If nothing else, the question of what should be done about it deserves a place on the agenda when the Senate considers Greenspan’s nomination for a fifth term, as is expected after his current four-year stint ends in June.
To be sure, both Citigroup and Chase agreed, after their role at Enron was exposed, to avoid new financing arrangements that pose similar legal and reputational risk. And under FIN 46, all deals involving SPEs must be disclosed on the balance sheet of either the bank, the borrower, or a third party. But it remains to be seen how effective the new rules will be in preventing future off-balance-sheet frauds (see “Longer Paper Routes“).
Complicating matters is the combination of commercial and investment banking and insurance blessed by the Gramm-Leach-Bliley Act of 1999, which ended the last vestiges of separation enacted by the Glass-Steagall Act and made the Fed the financial system’s primary regulator. But while the central bank supervises private banks involved in these lines of business, including Citigroup and Chase, the Fed’s primary interest isn’t stopping financial fraud, but making sure the U.S. banking system remains safe and sound. “The Fed doesn’t even believe in firewalls,” says Dimitri B. Papadimitriou, president of the Levy Economics Institute at Bard College.
In contrast to the multiline banks (called “universal,” in industry parlance), monoline investment banks such as Merrill are subject to regulation by the SEC, whose regulatory mission is the protection of public investors. With that in mind, the commission sets reserve requirements for Merrill as well as for the broker-dealer affiliates of Citigroup and Chase, along with those of such foreign institutions as the Canadian Imperial Bank of Commerce (CIBC). But the SEC, unlike the Fed, doesn’t inspect their operations.
Thus, to prosecute violations of securities law by banks, the SEC depends on bank supervisors to turn over evidence of such activity. Yet the Fed clearly has a reason to look the other way—that is, to ensure the profitability of the banks it oversees. “In doing so, it doesn’t care very much about” the interests of investors, charges Papadimitriou. In fact, Chase and Citigroup were treated much more leniently than Merrill and CIBC (see “Unequal Treatment,” at the end of this article).
Regulators dismiss any suggestion that Citigroup and Chase were given special treatment. Last February, at a conference held by The Bond Market Association (TBMA) in New York, SEC official Annette Nazareth waved off suggestions by CFO that the regulators’ differing objectives might cause them to work at cross-purposes when it came to questionable structured-finance deals. Indeed, Nazareth, the SEC’s director of the division of market regulation, and her counterparts at the Fed and the Office of the Comptroller of the Currency (OCC) insisted at the December 2002 Senate hearings that they had more than sufficient means of preventing banks from aiding and abetting corporate fraud. And that testimony was reiterated in a letter to the Senate investigations subcommittee from the officials several weeks later.