8th August 2015
John Reed became CEO and Chairman of Citicorp in 1984, oversaw its merger with Travelers in 1998, and maintained his positions in the resulting Citigroup until 2000. He was interim Chairman of the New York Stock Exchange between 2003 and 2005.
Q: The NYSE used to be the dominant American exchange, but in the last decade or so we’ve seen the emergence of a variety of other exchanges. How has this challenged the Big Board, and how has it had to adapt?
A: Well I think what’s happened is electronics, and after electronics a decision by the regulators, the SEC in this case, to allow time to play a role in deciding what constitutes a fair price. For years, the regulation was that an exchange had to offer the best price, either for a buyer or a seller. When a specialist received an order and there was a better price available at a different exchange, they would go to that exchange in order to secure that price. No one paid any attention to the notion of time, because in the manual world, time was basically seconds, it was whatever happened to be on the screen when a specific order came in, it would be executed. Around the year 2003 the SEC, under pressure from those in the electronics trading business, began to say “You must offer the best price in an instant in time measured by computers.” And of course, all of a sudden this changes everything. As you can imagine, if you’re trying to sell your house and you have to do so in one week, you’re going to get a very different price than if you do so over a period of months. And the electronics traders wanted the best price at a specific instant in time, and this meant that electronic exchanges began to displace the prior human exchanges. All of a sudden, the liquidity that characterised the New York Stock Exchange, and which attracted most of the buying of the business, began to be spread out. The Stock Exchange had to adapt to a more electronic world, where human intervention was only the case at specific times, and at other times, everything was computer vs computer. Of course, computers can go to many exchanges at the same instant, and so we’ve seen not only in the United States, but in Europe as well, the dispersion of the buying to many different venues, some of them called dark pools because no one has any ideas who’s trading, some of them more established centres. So this change and the adaptation simply meant that the characteristics that had made New York Stock Exchange so central to trading have disappeared, and we now have trading that is dispersed to many different venues.
Q: The NYSE’s merger with Archipelago Holdings had drastic changes for the exchange, both in terms of automation and how it functioned (the NYSE Group was formed, and became publicly traded, operating for a profit). From an inside perspective, how did the deal come about?
A: Well, I had left by the time that came out, it was done by my successor, John Thain. But it made a dramatic change, because as I said before, the historical New York Stock Exchange was very much made up of human beings, and you had specialists on the floor of the Stock Exchange who made sure the markets were orderly, and you had brokers who represented buyers and sellers, but it was all human interaction. When the merger with Archipelago took place, as you pointed out, it became electronic. All of a sudden, the flows of electronic purchases began to dominate the activities of the exchange, and human intervention now only occurs when markets are disrupted. There are periods when humans are in fact better than machines, particularly at the opening and closing of the trading period, where you can have severe mismatches of selling and buying orders, and obviously if somebody puts an order in at the last second that an exchange is open, it is not clear whether there is going to be a countervailing buy or sell in that second. So opening and closing still benefit having human intervention. But the Exchange became, as you said, for profit. The owners of the Stock Exchange who had seats on the Exchange basically sold their positions, the Exchange became publically listed, and the dominant form of buying and selling became electronic.
Q: Has technology become too powerful in trading, considering the effects of the Flash Crash and the possibility of another one occurring?
A: It certainly is questionable whether it has improved things. You can’t roll back technology. There is a lot of trading that is strictly computer driven, where the devices don’t have any understanding of what is being bought and sold, they are looking specifically at price movements. It is a statistical trading game, and is subject to potential disruptions as we saw, because when you get large buy-ins of electronic transactions, you can occasionally get disrupted patterns emerging, as has happened. You have to ask yourself whether it is really good for an exchange to have computers trading with computers based simply on statistics. The other thing is that 90% of the trades are cancelled, so you have to build a tremendous infrastructure to manage the volume of transactions, while only a very small fraction of transactions actually resolve in a buy sell. And the reason that happens is that the computers enter in a nanosecond, and they are looking for a specific price. If that price is not there at that particular nanosecond, they cancel the trade. Statistically, it’s not going to be there very often, and that’s why the great majority of trades are cancelled. But from the point of view of having to provide infrastructure, you have to provide computer capability and communication capability to handle all of those trades, even though very few of them actually are consummated. So I think there are questions that can be asked, on the other hand I think it is highly unlikely that you are going to do anything that will revert to a non-computer type of environment. The world’s gone too far, and as I said, there are many venues where buyers and sellers come together. I think this is something we’re going to learn to live with. Undoubtedly, we’re going to get better at it over time. But I do think we are in an electronic world.
Q: What do you think about the big banks being ‘Too big to fail’?
A: It’s a big problem. It’s not a situation that society can really tolerate, because you can’t have institutions that are on the one hand supposedly private and owned by their shareholders, who during crisis periods are bailed out by governments, because the governments can’t afford to allow them to collapse. So it is a problem which has to be resolved.
Q: In your opinion, has the Volcker Rule of 2010, which banned commercial banks from proprietary trading, made a 2008 type of crash less likely to happen?
