Broke, USA

by Gary Rivlin

  The woman Weill had hired as his personal assistant tried to talk him out of Commercial Credit. It’s the loan-sharking business, she chided him—and he barked back that she was being a snob. Regular people have the same right to capital as Wall Street rich guys, he told her. He would be like a Walmart or a McDonald’s, selling to ordinary Americans. A friend from his American Express days was equally incredulous. Weill had reached the pinnacle of the corporate world and Commercial Credit was a third-rate company with a mangy reputation. It’s beneath you, he counseled. But Weill had looked at Commercial Credit’s numbers and if nothing else he was a pragmatic businessman. The publicly traded giants like Household and Beneficial were reporting double-digit profits but Commercial Credit’s profit margin was 4 percent. Commercial Credit had 600,000 customers and he wondered why it couldn’t have 5 million. There seemed a huge upside in operating a business that made small loans at high rates to blue-collar customers, and especially this one, which by Weill’s standards had not come close to reaching its potential.

  On Wall Street they call it “the spread.” In short, it’s the difference between what money costs a company to borrow and the rate at which they can loan it out to others. The loan sizes inside Commercial Credit were minuscule by Weill’s standards—a thousand dollars plus fees to buy a new dining room set—but they were loaning money at a spectacular interest rate of 18, 20, or as much as 23 percent. If Weill could whip the company’s finances into shape and improve Commercial Credit’s lousy credit rating, he could further widen that spread. Everywhere Weill looked he seemed to see only upside and so he decided to move to Baltimore to take over a company so sleepy that he had nicknamed it “Rip Van Winkle.” By dangling generous stock option packages in front of old friends from Wall Street, he was able to lure more than a few of them to Baltimore to join him.

  For years, Commercial Credit had been run by a CEO who had started in the business as a repo man thirty-five years earlier. The company hadn’t opened a new branch in years but perhaps more offensive to Weill and the A-team he had assembled was Commercial Credit’s compensation system. Bonuses weren’t based on performance, as they are on Wall Street, but instead every branch manager throughout the company was given an automatic increase of 5 percent a year. One of Weill’s earliest changes was a new bonus system to inspire managers to think more entrepreneurially about the small office under their charge. Those who ran a branch whose performance ranked in the company’s top 10 percent would receive double their salary for the year; those whose stores ranked in the bottom tenth would be out of a job.

  Among those eager to accept the new boss’s challenge was Henry Smith, a Commercial Credit branch manager in Hazard, Kentucky. That’s what he told a BusinessWeek reporter whom Weill, anxious to show his former compatriots back home that he was still on the hunt, had invited inside the company to profile the turnaround. Commercial Credit peddled a high-priced, potentially dangerous product designed expressly for people living on the economic margins. Yet as Smith described it, the brilliance of Weill’s system was that he turned the company’s business model on its head: Where once the branch manager and his sales team spent their days deciding whether to extend credit to those who applied for it, they were now aggressively soliciting new business. Smith had lived in Hazard his whole life and his plan, he told BusinessWeek, was to tap into his extensive network of families, friends, and acquaintances in search of extra revenues. To save costs, Weill had fired most of the company’s human resources department and given the individual branch managers responsibility for hiring, training, and disciplining their staff. That meant one less check on the branch manager operating in the hinterlands, determined to run a top store. To no one’s surprise, profits inside Commercial Credit soon reached into the double digits. Eventually, Weill would declare that it was Commercial Credit, more than any other enterprise he had ever owned, that had rendered him a very, very wealthy man.

  It didn’t take Weill long to expand his focus beyond consumer finance. He had purchased Commercial Credit in the middle of 1986; in 1988, he bought Primerica, the parent company that owned Smith Barney, and in 1992 he snapped up a 27 percent share of Travelers Corporation, the insurance giant. In 1993, he paid $1.2 billion to buy his old brokerage house from American Express, and that same year he bought the remainder of Travelers for $4 billion in stock and changed the name of his company to the Travelers Group. In 1996, he paid $4 billion for the property and casualty division of Aetna Life & Casualty, and in 1997 he traded more than $9 billion in stock for control of Salomon Brothers, another Wall Street giant. Weill’s signature deal took place the next year, in 1998, when he brokered a merger between Travelers and Citicorp. That meant tearing down the wall that for seventy years had existed between commercial banking, investment banking, and insurance but Weill and his minions were able to do just that with passage of the Gramm-Leach-Bliley Act.

