Glass-Steagall, Gramm-Leach-Bliley, and Citigroup

"We have the best government that money can buy." -- Mark Twain

In 1933, during the depths of the Great Depression (not so great if you had the experience of living during those times), a bill was passed by the U.S. Congress that was named the Banking Act of 1933. Over time it became known as Glass-Steagall, after the names of its two sponsors, Carter Glass and Henry B. Steagall (there were two different bills that passed sponsored by both men, but the one passed in 1933 is much better known than the one from 1932 which also dealt with financial regulation).

Glass-Steagall was a response to risk-taking by banks and other financial institutions which became part of the speculative orgy which blew up in 1929 so spectacularly. Under Glass-Steagall, investment banks and depository banks were split up, bank holding companies were not allowed to own other financial companies, and banks were not allowed to own companies which underwrote insurance. Glass-Steagall was designed to ensure that another collapse of the American commercial banking system such as that which occurred in early 1933 would never happen again.

Thousands of banks failed during the Great Depression. One which did not was National City, a major bank based in New York City. One of the reasons National City did not fail was government policies enacted during the Depression to prop up the banking system. National City Bank no longer exists under that name. It is better known by the name of one of its descendants, Citigroup.

Glass-Steagall or no Glass-Steagall, banks and other financial institutions still took risks and some of those risks blew up in their faces, though nothing quite ranked up there with the stock market crash of 1929. In the 1980s, the financial institution then known as Citicorp found itself in a pickle as loans made to emerging market economies (particularly in Latin America) began to sour. The U.S. government weakened capital requirements and accounting rules to keep some of the largest banks affected by the crisis from being forced into receivership (sound familiar?).

In spite of the relaxed rules, Citicorp was still in a very sticky position by the early 1990s. It was not out of the woods with the iffy Latin American loans, and exposure to the commercial real estate market and the weakening American economy, which had just slid into a recession, once again imperiled the bank's health.

Citicorp ended up with not one, but two, white knights who rode to the rescue. One was a Saudi Arabian prince, Walid bin Talal, who bought $600 million worth of Citicorp stock in 1991. Another was the chairman of the Federal Reserve, Alan Greenspan, who eased interest rates courtesy of the Fed and allowed troubled banks like Citicorp to borrow money for almost nothing from the Fed and loan it out to the bank's customers at higher rates, making a tidy profit. Over time, Citicorp and most of the other large banks were able to repair their balance sheets and, indeed, return to genuine profitability.

Let's fast forward to October 1998. Citicorp merges with Travelers Insurance in a $140 billion dollar deal. There's just one problem. Under the provisions of Glass-Steagall, the merger is not legal. Under the existing laws Citigroup (as the new company is known) has up to five years to spin off enough pieces of the combined company to once again be in compliance with the law.

Problem? What problem? Citigroup and its army of lobbyists swing into action. Honestly, they were probably in action well before this, I doubt if a deal this big would have been consummated unless the legislative branch was well on its way toward blessing such a union. Citigroup and other companies spent around $300 million dollars lobbying members of the U.S. Congress and Executive branch in their efforts to get Glass-Steagal repealed. Their reward for their largesse? Gramm-Leach-Bliley.

Don't get me wrong, Citigroup was obviously not the only entity that spent big bucks trying to get Glass-Steagall overturned. But they were probably the single loudest voice for it, and probably the biggest single lobbyist, for two reasons: Citigroup's corporate future was at stake because it was rolling the dice, if Glass-Steagall was not overturned the entire company likely would be broken up again; and secondly, the merger of Citicorp and Travelers had created a financial monstrosity that was now the largest single financial services company in the U.S., if not the world. Citigroup was the 800 pound gorilla in the room, and had disproportionate influence because of its size and resources.


In November 1999 the Gramm-Leach-Bliley Act was passed. It was sponsored in the Senate by Phil Gramm (Republican-Texas) and in the House by Jim Leach (Republican-Iowa). The third name on the bill belongs to Thomas J. Bliley, Jr (Republican-Virginia), who was at the time another member of the House of Representatives. In the wake of its passage, Sanford "Sandy" Weill and John S. Reed of Citigroup released the following statement:

"By liberating our financial companies from an antiquated regulatory structure, this legislation will unleash the creativity of our industry and insure our global competitiveness. As a result, all Americans - - - investors, savers, insureds - - - will be better served."

There were valid reasons for keeping Glass-Steagall as it was, and valid reasons for changing it. Rather than go into a point-by-point analysis of the pros and cons, I'm just going to discuss some of the things that happened at Citigroup after its newfound status was legalized by Congress.

