Remember Citigroup

By Simon Johnson

On Thursday of last week, four senators unveiled the 21st Century Glass-Steagall Act.  The pushback from people representing the megabanks was immediate but also completely lame – the weakness of their arguments against the proposed legislation is a major reason to think that this reform idea will ultimately prevail.

The strangest argument against the Act is that it would not have prevented the financial crisis of 2007-08.  This completely ignores the central role played by Citigroup.

It is always a mistake to suggest there is any panacea that would prevent crises – either in the past or in the future.  And none of the senators – Maria Cantwell of Washington, Angus King of Maine, John McCain of Arizona, and Elizabeth Warren of Massachusetts – proposing the legislation have made such an argument.  But banking crises can be more or less severe, depending on the nature of the firms that become most troubled, including their size relative to the financial system and relative to the economy, the extent to which they provide critical functions, and how far the damage would spread around the world if they were to fall.

Executives at the helm of Citigroup argued long and hard, over decades, for the ability to expand the scope of their business – breaking down the barriers between conventional commercial banking and all of forms of financial transactions, including the most risky.  In effect, the decline of the restrictions established by the original Glass-Steagall – at first gradual but ultimately dramatic – allowed Citigroup to increase the scale and complexity of gambles that it could take backed by deposits and ultimately backed by the government.

At its peak in 2008, Citigroup’s assets were around $2.5 trillion (under US GAAP accounting, which gives a relatively low estimate for derivatives’ exposure) – we can call that over 15 percent of GDP.  It was the largest bank in the US and arguably the largest bank in the world.   A large part of its business was – and remains – outside the US but there is no doubt that policymakers, here and abroad, felt that the US government was responsible for the havoc that the failure of Citigroup could wreak.

Citigroup had been in trouble before, for example on the back of loans to emerging markets made during the 1970s and that went bad in 1982.  But Citigroup was much smaller in the early 1980s – no more than a few percent of GDP – than it was in 2007.  And the scope of its activities was much more limited.  By the early 2000s, Citi had also become much more complex, with a presence throughout the financial system.  And the opaqueness of derivatives meant that it was very hard for anyone – including the very smart people who run the Federal Reserve – to know how Citigroup’s losses could spread throughout the system.

Accounts of the financial crisis agree that the potential failure of Citigroup was viewed by policymakers as a major potential calamity to be avoided.  As a result, a huge amount of official support was provided, directly and indirectly to keep Citigroup afloat.  (For details, see Sheila Bair’s book, Bull by the Horns.)

Looking backwards, you could think of the 21st Century Glass-Steagall Act as a measure to unwind the structure that Citigroup would become.

But this would be to miss the point of the legislation – and why this is now an urgent public policy priority.  As a result of the crisis and the bailout measures put in place by both the Bush and Obama administrations, we have five groups of firms (with a holding company at the core) that resemble Citi in the run-up to 2007: JP Morgan Chase, Bank of America, Goldman Sachs, Morgan Stanley, and Citigroup itself.  (And there are several other contenders for this status.)

All five of the firms contain some mix of boring traditional commercial banking, backed by insured deposits, and high risk activities – such as are inherent in investment banking and dealing in securities.

All of them are now undoubtedly too big to fail.  And this creates exactly the kind of perverse incentives that prevailed at Citigroup – excessive and mismanaged risk-taking mean a few people get the upside when things go well, while the taxpayer and the broader economy gets a crazy amount of downside risk.

Even Sandy Weil, former CEO of Citigroup who led the charge against the remnants of Glass-Steagall in the 1990s, concedes that this was a regrettable mistake – and argues for all of the biggest banks to be broken up.

Meanwhile, JP Morgan Chase is bigger today than Citigroup was at its largest.  And executives at the biggest banks repeatedly demonstrate their willingness to use all the economic and political means at their disposal to bulk up even further.

The point of the New Glass-Steagall Act is to complement other measures in place or under consideration, including much higher capital requirements (both in the Brown-Vitter proposed legislation and in the new regulatory cap on leverage now under consideration), the Volcker Rule, and efforts to bring greater transparency to derivatives.

These measures are not substitutes for each other – they are complements.  Each would be more effective if the others are also implemented properly.

Nothing can completely remove the risk of future financial crisis.  Anyone who promises this is offering up illusions and deception.

But, like it or not, public policy shapes incentives in the financial system.  We can have a safer financial system that works better for the broader economy – as we had after the reforms of the 1930s.  Or we can have a system in which a few relatively large firms are encouraged to follow the model of Citigroup and to become ever more careless and on a grander scale.

