At a hearing today, executives from Citigroup (NYSE:C), and former executives, gave testimony concerning the CDO holdings of the company, and so far have revealed everyone at the company, and those consulting them, missed the risks inherent in the CDOs to the company.
To begin with, former trading head at Citigroup, Thomas Maheras, pointed the finger at consultants hired by the company to give them direction on the CDOs or collateralized debt obligations. Maheras added the company took action on the advise of those outside consultants concerning the securities, while not seeing the risks involved.
What these collateralized debt obligations entailed, were taking home loans and creating bonds, which were repackaged into CDOs. So while there were bad loans used to create the bonds, they carried a AAA rating, which are considered about as safe as you can get for an investment.
According to former Citigroup Chief Risk Officer David Bushnell, it was the methodology used for analyzing the condition of the CDOs which was what failed them, as they used risk models based on historical performances as a guide to measure their financial health.
The assumption was “any annual decline in real-estate values would not exceed the worst-case historical precedent.”
This was a gamble of course, and contradicts the most basic of investment advice that past performance doesn’t guarantee future performance for any investment. As one commissioner in the hearings commented, how can borrowers with terrible credit scores receive mortgages which are them packaged into triple-A rated bonds?
My question in all of this is why the government hasn’t taken responsibility for their part in all of this, by forcing lenders to take on borrowers in order to meet certain quotas of people as a representation of the population, which pushed them in many cases to underwrite low-credit people. It’s called the community reinvestment act, which while has the usual good intentions, forces and pressures loans upon people not qualified to receive them. This isn’t the entire story of course, but it is a major part of it.
As far as why this wasn’t discovered by anybody in the chain of command at Citigroup, it’s baffling, as it seems everyone referred back to the historical models as their guidelines, and no one went beyond that to check out any other metrics, which surely should have been consulted, knowing the many weak loans under-girding the CDOs.
