio than we 22 did. 23 others were asking us is just what is your view so that they 24 can take that into account in the subsequent policy actions 25 that they took. I think that the question that the Federal Reserve and 209 1 2 COMMISSIONER HOLTZ-EAKIN: One of the unique features -- 3 VICE CHAIRMAN THOMAS: Are going to continue 4 that line of questioning or are you going to shift to 5 something else? 6 COMMISSIONER HOLTZ-EAKIN: 7 VICE CHAIRMAN THOMAS: 8 COMMISSIONER HOLTZ-EAKIN: 13 I would never leave you out. 11 12 Okay, because then I want to get in on this at the end. 9 10 It's related. VICE CHAIRMAN THOMAS: And I -- and I got time to give. COMMISSIONER HOLTZ-EAKIN: Okay. One of the 14 unique features of Fannie Mae and Freddie Mac is in the fact 15 that your banks and others can hold unlimited amounts of 16 their securities and their portfolios under the presumption 17 that they are as riskless as treasuries. 18 Knowing that they were, in fact, not, because 19 nothing about this examination surprise you, did this give 20 you any concern about the safety and soundness of those 21 which you supervised? 22 MR. DUGAN: Well, it is, you know -- 23 statutorily, they have always received a favored position in 24 what they can be invested in because of the 25 quasi-governmental status of the institutions. 210 1 And it did have effects on institutions that 2 caused the failure of a number of banks, including several 3 that we supervised, smaller ones, so, yes, it was a concern. 4 COMMISSIONER HOLTZ-EAKIN: And did you express 5 this concern to other regulators or in any way attempt to 6 change this treatment? 7 MR. DUGAN: We have not taken; the write-downs 8 were occurred, and it was more in the -- preferred stock was 9 where the big hit was taken when that got wiped out. That 10 was the part that got done, but we have not changed the 11 capital rules on that. 12 13 14 15 COMMISSIONER HOLTZ-EAKIN: I yield to the Vice Chairman. VICE CHAIRMAN THOMAS: Thank you, and it will be on my time, and you can have some more if you want. 16 COMMISSIONER HOLTZ-EAKIN: Okay. 17 EXAMINATION BY VICE CHAIRMAN THOMAS 18 VICE CHAIRMAN THOMAS: I want to put this in 19 context, because I was going to talk about this later, but 20 it's kind of a preview of coming attractions for tomorrow as 21 you indicated. 22 Freddie Mac after the conservator? 23 MR. DUGAN: 24 VICE CHAIRMAN THOMAS: 25 MR. DUGAN: But you were asked to look at Fannie Mae and Before. Before? Oh, well, let's say, yes, before the 211 1 conservatorship. 2 3 VICE CHAIRMAN THOMAS: And -- and you were requested to come in by? 4 MR. DUGAN: The Federal Reserve, who was 5 conducting the exam, and they wanted help from our expert 6 retail credit examiners because we have a tremendous amount 7 of retail credit experience in the national -- 8 9 VICE CHAIRMAN THOMAS: And did it reflect, at all, in your opinion on the regulatory structure that they 10 were ordinarily operating under? 11 the term deficiencies, but perhaps undermanned or anything 12 else about OFHEO or FHFA? 13 MR. DUGAN: 14 looking at it. 15 a very -- 16 Any -- I don't want to use I guess that wasn't the way we were We were trying to help; there was obviously VICE CHAIRMAN THOMAS: But the only reason 17 you're asked to help is because the folks who are supposed 18 to row the boat can't. 19 MR. DUGAN: And I think they -- the reason why 20 I'm hesitating is they had a different regulatory structure 21 and a different mandate and a different set of rules that 22 they were operating under. 23 And we weren't asked to look at those rules and 24 say, are you deficient? We were asked to say, now, if this 25 were a bank, how would you treat it? And so we were happy 212 1 to provide that because that's an expertise we had. 2 VICE CHAIRMAN THOMAS: And why do you think you 3 were asked to look at it that way, which, after all, was 4 different than the way it was supposed to operate under 5 while on regulatory structures? 6 MR. DUGAN: I think there was concern by -- at 7 the time by the Federal Reserve and by the Treasury 8 Department about the ongoing solvency of the companies. 9 they wanted to get some other judgments about that from And 10 different regulators who had expertise with these kinds of 11 instruments. 12 VICE CHAIRMAN THOMAS: You know the old jag 13 about going across the suspension bridge, and you don't want 14 the troops to march in step, you want to break that pattern, 15 is it your observation, would you be willing to say, that 16 it -- it wasn't just the size, but obviously it was the 17 lockstep, the single theme of Freddie Mac and Fannie Mae in 18 terms of what they were involved in was a concern? 19 is it just the sheer size and what was deteriorating around 20 them? 21 MR. DUGAN: Or was I don't know that I can comment. I 22 mean I think, as I said before, a company that's a hundred 23 percent in the United States mortgage business when it has a 24 crisis in home values that drops the value of those 25 mortgages is going to raise concerns at any time. The same 213 1 thing happened, you could say, with the thrift industry, not 2 once, but now twice. 3 had very substantial strains on them as well and ultimately 4 had to be taken over or acquired. 5 VICE CHAIRMAN THOMAS: And the largest of those institutions And when you're dealing 6 with people, helping them get a mortgage to own a home on 7 the way up, it's all good, and more is better until? 8 9 MR. DUGAN: Yeah, as I said before, I mean, I think we had a whole cluster of things that cause us to 10 loosen our underwriting standards when times are good in the 11 name of home ownership. 12 Of course, Fannie and Freddie did have some 13 statutory down payment requirements, but in what happened 14 and how those were done over time, they proved not to be 15 adequate protection for what later happened. 16 17 VICE CHAIRMAN THOMAS: Just very briefly, you were asked to intervene? 18 MR. DUGAN: Yes. 19 VICE CHAIRMAN THOMAS: Did you -- did you 20 consider it a positive experience, and was there some 21 cross-fertilization of knowledge and understanding, although 22 people are talking about Fannie -- 23 MR. DUGAN: 24 VICE CHAIRMAN THOMAS: 25 being there anymore? Yes. -- and Freddie Mac not 214 1 MR. DUGAN: 2 VICE CHAIRMAN THOMAS: 3 Yes. For you, in your particular area of expertise and responsibility? 4 MR. DUGAN: Yes. I mean I think it was -- we 5 were -- I think we were appreciated the recognition of our 6 expertise in this area. 7 this quite unusual institution. 8 9 And we learned things by looking at And I think there was coordination not just between us, and cooperation between us and the Federal 10 Reserve, but also with the then-Office of Federal Housing 11 Enterprise Oversight, which is now the GSC regulator of 12 FHFA. 13 VICE CHAIRMAN THOMAS: One last question. We're 14 worried about what the structure needs to look like, where 15 and how we can deal with this, and people are talking about 16 a super agency or reinforcement in the smaller. 17 Do you have any sense that if you've got some 18 folks who have a type of speciality, given the complexity 19 and the blending of what's going on, that it might be useful 20 to have some folk who aren't so locked into a narrow area 21 but that you can be called on, when necessary, so that your 22 expertise is unique, but you don't have to replicate it in 23 whatever regulatory structure is available? 24 25 And that might be a part -- partial model that might be useful, the cavalry coming to the rescue, when and 215 1 if it's necessary. 2 MR. DUGAN: I think it is a good idea to tap 3 into areas where particular agencies may have some 4 comparative expertise or things to contribute in other 5 areas, and so not just this area, but when we did the senior 6 supervisors group in the wake of the -- in the heart of the 7 crisis and looking at lessons, it's the same kind of ideas. 8 There are things where agencies can go outside their normal 9 zone to help out in other areas. 10 I'm all in favor of that, you raise a good point. 11 VICE CHAIRMAN THOMAS: 12 course, is it's almost always after the fact. 13 MR. DUGAN: 14 CHAIRMAN ANGELIDES: And the downside, of Unfortunately, yes. Before we move on, 15 Mr. Thompson, I believe Mr. Holtz-Eakin. 