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Cassandra Among the Banksters

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Nelson Ching/Bloomberg Images
William Rhodes, senior vice-chairman of Citigroup, with Josef Ackermann, chairman of Deutsche Bank, at the Institute of International Finance spring membership meeting, Beijing, June 2009

The banksters, as some people have taken to calling them, have had a mixed run lately.1 Just a year or two ago, at the height of the financial crisis and during its immediate aftermath, most Americans were acutely aware of the damage done to our financial system and our economy by lax lending standards at many of our major financial institutions and their parallel willingness to take what amounted to one-sided gambles with other people’s money. There was as well the personal cost inflicted on millions of families, as borrowers went bankrupt or owed more on their mortgages than their homes were then worth.

Congress, with the encouragement of President Obama, was writing new legislation to restrain the most dangerous excesses and limit the damage should another such system-wide disaster threaten in the future. The huge sums paid out to top-level executives, often regardless of whether their institutions prospered—in some cases, even whether they survived—only intensified the opprobrium. In short, bankers were in bad odor.

Memories are short. Today many of the country’s largest financial institutions are eagerly engaging again in the kinds of risk-taking activities that put them in trouble just a few years ago, among them the use of highly risky loans and derivatives. With a very few isolated exceptions, the worst individual offenders have escaped prosecution. Most executives have retained all, or at least the greater part, of the outsized compensation they received for leading their institutions to ruin. (Angelo Mozilo, former CEO of Countrywide Financial, the nation’s largest mortgage lender, faced civil fraud charges for misleading investors about the risks involved in subprime lending; the charges stuck, and so he was allowed to keep “only” $454 million of the $521.5 million that he made between 2000 and 2008.)

The economy’s turnaround, together with continuing near-zero interest rates for most kinds of deposits, has boosted the profits of lenders who can take advantage of such cheap money. The resulting (very partial) recovery in the stock prices of banks that would have failed in the crisis except for government assistance has become an occasion for a new round of large salaries and bonuses. Shareowners in Bank of America, for example, saw their stock fall from $55 per share to $2.50; with the recent increase to $13, the firm set CEO Brian Moynihan’s 2010 pay package at $10 million.

More important for the future, the country’s largest financial institutions and their leaders have regained sufficient confidence that they are again seeking to resist or undermine restrictions on their activities. The Dodd-Frank Wall Street Reform and Consumer Protection Act, which Congress passed last July, imposed several significant changes (some for the better, some not) on how US financial firms do business and how they are regulated. But the new legislation failed to specify how to implement many of its key reforms, such as changes in financial institutions’ capital structures. Instead, the bill left the actual decisions to one or another regulatory agency: the Federal Reserve Board, the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, and more besides. The sheer volume of work to be done under the bill—some 350 separate rule-making efforts, in principle all to be completed within a year of the bill’s passage—is now overwhelming the capacity of the government’s regulatory apparatus.2 Predictably, delegating these decisions to individual agencies has been an invitation to bankers and other potentially affected parties to lobby for lenient treatment, hoping to win back at the regulatory level the battles they appeared to lose in the legislation.

Citibank, currently the country’s third-largest bank, and linked through its holding company Citigroup to other major financial institutions like Salomon Brothers and stockbroker Smith Barney, is a particularly interesting case. Citi was especially active in securitizing residential mortgages—that is, acquiring the loans, assembling them into packages, and selling securities backed by them, all in exchange for considerable fees. But along the way the bank also kept some of the securities it had created, thereby exposing itself to the same losses that hit its investors. The process continued well after house prices started declining in the summer of 2006, while concerns about the creditworthiness of recently issued mortgages mounted. As the bank’s CEO Charles Prince famously said a year later, “As long as the music is playing, you’ve got to get up and dance.”

In fact the music had already stopped. By mid-2008 Citi had taken losses of $55 billion, mostly on its portfolio of mortgage-backed securities including collateralized debt obligations (a form of derivative based on underlying bonds backed by subprime and other mortgages).3 The bank was actually holding most of these assets through separately structured entities from which in principle it could simply have walked away, just as Bear Stearns did when that firm let one of its sponsored hedge funds collapse in the summer of 2007. But Citi had apparently marketed claims against these special-purpose vehicles as if it stood behind them. The bank did not want to suffer the damage to its reputation from letting the investors take the losses. If its large depositors had taken out their money in the same way that Bear Stearns’s short-term creditors had, Citi would have been ruined just as Bear Stearns was.

The bank therefore took the assets back from investors and absorbed the losses itself. Without the $45 billion in direct capital infusions it received under the Treasury’s TARP and TIP programs, a guarantee from the Treasury and the FDIC of more than $300 billion of the bank’s troubled assets, and the further FDIC guarantee of new debt issued by all banks, Citi would presumably have failed. Even with that assistance, by early 2009 Citigroup stock had fallen from $55 per share, as recently as late 2006, to just 97 cents.

Despite the destruction of so much of the stockholders’ value, and notwithstanding the enormous taxpayer assistance, Citi’s management announced in the spring of 2009 that it was paying out $5.3 billion in bonuses for 2008, including payments of more than $5 million apiece to forty-four employees of the bank.4 Because of the $45 billion investment of TARP and TIP money, by 2009 the US government was Citigroup’s largest shareowner.5 Hence the issue these lavish bonuses raised was not merely a private firm’s right to set its employees’ compensation. What Citi’s management was giving away was, in significant part, the taxpayers’ money. Yet the Obama administration voiced no objection, at least not publicly. As a political matter, this was when President Obama took responsibility for the bankers’ excesses.

