Citigroup

The [Ron] Suskind book [Confidence Men], the story that is told is what the president really thought he was agreeing to was that there would be some partial breaking apart of Citigroup while the stress tests went ahead, and that basically he was end-run around him and he was slow-walked by Geithner. What do you say of that?

There's no chance we slow-walked the president of the United States. There was nothing slow about what we were doing. There were times where I think all of us wished we could have pushed the pause button, but in terms of slow-walking the president, it just didn't happen. ...

[What was Citigroup doing in the subprime market?]

One rule that Citigroup was playing in the subprime markets was to go out and find subprime bonds and package them and then offload that risk to get rid of the risk associated with these markets. And people really thought that that's what Citigroup was doing. They didn't imagine that Citigroup was then taking those risks back onto its balance sheet.

But one of the incredible things about Citigroup we now know was that although it was tossing these risks off its balance sheet, those risks came right back, almost like a boomerang; that they ended up doing these other transactions, which took precisely the same risks that the first transactions were designed to get rid of. And so without knowing it, they had set up one business to offload risk, and then completely reversed that business in an undisclosed way doing these complicated super senior swaps that then took on precisely the same kinds of risks.

Some people complained that all these progressive economists were all around Obama during the election, but then he brings in the Clinton team, basically, much more conservative in a lot of ways. …

At a very fundamental level, it's not liberal or conservative economics, it's a matter of getting the credit system back up and running. …

I think where you maybe see a breakdown between conservative or centrist, more liberal economists is in this idea of regulating financial markets.

Sure, there are Democrat, supposedly liberal economists who believe that the fragility of the financial sector is such that if there's too much oversight, if we're not kind of ginger in the way we handle these banks that they'll leave the country, they'll tumble. If there's any kind of a tax on financial transactions, they'll all go to Europe, or they'll all disappear.

That's a problem. We need more economists in powerful places who have a more realistic view of, frankly, the durability of that sector, and what terrible things can happen if there isn't enough oversight.

I mean, if you're all thinking these institutions can police themselves, and you haven't been convinced otherwise yet, then you really shouldn't be hanging around halls of power.

Before we move on … this idea that Geithner was taking sort of the idea that perhaps we would nationalize Citigroup and then slow-walking the parts of the policy he didn't agree with. Was the president being slow-walked?

The president was never being slow-walked. Whoever said that just got it wrong. Was the president as exposed to as many good, knock-down, drag-out debates about this stuff as he should have been? With hindsight, maybe not enough. But he was apprised of the options, and nothing was slow-walked.

... One bank is late to the party, Citibank. Tell me what happened there.

... In the late 1990s, the merger between Travelers and what was then Citigroup created this financial behemoth. And basically, there was enormous pressure to make the merger work and to make higher returns for shareholders, because the merger itself had been controversial for a whole bunch of reasons. They even had to get Glass-Steagall basically repealed to make the merger work, so it was a big deal.

They started to expand, ... and as the mortgage market started to spiral into this behemoth and this huge business, Citicorp, as did other banks, wanted a share of it. And basically they, being latecomers, bought into the market by sheer power of their balance sheet and their pricing muscle. They tried to buy shares, and one of their strategies was to take more risk. ...

This took several forms. One is they now very aggressively went and bought mortgages from their own operations but also from other people's operations, and they set up this massive securitization engine to repackage those mortgages and sell them.

But at the same time, what they did was they started investing in these mortgages and/or slices of these mortgages for their own return. ... Basically they were buying up these mortgages and putting them on their balance sheet because of a strange thing that had happened known as Basel II, which was the banking regulations which had existed since about the middle '80s had been tweaked and changed. ... So Citigroup and all these people started to buy up these mortgages in an enormous way.

And Citigroup got caught in the crisis in two ways. One is on all the stuff that they owned and was sitting on their balance sheet, they basically lost an enormous sum of money because of the fall in the value of these securities. But they lost on two other counts. One is they had a pipeline of mortgages which they'd bought up and were hoping to repackage and sell. But when the music stopped and the securitization market stopped, they were stuck with that, and they'd never really assumed they were going to get stuck with that.