16 MR. HOLTZ-EAKIN: 17 CHAIRMAN ANGELIDES: 18 19 Briefly. I'm going to grant you two minutes. EXAMINATION BY COMMISSIONER HOLTZ-EAKIN 20 COMMISSIONER HOLTZ-EAKIN: 21 wanted to ask you essentially the same questions. 22 the, I guess, the good luck to serve prior to the housing 23 bubble and -- and financial crisis. 24 25 Briefly, Mr. Hawke, I You had Are you surprised by what you hear about the state of risk management, risk exposures, that we learned 216 1 2 about at Fannie Mae and Freddie Mac? MR. HAWKE: Well, I have to say, yes. The -- I 3 never had an occasion to look at the risk management systems 4 at Fannie Mae and Freddie Mac before. 5 COMMISSIONER HOLTZ-EAKIN: So do you think you 6 would have benefitted from the ability to examine the 7 underlying economic riskiness of these entities before 8 allowing your banks to hold large amounts of their preferred 9 stock and securities? 10 MR. HAWKE: Oh, I think undoubtedly had -- had 11 we had more information about Fannie and Freddie, it would 12 have helped in our assessment of investments that our banks 13 had and their obligations. 14 COMMISSIONER HOLTZ-EAKIN: 15 CHAIRMAN ANGELIDES: 16 COMMISSIONER THOMPSON: 17 EXAMINATION BY COMMISSIONER THOMPSON 18 COMMISSIONER THOMPSON: 19 20 Thank you. Mr. Thompson? Thank you, Mr. Chairman. If I might, I would like to shift the focus of the discussion, just a bit. If we were to go back to the very first round of 21 hearings that we had, Commissioners Bair and Schapiro 22 commented about the effectiveness of their agencies and 23 their execution of their role, and when asked while 24 regulations or more regulations would be helpful, would 25 existing regulations, if well-executed, would they have 217 1 blocked or stopped this activity or effect? 2 it was, in fact, a supervisory failure. 3 MR. DUGAN: 4 COMMISSIONER THOMPSON: 5 Pardon? The answer was, So my question -- Sorry? It was a supervisory failure. 6 MR. DUGAN: Okay. 7 COMMISSIONER THOMPSON: So my question of you 8 is, were there things that OCC could have done in this 9 process that might have forestalled or at least identified 10 some of the risk? 11 some shortcomings in OCC's execution? 12 And do you feel that, perhaps, there were MR. DUGAN: So I would say, there were some 13 things we did and saw in a timely way and other things less 14 so. 15 So when I first came to the agency, our 16 examiners were getting very uncomfortable with what was then 17 called exotic mortgages, payment option mortgages and the 18 like, and not only the offering of them, but the layering of 19 the risks over that with stated income and some other 20 things. 21 And so we became very active in that area, 22 early. We got out with speeches and then, ultimately, with 23 guidance. 24 horizontal way to our banks, and we basically did not have a 25 payment option mortgage, exotic mortgage problem in our We applied that guidance quite strongly in a 218 1 system. 2 I regret that we didn't act sooner on stated 3 income mortgages, more generally. 4 stronger speech in the context of subprime mortgages. 5 that, the stated income there, the low-doc mortgage area was 6 a place where we just lost our way, not just the OCC, but 7 all the regulators did. 8 9 And a year later I gave a But And it's something that not only was wrong, in and of itself, but it was an invitation to fraud in the 10 actual doing of the business, because it invited people to 11 lie about their income, which many people did, and it was an 12 unhealthy thing that we should have acted sooner and 13 stronger. 14 And it goes back to the point I made earlier 15 about we needed to be more muscular about imposing 16 underwriting standards. 17 I think the other piece of that, though, is what 18 I said before. There was a constraint on doing that, and 19 there was a constraint even when we did it with the 20 nontraditional mortgages that you had to get the consensus 21 of all the other regulators, that took time, and you couldn’t 22 get this huge chunk of the mortgage system that was operating 23 outside of federal purview. 24 say, we wouldn't mind doing this if you apply this across 25 the board, but if you don't and you apply it individually, And industry participants would 219 1 you'll take us out of this business. 2 And that is an inappropriate -- now we went 3 ahead with that, but it's a powerful argument at times for 4 businesses. 5 having -- going back to common sense underwriting standards 6 but doing it in a way where you can apply it across the 7 board is so important. 8 9 10 And so that's why I feel so strongly that COMMISSIONER THOMPSON: Well, you comment on your agency's ability to keep pace with the innovation. MR. DUGAN: I think that's always something that 11 we struggle with, to try to maintain the expertise, we work 12 very hard at this. 13 people, but continually trying to renew it with external 14 training and hiring industry hires who have expertise in 15 particular areas. 16 We do it by how we train our existing I think in many parts of what we did during the 17 crisis, actually, in some of the most complex areas, that 18 supervision proved very effective. 19 that we were in a better spot with the super senior things, 20 of ABS CDOs, but honestly, not only did we not see it, but 21 nobody in the industry saw it. 22 those who had a lot of losses and those who didn't are the 23 ones who piled into that in huge ways. 24 25 And, you know, I wish The only difference between COMMISSIONER THOMPSON: How stable are the exam teams themselves that are a part of the review process, the 220 1 attrition rates, skill levels, experience? 2 on that? 3 MR. DUGAN: Yes, I can. Can you comment We spend an awful lot 4 of time on this as well. 5 although we always worry about the demographic of an aging 6 examiner force, as so many companies have. 7 very significant hiring process, which actually began in 8 former Comptroller Hawke's tenure that I continued in ours 9 to really make sure we were getting a pipeline of people. 10 We have excellent stability rates, We embarked on a We were worried that a whole generation of 11 seasoned examiners that had been through the `80s would 12 retire and we wouldn't be able to replace that expertise. 13 But we found a way to do that by having this crisis. 14 we're training all our young examiners. 15 able to get this -- 16 COMMISSIONER THOMPSON: 17 MR. DUGAN: 18 So now And so we're now Whoops. -- knowledge transferred, not exactly the way we would have done. 19 So the OCC has the very high esprit de coeur. 20 It is partly because of very focused mission, all we do is 21 supervision. 22 places to work in the federal government and even in the 23 United States, we rank high and we prize that. 24 at it. 25 And if you look actually at surveys of best COMMISSIONER THOMPSON: We work hard Some say that the 221 1 back-and-forth between the public and the private sector for 2 some of the people who are in oversight or supervisory roles 3 creates an inherent conflict. 4 that? Do you agree or disagree with 5 MR. DUGAN: 6 COMMISSIONER THOMPSON: 7 Given that you're from -- 8 9 I disagree. MR. DUGAN: was a lawyer. Well, I am, but I am one person. I was in private practice. And I think it's 10 good to bring some expertise coming in. 11 from the private sector as well, from time to time. 12 I We do hire people Although I will say, the core of our examiners 13 is made up of people who come out of college and worked 14 their way up through the ranks, get commissioned as a 15 national bank examiners and then find their way. 16 don't think that is an issue, at least in our supervision. 17 MR. HAWKE: I honestly Can I -- yeah, I'd like to -- since 18 I've been in and out of the government several times in my 19 almost 50 years in Washington, I have a very strong view on 20 that. 21 the private sector and the public sector to have mobility in 22 and out of -- out of government. 23 I think -- I think -- I think it is enriching both to The -- the notion that people come out of 24 government and immediately start trading on their experience 25 and go back and exercise significant influence over their 222 1 colleagues is just wrong, in my experience. 