Financial Fraud: Citigroup not in a class by itself

Jeff Madrick

And now for a word about class.  The Republican right wing has long been charging liberal commentators with fomenting class warfare. It is an otherworldly charge.  Wages for typical Americans have been outright bad for a generation, while a top sliver has made the fortunes of a century.  Even the Hamilton Group, the centrist think tank housed in the Brookings Institution and put together by Robert Rubin, just published a paper about how wages for males have fallen since 1969.  But real Americans, we are told, don’t complain about the wealth of a few at the top.

In fact, the class warfare has been carried on by those at the top, aided by politicians, regulators, unthinking media, and not a few economists with simple half-truth theories about the universal stabilizing value of speculation, the rationality of stock prices and therefore stock options to reward CEOs, and the enormous dangers of wage increases that might contribute even to mild inflation.

It’s time to recognize that TARP, the $700 billion Troubled Asset Relief Fund of the Bush Treasury, was also a classic example of class privilege at work. How is it possible that no bankers were removed from their jobs when, according to Ben Bernanke, as quoted in the valuable, recently published Report by the Financial Crisis Inquiry Commission run by Phil Angelides, that he thought 12 of the 13 major financial institutions were in danger of failure in the fall of 2008?  The Federal government shelled out hundreds of billions of dollars to save these banks and—with the exception of the insurance giant AIG, which it took over—demanded no managerial changes.  On incompetence alone, heads should have rolled. Given evidence of deception and possibly fraud, all the more reason for heads to roll. But mostly because deceptive and incompetent cultures run deep in firms, and will continue to distort markets, heads should have rolled.

One reason they didn’t was because the regulators and the regulated were of the same class—Ivy League or near-Ivy League semi-dandies, who essentially belonged to a big club and protected each other. The Obama administration didn’t hesitate for a moment to fire the head of General Motors, and then claim doing so saved the day. He was simply of the wrong class. He never tried to join up. He worked in Michigan, not New York, or LA, San Francisco or even Chicago, no less DC. He ran a blue-collar organization. There are no blue-collar workers at Goldman, or even Citigroup.

What prompts this comment right now is the revelation in the March 1 Financial Times that Citigroup has not been properly valuing the mortgage-backed securities on its books, thus it is charged with deceiving shareholders.  Citigroup is still run by Vikram Pandit, whose membership in the club could never be challenged. Pandit even has a Ph.D. in finance from Columbia. An investment banker at Morgan Stanley, a firm that also went under, he was appointed in 2007 to take over from the irresponsible and foolish Charles Prince, the successor to Sandy Weill—supposedly to clean up the mess.

Improper valuation of mortgage-backed securities is at the core of Citigroup’s failure. The banking giant built by Sandy Weill, Citigroup loaded up on subprime mortgage-backed securities under Prince because they were rated triple-A and paid handsomely.  It also had to buy some of these bonds in order to sell the rest. Citigoup vaulted to the number two position in the sales of collateralized debt obligations, the truly toxic version of mortgage-backed securities.  We now know they weren’t remotely triple-A quality. Something like 60 percent of such securities originally rated triple A were downgraded to B-, basically junk.  Prince said he never realized they were risky and resigned just as Citigroup was taking a $40 billion loss. Former Treasury Secretary Rubin, long a high-up Citigroup executive, also claimed ignorance.

What now? The Office of the Comptroller of the Currency expressed concerns about how the bank was valuing its mortgage bonds back in February 2008.  Citigroup was supposed to disclose any such questionable valuations by law.  But Pandit, the recipient of $45 billion in TARP money to save his firm, did not do so. The FT cited people close to the bank claiming they did not specify these weaknesses were “material.” Analysts on Wall Street are blowing the whistle.

The Bush and Obama administrations chose to leave Pandit and most of his management team in charge of a bank that was the worst of the lot.  Its careless deceptive culture ran deep. It was the most heavily fined bank in the early 2000s. It was reprimanded repeatedly by federal regulators to clean up its act. Would he fire friends? Would he undo this culture?

There were plenty of other examples of such class behavior. Best-known was when Washington bailed out AIG, thus insuring that Goldman and others of its creditors got back all their money—in Goldman’s case, $14 billion. The inspector general of TARP severely criticized the Geithner Treasury for this. Goldman claimed it would have covered its losses elsewhere, but the FCIC Report now makes clear this was dubious. And on it goes.

Meanwhile, look what’s going on.  The Dodd-Frank Act, which it should be conceded covered a lot of ground, mostly kicked the can down the road in terms of writing specific rules governing Wall Street.  The SEC and the CFTC are already missing their rule-writing deadlines. Wall Street is paying big bonuses again, not because they earned it, but because the Federal government saved the day. Warren Buffett also made an investment in Wall Street (Goldman, in particular). We shall one day be able to compare his returns on investment to what the federal government earns after taking far more risk with taxpayer money.

And as federal regulators struggle to make new, tougher rules, a new bubble is already underway in social media private companies like Facebook and Twitter. Should the economy continue to recover, many of the Dodd-Frank rules may never get written under relentless pressure from Wall Street lobbyists. And some of the White House team, as well as regulators, will find cozy jobs on Wall Street with the members of their own class.

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