Examination of Witnesses (Questions 1160
TUESDAY 4 DECEMBER 2007
MR E GERALD
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
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
Q1162 Chairman: We are getting somewhere,
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
inevitableit is a trait of human naturethat 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
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
Q1169 Chairman: Mr Mills, do you
have empathy with that sentiment?
Mr Mills: I do recognise the complexities,
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
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"
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
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 productsI agree with
that characterisationwas 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