While nearly every other Wall Street firm had AIG’s Financial Products group in Wilton, Connecticut on speed dial, Citigroup reportedly avoided doing business with them. Instead of off-loading risk onto the insurance giant by taking out credit default swap contracts, Citigroup prefered to keep one-hundred per cent of the risk themselves, an AIG trader tells Michael Lewis in Vanity Fair.
Lewis has a long article in this month’s Vanity Fair that describes how AIG FP blew up. It’s finally online and makes for an entertaining read. In case you are pressed for time, here’s the short version: they sold lots of credit default swaps on subprime mortgage backed paper while no one internally had a clue what was going on.
But almost in passsing he mentions a conversation he had with a trader that reveals that Citi was different than every other firm on the street. It avoided doing business with AIG FP. While AIG was ramping up its credit default swap business from a single half-billion dollar deal each month to 20, Citi never got in on the game.
“We were doing every single deal with every single Wall Street firm, except Citigroup,” the trader tells Lewis. “Citigroup decided it liked the risk and kept it on their books. We took all the rest.”
In a sense, this is not ground-breaking news. When AIG released its list of counter-parties to credit default swaps and securities lending transactions, CIti wasn’t on the list. There were fifteen others, including Goldman Sachs, Wachovia, Bank of America and Merrill Lynch. But no Citi. At the time, however, no one seems to have noticed. (Incidentally, now that we’re thinking in terms of the presence of absence, why weren’t Morgan Stanley and Wells Fargo on the list?)
So why was Citi hungrier for risk than other firms? Why wasn’t it a buyer of credit default swaps from AIG? Our best guess is that Citi believed it had discovered a cheaper alternative to credit default swaps–the structured investment vehicles. You remember those right? The SIVs were off-balance sheet entities that owned long term debt and were funded with short-term debt. Citi managed at least seven of them holding a total of $100 billion worth of assets at their height. When these began to meltdown, the government attempted to organise a bailout ominously called the M-LEC (and nicknamed by bloggers as “The Entity”) that faltered because other Wall Street banks saw it as a gift to Citi.
It’s very possible that instead of buying credit default swaps on its mortgage backed securities, Citi was just selling them to the SIVs it managed. Since these were off-balance sheet, Citi wouldn’t have faced the capital requirement constraints that often prompted other banks to buy credit default swaps. Citi could lend and securitize, then sell off any extra inventory into its own SIVs, freeing up the capital it got from the SIV to make more loans. Lather, rinse, repeat.
If we’re right about this, the SIVs provided Citi with credit protection the same way AIG did for the rest of Wall Street. Except, of course, that when the government made AIG’s counter-parties whole, Citi found it had come up short. When the SIVs collapsed, it wound up having to fund their bailout itself. The enormously expensive SIV bailout helped contribute to the pitiful financial condition that has made Citi more or less a ward of the federal government.
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