by Prins, Nomi
Investment banks advocated broadening the deregulation proposals “to include full securities powers for banks and bank power for securities firms.” They also wanted to be permitted to expand across state lines so they could be subject to national rather than state laws—it was easier to lobby the federal government on deregulation than deal with each state individually. And they wanted the “expanded rights” that the commercial banks wanted, including easier paths to becoming bank holding companies and the right to create mutual funds within their firm, in order to keep customers from taking such business elsewhere.60 In short, they wanted full reversion to pre-Glass-Steagall times.
All the other financial service factions wanted to preserve their corner of the market and have more deregulation. For their part, thrifts, or S&Ls—which tended to be smaller, more localized institutions—believed FIDA put them at a competitive disadvantage. Mortgage bankers supported FIDA as it applied to banks but thought the entire idea of the holding company approach “limits flexibility.”61 The housing industry objected to subsidiaries of bank holding companies and S&L holding companies participating in direct real estate investment, development, and brokerage, because it would infringe on their business. They also generally opposed FIDA because it would “tend to create fewer, larger financial institutions.”62 That was exactly what the commercial banks counted on.
Commercial banks, with their powerful and politically connected leaders, were angling for broader powers, including authority for corporate underwriting in their securities affiliates.63 Their demands would be honored to the extent the administration could get them through Congress.
Taking all this into account, on November 19, 1983, Bush’s task force crafted a list of bills that largely ignored noncommercial bank concerns. Title I, the Financial Institution Competitive Equity clause, for instance, deregulated a wide range of financial services that could be offered by depository institution holding companies.64
But it took time to wriggle these concepts through Congress. So on March 28, 1984, Regan had to testify again before the Senate Banking Committee regarding Senator Jake Garn’s Financial Services Competitive Equity Act, which was based on the group’s proposals. His logic remained that banks were already moving past their boundaries, so their initiative might as well be made legal. For instance, BankAmerica had moved into the insurance business by allowing Capital Holding Company, a Louisville-based firm, to sell insurance in its branches. Citicorp was operating S&Ls in California, Florida, and Illinois. And national banks were already permitted to offer investment advice.65
“You can continue to do nothing, and allow the marketplace, the states, and the federal regulators to mold the financial services industry as they see fit,” he told the committee, “or you can enact legislations, which will respond to the realities of today.”66
Wriston Retires
The New York Fed was fully supportive of expanding the powers of commercial bankers, too, such that they could acquire the depositors and business of other banks. In addition to authorizing commercial banks to purchase flailing thrifts, New York Fed president Anthony Solomon also promoted “a practical, federal plan for phasing in nationwide banking.”67
Citicorp particularly benefited from this expansionary stance and interstate banking loophole. On January 20, 1984, the Federal Reserve Board permitted it to purchase two flailing thrifts, First Federal Savings & Loan Association of Chicago and New Biscayne Savings & Loan Association of Miami.68 The acquisitions placed Citicorp, the biggest US commercial bank holding company, and now one of the nation’s biggest S&L association operators, a step closer to full-service interstate banking. Citicorp flexed its muscle by bending laws that still prohibited banks from taking deposits across state lines.
American Banker observed that Citicorp’s takeovers had been pushing legal boundaries for years: “Citicorp . . . has used a weakening in the regulatory fabric to gain a foothold in California, Florida, and Illinois . . . [which] emerged in cases of failing S&Ls when regulators have taken merger bids from out-of-state institutions rather than let a thrift fail. The acquisition of Fidelity, now with $3.3 billion in assets and the new name of Citicorp Savings, was the first merger over state lines to be approved by federal regulators.”69
On September 1, 1984, John Reed succeeded Wriston as chairman and CEO of Citicorp.70 Initially, he kept a relatively low profile that matched his more subdued personality relative to the broad media Wriston had coveted to express his views.
Wriston’s seventeen-year reign had catapulted Citibank past Chase to become America’s largest commercial bank, with $130 billion in assets. When he retired, a few years after his old rival David Rockefeller retired from Chase, he similarly bequeathed a company saddled with unstable Latin American debt and other crises. The Wall Street Journal’s Charles Stabler described the situation by declaring that the risk-free world of banking in 1967 had transformed into a risky, aggressive, innovative, and exciting enterprise, adding that “the adaptation of banks to this revolution, and even the encouragement of it, is Walt Wriston’s doing.”71 Stabler neglected to mention the downside of that excitement.
Reagan praised Wriston and a group of other businessmen at a White House dinner on May 21, 1986. “We’ve raised $7 million this year. That’s almost enough to buy a small oil company,” said Reagan.72 Wriston continued his post-Citicorp influence through op-eds, speeches, and fundraising.
