The Strange Transformation of Citibank

The case of Citibank is perhaps the most interesting transformation of the four banks. Indeed, its transformation was so subtle that two of the most popular trade books written about the company barely mention the mortgage business and how it had become core to the firm (Zweig, 1995; Stone and Brewster, 2002).

Wriston championed financial deregulation and pushed constantly to have the government allow banks to expand geographically and diversify their prod­ucts. Indeed, Citibank was one of the main drivers behind the removal of regu­latory barriers. One of the reasons that it was so aggressive in its overseas expan­sion is that there were fewer rules governing its products. In the 1990s, Citibank was one of the leading banks that worked to have the Glass-Steagall Act repealed. That act, passed during the Great Depression, made it illegal for banks to be both investment banks and commercial banks.

Citibank was also a relative latecomer to the mortgage business. That business was not viewed as important to the growth of the firm, although it first entered the business in the 1980s. But beginning in the 1990s, Citibank began to rapidly expand its mortgage lending. It also became a central player in mortgage securi­tization and mortgage servicing. By the late 1990s, it had entered the unconven­tional loan markets. It held a large portfolio of MBSs funded by borrowed mon­ey. Like the other banks we have discussed, Citibank built a vertically integrated silo to house its housing activities. That part of the bank was eventually made into a division of the bank called CitiFinancial and a wholly owned subsidiary, CitiMortgage. The activities associated with mortgage securitization were so fundamental to the financial well-being of the bank that when the financial crisis hit, Citibank was one of the major banks at the center of the meltdown. Without the bailout by the government, Citibank would have gone bankrupt.

The curious thing is that if you read Citibank's 10-Ks or annual reports from this era, you would never realize how deeply the bank was dependent on the mortgage industry. The bank's self-presentation was as a global, conglomerate bank that con­sidered all parts of the banking business relevant to its mission.

Citibank's massive involvement with the mortgage securitization industry re­flected both a set of crises and an opportunity. The commercial banking business was in decline from the mid-1960s onward. Large corporations, the bread and butter of Citibank's business, increasingly moved away from borrowing at com­mercial banks and instead moved toward using the commercial paper markets for their borrowing needs. This decline accelerated during the 1970s and 1980s, and Citibank responded by looking for other businesses. It was this crisis that pushed them toward massive international expansion and entry into consumer lending. In the 1980s and early 1990s, the international economic situation made Citibank's position even more tenuous. By the early 1990s, Citibank's core busi­nesses, except consumer lending and credit cards, were floundering.

The opportunity that presented itself to the company was the mortgage market. The collapse of the savings and loan banks and the emergence of the mortgage securitization market provided Citibank an opportunity to enter into a lucrative business based on fees. This was the growth opportunity par ex­cellence in this historic period, and Citibank embraced it despite its seeming indifference to the idea. Moreover, mortgage securitization became Citibank's entrance to investment banking. It also discovered, like other banks, that mort­gage securities were excellent investments that paid high returns and could be held using borrowed money. Citibank was not the only commercial bank to dis­cover mortgage securitization. Other large commercial banks such as Bank of America, Chase, and J.P. Morgan entered the industry as well. Unpacking how this happened requires delving into how Citibank altered its banking strategy over time.

The original Citibank was the de facto successor to the Bank of the United States that was chartered in 1812. Throughout the nineteenth century, the bank, then called City Bank, had a series of ups and downs that followed closely the constant financial bubbles and panics. It operated mostly as a private merchant bank. This meant that it combined the activities of stock ownership and loans to command control over not just the financial sector but also the industrial sector. In 1895, City Bank was chartered as a national bank following the passage of the National Currency Act of 1863 and the National Bank Act of 1864. This legisla­tion helped unify the US currency around the dollar and paved the way for the growth of banks. The bank, renamed National City Bank, became one of the most successful banks in New York and the entire country.

In 1881, James Stillman became president of the bank. Stillman was good friends of the Rockefellers, and with their support, he helped make the bank the most important one in New York City. The deposits of Standard Oil provided the bank with the liquidity it needed to pick and choose to whom it made invest­ments. It took on the best customers (i.e., those with deep pockets and growing businesses) and took equity positions and made loans to help grow businesses.

