The Region

Interview with Carter H. Golembe

Melvin L. Burstein - Senior Vice President and General Counsel

Published June 1, 1998  |  June 1998 issue

Carter Golembe has been called one of the senior statesmen of American banking, and his experience certainly merits that distinction. He began his banking career in 1951 with the Federal Deposit Insurance Corp. (FDIC); since then he has worked for Congress, for major banking organizations and their trade groups, formed his own bank consultant business and served on numerous boards. He is currently the president of CHG Consulting.

From 1966 to 1989, Golembe's primary occupation was the management of Golembe Associates, a Washington-based consulting firm, but he also found time for other endeavors, including the formation of the International Financial Conference, an education corporation dedicated to a better understanding of multinational banking and financial issues. He has also been a prolific author of articles, columns and analyses, and is the principal author of the Golembe Reports, a long-running review of major policy issues relating to banking. He is also the co-author of a college-level text, Federal Regulation of Banking.

During this time of major change within the banking industry, Melvin Burstein, the Minneapolis Fed's general counsel and long-time friend of Golembe, asked the bank consultant to share his thoughts on everything from his early days at the FDIC, to motivation for large bank mergers, the real purpose of deposit insurance and the future of European monetarization—and much else in between.

BURSTEIN: Carter, tell me a bit about your academic background.

GOLEMBE: I have two degrees: the first, a Ph.D. from Columbia and the second a law degree from George Washington University. I've never practiced law, but I enjoyed getting a law degree. I can't really say I've ever practiced economics, but I enjoyed getting a Ph.D.

BURSTEIN: I know you worked for some time at the FDIC. How did you get involved in public policy?

GOLEMBE: Pure accident, beginning with a traumatic event. I had only been at the corporation for about two months when I was called into the office of the Chief of the Division of Research and Statistics and told that it was quite possible they would have to fire me. The reason was pretty simple, at least for Washington in those days: You could not be hired by the FDIC, or many other so-called independent federal agencies, without the written endorsement of the chairman of the Democratic Party in the county from which you had come. One of my reference letters had just arrived, late, and included what the writer had intended to be a great compliment, specifically, that I got along with people very well and had some speaking ability, which he knew to be a fact because we both had been active "Young Republicans" in Rockland County (New York)! Fortunately, the division chief did not like the policy nor did the FDIC's director of personnel. Together, they apparently were able to keep the letter from the chairman until he had left on a long vacation, after which I guess it was decided to overlook my sin.

Several years later, Mr. Eisenhower became president, and the Republicans who took over the agency were obsessed with the idea that they could trust no one on the present staff, all of whom, they were convinced (incorrectly) were dyed-in-the-wool New Dealers. Except, someone must have pointed out, there was an individual in the Division of Research with some writing ability and some interest in history who might be useful in working on speeches and testimony for the new Republican chairman.

Later, Jesse Wolcott became chairman of the FDIC. He had been a congressman from Michigan at the time that the deposit insurance legislation became law in 1933 and, along with a good many Republicans, notably Sen. Vandenberg of Michigan, he had been a strong supporter of deposit insurance. He called me into his office one day, smiling so that I need not be concerned, to tell me that, once again, I was fired. But this time it was to clear me for going to work for Sen. Wallace Bennett of Utah. This was in 1957, I believe, and the Democrats, using a large staff collected for the purpose, were about to begin a highly publicized set of hearings intended to show that Republican policies, particularly as implemented by Treasury Secretary George Humphrey, were detrimental to the economy, were choking off growth and a host of other bad things. The White House had selected Sen. Bennett from the Senate Finance Committee, which was holding the hearing, to lead its forces in the Senate because he was clearly the most able Republican on Senate Finance, though far from senior. The White House had also assembled its own core of experts (one, I recall, was Professor John Chapman from Columbia). It was decided that there had to be a person in Sen. Bennett's office who would coordinate the information that would be coming to the senator from the White House and other places.

I stayed with the senator for a bit less than a year, but came to know and appreciate his strength and dedication to a good banking system. In fact, he became, eventually, the leading champion in the Congress of the Federal Reserve System. We worked closely with Chairman Martin of the Federal Reserve, for whom Bennett had an extremely high regard, and my recollection is that things came out pretty well. I was then rehired by Chairman Wolcott at the FDIC, as he had promised. It was an assignment that probably got me more firmly pointed toward public policy work than any other single event.

BURSTEIN: So, tell me a little bit about some of your consulting business and how it started out and ...

GOLEMBE: Actually, I was not a good consultant; in fact, I didn't like consulting particularly. However, it turned out I had some ability to identify good consultants and persuade them to join me. After about 20 years we ended up with a total staff of 60 or so, including John Danforth [formerly director of Research with the Minneapolis Fed, 1979-1981].

BURSTEIN: What makes a good consultant?

