Citigroup exec found gold in toxic assets that led to bailout

by 09 Jun 2016
The memo landed on a Sunday in November. It was 2007, and securities backed by subprime mortgages were roiling markets and imperiling banks. Merrill Lynch Chief Executive Officer Stan O’Neal had just resigned under pressure, and Citigroup CEO Chuck Prince was rumored to be on his way out.

So the Nov. 4 memo to employees in Citigroup’s markets division seems bold in hindsight. While other banks were looking to unload the toxic securities and Citigroup was taking an $11 billion writedown on its holdings, then-trading chief Jamie Forese and fixed-income head Paco Ybarra had other plans. They announced they’d turn the bank’s souring mortgage debt over to a new team and chart a course for the future. It was, they said, a “great opportunity.”

The man they would soon ask to oversee that strategy was Mark Tsesarsky, a refugee from Ukraine with intense blue eyes and a cool demeanor. At the time, T-Man, as he was known around the bank, was head of special situations for securitizations, which meant he made bets on Citigroup’s behalf with bonds backed by mortgages and other assets. Now his bosses were asking him to help limit losses on someone else’s portfolio of collateralized debt obligations—instruments with names such as Bonifacius and Jupiter that were threatening to destroy the bank—and find a way to profit from the turmoil.

Over the next eight years, Tsesarsky and his team did just that. They rebuilt their bank into Wall Street’s biggest for CDOs, not by issuing securities but by buying billions of dollars of debt, holding it as values rose, and trading with customers. In the three years ended in December 2015, the handful of traders notched almost $2 billion in revenue, more than any other desk at the bank, according to people familiar with the company’s operations. Their performance was made possible by an unprecedented rescue of the financial system, including a bailout of Citigroup, and a flood of central bank money that lifted asset prices.

Tsesarsky, 54, declined to comment. He hasn’t given an interview since 1999, when he told the Jewish Week that his experience being discriminated against as a Jew in the former Soviet Union “makes me stronger and different.” The bank’s senior executives declined to comment as well. But the story of how he did it, pieced together from conversations with more than a dozen current and former executives, shows that even on a safer and sounder Wall Street and at a bank that says it wants to be more boring, a trader can wager billions of dollars in often opaque debt markets.

On a sunny day this spring, construction workers in hard hats mingle outside two buildings in Lower Manhattan that have long housed Citigroup’s investment bank and that this year became the company’s headquarters. Michael Corbat, who became CEO in 2012, has been restructuring Citigroup, selling unwanted assets, shrinking its global footprint, boosting capital, and trimming staff. The scaffolding shrouding the bottom of one building is a sign of the changes.

But on the trading floor where Tsesarsky has a desk, at the top of the other building, little has changed. A wiry man who favors designer suits and ties, Tsesarsky runs the asset-backed bond-trading business behind a veil of secrecy. CDOs are only a small part of an empire that includes securities linked to auto or credit card loans, mortgages, and consumer-installment debt. For two decades, Tsesarsky shared leadership with Jeffrey Perlowitz, who announced his retirement in March. The louder of the two, Perlowitz was the id to Tsesarsky’s superego, says one person who’s known both men for years.

“There’s a serene balance that he has,” James Zelter, a former Citigroup colleague and now head of investments at Apollo Global Management’s credit unit, says about Tsesarsky.

To understand how Tsesarsky turned toxic assets into gold, it’s worth going back to the market’s beginnings. In the 1970s, less than 10 years before Tsesarsky joined Salomon Brothers in 1986, a trader there created the first private mortgage bond by pooling home loans and divvying up the cash flows into different securities. The innovation spread risk across thousands of loans, making them easier to trade and attracting investors unwilling to buy single mortgages. It catapulted Salomon to the top of Wall Street.
By the turn of the century, the idea’s success led bankers to a little-used instrument with an esoteric name, the collateralized debt obligation. Working much like a mortgage bond, a CDO packaged existing securities into new debt. It was a second-generation magic trick that enabled even subprime mortgages to be transformed into triple A-rated paper. The market took off, increasing to $521 billion in 2006 from $68 billion in 2000, according to Securities Industry and Financial Markets Association data. Citigroup, which had swallowed Salomon in 1998, became the biggest issuer of CDOs.

