We know that deregulation played a significant role in our current financial crisis, but I was surprised to learn how prominently the righteous Democrats factored into the problem. So selective-memory liberals need to cut the revisionist blame (Bush) game, especially Obama, who will inherit a Biblical-scale crisis partially of his party's making. And maybe the Clintonites shouldn't take so much credit for the "great economy" they presided over in the 1990s, when some of their policies contributed to the spread of casino capitalism and our current mess. Needless to say the free-market GOP didn't help much either, but many House Republicans have fought for Main Street common sense since the 1980s, trying to resist Wall Street lobbied and funded initiatives to "emancipate" commercial banks like WaMu to invest our money however they please, and permit the creation of total financial services juggernauts like Citigroup. Such beasts are powerful enough to hold an entire economy hostage (as we now know), and are "too big to fail", even if they blatantly screw themselves and everyone.
http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/weill/demise.html
This link is an interesting timeline from a 2005 PBS Frontline series about "fixing Wall Street" (oh, if only our leaders listened!). They discuss the gradual dismantling of the 1933 Glass-Steagall Act, which established the FDIC in response to the 1929 crash. It also prohibited US commercial banks and bank-holding companies from being both lending hubs and brokerage houses, which creates an inherent conflict of interest and purpose (as we've seen recently). Banks are naturally security and stability-oriented, while securities traders are more risk and volatility-oriented (despite the misleading name). So if banks underwrote securities, then they couldn't lend, and vice versa. I think that makes a lot of sense, but obviously bankers felt that it impeded their ability to make money and be "competitive" with foreign financial conglomerates.
So over the years, Citi, JPM, and others lobbied Washington to repeal Glass-Steagall restrictions. In the 1970s, brokerage houses started to become pseudo-banks, offering FDIC-insured money-market accounts and issuing checks/plastic. We take this for granted today as "normal", but it was not always so, and for the good reasons previously described. In 1986, for the first time the Fed reinterpreted Section 20 of the Act separating lending banks from brokerage houses. They decreed that banks cannot be "principally" involved in securities, but permitted up to 5% of a bank's revenues to come from investing in commercial paper. That percentage seems minor, but for heavyweight banks, it could entail billions in investments able to threaten the other 95%. In 1987, the Fed narrowly voted 3-2 to permit banks to trade in municipal bonds and now-infamous mortgage backed securities. Then-Fed Chairman Paul Volcker was skeptical, and feared that easing restrictions would make banks lower their lending standards, recklessly pursue attractive-yet-irresponsible investments, and push bad loans on the public. To assuage concerns, banking heads testified that these changes wouldn't be harmful, because unlike 1930, we now have external protections like the "effective" SEC and "sophisticated" rating agencies, plus modern investors are much more savvy and informed, allowing them to shun risky investments/institutions. The last few years have shown that all those claims were false and Volcker was right.
Also that year, former JP Morgan head and deregulation proponent Alan Greenspan became the new Fed Chairman, replacing "killjoy" Paul Volcker. The Greenspan Fed expanded the bank revenue limit stemming from securities underwriting from 5 to 10%, and later to 25% in 1989. This final change essentially neutralized the purpose of Glass-Steagall, since any major bank could easily do all the risky speculation and underwriting it wanted, and still fly below that generous ceiling. This also opened the door for merger-mania, as commercial banks craved securities firms to turn larger, more diversified profits, and investment houses lusted after banks' vast deposits and loans to package and play on the market. In the majority-Democrat Congress, twice the Senate passed a bill to repeal Glass-Steagall (1984, 1988), but twice the House blocked it, similar to the financial bailout bill this month. Not coincidentally, the FIRE sector (finance, insurance, real estate) was one of the most generous contributors to Congress. In the midterm election cycle of 1997-8 alone, they gave $150M to campaigns and spent $200M on lobbying activities. I can only assume the numbers have gone much higher in this decade.
Many of us were a bit young to absorb the scale of the event, but in 1998 a bomb dropped on Wall Street and Washington, with the biggest merger in history that created Citigroup from Citicorp and Traveler's Insurance (which previously bought the investment bank Salomon Smith Barney). But the deal didn't pass easily and was fraught with controversy. Foremost, Traveler's was an insurance company, and what remained of Glass-Steagall prohibited such a company from becoming a bank as well. So Congress and regulators had three choices: can the deal, change the laws, or force Citi to scrap its lucrative insurance division. But of course those companies' chairmen John Reed and Sandy Weill pushed the Clinton administration, Greenspan, and the Gingrich Congress to change the laws and approve the deal. They met him half-way: the deal would go through, and Citi would have 2 years to divest from insurance. So now Weill et al. were under time pressure to change the laws, and midterm elections were approaching. But more pressure came from Wall Street, where investors punished the stock, fearing Congress wouldn't approve the deal or change the laws in time. In May, the House approved changes to permit banks to also deal in insurance by a razor-thin 214-213 vote, and the Phil Gramm-led Senate Banking Committee signed onto a modified version later.
