[Corp. Watch] Wall Street ran wild while Obama's Treasury Secretary fiddled

[Corporation Watch]

How Citigroup Unraveled Under Geithner’s Watch

by Jeff Gerth

(ProPublica, Jan. 14) -- As president of the New York Federal Reserve  
Bank, Timothy Geithner often preached that gargantuan financial firms  
like Citigroup should be held to the highest regulatory standards to  
make sure they couldn't take on too much risk.

	But when it came to supervising Citigroup in recent years, the record  
shows that the New York Fed eased the reins as the company blew  
billions on sub-prime mortgages and other risky deals that ultimately  
forced the biggest bank rescue in U.S. history.

	Now, the 47-year-old Geithner heads to the Senate in coming days as  
President Barack Obama's nominee for Treasury secretary. He's won  
accolades for his expertise and work ethic, but there's been little  
attention to his record as a Fed watchdog.

	Geithner's tenure at the New York Fed -- which bore the major  
responsibility for supervising Citigroup -- covers a tumultuous span  
in which the sprawling conglomerate spiraled from the country's  
biggest banking company to one of its largest welfare cases.

	Now under much closer government supervision -- after a $52 billion  
rescue -- Citigroup appears headed for dismantling amid a leadership  
shuffle that included last week's announced departure of former  
Treasury Secretary Robert Rubin as senior counselor and director.

	Should the New York Fed have seen trouble coming and prevented it? As  
Citigroup took on risk and its capital deteriorated, what oversight  
did Geithner exercise? And what contacts, if any, did Geithner have  
about regulatory matters with Citigroup officials, including Rubin,  
under whom Geithner worked at Treasury in the 1990s?

	All are issues that may come up when Geithner appears before members  
of the Senate Finance Committee at his confirmation hearing, which has  
been put off until the day after Tuesday’s inauguration amid questions  
about Geithner’s taxes and past employment of a housekeeper.

	Because the Fed conducts much of its work in secret, details about  
Geithner's role in the Citigroup debacle remain hidden. But a review  
of publicly available records shows that the New York Fed, in a key  
period, relaxed oversight as Citigroup went on a risky spree.

	Geithner, following practice common among Cabinet nominees with  
pending confirmation hearings, declined an interview for this story.  
Neither the New York Fed nor Rubin responded to written questions  
about Citigroup.

	The New York Fed's supervisory unit reports directly to the bank  
president, Geithner. The unit's job is to ensure that firms manage  
risk and have enough capital to cushion against losses. Large  
companies tend to be held to more stringent capital standards.

	Yet poor risk management and weak capital levels were central to  
Citigroup's undoing. One enforcement agreement in place before  
Geithner took office in 2003 -- an order requiring quarterly risk  
reports -- was lifted during his watch. A ban on major acquisitions  
also was eliminated a year after it had been imposed in 2005.

	Afterward, in 2006 and 2007, Citigroup aggressively expanded into the  
sub-prime mortgage business and bought a hedgefund and Japanese  
brokerage, among other assets.

	A year later, as the global financial crisis took hold, Citigroup  
took losses and write-downs of more than $50 billion. The New York Fed  
brought no public enforcement case, although examiners privately sent  
a critical letter to the company in the first half of 2008.

	Compared with its peers, Citigroup had a thinner capital cushion and  
relied more heavily on less-desirable types of capital, records show.  
The New York Fed knew -- in 2007 it allowed Citigroup to count as  
capital various securities that some regulators and credit agencies  
frown upon or discount.


	Last May, after the collapse of investment firm Bear Stearns set off  
alarms, Fed regulators and Citigroup were in lockstep about risk and  
capital levels. "Perfect agreement" is the way CEO Vikram Pandit  
described it at a meeting with analysts.

	A month later, Geithner gave a speech saying regulators needed to do  
more to make sure that companies had fatter capital cushions -- but  
not until the financial system had stabilized.

Inheriting Citigroup

	When Geithner was named president of the New York Fed five years ago,  
he was youthful but experienced. As undersecretary of the Treasury  
Department in the late 1990s and later, at the International Monetary  
Fund, he was no stranger to problems in global credit markets.

	Rubin, his former boss at Treasury, described Geithner to the New  
York Times in 2007 as someone with a "calm way" no matter the  
circumstance. Rubin, a senior counselor and director at Citigroup  
after leaving Treasury, called Geithner "elbow-less," referring to his  
widely recognized collaborative skills and easy manner.

	As president, Geithner inherited two Citigroup enforcement matters.

	One, stemming from examinations in 2001 and 2002, involved  
allegations that Citigroup's consumer finance subsidiary converted  
personal loans into home equity loans without properly assessing  
credit risk. By May 2004, the Fed filed an action against Citigroup  
and ordered the firm to pay a record $70 million in penalties.