As home prices crested in 2006, investors found themselves too far from borrowers to judge the securities’ risk and rushed for the exits. Banks had trouble unloading their inventory. The busiest arrangers—Citigroup, Merrill Lynch, and UBS, among them—suffered billions of dollars in losses as the debt plunged in value. By the time of trading chief Forese’s November 2007 memo, it wasn’t clear there’d be much left but rubble for Tsesarsky to manage. In December analysts at Barclays predicted the safest portions of the securities could lose as much as 80 percent of their value. Many considered the instrument broken, and much of Wall Street left the market for dead.

Citigroup, however, wasn’t ready to give up. Executives, including Forese, viewed their experience in the business as the key to growth. Add to that Tsesarsky’s more than two decades in the mortgage markets, and Citigroup’s leadership thought it could make money and avoid another near-death experience, according to an executive privy to the discussions. In short, the bank decided to go long.

Ten months later, Lehman Brothers declared bankruptcy, plunging the world into a crisis that threatened the financial system. Citigroup needed a government transfusion of more than $500 billion, including emergency loans and asset guarantees— at least $14 billion for risky mortgages in Tsesarsky’s portfolio—and the U.S. Department of the Treasury took a 27 percent stake in the bank.

Even so, Tsesarsky’s team enjoyed more freedom than others, says a former colleague. In at least one instance, Tsesarsky helped persuade management to give more resources to the business, beating Bank of America and other rivals that didn’t want to commit the additional capital.

“It’s impossible to imagine. You’re being bailed out with one hand, and you’re pouring money into the very same assets that precipitated the bailout with the other.”

Citigroup was ready when the Federal Reserve Bank of New York auctioned a portfolio of CDOs in 2012. The team canvassed customers and collected orders, making pitch after pitch about its deep knowledge of the securities and their cheap prices, according to a person with knowledge of the strategy. In cases where the bank saw something too good to pass up but couldn’t persuade investors to bid, it used its own money to buy the debt, the person says. Of the more than $45 billion sold by the central bank, Citigroup won $6.3 billion, paying an average of 38¢ on the dollar.

Over the next few years, the bank reaped the rewards, becoming the go-to source for the more than 500 mutual funds, hedge funds, and other institutions still trading CDOs, according to one person familiar with Citigroup’s operations. And because there was less competition in an illiquid market, the difference between what Citigroup paid for the bonds and what it sold them for was greater than in less opaque parts of the debt markets, the person says.

The bank also stocked up on inventory and profited when those positions rose in value. In the first years after the crisis, bargains were plentiful: Much of the CDO market traded at deep discounts. As home prices rebounded, borrowers refinanced loans or started making payments, and the securities recovered.

In some cases, Citigroup took steps to force gains by amassing senior positions in CDOs and unwinding the structure, getting access to the mortgage-backed securities inside that traded at higher prices, says a person with knowledge of the bank’s strategy. The trade has typically been a hedge fund strategy because banks face capital constraints, according to Grant Buerstetta, a partner at Blank Rome who specializes in the deals. “To get a deal unwound is a home run,” he says.

While it isn’t clear how much Citigroup made from marking up inventory, one thing is certain: By 2015 the bank had full control of the CDO market. It traded about $6 billion of the securities with roughly 150 customers that year, according to a person with knowledge of the operation. That amounted to about $700 million of revenue, or 80 percent of the market, says another person. The tally, more than 6 percent of the bank’s total from bond trading last year, was large enough to save the unit from reporting its worst performance since before the financial crisis. The team booked $700 million in 2013 and $500 million in 2014, that person says. The gains helped the larger securitized-markets operation run by Tsesarsky and Perlowitz tie for No. 1 on Wall Street, according to Coalition, a London-based research firm.

