Titans of industry do not readily admit their errors, so it was noteworthy when John S. Reed, who helped to orchestrate the 1998 merger that created Citigroup, Inc., said last week that the merger was a mistake.
In 2008, Citigroup lost $27.7 billion and took $118 billion in writedowns. The company was spiraling into an abyss and threatened to bring the entire U.S. economy down with it. Realizing that the firm was “too big to fail,” Washington contributed $45 billion in capital and agreed to backstop $300 billion in troubled assets to help it get back on its feet. The U.S. Treasury Department is now the proud owner of a 34 percent stake in the business.
Reed, who retired in 2000, blames his former company’s present woes on the merger he helped to engineer. In the merger, Citicorp, a commercial bank headed by Reed, combined with Travelers Group Inc., which owned the investment firm Salomon Smith Barney Holdings Inc.
The former co-chairman and co-chief executive officer now says banks that take deposits from consumers should be kept separate from those that are in the business of buying, selling, and trading companies and other investments.
“I would compartmentalize the industry for the same reason you compartmentalize ships,” he said. “If you have a leak, the leak doesn’t spread and sink the whole vessel. So generally speaking you’d have consumer banking separate from trading bonds and equity.”
There used to be a law keeping the different parts of the banking industry separate and helping to keep the financial boat afloat. The Glass-Steagall Act, enacted amid the widespread bank failures of the Great Depression, forbade companies from mixing traditional consumer banking and investment banking. But that restriction was repealed by the Gramm-Leach-Bliley Act of 1999, opening the way for the risky practices that helped bring on the current recession.
Reed, who supported Glass-Steagall’s repeal at the time, now says Congress was wrong to overturn it. He explained his change of heart to The New York Times, writing in a letter to the editor, “When you’re running a company, you do what you think is right for the stockholders. Right now I’m looking at this as a citizen.”
This time, Reed is right.
Mergers like the one that created Citigroup do not just produce companies that are too big to fail; they also allow problems in separate industries to reinforce one another. This is exactly what happened in the credit crisis.
Bad loans issued by commercial banks were sold to investors around the world by investment banks that were often the same institution. This encouraged the commercial banks to write more bad loans that could likewise be sold.
Citigroup was at the forefront of this development, pioneering the production of collateralized debt obligations, the bundles of consumer loans that were sold to investors. Then, when the loans could not be repaid, these mega-institutions froze credit throughout the economy and brought on a massive and worldwide economic contraction.
If consumer banks and investment banks had remained separate, consumer banks would have had less incentive to continue issuing bad mortgages and other shaky debt, and investment banks might have been less eager to peddle the overrated paper into which those loans were bundled. This could have prevented much of the pollution in the global capital pool that eventually brought on the credit crunch. (We should not forget, however, about the roles played by government-sponsored entities such as Fannie Mae and Freddie Mac in fostering the lending binge, or by AIG and other speculators that gorged themselves on leverage. Then, of course, there were the borrowers of all that easy money. There is more than enough blame to go around.)
Congress ought to learn from its mistakes, as Reed has. It should restore the old Glass-Steagall prohibition against combining commercial and investment banks. Though it is too late to prevent what has already happened, it is not too late to fix what went wrong to stop the same problems from occurring yet again.
And it’s never too late to say you’re sorry.