“Sweeping Revisions” for Bankers
Following a brief one-month review period, Reagan approved Bush’s task force recommendations for submission to Congress. (Reagan vetoed only thirty-nine acts in his first four years in office, compared to Ford’s total of sixty-six in less than two years.) On February 2, 1984, Bush announced that “the task group’s regulatory proposals, together with the administration’s pending legislation concerning product deregulation [are] the most comprehensive revision of federal law affecting financial institutions in the last 50 years.”73
The focal point of Bush’s recommendations was the Group’s Blueprint for Reform. Bush considered the proposal a “sweeping revision of the federal regulatory system for commercial banks.” With an obligatory nod to the public, he promised the plan would put “the overall regulatory structure in a position to protect the integrity and stability of financial markets over the coming decades.”74
In July 1984, Butcher pressed Chase to acquire the Lincoln First Corporation. The acquisition marked a radical shift in federal regulatory sentiment. During the mid-1960s, Chase failed to gain the regulatory approval to become a holding company a fraction of the size of Lincoln First.75 Now size was no longer an obstacle.
Emboldened by the situation, Butcher beat the drum harder for full interstate banking. “We want to be an interstate bank,” he said during a press conference at the annual American Bankers Association convention on October 26, 1984. “We can put a branch in Bangkok, Thailand, which I can tell you is exactly half-way around the world, but not in New Jersey, which I can see over the river.”76
By 1985, Chase had facilities in twenty-three states and Washington, DC, and spanned seventy-one nations. It was assiduously buying international banks to access fresh networks of clients. Piggy-backing on Rockefeller’s legacy, twenty-two offices for private banking of high-net-worth individuals spanned the globe, concentrating in Latin America, the Middle East, and, increasingly, Asia.77
Reagan’s Reelection
During the summer of 1984, Volcker met with Reagan and his chief of staff, James Baker, in the East Wing of the White House to discuss interest rates in the lead-up to the 1984 presidential campaign.
“For Baker, it was more a routine discussion,” wrote Bob Woodward in his biography of Alan Greenspan, Maestro. “He didn’t want to be seen as pressuring Volcker. Of course the administration wanted lower rates. The White House always did.”78 So did the bankers. Lower rates would enable banks to fund themselves more cheaply so as to plug holes from potential losses arising from third world debt de
faults or payment delinquencies.
Volcker ultimately did lower rates.79 The Fed obtained greater influence over banking, too. On October 9, 1984, Bush’s task force sent its final report to Reagan. It contained fifty legislative recommendations. The report called for extending the power of the Federal Reserve by requesting the nearly nine thousand nonmember state banks supervised by the FDIC to fall under Federal Reserve supervisory jurisdiction. The Fed would maintain control over the fifty largest US bank holding companies.80
A month later, Reagan was reelected in a landslide. After his victory, on January 9, 1985, Reagan announced that Treasury Secretary Regan and Chief of Staff Baker would switch roles.81
The Independent Bankers Association of America, among others, believed that Baker understood “the value of strong regional banks,” whereas former Wall Street leader Regan “maintained close ties to the giant New York money center banks” and was thus perceived as being more sympathetic to their demands.82
Yet the distinction was meaningless in the scheme of deregulation and the commercial bank support it had in Washington. It was true that Regan had gone to bat for Wriston and the rest of the commercial bankers repeatedly, and that he was philosophically aligned with them. But Baker would turn out to be equally helpful to their power plays.
Baker, Bankers, and the Developing World
Baker unveiled the rough version of his plan for dealing with the third world debt crisis at a joint meeting of the World Bank and IMF in Seoul, South Korea, on October 6, 1985, and provided more details two days later. He called for a “new global compact among commercial bankers, debtor countries, and the international development institutions.”83 The plan urged private banks to increase their lending. It also called for $9 billion in IMF and World Bank loans in exchange for austerity measures.
Tom Clausen, president of the World Bank and the International Finance Corporation, also delivered a speech there. He stated, “Developing countries must undertake policy reforms, and they must receive adequate capital flows to support their reform efforts.”84
Clausen believed the third world needed funds to avoid defaults, but he also thought that it would have to give up resources and control to private companies in return for the financial aid. He criticized commercial banks for slowing their lending at this critical juncture and blamed them for taking “a narrow view of their own interests.”
Clausen knew well that private bankers would only help in ways that suited them. They did not want defaults, nor did they want to forgive debt or put more of their money at risk if there were other avenues through which to deal with the situation.
During his speech, Baker also urged banks “to boost their lending to the fifteen major debtor nations by $20 billion over the next three years.” He demanded debtor countries “adopt policies favoring economic growth, modeled on the tax-slashing and private-sector-oriented ideas of the Reagan administration” as well as for “continued tough scrutiny by the IMF.” In practice, Baker was calling for struggling countries to sink further into debt, plus give up more of their economic sovereignty and resources to external financial forces.
Though in essence the plan differed little from Clausen’s, Clausen was not consulted regarding Baker’s speech.85 He informed Baker that he would not be seeking a second term.86 The feeling of the administration was mutual.
CHAPTER 16
THE LATE 1980S: THIRD WORLD STAGGERS, S&LS IMPLODE
“Greed is good.”
—Gordon Gekko, Oliver Stone’s leveraged buyout king in Wall Street
AS THE BIG BANKERS WORRIED ABOUT THE THIRD WORLD, THEY CONTINUED TO press the Reagan administration to back their related bets. Domestically they worried about the attempts of the S&Ls to encroach upon their depositor territory. On the one hand, deregulated S&Ls meant the larger banks could use the smaller firms as dumping grounds for questionable real estate deals. On the other, big banks had their own deregulation agenda to push in Washington.
