Arthur E. Wilmarth

Conflicts of Interest and Corporate Governance Failures at Universal Banks During the Stock Market Boom of the 1990s: The Cases of Enron and Worldcom

Recent corporate scandals, together with the effects of globalization, have led to an increasing interest in corporate governance issues. Little attention has been paid, however, to international laws and recommendations dealing with corporate governance in banking from a global perspective. This impressive international set of expert contributors – academics, practitioners and regulators – remedies the lack of attention by examining the various issues and concerns of this important topic.

The Panic of 2008

The Panic of 2008 brings together scholars from a variety of disciplines to examine the causes and consequences of the global credit crisis, the subsequent collapse of the financial markets, and the following recession. The book evaluates the crisis in historical context, explores its various legal, economic, and financial dimensions, and considers various possibilities for reform. The Panic of 2008 is one of the first in-depth efforts to study the crisis as it was in the very earliest stage of resolution, and establishes a foundation for thinking about and evaluating current reform efforts and the likelihood of recurrence.

Citigroup: A Case Study in Managerial and Regulatory Failures

Citigroup has served as the poster child for the elusive promises and manifold pitfalls of universal banking. When Citicorp merged with Travelers to form Citigroup in 1998, Citigroup’s leaders and supporters asserted that the new financial conglomerate would offer unparalleled convenience to its customers through “one-stop shopping” for banking, securities and insurance services. They also claimed that Citigroup would have a superior ability to withstand financial shocks due to its broadly diversified activities.By 2009, those bold predictions of Citigroup’s success had turned to ashes. Citigroup pursued a high-risk, high-growth strategy during the 2000s that proved to be disastrous. As a result, the bank recorded more than

Cuomo v. Clearing House: The Supreme Court Responds to the Subprime Financial Crisis and Delivers a Major Victory for the Dual Banking System and Consumer Protection

130 billion of losses on its loans and investments from 2007 to 2009. To prevent Citigroup’s failure, the federal government provided

Comment Letter to the U.S. Treasury Department Concerning the Regulatory Structure for Financial Institutions

45 billion of new capital to the bank and gave the bank

The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis

500 billion of additional help in the form of asset guarantees, debt guarantees and emergency loans. The federal government provided more financial assistance to Citigroup than to any other bank during the financial crisis.During its early years, Citigroup was embroiled in a series of high-profile scandals, including tainted transactions with Enron and WorldCom, biased research advice, corrupt allocations of shares in initial public offerings, predatory subprime lending, and market manipulation in foreign bond markets. Notwithstanding a widely-publicized plan to improve corporate risk controls in 2005, Citigroup continued to pursue higher profits through a wide range of speculative activities, including leveraged corporate lending, packaging toxic subprime loans into mortgage-backed securities and collateralized debt obligations, and dumping risky assets into off- balance-sheet conduits for which Citigroup had contractual and reputational exposures.Post-mortem evaluations of Citigroup’s near-collapse revealed that neither Citigroup’s managers nor its regulators recognized the systemic risks embedded in the bank’s far-flung operations. Thus, Citigroup was not only too big to fail but also too large and too complex to manage or regulate effectively. Citigroup’s history raises deeply troubling questions about the ability of bank executives and regulators to supervise and control today’s megabanks.Citigroup’s original creators - John Reed of Citicorp and Sandy Weill of Travelers - admitted in recent years that Citigroup’s universal banking model failed, and they called on Congress to reinstate the Glass-Steagall Act’s separation between commercial and investment banks. As Reed and Weill acknowledged, the universal banking model is deeply flawed by its excessive organizational complexity, its vulnerability to culture clashes and conflicts of interest, and its tendency to permit excessive risk-taking within far-flung, semi-autonomous units that lack adequate oversight from either senior managers or regulators.

The Transformation of the U.S. Financial Services Industry, 1975-2000: Competition, Consolidation and Increased Risks

