Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 1160 - 1179)



  Q1160  Chairman: They were in relation to risk. He kept dancing. Has Citigroup now stopped dancing?

  Mr Mills: Sir, as you mentioned, we have taken our fair share of losses on this.

  Q1161  Chairman: You all come before us. Citigroup lost between $8 billion and $11 billion. UBS has lost $3.6 billion in subprime-related loss. Deutsche Bank, the City-based investment arm, recorded a pre-tax loss of $179 million. Pre-taxed earnings are down by 19% to €1.4 billion. Goldman Sachs' flagship hedge fund fell by 12%. The BBC reported that its losses caused by the subprime ran to about £1½ billion. I asked you about the comments of the Bank of England. Have you lost sight of the risks involved? It seems here as if you are flying in the face of reality. You have not lost sight of the risks involved and everything that you are doing is somebody else's fault.

  Mr Corrigan: Let me take a stab at that. There is no question that over recent years the inner workings of the financial system have become enormously more complicated and complex.

  Q1162  Chairman: We are getting somewhere, Mr Corrigan.

  Mr Corrigan: In addition to that, the structure of the system has tightened further the linkages between markets and institutions. I think it is incumbent upon all of us, whether we are in the private or official sector, to spare no effort in seeking to master our understanding of this highly complex environment. Unfortunately, I think it is also inevitable—it is a trait of human nature—that when markets are strong and ebullient there is a natural aversion to be, as we say, the last one into the market or the first one out of it. That is a fact of life, unpleasant as it may be.

  Q1163  Chairman: Nobody wants to get caught with their pants down because, according to Citigroup, you are all dancing, but at the end of the day all of you get caught with your pants down?

  Mr Corrigan: I do not want to associate myself with comments about dancing.

  Q1164  Chairman: A split already!

  Mr Corrigan: But I think we need to recognise that there is here a basic element of human nature.

  Q1165  Chairman: In other words, the herd mentality?

  Mr Corrigan: That is correct.

  Q1166  Chairman: I come back to the complex products. Last week we had before us Professor Buiter, a former member of the MPC and a distinguished economist at the London School of Economics. He said of the process of securitisation that "by the time you get to the ultimate investor, who is six transactions or more away from the originator of the loan, neither the buyer nor the seller has any ideas as to the underlying risk characteristics of the security they are buying. That gets worse when securitised mortgage loans get packaged with credit card receivables, the square root of car loans and whatever else. The structure they have put together became so complex they probably were not even understood by their designers." Do you recognise that sentiment and, if so, do you have some empathy with it?

  Mr Corrigan: Speaking for myself, I certainly do.

  Q1167  Chairman: Mr Palmer, do you agree with that sentiment?

  Mr Palmer: Things have undoubtedly become more complex.

  Q1168  Chairman: Do you have empathy with that sentiment, Lord Aldington?

  Lord Aldington: I certainly recognise that sentiment.

  Q1169  Chairman: Mr Mills, do you have empathy with that sentiment?

  Mr Mills: I do recognise the complexities, Sir.

  Q1170  Chairman: We have heard of CDOs-squared and CDOs-cubed. Lord Aldington, can you explain to me what a CDO-squared or CDO-cubed is?

  Lord Aldington: I have not come before this Committee as an expert on CDOs.

  Q1171  Chairman: But your organisation is involved in collateralised debt obligations?

  Lord Aldington: That is true. My organisation is involved in a very broad range of products and I would not claim to be an expert on all of them.

  Q1172  Chairman: You cannot tell me what a CDO-squared is? Can anybody tell me what it is?

  Mr Palmer: A CDO-squared is a derivative structure designed to give investors exposure to a CDO.

  Q1173  Chairman: Mr Corrigan, can you try to explain it to us in simple language?

  Mr Corrigan: I think the easiest way to understand what a CDO-squared is to start with what a CDO is. If I were to take the example of mortgage-backed securities, institutions package up a family of individual mortgages into what is a fairly plain vanilla mortgage-backed facility. I think it is entirely fair to say that when those mortgage-backed securities are issued the disclosures associated with the issuance of those instruments are quite wholesome.

  Q1174  Chairman: What does "wholesome" mean?

  Mr Corrigan: A CDO carves out of a plain vanilla mortgage-backed security certain credit tranches of that security and reformulates them in what is called a structured credit product into a particular class of credit standards affecting those particular mortgages, not the full pool of mortgages. That is called a CDO. When you take a CDO and then roll it into a second CDO that is called a CDO-squared; in other words, it is a CDO made up of other CDOs.

  Q1175  Chairman: If you put in another one it is a  CDO-cubed?

  Mr Corrigan: Thank God, we have not got that far yet.

  Q1176  Chairman: At the end of the day it is becoming more complex and opaque, is it not?

  Mr Corrigan: It is certainly complex.

  Q1177  Chairman: Professor Buiter cannot understand it. If Lord Aldington cannot explain what a CDO-squared is what does that mean for ordinary people?

  Mr Corrigan: With all due respect, it is important to recognise, as I am sure you do, that the CDO product, much less CDO-squared, is clearly one that is aimed at sophisticated institutional investors. It is not aimed at retailer investors and in my judgment should not be.

  Q1178  Chairman: But you have insurance companies and others putting their money into these things and the pensions and insurance of ordinary people are involved in them, so at the end of the day the ordinary man can lose?

  Mr Corrigan: That is true.

  Q1179  Mr Dunne: There has been an explosion of issuance of structured finance instruments over recent years. We were told by Fitch that there were now only 15 industrials, 32 financial institutions and 16 sovereigns with triple A-rated debt paper. Would any of the witnesses care to hazard a guess as to how many structured finance products there are with triple A-rated status? I can tell you that it is a trick question and I know the answer. There are 8,409 compared with a handful of real companies with triple A-rated paper. Clearly, that has been a bonanza for all of your firms and investment banks. Who would like to comment on the impact of the explosion of issuance on financial stability?

  Mr Corrigan: For starters, it is important to recognise that in a very real way the fundamental driving force that goes a considerable distance in explaining the explosion of structured credit products—I agree with that characterisation—was the long period during which there were abundant amounts of liquidity on a worldwide basis and very low nominal and real interest rates. To a significant degree it has been the reach for yield on the part of institutional investors in particular that goes a considerable distance in explaining this very rapid growth of structured credit products. In my judgment there will be at least some classes of such products which will go the way of the dinosaur. Experience over the past 18 months or so has shown that in some classes of instruments there will probably be a permanent retrenchment in these kinds of activities

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