Blame Citigroup's Woes on the Citi-Travelers Merger

Justin Fox -- rightly, I think -- reckons that the repeal of Glass-Steagal was on net a good thing, not a bad thing, for the US banking system, if only because it has allowed big commercial banks like Bank of America (BAC) and JP Morgan (JPM) to buy failing investment banks like Merrill Lynch (MER) and Bear Stearns.

But what of Citigroup (C), the creature which caused Glass-Steagal's repeal in the first place? Can we pin its problems, at least, on that decision, or would the same problems have cropped up at Travelers regardless? Justin writes:

The biggest problems at Citigroup have come from the Travelers' side of the marriage. The Travelers insurance businesses have been spun and sold off, and Smith Barney, as part of Citi's wealth management division, doesn't seem to have been a disaster. But Citifinancial was a leading subprime mortgage lender, and Citi's investment banking arm--the descendant of Salomon Brothers--got into mortgage securitization late and ended up with a huge pile of unsellable junk on its hands.
Now that junk has rendered all of Citi suspect.

First, Citifinancial is the rebranded Associates, which was bought by Citigroup in 1999, after the Travelers-Citicorp merger. Associates was a subprime lender which was considered a complement to Citibank's higher-quality lending operations. I doubt that Travelers would have bought Associates on its own, and so it seems a bit of a stretch to say that Citifinancial came from the Travelers side of things.

But more to the point, Citi's investment-banking arm would never have got into the mortgage business to anything like the degree it did were it not for the fact that it had recourse to Citibank's enormous balance sheet. It's the same as the story of how a small group in London called AIG Financial Products managed to blow up so spectacularly: it had recourse to AIG's even-more-enormous resources.

Investment banks have a natural tendency to expand until they use all of the balance sheet they're given. That's one of the reasons the SEC's 2004 decision to remove constraints on leverage was such a bad one -- they're constitutionally incapable of constraining themselves. And when they merge with -- even when they're taken over by -- commercial banks, they invariably end up taking over the host organism and seeding their high-tech products all over its balance sheet.

The two most important people at Citigroup -- Vikram Pandit and Robert Rubin-- are both investment bankers. And it was the Citi-Travelers merger which turned the relatively sober Citicorp into an investment bank. So while I still think that repealing Glass-Steagal might have been sensible, the problem is that it was never accompanied by the extra regulation that these new merged entities required. Quite the opposite, in fact. And so, with no idea how to run such a thing, Citigroup's managers let it get to a point at which they could blow up spectacularly.

Disclosure: Author has no positions.

Comments

[Michael L:]

The biggest side of the problem did not come form the Travellers side. It came from no side at all, rather from between the ears of Rubin and Prince.

2008 Dec 02 04:23 PM

[mad10311:]

Get your facts right before you write a story. CitiFinancial did NOT engage in any of the lending products that are causing the collapse of the mortgage industry. NO option arms, NO Interest Only Mortgages, NO no income verification loans, NO teaser products .CitiFinancial is not a rebranded Associates. CitiFinancial (or Commercial Credit, it's previous name) has been a community based lender with the lowest delinquency ratios in the business for years. It also has the highest customer satisfaction % in the industry. You should write a retracion.

2008 Dec 02 04:34 PM

[Arty Fufkin:]

Citifinancial existed before Associates was acquired by Citigroup. Citifinancial is the rebranded Commercial Credit which was always part of Travelers.

2008 Dec 02 05:52 PM

[Budro31:]

For many years, Citigroup has been an interesting sleighride.... All the way back from my original American Can holdings in the 50's through PriAmerica, Travelers and finally being morphed into Citigroup. The ride has been quite rewarding however when Bobby Rubin came on board, I had a cold chill sitting on the railed buckboard. Not surprising, my letter expressing concern directed to Sandy Weill went unanswered. In retrospect, he obviously was not a responder to fan-mail. Then with that Prince of a guy taking the reins, I possibly should have bailed out into a snow bank on seeing the horse lifting its tail... but did'nt.
"Merry Christmas all ye bold investors." Citi will rise again!

2008 Dec 02 08:14 PM

[User 311556:]

I suggest that when the US Treasury makes allowances for a bailout for these banks, besides the usual clauses of capping executive bonuses, perks , etc... it is time to ensure these financial institutions start to shoulder some corporate social responsibility.

There needs to be an agreement with these banks to stop outsourcing work to countries like India, Philippines etc.. and create these jobs internally

Outsourcing is often seen to lower costs but reality check is that often outsourcing leads to poorer quality of work and the outsource workforce is not really much more productive than the US workforce. Moreover, the cost of outsouring to India is becoming increasingly expensive
These type of cost savings are have a short-term focus, and becomes a balance sheet item to 'boost' profits, increase sharevalue and enrich the senior management.

Jobs need to be created in the States so that US folks can be hired and these folks have to economic means to continue to spend domestically. If Obama can't creat jobs in the States, he can at least make it expensive for US corporates to outsource work to 'lower-cost' countries so that employment can be created.

2008 Dec 03 02:29 AM

[siew_wah:]

Dear All, continue to support the great American banking icon Citigroup. With the bailout by the US government and backing from sovereign wealth funds, it should nurse its way back to health. Take comfort and give it time. Cheers

2008 Dec 03 08:27 AM

[someone in ...:]

Although the Citi-Travelers merger was the catalyst for Glass-Steagal's repeal, it was by no means the only reason. Repeal of GS was in the works for some time - the law was antiquated and regulators had to jump through hoops to allow banks to engage in services that would enable them to compete with foreign banks and provide more unified risk oversight.

Repeal was stalled by politics - former head of the Senate banking committee, Al D'Amato had too much support from Wall St I banks to push for reform. it wasn't until Phil Gramm took his place that a more pragmatic piece of legislation was enacted.

Gramm-Leach-Riley not only repealed Glass-Steagal, it also enabled more efficient regulatory oversight by removing unnecessary red-tape hurdles (i.e. requiring banks to seek regulatory approval to open a branch, costing hunderds of $'s in legal fees).

The cause of Citi's problems go beyond repeal of GS.

2008 Dec 03 09:34 PM

[TiredandDis...:]

Citi was a bank until the 1998 takeover by Travelers. It was a downhill run from there as Weill tried to turn it into his idea of a financial supermarket where everyone could go get anything they needed. In the process, he and HIS management team (most all the original bankers in positions of management were canned under the guise of job discontinuance, or just downright ousted) destroyed the place. They essentially forgot, or never knew, that while they were cobbling together this financial institution behemoth, it was still a bank. Oversight? What's that. Accountibility? Say what. Controls? Oh please. The desire to have more customers than any other bank in the world dwarfed any rational thinking, products were created that couldn't even be properly supported, or some cases, even understood, and banking laws were either entirely ignored deliberately, or because of. . .ignorance of them - not sure which. Service was measured strictly by numbers in reports, and everything was widgetized, even if it meant pounding square pegs into round holes (oh wait, that's what most of corporate America does these days, isn't it?) And the executives that did it all, along with the people they brought in with them, sat back, patted each other on the back, and took home fat bonuses for a job well done. It was only a matter of time before it would all start to unravel, and that time has arrived. The guy who made the mess already got out with his golden parachute but the people still in charge are still operating under the same collective mindset developed over the past 10 years. Citi is not going to improve until the management from the top down is completely overhauled. The only way they should be receiving ANY bailout funds, is with strict parameters attached and subsequent follow-up to ensure they have done with the funds as directed. Unless they are held accountable, it is a guarantee they will inappropriately utilize the money. And I detest knowing my tax dollars are helping to fund it.

Feb 06 12:19 AM