In Cuomo v. Clearing House Ass’n, L.L.C., the United States Supreme Court struck down a regulation issued by the Office of the Comptroller of the Currency (OCC), which barred state officials from filing lawsuits to enforce applicable state laws against national banks. In upholding the New York Attorney General’s authority to seek judicial enforcement of New York’s fair lending laws against national banks, Cuomo revealed a perspective on banking regulation that was significantly different from the Court’s approach only two years earlier in Watters v. Wachovia Bank, N.A. In Watters, the Court upheld another OCC regulation, which preempted the application of state laws to nonbank mortgage lending subsidiaries of national banks. Watters took a broad view of the preemptive reach of the National Bank Act and indicated that national banks would not benefit from supplemental regulation by the states. In Cuomo, however, the Court took great pains to limit the scope and precedential force of Watters. Three members of the Supreme Court (Justices Breyer, Ginsburg and Souter) switched from supporting the OCC in Watters to opposing the OCC in Cuomo. Evidently those Justices changed their views about the merits of the OCC’s preemptive regime and the value of state regulation between April 2007, when Watters was decided, and June 2009, when Cuomo was issued. The most plausible explanation for the three Justices’ change in perspective is that they were influenced by the outbreak of the subprime financial crisis in August 2007 and subsequent federal bailouts involving several major national banks. Amicus briefs filed in support of New York Attorney General Andrew Cuomo included numerous references to the financial crisis. In addition, the briefs sharply criticized the OCC for its sweeping preemption of state laws and for its weak record of protecting consumers from abusive lending practices. Statements made by Justice Ginsburg and Justice Souter during oral argument in Cuomo, and by Justice Stevens in his dissenting opinion in Watters, indicate that the Court was aware of the mortgage crisis and the growing controversy over the OCC’s preemptive actions. Cuomo represents a much-needed victory for consumers and for the principles of regulatory federalism inherent in the dual banking system. In addition, Cuomo supports current legislative proposals by the Obama administration, which seek to strengthen consumer protection and preserve the states’ longstanding role in regulating financial services. During the past decade, the states have been far more proactive than the OCC and other federal agencies in enacting laws and bringing enforcement proceedings to protect consumers against predatory lending and other abusive financial practices. The subprime financial crisis has demonstrated that effective consumer protection is closely linked to the safety and soundness of financial institutions. The states’ positive record of legislation and enforcement over the past decade demonstrates the wisdom of preserving a federalist system of financial regulation, which includes not only a federal component but also a supplemental state role in enacting and enforcing consumer protection laws. The only disappointing aspect of Cuomo for the states is that the Supreme Court failed to resolve a recurring issue about the appropriate level of judicial deference that federal agencies should receive when they claim authority to preempt state laws. Cuomo did not apply a four-part test for judicial review of agency preemption claims that was indicated by Justice Stevens’ opinion for the Court in Wyeth v. Levine. That test would strike an appropriate balance between (i) the expectation that administrative agencies should receive some deference based on their specialized expertise and (ii) the judiciary’s responsibility to ensure that preemption issues are resolved in accordance with the Constitution’s allocation of federal and state powers. Instead of following Wyeth, Cuomo left open the possibility that future preemption claims by federal agencies could receive a more accommodating level of judicial deference known as “Chevron deference.” However, the Court in Cuomo refused to defer to the OCC’s preemptive regulation, based on the Court’s conclusion that Congress did not delegate the preemptive authority asserted by the OCC. Cuomo may indicate that, even if the Supreme Court chooses to apply Chevron in future cases involving agency claims of preemptive authority, the Court will apply a heightened level of scrutiny in answering the question of whether Congress has actually delegated the preemptive power claimed by the agency.

The Dodd-Frank Act: A Flawed and Inadequate Response to the Too-Big-To-Fail Problem

This comment letter was submitted to the U.S. Treasury Department in connection with that Departments review of proposals for changes in the regulatory structure for financial institutions. The comment letter presents the following policy recommendations: (1) the thrift charter should be eliminated, existing thrifts should be required to convert into banks, and the Office of Thrift Supervision should be merged with the Office of the Comptroller of the Currency (OCC); (2) the dual banking system should be preserved and strengthened in order to promote innovation in banking regulation and to support the community bank sector; (3) at least one federal agency that is separate and independent from the OCC should be designated as the primary federal regulator for state-chartered banks; (4) the existing statutory limits on bank mergers and acquisitions should be maintained, including the 10% nationwide deposit cap and the 30% statewide deposit cap; (5) greater scrutiny and special conditions should be required for large bank mergers; (6) Congress should establish federal consumer protection standards for all home mortgage lenders, credit card lenders, and other providers of consumer credit; (7) Congress should prohibit the OCC from issuing regulations that preempt state law, except in specific areas where Congress has given the OCC explicit authority to adopt preemptive rules; (8) Congress should establish a separate and independent federal authority to enforce federal consumer protection laws against all providers of financial services, including national banks; (9) Congress should recognize the authority of state attorneys general to enforce applicable state laws against all financial service providers, including national banks, (10) Congress should provide the Federal Reserve Board (FRB) with direct oversight over all significant financial conglomerates that control FDIC-insured banks; (11) Congress should prohibit the FDICs deposit insurance fund from making any payments to uninsured depositors or other uninsured claimants; and (12) all responsibility for protecting uninsured creditors of too big to fail (TBTF) financial institutions should be assigned to the FRB, and the FRB should impose assessments on significant financial conglomerates to recover the FRBs cost of providing financial assistance to TBTF institutions.