2 you go back to your old agency after the period of 3 quarantine is over, you're likely to be under a heavier 4 burden than somebody who hasn't been there in the past. 5 If anything, if But in any -- in any event, I think that people 6 who have been in the agencies, understand the agency's 7 concerns and problems, and can transmit that to the private 8 sector, and people who come into the government from the 9 private sector can bring perspectives and experience that 10 11 12 13 are very valuable. So I think arguments about the revolving door are frequently, generally misplaced. COMMISSIONER THOMPSON: Okay, good. It's 14 encouraging to hear that OCC would be considered one of the 15 best places to work in government. 16 don't have challenges attracting talent? 17 MR. DUGAN: No. Does that mean that you I mean, I will say that I have 18 been very impressed with the talent that we've been able to 19 recruit from colleges across the country. 20 worry when we get into the areas that you were talking about 21 earlier, the more complex areas, can we find people, but I 22 think we have been able to attract the talent. 23 And I always And honestly, when you get into a recession and 24 people don't have jobs, you've got another pool of talent of 25 people that are willing to come on and take the job. 223 1 And there are benefits. And I don't mean that 2 just in the monetary sense, benefits of being -- of working 3 for the government that aren't the same as being in the 4 private sector that people value. 5 6 COMMISSIONER THOMPSON: very much. 7 Thank you I yield the balance of my time. CHAIRMAN ANGELIDES: 8 We need a break? 9 five-minute break. Ms. Born? Thank you, Mr. Thompson. Mr. Thomas is asking for a 10 VICE CHAIRMAN THOMAS: 11 CHAIRMAN ANGELIDES: 12 All right. Yes. Oh, just five -- for the gentlemen. 13 VICE CHAIRMAN THOMAS: 14 CHAIRMAN ANGELIDES: You don't have to direct. Okay, for Mr. Thomas, 15 Mr. Thomas needs a break. Five minutes we'll come back with 16 Ms. Born. 17 commissioners have follow-up questions, we can -- let's make 18 it five minutes, no more than. I'll have some questions. 19 (Recess.) 20 CHAIRMAN ANGELIDES: 21 22 23 24 25 come back to order. And if any of other So run, gentlemen. We will -- the meeting will Ms. Born. COMMISSIONER BORN: Thank you very much. EXAMINATION BY COMMISSIONER BORN COMMISSIONER BORN: And thank you both for appearing before us and helping us with these difficult 224 1 2 issues. Mr. Dugan, in your testimony, you point out the 3 different levels of regulations for banks and some shadow 4 banking institutions, and I wanted to ask you about that. 5 In your view, has the growth of 6 lighter-regulated shadow banks in the shadow banking system 7 created competitive pressures on traditional banking 8 institutions? 9 MR. DUGAN: Absolutely. I mean, I think in the 10 mortgage crisis, it was a particular example of this. When 11 you had the dramatic increase in mortgages that could be 12 securitized and never touch a regulated institution, you had 13 a big growth in that part of the market. 14 And the standards that were going on in that 15 kind of market began to influence the standards that our 16 regulated lenders were doing. 17 might add, even in things like the leveraged lending market, 18 where we were seeing a disconnect between the standards that 19 banks would -- we would hold to if they were holding the 20 loans on their books and the ones that they were selling for 21 distribution to third parties. 22 And that was also true, I And that is precisely why, when I came back to 23 the notion about underwriting standards, it's critical that 24 you can't just apply them to the regulated side. 25 do it across the board. You got to 225 1 COMMISSIONER BORN: Are there -- it also raises 2 a question, I think, of whether or not this has put a 3 pressure on the banking regulators to permit the banking 4 institutions they supervise to engage in a greater range of 5 activities. 6 And we've been told through testimony that, in 7 fact, the semi-repeal of Glass-Steagall by the Gramm-Leach-Bliley 8 Act didn't really change that much because there have been a 9 lot of -- of big range of activities that banking 10 institutions were permitted to engage in. 11 this competition from the unregulated or under-regulated 12 shadow banking system had had some -- played some role in 13 that kind of erosion of the separation between investment 14 banks and banks. 15 MR. DUGAN: And I wondered if I don't think so much. I mean, I 16 think, over the years, well, let me put it this way. 17 think that over the years, as markets changed and the kinds 18 of ways that institutions provided credit intermediation 19 services changed and moved more towards standardization, in 20 many ways, began to mean that financial intermediation could 21 be done by investment banks that have -- with clients that 22 previously could only be done by commercial banks. 23 I So the pigeonholed roles began to change as a 24 market mechanism, as you suggest. And then in order for 25 banks, banking organizations, to compete in credit delivery 226 1 services, they did need to have that greater ability to be 2 in the securities business. 3 And I think that was a market pressure, it was a 4 real market pressure, and that over time caused legal 5 interpretations and changes to standards and piecemeal 6 adoption by Congress, and finally, it was really more of a 7 ratification, as Mr. Hawke said: 8 full -- full ability to affiliate between commercial banks 9 and investment banks was adopted. 10 The full separate -- So I think it was in response to changes in the marketplace. 11 COMMISSIONER BORN: Well we, as a Commission, 12 will be looking more deeply into the role of the shadow 13 banking system and the impact it's had on banking regulation 14 and also the role it's played, if any, in the financial 15 crisis. 16 more interaction with OCC on that -- And I hope that we'll be able to, you know, have 17 MR. DUGAN: Sure. 18 COMMISSIONER BORN: 19 It's occurred to me that, for example, the -- as we go forward. 20 growth of money market funds must have impacted 21 significantly on commercial banks' deposits. 22 MR. DUGAN: Absolutely. Yes. That -- no, that, 23 you're absolutely right. There are a number of places that 24 things have come up that have put pressure on the regulated 25 sector that there has been response over the years. 227 1 I think one of the interesting things, I 2 wouldn't call them shadow banks, but investment banks were 3 certainly regulated quite differently at a consolidated 4 level than commercial banking organizations were, and I 5 think that did prove to be a problem in the crisis that 6 led -- they were much more highly levered, the problems 7 really started outside in that part of the sphere, and they 8 had more problems dealing with confidence issues. 9 And the result of the crisis is, of course, the 10 investment -- independent investment banking industry ended, 11 and they either were failed, taken over, or became bank 12 holding companies. 13 tenet and subject to a more level part of regulation. 14 But the differences were more of an issue 15 And so they're now more inside that same leading up to the crisis than they are now. 16 COMMISSIONER BORN: 17 indicated that there's still some siloing? 18 MR. DUGAN: 19 COMMISSIONER BORN: Except I think you have Yes. With the broker-dealers and, 20 I assume, the FCMs, as well, being primarily supervised and 21 regulated by the SEC and the -- 22 MR. DUGAN: Yeah. And I think that still is an 23 issue, but more I just meant at the holding company as 24 opposed to the functional level. 25 COMMISSIONER BORN: Do you think there should be 228 1 a move toward more consolidated standards for regulating the 2 entire structure of the financial institution? 3 MR. DUGAN: I think you need consolidated 4 supervision of any systemically significant financial 5 institution. 6 learned from the crisis, certainly at the heart of the 7 administration's proposal, which I support. 8 I think that's at the heart of the lessons we COMMISSIONER BORN: Let me ask in another area, 9 we have heard a lot about the issue of regulatory arbitrage 10 between banking supervisors, the OCC, the OTS, the Fed, the 11 state banking regulators, since, as I understand it, banks 12 have the ability to change their charters, and also OCC, 13 among others, depends on the banking, the fees paid by your 14 banks in order to fund your operations. 