  As the new millennium dawned, Citigroup, a $250 billion behemoth, was being described by the New York Times as the most powerful financial institution since the House of Morgan a century earlier and its CEO and chairman was being richly compensated for his efforts. Weill owned tens of millions of shares in Citigroup, and already his net worth was tied to his company’s fortunes. But that was the advantage of handpicking your own board of directors and having a close relationship with people on the executive compensation committee. Weill would pay himself $15.5 million in 1999 and then grant himself nearly twice that amount the next year: $1 million in salary, an $18.5 million bonus, and $8.7 million in restricted stock. In short order, he would make the Forbes 400 with a net worth of more than $1 billion.

  Still, does a Sandy Weill ever lose his appetite for the profits generated by a subprime lender? Years later Weill would declare Commercial Credit the single best investment he had made during a career marked by smart deals, and it was the bushels of cash Commercial Credit was spinning off, especially in the early years, that allowed Weill to launch his ambitious buying spree. And Commercial Credit continued to be a robust if not minor producer within Citi throughout the 1990s. Under Weill, the company had tripled to 1,200 the number of consumer finance stores under its control by the time it renamed them CitiFinancial in 2000—and each new branch more than pulled its weight on the ledger sheet. Where Commercial Credit was earning about a 2.5 percent return on its assets inside Citigroup, the conventional banking side of things was generating close to a 1 percent return. A year before the proposed Associates deal, Citigroup snapped up the assets of a relatively small failed lender called IMC Mortgage in Tampa, Florida. Sandy Weill was not a man to turn up his nose at a rough-style lender like Associates, not when the company was spinning off $1 billion in profits each year.

  CEOs love talking about their “vision.” For Weill that was the dream of creating a full-service global supermarket of financial products. That provided Weill with another rationale for pursuing Associates. The very rich could avail themselves of the advice offered in the well-appointed offices of Citigroup’s Private Wealth Management. Citi sold any number of products to the country’s professional class, including insurance, standard banking, and the brokerage services offered by the hundreds of Shearson and Smith Barney outposts that Citigroup owned. But what about those of modest means who had bounced too many checks in their lives or who didn’t carry a credit card?

  If Weill was always on the prowl for his next deal, his target in this case, Associates, was a battered company eager to find a suitor. North Carolina had proven a blow to Associates and the bad news only seemed to pile up in the intervening months. Even the Dallas Morning News, the hometown newspaper, got into the act, reporting on a leaked memo, “The Roadmap to Continued Record Profits in 1995,” that showed that flipping loans wasn’t happenstance but company policy. Older loans are far less profitable than new ones, the memo pointed out, so it was crucial to continued success to convince existing customers to refinance. “Your controller can provide lists to you of aged personal loans to target for
renewal,” the memo suggested. Not surprisingly, the paper found, half of all customers had refinanced with the company and one in four had refinanced with Associates two or more times.

  Credit insurance products were another huge source of profits for the company. Sixty percent of all loans included some kind of credit insurance, according to the “Roadmap” memo, but that apparently wasn’t a high enough penetration rate. The key to selling more credit insurance, Gary Ayala, a former assistant branch manager at Associates in Tacoma, Washington, said in a deposition, was to never use the word “insurance.” Call it a “payment protection plan,” his bosses instructed him. Use phraseology like “Just so you know, that includes a payment protection plan if anything happens to you.” Anything to make it sound like a policy came automatically with the loan and hide the fact that it could add as much as 20 percent to the amount of principal owed.

