Former Treasury Secretary and Citi Director Bob Rubin has begun to defend his role in the bank’s collapse. His position appears to be that he is not personally responsible because he was only a director and that, in fact, no one at Citi is responsible because what nearly destroyed the firm was an unforeseeable act of God.
We have a lot of respect for Bob Rubin, who earned his tremendous reputation through decades of work in the Clinton Administration and at Goldman Sachs. Someday, therefore, when the legal and reputational concerns have faded, we hope to hear him accept more responsibility.
In today’s WSJ, Rubin’s argument boils down to two points:
- Board members should not be expected to have a handle on the day-to-day risks a firm is taking. This is true, but that doesn’t mean board members shouldn’t have some appreciation for these risks–especially board members who used to be exceptional bond traders.
- The financial collapse was unforeseeable. This is simply false. Lots of people foresaw it. Just not, apparently, Bob or Citi.
Viewed from a distance, what happened at Citi is clear. It’s the same thing that happened at Bear Stearns, Lehman Brothers, Fannie, Freddie, and a host of other financial institutions that have since tried to blame their implosions on anything but themselves: The firms gambled and lost. The only relevant question is “why?”
In 2004 and 2005, Citi explicitly decided to take more risk–a decision in which Bob was reportedly deeply involved. Like Merrill Lynch and other firms, Citi appeared to make this decision for competitive reasons: Other firms were doing it and coining money, and their shareholders wanted them to do it, too.
Taking more risk means exactly what it sounds like it means: taking…more…risk. It does not just mean “making more money,” which is what many folks on Wall Street often assume it means. It also means “exposing yourself to bigger losses.” So in 2004-2005, at least, Bob and Citi knew exactly what they were doing.
In and of itself, taking more risk is not necessarily a mistake: It’s just a strategy. (Albeit one that, in hindsight, a lot of people came to regret.) After deciding to take more risk, however, Bob and Citi did make a fatal mistake: They underestimated the magnitude of the risk they were taking and/or the likelihood of disaster occurring.
Mr. Rubin said he believed in 2004 and ’05 that while a cyclical downturn such as the 1994 Mexican devaluation or 1997 Asian financial crisis was possible, the losses the bank might suffer wouldn’t come close to wiping out the profits made during the good times.
The first order of business for any responsible risk-taker is to get an accurate sense of the downside. Bob and Citi failed to do this. This is not an act of God. It is a mistake.
(And it bears noting that, although Bob and Citi failed to foresee the current disaster, many other respected analysts didn’t: Robert Shiller, Dean Baker, Jeremy Grantham, Andrew Smithers, Nouriel Roubini, and others were shouting from the rooftops for years about some flavour of this in the making. Bob and Citi could not have been oblivious to these arguments. They either thought they were wrong or just judged the risks to be worth taking.)
Financial systems do not just collapse with no warning. Global banks with $250 billion market values do not just drop 90%+ in a year without mistakes being made. In a few years, when the blame game has ended and the lead actors can afford to view their behaviour more objectively, we hope folks like Bob Rubin will accept more responsibility.
For example, we hope someday to hear Bob say some things like this:
- Our competitors were taking more risk and our shareholders wanted us to take it, too–so we did. In hindsight, this was a mistake. It was also, to some extent, I think, inevitable. Managements and boards who ignore shareholders eventually get fired.
- Our risk-control people were not smart enough to accurately assess the risks we were taking (or to admit that they couldn’t assess them) and/or were not powerful enough to limit the risks we were taking. In hindsight, we chose the wrong risk-control people and/or we didn’t give them enough power. In hindsight, this was a mistake.
- We employed a CEO who knew little about banking or trading to oversee a global origination and trading machine. In hindsight, this was probably a mistake. That said, it’s not clear that employing a trader as a CEO would have helped.
- We implemented compensation policies that incented everyone in the firm to take big risks without worrying enough about big losses–because if they won they would get dynastically wealthy and if they lost they would just lose their jobs. In hindsight, this was a mistake. (But given that everyone else had the same compensation policies, it was also probably unavoidable.)
- We came to believe, as many generations of managers, traders, and policy-makers have before us, that this time it was different. It wasn’t different. In hindsight, this was a mistake.
Mr. Rubin said it is a company’s risk-management executives who are responsible for avoiding problems like the ones Citigroup faces. “The board can’t run the risk book of a company,” he said. “The board as a whole is not going to have a granular knowledge” of operations.
Still, Mr. Rubin was deeply involved in a decision in late 2004 and early 2005 to take on more risk to boost flagging profit growth, according to people familiar with the discussions. They say he would comment that Citigroup’s competitors were taking more risks, leading to higher profits. Colleagues deferred to him, as the only board member with experience as a trader or risk manager. “I knew what a CDO was,” Mr. Rubin said, referring to collateralized debt obligations, instruments tied to mortgages and other debt that led to many of Citigroup’s losses.
Mr. Rubin said the decision to increase risk followed a presentation to the board by a consultant who said the bank had committed less of the capital on its balance sheet, on a risk-adjusted basis, than competitors. “It gave room to do more, assuming you’re doing intelligent risk-reward decisions,” Mr. Rubin said. He said success would have been based on having “the right people, the right oversight, the right technology.”
The decision has been blamed in part for Citigroup’s problems, including the growth of its CDO holdings amid signs the mortgage market was unravelling. Mr. Rubin doubts that’s true. “It was not an inflection point,” he said, but “I just don’t know what would have happened” if the decision had been different.
At the time, Mr. Rubin was saying in speeches that most assets were overvalued. He would quote a noted investor he knew as saying that “the only undervalued asset class in the world is risk.”
But it wouldn’t have been right for the board to act on his concerns, Mr. Rubin said in the interview: “I wouldn’t run a financial institution based on someone’s view about what markets would do.” He noted that the stock market kept rising for more than three years after Mr. Greenspan, in late 1996, wondered aloud about possible “irrational exuberance.”
Mr. Rubin said he believed in 2004 and ’05 that while a cyclical downturn such as the 1994 Mexican devaluation or 1997 Asian financial crisis was possible, the losses the bank might suffer wouldn’t come close to wiping out the profits made during the good times….
Mr. Rubin, senior counselor and a director at Citigroup, acknowledged that he was involved in a board decision to ramp up risk-taking in 2004 and 2005, even though he was warning publicly that investors were taking too much risk. He said if executives had executed the plan properly, the bank’s losses would have been less.
Its troubles have put the former Treasury secretary in the awkward position of having to justify $115 million in pay since 1999, excluding stock options, while explaining Citigroup’s $20 billion in losses over the past year and a government bailout of at least $45 billion.
In the current crisis, “what came together was not only a cyclical undervaluing of risk [but also] a housing bubble, and triple-A ratings were misguided,” he said. “There was virtually nobody who saw that low-probability event as a possibility.”
He said the Citigroup board could bear some responsibility. “Maybe there are things, in the context of the facts we knew then, we should have done differently,” he said.
Asked if he had any regrets, Mr. Rubin said: “I guess that I don’t think of it quite that way,” adding that “if you look back from now, there’s an enormous amount that needs to be learned.”
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