The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . an by Dunbar Nicholas

Author:Dunbar, Nicholas [Dunbar, Nicholas]
Language: eng
Format: epub
ISBN: 9781422177815
Publisher: Perseus Books Group
Published: 2011-07-12T04:00:00+00:00

Fed Up with the Fed

The Federal Reserve may have been at the top of the U.S. regulatory pecking order, but within the Fed itself, the New York branch was top dog when it came to regulating banks. This was hardly surprising given the dual importance of Wall Street as the engine room of the bond markets and as the base for the largest multinational U.S. banks. It was only natural that industry risk-management innovations like VAR were first identified by staff in the New York Fed’s markets division, such as Peter Fisher, who transmitted the ideas to the rest of the regulatory community.

Ever since the regulatory blessing of VAR in the mid-1990s, the New York–based multinational banks had been growing rapidly. By 2003, when William McDonough retired as New York Fed president and was replaced by Timothy Geithner, an ambitious former Treasury and International Monetary Fund bureaucrat, bank supervision was equally important to markets.

If any U.S. commercial bank needed to be challenged, it was Citigroup. In 1999, when then-chief executive Sandy Weill had needed an act of Congress in order to fuse the SEC-regulated Salomon Brothers with Fed- and OCC-regulated blue-chip lender Citibank, he had taken care to reassure his new shareholders and supervisors about the importance of governance. A veteran ex-AIG and Chemical Bank executive, Petros Sabatacakis, was appointed chief risk officer of the new conglomerate and ordered to rein in the freewheeling Salomon traders. Sabatacakis was so tough in applying position limits that on the trading floor he was known as “Dr. No.”

Then came Enron and the dot-com bust. Sabatacakis may have ensured that the bank (unlike Chase Manhattan) avoided significant losses in the shakeout, but Citigroup’s conflicted role in bond underwriting, derivatives, and investment research left it open to the charge of having facilitated massive fraud at Enron and WorldCom. That led to the New York Fed and the OCC censuring the bank in July 2003, as part of a settlement in which it didn’t have to admit wrongdoing.23 Weill was forced to quit as chief executive (while remaining chairman).24

The incoming CEO, former general counsel Chuck Prince, may have seemed like a steady pair of hands on the wheel, but it was Prince who undermined the risk governance mechanism that Weill had put in place. Prince allowed Tom Maheras, the head of fixed income, to appoint his own risk managers. Feeling that his independence had been compromised, Sabatacakis quit in 2004 and was replaced by a Maheras crony, David Bushnell, whose first move was to abolish Sabatacakis’s trading book position limits.25

Hidden from public view, this weakening of internal risk governance made it ever more essential that Citi, the largest bank in the United States, was supervised properly. It was essential that the bank’s day-to-day supervisors were not intimidated by the conglomerate and Weill, its charismatic chairman. A former senior New York Fed staffer recalls that the OCC seemed particularly cozy with Citigroup: “I remember being in a meeting in Citigroup, and Sandy Weill stopped by. He gave a big hug and a kiss to this lady examiner from the OCC .

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