The immediate consequence, of course, was that the bonuses were paid. Of greater significance is the current US political dynamic, otherwise difficult to comprehend, in which populist resentment at the banksters’ excesses is today directed at Obama and not at the Republicans who are resisting measures to restrict banks’ risk-taking and are also seeking to strip the power of the new Consumer Finance Protection Bureau created by Dodd-Frank.

Nor was the financial crisis of 2007 to 2009 the first time Citibank had gotten into trouble. In the early 1990s the bank was probably insolvent after its real estate and leveraged buyout portfolios suffered major losses. In the early 1980s the bank was in a similar situation after many of its loans to Latin American and other developing-country borrowers turned sour. (Presaging Charles Prince a quarter-century later, the CEO at the time, Walter Wriston, famously justified these loans on the ground that “countries don’t go broke.”) Neither of these episodes required a government infusion of capital. Instead the bank survived through a combination of accounting strategies that enabled it to avoid recognizing the loss of value on its troubled loans, implicit permission from the regulators to operate while undercapitalized, and other forms of regulatory forbearance.

A disinterested observer might well wonder, wasn’t there anyone at the bank who learned from these earlier near failures? It turns out there was. William Rhodes, Citi’s international banker who had led the complex negotiations that resolved many of these earlier difficulties, publicly warned as early as the summer of 2005 that “lenders and investors have to be careful that they exercise proper risk management. If they don’t they’re going to get burned.”6 By the spring of 2007—more than three months before his boss Charles Prince insisted that the bank had no choice but to keep dancing—Rhodes was calling attention to “pockets of excess” in the financial system that were becoming “harder to ignore,” pointing in particular to the US housing and mortgage markets as “one such example of excess.” Writing in the Financial Times, he predicted trouble to follow:

As lenders and investors inevitably become more discriminating, liquidity will recede and a number of problems will surface…. I believe that over the next 12 months a market correction will occur and this time it will be a real correction.

The solution? It was, he wrote, clearly “the time to exercise greater prudence in lending and in investing and to resist any temptation to relax standards.”7 But of course by then it was already too late. Rhodes, mainly concerned with international finance and in any case not the bank’s CEO, could issue warnings; but he was not in charge.

Now Rhodes has written Banker to the World, a book recounting his experiences and highlighting the lessons he’s drawn from his fifty-three-year career at Citi. Rhodes’s recollections are lively and richly detailed, replete with glimpses of top-ranking personalities from the world of banking and government interacting under pressure, and they provide a rare window into how these important but normally secretive operations of high-level international finance actually work. As the title suggests, the principal focus is his role as not only Citibank’s chief international representative and negotiator in international debt restructurings but, more often than not, the chairman of the committees that represented all of the lenders in episodes like the Latin American debt crisis of the early 1980s and the Asian debt crisis of the late 1990s. As one would also expect for someone working at such a senior level at so important a financial institution, Rhodes was in close touch with the International Monetary Fund, the governments of the countries abroad with which he worked, and parts of the US government like the Treasury and the Federal Reserve System, all at the very top levels.

Banker to the World consists mostly of first-person accounts of Rhodes’s involvement in these and other activities over the years, organized not chronologically but in groupings intended to illustrate various “lessons.” The arrangement is useful for some purposes, less so for others, and the assignment of particular episodes and recollections of Rhodes’s actions to illustrate one “lesson” rather than another is often somewhat arbitrary. He gives a fascinating account of his role in “restructuring” Mexico’s foreign debt in 1982–1983, for example (“restructuring” mostly being a euphemism for changing the terms of a loan so as to reduce the obligations of the debtor without requiring the lenders to record losses on their books). He describes how he had to deal directly with not only the Mexicans and 526 separate lending banks but also Federal Reserve Chairman Paul Volcker and IMF head Jacques de Larosière before there was a clear consensus to rescue Mexico from possible default. But why this episode illustrates the need to “Take Prompt, Comprehensive Action,” rather than, say, to “Execute in a Timely Fashion” or “Build Consensus and Use Innovative Ways to Solve Problems” is not evident.

  1. 1

    I first encountered the word in John Lanchester’s I.O.U. (Simon and Schuster, 2010). 

  2. 2

    For views on what remains to be done following Dodd-Frank, see Randall A. Kroszner and Robert J. Shiller, Reforming US Financial Markets: Reflections Before and Beyond Dodd-Frank (MIT Press, 2011). 

  3. 3

    The loss estimate is from “Bank Losses: Hall of Shame,” The Economist, August 7, 2008. 

  4. 4

    See Louise Story and Eric Dash, “Bankers Reaped Lavish Bonuses During Bailouts,” The New York Times, July 30, 2009. 

  5. 5

    After the Treasury converted the initial $25 billion of preferred stock it received into common, it held 33.6 percent of Citigroup common stock. See Special Inspector General for the Troubled Asset Relief Program, “Extraordinary Financial Assistance Provided to Citigroup, Inc.,” January 13, 2011, p. 31. 

  6. 6

    See Jon Hilsenrath and Patrick Barta, “Amid Low Rates, Home Prices Rise Across the Global Village,” The Wall Street Journal, June 16, 2005. 

  7. 7

    William Rhodes, “A Market Correction in Coming, This Time for Real,” Financial Times, March 28, 2007. 

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