15 whether there's any validity to this concern. 16 And I wondered And I wanted to ask you whether, in your 17 experience, such regulatory arbitrage actually occurs? 18 example, have you felt pressure to change standards or to 19 permit activities, because another banking supervisor is 20 doing that? 21 MR. DUGAN: The answer's no. For I have not felt 22 such pressure. 23 circumstances where institutions have flipped charters, 24 changed charters in ways that I don't think are appropriate. 25 I do think that on occasion, there have been I think it's one of the reasons, and this was 229 1 something I strongly supported, that the banking regulators 2 got together and adopted a document that said you couldn't 3 avoid a supervisory action by switching regulators. 4 We had something like that. Frankly, there were 5 a number of them where they left the national banking system 6 to go to the state banking system far more than coming the 7 other way. 8 9 But in terms of that being a systemic problem, it certainly was not and it has not been. And I have not 10 felt any pressure at all to change as a result of that kind 11 of pressure. 12 COMMISSIONER BORN: 13 to address that issue further? 14 MR. DUGAN: 15 COMMISSIONER BORN: 16 17 Do you think there's a need Well, I think -Beyond, you know, your suggestion of cooperation? MR. DUGAN: Well, I testified on regulatory 18 consolidation before, you know, it's -- it's fond of 19 quoting, actually, Jerry Hoffman, the subject where it says 20 it's something that no one would design in theory, but it 21 works okay in practice. 22 I don't think it was the root cause of a bunch 23 of problems, but on the other hand, could we use some 24 regulatory consolidation; would it be a better system? 25 I think the answer is yes. 230 1 But I don't think it's critical that you go to 2 one regulator to address that issue, either as a matter of 3 supervisor efficiency or to avoid the kinds of inappropriate 4 charter arbitrage that you're talking about. 5 talk about doing that -- not some talk, there are proposals 6 to do some regulatory consolidations that are in both; the 7 House-passed bill and the Senate Banking Committee 8 passed version, and I think making progress in that area 9 is appropriate. 10 MR. HAWKE: There is some Can I just add one point on the 11 question of regulatory arbitrage? 12 Comptroller says, banks convert back and forth all the time. 13 The -- I always gave the mandate to our examiners that they 14 should -- they should be as vigorous as they needed to be to 15 make sure that their banks were operating in a safe and 16 sound manner without regard to the possibility that the bank 17 might decide to convert to another charter. 18 And the -- the -- as the The OCC has adequate resources to fund its 19 operations without having to worry about -- about individual 20 banks. 21 dynamic is that the state-chartered banks have a very 22 significant subsidy from the FDIC and the Federal Reserve 23 with respect to their examination costs, because all of the 24 costs of their federal regulation are absorbed by those 25 agencies. And I should say that one of the aspects of this So they pay, on average, about half of what 231 1 national banks pay. 2 So national banks have, and particularly smaller 3 banks have an incentive to move to state charter to take the 4 benefit of that subsidy. 5 COMMISSIONER BORN: 6 CHAIRMAN ANGELIDES: 7 8 9 Thank you very much. Mr. Thomas? EXAMINATION BY VICE CHAIRMAN THOMAS VICE CHAIRMAN THOMAS: We talked about -- we talked about your brief involvement with Fannie Mae and 10 Freddie Mac, and I don't think we scored the circle, but we 11 just got into it with that discussion when Commissioner 12 Wallison was talking to you about any potential pressure or 13 slanting coming from either Democrat or Republican 14 administration since both of you saddled, and your answer 15 clearly was no. 16 I would ask you if there was any of that coming 17 from Congress, except I want to put this on the record, as 18 far as Fannie Mae and Freddie Mac, Congress would have no 19 worry because their oversight structure is funded through 20 the appropriations process. 21 of responsiveness, they have a direct course of action. 22 And if they don't feel a degree You clearly do not, as you indicate, Mr. Hawke, 23 because you get it from the funds of those that you oversee. 24 As a structure, as a degree of independence in terms of 25 decision making or esprit de coeur and the rest, I mean it's 232 1 got to be, to a certain extent, isn't it, from the way in 2 which you're funded versus OFHEO and Fannie Mae and Freddie 3 Mac living or dying based upon Congress's willingness to 4 offer appropriated funds. 5 that temporary oversight work with Fannie and Freddie, or do 6 you have any comment on that? 7 to them tomorrow and I would like a little preview if you 8 have any. 9 10 11 MR. DUGAN: Did you feel that when you had Because we're going to talk Really, I don't have any. I didn't have any experience with that aspect of it. VICE CHAIRMAN THOMAS: Well, just let me ask 12 you, if you had your druthers, would you rather have it come 13 out of appropriated funds? 14 15 16 17 18 MR. DUGAN: This is what my son refers to as an IQ test, and I'm hoping I'm going to pass. VICE CHAIRMAN THOMAS: Yes, we -- Actually, it's called a pain test rather than IQ. MR. DUGAN: Well, there's a long history of 19 this, actually, and the regulators were once partly 20 appropriated, some were and some weren't, and the Federal 21 Reserve never was. 22 piece of our ability to have and hire -- have the necessary 23 resources and hire the people we need and to have the budget 24 flexibility to maintain our independence with respect to 25 this very highly regulated industry. And it was historically a very important 233 1 And even in those days, it was a -- it has 2 always been the case, it's true of state bank regulators, 3 has been forever funded with the fees, sometimes still went 4 through the appropriations process. 5 But I believe it is a very important part of our 6 independence to not only be funded through those fees, but 7 not go through the congressional appropriations committee. 8 9 VICE CHAIRMAN THOMAS: And then you're only down to the criticism or accusation that Mr. Hawke addressed on 10 the revolving door, that you're the lackeys of the ones who 11 pay your fees, and I would probably rather fight that 12 argument than deal with the appropriations process. 13 14 MR. DUGAN: I think that's right. And if you look at the record -- 15 VICE CHAIRMAN THOMAS: 16 MR. DUGAN: Exactly. -- it's just not that many people 17 who actually -- I mean, there are some, and we have ethics 18 rules we are careful about, and that's all you need to do 19 it. 20 21 22 VICE CHAIRMAN THOMAS: need to do. Arm's-length is all you Thank you, Mr. Chairman. CHAIRMAN ANGELIDES: Great. So I have a few 23 questions about your oversight of Citi, and then I have a 24 couple of policy questions. 25 The first is, I think, wonders -- 234 1 VICE CHAIRMAN THOMAS: 2 CHAIRMAN ANGELIDES: 3 didn't see, Mr. Wallison. 4 to my right, Mr. Wallison. 5 6 Before you start that -Oh, I didn't see -- yeah, I I'm sorry. I don't always look It's not a natural for me. COMMISSIONER WALLISON: I'm always on your right. 7 CHAIRMAN ANGELIDES: Go ahead, Mr. Wallison. 8 EXAMINATION BY COMMISSIONER WALLISON 9 COMMISSIONER WALLISON: I just really had one. 10 One question for Comptroller. 11 standards are very important in preventing predatory 12 lending. 13 down is the degree to which predatory lending was 14 responsible for the poor quality of the mortgages that were 15 in the market. 16 You note that the federal And one of the things that we are trying to track I know we've made a number of requests to 17 various people who have appeared before us and people who 18 haven't in looking for data on this information on this, on 19 this subject. 20 And so if -- if your office has any, or know 21 where we can find it, we would appreciate seeing any of 22 that. 23 how much predatory lending do you see in the course of your 24 work and the work of your examiners and others? 