In 1893, there was a financial panic, which ushered in the depression of the 1890s. This downturn had a profoundly negative effect on the railroads in the United States, at the time the largest industry in the country. Essentially, all of the railroads went bankrupt. National City Bank was at the center of a group of men (Stillman, William Rockefeller, Edward Harriman, and Jacob Schiff) who eventually took over the Union Pacific Railroad. They also took over the Chicago, Burlington, and Quincy Railroad and ended up controlling half of the US railroad system. At the same time, there grew up a competitor to challenge them. J.P. Morgan threw in with James Hill and George Baker, head of the First National Bank, to buy the Great Northern Railroad and Northern Pacific.

But National City Bank was not just involved in the business of owning and lending to corporations. Stillman worked hard to establish National City Bank as a worldwide institution. They played an important role in overseas banking, financing exports, and importing, buying, and selling foreign exchange. In 1897, the bank consolidated all of its foreign business into a single business unit. It claimed to be able to move money anywhere in the world within twenty-four hours. The bank also became central in operating as a depository and trader for US Treasury bonds. In 1906, the company moved into foreign lending to corpo­rations but mainly to governments. They started their long association with Lat­in American companies and governments. In 1908, Frank Vanderlip took over as president of the bank.

During the panic of 1907, National City Bank threw in with J.P. Morgan to save the financial system. This led to two important outcomes. First, populist forces called for an investigation of the so-called money trusts. The Pujo hear­ings documented the concentration of ownership and control of the Morgan interests and the group centered on National City. While these hearings never produced a legislative outcome, they did promote a national political discussion about stabilizing the financial system by creating a federal organization. In 1913, President Woodrow Wilson signed into law the Federal Reserve Act to establish such an organization.

In the next ten years, National City Bank increased its presence in foreign markets. In particular, it began to lend a lot of money in Cuba. During the De­pression, these loans went bad, and the bank almost went under.

The postwar era was dominated by highly regulated banks. Savings and loan banks, commercial banks, and investment banks each had their own rules, reg­ulators, and statewide or regional footprints. No commercial bank was involved in investment banking or even much retail banking. But in general, these regu­lations produced a stable banking system. The constant systemic financial melt­downs of the previous one hundred years ended. While particular banks still had crises, the whole system was stable from the mid-1930s until the late 1970s. The real opportunity right after the war for commercial banks was to resume lending to corporations. National City Bank led the way by going from having 70 percent of its loans to the government in 1946 to almost 65 percent loaned to businesses by 1956. The economic recovery brought National City to underwrite expansion in the shipping, airline, and automobile industries. National City was a leading lender to the rejuvenated multinational corporations. By the end of the war, the bank's presence overseas had dropped dramatically. But beginning in the mid- 1950s, the bank began to restore its international businesses.

Citibank was organized into two main divisions at this point, the commercial credit division and the international division. The commercial credit division was also organized around industries, reflecting the need for bankers to have some expertise in what their customers were doing. The international division was organized on a geographic basis. In the mid-1950s, the bank almost closed down its international division. The war had devastated the bank's branches ev­erywhere. The overseas expansion was undertaken by George Moore and his protege Walter Wriston. Their strategy was to go anywhere in the world and offer whatever banking service they could. Their idea was that in the postwar era, world trade would expand dramatically, and that would require a rapid expan­sion of banking services. They decided to try to enter every major commercial center in the world.

They did so by engaging in several new organizational strategies. First, they decided to give bankers on the ground wide latitude in terms of the kinds of things they could approve for loans. Second, they worked to hire the best and brightest people to run these new banking centers. This was a radical departure for the bank in that previously its overseas posts had been under little pressure to produce profits. They were often staffed by second-tier employees. Moore and Wriston wanted smart people who would be opportunistic and take advantage of whatever investments would come their way. Many of these investments nev­er worked out. One can argue that National City's aggressive overseas moves were important to the organization mostly because they reflected a shift in the organizational culture from one that was highly risk averse to one that embraced innovation and risk. By 1965, the overseas division had 177 offices in 58 coun­tries. Both Moore and Wriston would ride the expansion of National City's in­ternational banking to the top of National City's executive ranks. Moore would become CEO in 1967.

By the mid-1960s, the bank had a sprawling, disorganized structure. They lacked enough financial controls to tell where and if they made profit. They had barely entered the modern age of computers. Then, Wriston hired John Reed. Reed eventually modernized the computing and accounting system of the bank. In doing so, he laid the foundations for the bank to be able to not only monitor its far-flung activities but engage in massive numbers of commercial and con­sumer transactions. He created a management information system that allowed the bank to decide how every one of its offices were producing returns on capital.