Meanwhile, flailing S&Ls were angling for more deregulation, too. John Rousselot, president of the National Council of Savings Institutions, complained directly to Reagan that “efforts to regulate the savings industry in the name of protecting the deposit insurance funds are misguided. The key to helping the industry regain its financial health is to free it up to compete.”1 The competition argument was everywhere.
To back his argument, Rousselot presented a twenty-one-page analysis of all 202 S&L failures between January 1981 and September 1985. The report was created by George Bentson, a University of Rochester professor who had found “no connection between those failures and the sector’s use of the new powers that had been granted by Congress and the states.”2 The Cato Institute and similar entities undertook their own studies with equivalent results.3
That conclusion ignored the codependent and carnivorous nature of banking, and the increasing intermingling of security creators and distributors and traders who needed to be regulated properly to protect the public from reckless practices within that chain. The Garn–St. Germain Depository Institutions Act of 1982 had removed the last restrictions on the level of interest rates that S&Ls could pay for deposits. That meant they could entice hoards of new consumers to open money market accounts with checking privileges at rates that matched inflation. The floodgates of depositors seeking higher returns were opened, and the S&Ls eagerly invited them into their firms.
As Martin Mayer wrote in The Greatest-Ever Bank Robbery, “The owners of what had just become decapitalized S&L’s could raise endless money and take it to whatever gambling table was most convenient. If they won, they kept it . . . if they lost, the government would pay.”4
It was no coincidence that securities backed by packages of risky mortgages simultaneously became vogue at Wall Street investment banks that converted questionable loans into more questionable securities and sold these for a hefty price. The business was so profitable that Wall Street took to sourcing deposits for the S&Ls, just so the S&Ls had more assets as collateral to buy more lucrative (to the investment banks) but risky securities from them.
The thrifts did, in turn, use those deposits (through arrangements called repurchase agreements) as collateral to buy additional securities (like faulty mortgage-backed securities).5 Those securities were also subsequently repurposed as collateral against additional loans with which to buy even more of them. The entire process resembled a casino wherein the house enabled even the most deadbeat players to keep making bets in a winner-take-all situation for the house. Wall Street houses used the S&Ls as a commission-producing dumping ground on all of the above-mentioned fronts. And they often traded against the positions they sold the S&Ls, hastening their demise.
Wall Street bankers were occupied with other forms of shady deals in the mid-1980s as well. In 1986, $50 billion of fresh junk bonds hit the market (compared to $3 billion in 1976).6 In an elaborate web of fraudulent corporate deals to augment the real estate deals plaguing the S&L industry, Drexel Burnham Lambert’s “Master of the Universe” banker Michael Milken fused together a network of junk bonds and investors, earning billions of dollars in the process. His boss, Ivan Boesky, complemented his efforts by breaking insider-trading rules.7 (Milken later pled guilty to six counts of securities fraud and served twenty-two months of a ten-year prison sentence.8)
Clausen after the World Bank, Armacost in Trouble
As the casino mentality minted millionaires on Wall Street, the tone in Washington turned more nationalist with respect to protecting US bankers against the world. In February 1986, the Senate Banking Committee heard another round of testimony from major bankers regarding the need for “competitive” deregulation.
“In order to assure continued leadership of our capital markets and of American financial institutions our laws must be updated,” Dennis Weatherstone, chairman of Morgan Guaranty Trust’s executive committee (later JPMorgan Chase), declared before the committee. “American banks must be freed to compete with foreign banks in the US securities
markets.”9 The matter to him was of fundamental liberty and national power.
Part of the fervent push for deregulation was a reaction to the epic failure of banking decisions regarding international lending, especially to the developing Latin American countries. These failures had to be supplanted by other means. The industry as a whole was buckling under the failure of the late-1970s loans it had extended, but BankAmerica was showing the worst record of the top five US banks. Clausen’s former exploits and Armacost’s subsequent leadership at the bank were suddenly under media scrutiny.
According to a Fortune magazine article, under Clausen’s leadership, “From 1976 to 1980, the bank’s rating had been sliding at an alarming pace.”10 During his five-year tenure as the president and CEO, Armacost regularly had to dodge bullets about the bank’s problems.11 For years, the board continued to believe Armacost when he promised that the sour loans, made so liberally under Clausen, were in fact solid.12
In the ongoing flare-up of Latin American debt problems, Armacost was forced to resign. In a bizarre déjà vu, this made room for Clausen’s return to the helm of BankAmerica on October 12, 1986.13 BankAmerica’s board reinstated the man who had so zealously pushed for those loan extensions to begin with rather than choose someone, anyone, with a more restrained notion of risk taking. The move even surprised an industry predicated on revolving public-private doors. The LA Times noted, “Clausen’s expected return to the bank . . . is a shock.”14
As the World Bank described Clausen, “He felt more comfortable with the private sector than with government bureaucracies and [took] his cues from the financial markets rather than the demands of the developing countries.”15 Shortly after he rejoined BankAmerica, the firm posted a $1 billion first-quarter loss.16 But that was nothing.
