Though investors and bankers are gushing about the future that the proposed joining of Citicorp and Travelers Group may bring about, a Wall Street sage has warned of new and "probably more intrusive" regulation in an age of huge financial services conglomerates.
The creation of Citigroup, which faces considerable regulatory and congressional hurdles, presents an unprecedented challenge to the doctrine of a bank's being "too big to fail," said Henry Kaufman, the former chief economist at Salomon Brothers.
In fact, the combined company would surely have to be treated as "too big to fail," Mr. Kaufman told a banking conference sponsored last week by UBS Securities, because so much of the world's money would be tied up in the conglomerate.
"It will have financial connections that course through into almost every city and town in America and into every major country abroad, too. It will have links to households, business enterprises, financial counterparties, and governments," he said. "It will be involved in every phase of financial life: securitization, lending, derivatives, asset management. Many tens of billions of dollars of payments will cross its books every day, reflecting transactions in foreign exchange, securities, and every aspect of the financial services business conducted under that spacious roof.
"How could the system as a whole deal with side effects of failure?" Mr. Kaufman asked. "It could not."
Averting the worldwide financial crisis that would ensue should Citigroup find itself beset by bad loans - as Citibank was some eight years ago - would require more vigilant and powerful regulators, he said.
"It is clear that the entire structure for overseeing large, complex institutions will have to change," said Mr. Kaufman, who heads his own consulting firm in New York, Henry Kaufman & Co.
"It will be necessary to make (Citigroup) and other gigantic entities that imitate that structure 'too good to fail,'" he said. "That cannot be without a much higher and probably more intrusive degree of supervision than presently exists."
Ultimately, he said, Citigroup and other financial conglomerates cannot be viewed merely as huge, entrepreneurial run businesses beholden to their shareholders. The size and scope of Citigroup and similar megafirms would require that they be viewed more as public utilities, Mr. Kaufman said.
With an eye toward checking accounts and insurance policies being offered by the same companies, Mr. Kaufman said that supervision of the insurance industry would have to become a federal responsibility. Currently, insurance is regulated by state agencies.
But a combination of banking and insurance may be some time off.
There aren't many big, publicly traded insurance companies with which banks can swap their stock.
There remain, however, many independent investment banks that may be sold to commercial banking companies. Ever since regulators gave the thumbs-up to such transactions a year ago, most big commercial banking companies have snapped up an investment bank.
The coming together of these businesses, Mr. Kaufman said, creates "inherent conflicts of interest" that "will worsen."
"The message to clients is fairly blatant, whether expressed explicitly or implicitly: Do your borrowing and securities issuance with us, and we will make sure that if push comes to shove our asset management people find a good reason to buy the paper."
