When Travelers chief executive Sandy Weill acquired Citibank for US$70bn in April 1998 he effectively forced a rewrite of the rules of financial regulation. The US system was set up in the 1930s to prevent a repeat of the crash that led to the Great Depression.
The Glass-Steagall Act kept investment banks on Wall Street separate from commercial and retail lenders on main street, so traders couldn’t bet bank deposits. It was effectively repealed during the dying days of the Clinton Presidency in November 1999.
The Citibank takeover, which brought together legendary bond trading house Salomon, acquired by Travelers in 1997, with one of America’s largest main street lenders, forced this issue out into the open.
It heralded a wave of similar deals, combining both sides of the banking business. Most notably in September 2000 Chase Manhattan bought JP Morgan for US$33bn shortly after it had snapped up UK investment bank Robert Fleming.
Soon afterwards inventive investment bankers made the most of the low interest rates put in place after the terrorist atrocities of September 11 2001 to create debt instruments that led ultimately to the current debacle.
The next Presidency looks as if it will be dominated by revising the current laissez-faire financial regulations, with Governments around the world determining how the banks they have taken stakes in should now operate.
It is impossible to imagine that the clock will be turned back. Indeed many of the rescues have involved conservative lenders, such as Bank of America, buying more speculative banks, the mighty Merrill Lynch for instance in this case.
And in Europe, even before Travelers-Citigroup was created, many conventional banks had long had a presence in investment banking, such as Barclays, or bought their way in: Deutsche acquiring Morgan Grenfell and Swiss Bank snapping up Warburgs.
The problem that universal banking has suffered is using the balance sheet to take inappropriate positions in the market. This ‘proprietary’ trading created immense profits in the boom times but has found out many on the way down.
Citi’s proposals to keep the same model, albeit on a much reduced basis, of combining retail, commercial and investment banking, whilst hiving off the ‘bad’ assets left from this trading frenzy, indicates how things might look for banks in the future.
Politicians after all want the banks to keep functioning and lending to businesses and consumers, using appropriate advice from investment bankers. However, they should focus on getting regulators to curb the betting using leverage on such group’s deposits.
If the right balance is obtained then acquisition finance could recover along similar lines albeit at a much reduced level.