26 responses to “Remember Citigroup

  1. Reblogged this on Gutek and commented:
    What a sober, persuasive, prescient analysis of the new Glass-Steagall Act should be welcomed.

  2. AGREE-financial system was stable from 1933 to 1982 deregulation of S&L’s and did not collapse until September 15, 2008 when Lehman Bros. filed for bankruptcy- that’s 78 years and 11 months. Investment banks should be required to be partnerships with unlimited liability. Risk management will be guaranteed to improve markedly if partners money is at risk rather than taxpayers. I think it’s called: moral hazard.

  3. Per Kurowski

    Most of the focus is on the banks, how they can fail and its impact, and so little on what the banks might be doing to the real economy and which impact upon failure would be so much worse.

    http://subprimeregulations.blogspot.com/2013/07/regulators-turned-our-banks-into-cash.html

  4. After the financial system collapsed in Sept. 2008, the “real” economy took a nosedive costing some 8.4 million jobs and severely reducing purchasing power. These people and their employer had nothing to do with the casino banking which did cause the collapse and it takes 10 years to recover as in 1929 to 1939. That’s why it’s so critical to reduce the risk of and severity of another.

  5. Informative post and appreciate the information. But – this is putting bandaids on bullet wounds. The entire global financial system is a Ponzi scheme profiting the predatorclass and predatorclass oligarch singularly and exclusively!! The socalled judicial system as we witnessed yet again this weekend, is a putrid swamp of institutionalized racism, systemic corruption, wanton profiteering, and impotent to the point of uselessness to holding the predatorclass accountable to the socalled ruleoflaw, or that quaint forgotten notion we used to call justice. The predatorclass and predatorclass interests are immune and above and beyond the socalled ruleoflaw, while every other American is ruthlessly punished and incarcerated for minor crimes, spied on, deprived of due process, freedom of speech, and all the former rights this nation held dear by a fascist policestate! Our socalled leaders, with exceedingly few exceptions are corrupt, pathological liars, wanton profiteers, and spaniels to the overlords in the predatorclass, who hold absolutely ZERO concerns for the people or the peoples best interests, “that goddamn piece of paper” we once called the Constitution or America. Our politician work for, are purchased by, or are part of the predatorclass. Our socalled corporate leaders with few exceptions work in concert with the socalled government, judiciary, and the predatorclass to undermine the ruleoflaw, gut and enslave the workingclass, and devour by any means necessary all the worlds wealth and resources with no constraint or any sense of morality or legality.

    The entire system, the government, – everything in every arena of leadership is a toxic malignancy! It’s a cancer! There is no cure! There is no fixing these systemic horrors, – there is no balm in Gilead.

    Finally – I read – and would greatly value a response from any of our erudite commentarians here or our hosts verifying or correcting what follows – but from what I understand – the entire derivatives markets and those markets exposure is at or around a Quadrillion dollars. How on godsgreenearth is that horrorshow EVER reconciled????

    Burn it all down! Reset!!! There’s no other hope, or prayer, or option!!!

  6. Dan Palanza

    @TonyForester: “Finally – I read – and would greatly value a response from any of our erudite commentarians here or our hosts verifying or correcting what follows – but from what I understand – the entire derivatives markets and those markets exposure is at or around a Quadrillion dollars. How on godsgreenearth is that horrorshow EVER reconciled???? ”

    No student of today’s corrupt monetary system will suggest it to be easy. But a return to a meaningful Glass Steagall reinstatement must confront a problem in how software is to be programmed to complete the proper double-entry book-of-accounts. In 1933 the bank’s books were balanced by human bookkeepers. Humans, given the accounting experience, become natural accountants by virtue of how a civil human reasons.

    Software developers do not become natural accountants. Software developers must learn the far more difficult task of understanding how a civil human reasons, and then to write software accordingly. A language such as The Lisp goes a long way in that direction, but is not being properly used in today’s accounting systems.

    The core problem that a revised Glass Steagall solution must resolve today, which did not exist in 1933, is in our incomplete understanding of a properly balanced-software-reasoning. One cannot do a proper double-entry proof by storing journal data in a relational database. Understanding why would make for a good starting point.

    And finally, to use Our Monetary System as gambling chips is an absolute book-of-accounts no-no. It must be stopped immediately. It was never allowed under Glass-Steagall.