The success of the unit and its unusual mandate stuns Ronald Colombo, a law professor at Hofstra University and former counsel to Morgan Stanley. “The theatrics are horrible,” he says. “It’s impossible to imagine. You’re being bailed out with one hand, and you’re pouring money into the very same assets that precipitated the bailout with the other.”

The performance of Tsesarsky’s team is notable not only for its size but also because of new rules that sought to limit the risks that banks could take. Deep in the 2010 Dodd-Frank Act, Section 619 forbids banks from engaging in proprietary trading, the practice of making bets with their own money. Known as the Volcker Rule for the former Federal Reserve chairman who championed it, the law sought to curb Wall Street’s speculative ways. It can be difficult to determine if a trade is for a client or the bank’s own account, so lawmakers zeroed in on banks’ inventory and the length of time securities are held. As a result, the rule stipulates that firms are exempt if they can prove that trades don’t “exceed the reasonably expected near-term demands of clients, customers, or counterparties.”

With illiquid positions such as those in the CDO market, that can be a blurry line, and companies have more opportunity to interpret the rule in their favor, according to Charles Whitehead, a Cornell University law professor. While Citigroup says the inventory buildup meets client demand, other banks may have shied away for fear of violating the letter or spirit of the rule, Whitehead says.

“All of our activities comply with every applicable regulation, including the Volcker Rule,” says Danielle Romero-Apsilos, a spokeswoman. “Citi has been successful in our securitized-markets and structured-credit businesses because we have stood with clients in all market environments.”

“He came here with nothing. You have very little room for error when you have nothing.”

For Tsesarsky, it was just the latest winning trade. As a teenager in Ukraine, he escaped with his mother, grandmother, and sister to the U.S. with $90, according to a 1999 profile in the Jewish Week, which interviewed him after he won the Young Leadership Award from the Wall Street division of the UJA-Federation of New York. Growing up Jewish in the former Soviet Union, he risked arrest to read Leon Uris’s novel Exodus, about the founding of Israel. He became a “Zionist in hiding,” he said.

That upbringing informed his career on Wall Street, where Tsesarsky is known for his skill analyzing complicated trades, says David Finkelstein, a former colleague and a senior executive at real estate investment trust Annaly Capital Management. “He came here with nothing,” Finkelstein says. “You have very little room for error when you have nothing.”

During high school in Colorado and college at the Colorado School of Mines, Tsesarsky delivered pizzas, ushered at a movie theater, and worked at Kentucky Fried Chicken. After earning an MBA from the University of California at Los Angeles, he headed east.
It was 1986—exciting times on Wall Street. Salomon, where Tsesarsky had won a spot in the training class, was pioneering new ways to package home loans into bonds. A year earlier, CEO John Gutfreund was crowned the “King of Wall Street.” In 1989, Michael Lewis’s Liar’s Poker would be published, further cementing the company’s reputation as a home for swashbuckling bond traders. After surviving the arduous program, Tsesarsky earned an assignment trading mortgage bonds.

It was the first time he’d prove adept at navigating the politics of Wall Street. While the typical mortgage trader was loud and obnoxious—eating marathons were common, Lewis wrote—Tsesarsky stood out for keeping kosher. In other ways, he fit right in. He was disciplined, fearless, and always looking for an edge, says Steven Beck, a former Salomon colleague. Before the widespread use of modeling software, Tsesarsky kept a manually updated list of hundreds of bond prices from the prior night’s close, Beck says. Competitors avoided big trades until Tsesarsky was on vacation, although he followed the market closely even when traveling. Tsesarsky once called a junior trader from the top of a Colorado ski slope to place a trade, according to Beck. “Mark was obsessed,” he says. “He wanted to win badly, he had a knack for winning, and he was determined to be the best trader on the Street.”

In 1991, Tsesarsky received a promotion to head the team that trades government-backed mortgage bonds after a trader got in trouble for rigging bids in Treasury auctions, Beck says. It was at about this time that Tsesarsky first worked with Corbat, then an Atlanta-based bond salesman.

