Summary
The history of of the banking cycle is rife with examples of boom and bust, just like the business cycle. The regulatory approach of the federal government is a key aspect of that cycle. How did the optimism of the late 1990's turn so quickly to our current situation. A look at a previous period in our nation's history can help to illuminate some of today's issues.
Analysis
As news broke last week that Citigroup's senior counselor Robert Rubin, and it's brokerage unit, Smith Barney, were being shown the door on the same day , a palpable sense of irony and chagrined bemusement was spreading among the legions of financial services lawyers and lobbyists in Washington. Second perhaps only to Alan Greenspan, Rubin came to symbolize an era of unstinted financial deregulation and singular American financial power that is coming to a painful end. Typical of others who have found themselves on the wrong side of history, his tenure will be defined, perhaps unfairly, by his failures rather than his successes. How did it come to this; the avatar of financial deregulation being felled by the very monster he had helped to create? As in many forensic investigations, the answer lies in a history that is hiding in plain sight. Before there were credit default swaps, subprime mortgage loans, lax rating agencies and a poorly managed financial regulatory system, there was The Banking Act of 1933, containing the Glass-Steagall provisions which would govern the securities activities of banks for another 66 years. Creating a bright yellow line between the banking and securities industries, the 1933 Act was passed to address a remarkably similar set of economic and market conditions to today's. Traditional credit standards were eroding, and businesses were creating commercial paper and other securitized instruments There was lax regulation and quality control after the liberalizing 1927 McFadden Act was passed at the instigation of President Warren G. Harding's Comptroller of the Currency, Henry May Dawes. Dawes was a pro-business oil executive who relied on the advice and recommendations of a committee of national bankers in drafting his proposals. He was indicted, and acquitted, of unrelated Sherman Antitrust Act violations in 1936. He firmly believed that banks, and business, were being strangled by the heavy hand of government regulation. The economic disarray and personal greed caused by a poorly regulated financial services sector was dramatically framed by the Gray-Pecora investigation and hearings in 1932, leading to passage of Glass-Steagall restrictions in 1933. In an eerie parallel, The Gramm-Leach-Blilely Financial Services Act of 1999 eliminated the separation of banks and securities. For 20 years before it passed, the banking, securities and insurance industries were engaged in a pitched lobbying battle in Washington D.C. which became the legislative equivalent of the 100 Years War. The banking industry, cheered on by a series of bi-partisan Comptrollers of the Currency lobbied and litigated for new and expanded powers. The securities and insurance industries fought to keep them out of their markets, and ultimately, when passage was assured, for acceptable terms of engagement. At every turn then Treasury Secretary Robert Rubin pushed to break down the "depression era", growth killing, antiquated structural model established by Glass-Steagall. In 1995 he told the House Banking Committee, "the banking industry is fundamentally different from what it was two decades ago, let alone in 1933." He regaled the committee with a vision of an unfettered financial services industry creating diverse new products to serve a global market, helping the United States to become the number one facilitator of international capital formation and economic growth. At the same time, Citicorp was pushing hard, both in Washington and in the marketplace, to move into businesses beyond banking. Years before, Walter Wriston, the legendary chairman of Citi, lectured the Congress that Citi had the market power to create it's own law. In fact, that is precisely what happened when the April 7, 1998 merger of Citicorp and Travelers Insurance created Citigroup, the world's largest financial services network. The merger pushed Congress to relax the Glass-Steagall restrictions, and in 1999 President Clinton signed Gramm-Leach-Bliley as Treasury Secretary Bob Rubin, looked on, along with Phil Gramm, the Chairman of the Senate Banking Committee and a central player in the deregulatory "reform" effort. Spurred by the new environment, Citigroup and other financial services companies began expanding and offering a dizzying array of products and services to the global marketplace, just as Rubin had predicted. A somnambulistic regulatory stance in the Bush years, epitomized by the humbling of the once proud enforcement staff of the Securities and Exchange Commission, turned a potential problem into an economic conflagration. President-elect Obama has indicated that reform of the financial services regulatory system will be a high priority, while European leaders are warning the United States that any reform efforts must also take into account the global nature of the financial system, and a need cooperate among nations in setting common standards. If the past is any guide, the task will be complicated by turf battles among existing regulatory agencies as much as by competing ideas about the proper road forward. In the coming days, we will watch as Citigroup "downsizes", like many individual American families have done. The House that Sandy Weill built will likely focus on it's corporate and investment banking business, shedding the less exotic, and underperforming consumer finance business. For 10 years, Citigroup was on the leading edge of the international financial services supermarket curve, but it is now on the leading edge of dismantling this ultimately failed model. As this is being written, senior officials at the Fed and the Treasury Department are assessing their options, but it is already clear that Citigroup as we have known it is a historical artifact. Rubin's own words are the perfect coda for the tale. In his resignation letter to Citigroup Chief Executive Vikram Pandit, Rubin stated that his "great regret is that I and so many of us who have been involved in this industry for so long did not recognize the serious possibility of the extreme circumstances that the financial system faces today."
