TUESDAY 4 DECEMBER 2007

MR E GERALD CORRIGAN, LORD CHARLES ALDINGTON, MR JEREMY PALMER AND MR WILLIAM MILLS

  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 asking.

  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 of 100%.

  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 of ...

  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 sheet.

  Q1227  John Thurso: Other institutions do. Why is your institution not bringing them onto the balance sheet?

  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.[2]

  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.