Wriston became CEO in 1970, and he served until 1984. In 1976, he changed the name of the bank to Citibank. One of Wriston's important goals was to in­crease the size and profitability of the bank by entering new businesses. He was one of the first bankers to push for the deregulation of banks. He lobbied against Regulation Q, regulations that prohibited interstate banking, and regulations that kept commercial banks from entering other kinds of financial services in­cluding mutual funds, investment banking, and insurance. Wriston also pushed the limits of what the law and regulators saw as the boundaries between busi­nesses. His fights with Congress and regulators went on for his entire term. In essence, Wriston wanted there to be conglomerate banking. He wanted Citibank to be the pioneer in this.

During the 1970s, Citibank began to take the consumer market more serious­ly. The bank had for decades sold loans to individuals and offered checking and savings accounts. But this was never a large part of their business. Most of this business was in New York. What pushed them toward this expansion of services was their realization that the commercial market for loans to corporations had declined. During the 1960s and 1970s, corporations began to go to the financial markets directly to raise capital. This meant that banks were losing some of their biggest customers. The international business was subject to the ups and downs of both the world economy and, in many cases, the political vagaries of particu­lar countries. Wriston and Reed began to see the consumer market as very large and possibly a source of good growth.

Reed proposed that the way to enter that market was through the rapid ex­pansion of credit cards. His ambition was to expand Citibank's presence in na­tional banking by rolling the card out across the country. This process took many years and had many dead ends. The high inflation and slow economic growth of the 1970s and early 1980s made it hard to make money on consumer loans and credit cards. With interest rates above 10 percent, there were few consumers who could afford to borrow. Moreover, given the cost of capital, giving consumers any kind of loan, secured or unsecured, was an unprofitable decision. The only way the business could grow was if interest rate ceilings were removed. Regulation Q had limited how much interest could be charge on these types of loans. When it was abolished, state laws on usury still made it unprofitable to issue credit cards.

Reed tried to get New York State to get rid of their usury laws. The State balked, and Reed was approached by South Dakota. That state was willing to suspend its usury laws in exchange for Citibank to move its credit card business there. In the end, Reed tried to play the two states against one another. New York State refused to change its law. So, Citibank moved its credit card center to South Da­kota. The 1980s also witnessed a relaxation of rules of interstate bank ownership. Citibank expanded its consumer business across the country through mergers and through starting branches in states that would allow it. As the decade went on, Citibank began to explore other markets. It entered the mortgage market in a serious way beginning in 1981. It also began to enter the market for other finan­cial products such as mutual funds and stocks. It toyed with the idea of selling insurance through its branches.

Reed became CEO in 1984. The bank was already in many ways a protocon­glomerate. Its activities were far flung and produced many financial products for many markets. However, the late 1980s and early 1990s saw a continued deterio­ration in the commercial banking business. It was also a time when the interna­tional business underwent a series of scandals whereby the bank lost a great deal of money. But Reed managed to turn the bank around by ridding it of unprofit­able businesses, investing in technology, and expanding the consumer market, particularly by rapidly expanding the mortgage business. In 1991, Citibank lost S457 million; in 1997, it had turned things around to earn $3.5 billion.

The company merged with Traveler's Insurance in 1998. Traveler's was led by Sandy Weill. Weill had been very active in building many financial firms. He, too, had the vision to create a financial conglomerate. The bringing together of Traveler's and Citibank meant the creation of a financial services firm that cov­ered most of the main markets for banks. The firm had added a large capacity for investment banking in the merger as well as an insurance company. In 1999, the Congress passed the Gramm-Leach-Bliley bill to repeal Glass-Steagall. Citibank, which had promoted the financial conglomerate model since the 1970s, had fi­nally attained that goal and become the world's largest and most complex bank. Weill and Reed shared the CEO job for two years, but eventually Weill took over. His main strategy was to engage in a series of mergers and acquisitions in order to complete Citibank's transformation and to make it even more profitable.