And the third was all these off-balance sheet vehicles, what we call the shadow banking system, which Citigroup were very prominent in, they'd set up. Everybody assumed they'd sold the risk, but they hadn't because there were connections back to Citigroup, and these were known as liquidity puts. What that meant is if these vehicles could not raise any more money, then they would be able to sell the mortgages and the entire structure back to Citigroup.

When they blew up, [former Treasury Secretary] Robert Rubin was asked about these, and he said he wasn't aware of the liquidity puts, and the first time he heard about them was after the crisis started, which is curious, because if you look at the Citigroup annual financial statements, they disclosed in the notes to the account. So there was public disclosure about them, but nobody ever thought that these risks would actually become real. ...

One thing that has puzzled me to this day is where were the risk managers? Where were the senior management in these banks? Where was the board of directors? Where were all the regulators who were supposed to oversee this? It was a massive failure in the end, I think, of common sense. ...

The March 15, 2009 meeting, dealing with banks -- there's lots of different opinions about exactly what was acceptable or what was not, this idea of nationalization or not. … Was there a real plan, or a real thought that in fact probably some banks would have to be taken over? What was the thinking around that period of time?

The thinking at the time was that we had to do whatever it takes to most efficiently get credit flowing again. And that meant that lots of toxic assets on balance sheets had to be dealt with as quickly and efficiently and cheaply as possible.

The question as to whether nationalization, conservatorship, taking over these banks was the best way to do that was in the room. But it wasn't the obvious first, best option. I mean, I remember some discussions where experts in such matters explained why that might work a lot better in Sweden than it would work in the United States, and making pretty good substantive arguments.

So what was the argument for nationalization?

The argument of nationalization was very much a kind of rip-the-Band-Aid-off argument.

It was an argument that asked, are we looking at a liquidity problem in our banks or a solvency problem? Are our banks insolvent, in which case, by far, the quickest and best way to go is to rip the Band-Aid off and nationalize? Or are we looking at something that's more of a temporary liquidity nature, because of some bad investments? If we help reflate them for a while, we can get in, we can get out, and they'll be back in business. …

Greece looks to me like insolvency. The U.S. at that time looked to me much more like a liquidity issue.

But the way that meeting, the 15th, specifically has been discussed is that at least the option of taking over one or two of the banks that were in a worse situation, like Citi, was an option that was being considered.

I'll tell you what my view is, and I don't know that I was in every meeting on this stuff.

From where I sat, from the meetings I was in, the option of nationalization was out there. But it was never an option that got all that close to the finish line, as far as I could tell. I think there's a view that the idea of nationalizing even a few banks was very close to a decision that the president made. I don't think that's quite realistic.

I think in the last quarter of 2008, [Citi] lost between $30 and $40 billion.

It was a very large number. They also had very unstable funding, so they used foreign deposits to fund a lot of their bad loans and other toxic assets that they had. ... But they were losing foreign deposits, and so they funded short-term too. They didn't have a lot of long-term debt that would have been stable, and their capital was low as well. They were in very bad shape at that point.

Just a few weeks later, Citi continues to be a problem. ... You have another crisis.

... They needed another bailout. ...

Another weekend.

... Got the call on Friday. We were playing catch up, but we had started paying a lot more attention to these large institutions, so we had a little bit of better sense.

But again, we weren't notified until Friday that the Fed and the Treasury wanted to do another bailout. They felt another bailout was necessary, and it had to be done that weekend.

Again, not much [time] to plan or look at alternatives, and so they got another very generous bailout, another $20 billion in capital. And the government agreed to guarantee losses above a certain point and about $306 billion of toxic assets that they had.

You commented that basically you had no real feel for whether or not Citi's failure at that point would have been systemic.

I think Hank and Tim Geithner have said that. ... What I did say was, can we at least explore putting the insured banks, the Citigroup structure, the bulk of the assets -- I think it was around 67, 65 percent of the assets -- can we explore running that through a receivership, creating a good bank, bad bank structure?

So you keep the bad assets back in what we call the bad bank. The current shareholders and unsecured debtors have to take whatever losses are associated with that. The good stuff, the good part of the franchise, you spin off. You sell or you recapitalize.

I wanted to explore doing that. I didn't want to do just another kind of one-off bailout. ... Obviously we needed to take action. We needed to do something to Citi, but I still think that would have been a better model to use. ...