But we still didn't have a new law. Through intense debate and negotiations in 1999, Weill et al. convinced the White House and Congress (often by direct phone call) to finally do the impossible. The Financial Services Modernization Act was the remaining step in their victory march: Glass-Steagall had finally and totally perished, after 12 failed attempts in Congress over 25 years, and $300M spent in the lobbying effort. The Clintonites were on the way out of the White House and needed a golden parachute, and they got it from Wall Street.
And as we know now, Glass and Steagall were RIGHT.
I'll close with this:
Oct.-Nov. 1999Congress passes Financial Services Modernization Act
Just days after the administration (including the Treasury Department) agrees to support the repeal [of Glass-Steagall], Treasury Secretary Robert Rubin, the former co-chairman of a major Wall Street investment bank, Goldman Sachs, raises eyebrows by accepting a top job at Citigroup as Weill's chief lieutenant.
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http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/
1933Glass-Steagall Act creates new banking landscape
Following the Great Crash of 1929, one of every five banks in America fails. Many people, especially politicians, see market speculation engaged in by banks during the 1920s as a cause of the crash.
In 1933, Senator Carter Glass (D-Va.) and Congressman Henry Steagall (D-Ala.) introduce the historic legislation that bears their name, seeking to limit the conflicts of interest created when commercial banks are permitted to underwrite stocks or bonds. In the early part of the century, individual investors were seriously hurt by banks whose overriding interest was promoting stocks of interest and benefit to the banks, rather than to individual investors. The new law bans commercial banks from underwriting securities, forcing banks to choose between being a simple lender or an underwriter (brokerage). The act also establishes the Federal Deposit Insurance Corporation (FDIC), insuring bank deposits, and strengthens the Federal Reserve's control over credit.
In 1956, the Bank Holding Company Act is passed, extending the restrictions on banks, including that bank holding companies owning two or more banks cannot engage in non-banking activity and cannot buy banks in another state.
1960s-70sFirst efforts to loosen Glass-Steagall restrictions
Beginning in the 1960s, banks lobby Congress to allow them to enter the municipal bond market, and a lobbying subculture springs up around Glass-Steagall. Some lobbyists even brag about how the bill put their kids through college.
In the 1970s, some brokerage firms begin encroaching on banking territory by offering money-market accounts that pay interest, allow check-writing, and offer credit or debit cards.
1986-87Fed begins reinterpreting Glass-Steagall; Greenspan becomes Fed chairman
In December 1986, the Federal Reserve Board, which has regulatory jurisdiction over banking, reinterprets Section 20 of the Glass-Steagall Act, which bars commercial banks from being "engaged principally" in securities business, deciding that banks can have up to 5 percent of gross revenues from investment banking business. The Fed Board then permits Bankers Trust, a commercial bank, to engage in certain commercial paper (unsecured, short-term credit) transactions. In the Bankers Trust decision, the Board concludes that the phrase "engaged principally" in Section 20 allows banks to do a small amount of underwriting, so long as it does not become a large portion of revenue. This is the first time the Fed reinterprets Section 20 to allow some previously prohibited activities.
In the spring of 1987, the Federal Reserve Board votes 3-2 in favor of easing regulations under Glass-Steagall Act, overriding the opposition of Chairman Paul Volcker. The vote comes after the Fed Board hears proposals from Citicorp, J.P. Morgan and Bankers Trust advocating the loosening of Glass-Steagall restrictions to allow banks to handle several underwriting businesses, including commercial paper, municipal revenue bonds, and mortgage-backed securities. Thomas Theobald, then vice chairman of Citicorp, argues that three "outside checks" on corporate misbehavior had emerged since 1933: "a very effective" SEC; knowledgeable investors, and "very sophisticated" rating agencies. Volcker is unconvinced, and expresses his fear that lenders will recklessly lower loan standards in pursuit of lucrative securities offerings and market bad loans to the public. For many critics, it boiled down to the issue of two different cultures - a culture of risk which was the securities business, and a culture of protection of deposits which was the culture of banking.
In March 1987, the Fed approves an application by Chase Manhattan to engage in underwriting commercial paper, applying the same reasoning as in the 1986 Bankers Trust decision, and in April it issues an order outlining its rationale. While the Board remains sensitive to concerns about mixing commercial banking and underwriting, it states its belief that the original Congressional intent of "principally engaged" allowed for some securities activities. The Fed also indicates that it will raise the limit from 5 percent to 10 percent of gross revenues at some point in the future. The Board believes the new reading of Section 20 will increase competition and lead to greater convenience and increased efficiency.