GOLEMBE: Above all, he or she must be very bright. Second, it has to be someone who does not fit well in a structured organization, say in a large bank or government agency. For example, we hired one guy who insisted on, and got, six weeks of vacation each year, and another young fellow who occasionally slept on a couch in the office because he didn't have a place to live. Third, a person has to be conscious of how bright he or she is.

BURSTEIN: So humility's not a strong suit.

GOLEMBE: Right. In talking with possible new associates, I always regarded confidence in one's self, even if it bordered on arrogance, as a good sign. Anyway, I was better at finding consultants than doing consulting. But my firm was sold in 1989, and since then I have concentrated almost entirely on writing and speaking.

BURSTEIN: Where do you see bank consolidation leading? Some assert that eventually we are going to have essentially a Canadian

GOLEMBE: I doubt it. Probably we're going to have a smaller number of banks, but we're never going to have a system like Canada's or most other countries, unless we change drastically both our laws and our culture, which won't happen. I don't think that there is another country in the world with so deep and so lasting a concern over banking or financial power as the United States. Our banking laws have reflected this over the years, and some still do. For example, we still have a dual banking system, unique in the world, which offers alternative routes of entry into the banking business. To be sure, the alternatives now are largely at the federal level—with the final decision lying with the Comptroller, the FDIC or the Fed—but this still means you can pick your federal supervisor, or switch from one federal supervisor to another. And the states—the —are still quite active.

I realize that the number of mergers continues to be large. But we often forget that the number of new banks organized each year is also fairly large and, more importantly, seems to be increasing rapidly. Five years ago, the number of new banks organized had fallen to about 50 per year, which is pretty low. Then, the number began to grow, so that during the past five years there were 543 new commercial banks organized in the United States, which is more than the total number of banks doing business in Germany, the Netherlands and Belgium combined. Moreover, there are early reports that the number of new bank charter applications this year is increasing rapidly (some say stimulated by the large mergers) so that 1998 may be a banner year for new bank organizations. Of course, some of these new banks will disappear, and some are started by people who hope someday to sell them. On the other hand, many are opened simply because of the belief that there is a business need for new banks. The point of course is that the United States has a unique, vibrant system—and it is not dying.

BURSTEIN: Well, let me ask you, do federal banking laws substantially limit the ability of states to do much? Is a state charter somewhat less appealing than it once might have been?

GOLEMBE:: During the banking troubles of 1989-91 we passed some pretty poor legislation, such as the Federal Deposit Insurance Corp. Improvement Act (FDICIA). This is the act that gave us the so-called "prompt corrective action" provisions, a sort of instruction manual devised by Congress to tell federal bank supervisors how they should act with respect to any bank at various capital-to-total-assets ratios. It is probably one of the silliest, and possibly one of the most dangerous, pieces of banking legislation enacted in this country.

I assume your question relates to another part of that great piece of legislation, which provided that a state bank with insured deposits could not engage as a principal in any type of activity not already permissible for a national bank, unless the FDIC permitted it to do so. As Carl Felsenfeld, one of the premier authorities on banking law and professor of law at Fordham University in New York, said in his Banking Regulation in the United States, in the opinion of many, this effectively ended the dual banking system. What Professor Felsenfeld had in mind was that the essence of dual banking—its great historic value—was in the ability of states to experiment with banking laws, rather than be tied to a single, federal standard. So it is true, as you say, because of FDICIA the state charter is probably somewhat less appealing than it once was. On the other hand, much of the dual banking system still offers a choice between federal and state banking codes and it continues to offer alternative routes of entry into the banking business.

Parenthetically, in almost all treatises on banking, it is regarded as a truth beyond question that the United States is a country that is seriously overbanked. Nobody is really quite sure how many banks we have, but I assume that there are about 7,000 or 8,000 independent banks at the moment, which is far greater than the number of banks in any other country in the world, or in any 20 countries for that matter. Thus one might say that the United States still suffers from "overbanking," but lately I have begun to entertain a heretical suspicion that this may not be all bad. It does seem strange that with so fragmented a banking system—a situation that has existed almost since the republic began and at one time gave us as many as 30,000 commercial banks—our economy has nonetheless out-performed those of the rest of the world for two centuries.

I guess one might wonder if, just maybe, the fact that we did not have in the United States only four banks during these past 200 years but, instead, thousands of banks of various sizes and various specialties, that this might have been part of the reason for this amazingly successful economic performance. In a recent article I posed, somewhat hesitantly, the question: Is it the United States that is overbanked, or are the other nations of the world in reality underbanked? Not many people noticed that piece of heresy, except Ken Guenther, the executive vice president of the Independent Bankers Association of America, who wrote to ask me whether I had been on the road to Damascus recently.

