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Congress's FCIC Nearly Nailed Former Citigroup Executives to the Wall -- Then Blew It

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Phil Angelides, Chairman of the Financial Crisis Inquiry Commission, had Robert Rubin, former senior advisor Citigroup (also former Treasury Secretary under President Bill Clinton, and former Co-Chair of Goldman Sachs), and Chuck Prince, former CEO of Citigroup, in the palm of his hand today. He asked them why they weren't alarmed for Citigroup in May of 2007, when the Bear Stearns hedge funds ran into trouble. He recalled they imploded in June 2007 and joked that it happened around the time of his birthday. Rubin and Prince shrugged it off, and Rubin that he didn't know about Citigroup's CDO troubles until the fall of 2007.

Seperately, Tom Maheras, then a top fixed income executive at Citigroup, said in the fall of 2007 that Citigroup's "super senior" CDOs were worth 100 cents on the dollar.

Angelides may not have realized it, but there were facts in the public domain that tie Citigroup very closely to the fate of Bear Stearns's hedge funds. Either these top people from Citigroup didn't ask their subordinates about their exposure -- and the nature of their exposure to the Bear Stearns hedge funds -- or the controls in Citigroup broke down. Rubin testified today: "I don't think Citi is too big to manage." Yet, these events suggest something is seriously amiss.

In my book on the financial meltdown, Dear Mr. Buffett, I explain how I knew Citigroup was in trouble and its involvement in value-destroying CDOs purchased by Bear Stearns Asset Management's imploding hedge funds. At the time, I spoke to investigative reporters Matthew Goldstein ("Bear Stearns's Subprime IPO," BusinessWeek, May 11, 2007. Goldstein is now with Reuters.) and Jody Shenn ("Bear Stearns Funds to Transfer Subprime-Mortgage Risk with IPO," Bloomberg News, May 11, 2007) about Bear Stearns and the disturbing assets, including some created by Citigroup, revealed by an SEC filing it made in May 2007 for a proposed initial public offering (IPO):

I went to the SEC's web site, and as I scanned the document I thought to myself: Has Bear Stearns Asset Management completely lost its mind? There is a difference between being clever and being intelligent. I was surprised to read that funds managed by BSAM invested in the unrated first loss risk (equity) of CDOs. In my view, the underlying assets were neither suitable nor appropriate investments for the retail market.

I did not have time for a thorough review, so I picked a CDO investment underwritten by Citigroup in March of 2007 bearing in mind that if the Everquest IPO came to market, some of the proceeds would pay down Citigroup's $200 million credit line.* [Emphasis added] Everquest held the "first loss" risk, usually the riskiest of all of the CDO tranches, and it was obvious to me that even the investors in the supposedly safe "triple-A" tranches were in trouble. Time proved my concerns warranted, since the CDO triggered an event of default in February 2008, at which time Standard & Poor's downgraded even the original safest "triple-A" tranche to junk.

All the banks that lent to Bear Stearns Asset Management's (BSAM) two problematic hedge funds pressured the managers to mark down the prices of their assets by late May and early June 2007 -- even the prices of "AA" and "AAA" rated assets. Before the hedge funds went under, BSAM circulated bid lists for the assets, and the prices were atrocious.

How is it that given Citigroup's huge loan and creation of CDOs that these two funds bought didn't draw the attention of Citigroup's senior management? Citigroup was deeply involved, and there was obvious danger to its own balance sheet.

Chairman Angelides was apparently unaware that Citigroup had reason to be deeply alarmed by the events that caused the Bear Stearns hedge funds to implode. He missed a golden opportunity to ask Citigroup's former executives about their seeming obliviousness to this enormous risk.

More to the point, Angelides might ask these executives why Citigroup's officers made rosy public statements and why Citigroup's financial filings with the SEC did not show huge accounting losses for the second quarter of 2007 (and earlier).

Note: After the negative publicity, the Everquest IPO did not come to market.

* Offering Circular for Octonion I CDO, Ltc. Octonion I CDO Corp., March 16, 2007. Most of Everquest's assets were priced as of December 31, 2006, but there were some 2007 additions to the portfolio. For example, it owned some of the "first loss" equity risk of a CDO named Octonion I CDO (Octonion), a deal underwritten by Citigroup in March 2007. If the IPO came to market, some of the proceeds from Everquest would pay down Citigroup's $200 million credit line. Octonion's prospectus disclosed an inexperienced CDO manager with conflicts of interest with the CDO investors. It used 95% credit default swaps referencing BBB rated asset backed securities including subprime assets. This CDO appeared to be a very risky investment for investors in the AAA or AA rated tranches. The equity, 48% of which was owned by Everquest, may have been entitled to the residual cash flow of the deal, even if they did not, the tranches looked high risk, undeserving of an investment grade rating. Time proved my concerns warranted, since Octonion triggered an event of default in February 2008, at which time even the original senior-most AAA tranche was downgraded to CCC by S&P (it was still AAA by Moody's). By the summer of 2008, the senior-most "AAA" had been downgraded to Caa3 by Moody's and CCC- by S&P.