Glass-Steagall: In Memorium II

Today was very interesting. I met with a man by the name of David Bloch who used to be the head of M&A over at Intuit. He's spent 20 years with the I-banks as a securities and banking regulation attorney. He said something to me that struck "Never invest in Citibank. They are always the first and worst." The fact that the market is dreading the Citi report isn't news, what's news (to me at least) is the systemic and repeated pattern of deception and irresponsibility by the investment banks. In talking to him about Glass-Steagall and it's repeal, he called it a "lobbyist guaranteed fait accompli." Here was there argument: All the foreign I-banks get to do it, so why can't we? Hate to boil all this down to that, but Glass-Steagall was taken down with the pariah of international competition. Credit Suisse and UBS could cross the lines, but BofA and Wells could not. So what? Credit Suisse and UBS have a MUCH MORE stringent reserve requirement of ACTUAL ASSETS outside of ECB guidelines. Some Swiss banks are required to carry 40% reserves! 40%! And our I-banks constantly complain about 2-3%, not only that, it's expanded to 2-3% of fiat money 1A assets!

More on my eye-opening meeting with him tomorrow. For now, let's get back to the dismemberment of Glass-Steagall:

1989-1990

In January 1989, the Fed Board approves an application by J.P. Morgan, Chase Manhattan, Bankers Trust, and Citicorp to expand the Glass-Steagall loophole to include dealing in debt and equity securities in addition to municipal securities and commercial paper. This marks a large expansion of the activities considered permissible under Section 20, because the revenue limit for underwriting business is still at 5 percent. Later in 1989, the Board issues an order raising the limit to 10 percent of revenues, referring to the April 1987 order for its rationale.

In 1990, J.P. Morgan becomes the first bank to receive permission from the Federal Reserve to underwrite securities, so long as its underwriting business does not exceed the 10 percent limit.

In 1984 and 1988, the Senate passes bills that would lift major restrictions under Glass-Steagall, but in each case the House blocks passage. In 1991, the Bush administration puts forward a repeal proposal, winning support of both the House and Senate Banking Committees, but the House again defeats the bill in a full vote. And in 1995, the House and Senate Banking Committees approve separate versions of legislation to get rid of Glass-Steagall, but conference negotiations on a compromise fall apart.

Attempts to repeal Glass-Steagall typically pit insurance companies, securities firms, and large and small banks against one another, as factions of these industries engage in turf wars in Congress over their competing interests and over whether the Federal Reserve or the Treasury Department and the Comptroller of the Currency should be the primary banking regulator.

1996-1997

In December 1996, with the support of Chairman Alan Greenspan, the Federal Reserve Board issues a precedent-shattering decision permitting bank holding companies to own investment bank affiliates with up to 25 percent of their business in securities underwriting (up from 10 percent).

This expansion of the loophole created by the Fed's 1987 reinterpretation of Section 20 of Glass-Steagall effectively renders Glass-Steagall obsolete. Virtually any bank holding company wanting to engage in securities business would be able to stay under the 25 percent limit on revenue. However, the law remains on the books, and along with the Bank Holding Company Act, does impose other restrictions on banks, such as prohibiting them from owning insurance-underwriting companies.

In August 1997, the Fed eliminates many restrictions imposed on "Section 20 subsidiaries" by the 1987 and 1989 orders. The Board states that the risks of underwriting had proven to be "manageable," and says banks would have the right to acquire securities firms outright.

In 1997, Bankers Trust (now owned by Deutsche Bank) buys the investment bank Alex. Brown & Co., becoming the first U.S. bank to acquire a securities firm.

In the summer of 1997, Sandy Weill, then head of Travelers insurance company, seeks and nearly succeeds in a merger with J.P. Morgan (before J.P. Morgan merged with Chemical Bank), but the deal collapses at the last minute. In the fall of that year, Travelers acquires the Salomon Brothers investment bank for $9 billion. (Salomon then merges with the Travelers-owned Smith Barney brokerage firm to become Salomon Smith Barney.)

April 1998: M&A Insanity

At a dinner in Washington in February 1998, Sandy Weill of Travelers invites Citicorp's John Reed to his hotel room at the Park Hyatt and proposes a merger. In March, Weill and Reed meet again, and at the end of two days of talks, Reed tells Weill, "Let's do it, partner!"

On April 6, 1998, Weill and Reed announce a $70 billion stock swap merging Travelers (which owned the investment house Salomon Smith Barney) and Citicorp (the parent of Citibank), to create Citigroup Inc., the world's largest financial services company, in what was the biggest corporate merger in history.

The transaction would have to work around regulations in the Glass-Steagall and Bank Holding Company acts governing the industry, which were implemented precisely to prevent this type of company: a combination of insurance underwriting, securities underwriting, and commecial banking. The merger effectively gives regulators and lawmakers three options: end these restrictions, scuttle the deal, or force the merged company to cut back on its consumer offerings by divesting any business that fails to comply with the law.