It is useful to understand how Citibank became so centrally involved in the mortgage industry. Most of our accounts of the rise of the bank focus on its ef­forts to be international and to be diversified. Yet by the early 2000s, in spite of becoming a financial conglomerate, the bank was growing most rapidly in the business of mortgages and mortgage securitization. Like the other banks we have discussed, the mortgage business proved to be quite large, generated massive fees, and was an industry that utilized investment banking services. The oppor­tunities it presented fit well with a bank that had spent its entire history aggres­sively investing in whatever seemed to be the brand-new thing.

The selling of mortgages was always part of Citibank's consumer business. During the 1980s, the bank also began to participate in the mortgage securi­tization business. One of its main forays into investment banking was in the production of MBSs (American Banker, 1988). The bank underwent a financial crisis in the late 1980s. As a result, it cut back dramatically on its participation in all aspects of the mortgage market. But beginning in 1994, Citibank began to re­build its mortgage presence (National Mortgage News, 1994a). By the mid-1990s, the bank had resumed mortgage lending to its customers and began to rebuild its MBS business. It also sold MBSs and held large amounts on its balance sheets as investments.

Because Citibank was so diversified in terms of the market segments it had entered, it was already a participant in originating, securitizing, trading, buying, and servicing mortgages. From the perspective of the 1990s, these businesses were spread across the divisions of the company. For example, in its annual re­port for 1996, Citibank reported making $9.8 billion in mortgage loans in its consumer division (Citibank Annual Report, 1996: 41). They securitized $2.6 bil­lion in mortgage loans in their mortgage division. At the end of the year, they had a little over $1 billion in inventory of MBSs to sell (1996: 59). They also report having $23.4 billion in mortgages as investments in their investment division, of which $4 billion were GSE MBSs and $3.2 billion were private-label MBSs (1996: 58). They collected $2.2 billion in servicing fees for mortgages in their mortgage division (1996: 45).

When Citibank was merged with Traveler's Insurance, the mortgage business became subsumed in a new financial institution now called Citigroup that had a large insurance company and a huge brokerage business alongside its large international commercial banking business and all of its consumer businesses (checking accounts, credit cards, and personal and mortgage loans). In a book about Sandy Weill and the merger, Stone and Brewster conclude, “The truth is that Citigroup, under Weill, is so well diversified that there seems to be little chance of it running into crippling financial problems. Few companies in the world can boast such geographic diversification, coupled with strengths across disparate businesses. Crises that have buffeted the bank in the past—bad real es­tate loans, poor bets on technology, emerging market difficulties—would hardly put a dent in today's Citigroup” (2002: 218).

Obviously, these authors were wrong. The bank became more dependent on the mortgage business for so much of its activity, that without government help it was close to collapse in 2008. How can we square the idea that Citibank was so diversified with the reality of the vulnerability of the bank when the collapse happened? Citibank had already built businesses around all of the segments of the mortgage securitization industry by 1996. Like the other firms that followed the opportunities presented by the huge expansion of the industry from the late 1990s until its collapse in 2008, Citibank's various divisions came to focus their attention on the mortgage market. It recognized this when it created a division called CitiFinancial and its wholly owned subsidiary, CitiMortgage, to deal with the origination and securitization of mortgages in 1999. In the 1990s, that market was between $500 billion and $1.5 trillion. But from 2000 to 2003, the market rose to almost $4 trillion and stayed at over $2.5 trillion until the collapse began in 2008. This meant that the opportunities for growth and profits for Citibank's investment banking, consumer banking, and even international banking busi­ness became focused on the production and sale of MBSs.

It is useful to see how important Citibank was in those businesses by using tables generated by Inside Mortgage Finance (2009). In 1996, Citibank was only the twenty-first largest mortgage originator in the country. In 2007, it was the fourth largest and produced almost $200 billion in mortgages, which was almost an 8.7 percent market share. Not surprisingly, Citibank was the fourth-largest producer of MBSs in 2007. In 1996, Citibank was seventeenth in mortgage ser­vicing. In 2007, it had risen to third in the ranks with $899 billion under manage­ment and an 8.1 percent market share. Citibank was only the twenty-first largest holder of all forms of MBS in 1996. It was fourth in 2007. Citibank owned $58.8 billion of GSE MBSs and $40.8 billion of nonconventional MBSs, making it the fourth-largest holder of these securities in 2007. This explosive growth in the mortgage securitization industry was the impetus to lead the bank to expand its activities in that direction dramatically. The collapse of that industry made the bank vulnerable when that market turned down.