When Sandy Weill’s Travelers Group bought Salomon in 1997, Tsesarsky was tapped to run mortgage trading for the combined company. He’d share the role with Perlowitz, beginning one of the longest-running partnerships on Wall Street. Named to lead the special situations securitization business in 2007, Tsesarsky oversaw Citigroup’s push into film financing, traveling from Colombia to South Korea to evaluate potential investments, says a former colleague.

During those years, Tsesarsky kept the Salomon culture alive for a generation of mortgage traders. That meant being tough on colleagues when they made mistakes and rebuilding their confidence once the lesson was learned, says Finkelstein, one of at least a dozen traders who learned from him and went on to leadership positions in the industry.

Tsesarsky also has a protective side, former colleagues say. According to Finkelstein, nothing was more terrifying than committing Citigroup’s capital as a junior trader under Tsesarsky. “When you make a mistake, you know it,” he says. “You are in the hot seat.” However harrowing the experience, Tsesarsky was always the mentor. “He makes sure you learn from it,” Finkelstein says. “He doesn’t let people fail.”

And even when they lose money, Tsesarsky stands up for them. Former colleagues say he championed Anna Raytcheva, a Bulgarian-born trader who lost billions of dollars during the financial crisis and an additional $50 million in 2011 on bad mortgage bets. (A team run by Raytcheva that used the bank’s money to make bets on government-backed bonds was disbanded in May.)

Tsesarsky and Perlowitz made their own blunders, too. They lost money on a 2004 German mortgage deal and in February 2007 provided a cash infusion to the struggling parent of Ameriquest Mortgage, once the largest U.S. subprime lender. By August, Citigroup had agreed to buy parts of the business.

Ameriquest ran late-night television ads that attracted lower-quality borrowers, and the acquisition was doomed from the start, says Richard Couch, an executive at the time in Citigroup’s corporate mergers-and-acquisitions group. Some executives opposed the plan, code-named Project Adventure, but lacked the power to stop them, according to Couch, who refused to bless the deal’s financials before sending Tsesarsky and Perlowitz to the board. “We wanted nothing to do with this thing,” he says.

Six months later, incoming CEO Vikram Pandit dismantled much of the Ameriquest operation. By then, Tsesarsky was overseeing the CDO business.

Tsesarsky's success in the CDO job—the $2 billion score Corbat, Forese, and other top executives don’t want to talk about—points to Citigroup’s continuing appetite for risk. The bank has more than doubled its derivatives holdings over the past decade, according to regulatory filings, and beefed up commodities trading.

Romero-Apsilos, the Citigroup spokeswoman, says the bank employs “prudent risk-management practices” in its asset-backed securities business. But the secrecy shrouding Tsesarsky’s unit and the history of complicated, structured products on Wall Street raise questions about Corbat’s commitment to making the company safer and more boring.

“No one really has any idea of the risks these banks are taking and therefore the threat they pose to the financial system at any point in time,” says Dennis Kelleher, president of Better Markets, a nonprofit that advocates for tougher financial regulations.

Those risks may be diminishing, at least for the CDO business, as new deals remain scarce and older ones unwind or pay off. For Tsesarsky, that means plenty of time to contemplate what’s next on the 4-mile walk he often takes between his office and the home on Central Park West he shares with his wife, who’s a rabbi, and their four children. There’s plenty to keep him busy: He sits on the board of an Upper West Side synagogue that calls itself the oldest Jewish congregation in the U.S., and he contributes to pro-Israel and Jewish causes. He once bought plane tickets for 250 Russians immigrating to Israel and joined them on the trip. “People on Wall Street become jaded and think that money is all that’s important in life,” he told the Jewish Week in 1999. “The indifference really bothers me.”

Yet Tsesarsky is always searching for the next profitable trade. “He has this ability to see the long game, and he has this feeling for the market and where it’s going,” Finkelstein says. “When he sees opportunity, he jumps on it.”

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