BURSTEIN: Let me make an observation related to this. Bankers complain a lot about other people doing banking business; there are nonbanks doing business like banks. I for one have often said, well if it's so bad, why don't they give up their bank charter and do what the other people are doing. But what you're pointing out with the increased number of new banks is that there must be some value in a bank charter.

GOLEMBE: Well I think so, and I think it's more valuable today than it used to be. As you know, we are in the midst of a great debate over the modernization of laws relating to banking and other financial institutions, probably something that Congress should turn over to a commission because of its obvious inability to handle detailed banking legislation. Nonetheless, out of all of this, and out of administrative action by the regulatory agencies, particularly the OCC, the net result should be a better banking charter.

BURSTEIN: Let me come back to consolidation for a minute. Do you have any view about how consumers of financial services will fare?

GOLEMBE: As long as there is a sufficient level of competition, I don't worry too much about consumers. What does bother me are the packages given to senior managements of banks acquired in major mergers. You have to wonder whether bank mergers are being driven largely by management self-interest rather than the economic factors we used to study in school. I received a call from a prominent consultant who had just read one of my recent reports in which I raised some questions about these management packages. His purpose in calling, he said, was to urge me to go into the subject more deeply which, he admitted candidly, he could not write about himself because of a likely adverse reaction from some of his important clients.

BURSTEIN: Are you a populist, Carter Golembe?

GOLEMBE: I don't think so, but I suppose it depends on what you mean. If a populist is an adherent of grass-roots democracy, I might be. But if a populist is someone who puts great faith in the "wisdom" of the common man, particularly his anti-intellectualism, then I am not a populist. Indeed, in its extreme form, populism is a bit frightening. Frankly I don't know how to characterize myself—probably as an irreverent conservative who takes a particular delight in history.

So-called "conventional wisdom" is often conventional because it is solidly based, but not always. Today, for example, I keep hearing that we should be quite comfortable about the bank mergers that are taking place, large as they are, because they are not "anti-competitive" in the ways we usually measure competition, which is to say by degree of market dominance, ease of entry, etc. Nonetheless, I am uneasy, as I have already indicated, because I don't entirely understand what is driving some of these mergers. And I have a hollow feeling in my stomach when I think of a state as large and as important as Florida losing its only major banking organization. Economics doesn't help me much there.

BURSTEIN: Haven't the mergers and acquisitions resulted in more banks that we might regard as too-big-to-fail?

GOLEMBE: I suppose so, but I don't know why that is very important. All that "too-big-to-fail" means, when it comes to banking, is that there are thought to be institutions which, if they fail, are too large to risk adverse systemic effects by having a deposit payoff by the FDIC. Some other arrangement must be made, to protect all depositors, it is argued, generally working out a merger with another institution, or perhaps a loan that keeps the troubled institution in business. The United States is loaded with institutions that, in a broad sense, are "too-big-to-fail" and which, therefore, would likely receive special attention from the government should failure threaten. General Motors, IBM, AT&T or Boeing would be illustrations and I don't see why, therefore, we have to give special attention to very large banking mergers that may or may not result in banks that meet the "too-big-to-fail" criterion, whatever that may be.

BURSTEIN: Are you saying it shouldn't be relevant in the sense that if you roll a safety net in with deposit insurance it's a different policy question?

GOLEMBE: Yes of course, if you mean that when it comes to banking we quickly get into the matter of deposit insurance and its possible reform.

BURSTEIN: Let me add a related dimension to the question. Some will tell you it's more efficient to have these large cross-country banking organizations, but the Federal Reserve Bank of Minneapolis and other research suggest efficiency of scale disappears at a fairly low level, maybe at $3 billion.

GOLEMBE: It used to be $100 million.

BURSTEIN: And I was being generous there.

GOLEMBE: The quick answer is I don't know. I'm not sure what scale means today because I haven't kept up with the literature. My recollection is that many of the earlier studies were narrowly based, focusing on just a few functions, like processing checks. Generally, I think they tended to show that after you reached a rather modest size there were no further efficiencies to be gained.

There was also a good deal of attention given to "economies of scope" which I think had to do with a bank's ability to provide a broad range of services, therefore justifying a larger scale. Even so, I am quite skeptical of some of the statements I have seen recently, implying that the future lies with very large banking organizations. The implication is that we will wind up in the United States with a sizable number of community banks—say a few thousand—plus five or six dominant banking organizations (or financial institutions that include banking). I really have trouble buying this. I cannot believe that an institution in, let us say, the $10 billion to $50 billion size range will not be able to remain in business and prosper. In fact, I know of no economic reason why the institution of which I was a director until three or four years ago (Barnett Banks of Florida) put itself up for sale. There must have been reasons of course, but I do not believe they had anything to do with Barnett's inadequate size ($40 billion plus) or inability to keep pace with technological change or some of the other financial reasons one frequently hears about.