You said again to the inspector general looking into this, "I don't think that additional assistance is going to fix Citi." So this was a patch-up job in your opinion?

It was a patch-up job. ...

I had a very tense conversation with [Former Comptroller of the Currency] John Dugan, their primary regulator. I said: "What is your supervisory plan? How are you going to fix this institution, because it's still sick? What are you going to do?"

He had no answers for me whatsoever. And the CAMEL rating, ... they had capped at a CAMEL 3.

CAMEL?

That's a supervisory rating. So 1, you're a very healthy bank; 5, you're a failing bank; 3, you're kind of an in-the-middle bank.

And Citi was?

Citi had failed twice and it required two government bailouts. It should have been a 5, right? If it had been a little bank. But they still had it as a 3.

When I asked him on that, his rationale was well, because it was getting all this government bailout money, it was a 3. So here we go. Now we're going to be rating the health of institutions based on how much government money they get.

After the fact.

So the fact that they were big and connected and can get a lot of government money, then we're going to give them a nice supervisory rating.

Like I would be less insolvent if you gave me a few million dollars.

It amazed me. And there was no plan and no sense of developing a plan to right the ship. ...

The criticism of the inspector general in looking at these deals was that these were ad-hoc assessments, sort of seat-of-the-pants, instinctual kinds of things.

They were. ... There is no question. ...

Then in October, Citi is trying to rescue itself with a purchase of Wachovia. ...Your client was Wachovia. ... Describe what happened there.

What happened was Wachovia was in very serious shape. They lost their funding at the end of a week. We had round-the-clock marathon negotiations with both Citi and Wells [Fargo].

The end of the day, neither was prepared to do a transaction without government assistance, at which point it now becomes the government's issue. And very early Monday morning, the FDIC [Federal Deposit Insurance Corporation] said that Citi was the successful acquiror of Wachovia with the assistance package.

We then tried to negotiate for several days to finalize a deal with Citi, and just as we were getting very close, Wells came in with a much higher offer without government assistance. I was frankly surprised that various government agencies would permit this to happen.

So after [Wachovia President and CEO] Bob Steel and I discussed it, we divided the government agencies and made our phone calls to make sure that they had no objection to Wells, because the last thing we wanted to do was disrupt the Citi transaction and then find that Wells was not buyable. And every sounding was either positive or neutral.

What did you do next?

Next we called the board of Wachovia. We got on the phone with Wells counsel to say that we would be interested in pursuing it. It would have to be done very quickly.

They said: Guess what? We have a merger agreement and you won't have any problems with it. These were lawyers we know very well and are very skillful at deal making from Wachtell, Lipton. The agreement came over, it was true to their word, and it was very easy to sign. We got the board together and we said, "Here are the two options," and we decided to sign the Wells transaction.

When and how did you inform [Citigroup CEO] Vikram Pandit? How did he react?

Mr. Pandit was called within a few minutes afterwards. Bob Steel felt it was very important as just a matter of humanity that Mr. Pandit didn't wake up the next morning and read about it in the newspaper. ...

I think Vikram Pandit was shocked, as I certainly would have been receiving news like that. ... He was angry, and I don't think that is unjustifiable in his position. This was a transaction which would have made a lot of sense for Citi, and now it looked like it would be lost. ...

... This is just before the TARP money is paid out. How did those bankers with whom you were working and talking explain to you the rationale for all the risk they had taken, and how their risk teams had missed the problems?

... This was not all banks by any means. If you look at the major U.S. banks and other financial institutions, only some of them had taken excessive risks. And some of the bankers that did were then, and are still, in denial.

I remember one banker, whom I will not name, who called me after I had said something which was critical of the risk management at his institution, ... and he said: "You just don't understand what happened. How could anybody have anticipated that we would have this huge decline in the housing market?"

It's a natural human instinct not to be willing to admit mistakes, but I think those who are more truthful with themselves and more introspective are willing to acknowledge that when you're making a lot of money in a particular area, you just don't look as carefully as you should.

Good risk management would have been if you're making outsized profits, to look if there is an outsized risk, since the two usually go hand in hand. But instead, perhaps there was even less analysis of the risk involved.