  Negative news accounts, however, might have been the least of the worries inside Associates as 1999 turned into 2000. The U.S. Justice Department, the Federal Trade Commission (FTC), and the North Carolina attorney general’s office were all investigating its lending practices, and the economy, suffering a brief recession following the collapse of the tech bubble, was putting a big dent in its earnings. They were in the mobile home financing business but what had once been a lucrative field had blown up once people realized that the thirty-year loans companies were typically writing were outlasting the trailers themselves. The market was beset by defaults. Even one of the company’s great strengths, its place as a top-five lender in Japan, had turned into a weakness by mid-2000, when that country lowered the cap on allowable interest rates from 40 percent a year to 29 percent for the type of loans Associates made, forcing the company to warn its investors that the change would hurt their profits there.

  “They were in any number of businesses that basically blew up on them,” a Credit Suisse First Boston financial analyst told the New York Times. Associates’ stock price sagged and Sandy Weill, a bargain hunter with a nose for weakness, pounced.

  The first batch of articles reporting Associates’ acquisition focused on Weill’s deal-making acumen. The financial analysts seemed especially impressed by the deal’s potential to spin off huge profits for Citi overseas. Through its various subsidiaries, they pointed out, Citigroup had $77 billion in overseas deposits. What better way for a burgeoning global colossus to put that money to work than loaning money to the working class the world over? Buying Associates meant Citigroup would be the fifth-largest consumer finance provider in Japan, which Weill described as the second-largest market for consumer lending, behind only the United States. “I really think Sandy scored,” a money manager named Robert Albertson gushed in a Times article announcing the deal. The piece ran on page one, but made only glancing reference to Associates’ reputational troubles.

  The trade press seemed to know better, though. “If there has ever been a deal that community and consumer activists would want to block,” American Banker predicted a few days after the announcement, “it is Citigroup Inc.’s planned acquisition of Associates.” The article quoted at length a spokesman for Associates who said there was no doubt that “certain groups” would use the merger “to draw attention to their cause.” Citigroup, however, had nothing to worry about. “Associates regards predatory lending as an abhorrent practice and is committed at every level to treating customers fairly,” said the spokesperson, who was left nameless in the article.

  The first time Martin Eakes was set to meet with someone at Citi he thought he was going to have a private session with Chuck Prince, the company’s general counsel and chief operating officer, at a Washington, D.C., law firm. But apparently Prince sought to send a message at that first meeting. “It was me and twenty Citibank lawyers,” not just Prince, Eakes said. Eakes delivered his change-or-else threat and Prince just leaned back in his chair and with a bemused smile said, “You know, we’re not accustomed to having anyone tell us what we have to do.”

  Their next meeting was held six weeks later in Durham. This time it was Eakes’s turn to flex his muscle. Eakes assembled a posse of around fifty activists and community leaders, including Bill Brennan, who had flown from Atlanta for the occasion. They dubbed themselves the Coalition for Responsible Lending, just as they had done during the 1999 North Carolina predatory lender fight. To drive home his point, Eakes had arranged for the testimony of a half dozen homeowners who believed Associates had defrauded them. Those in attendance described Chuck Prince as genuinely moved by what he had heard. He gave the group his fax number and asked them to send him the details of specific cases. He also designated one of the aides who had flown down with him, a top Citigroup lawyer, as his point person in charge of all Associates-related complaints.

  “He tells us, ‘We’re going to fix everything,’” Bill Brennan recalled. “He assures us, ‘We’re going to straighten this company out.’” Brennan ate up every word Prince said—and then felt like a fool after doing some research. Commercial Credit might have been smaller than Associates but that only meant they had been less successful following more or less the same formula. Gail Kubiniec, for instance, who ran a CitiFinancial branch just outside of Buffalo, sounded like she was reading from Associates’ playbook when she told FTC investigators about her secrets for boosting revenues by packing loans with unnecessary insurance policies. “The more gullible the consumer appeared,” Kubiniec said, “the more coverage I would try to include in the loan.” By “gullible,” she explained, she meant the very young or very old, minorities and those who “appeared uneducated, inarticulate.” And then there was Prince. For years Chuck Prince had served as the general counsel at Commercial Credit. He had risen to the top of Citigroup in no small part because of the deftness with which he helped Weill take care of political messes like the one he faced with his planned purchase of Associates. “Chuck Prince didn’t know what Associates was up to? He was blindsided by all these subprime mortgages? What a joke,” Brennan said.

