Examination of Witnesses (Questions 1220
TUESDAY 4 DECEMBER 2007
MR E GERALD
Q1220 Chairman: You have flown across
the Atlantic. Here there is a BBC programme called Strictly Come
Dancing which has a scale of one to 10. On that basis you are
doing well. Mr Palmer, what was your figure?
Mr Palmer: I did not give a figure.
Q1221 Chairman: That is why I am
Mr Palmer: I am not going to give
a figure. We do the best job we possibly can.
Q1222 Chairman: Are you sure it is
10 out of 10 if it is 63¢ on the dollar?
Mr Palmer: It is 10 out of 10
in terms of effort and integrity. History will prove whether we
are right or wrong.
Q1223 Chairman: You have taken the
Cistercian vow of silence?
Mr Palmer: I am telling you that
as far as we are concerned to the best of our ability we performed
the task of independent verification.
Mr Mills: I just wanted to clarify
my comments. We gave a range of $8 billion to $11 billion in terms
of what we could anticipate as losses. That was the number I gave
you. In terms of our books, records and in terms of our disclosures,
we make our absolute best determination; we do that to a standard
Chairman: Looking at it from a simple
point of view, if the banks cannot mark their assets to either
model or market to try to understand where we are in this situation
is very difficult.
Q1224 John Thurso: I turn to the
question of off-balance sheet vehicles. Perhaps I may start with
Mr Mills because his group has about $141 billion of exposure
at the moment. What is the purpose of hiding assets and liabilities
off balance sheet?
Mr Mills: I would not characterise
it as hiding assets off balance sheet. I think, these vehicles
have been appropriate in the sense they have helped facilitate
the raising of capital for various endeavours. We have a number
Q1225 John Thurso: What is the financial
purpose of not having it on your balance sheet? If it is an asset
it makes you look good and if it is a liability you ought to disclose
it, so what is the purpose of not having it on the balance sheet?
Mr Mills: The vehicles that you
are referring in our instance are arm's length transactions. We
have not invested any equity in these vehicles and do not have
any obligation to make sure that we support these vehicles. We
have helped the sponsors of these vehicles by raising capital
for them, but we are not equity investors in these vehicles. They
have been somewhat misclassified as vehicles that we have provided.
Q1226 John Thurso: What do you need
to bring them back onto your balance sheet now?
Mr Mills: We have made a public
statement that we are not going to bring them onto our balance
Q1227 John Thurso: Other institutions
do. Why is your institution not bringing them onto the balance
Mr Mills: I cannot comment on
other institutions. From our perspective, these have all been
arm's length transactions set at commercial terms.
Q1228 John Thurso: You have an arm's
length transaction in which you have invested nothing and for
which you have no liability. Can you explain why you have an exposure
of $141 billion?
Mr Mills: I think the numbers
that people are throwing round are somewhat exaggerated and they
are, frankly, more along the lines of what we would potentially
be supporting in the commercial paper market and what would be
the potential exposure if we chose to bring these vehicles onto
our balance sheet.
Q1229 John Thurso: I am now thoroughly
perplexed. You have something that is not an asset or a liability;
it is classed as an exposure by other people. If you did bring
it into your balance sheet it would have an impact but you do
not intend to do so. Can you help me?
Mr Mills: I will do the best I
can. The facts are: we have sponsored vehicles that have outside
investors that have provided the equity to support these vehicles.
Those equity investors have an economic interest in these transactions.
The exposure arises from the fact that from a business model point
of view they are funded short term and their assets are long term.
What the market is trying to estimate is, if, in fact the liquidity
crisis continues, will we, Citigroup, provide the liquidity to
fund these vehicles so they do not have to go into an asset disposal
mode, especially in an environment where people feel that that
would just add more fuel to the fire. What we have said, particularly
because we understand the assets in these vehicles, is that these
vehicles are in the process of orderly unwinding. The vehicles
have sold ...
Q1230 John Thurso: You are saying
that you do not have an exposure?
Mr Mills: There is the moral hazard
issue as to whether or not from a reputational point of view if
we do not step in and support these vehicles it will somehow hurt
our reputation in the market.
Q1231 John Thurso: But as far as
your stated public balance sheet goes there is no asset or liability
on you involved in these things?
Mr Mills: Right now, Sir, we have
supported the vehicles. I can get back to the Committee with an
exact number, but it is somewhere in the neighbourhood of $8 billion.