25 cases have you had where you've had to bring an enforcement But I'd like to ask you directly, Comptroller Dugan, How many 235 1 action or counseled an institution about predatory lending? 2 So we can get some sense of how much of this is really going 3 on. 4 MR. DUGAN: There is a definitional question, of 5 course. 6 But we took, as an agency -- actually, Mr. Hawke can speak 7 to this even better than I, because it was in a bunch of the 8 early guidance and actions that we took were during his 9 tenure as comptroller. 10 There's no single definition of predatory lending. But we made very clear that predatory lending, 11 whether it was in the mortgage space or the credit card 12 space, was not something we would tolerate; things like 13 loans flipping, equity stripping types of mortgages, the 14 really abusive practices were things we cracked down on. 15 had to -- we took some enforcement actions in the area, 16 where it was necessary, but honestly, those practices never 17 really took root in the national banking system. 18 We We had more questionable practices in the 19 subprime credit card space. 20 series of enforcement actions with respect to mono-line 21 subprime credit card lenders to the point where we basically 22 ran them out of the national banking system. 23 And we did have to take a And I do think it's important, however, that 24 there is a distinction between predatory lending and other 25 kinds of subprime lending. And I think, unfortunately, 236 1 sometimes and particularly as a result of the crisis, people 2 tend to think of all subprime lending as bad and predatory, 3 and that is not the case. 4 You can also have very poorly underwritten 5 subprime loans that are not predatory, and I think that, in 6 fact, was the heart of the losses that we saw, not -- there 7 are consumer protection problems in some of those as well. 8 There's an important distinction. 9 We can get to you, for the record, the number of 10 enforcement actions we took for unfair and deceptive 11 practices and provide the guidance that we've provided. 12 13 COMMISSIONER WALLISON: And also more than simply the -- the number of enforcement actions? 14 MR. DUGAN: Correct. 15 COMMISSIONER WALLISON: But, in fact, rather, 16 the counseling that you've had to done with banks so we can 17 get a sense of how pervasive it is in this large system that 18 you regulate. 19 MR. DUGAN: Absolutely. 20 COMMISSIONER WALLISON: 21 MR. HAWKE: 22 COMMISSIONER WALLISON: 23 MR. HAWKE: Thank you. Could I just add to that? Sure. I believe the commission has a 24 document dated February 21, 2003, which was a statement that 25 we put out on -- on predatory lending and where we tried to 237 1 define it, and we said in that that the OCC did not have 2 reason to believe that national banks or their operating 3 subsidiaries generally engaged in predatory lending 4 practices. 5 And we had requested both from consumer groups 6 and from state law enforcement people that they inform us of 7 any such examples. 8 And we really got nothing. Having said that, predatory lending exists, and 9 we -- we -- I know on tours that I have taken in suburban 10 neighbors of Chicago, for example, we've seen evidence of 11 it, and it comes back to a point that I've made several 12 times about the way loans are underwritten. 13 The essence of predatory lending is making a 14 loan without regard to the borrower's ability to repay, with 15 reliance being placed on the value of the equity in the 16 property, because the predatory lenders have -- are really 17 interested in stripping equity that people have built up in 18 their homes. 19 And that's why there's such a much higher degree 20 of foreclosures with respect to predatory lending, really, 21 true predatory lending, as I've defined it, than other types 22 of lending. 23 And that's the reason why we have emphasized, on 24 so many occasion, the importance of underwriting practices 25 that look at a borrower's ability to, through their regular 238 1 resources to handle the interest and principal payments on 2 loans without regard to the collateral. 3 If that very fundamental principal of loan 4 underwriting is observed it is a cure for a lot of the bad 5 things that we've seen. 6 COMMISSIONER WALLISON: 7 CHAIRMAN ANGELIDES: 8 9 10 Good. Thank you. Mr. Georgiou, do you have a quick question? COMMISSIONER GEORGIOU: Yes, just a quick follow-up on that point. 11 EXAMINATION BY COMMISSIONER GEORGIOU 12 COMMISSIONER GEORGIOU: Mr. Hawke, you testified 13 about your guidance that you issued in 2003 in this regard, 14 regarding predatory lending, that they ought not to 15 originate predatory loans, but the OCC never issued any 16 guidance saying national banks shouldn't make loans to firms 17 to facilitate predatory lending. 18 I mean, I would -- and I guess I would really 19 direct the question, in part, to -- to Mr. Dugan. 20 page 10 of your testimony, you noted that the 33 billion in 21 the short-term loans provided by national banks to subprime 22 lenders in 2006 called warehouse financing was a small part 23 of all the warehouse financing. 24 25 On But isn't there a question about whether you ought to have issued guidance with regard to that 239 1 warehousing; in other words, they may not have originated 2 the predatory loans themselves but they facilitated the 3 origination of the predatory loans by providing warehouse 4 financing to entities that many people regard as having 5 engaged in predatory lending? 6 MR. HAWKE: We did, Commissioner, on -- on that 7 same date that we put out that other guidance; we put out a 8 statement on avoiding predatory and abusive lending 9 practices in brokered and purchase loans. 10 And we did address there the need for banks, the 11 national banks, to use diligence when they make or purchase 12 loans that are originated through the mortgage brokers or 13 other intermediaries. 14 COMMISSIONER GEORGIOU: But make or purchase 15 loans, but what if they didn't, what if they just 16 facilitated, they didn't make them themselves or even 17 purchase them, but they permitted them to be made by 18 providing extensive warehouse financing? 19 MR. DUGAN: And I think on that point, this is a 20 difficult area, I will acknowledge this, because you don't 21 control the lending of a lender that you lend to, and you 22 don't examine them for their banking practices. 23 And some people are legitimate subprime lenders 24 and others are not. And it's hard to issue something that 25 says that banks can't make loans to other businesses unless 240 1 they all abide by the same practices that are required by 2 the banking laws. 3 as going quite that far but -- 4 We never viewed the scope of our things COMMISSIONER GEORGIOU: Understood. Okay. 5 Well, thank you, and if you want to -- if there's anything 6 you want to supplement to us on that -- 7 MR. DUGAN: I would say that, as I noted, my 8 testimony was still quite small percentage of the overall 9 industry that were funded by national bank warehouse loans. 10 CHAIRMAN ANGELIDES: All right. Let me see if I 11 can run through these, quickly, with your help. 12 EXAMINATION BY CHAIRMAN ANGELIDES 13 CHAIRMAN ANGELIDES: Based on your experience, 14 big picture, Citigroup too -- an institution like Citigroup, 15 too big to regulate? 16 MR. DUGAN: No, I don't think that. I think 17 that the issue is not so much size, as whether the 18 complexity is, and what they're doing prevents risk 19 management challenges, and I don't think they're too big to 20 regulate. 21 CHAIRMAN ANGELIDES: 22 MR. HAWKE: Any sense? I -- I -- I agree, we had 45 full 23 time on-site examiners at Citi, and the Fed had another 24 dozen or so, and I -- I think that they -- they were 25 involved in virtually every aspect of the bank's business. 241 1 CHAIRMAN ANGELIDES: What about the issue of 2 essentially leakage of their business lines to non-bank 3 entities? 4 Were there very substantial losses? MR. DUGAN: Well, is it something that can be 5 addressed, is that what you're saying? 6 issues that obviously got identified in the crisis. 7 to address them. 8 coordination with the other regulators and with the 9 consolidated regulators. 10 I think we had some We need We can address them through better CHAIRMAN ANGELIDES: All right. Second question 11 is, internal risk management, is it a second line of defense 12 or first line of defense? 