Did Repeal of Glass-Steagall for Citigroup Exacerbate the Crisis?
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ETHICS Curtis C. Verschoor, CMA, Editor Did Repeal of Glass-Steagall for Citigroup Exacerbate Freed from the restrictions of the Glass-Steagall Act, giant bank- the Crisis? holding companies appear to have been focused more on industry should be recognized as Citibank and Travelers Group. In meeting the expectations of Wall at least a quasi-public utility, exist- addition to the traditional bank- Street analysts than on protect- ing in large part for the benefit of ing services, this $140 billion ing depositors’ funds from risk. depositors who need to have con- umbrella encompassed brokerage, tinuing confidence that their investment banking, and several funds are safe. insurance companies, including mid the finger-pointing After the savings and loan disas- Travelers. Agoing on in regard to the cur- ter caused the previous banking More recently, urged on by for- rent banking crisis, it seems that debacle, the FDIC Improvement mer U.S. Treasury Secretary we may be forgetting who the real Act of 1991 mandated that insured Robert Rubin, Citigroup’s director culprits are. Should we blame the institutions employ adequate con- and chair of its Executive Com- bungling bureaucrats in Fannie trols to manage their risks in order mittee, Citi acquired heavy expo- Mae, Freddie Mac, the Federal to maintain the safety and sound- sure to Collateralized Debt Oblig- Reserve, the Securities & Exchange ations (CDOs) based on subprime Commission (SEC), and the Trea- mortgages. By 2006, Citi had sury Department? Or are the regu- It will take a major become the second largest under- lators (perhaps they should be overhaul of business writer of CDOs. Unfortunately, called “watchers” considering their Citi’s risk management function recent performance) not at fault culture and its failed to rein in these activities as for problems that arise? After all, governance to reduce danger signals began to appear. regulators are only interpreting (In January 2009, Rubin resigned the will of Congress, which passed the tremendous from Citigroup with some observ- the laws the regulators are sup- costs of unethical ers describing it as “in disgrace.”) posed to be enforcing. Similar to what other firms did Or should we put the blame for behavior. (see December 2007 column, the crisis on the scheming actions “Who Should Be Blamed the Most of CEOs of banks like Citigroup ness of banks and thrifts. Perhaps for the Subprime Loan Scandal?”), (Citi) and their hirelings, who take the financial services landscape Citi’s risk efforts relied heavily on advantage of every legal loophole, has changed so much since then the flawed work of credit rating only look out for their own inter- that bank-holding conglomerates agencies. It believed that the possi- ests, and forget they are fiduciaries such as Citi are so diverse that any bility of trouble with its CDOs for other stakeholders, which focus on managing risks for bank was so tiny (less than 1/100 of include their depositors, share- depositor protection has become 1%) that it excluded them from its owners, employees, and the gener- so diluted it hardly exists. risk analyses—even after Bear al public? After all, the highly Citigroup was formed in April Stearns ran into serious subprime regulated commercial banking 1998 through the merger of trouble in the summer of 2007. F ebruary 2009 I STRATEGIC FINANCE 13 ETHICS Unfortunately, the continuing rationale, the Gramm-Leach- the high rewards inherent in subprime crisis hit Citi hard, Bliley Act (GLB) was enacted in investment banking and to avoid resulting in the largest federal November 1999, repealing G-S. recognition of the risks necessary bailout in history. In October and This legislation was encouraged to achieve them. The giant bank- November 2008, Citi received a by then-Treasury Secretary holding companies seemed to total of $45 billion in equity fund- Rubin, who joined Citigroup minimize the protection of depos- ing from the Troubled Assets shortly thereafter. GLB eliminated itors’ funds from excessive risk Relief Program (TARP). Treasury the ban on entities engaging in that is so necessary in commercial made additional guarantees to both insurance underwriting and banking. The concentration of assume losses (with taxpayer wealth in fewer hands also fueled money). a level of competitive greed that Because Citi became such a For guidance in applying seemingly overcame good busi- diverse financial services enter- the IMA Statement of ness sense. prise in 1998, it was legally incom- Long-time former Federal patible with the Glass-Steagall Act Ethical Professional Reserve Chairman Alan Green- of 1933 (G-S), the legislation that Practice to your ethical span testified before Congress in established the Federal Deposit October 2008 that he had made a Insurance Corporation (FDIC) dilemma, contact the “mistake” in believing that banks