A: Not really, I’m in favour of the Volcker Rule and I’ve supported it publically: I think that it’s a step in the right direction. But no, I think not. I think the thing that will move us in the right direction, I’m not sure it will get us where we need to go, is the requirement for banks in the United States to provide so called living wills, which means they have to submit a plan to the regulators which realistically shows how they could fail, and the individual institutions could fail, without bringing down any of those who finance them. And if such plans are produced, they have not yet been finalised. If the regulators are tough minded in assessing how valid the plans are, this will take a large step in that direction. But the problem is there are too few institutions and they are too intertwined. The problem when I first started in the banking business was there was a limitation that you could not lend more than 15% of your capital to any single entity, whether it was another financial institution or a company. That put a limit on your potential losses: no one company could cause you to lose more than 15% of your capital. 15% is a lot, but it’s not likely to bankrupt you. If you put such a limit on the institutions today, this would go a long way towards solving the problem, but you would have to break up the structure of the industry into smaller companies to reduce the exposure of one company against another. In other words, you would need to reduce systemic risk, where the destruction of one entity virtually ensures the destruction of those who lend to it. And so I think the Volker is a step in the right direction. I think the living wills, if they are managed strictly, will be a very good step in that direction, but we should as a society continue to be concerned: I don’t think that it is an acceptable situation to have private entities living in an environment where they are assured of government support in the event of making serious mistakes. Capitalism is supposed to allow people to go bankrupt, and we have a situation where major institutions can’t be allowed to go bankrupt, due to the impact they would have on society, and I think that is unacceptable.
Q: What lessons did you learn in your position at Citi?
A: We could talk for a couple week about that. I was the Chief Executive of Citi for 16 years, from ’84 until 2000. I learned a tremendous amount, as you can imagine. The first part of my time, I was quite involved with the sovereign risk problems in Latin America and parts of Asia, and so I learned an awful lot about bank lending, sovereign states, and working with the IMF and the regulators to solve those problems over a period of almost ten years. I learned a lot about working with other banks. I went through a real estate crisis in the early ‘90s when the bank was not a perfectly capitalised one. We had to raise new capital and run the bank in a sort of crisis mode for a period of about two and a half years. I learned a lot about how to operate under those circumstances, I learned a lot about the people with whom you work, and how people react under crisis, and that’s a valuable learning. I learned from others who had gone through crises, and they helped me tremendously in coping with it. I learned about opportunities not taken. People often wonder what you did, and what you learned from what you did. Sometimes, you learned from what you didn’t do, and there were certainly opportunities that in retrospect I wish I had taken advantage of and I did not. I never will know how they might have turned out, but as a manager, you do learn not only about the things you do, but the things you might have done. The merger with Travelers that took place towards the end of my career turned out to have been a mistake. It was not a mistake from an economic point of view: if you are doing this as a school project, you would analyse the economics of the two companies and you would say to yourself this will probably be a very good merger, and there was not much of an overlap in the businesses we were in, we could work well together. It was a mistake for cultural reasons. The kind of people that choose to work in commercial banks are quite different in their orientation than the kind of people who work in businesses that are more trading orientated, and those groups of people cannot get along with each other. It’s sort of like trying to merge a cricket team with a rugby team, and have equal players on each of the teams, and you’d find that the skills may not translate. There are some people who would probably be lousy at cricket who are quite good at rugby, and vice versa. So this merger was, from my point of view, a great mistake, but it wasn’t a mistake on economic grounds, it was a mistake on human grounds. The type of people working in the different institutions simply have different values and don’t work well together, and that did not produce a good result. When you spend 16 years doing something and you’re working basically full time, there is an awful lot of learning. One of the benefits of being retired is that I am now able to reflect back on it, and tell some of the learning, but there are many lessons.
Q: What career advice would you give to someone my age?
A: You should do things that you love, and that you’re good at. You should pay an awful lot of attention to the people with whom you’re going to be working with, because you spend a long time in a career and if you’re working with people who don’t like and you don’t respect, it’s a great mistake because after you finish working and you look back, you’ll find that the people with whom you work are a very important ingredient as to how satisfied you are. I heard somebody give a talk once to a graduating university in the United States, and he said when he was young he had a dog that chased a red ball and whenever he took the ball out of his drawer the dog’s face would light up, and he would get ready to go chase this red ball. And this person’s advice was find your red ball: find this thing in life that causes you to light up and say this is something I really want to do, and then chase it with all of your ambitions. So my recommendation would be find something that you’re reasonably good at and that you really love, and be very supportive of the people who are going to be working with you, because they’re going to have a major impact on how much you get out of your work experience.
Q: Who is the most interesting person that you’ve met and why?
A: That’s a very difficult question. I’ve met a lot of interesting people. I suspect that maybe the most interesting was Jacques de Larosièrehe, who was head of the IMF when I was working with them on the Latin America debt crisis. He was really professional in the sense that a well-educated Frenchman can be: he had a wonderful mind and he still does when I see him occasionally, and he’s very meticulous. He thinks through things in great detail, and he has a breadth of historical understanding that he also applies to situations. So on the one hand, he’s very good at thinking through details, and he is very broad in his approach. I think another person would have been Lord Richardson, who was governor of the Bank of England. Unfortunately, he is not alive any longer, but he had those same qualities. He was wonderfully able in terms of the details of the problems, but he also saw them within a much broader context. Both Jacques de Larosièrehe and Gordon Richardson were very decent human beings. Character eventually counts, and both of them have great character, and so these are two things which jump out.