Citigroup Still Rolls the Dice on Mortgage Bonds

In-house traders speculate with the bank’s money

Anna Raytcheva’s bets on mortgage bonds for Citigroup lost billions of dollars in value as the financial crisis raged. Now, thanks to an exemption in rules meant to curb risk-taking by banks, Raytcheva is gambling with Citigroup’s money again. This year, Citigroup put Raytcheva in charge of a four-person team to wager on government-backed mortgage bonds. The group manages more than $1 billion and does not work with the bank’s clients, according to a person with direct knowledge of the unit who declined to be named because the information is not public.

In writing the Volcker Rule, part of the 2010 Dodd-Frank Act, regulators sought to curb banks’ proprietary trading—that is, making speculative short-term investments with their own money. The law makes an exception for trading in government securities, including more than $5 trillion of “agency” mortgage bonds guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Lawmakers created the exemption to make sure there would be an active market for government debt, according to Barney Frank, who as a Democratic congressman from Massachusetts helped draft the Dodd-Frank Act, and because the bonds are guaranteed not to default. “To the extent the instruments being traded are completely secure, some of the rationale for the rule disappears,” Frank says.

Although government securities are immune from default, they can still be risky. Traders can suffer losses when interest rates fluctuate, especially if they use borrowed money to magnify returns, according to Josh Siegel, a former Citigroup banker and now chief executive officer of investment firm StoneCastle Partners. “Is there risk?” Siegel says. “Of course there is.”

Raytcheva, 41, is a Bulgarian-born bond trader educated at Princeton University. As the housing bubble inflated in the 2000s, she was on a Citigroup team that amassed $30 billion in assets, including mortgage bonds that didn’t have government backing and were tied to borrowers with weak credit profiles, according to a person with knowledge of her work. The value of Raytcheva’s position dropped by at least $2 billion from the market’s peak to its lows in early 2009, though not all the paper losses were recognized because of accounting rules, a former colleague says.

The Volcker Rule limits the exemption for government securities if the trading involves conflicts of interest, exposure to high-risk strategies, or risks to the safety of the financial system. Mark Calabria, director of financial-regulation studies at the Cato Institute, which supports free markets, says Raytcheva’s group raises questions about how much risk banks are taking. “This could run afoul of the spirit of the law,” he says.

Citigroup may be interpreting the exemptions more liberally than other banks, says Clifford Rossi, a former risk manager at the lender. Citigroup’s catastrophic losses during the financial crisis prompted a $45 billion taxpayer bailout. “I would have expected Citi to take a different path,” says Rossi, who left in 2009 and is now an executive in residence at the University of Maryland’s Robert H. Smith School of Business. The team’s existence, he adds, is “surprising and a little disappointing, to be quite honest.”

Asked about Raytcheva’s team, Citigroup said in a statement that “the products traded in this business will be fully compliant with the Volcker Rule.” Spokesmen for the Office of the Comptroller of the Currency, the Fed, and the Federal Deposit Insurance Corp., all of which regulate Citigroup, declined to comment.

At least a half-dozen Wall Street traders of agency mortgage bonds say they are not aware of proprietary trading teams such as Raytcheva’s at Citigroup’s rivals, including JPMorgan Chase, Bank of America, Goldman Sachs Group, and Morgan Stanley. Senior executives at two global banks, who asked not to be identified because they weren’t authorized to speak about the matter, say they see the government debt exemptions as geared toward market making—facilitating trading by clients—which is why they don’t have separate proprietary desks for the securities.

Bets on the debt may be unusually treacherous now with the Federal Reserve reducing its bond purchases this year and interest rates poised to rise, according to Anthony Sanders, a professor of real estate finance at George Mason University. “All it takes is a hiccup in rates and we could see some serious losses,” Sanders says. “As soon as the Fed stops buying these bonds, it’s going to be like musical chairs, and someone is going to end up without an empty seat.”

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