	The other case involved Citigroup's role in helping Enron structure  
dubious off-balance sheet transactions that first propped up but later  
brought down the high-flying energy company.

	In July 2003, Citigroup agreed to pay $120 million to the SEC and  
entered into an agreement with the New York Fed to beef-up its risk  
management practices. Fed supervisors were to be informed of the  
company's progress every three months.

	Citigroup's investment bank had run afoul of regulators around the  
world by 2004.

	Japanese supervisors forced the company to shut down a private bank.  
In Great Britain, Citigroup paid $25 million for an improper bond  
trading scheme, dubbed "Dr. Evil," that regulators said resulted from  
a corporate request "to increase profits by taking more proprietary  
market risk."

	Higher risk can lead to more profit -- or big losses. To cushion  
against the latter, financial firms must set aside capital, especially  
shareholder equity, or common stock.

	Regulators closely watch a firm's "Tier 1" capital ratio, a  
percentage of stockholder equity and other stock against total assets,  
after risk adjustments. Regulators require a well-capitalized holding  
company to hold at least 6 percent Tier 1 capital, but very large  
firms or rapidly growing firms are expected to have significantly more.

	Geithner made his views on the subject clear at a risk management  
forum in January 2005. He said the biggest firms needed "exceptionally  
strong" capital cushions and risk management systems because of their  
influential role in the financial system.

	Citigroup's ratio exceeded 8.5 percent between 2003 and 2006, filings  
show. Although the company had a Tier 1 target of 7.5 percent, a top  
executive told securities analysts in 2004 it was "substantially more  
than what our risk analysis says we need."

	As Geithner noted in his speech, the economy was "broadly positive"  
in 2005. But as Citigroup looked to grow, the Federal Reserve gave  
mixed signals.

	In Washington, Citigroup was asking the Fed Board of Governors to let  
it buy First American Bank in Texas. The board assessed Citigroup's  
risk management in conjunction with the New York Fed and OK'd the deal  
in March 2005, concluding that controls were sound.

	Taking note of the firm's problems abroad, however, the governors  
also put a hold on any "significant expansion" until Citigroup could  
enact a new risk and compliance plan it had developed to address the  
previous problems.

	Citigroup was back in good graces a year later. After the head of  
bank supervision for the NY Fed wrote Citigroup indicating the company  
had made "significant progress" in managing risk, the freeze on  
acquisitions was lifted in April 2006.

	Then, the Friday before the Christmas weekend, the Fed announced that  
it had terminated the 2003 enforcement agreement and its requirement  
to file quarterly risk management reports. No explanation was offered.

Flurry of deals boosts risk

	By then Citigroup was racing ahead at full speed. In 2006,  
Citigroup's issuances of collateralized debt obligations -- securities  
in which mortgages and other debts are bundled and sold based on risk  
-- grew to $40.9 billion, more than double the prior year.

	The number of sub-prime mortgages originated by Citigroup rose 85  
percent that year, while other top originators had already begun to  
reduce their sub-prime output, Fed data show.

	Citigroup, which at the time was the nation's largest banking  
company, also began buying other financial firms. "They became very  
aggressive on the acquisition front, with a whole flurry of deals,"  
said Joseph Scott, a senior director at the credit agency Fitch Ratings.

	The deals pumped up Citigroup's balance sheet. Assets nearly doubled  
from $1.2 trillion at the end of 2003 to $2.3 trillion by September  
2007.

	But the bank's defenses weakened during the same period. By the end  
of September of 2007, records show, Citigroup's once comfortable Tier  
1 capital ratio had fallen to 7.32 percent, below the bank's target.

	Other indicators of a flawed risk strategy surfaced in 2007. For  
instance, Citigroup repeatedly revised or "reclassified" its exposure  
to sub-prime losses, its definitions for accounting valuations and its  
reserve allowances. Analysts say an inability to accurately account  
for losses is a sign of inadequate risk management.

	Geithner, in a 2006 speech on risk management, foresaw some of the  
troubles ahead. He said continued success required major institutions  
"to strengthen their capacity to withstand a less favorable"  
environment by better calibrating risk and capital.

	Trouble became a reality for Citigroup by the end of 2007, when  
exposure to sub-prime loans caught up with it, and the bank's belated  
attempts to protect itself proved to be insufficient.

	Citigroup tried to hedge its debts by purchasing credit default swaps  
and other instruments from insurance companies that themselves took on  
too much risk and couldn't cover all their contracts. That added  
billions to the company's record losses. "They were late to hedge to  
begin with," said Scott, and "a lot of the hedging didn't work."

	A management shuffle in late 2007 led to the selection of Pandit, who  
helped run a hedgefund bought by Citigroup, as the company's CEO. He  
later concluded that what "went wrong" at Citigroup was a "tremendous  
concentration" in U.S. real estate deals.

	Pandit quickly put in a new risk management team, a tacit  
acknowledgement that previous efforts failed.