At the same time as the passage of Gramm-Leach-Bliley, Citigroup was now the largest U.S. bank by assets. Citigroup was able to underwrite and buy and sell Mortgage-backed securities and collateralized debt obligations. In addition, it was able to create Structured Investment Vehicles (essentially a kind of virtual bank) that it could transfer assets and liabilities to, mainly as a way to take liabilities off of the bank's books while still being able to profit from earnings generated by the assets associated with those liabilities. To this day, most Americans don't even understand what these kinds of instruments were (I would recommend you read The Big Short by Michael Lewis if you actually have an interest in this kind of thing). In a nutshell, Citigroup was pioneering the process of securitization -- that is to say, taking tangible assets such as houses and cars and commercial real estate -- and turning them into securities which can be traded like corporate equities.

In theory, securitization might be a good thing. It allows companies to take assets they hold title to or a security interest in and sell them in ways that would have been impossible before, and spread the risk around. Other entities can then purchase these asset backed securities and participate in the revenue stream from them, while the originating entity can raise money from the process which is then freed up to find other lucrative opportunities to pursue.

In practice, as we are now finding out from the current (November 2010) rash of problems with foreclosures that are being experienced, securitization has had one huge unintended side effect. By muddying the waters of who actually owns what, it has cast a giant shadow over the foreclosure process in this country because banks are now trying to foreclose on properties that they may or may not have title to, because title may have passed in part or in full to another entity because the other entity may have bought securities that carry an ownership stake in the properties the banks are trying to foreclose on. The implications are profound and widespread.

Beyond that problem, another problem with securitization is that the rating agencies were absolutely ineffectual in every possible way at rating the unbelievably complex financial instruments that were created by some of the banks. As a result, securities that had a 100% certainty of complete loss in some circumstances (such as a loss in real estate values that spanned the entire U.S., which at the time seemed highly unlikely) were rated as being as safe as U.S. Treasuries, which were viewed as having zero risk. I think we've seen how that turned out.

In 1999, Secretary Treasury Robert Rubin resigned his position in the cabinet of President Clinton and joined the board of Citigroup. He remained as a member of the board until 2009. While Secretary Treasury in 1997, Rubin had vehemently opposed (along with then-Fed chairman Alan Greenspan) giving the Commodities Futures Trading Commission oversight of over the counter credit derivatives, another kind of exotic financial instrument which, in retrospect, has proven to be insanely dangerous. Without going out of our way to worry about Rubin's motives (I mean, who wouldn't want to be associated with one of the biggest, sexiest financial services companies in the world to cap a long and distinguished career) one has to wonder about the wisdom of this kind of "regulatory capture" being allowed, when the public guardians are so easily allowed to rejoin the ranks of those whom their duty was to oversee and regulate just a few short months before.

While Citigroup was growing bigger and bigger and was creating and selling more and more exotic financial instruments, the amount of risk it was taking on was also growing by leaps and bounds. The Federal Reserve Board of New York did bar Citigroup from making new acquisitions for a year between 2005 and 2006, apparently with some awareness of the possibility of problems. But that did not cause the FRBNY (under the lead of future Treasury Secretary Timothy Geithner) to do anything else to slow down Citigroup's acquisition of a portfolio that would later generate over $35 billion in losses.

Fast forward again to the fall of 2008, when the U.S. Congress, faced with mounting losses on Wall Street and the failure of Bear Stearns and the bankruptcy of Lehman Brothers, approved the mother of all bailouts for the banking industry. Citigroup is one of the firms facing the largest losses, and becomes the epitome of the "too big to fail" or "TBTF" bank. Even now, two years later, its continued survival is in doubt, even after infusions of government money and access to cheap funds from the U.S. Federal Reserve.

Glass-Steagall is gone now but not forgotten. The much-hyped Dodd-Frank Act of 2010 (please, God, don't even let me get started on those two gentlemen) is a weak substitute for Glass-Steagall and doesn't go nearly far enough to undo the excesses that have accumulated in the 11 years since Gramm-Leach-Bliley was passed. For all the belly-aching of the financial industry, Dodd-Frank is a lot of sound but not much fury. Economists such as Nouriel Roubini have gone on record as saying that we either need Glass-Steagall back or something much closer to it than we currently have. But the representatives of the financial services industry and the TBTF entities fight every step at reform tooth and nail. As long as they can stay TBTF they know that they will be bailed out, no matter how badly they mismanage their affairs.

According to the Center for Responsive Politics, Citigroup is the 16th largest political campaign contributor in the U.S. According to Wall Street Watch, between 1998 and 2008 Citigroup spent more than $108 million on political lobbying. According to the Capital Research Center, Citigroup is a heavy contributor to left-of-center political causes. But members of the firm donated over $23 million between 1989-2006 which was split almost evenly between the two major parties, 49% to Democrats and 51% to Republicans.

Senate Voting Record Gramm-Leach-Bliley

House Voting Record Gramm-Leach-Bliley

November 9, 2010

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