In August 1987, Alan Greenspan -- formerly a director of J.P. Morgan and a proponent of banking deregulation -- becomes chairman of the Federal Reserve Board. One reason Greenspan favors greater deregulation is to help U.S. banks compete with big foreign institutions.
1989-1990Further loosening of Glass-Steagall
In January 1989, the Fed Board approves an application by J.P. Morgan, Chase Manhattan, Bankers Trust, and Citicorp to expand the Glass-Steagall loophole to include dealing in debt and equity securities in addition to municipal securities and commercial paper. This marks a large expansion of the activities considered permissible under Section 20, because the revenue limit for underwriting business is still at 5 percent. Later in 1989, the Board issues an order raising the limit to 10 percent of revenues, referring to the April 1987 order for its rationale.
In 1990, J.P. Morgan becomes the first bank to receive permission from the Federal Reserve to underwrite securities, so long as its underwriting business does not exceed the 10 percent limit.
1980s-90sCongress repeatedly tries and fails to repeal Glass-Steagall
In 1984 and 1988, the Senate passes bills that would lift major restrictions under Glass-Steagall, but in each case the House blocks passage. In 1991, the Bush administration puts forward a repeal proposal, winning support of both the House and Senate Banking Committees, but the House again defeats the bill in a full vote. And in 1995, the House and Senate Banking Committees approve separate versions of legislation to get rid of Glass-Steagall, but conference negotiations on a compromise fall apart.
Attempts to repeal Glass-Steagall typically pit insurance companies, securities firms, and large and small banks against one another, as factions of these industries engage in turf wars in Congress over their competing interests and over whether the Federal Reserve or the Treasury Department and the Comptroller of the Currency should be the primary banking regulator.
1996-1997Fed renders Glass-Steagall effectively obsolete
In December 1996, with the support of Chairman Alan Greenspan, the Federal Reserve Board issues a precedent-shattering decision permitting bank holding companies to own investment bank affiliates with up to 25 percent of their business in securities underwriting (up from 10 percent).
This expansion of the loophole created by the Fed's 1987 reinterpretation of Section 20 of Glass-Steagall effectively renders Glass-Steagall obsolete. Virtually any bank holding company wanting to engage in securities business would be able to stay under the 25 percent limit on revenue. However, the law remains on the books, and along with the Bank Holding Company Act, does impose other restrictions on banks, such as prohibiting them from owning insurance-underwriting companies.
In August 1997, the Fed eliminates many restrictions imposed on "Section 20 subsidiaries" by the 1987 and 1989 orders. The Board states that the risks of underwriting had proven to be "manageable," and says banks would have the right to acquire securities firms outright.
In 1997, Bankers Trust (now owned by Deutsche Bank) buys the investment bank Alex. Brown & Co., becoming the first U.S. bank to acquire a securities firm.
1997Sandy Weill tries to merge Travelers and J.P. Morgan; acquires Salomon Brothers
In the summer of 1997, Sandy Weill, then head of Travelers insurance company, seeks and nearly succeeds in a merger with J.P. Morgan (before J.P. Morgan merged with Chemical Bank), but the deal collapses at the last minute. In the fall of that year, Travelers acquires the Salomon Brothers investment bank for $9 billion. (Salomon then merges with the Travelers-owned Smith Barney brokerage firm to become Salomon Smith Barney.)
April 1998Weill and John Reed announce Travelers-Citicorp merger
At a dinner in Washington in February 1998, Sandy Weill of Travelers invites Citicorp's John Reed to his hotel room at the Park Hyatt and proposes a merger. In March, Weill and Reed meet again, and at the end of two days of talks, Reed tells Weill, "Let's do it, partner!"
On April 6, 1998, Weill and Reed announce a $70 billion stock swap merging Travelers (which owned the investment house Salomon Smith Barney) and Citicorp (the parent of Citibank), to create Citigroup Inc., the world's largest financial services company, in what was the biggest corporate merger in history.
The transaction would have to work around regulations in the Glass-Steagall and Bank Holding Company acts governing the industry, which were implemented precisely to prevent this type of company: a combination of insurance underwriting, securities underwriting, and commecial banking. The merger effectively gives regulators and lawmakers three options: end these restrictions, scuttle the deal, or force the merged company to cut back on its consumer offerings by divesting any business that fails to comply with the law.
Weill meets with Alan Greenspan and other Federal Reserve officials before the announcement to sound them out on the merger, and later tells the Washington Post that Greenspan had indicated a "positive response." In their proposal, Weill and Reed are careful to structure the merger so that it conforms to the precedents set by the Fed in its interpretations of Glass-Steagall and the Bank Holding Company Act.
