Robert Rubin Still Doesn't Get It

Robert Rubin still doesn’t get it. The former Treasury secretary may have been credited—rightly or wrongly—with the economic boom during the later Clinton years, but ever since he left Washington he’s better known for enabling one of the largest catastrophes in modern financial history, the implosion of financial giant Citigroup.

Some blame this economic mess on the 1999 repeal of the Glass-Stegall Act, which, among other things, established the FDIC, and separated investment and commercial banking. But not Robert Rubin.

No one really knew how much bad debt was actually on Citigroup's books—not the risk officers, not the senior management, and not the board.

"Don't blame any of this on the end of Glass-Steagall."

That was the message delivered to me just yesterday from an obviously nervous Rubin. The message was relayed to me while I was having lunch with a senior Wall Street executive who has regular contact with Rubin. I, of course, do not, though I know him well and consider him a good man, though terribly misguided when it comes to economic policy--Rubin is a proponent of higher taxes and banking policy. Through his long career on Wall Street and in government, Rubin has been among the most vocal opponents of Glass-Steagall, which, if left in effect, would have prevented the creation of Citigroup and saved investors and taxpayers tens of billions of dollars. (Glass-Steagall also would have prevented Bank of America’s shareholders from getting creamed following its proposed takeover of Merilll Lynch.)

For more than 65 years, Glass-Steagall survived various attempts by Wall Street to convince Congress that it was nothing more than a 1929 Crash relic—that is until financier Sandy Weill tested its limits. In 1998, Weill merged his investment bank and insurance empire Travelers Group with the commercial banking powerhouse Citicorp. The deal created the largest financial services company in the world and was considered the future of Wall Street. The minute that Weill announced the deal, others sought to replicate his "financial supermarket” model.

The concept was simple—one-stop shopping, Wall Street-style. Under this new model, depositors at Citibank, could easily buy a mutual fund, open an IRA, or buy stock through a Citigroup broker. Large companies issuing debt through Citigroup's investment bank could take out a loan from the firm's banking arm, known as Citibank. The synergies were everywhere; it was a win-win for everyone. It was also technically illegal, that is until Weill applied enough pressure on Congress and the Clinton administration, which signed legislation that ended law once and for all, nearly a year after Weill’s merger was announced. It took years of Wall Street lobbying, secret side deals between Republicans and Democrats, to kill Glass-Steagall, but it also took strong support by the then-Treasury Secretary, Bob Rubin, to kill it once and for all. It's interesting to note, that just a few days after the legislation was signed, Robert Rubin left government and joined Citigroup as a senior advisor and board member.

These aren't happy days for Bob Rubin of course. He recently announced his resignation from the Citigroup board and as a senior adviser amid wide spread criticism over his role in the firm's financial disaster. Rubin has become very rich while working at Citigroup—earning $115 million over the years—but Citigroup and its shareholder have become quite poor. During Rubin's tenure, the government had to bailout out Citigroup not once but twice. Even with the government's help, Citigroup continues to struggle. It may be Too Big To Fail, but shares have fallen below $5 again, nearing the so-called penny stock level.

The firm's current management is shedding assets, including chunks of its crown-jewel retail brokerage business, and on Friday, CEO Vikram Pandit will announce a massive shift in the giant firm's business model. Citigroup will strip down to its core business, ending its love affair with the financial supermarket model that was designed to produce huge profits by offering every type of banking service to individuals and institutions. It will also likely announce yet another quarterly loss, this one totaling around $10 billion.

Even more than that, Rubin's vision of the modern financial firm—the massive conglomerate that combined investment banking and commercial banking and was made possible by the end of Glass-Steagall—has been an utter failure, which is why, perhaps, he's so sensitive about the subject.

Rubin isn't the CEO of Citigroup, so he doesn't bear primary responsibility for the problems facing the firm. But he was an enabler of the CEO's bad behavior, which I believe is a direct result of the firm's size and scope. People I speak to at Citigroup say when Pandit took over as CEO in early 2008, he was shocked when he discovered all the non-essential businesses past management had scooped up in an attempt to grow and offer every conceivable banking product there is. These operations were costly and inefficient, and Pandit has been busy cutting them from the time he took the job.

But that's only part of the problem. When Pandit took over he realized something else: Citigroup was drowning in hundreds of billions of dollars in soared loans and real estate debt that past management thought were going to be great investments. They weren't, but more than that, they evaded proper risk controls. No one really knew how much bad debt was actually on Citigroup's books—not the risk officers, not the senior management and not the board.

The best reason I can get from Citigroup's current management was that the firm was way too big. In the context of running a balance sheet worth more than a trillion dollars, a couple hundred billion of loans and debt can seem insignificant, particularly when your management tells you they think they have everything under control.

Rubin's point to me, relayed through my lunch date, was that Glass-Steagall would not have prevented Citigroup from betting on real estate, which is at the heart of its current problems. Technically speaking, I suppose that's accurate. But it misses the larger point. Citigroup may be Too Big To Fail, but it was also too big to manage. Rubin and his fellow board members didn't understand the magnitude of the firm's real estate bet, or the wasted billions on unproductive units because no one could. Citigroup was simply too big to understand, even for Robert Rubin.

Related: Deal or No Deal, by Charles Gasparino

Charles Gasparino appears as a daily member of CNBC's ensemble. Gasparino, in his role as on-air Editor, provides reports based on his reporting throughout the day and has broken some of the biggest stories affecting the financial markets in recent months. He is also a columnist for Trader Monthly Magazine, and a freelance writer for the New York Post, Forbes and other publications.