13 interesting -- it caught my eye because of the wording. 14 There's an OCC staff memo to the file, September 27, 2004, 15 one of the employees, a guy named Bruce Johnson, who wrote, 16 who was on the Citi. 17 the chief examiner. And there's actually an I don't know if he was the examiner, 18 MR. DUGAN: No, not the examiner. 19 CHAIRMAN ANGELIDES: Yeah, he did a memo. It 20 was called -- and one of his concerns was called relativity 21 and the boiling frog theory. 22 I explained that I was concerned that management 23 committees, such as CMAC, which is what we referred to 24 earlier in the day, the committee within Citigroup that 25 approved new products, which are too closely types of 242 1 products may become too conditioned, not perceived subtle 2 changes over a longer period of time, much like what had 3 happened in real estate in the 1980s. 4 I explained that occasionally, seeing the most 5 extreme deals to David Bushnell, who was here chief risk 6 officer, and Randy Farmer, who was a good practice, and help 7 them occasionally dip their fingers in the pot to ensure the 8 water was not getting too hot. 9 what's your subsequent internal risk management at Citi? 10 MR. DUGAN: I guess I would ask you, Well, as I said earlier, it was 11 something where I believed and we believed before the crisis 12 that they were smart, that they generally understood the 13 risks they had, that where we did identify problems, they 14 did respond to those problems. 15 identify some significant problems. 16 And sometimes we did But it wasn't until the crisis and we saw more 17 pressure put on the system, that it revealed other problems 18 that were more significant as we saw them, in particular the 19 closeness between the risk management and the lines of 20 business. 21 22 23 CHAIRMAN ANGELIDES: And the lines of business, yes. VICE CHAIRMAN THOMAS: On that point, and this 24 may be an unfair characterization, were they better at 25 selling risk management than performing it? 243 1 2 MR. DUGAN: I can't speak to that, and as I said -- 3 VICE CHAIRMAN THOMAS: Well, it was your 4 impression that they were doing a good job, and it was based 5 on your independent examination? 6 MR. DUGAN: Yes, at the time -- at the time and 7 that they would respond to things that we were bringing to 8 their attention. 9 number of things that happened to them that they had to They had a bunch of issues. They had a 10 respond to problems. They were under documents in ways that 11 other institutions weren't. 12 those with them more so than with other institutions. We had to keep working through 13 VICE CHAIRMAN THOMAS: 14 CHAIRMAN ANGELIDES: Thank you. Yes. Mr. Chairman? So, actually, apropos 15 of that, the OCC had actually issued some warnings to Citi 16 with respect to complex products. 17 run-up, you know, you had noted, I think, in January of `05, 18 that inner earnings and profitability growth were taking 19 precedence over risk management and internal controls. 20 And in the course of the You had warned that -- I think you had been 21 concerned about the bank's ability to perform future 22 business. 23 onto this, I would ask you, do you think you did -- you 24 identified some problems, I noticed earlier on, about 25 internal controls and their growth. I think I would ask you, and let me actually tail On reflection, and this 244 1 builds on something I think Ms. Murren and I were talking 2 about, I don't know if it was in public session or a 3 conversation we had, about whether your examinations really 4 were like audits, where there was acidulous follow-up, to 5 make sure all those things were identified, that you stayed 6 on them to make sure that they're correct, do you think -- 7 it looks as though you spotted some problems; maybe you 8 didn't quite understand the depth of what they might become, 9 but do you feel you did an adequate job of following up or 10 do you, on reflection, feel like there should have been more 11 deliberate and consistent follow-up on some of your findings 12 in `05? 13 MR. DUGAN: No. I believe we followed up quite 14 rigorously on that, we have a quite good system for that 15 where we identify problems, particularly when we identify 16 them in a way that would generate a supervisory letter; we 17 go back to test to make sure that they've complied with 18 that, and so I think what I would say is where the places 19 where we identified and pushed them, they responded. 20 made sure they responded. And we We followed up on that. 21 They, over the years, had more of those than 22 other companies did, and we needed to -- to do that more 23 than we should have and, as I said during the crisis, some 24 things happened that weren't revealed and that -- that 25 particular examination, that gave us pause in other areas. 245 1 CHAIRMAN ANGELIDES: I guess in 2009 there was 2 an inspector general report about two failed institutions 3 OCALA National Bank and first National Bank, in Nevada, 4 where the inspector general, you know, it's always easy to 5 look back, said that, I guess, the problems were spotted 6 early on, and there wasn't formal enforcement action. 7 Now, there hasn't been an IG report with 8 Citigroup, but you're convinced that you did everything you 9 could to make sure these things, these problems didn't 10 metastasize, that you acted early enough? 11 MR. DUGAN: You know, I never say that, given 12 all that's happened, that we shouldn't have done more, 13 sooner, with the benefit of hindsight. 14 definitely, that we perhaps should have leaned harder on 15 them, better reporting around the whole area of contingent 16 problems to the banking institution. 17 There are things, I mean, I'm certainly not going to say we were 18 perfect. 19 report, there, is different, it's a smaller institution, 20 it's a different kind of thought. 21 separately and you have to take these on their own cases. 22 I think the kind of thing you pointed out in your And we address that And I will say that this institution, as I 23 mentioned earlier, because it came, was put together over a 24 period of time in a quite idiosyncratic way. 25 CHAIRMAN ANGELIDES: Meaning Citigroup? 246 1 MR. DUGAN: 2 CHAIRMAN ANGELIDES: 3 Yes, Citigroup. There was a set of acquisitions? 4 MR. DUGAN: Yes, it was a very large investment 5 bank with a very powerful impact on the culture where that 6 was not a traditional commercial banking culture, then that 7 was something that we continually had to deal with, that was 8 different. 9 CHAIRMAN ANGELIDES: Well, that leads to my next 10 question, but I think you answered it, which is, was the 11 investment bank culture beginning to predominate the state 12 banking. 13 MR. DUGAN: 14 CHAIRMAN ANGELIDES: 15 MR. DUGAN: 16 CHAIRMAN ANGELIDES: 17 I would say the answer is yes. I would say the answer is yes. Okay. MR. DUGAN: 19 CHAIRMAN ANGELIDES: Yes. Leakage, arbitrage, how big an issue? 21 MR. DUGAN: 22 CHAIRMAN ANGELIDES: Between? For example, Countrywide, 23 didn't Countrywide go from OCC to OTS? 24 path? 25 Couple more questions, the OTS? 18 20 Hmm? MR. DUGAN: Isn't that their You would have to ask -- I -- it was 247 1 in the wake of our nontraditional mortgage guidance that we 2 were spearheading that they -- it was not long after that or 3 in the context of that that they flipped their charter. 4 The institution said that they were changing 5 their thoughts and didn't want to be a diversified 6 institution, wanted to concentrate on mortgages, and the OTS 7 was who had more expertise. 8 9 10 CHAIRMAN ANGELIDES: I know you have colleagues but do you think it's a significant issue, charter flipping, potential risk, real and potential? 11 MR. DUGAN: Well, number one, I think most of 12 the regulatory proposals now have OTS being pulled together 13 in that kind of thought. 14 significant issue, the thing that we took about people 15 leaving because of regulatory actions also helped address 16 that, so I don't think it's as significant a risk. 17 Number two, I think the CHAIRMAN ANGELIDES: Okay. I took it from your 18 earlier remarks, but I just want to be clear, you thought 19 there should have been national standards on subprime high 20 cost -- 21 MR. DUGAN: Yes. 22 CHAIRMAN ANGELIDES: -- risky loans? So I take 23 it that you believe the Fed, Federal Reserve, should have 24 adopted much more comprehensive rules under HOEPA? 