Associated Press

Looking Back at How Citigroup Got to Where It Is

January 16, 2009 09:01 AM
by Anne Szustek
Citigroup’s sale of brokerage unit Smith Barney to Morgan Stanley in a bid to shore up capital raises the question: is bigger really better?

Citigroup: Things Fall Apart

On Wednesday, Morgan Stanley purchased a 51 percent stake in a joint venture with Citigroup to take over the latter’s Smith Barney, Smith Barney Australia and Quilter units for $2.7 billion.

The deal is to create Morgan Stanley Smith Barney, which with more than 20,000 advisers on staff, would be the world’s largest brokerage firm by far. The joint venture expects it will save $1.1 billion in costs. But on Citigroup’s end, it was a capital-raising move that could help fend off government scrutiny in light of the bank’s acceptance of $300 billion in Troubled Assets Relief Program, or TARP, funds.

Citigroup acquired these brokerage services in the late 1990s in its acquisition of the Travelers Group, a deal that required legislative overhaul—much due to the pushing of former Travelers and later Citicorp and Citigroup CEO Sandy Weill.

The deal, which went through because of the passage of the Financial Modernization Act in 1998, created financial one-shop shopping: commercial banking, investment banking and insurance under one roof—or umbrella, as was the Travelers Group logo.

Fast-forward a decade: there is no such thing as an investment bank. The two survivors in the sector, Morgan Stanley and Goldman Sachs, had to convert to holding companies in order to be able to tap into TARP funding. And Citigroup leaders are looking in hindsight: some with pride, some with melancholy.

Weill defended his all-inclusive strategy in an April Financial Times article: “What [former Citigroup chair and CEO John Reed] and I created in 1998 was a model that worked very well for customers, employees and shareholders,” he said, pointing out that Citigroup’s price per share had risen 160 percent. “What didn’t work was that we had very poor management and management decisions over the past couple of years,” during which Charles Prince was Citigroup CEO.

“After 10 years there is still no other financial services firm that has the combination of businesses or the global reach that Citi has,” Citigroup Chief Administrative Officer Don Callahan told the Financial Times last April.

Reed does not have such a positive review of Citigroup’s expansion, however. “The specific merger transaction clearly has to be seen to have been a mistake,” Reed told the Financial Times. “The stockholders have not benefited, the employees certainly have not benefited and I don’t think the customers have benefited because our franchises are weaker than they have been.

The writers of Time magazine’s Curious Capitalist blog point out that the all-in-one financial model offered by Citigroup is the standard in Europe. But, they continue, “there’s the possibility that the investment banks/securities firms that have evolved over the past quarter century just aren't very good businesses … Investing in them as an outsider is turning out be, on a risk-adjusted basis, something akin to stuffing cash down a garbage disposal—albeit it without the fun grinding noises.”

Background: The Glass-Steagal Act and Citigroup’s role in its demise

As in the current credit crunch, rumors over creditworthiness and lenient lending practices factored into the stock market crash of 1929, which in turn brought on the Great Depression. One legal result was the Glass Steagal Act of 1933, which, by stipulating that only 10 percent of a bank’s capital could be open to an affiliate business, effectively split investment banks from commercial banks. The law also intended to stave off conflicts of interest in securities trading, and established the FDIC.

Interpretation of the law began to grow increasingly lax in the 1960s and ’70s, starting with brokerage firms offering money-market debit and checking accounts as well as credit cards. In December 1986, the Fed ruled that commercial banks could earn up to 5 percent of revenue from short-term, unsecured credit transactions, known in the industry as “commercial paper.”

A few months later, in 1987, the board of the Federal Reserve voted 3-2 to further lessen Glass-Steagal regulations, despite opposition from then-Fed Chief Paul Volcker. PBS Frontline writes that he made clear “his fear that lenders will recklessly lower loan standards in pursuit of lucrative securities offerings and market bad loans to the public.” Speaking on behalf of banks, Citicorp Vice Chair Thomas Theobald argued that the SEC, credit-ratings agencies and informed investors could keep any sort of corporate malfeasance in check.