Unless Congress changed the laws and relaxed the restrictions, Citigroup would have two years to divest itself of the Travelers insurance business (with the possibility of three one-year extensions granted by the Fed) and any other part of the business that did not conform with the regulations. Citigroup is prepared to make that promise on the assumption that Congress would finally change the law -- something it had been trying to do for 20 years -- before the company would have to divest itself of anything.
Citicorp and Travelers quietly lobby banking regulators and government officials for their support. In late March and early April, Weill makes three heads-up calls to Washington: to Fed Chairman Greenspan, Treasury Secretary Robert Rubin, and President Clinton. On April 5, the day before the announcement, Weill and Reed make a ceremonial call on Clinton to brief him on the upcoming announcement.
The Fed gives its approval to the Citicorp-Travelers merger on Sept. 23. The Fed's press release indicates that "the Board's approval is subject to the conditions that Travelers and the combined organization, Citigroup, Inc., take all actions necessary to conform the activities and investments of Travelers and all its subsidiaries to the requirements of the Bank Holding Company Act in a manner acceptable to the Board, including divestiture as necessary, within two years of consummation of the proposal. ... The Board's approval also is subject to the condition that Travelers and Citigroup conform the activities of its companies to the requirements of the Glass-Steagall Act."
1998-1999Intense new lobbying effort to repeal Glass-Steagall
Following the merger announcement on April 6, 1998, Weill immediately plunges into a public-relations and lobbying campaign for the repeal of Glass-Steagall and passage of new financial services legislation (what becomes the Financial Services Modernization Act of 1999). One week before the Citibank-Travelers deal was announced, Congress had shelved its latest effort to repeal Glass-Steagall. Weill cranks up a new effort to revive bill.
Weill and Reed have to act quickly for both business and political reasons. Fears that the necessary regulatory changes would not happen in time had caused the share prices of both companies to fall. The House Republican leadership indicates that it wants to enact the measure in the current session of Congress. While the Clinton administration generally supported Glass-Steagall "modernization," but there are concerns that mid-term elections in the fall could bring in Democrats less sympathetic to changing the laws.
In May 1998, the House passes legislation by a vote of 214 to 213 that allows for the merging of banks, securities firms, and insurance companies into huge financial conglomerates. And in September, the Senate Banking Committee votes 16-2 to approve a compromise bank overhaul bill. Despite this new momentum, Congress is yet again unable to pass final legislation before the end of its session.
As the push for new legislation heats up, lobbyists quip that raising the issue of financial modernization really signals the start of a fresh round of political fund-raising. Indeed, in the 1997-98 election cycle, the finance, insurance, and real estate industries (known as the FIRE sector), spends more than $200 million on lobbying and makes more than $150 million in political donations. Campaign contributions are targeted to members of Congressional banking committees and other committees with direct jurisdiction over financial services legislation.
Oct.-Nov. 1999Congress passes Financial Services Modernization Act
After 12 attempts in 25 years, Congress finally repeals Glass-Steagall, rewarding financial companies for more than 20 years and $300 million worth of lobbying efforts. Supporters hail the change as the long-overdue demise of a Depression-era relic.
On Oct. 21, with the House-Senate conference committee deadlocked after marathon negotiations, the main sticking point is partisan bickering over the bill's effect on the Community Reinvestment Act, which sets rules for lending to poor communities. Sandy Weill calls President Clinton in the evening to try to break the deadlock after Senator Phil Gramm, chairman of the Banking Committee, warned Citigroup lobbyist Roger Levy that Weill has to get White House moving on the bill or he would shut down the House-Senate conference. Serious negotiations resume, and a deal is announced at 2:45 a.m. on Oct. 22. Whether Weill made any difference in precipitating a deal is unclear.
On Oct. 22, Weill and John Reed issue a statement congratulating Congress and President Clinton, including 19 administration officials and lawmakers by name. The House and Senate approve a final version of the bill on Nov. 4, and Clinton signs it into law later that month.
Just days after the administration (including the Treasury Department) agrees to support the repeal, Treasury Secretary Robert Rubin, the former co-chairman of a major Wall Street investment bank, Goldman Sachs, raises eyebrows by accepting a top job at Citigroup as Weill's chief lieutenant. The previous year, Weill had called Secretary Rubin to give him advance notice of the upcoming merger announcement. When Weill told Rubin he had some important news, the secretary reportedly quipped, "You're buying the government?"
Sources: FRONTLINE's interviews for "The Wall Street Fix" and published reports by The New York Times, The Wall Street Journal, The Washington Post, Time, Fortune, Business Week, and other publications.
