Mike Mayo, a bank analyst who has been covering Wall Street for more than 20 years, had an epiphany recently. It suddenly occurred to him that our recent financial crisis "didn't occur because of something that banks did. No, it was the natural consequence of the way banks are, even today."
In his new book, Exile on Wall Street, Mayo argues that the big Wall Street banks are set up nowadays to take excessive risks, while providing outsized compensation for bankers. And despite numerous though lightly enforced regulations, the federal government is there to bail these institutions out when things go wrong.
Mayo believes that Citigroup (NYSE: C ) , which he describes as the "poster child for the financial industry's problems," provides a perfect example of all that is wrong with our big banks right now. The two chapters that he devotes to Citi are very disturbing.
A dubious track record
Mayo shows us that over the past decade Citi has been "involved in virtually every major financial screw-up, from Enron to WorldCom, to the analyst scandals of the tech bubble, to the mortgage fiasco." And this has cost shareholders a lot of money. Mayo calculates that this dubious track record has resulted in "about $100 billion in pre-tax losses from fines, settlements, reserves, or writedowns from 2001 to 2010."
Perhaps more troubling is that Citi's entire history reveals a similar recklessness. Mayo notes that the company has "come close to failing six times in its history." And on many occasions it has required a federal bailout to remain in business. Sadly, a predictable pattern has emerged during the course of Citi's history. First, it takes excessive risks and then gets into trouble. At that point, the government has to "step in simply so it can survive." Ultimately, new regulations are created, which Citi "grumbles about and then doesn't follow anyway."
The latest version of this pattern, of course, happened during the financial crisis. Citi got the "mother of all bailouts" for a bank. According to the congressional oversight panel which oversees the Troubled Asset Relief Program, Citigroup received $476.2 billion in cash and guarantees during the financial crisis. This made it No. 1 among banks, followed by Bank of America (NYSE: BAC ) and Morgan Stanley (NYSE: MS ) .
Perhaps the worst part of the entire Citi story of recent years is that nothing has changed, according to Mayo. He feels that the dubious accounting, excessive risks, and outsized executive pay "are still happening." He writes, "It's like we've learned nothing. Forget it, Mike. It's Wall Street."
First among equals
Citi, of course, isn't the only bank on Wall Street with a troubled history, and Mayo, of course, makes that clear in his book. In his gripping chapter on the financial crisis, he notes that the entire banking sector was making record profits in the years prior to 2007 and 2008. He also admits that he became very concerned when he learned that Wells Fargo (NYSE: WFC ) and JPMorgan (NYSE: JPM ) -- traditionally very conservative banks -- admitted in November 2007 to having "toxic housing-related loans on their books." In one of the more alarming asides, Mayo admits that in the fall of 2008 he went to 100% cash in his own portfolio. And he also kept $10,000 in cash in his apartment. Apparently, one of the smartest bank analysts on Wall Street thought we were in some serious ... stuff.
Mayo tells an interesting story about when he was called upon to testify before the Financial Crisis Inquiry Commission in January 2010. He was there to provide a "check on the statements" made by the CEOs of Goldman Sachs (NYSE: GS ) , Merrill Lynch, and JPMorgan who appeared just before he did. In his testimony, he compared financial creativity over the past decade to bad sangria. You had "a lot of cheap ingredients repackaged to sell at a premium. It might taste good for a while, but you get headaches later and you have no idea what's really inside."
Back to our ABCs
Despite his tough stance toward the big banks, Mayo is an optimist who "fundamentally believes in the US banking system." He feels we must move toward what he calls the ABCs. "A" stands for more transparent accounting. "B" stands for bankruptcy -- in other words, let banks fail if they deserve to. Finally, "C" stands for clout -- let's make sure regulators, shareholders, and others have just as much clout as the insiders who have been allowed to stack the deck in their own favor for too long.
Exile on Wall Street provides tremendous insights on the failures of our banking system and should be required reading for citizens who are concerned about our financial system. One of the biggest takeaways of all is that despite the enormous pain and suffering of the financial crisis, things are not that much better today. I think it's fair to say that the financial crisis of 2008 caught most people by surprise. Will the same be true of the next one?