There's the old adage that if it's too good to be true--

It is. ... They haven't uncovered the magic formula to spin straw into gold, so when you're making outsized profits, it is almost always the fact that you're just going out further on the risk curve. ...

So should Bear have been let go? Should Lehman have been let go, but also in a smarter way?

What we did with Bear is we kept it alive but within JPMorgan. That was a case where we took the position of preserving the institution but not the shareholders and the bondholders.

But the way we did it was not transparent. The cost to the taxpayers almost surely was greater than was necessary. And I think there's a very heavy cost to our democracy when we don't do things in a transparent way.

In the case of Lehman Brothers, I think we should have followed the same kind of thing, save the institution but not save the shareholders, not save the bondholders.

And this inconsistent pattern -- AIG we should have done the same thing. When it came to the CDSs, part of bankruptcy is they wouldn't have been honored. They would have gone with everybody else. And if that put Goldman Sachs into bankruptcy, well that's part of the cost of letting the shareholders and the bondholders pay the price. It would not have gone into bankruptcy; it would have only meant the shareholders would have lost and the bondholders would have become the new shareholders.

Same thing in Citibank: If we hadn't rescued Citibank, there was enough long-term debt to have kept it going. It's only the shareholders would have lost and the bondholders would have become the new shareholders.

People will argue that if you had done that, if you had let all these things go in that way, then credit would have dried up immediately everywhere, that banking systems around the world would have stalled to a stop, that economies would crumble.

There is no evidence of that. The institutions would have been preserved, and in fact they would have had more capital, more equity if we had turned all of the debt into equity, over $300 billion in the case of Citibank. That's more money than the U.S. taxpayer put in.

It's an example of the kind of scare tactics that Wall Street has used repeatedly to get the money to hold up the American taxpayers, to hold up taxpayers in other Western governments. ...

Explain the role of leverage in making all focus this worse. And how did get to the point where banks could really take so much risk, and have such low capital levels?

Leverage is an important piece of the puzzle because it enables the banks to take on much bigger bets. So if they are only using their capital, then they have leverage of one-to-one. For every $3, they make a $100 bet, they're leveraged more than 30-to-1. And it will only take a 3 percent loss, a relatively small loss, to wipe out all of their capital. So leverage is important because it magnifies the bet. …

I actually think that the role of leverage in the financial crisis has been overstated. I think that banks have been massively leveraged throughout history. During the 1990s, banks were massively leveraged. …

I think the one thing that has changed dramatically is that we aren't able to tell how much leverage there is at banks, that it's not as simple as looking at their financial statements and saying, "Oh, look, they're leveraged 40-to-1 instead of 30-to-1." Or, "Look, they're now 30-to-1 instead of 25-to-1." I think we're looking at the wrong issue if we look at their financial measures of leverage.

I think the big thing that's changed is the extent of off-balance sheet exposure. The amount of leverage in some of these super senior positions is infinite. It's 100 percent. There's no capital put down. AIG had unlimited leverage for many of its positions. …

I think that the distinction between Goldman and Citigroup is particularly interesting because I think Goldman showed itself as being a very sophisticated actor that understood the risks in the financial markets. It's certainly been a vilified bank, and some employees engaged in unacceptable conduct. But the folks at Goldman were smart.

The folks at Citigroup were not smart. They did not understand their bank's exposure, even at the very end when they were in an almost Keystone Cops way trying to figure out what to tell the regulators, what had gone wrong, and what are they going to tell investors.

To me, one of the most surprising things about Citigroup is that their senior leaders, their CEO and the CFO, were willing to sign their names certifying the accuracy of their financial statements in late 2007 and early 2008, when the bank was completely out of control. They signed a testing that there were adequate internal controls when Citigroup couldn't understand and evaluate its risk. And the regulators were involved in that, and ultimately found that there were risks within Citigroup that Citigroup didn't understand, it didn't adequately control.

I think it's really interesting that often, we tar Wall Street with all of one brush. But if everyone had acted like Goldman, we wouldn't have had a financial crisis. If everyone had acted like Citigroup, the financial crisis would have been much, much worse. And I think it doesn't serve policy well to paint everyone the same way. I think what we want to try to do is to make sure the financial institutions don't ever act like Citigroup acted again. …