Q1232 John Thurso: Mr Palmer, I put
the same basic question to you. It is my understanding that there
are assets and liabilities that are off-balance sheet. That has
been stated in a great deal of press comment and there are various
filings and other things to indicate that. The evidence of Mr
Mills is that it is off-balance sheet because there is no asset
or liability and no exposure. Is that also true of your firm?
Mr Palmer: As a general rule,
my firm does not have any activity in off-balance sheet vehicles
of this kind.
Q1233 John Thurso: Lord Aldington,
does Deutsche Bank have off-balance sheet items?
Lord Aldington: We do have off-balance
sheet vehicles. The original purpose of those vehicles which remains
is to provide a service to clients on both sides of their balance
sheets, that is, clients wanting financing or a slightly enhanced
return. That is the origin of these vehicles; in other words,
it is of perfectly proper commercial origin. As a matter of fact,
under IFRS they have to be consolidated and, further, under Basel
II they would be subject to prudential regulatory control.
Q1234 John Thurso: Mr Corrigan, for
completeness what is your response?
Mr Corrigan: I think that most
financial institutions have at least some form of off-balance
sheet activities, typically in the form of special purpose vehicles.
In the context of these so-called SIVs some institutions have
them; others do not. We at Goldman Sachs do not. The important
point here is that there are fairly clear standards of accounting
in USGAAP, ISB here in the UK and in Europe that stipulate the
ground rules under which any instrument may qualify for off-balance
sheet treatment. At the risk of considerable over-simplification,
the defining principle in making this determination is whether
the purpose of the instrument in question and the risks associated
with it have been transferred to that vehicle such that the sponsoring
organisation unambiguously is not at risk by virtue of that instrument
or vehicle. As we have learned, it is not always quite as easy
in practice to determine whether or not the risk has been fully
transferred to that vehicle, but that is certainly the principle.
Q1235 John Thurso: Perhaps I may
ask for clarification for my simple Scottish mind. It always seems
to me that the risk should be relatively clear, inasmuch as I
lend you some money and am taking a risk. The level of the risk
is whether or not you will pay me back. What you are saying is
that these are elements where the risk I have taken has somehow
been laid off.
Mr Corrigan: That is correct.
Q1236 John Thurso: That is done in
such a manner that if you fail to pay me back I do not take the
hit. If that is 100% true then it is off-balance sheet, but the
problem is that these things are so complicated and complex that
I may think I have laid it off but in reality I have not.
Mr Corrigan: I have some sympathy
for what you have just said. I fully expect that as a result of
some of the things we have seen in the recent past accountants
and others will take a fresh look at the precise criteria that
satisfy the conditions of that sort of risk.
Q1237 John Thurso: The exposure of
Mr Mills has to do with the potential loans he may have to make
to fulfil the obligations that may or may not be in those vehicles.
Mr Corrigan: With all due respect,
Mr Mills made a point that should not be ignored. Even if it is
true, as I expect it probably is in this case, that the risk differentiation
is clear enough it still does not solve the reputational risk
problem. Over the decades and centuries we have seen cases in
which financial institutions have made a determination that even
if they are fairly confident that the legal and accounting risk
is clear considerations of reputation may leave them with little
or no choice but to step up anyway. The reputational and financial
risks have to be thought out in juxtaposition to each other.
Q1238 John Thurso: Ultimately, on
the grounds that the objective of a balance sheet is truly and
fairly to state the assets and liabilities of an entity with a
view to the outside observer being able to have proper view of
net worth, do you agree that we need to take a long hard look
at off-balance sheet vehicles and be a lot more rigorous about
them? Perhaps we can have quick answers from the panel.
Mr Mills: I think that the answer
clearly is yes. I would say that in response to your point, the
equity market is already assuming that risk when it looks at the
valuation of the stock.
Lord Aldington: Yes. I add that
in all of my banking experience the issue of what should be on
and off-balance sheet always comes up for discussion.
Q1239 John Thurso: I think Mr Corrigan
has given me his answer. What do you say, Mr Palmer?
Mr Palmer: I agree, and I think
it is already happening.
2 Note by witnesses: a) Whilst DB has structured
off balance sheet vehicles, in answer to this question I was specifically
referring to ABCP (IE asset backed commercial paper) conduits
rather than all off balance sheet vehicles. b) The vast majority
of these conduits have to be consolidated under IFRS. As of 30
September, DB had EUR 32 bn of sponsored conduits of which EUR
5 bn were not consolidated under IFRS. c) Under Basle II, the
exposure of the Bank to these vehicles will need to be reflected
in a more risk sensitive manner, which may trigger higher regulatory
capital charges. Back