Weill meets with Alan Greenspan and other Federal Reserve officials before the announcement to sound them out on the merger, and later tells the Washington Post that Greenspan had indicated a "positive response." In their proposal, Weill and Reed are careful to structure the merger so that it conforms to the precedents set by the Fed in its interpretations of Glass-Steagall and the Bank Holding Company Act.

Unless Congress changed the laws and relaxed the restrictions, Citigroup would have two years to divest itself of the Travelers insurance business (with the possibility of three one-year extensions granted by the Fed) and any other part of the business that did not conform with the regulations. Citigroup is prepared to make that promise on the assumption that Congress would finally change the law -- something it had been trying to do for 20 years -- before the company would have to divest itself of anything.

Citicorp and Travelers quietly lobby banking regulators and government officials for their support. In late March and early April, Weill makes three heads-up calls to Washington: to Fed Chairman Greenspan, Treasury Secretary Robert Rubin, and President Clinton. On April 5, the day before the announcement, Weill and Reed make a ceremonial call on Clinton to brief him on the upcoming announcement.

The Fed gives its approval to the Citicorp-Travelers merger on Sept. 23. The Fed's press release indicates that "the Board's approval is subject to the conditions that Travelers and the combined organization, Citigroup, Inc., take all actions necessary to conform the activities and investments of Travelers and all its subsidiaries to the requirements of the Bank Holding Company Act in a manner acceptable to the Board, including divestiture as necessary, within two years of consummation of the proposal. ... The Board's approval also is subject to the condition that Travelers and Citigroup conform the activities of its companies to the requirements of the Glass-Steagall Act."

1999: The End

Following the merger announcement on April 6, 1998, Weill immediately plunges into a public-relations and lobbying campaign for the repeal of Glass-Steagall and passage of new financial services legislation (what becomes the Financial Services Modernization Act of 1999). One week before the Citibank-Travelers deal was announced, Congress had shelved its latest effort to repeal Glass-Steagall. Weill cranks up a new effort to revive bill.

Weill and Reed have to act quickly for both business and political reasons. Fears that the necessary regulatory changes would not happen in time had caused the share prices of both companies to fall. The House Republican leadership indicates that it wants to enact the measure in the current session of Congress. While the Clinton administration generally supported Glass-Steagall "modernization," but there are concerns that mid-term elections in the fall could bring in Democrats less sympathetic to changing the laws.

In May 1998, the House passes legislation by a vote of 214 to 213 that allows for the merging of banks, securities firms, and insurance companies into huge financial conglomerates. And in September, the Senate Banking Committee votes 16-2 to approve a compromise bank overhaul bill. Despite this new momentum, Congress is yet again unable to pass final legislation before the end of its session.

As the push for new legislation heats up, lobbyists quip that raising the issue of financial modernization really signals the start of a fresh round of political fund-raising. Indeed, in the 1997-98 election cycle, the finance, insurance, and real estate industries (known as the FIRE sector), spends more than $200 million on lobbying and makes more than $150 million in political donations. Campaign contributions are targeted to members of Congressional banking committees and other committees with direct jurisdiction over financial services legislation.

After 12 attempts in 25 years, Congress finally repeals Glass-Steagall, rewarding financial companies for more than 20 years and $300 million worth of lobbying efforts. Supporters hail the change as the long-overdue demise of a Depression-era relic.

On Oct. 21, with the House-Senate conference committee deadlocked after marathon negotiations, the main sticking point is partisan bickering over the bill's effect on the Community Reinvestment Act, which sets rules for lending to poor communities. Sandy Weill calls President Clinton in the evening to try to break the deadlock after Senator Phil Gramm, chairman of the Banking Committee, warned Citigroup lobbyist Roger Levy that Weill has to get White House moving on the bill or he would shut down the House-Senate conference. Serious negotiations resume, and a deal is announced at 2:45 a.m. on Oct. 22. Whether Weill made any difference in precipitating a deal is unclear.

On Oct. 22, Weill and John Reed issue a statement congratulating Congress and President Clinton, including 19 administration officials and lawmakers by name. The House and Senate approve a final version of the bill on Nov. 4, and Clinton signs it into law later that month.

Just days after the administration (including the Treasury Department) agrees to support the repeal, Treasury Secretary Robert Rubin, the former co-chairman of a major Wall Street investment bank, Goldman Sachs, raises eyebrows by accepting a top job at Citigroup as Weill's chief lieutenant. The previous year, Weill had called Secretary Rubin to give him advance notice of the upcoming merger announcement. When Weill told Rubin he had some important news, the secretary reportedly quipped, "You're buying the government?"

From the Great Crash of 1929 to the present, the "red team" has demonstrated a pernicious desire to bilk the American consumer. The line between the Commercial Banks and Investment Banks that existed to protect the Blue team from all of the abuses that today come to light have been eliminated. It just so happens that the failure du jour of I-banks went so far as to bribe Moody's and AM Best for ratings. More on that later, and tomorrow I promise to get back to the IPS's. Now that we've put Glass-Steagall to bed tomorrow we can really get into the link between inflation, 1B assets, and global capital markets.