The Corner

This is the first in a two part series on modern day banking in the U.S.

The most significant event in modern day banking was the decision by Citibank in 1968 to transform itself into a one-bank holding company. This seemingly technical move, the first by a large money-center institution, opened a period of aggressive efforts by banks, led by the newly created Citicorp, to extend the range of their activities.

The creation of the one-bank holding company was a move designed to take advantage of a loophole in the Bank Holding Company Act of 1956. That law restricted the involvement of multibank holding companies in nonbanking businesses in order to prevent them from gaining monopolistic powers. The act excluded holding companies owning only one bank from the rule, in the assumption that they would be small and thus less threatening operations.

Instead giants such as Citicorp used the loophole to enter a wide range of new activities, such as equipment leasing, data processing services, mortgage banking, travel services and financial counseling. The banks also began pushing for the right to expand their investment banking business, which since the Glass-Steagall Act had been limited to the underwriting of U.S. government bonds. Amendments to the Bank Holding Company Act passed by Congress in 1970 ended the distinction between one-bank and multibank entities and permitted both varieties to engage in any activity approved by the Federal Reserve (Fed).

The halcyon days for the banks did not last long. By the early 1970s there were signs that the rapid expansion of assets, in both loans and noncredit businesses, was beginning to cause instability. The strain was intensified by the tight money policy adopted by the Fed to rein in the inflation generated by the rise in oil prices.

The most dramatic result was the collapse of the high-rolling Franklin National Bank of New York in 1974. Franklin, among others, had fallen into the dangerous trap of relying on short-term funds to make longer-term loans. This trend (like many others) had been pioneered by Citicorp. But its imitators often lacked the financial expertise to pull it off; when short-term rates started escalating, it was the undoing of Franklin, Security National of New York and others in 1975.

By the mid-1970s, the first stage of the banking revolution—what Business Week once called the “wild and woolly growth phase” was over, brought to an end by inflation, recession and the excesses of the banks themselves.

As part of their expansion in the late 1960s and early 1970s commercial banks took over from first-world governments and international agencies the role of lending to so-called less developed countries (LDCs). When rising oil prices and the international recession exacerbated the LDCs’ balance of payments, the volume of bank lending rose sharply. With Citicorp once again in the vanguard, the banks eagerly loaded up countries such as Mexico, Brazil and Argentina with debt, in part to “recycle” the petrodollar deposits the banks were receiving from OPEC countries.

As things worsened through the mid and late ‘80s financial gimmickry did not resolve the LDC debt crisis. By 1990 the debt problem in the Third World was intensified once again when the Persian Gulf crisis brought about a surge in oil prices. The few less developed countries that exported oil stood to gain from the situation, but for most of the Third World it meant going further in the hole.

While large U.S. financial institutions managed to pull through the LDC crisis, many of their smaller counterparts were not so lucky in dealing with the domestic travails of the banking industry. The major victims were the thrifts, and their major affliction was the galloping interest rates of the late 1970s.

The escalation of rates hit the S&Ls and savings banks in two ways. First, it sharply increased the cost of the funds they obtained in the money market while many of their loans were tied up in long-term fixed rate home mortgages at much lower levels. At the same time, their depositors were abandoning savings accounts that paid the legal limit of 5.5 percent and were turning instead to more lucrative money market mutual funds that had been created. By the end of 1986 the thrifts government insurance arm, the FSLIC, was confronted with hundreds of S&Ls that needed to be taken over and restructured, yet the fund’s reserves were used up.

While the government’s rescue of the S&Ls worsened with scandals, outright looting (the Charles Keating affair and others) and inadequate financing, the attention of commercial banks was directed to their crusade to break through many of the legal limitations on their activities—both geographic barriers and restrictions on their entry into certain lines of business. While banks were free to make loans anywhere in the country, they were limited in their ability to take deposits across state lines. As the big holding companies such as Citicorp became major national and international lenders, they hungered for broader sources of deposit funds. There was a tireless quest for the legation of interstate banking.

Finally, by the time the thrifts were cleaned up there was a significant consolidation of the major money center banks underway. For instance JPMorgan Chase is the result of the combination JP Morgan and Guaranty Trust Company, Chemical Bank, Manufacturers Hanover, First Chicago Bank, National Bank of Detroit, Texas Commerce Bank, Providian Financial and Great Western Bank. And more recently Morgan was combined with Chase Manhattan, Bank One, Bear Stearns and Washington Mutual. Similar combinations occurred for Citicorp, Wells Fargo and BankAmerica. For the rest, check in next week.

Quote of the Week: “Good judgment is usually the result of experience and experience frequently is the result of bad judgment.”—Robert Lovell quoted by Robert Sobel, Panic on Wall Street.

Bart Ward is the chief executive officer of Ward & Co. Ltd. an Anoka based registered investment advisor – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.

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