...when examiners from the Securities and Exchange Commission began scrutinizing Citigroup’s subprime mortgage holdings after Bear Stearns’s problems surfaced, the bank told them that the probability of those mortgages defaulting was so tiny that they excluded them from their risk analysis, according to a person briefed on the discussion who would speak only without being named.Another amazing item is that Citigroup mainly relied on ratings agencies rather than its own risk managers to assess the risks from assets like CDO's. One might understand this if Citi was just selling the assets to gullible investors (which it did), but it held huge slices itself, and it is the losses on the assets it retains that have caused such large losses.
It is amazing to read how a company could lose $220 billion in market value in just two years. As Brad DeLong emphasizes, however, the losses in market value dwarf the announced losses on CDO's and other real estate loans. DeLong's argument is that the risk premium on holding Citi equity has risen as the crisis worsened. After all, the probability that the government will dilute the shares in a takeover has increased dramatically. He takes the rise in the risk premium as the major factor causing the value of Citi's shares to decline so dramatically.
DeLong's analysis is based on the observation that banks are institutions that trade on reputation and trust. The borrow short and lend long. Hence, they are always on the edge in a financial crisis. The risks bank take that are sensible in normal times appear insane in rough times.
Rescue package soon to follow.