and forbade banking entities from IMA Ethics Help-Line at operating in their own self- acting as both a commercial bank interest (without regulatory (800) 245-1383 in the and an investment bank or broker. oversight) would be sufficient. Reasons for the establishment of U.S. or Canada. In other He said that he had found “a flaw G-S include: countries, dial the AT&T in the model that I perceived is 1. Conflicts of interest character- the critical functioning structure ize the granting of credit USADirect Access that defines how the world lending and the use of credit Number from works.” Greenspan bluntly called investing by the same entity. the current financial crisis a 2. Depository institutions possess www.usa.att.com/ “once-in-a-century tsunami.” enormous financial power by traveler/index.jsp, then Greenspan said that he and oth- virtue of their control of other ers who believed lending institu- the above number. people’s money; their influence tions would do a good job of must be limited to ensure protecting their shareowners are soundness and fair competition in a “state of shocked disbelief.” in the market for funds. commercial banking, thus What Greenspan is really saying 3. Securities activities can be risky retroactively approving the com- is that the CEOs and staffs of and can threaten the integrity bination of Citibank and Travel- companies such as Citigroup can’t of deposits. Since the govern- ers. GLB also required strict con- be trusted to act in the interest of ment insures deposits, it could formity to the Community their own shareowners, let alone be required to pay large sums if Reinvestment Act (CRA), which in the public interest, even when a securities losses led to bank requires depository institutions to regulator is supposed to be look- failures. meet the needs of borrowers, ing over their shoulder. The mes- 4. Managers of depository institu- including low- and moderate- sage we should take from the cur- tions may not be conditioned income neighborhoods, thus rent financial crisis is that people to operate prudently in more eliminating “red-lining.” will act in their own short-term speculative securities Many observers believe GLB self-interest unless there businesses. allowed firms such as Citi to focus are strong cultural, not legal, too much on meeting the expecta- impediments. In spite of this compelling tions of Wall Street analysts and Unfortunately, it appears that 14 STRATEGIC FINANCE I F ebruary 2009 acting ethically in the long-term ance and investment banking in best interests of others isn’t very the same corporate entity won’t popular these days. Over just a work. This approach only invites few days, the words “major action to legally circumvent the fraud” jumped out of almost objectives of separation. Totally every page of the newspaper. separate legal entities are neces- Bernie Madoff apparently lied to sary to permit good governance his friends for years while mak- functions, transparency, and nec- ing off with an estimated $50 bil- essary regulatory oversight to pro- lion with only a one-man store- mote regained trust in a market- front CPA firm watching him. based savings and investment Fry’s Electronics Inc. executive community. Transparency and Ausaf Umar Siddiqui was arrest- accountability, two ethical charac- ed on federal charges that he teristics very much needed today, defrauded Fry’s of $65 million in can be better achieved in smaller, a kickback scheme. Lawyer Marc less complex, and less diverse Dreier was accused of causing entities. losses of at least $380 million by It will take a major overhaul of scamming hedge funds into buy- business culture and its gover- ing worthless securities. In India, nance to reduce the tremendous the CEO of Satyam Computer costs of unethical behavior. As Services said he “created” a bil- mentioned in last month’s col- lion dollars of fictitious cash. umn, the Federal Sentencing “This is probably the biggest Commission has it right by surge in financial crime [per- requiring organizations to have a haps] since the savings and loan strong ethical culture. crisis of the 1980s,” said David Congress has to be up to the Cardona, head of the criminal task of prescribing strong medi- division in the FBI’s New York cine for curing the ethical ills of office, where most of the business. The new administration Bureau’s Wall Street probes start. must make sure the medicine Yet fewer fraud cases are being works. SF prosecuted by the FBI and the Justice Department because of Curtis C. Verschoor is the Emeritus reductions in staffing. Ledger & Quill Research Professor The new administration has at the School of Accountancy and promised to correct past ills MIS, and an honorary Senior through stronger regulation of the Wicklander Research Fellow in the financial services industry. The Institute for Business and Profes- addition of more regulation with- sional Ethics, both at DePaul Uni- out changing the basic structure versity, Chicago.