It hit the front page of the New York Times and Wall Street Journal and papers all around the country: Paul Krugman, Nobel Laureate and New York Times columnist permitted himself to be "outraged." Here was another example of Wall Street and Banks going off the deep end after very nearly taking all of us over a cliff.
And yet I would suggest that Mr. Andrew J. Hall the head of Citigroup's oil and energy trading unit, Phibro LLC, and focus of the $100,000,000 pay controversy, has rendered a great service to the nation. His payday though munificent in the extreme, is but a drop to what his odyssey may well save us all in the years ahead. That, especially given the lessons learned over the past months and the billions -- no, trillions --placed a great risk through guarantees and at public cost to grossly mismanaged financial institutions freighted with speculative excess.
The questions raised over Mr. Hall's compensation has given us the opportunity to focus on the primordial underlying issue of this whole drama. The Citicorp/Hall episode puts into clear focus the question that should have been posited from the very outset:
WHAT IN THE WORLD IS A BANK DOING IN THE OIL TRADING BUSINESS?!
It is one thing for a bank to finance oil or commodity trading with letters of credit or transaction financing, but to be a principal, that is, taking title on speculative positions in say oil, or other commodities, as owners and risk takers? What does that have to do with banking??
When hundreds of millions -- no, billions -- of dollars are being used by banks to play the oil contango game that is filling up supertankers with millions of barrels of oil, paid for by cheap money made available by the Fed, keeping the oil laden supertankers at sea months at a time in order to sell the oil at higher prices at a later date, thereby:
- Tying up vast swaths of money that this economy needs for the revitalization of industry and housing. How many loans/mortgages could have been modified throughout the country with the million/billions tied up months at a time in floating oil inventory? How many payrolls of small business in deep stress could have been met?
- By taking these positions, buying the oil now and storing it away, they are significantly impacting the price of oil and its downstream products (gasoline, heating oil and on) with price increases coming out of each consumer's pocket. Hereby the banks with their access to cheap funding, Fed programs, FDIC insured deposits, Tarp funds and government guarantees covering their speculative binge are simply returning to their irresponsible behavior, speculating instead of banking.
What commodity speculation has to do with banking is a question that should be asked by our press and our lawmakers of the banking authorities. That Citigroup's Phibro oil trading operations are successful is well and good. However, it exposes Citigroup to enormous risk and the same degree of downside as the failings they were unable to manage in the recent crisis. One need only recall that in 1985 Phibro-Salomon (before its merger into Travellers and in turn into Citigroup) reported a 1984 writeoff of $307 from its oil investments in the Beaufort Sea (" Phibro-Salomon in Red: Huge Oil Wrte-Off Cited," L.A.Times 02.20.85) underlining that oil profits are not a one way street- being a sum that had a vastly different connotation then, than it would have today.
Of particular note, a Federal Reserve/Treasury Department "Report to Congress on Financial Holding Companies" commented that the 1999 Gramm-Leach-Bliley Act significantly altered the legal framework that governed the permissible affiliations and activities of banking organizations, repealing the provisions of the Glass-Steagall Act and the Bank Holding Companies Act of 1956. It removed the barriers that previously inhibited the ability of banking organizations, securities firms and insurance companies to affiliate with each other. In other words the Act now allows existing bank holding companies to acquire full service securities firms and insurance companies and it allows securities firms and insurance companies to acquire banks (and thereby become a bank holding company).
The report contained an especially telling paragraph:
"Commercial Activities of Financial Holding Companies: Virtually all domestic FHC's engage only in financial activities. One domestic FHC-Citigroup- currently is engaged in trading activities involving non financial commodities (for example oil and gas).These commercial activities, however, represent a de minimis portion of Citigroup's total consolidated assets and are conducted pursuant to conditions imposed by the Board that are designed to ensure the activities are conducted in a safe and sound manner. Accordingly, the existing commercial activities of FHC's pose little risk to the safety and soundness of the depository institution subsidiaries"
- "conducted pursuant to conditions imposed by the Board that are designed to ensure that the activities are conducted in a safe and sound manner" -- this the same Board that brought a great institution to its knees with a net loss in 2008 of $27.7 billion .
- "pose little risk to the safety and soundness of the DEPOSITORY INSTITUTION. " -- That was then and this is now. And in its way this is the very crux of the issue.
Financial Holding Companies or Bank Holding Companies have become the time bombs of our financial system. Citigroup's Phibro trading division was the camel's nose under the tent of the American Banking System. The leniency extended toward Citigroup permitting it to engage in commodity trading was subsequently extended to FHC's including Morgan Stanley, JPMorgan Chase, all of whom are playing the oil/commodities game and not to be outdone, also have fully loaded vessels at sea (JP Morgan having recently chartered the VLCC Supertanker Front Queen, loaded with 2 million barrels of heating oil for a duration of nine months to sit at anchor off the coast of Malta. The commodity speculation doesn't stop with oil, but these bank's traders along with the likes of Goldman Sachs (now a Bank Holding Company) take huge trading positions on all manner of commodities for which they are clearly neither producer nor consumer, but only speculators. Given recent experience and its enormous cost can the Fed and the Treasury truly say that these rote speculative activities -- "pose little risk to the safety and soundness of the depository institution."
Under current conditions one would think that the Fed and the Treasury would be moving heaven and earth to get Citigroup to divest itself from its Phibro Division, and would call a halt to all commodity speculation by all Bank Holding Companies protected by the Fed and Treasury through their myriad programs, having access to minimal funding costs at the Fed window, to FDIC guaranteed deposits, to TARP monies, to government funded counterparty bailouts (e.g., AIG /Goldman), and being cushioned in their belief that they are too big to fail and will be bailed out by the rest of us if their trades go wrong.
Given the financial storm clouds gathering once again, given that Mr. Hall's imbroglio has brought this all to a head and helped us clearly define what is at risk, one can only say that Andrew Hall, directly or indirectly, has done the nation a great service!