  7. David Kelland

    CORRECTION: “breaking down the barriers between conventional commercial banking and all of forms of financial transactions, including the most risky”

    It should read “…all OTHER forms…”

  8. As counterintuitive as it seems, the banks didn’t cause the financial crisis directly. By all means, let’s force them to hold much more capital. But it’s important to recognise that the collapse in nominal growth was a monetary phenomenon, caused by the Fed.

    Sovereign central banks have all the power they need to maintain constant nominal growth.

  9. I should say, “raise” more capital, of course.

  10. Why has everyone excluded the American public in the financial collapse? Beyond the criminal gluttony and greed of the financial institutions, they were the pigs calling for more swill. Lying on credit applications was a two sided deception.

    Our credit based society extends down from both political parties vested interests in buying or financing the buying of votes, to corporate run government, to the individual. All took part in excesses. All are to blame.

  11. The incentives were perverse for everyone Vegas Vic. And you should know If you have any connection with Vegas, that the American public, (and Vegas is one of the bellwethers markets for all that went wrong and insane leading up to the housing meltdown) – but the American public has paid dearly for their sins. The predatorclass has not. The American public has been savaged by the financial crisis, loosing homes, home value, jobs, any hope for a real job, earning power, and of course the ruthless and accelerating rape and butchering of that thing we call the Constitution, and all former rights, freedoms, and protections we formally enjoyed – and the militarized policestate thing as well. No doubt there were some abuses on the people’s side, – but millions who did nothing wrong have been hurled into poverty, or borderline poverty as a result of the finance oligarchs and their derivative Ponzi operations and numerous other criminal activities that fall squarely on the finance oligarchs.

    Riddle me this brother, – what masteoftheuniverse or competent or ethical lender would approve a $400,00.00 mortgage to a janitor making 40k if lucky with a minimal down payment??? You ignore that fact that the mortgage providers were incentivized by the den of vipers on Wall Street issue loans, (NOT because there was any hope in hell of those loans EVER being paid off) but because the quantity, not quality of the loans looked good on the finance oligarchs balance sheets (as long as housing prices increased). No my brother, this fault, the lax accountability, and the criminal conduct of the den of vipers and thieves on Wall Street are the SINGULAR cause of the ongoing great recession and ushering the entire global financial system to the brink of collapse. Worse – the American public has been brutally punished in manifold ways – and absolutely NOTHING has changed for the predatorclass and the Ponzi operations of the den of vipers and thieves in the finance oligarchs.

    We are in the midst of and the cusp of an even larger bubble inflated by the Fed and other central banks printing trillions of dollars out of the myst and funneling into the offshore taxfree accounts of the finance oligarchs. Apparently the socalled mastersoftheuniverse has short and selective memories – because much like 2008, when all the finance oligarchs, the fascist in the bushgov, McCain, and every other predatorclass spaniel and mouthpiece were repeating incessantly on TV that “the fundamentals of the economy were sound ” in October of 2007 – then like now – they were lying through their teeth, and forked tongues. The robosigning of chain of title tranches was FRAUD on an epic scale, – and the predatorclass finance oligarchs paid paltry fines, admitted no wrongdoing, and NO ONE went to jail. This after perhaps the largest single act of thievery and skullduggery in the history of the world. The public has been and will continue being ruthlessly punished. It’s the predatorclass that walks free, untouched and unpunished for wanton, systemic, and ongoing criminality!!!

    Burn it all down. Reset!!! It’s the only option!

  12. But the fundamentals of the economy were fine, for the financial aristocrats at the helm of the international banking cartel, and those fundamentals got much, much finer with Hank Paulson running the Treasury. What we have seen, over the last fifty years, is the re-amalgamation of the “Money Trust”, with no Teddy Roosevelt to bust it up.

  13. When will progressives ever learn to boil their arguments down to their simplest form. Repeat after me, “Repeal the Leach Act”. However you want to do that, that should be the motto. Simple, effective, and accurate. http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act#1999_Gramm.E2.80.93Leach.E2.80.93Bliley_Act

  14. @TonyF, you wrote, “…The incentives were perverse for everyone Vegas Vic. And you should know If you have any connection with Vegas, that the American public, (and Vegas is one of the bellwethers markets for all that went wrong and insane leading up to the housing meltdown) – but the American public has paid dearly for their sins. The predatorclass has not. The American public has been savaged by the financial crisis, loosing homes, home value, jobs, any hope for a real job, earning power, and of course the ruthless and accelerating rape and butchering of that thing we call the Constitution, and all former rights, freedoms, and protections we formally enjoyed – and the militarized policestate thing as well. No doubt there were some abuses on the people’s side, – but millions who did nothing wrong have been hurled into poverty, or borderline poverty as a result of the finance oligarchs and their derivative Ponzi operations and numerous other criminal activities that fall squarely on the finance oligarchs….”