25 MR. DUGAN: I think if they would have done 248 1 that, it would have made a difference. 2 CHAIRMAN ANGELIDES: 3 MR. HAWKE: 4 CHAIRMAN ANGELIDES: 5 Mr. Hawke, do you agree. Yes. Thank you. Final, I think, set of questions, trying to go quickly, members, here. 6 I want to talk about preemption, because I -- we 7 really haven't touched this today. 8 because I do think it's worth touching. 9 And I want to touch it In our first hearing, Attorney General Lisa 10 Madigan of Illinois was in the door here testifying before 11 us, and I think you know it's no secret that states all over 12 the country did not agree with your decision to preempt. 13 MR. DUGAN: That I'm well aware of. 14 CHAIRMAN ANGELIDES: And I was a state official 15 in California and, while I was not directly involved in 16 those, I followed very closely the legislative efforts in 17 California. 18 Now, you state that national banks and their 19 subsidiaries, which are both regulated by the OCC, made only 20 10 percent of all subprime loans made in 2006 was subprime 21 loans being defined as loans with FICO scores 620 or below, 22 people can cut that out of different places, so depending on 23 where you cut it, it can be somewhat higher. 24 25 MR. DUGAN: I want to be clear on this. When we had the interview, we talked about this, and we went back 249 1 and I wanted to make sure we were clear exactly how we got 2 to the number before, how we got to it now; that's not the 3 definition. 4 definition. We could use that definition but that's not the 5 CHAIRMAN ANGELIDES: 6 MR. DUGAN: 7 CHAIRMAN ANGELIDES: 8 It is not? It is not the definition. Thank you very much, we'll -- is there a short definition? 9 MR. DUGAN: Yes, it's what the -- in our -- in 10 the database is the loan, the premier database, that it's 11 called loan production corporation, I believe, or loan 12 production something, it's for -- 13 14 CHAIRMAN ANGELIDES: data? 15 16 Is it loan performance MR. DUGAN: Loan performance data, okay. Thank you. 17 A combination of that with our supervisory 18 mortgage metrics that we collect information on and it's all 19 spelled out exactly, but it's basically it's what lenders 20 identify. 21 CHAIRMAN ANGELIDES: 22 MR. DUGAN: 23 CHAIRMAN ANGELIDES: 24 MR. DUGAN: 25 CHAIRMAN ANGELIDES: Self-identification? As prime and subprime. Self-identification? Yes. All right. We'll look at 250 1 the data. 2 the big picture, here's what some would argue, and I want to 3 put it on the table that you tied the hands of the states 4 and then you sat on your hands. 5 But -- but I just want to point out, I mean, in So Lisa Madigan told us or attorney or General 6 Madigan, I guess is the term to use, first of all, there is 7 this real issue of warehouse lending, and it's not directly 8 related to preemption, but national banks were facilitators. 9 They extended warehouse lines to 21 of the big 25 biggest 10 11 subprime lenders. But in terms of at least the data that was 12 provided by Ms. Madigan, which was from the national 13 consumer law center, that when you add up national banks and 14 thrifts, because I think you really have to look at 15 preemption, not just in terms of national banks, but 16 national thrifts, and there's operating subsidiaries, their 17 data shows that I believe in 2006, 31 percent of the 18 subprime, 40.1 percent of the Alt-A, 51 percent of the pay 19 option and ARMs and interest-only adjustable rate loans were 20 made by national banks and thrifts and their subsidiaries, 21 so not inconsequential. 22 Critics also point out that you only brought 13 23 consumer-related enforcement actions from 2000 to 2006, and 24 only one of those involved subprime mortgage lending. 25 Two of the largest subprime lenders weren’t 251 1 national banks, Countrywide, until they shifted over, and 2 National City, which did its work through First Franklin. 3 So I want to put that on the table. 4 MR. DUGAN: 5 CHAIRMAN ANGELIDES: 6 So -- of you, actually, much of this happened under Mr. Hawke. 7 MR. DUGAN: 8 CHAIRMAN ANGELIDES: 9 MR. DUGAN: 10 And I'd like perhaps both So let me go first and then -Okay. So in terms of those numbers -- CHAIRMAN ANGELIDES: I'm looking at you and 11 Mr. Hawke, because I want you both to address it, because I 12 think it's a very significant issue, and I would add this; 13 let me just say this. 14 tell me why you think that the public interests -- because I 15 know it develops, why it was better served, even if it was 16 10 percent, 20 percent, or 30 percent, was the public 17 interest best served by handcuffing state actions which 18 would have been supplemental to any enforcement actions to 19 the federal government. 20 In the end, I would also like you to VICE CHAIRMAN THOMAS: Mr. Chairman, could we 21 get a brief overview of the point that you're making? 22 would very much like to have you take a little time and put 23 it in writing. 24 MR. DUGAN: Yes. 25 VICE CHAIRMAN THOMAS: So we have a But I 252 1 better understanding -- 2 MR. DUGAN: 3 VICE CHAIRMAN THOMAS: 4 MR. DUGAN: CHAIRMAN ANGELIDES: MR. DUGAN: 10 Okay. CHAIRMAN ANGELIDES: 11 you trigger five more. 12 MR. DUGAN: And it's in my testimony and it's in an appendix. VICE CHAIRMAN THOMAS: 15 CHAIRMAN ANGELIDES: Ahh, okay. But I would like you to address it here for public record and public watch. 17 18 Unless you really, unless We actually did put it in writing. 14 16 And that is my last question. 9 13 I would be happy to do it, as a matter of fact -- 7 8 -- of it as we go forward? 5 6 Sure. MR. DUGAN: To the extent I need to supplement it, I certainly will. 19 CHAIRMAN ANGELIDES: And, again, I believe this 20 was done in your -- when you were comptroller; right, 21 Mr. Hawke? 22 MR. HAWKE: 23 CHAIRMAN ANGELIDES: 24 25 responsibility? It has been by all -It is mutual Okay, good. MR. DUGAN: So, on the numbers, there are 253 1 different numbers that have come out, and we wanted to 2 address these because we believed that the numbers that we 3 cited are the best, most accurate, most rigorous, and so the 4 appendix that we attached to the testimony explains in great 5 detail exactly how we got our numbers and why they're 6 different from other numbers, including the numbers you 7 cited in the testimony. 8 happy to respond further if you have further questions. 9 10 So it's in there and we would be Let's see, the second question was? CHAIRMAN ANGELIDES: One is about the numbers, 11 but I think the second and biggest question is, was this in 12 the public interest and why? 13 MR. DUGAN: Okay. 14 CHAIRMAN ANGELIDES: And again, going back to 15 whether the number -- again, it didn't include thrifts, but 16 whether it was 10 or 20 or 30 or 40. 17 MR. DUGAN: So, since we have an appendix in 18 here on why we believe that preemption and uniform national 19 standards is a good thing and has been a good thing; it's 20 been in place since the Presidency of Abraham Lincoln; it's 21 how national banks operate in the banking business, and 22 there is a great value in being able to have a common set of 23 standards that apply regardless of the state in which you 24 operate so that you don't have 50 different sets of rules, 25 50 different sets of disclosures, 50 different types of 254 1 enforcement actions brought on different kinds of standards. 2 We believe that produces more efficient products 3 and services delivered to people. 4 course, you have to have high consumer standards and 5 consumer protection standards, and we understand that. 6 think one of the things that the new legislation puts in 7 place, which I support, which is to have a strong federal 8 agency to write consumer protection rules that apply across 9 the board. 10 And it's important. Of I But the point is to have a set of uniform 11 national standards, that's always been something that's been 12 viewed as a benefit to the delivery of financial services, 13 products and services to consumers, that's point one. 14 Second -- 15 CHAIRMAN ANGELIDES: 16 Can I ask you one question on that point one, though? 17 MR. DUGAN: Yes. 18 CHAIRMAN ANGELIDES: And that is, and maybe you 19 can address this, was the standard high enough effectively? 