A number of other steps were taken to loosen Glass-Steagal in the coming years. These paved the way for the $70 billion merger of Citicorp and Travelers Group, the parent company of what was then known as Solomon Smith Barney, on April 6, 1998, establishing Citigroup. Under the law at the time, Citigroup would have to dissociate the insurance division of Travelers Group. Sandy Weill, the head of Travelers and later the head of Citigroup, then spearheaded a $200 million lobbying effort to have Glass-Steagal repealed.

In May 1998, Congress passed legislation by a 214-213 vote allowing for insurance and securities firms, as well as banks, to form large conglomerates. On Nov. 4, 1999, parts of the Glass-Steagal Act were replaced by the Financial Modernization Act, signed into law on Nov. 4, 1999, removing the last hurdle for banks to offer both brokerage services and debit accounts.

Key Player: Sandy Weill (1933–)

Sanford “Sandy” Weill was born in 1933 and grew up in Brooklyn, N.Y. He graduated college in 1955 from Cornell University, to which he would become a heavy donor. He married his wife Joan soon after completing his education. His plans to be an Air Force pilot were put aside due to federal military spending cuts, so he took up a job on Wall Street as a runner for Bear Stearns. Weill made a weekly salary of $35.

While Weill was in his 20s, he, along with three partners, launched brokerage firm Carter, Berlind, Potoma & Weill. Over the following two decades, Weill would be behind 15 acquisitions before weaving the company into Shearson, then the second-largest securities firm. Weill sold Shearson to American Express in 1981 for $930 million and became president of that financial services firm, but resigned in 1985 out of frustration with AmEx’s working conditions.

A year later, Weill set off on convincing Control Data to spin off subsidiary Commercial Credit and sell 82 percent of it in an $850 million initial public offering. Weill became Commercial Credit’s CEO and took over Gulf Insurance, a subsidiary concentrating on property and casualty insurance. In 1988, for $1.5 billion, Weill bought Primerica Corp and its subsidiaries, insurance company A.L. Williams and brokerage firm Smith Barney.

Several acquisitions followed, including buying back Shearson, taking over Barclays American/Financial’s lending operations and, bit by bit, acquiring Travelers Insurance.

“Weill merged Shearson with Smith Barney, retaining the formidable Shearson office facilities, and closing Smith Barney's,” writes Academy of Excellence. “Travelers Group, as the resulting parent company was called, included brokerage, term insurance, consumer finance, property-casualty insurance, life insurance, money management and investment banking operations. “

In 1998, Travelers Group merged with Citicorp to create Citigroup, the world’s largest financial institution, and Weil served as its CEO. He lives in Greenwich, Conn., and is a well-known philanthropist for many causes, including his alma mater, Cornell University. Weill Medical College of Cornell University is named for him.

Opinion & Analysis: What’s next for Citigroup?; “diworsification”

Roy C. Smith, finance professor at New York University’s Stern School of Business, writes in Forbes that Citigroup “shareholders will have the most to gain by burying the legacy of Sandy Weill, and freeing the zombie, than from anything else the company might do.”

The professor argues that Citigroup should be dismantled, and the bad assets, perhaps under the direction of John Reed, could be sold back to TARP, shareholders or a private equity firm.

“The rest of the businesses, including the formidable Salomon Smith Barney investment banking business, should be sold or spun off to shareholders,” he writes in Forbes, “as Lehman Brothers was by American Express in 1994.

Whatever the destination of Citigroup holdings, dismantling is key, he writes.

Financier Peter Lynch coined the term “diworsification”. Investopedia defines it as “the process of adding to one's portfolio in such a way that the risk/return tradeoff is worsened,” going on specifically to apply the concept to mutual funds. But it could work for business conglomerations as well. The writers of Time’s Curious Capitalist blog argue that the jack-of-all trades approach does not mean financial mastery. They cite the “Dick Kovacevich rule,” named for Wells Fargo’s chair: “When you have a large diversified company the only thing that holds it together is a shared culture and common vision. You can't have multiple cultures working in a large company or it is going to be dysfunctional.”

Reference: Investing guide


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