    I do not disagree with any of that – but what next in the “now” of time?

    Because the former USSR’s “5 year plan” model was unable to provide an economy that supported sustainable life maintenance, certain satellite mono-culture nationalists built an “unofficial” black market that prevented their 1000 year old experientially-earned Main Street commerce from becoming a Back Alley.

    That kind of peaceful morph replacing a delusional “ism” of rank savagery and theft supporting a perpetual war machine with an unofficial FUNCTIONING economy can’t happen in the USA for many reasons but an easy Prima Facie reason is the inner city turf economy that gangs all across the USA own and operate. Do they have a plan in place for educating their Ink artists to be surgeons, dentists, or other designers and operators of sophisticated contributions to a USA basic standard of living that had a 20 year run right after all the WWII refugees arrived who knew what they were doing and before “taliban envy” set in and the foreign banksters set up the Ponzi scheme on steroids through FIAT $$?

    Nope, those gangs are yet another layer of in-your-face brute force that the same people who never did anything wrong have to clean up themselves – with what?! The 480 worth 2.08 TRILLION tell you to use “Ideas” to deal with the Back Alley economy they left behind for what Vic from Vegas is talking about – robbing Peter to pay Paul and both Peter Paul, and Mary are retards.

    Ethical scientists deserve to Unionize nationally. Especially a UNION that will provide a path for the Ink artist who has what it takes to be a surgeon…

    I want my own “gang” :-)) and common sense cult and, yes, a lot of the sustainable life-maintenance values, morals and social graces I want to bring with me are 1000 year old traditional white chick “culture” – sorry if you got a problem with that even before you know how it successfully operated as the ORIGINAL melting pot where east met west. We welcomed all “people of the earth” science, go figure :-)

  15. “The pushback from people representing the megabanks was immediate but also completely lame – the weakness of their arguments against the proposed legislation is a major reason to think that this reform idea will ultimately prevail”

    My God, what a childish fantasy! Do you actually believe that strength or weakness of arguments is the determining factor in legislation? Or could it be — just maybe — that big banks will bribe their way to whatever they want? Your Congress is paid-for.

  16. I suppose Scot M deserves some credit for actually trying to get everyone to read what Gramm, Leach Bliley actually did, but did he read it himself;

    ‘The GLBA repealed Sections 20 and 32 of the Glass–Steagall Act, not Sections 16 and 21.[17] The GLBA also amended Section 16 to permit “well capitalized” commercial banks to underwrite municipal revenue bonds (i.e., non-general obligation bonds),[242] as first approved by the Senate in 1967.[84] Otherwise, Sections 16 and 21 remained in effect regulating the direct securities activities of banks and prohibiting securities firms from taking deposits.[17]

    ‘After March 11, 2000, bank holding companies could expand their securities and insurance activities by becoming “financial holding companies.”[243]‘

    What were repealed were the ‘affiliations provisions’, which only prevented the same person sitting on the boards of both a commercial and an investment bank, and wouldn’t allow a holding company to own both.

    As the Wiki article, says, provisions 16 and 21 (which define what a commercial bank is and what an investment bank is) were not repealed, and are still law. IOW, Glass-Steagall has not been repealed.

  17. The Credit Score of the People is Broken! remeber the financial structure created is fake and it doesn´t have the Support of a Great idea that would help Economy increase.

    Citi give some money out.

  18. http://www.cnbc.com/id/100895812

    Clever – finally including Back Alley “hiring” and then “firing” numbers – “jobs created that will never qualify for unemployment benefits”.

  19. http://rt.com/usa/dempsey-syria-us-assad-268/

    stock market UP UP UP, but sustainable life-maintenance economy still not “getting-off”….

    narcissistic, sadistic, nihilist monkey-sex = MICism

  20. Anonyomouse

    Yea…I don’t understand the over sexual thing, and as Sting said in an interview approaching his 60th birthday, [he was 57 at the time]. He said he wasn’t worried, he said “I still have 3 sexy years left in me.”

  21. @tonyforesta — glad to see you still kickin’ a*s on this blog. I’m with you, bro.

  22. Must celeberate: 2-year anniversary of the CFPB, this Sunday July 21, 2013. Happy Birthday to the Consumer Financial Protection Bureau.

  23. A thousand thanks Varla.

  24. I hate Apple for misspelling and misforming my words, continuously and relentlessly. . It happens all the time. But I meant to say – a thousand thanks Carla!