Remarks
Allen Frankel*
Federal Reserve Board

This panel session offers us an opportunity to reflect on broader ideas concerning
the relationship between the institutional architecture of financial risk bearing andsystemic risk. This relationship has been touched on throughout this conference.
Indeed, at our first conference this was the focus of Professor John Campbell’sremarks as the moderator of the wrap-up panel session when he spoke of the needfor innovations in the means through which concentrations of risk exposures canbe dissipated.
In my remarks today, I thought that it would be most relevant to explore someof the issues of financial architecture raised for me by recent failures and nearfailures of financial firms. These issues are concerned with the relationships
between leveraged specialized financial firms and the major international dealers
in risk transfer products in periods of financial stress. I have chosen to get at theseissues by reviewing the case of Criimi Mae, a publicly traded U.S. financial firmthat filed for protection from its creditors under Chapter 11 of the U.S. bankruptcy
code in early October 1998. The filing, in addition to extensive routine publicfinancial disclosures, has made public much information concerning the activitiesof Criimi Mae and recent disputes with its creditors that precipitated the bankruptcy filing.
In its court filing, Criimi Mae outlined the following chain of events. The very
recent (post Russian debt default) turmoil in global credit markets precipitatedcollateral calls by its secured creditors. The collateral calls created an extraordinary strain on the firm’s available cash resources at a time when it was extremely
difficult to raise capital or secure cash from market sales of “in the money” risk
exposures. That is, Criimi Mae holds itself to be a victim of global financial
market contagion, and, therefore, entitled to protection from its creditors. The
protection, if granted, will afford Criimi Mae an opportunity to stabilize its operations and reorganize its business.
By way of background, Criimi Mae is a full-service commercial mortgage
company that is operating as a real estate investment trust (REIT) to benefit fromU.S. tax law. Criimi Mae’s primary activities include (i) acquiring non-investment(rated and non-rated) grade subordinated securities backed by first mortgage
loans on multi-family properties and other commercial real estate and (ii) origi*

The views are solely the responsibility of the author and should not be interpreted as reflecting
the views of the Board of Governors of the Federal Reserve System or of any other person associatedwith the Federal Reserve System.

2Kenneth J. Singleton

nating, servicing and securitizing commercial mortgage loans and mortgagebacked securities. Press reports have characterized Criimi Mae as the single
largest holder of non-investment grade commercial mortgage-backed securities,
complex structured securities with concentrated credit risks.1
Criimi Mae financed its securities positions through collateralized borrowings
from major dealers in risk transfer products, a number of U.S. money-centerbanks and U.S. investment banks. In the wake of the generalized surge in credit
risk premia over recent months, these counterparties upped the face amount of thesecurities to be placed with them as the collateral they required from Criimi Mae
to secure their financing. In public statements on the case, Criimi Mae’s management commented that the firm’s creditors had been using financial news
reports of general market turmoil to rationalize low prices for performing mortgage assets that were generating as much cash flow as they did three months
earlier.2 The creditors responded by commenting on the risk to their interests
involved in a delay of their liquidation of the collateral holdings.
In a post-filing discussion of the firm’s financial situation, Criimi’s management acknowledged that the market for the types of securities that were held by
the firm is not highly liquid. They asserted that this condition explained theabsence of a reliable public benchmark to be used in the valuation of the mortgage-backed security collateral that Criimi had provided its creditors to secure
financing. Nevertheless, the 30 percent discrepancy in valuation that emerged inCriimi’s lawsuit against Morgan Stanley has to be considered surprising in viewof the prominent professional roles played in the market for commercial mortgage-backed securities by both firms.3 This very large discrepancy in the supposed mark-to-market valuations of securities possibly highlights why there areconcerns about the limited information content of mark-to-market based valuation
data for non-traded securities or, for that matter, customized OTC derivativespositions.
The bottom line of my remarks for research on systemic risk issues is straightforward. The volatile conditions that we have witnessed in global credit markets
over recent months have stressed important elements of the current system for thedistribution of financial risks in global markets. These experiences should berecorded by researchers as case studies since such efforts promise to produce dataon questions related to the usefulness of public and private disclosures of information in controlling risk taking by leveraged financial firms. In turn, such casestudies, in aggregate, can provide a body of evidence required for our making
judgements about judging the structural integrity of the system as a whole.

1
A discussion of securities held by Criimi Mae is found in the motion filed by Merrill Lynch
Mortgage Capital Inc. on October 16, 1998 in United States Bankruptcy Court for the District ofMaryland (Southern Division) – Chapter 11 Case No. 98-23115.
2An overview of the public positions that have been set out in the Criimi Mae can be found in aNovember 4, 1998 article in the American Banker entitled “Credit Drought Withering Speciality
Finance Firms.”
3For a background discussion of Criimi Mae’s now pending lawsuits against its creditors see anarticle by Jerry Knight entitled “Criimi Mae Sues 3 Major Creditors,” Washington Post, October 22,
1998.