20 Was it high enough on reflection, and was the standard high 21 enough in terms of the products which were offered? 22 MR. DUGAN: And I would say the answer is yes. 23 In some particular areas, that could have been higher, 24 that -- but, generally speaking, I think the answer is yes. 25 I think there are places where we needed higher standards to 255 1 apply across the board. 2 rules, for example, where we did not have that authority. 3 And let's call it credit card CHAIRMAN ANGELIDES: But even with default rates 4 that are 86 percent of the market average, that's pretty 5 darn high. 6 It's not that differential. MR. DUGAN: Well, what I would say is we're 7 going through the worst housing recession in our country's 8 history. 9 CHAIRMAN ANGELIDES: No, but I'm just being 10 relative. 11 from `05 to `07, the default rate for national banks for 12 non-prime loans between `05 and `07 was 86 percent of the 13 market average, so give me a breakdown. 14 You're saying -- I think what you said was that MR. DUGAN: What I'm saying there is -- I'm not 15 saying that all the underwriting for those loans was good, I 16 think I said that at the outset, I think there are things 17 that we should have had that were stronger, but I think it's 18 also difficult to trace the differences in the rules between 19 the different persons as how much of that has accounted for 20 it, but the other thing I would say is I don't accept the 21 proposition that the states should spend all their time 22 trying to bring enforcement actions under state law against 23 national banks where you have this huge shadow banking 24 system that's not touched by federal regulations, where you 25 have the biggest problem, and the states are not addressing 256 1 that issue adequately. 2 And that's where those resources should be 3 directed, to the shadow banking's system of unregulated 4 people. 5 beat; my answer is, yes, you can, if you don't have an 6 adequate number of cops in total. People say you can't have too many cops on the 7 We've got people who can monitor the national 8 banking system, and we should be held accountable for it, 9 but the parts where we have problems with the states, we 10 haven't handcuffed the states' ability to go after and deal 11 with problems in the state-regulated state institutions that 12 issue mortgages. 13 And I think if there were more attention paid to 14 bringing that level of compliance up to what not just 15 national banks but state banks that are also federally 16 regulated are, we'd have a better across-the-board system. 17 18 19 CHAIRMAN ANGELIDES: All right. Mr. Hawke, do you want to comment on this? MR. HAWKE: I certainly do, Mr. Chairman. First 20 of all, I think it has to be appreciated that preemption is 21 not something we invented or was discretionary with the OCC, 22 it's a constitutional doctrine that has been the law of the 23 land since 1819. 24 25 And it basically states a very simple principle, that the states do not have the constitutional authority to 257 1 regulate or interfere with the activities that Congress has 2 empowered federally created entities to exercise. 3 that -- that has been a doctrine that has carried through 4 our history. That -- 5 And I think, I'm sure I'm right, that with every 6 preemption issue that has come up, in my knowledge, that has 7 been subject to court review, the courts have upheld that 8 principle. 9 Congress can change that, if it sees fit, and it 10 could subject federally created entities to state law, but 11 if it hasn't, then I believe that it's our obligation, 12 having taken an oath to defend the Constitution, to -- to 13 enforce the Constitutional principle of preemption. 14 Second, I -- I think it's very misleading to 15 look at formal enforcement actions as -- as -- as the 16 measure of -- of what an agency's record is in -- in dealing 17 with consumer issues. 18 And we have -- and the Comptroller's testimony 19 lists a number of formal enforcement actions. 20 the extreme. 21 action that -- that -- that reflects a fairly serious 22 conduct. 23 But that's When a matter gets to a formal enforcement An enormous number of problems, consumer 24 complaints, are handled every day in the bank examination 25 process. Every time examiners go into a bank if they 258 1 find a violation of consumer laws, they cite the bank for 2 it, and if the bank doesn't fix it, the regulators come in 3 with an enforcement action. 4 Besides that, the OCC has what I consider a 5 world class ombudsman's operation that fields literally tens 6 of thousands of communications from consumers every year. 7 And the ombudsman feeds that back through 8 examiners into the banks. And if there's merit to the 9 complaints that the consumers have raised, we get fixes. We 10 get fixes without a lot of formal action. 11 in place generally with very little formality or other kinds 12 of controversy. 13 it, then we fight it and it results in a formal enforcement 14 action. 15 The fixes get put If a bank resists and wants to fight about CHAIRMAN ANGELIDES: All right. In the 16 interests of my fellow Commissioner's time, there is one, I 17 think, question that I'll just pose to both of you to be 18 answered in writing. 19 this. 20 And I just want you to reflect on So here's what struck me about this. I 21 understand, and I do not dismiss, and I appreciate the 22 quality of your answers on this issue, and certainly, you 23 know, the importance of the Constitution. 24 So -- but when you see, I think, 26 states 25 actively trying to deal with this, because they saw an 259 1 on-the-ground problem, there's a fascinating article you may 2 or may not have seen from the Columbia Journalism Review 3 about whether or not the press saw the coming financial 4 crisis. 5 The only reason I mention it is there's a piece 6 of the article that talks about how much press coverage 7 there was from 2002, 2003 as states were actively trying to 8 fight deceptive unfair lending across the country, the 9 boiler rooms, the aggressive lending. I guess I would, in a 10 question, probably posed to both of you, given the ground 11 reality that you have state officials all over the country 12 concerned about the level of unfair deceptive lending, I'm 13 going to ask you both to consider what might have been 14 deficient therefore in national -- in national enforcement 15 that would have led them to believe it was such a para- -- a 16 matter of such paramount concern. 17 MR. HAWKE: Well, I should say, Mr. Chairman, 18 that we asked state law enforcement officials on many 19 occasions to refer to us any evidence that they had or any 20 incidences they had of national banks involved in conduct of 21 the sort that you described. 22 And we got zero. And we asked consumer groups for the same thing. 23 We even asked the state attorneys general to enter into a 24 memorandum of understanding with us where we could share 25 information and cross-pollinate on enforcement actions. 260 1 And until very recently, with Comptroller Dugan, 2 they refused, they refused to do that, so we did not have -- 3 we did not have evidence emanating from the states or from 4 consumer groups that national banks were -- 5 CHAIRMAN ANGELIDES: Right. 6 cut you off. 7 definitely do that for the record. 8 9 And I don't want to The full response, in writing, if you could VICE CHAIRMAN THOMAS: All right, Mr. Thomas? We'll definitely want what, when, written in terms of those contacts that you 10 mentioned, Mr. Hawke, because this is a -- everybody was 11 involved after the fact. 12 terms of who, when, and how. 13 14 CHAIRMAN ANGELIDES: Be very helpful. Any other -- 15 16 I would like a real timeline in VICE CHAIRMAN THOMAS: Thank you for your testimony. 17 CHAIRMAN ANGELIDES: Any other Commissioners? 18 Hearing none, we'll adjourn today and we will meet here at 19 9:00 A.M. 20 out of here without fail, tomorrow, at 3:00 because of the 21 travel schedules of several Commissioners. 22 done prior to 3:00 tomorrow, 9:00 A.M. here in this room. 23 Thank you very, very much for your time, your answers to our 24 questions. 25 26 And just to tell the Commissioners, we will be So we will be (FCIC Hearing adjourned at 5:28 P.M.)
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