Instead of enforcement, a strong letter

	Around this time, examiners from the Fed wrote a letter to Citigroup  
very critical of its risk management practices, the New York Times  
later reported, citing an unnamed source. The Times report also said  
Citigroup responded with a plan for a sweeping overhaul of risk  
management.

	Although examination letters are part of the supervisory process,  
they are not considered enforcement actions, which carry more weight.

	Scott, the Fitch senior director, called the firm's new risk team  
impressive, but "they inherited a lot of problems." The problems cut  
into Citigroup's all-important capital base.

	When it comes to valuing that base, regulators and credit-rating  
agencies favor using common stock. But Citigroup, beginning in late  
2007, relied increasingly on "hybrid" capital forms, such as trust- 
preferred securities, to prop up its Tier 1 ratio.

	In general, the NY Fed and the Federal Reserve allow the use of  
hybrid capital, but apply limits and ask firms to obtain prior  
approval. In 2007, Citigroup exceeded the limit -- the only bank among  
its peers to do so.

	Even with these hybrids, Citigroup's capital ratio dipped to 7.12,  
well below peers like JP Morgan Chase, at 8.44 percent, or Bank of New  
York Mellon, at 9.32 percent.

	The Federal Deposit Insurance Corporation (FDIC) opposes the Federal  
Reserve's allowance of trust preferred securities for Tier 1  
calculations. In 2005, when the Fed was drawing up the rules for trust- 
preferred securities, the FDIC argued that they should not qualify as  
Tier 1 capital because they are reported as debt on banks' balance  
sheets.

	Though the Federal Reserve is the primary regulator of Citigroup,  
other regulators have jurisdiction over pieces of the firm and work  
closely together: the Comptroller of the Currency supervises Citibank,  
the FDIC insures Citibank's deposits, and the Securities and Exchange  
Commission oversees its investment banks, like Smith Barney.

	As part of the bail-out, Citigroup indicated it had previously  
entered into regulatory agreements with some of these bank  
supervisors, but did not disclose details.

	When Citigroup executives spoke with independent securities analysts  
last May, they were questioned extensively about their capital  
adequacy. By then Bear Stearns had collapsed, the result of too much  
sub-prime exposure, and had been swallowed up by JP Morgan Chase in a  
government-backed deal that Geithner helped broker.

	Analysts wondered if Citigroup and others faced such risk. Surely,  
one analyst told Citigroup brass, you are being asked by federal  
supervisors to hold more capital, given the market strife and the  
normal "tension" between the bank and its regulators and auditors.

	Pandit, in reply, said there was no tension; all were in "perfect  
agreement." The analyst said he didn't believe Pandit. But another  
Citigroup executive followed up, saying the bank enjoyed "unusual  
symmetry" with regulators and auditors.

In choppy seas, a tempered approach

	Speaking at a conference in New York a few weeks later in June 2008,  
Geithner discussed the role of federal oversight in reducing risk or  
building capital, especially at major firms. He didn't mention  
Citigroup -- regulators avoid talking about specific institutions.

	Geithner publicly backing a cautious approach to building stronger  
capital margins, and said regulators could not be omnipotent. It  
wasn't "realistic" to "expect [federal] supervisors to act  
preemptively to defuse pockets of risk and leverage," he said, but  
they could make the "shock absorbers stronger."

	That meant "inducing institutions to hold stronger cushions of  
capital and liquidity in periods of calm." But mid-2008 was not the  
time.

	"After we get through this crisis and the process of stabilization  
and financial repair is complete," Geithner said, "we will put in  
place more exacting expectations on capital, liquidity, and risk  
management for the largest institutions."

	The crisis Geithner hoped would recede only got worse. Lehman  
Brothers went bankrupt, insurance giant AIG had to be rescued, and  
credit markets froze up.

	By far the biggest banking casualty was Citigroup. The firm received  
a $25 billion capital infusion in October, as part of the federal  
rescue plan Geithner helped engineer. That plan was designed to help  
"generally sound banking organizations."

	But the markets continued to lose confidence in Citigroup; its stock  
slid and its cushion of capital grew still thinner. By November, the  
government announced further aid for Citigroup under a new program for  
less healthy firms.

	The deal called for a $20 billion cash infusion in exchange for  
preferred securities, and a fee -- paid by Citigroup -- in the form of  
$7 billion more in preferred securities, for Treasury and FDIC to  
guarantee about $250 billion in bad assets.

	A few hours later, President-elect Obama announced his selection of  
Geithner to replace outgoing Treasury Secretary Henry Paulson, with  
whom Geithner collaborated to design the government's program to bail  
out banks and Wall Street firms.

	Rave reviews poured in from the street to Washington. One of the  
financial executives quick to praise Geithner was Citigroup's chief  
executive, Vikram Pandit. "It's good to have him," he said.