Citigroup: Poster Child For Poor Regulatory Oversight

by: Larry MacDonald posted on: July 29, 2008 | about stocks: C Font Size: PrintEmail Nandu Narayanan, chief investment officer at Trident Investment Management, argues in his latest commentary that Citigroup is the "poster child": for what has gone awry in the U.S. financial sector (Mr. Narayanan’s hedge funds are doing quite well this year). What follows is a summary of the relevant sections.

Citigroup is the archetypical, supermarket-style financial firm, made possible by regulatory changes. The Glass Steagall Act of 1933 created deposit insurance in the U.S. and to limit risk prohibited mergers between banks and brokerages, insurance companies and other financial firms. But Fed Chairman Alan Greenspan endorsed the merger of Citicorp and Travelers in September, 1998, to give birth to Citigroup. The Clinton administration, with Robert Rubin as Treasury Secretary, then pushed for a repeal of provisions in the Glass Steagall Act to give Citigroup more scope to operate. In the fall of 1999, the Act was repealed and days afterward, Robert Rubin joined Citigroup.

The new Citigroup, with chief executive Sanford Weill in charge, was "riddled with internal conflicts of interest": and had a culture where "profits were given undue importance,": says Narayanan. For example, Jack Grubman, Citigroup’s star telecommunications analyst, was reportedly influenced by Weill to upgrade his rating on AT&T Corp. because the latter’s chief executive was on the Citigroup board and Weill needed his vote in a boardroom showdown with another board member.

Also, Citigroup "was a key player in the Enron scandal where it averaged one deal a month with the firm from 1997 till bankruptcy,": and was found by the bankruptcy examiner to have helped Enron produce misleading statements. Yet another example of pushing the limits was the directive from Japan’s stock-market regulator in 2004 to close Citigroup’s Japanese private-banking operations because of "unscrupulous violations": of rules and regulations.

In the mid-2000s, Weill passed the reins to Chuck Prince, while Weill’s team, including Rubin, stayed on. Narayanan believes "Rubin pushed the bank to increase its activity in high-growth areas like structured credit": - just as things were peaking. Rubin may have also assisted with the $800-million (U.S.) purchase in 2007 of the Old Lane Partners hedge fund, which was months before formed by a team led by Vikram Pandit. Just over a year later, the fund had to be written off.

Now Rubin is in charge of Citigroup following Prince’s resignation and has hired Pandit (from the failed hedge fund) to be chief executive. Yet, "Mr. Pandit has no prior experience to speak of in classic banking, let alone with one as large as Citi,": states Narayanan.

What Citigroup’s example shows is that "regulators and investors exercised little to no oversight of the bank and allowed it to operate unchecked.": It also shows that original participants in events leading up to the financial messes are still at the helm. "If an investor of sound mind were presented with Citigroup today it all its glory with its complex balance sheet and rivers of red ink, how could he possibly feel comfortable about investing in the firm to shore up its capital base ..,": wonders Narayanan.