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Finance

The usual suspects

The economic crisis rogue’s gallery
Captain Renault (Claude Rains, in black): “Round up the usual suspects.” (Photo: From Casablanca, 1942, Warner Bros. Pictures)

In the classic 1942 film Casablanca, when French police captain Louis Renault hears that German Major Strasser has been shot, he utters the famous words:

“Round up the usual suspects.”

I was reminded of this when I read of the recent $2-billion to $3-billion loss by JP Morgan Chase, because the cast of characters seemed quite familiar. Front and center was one of the usual suspects, Jamie Dimon, JP Morgan CEO and opponent of the “Volcker Rule” that would prevent banks with FDIC-insured deposits from engaging in proprietary trading (which is speculating with the depositors’ money).

Conflicts of Interest

In 1933, Congress passed the Glass-Steagall Act, which sought to limit the conflicts of interest created when commercial banks were permitted to underwrite stocks or bonds. Individual investors in the 1920s had suffered at the hands of banks whose main interest was promoting stocks in which the bank held a position, rather than promoting the interests of their individual clients. Glass-Steagall banned commercial banks from underwriting securities. It also established the FDIC to insure people’s individual bank deposits.

In 1987, Alan Greenspan – a former director of JP Morgan and one of the usual suspects – became chairman of the Federal Reserve, and the Fed decided to relax Glass-Steagall to allow Chase Manhattan (yet another of the usual suspects) to engage in underwriting activity, provided it amounted to less than 5 percent of their revenues.

Two years later, the Federal Reserve allowed more of the usual suspects (J.P. Morgan, Chase Manhattan, Bankers Trust, and Citicorp) to deal in debt and equity securities, municipal bonds, and commercial paper – up to 10 percent of their revenues.

In 1996, the Fed decided to loosen the 10 percent limitation to 25 percent.

By 1997, the Fed was satisfied that the risks of allowing banks to be underwriters of securities had proven “manageable,” so banks should be allowed to acquire securities firms outright. Bankers Trust bought the investment bank of Alex Brown, and Travelers Insurance added Salomon Brothers to its prior acquisition of Smith Barney.

The deal that would finally kill Glass-Steagall was the proposed 1998 merger between Travelers and Citicorp to form Citigroup, which would put the investment banks of Smith Barney and Salomon Brothers under the same management as the FDIC-insured Citicorp. An intense lobbying effort was led by Citigroup’s chairman, Sandy Weill, and his second-in-command – none other than usual suspect Jamie Dimon. Weill made personal calls to Greenspan, Treasury Secretary Robert Rubin, and President Clinton. During the 1997–98 election cycle, it is estimated that finance, insurance and related industries spent over $200 million on lobbying and $150 million in political donations targeted at members of Congressional banking committees and others with jurisdiction over financial services.

The Financial Services Modernization Act (also known as the Citigroup Relief Act) passed Congress in November 1999 and President Clinton signed it into law. It repealed part of Glass-Steagall by removing barriers to any one institution being a combination of investment bank, commercial bank and insurance company. It passed the Senate by a vote of 90 to 8.

In the meantime, Citigroup had fired Dimon in November 1998 and replaced him in October 1999 with another of our usual suspects, Robert Rubin. I am sure it was pure coincidence that Rubin left the Treasury and went to work as No. 2 at Citigroup just around the time that legislation was approved allowing the Travelers merger with Citicorp. But before Rubin left the Treasury, he hired as Under Secretary for International Affairs – you guessed it – another usual suspect, Tim Geithner.

If we move forward about 10 years, we find candidate Barack Obama running hard for election with Paul Volcker as a key economic advisor. Meanwhile, Tim Geithner had become president of the Federal Reserve Bank of New York, and Jamie Dimon had become the CEO of JP Morgan Chase. Bear Stearns was about to collapse and the Fed, together with the Bush administration, had decided that it was too big to fail. So Tim called his friend Jamie and offered him $30 billion in federal guarantees if JP Morgan Chase would rescue Bear Stearns. Volcker was highly critical of the move, describing it as barely legal.

Obama was elected after accepting significant campaign contributions from Wall Street, Geithner was appointed Treasury Secretary, and Volcker was dropped from Obama’s inner circle.

Back to the Future

Now let us return to 2012 and JP Morgan Chase’s $2-billion to $3-billion loss. The loss involved multi-layered credit default swaps, which were the type of derivative instruments that led to the failure of Lehman Brothers, Bear Stearns, Countrywide, Washington Mutual, and to the government bailout of AIG. I described credit default swaps in an earlier column as similar to buying fire insurance on your neighbor’s house. However, one of our usual suspects – eminent economist and Federal Reserve Chairman Greenspan – had described them in 2005 as “facilitating the dispersion of risk” and making our financial system “far more flexible, efficient and resilient.” So much for
eminent economists.

As I think of the sophisticated form of casino capitalism that has brought our economy to its knees and recently embarrassed even Jamie Dimon, I am reminded of another line from Casablanca. Captain Renault has ordered that Rick’s place be closed immediately saying:

“I am shocked, shocked, to find that gambling is going on in here”.

As Renault prepares to leave, one of Rick’s employees hands him some money saying, “Your winnings, sir.”

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