  Martin Eakes was similarly disgusted. “Citigroup has stated that they would solve the problems in Associates by bringing Associates up to Citigroup’s standards,” Eakes told a New York Times reporter around the time of the Durham meeting. “But it’s not totally clear that Citigroup’s standards are any tighter.” During the conference call announcing the deal, Weill had told analysts that he thought that Citi could squeeze much more profit per customer once Associates was under his control. “I remember thinking,” Eakes said, “More per customer? You need to extract much, much less from every customer.”

  In 1998, when First Union, then the country’s sixth-largest bank, announced it was buying the Money Store, then the nation’s third-largest subprime lender, for $2.1 billion, a monthly magazine called Mortgage Banking ran a cover story expressing its shock. Bankers, after all, were “the staid elder statesmen of the financial world.” The “go-go entrepreneurs of sub-prime” operated “out of nondescript strip malls [and used] veteran sports celebrities as TV spokesmen” (Terry Bradshaw for Associates, Phil Rizzuto for the Money Store). There would be some occasional intermingling between those Mortgage Banking dubbed the “odd couple of financial services,” as when NationsBank bought Chrysler First and EquiCredit, but then people concluded that NationsBank was a different breed of bank. But it was becoming increasingly plain that NationsBank hadn’t been an outlier but instead a trailblazer.

  The motivator, of course, was the same thing that had first drawn Sandy Weill to subprime: the spread. At its core, banking is a pretty straightforward business. A bank pays a depositor an interest rate that’s not as high as the interest rates a bank charges those who borrow money—and the Money Store was charging its customers as much as 14.95 percent on a home equity loan. “These two sectors of the financial world rarely crossed paths until recently,” Mortgage Banking reported, “when the profit potential of the sub-prime industry convinced banks this might be a business opportunity.” Was it any wonder, then, that a man named Hugh Miller, the
president of Delta Funding, a large New York–based subprime lender, boasted, “my phone has been ringing hot and heavy,” though his company was under federal investigation. The “profit potential” of players in this “promising sector,” the magazine reported, were making such deals “irresistible.”

  Yet never before had there been a deal of this magnitude, and never before had it involved a player like Citibank. The Times may have put Weill’s blockbuster announcement on page one because of the flabbergasting price tag—$31 billion for a lender whose name few readers of the Times even recognized—but more likely it was because of the star power of Citigroup and its flamboyant CEO and chairman. Under Weill’s direction, Citigroup ranked among the most valuable corporations in the world.

  There was opportunity for Eakes and his allies in the business press’s interest in all things Sandy Weill and Citigroup. Citi offered both a big target and a large stage; the same bright light that shined on this Wall Street giant might also help expose the predatory lending spreading within working-class enclaves across the country and finally make subprime part of the national dialogue. There was also the potential to make an example of Citigroup. If they could force reform on a corporation powerful enough to steamroll its way over one of the key reforms enacted following the 1929 crash, then maybe other lenders would fall into line.

  Yet Citigroup’s might and its prodigious reach also raised the stakes. Citi had burnished and polished its brand through hundreds of millions of dollars’ worth of advertising, building up trust. If the deal with Associates was consummated, Weill and his team would be running nearly two thousand storefronts in forty-eight states, all carrying the CitiFinancial name. Weill, when announcing the deal, promised the Street that the addition of Associates to his holdings would add at least ten cents a share in additional earnings, or about $500 million. Everything from the stock price to the size of next year’s bonuses depended on hitting that number. “The Citi Never Sleeps”: Citigroup was large and ravenous, and if the activists were to fail, there might be no stopping the company and its copycats from treading unrestricted through a deregulated landscape in search of new profits.