BURSTEIN: If you look back, before the current mergers, let's say five or 10 years, when the United States maybe had one bank among the world's 25 largest, and you had banks in Germany, in Japan and elsewhere that were very huge, their profitability did not come close to that of much smaller U.S. banks.

GOLEMBE: I remember when I was with Barnett, the most profitable bank competitors we faced in Florida, as a group, were the small independents. It seems to me that the argument that you must have mega-sized banks in the future, and every step toward that is a mark of progress, is wrong. If that makes me a "populist," so be it. I am simply skeptical about the argument and I think that a lot of people agree with me.

BURSTEIN: Let me ask you one more question on this subject and then I will move on. Some commentators argue that larger banks tend to take on more risk.

GOLEMBE: I really don't know. My instinctive reaction is that large banks should be a bit safer than small banks, or at least very small banks, simply because of their ability to diversify in terms of product and geography. The community banks may be run brilliantly or poorly and the same is true of megabanks. Aside from the matter of diversification, I don't see that there is any difference.

BURSTEIN: Let me come back a little bit to what it is that banks do. Bankers complain a great deal about the limitation of their activities in relation to a number of businesses that they view as competitors. From your perspective, what is the business of banking?

GOLEMBE: I think of the business of banking in the broadest possible sense: facilitating the movement of funds from where they are in surplus to where there is a need for them. I therefore tend to regard commercial banks, investment banks, savings banks, insurance companies, mutual funds, etc., as being in the same business.

BURSTEIN: On that note, let me just turn to the issue of "special." In 1982 Jerry Corrigan, who at that time was president of the Minneapolis Fed, wrote the annual report essay, "Are Banks Special?" I think he had in mind banks in a more narrow definition.

GOLEMBE: Commercial banks.

BURSTEIN: Right, and he cited three characteristics: They hold demand deposits; they are the backup source of liquidity of all other institutions, financial and nonfinancial; and they are the transmission valve for monetary policy.

GOLEMBE: I recall that essay, and I remember we criticized it, arguing that banks may be special but not nearly as special as he maintained. In a sense, the "specialness" he was talking about was one largely created by government, whose rules could not really keep pace with the market. Banks were probably special then but not nearly as special as Corrigan said they were, and today they are not nearly as special as they were in 1982, because of the changes that have taken place. With each passing year, they become less special.

BURSTEIN: What are your thoughts about legislation before Congress that would allow banks to expand their scope to get into nonbanking or commercial activities? Should we be concerned about this?

GOLEMBE: I guess the answer depends on what you mean by nonbanking or commercial activities. There are many who think that insurance is nonbanking, but I think it is perfectly proper for a bank to engage in insurance activities, or investment banking or any other financial service. Nor do I see any need for this to be done through holding companies. In other words, I favor so-called "universal banking," and have yet to see anything in print that is more persuasive on this than the judgment reached by Professor George Benston of Emory University in his book a few years ago on the Glass-Steagall Act. The last part of his book deals with universal banking and is worth reading closely.

On the other hand, if you were asking whether banks should be able to engage in cattle ranching or manufacturing automobiles, this has pretty much been made impossible by law. To be sure, there was a time when banks did engage in such activities, directly, and there is no evidence to show that those that did had any different failure rate than those that didn't. The fact is that our banking history is studded with all kinds of illustrations of mixed bank and nonbank activities, particularly in the South and Midwest during the early decades of the 19th century.

However, I think you may be asking whether it is proper for banks to be owned by nonbank organizations, and there I don't really see a problem. I recall once that Bill Isaac, when he was chairman of the FDIC during a particularly troublesome time, remarked to me that he would rather that General Motors owned one of his troubled banks than three dentists from Houston. As long as laws remain in place so that the bank is separately capitalized, separately regulated and the usual (but not extreme) types of separateness are maintained, I don't see why there is any reason to prevent nonbank corporations from owning banks. And I certainly see no reason for regulating the corporate owners of banks, something that we do in this country but I doubt is done in most other parts of the world.

BURSTEIN: That leads me to my first question on deposit insurance. A long-time former colleague of yours, Jack Kareken, wrote a piece in 1983 essentially arguing that we shouldn't put the cart before the horse in terms of deposit insurance, that is, no deregulation of banking until we improve deposit insurance.

GOLEMBE: In all honesty, while I remember the article I don't recall the grounds for his conclusion. In one sense, it seems to me that his hypothesis must be wrong. If activity A is a financial activity not permissible for banks under present law, but is a far less risky activity than activity B, which is permissible for banks, I would deregulate by permitting banks to engage in activity A. Do I have to wait for deposit insurance to be reformed? On the other hand, John might have been talking about an early version of the present thesis being advanced by the Federal Reserve Board, namely, that there is a significant subsidy to banks flowing from deposit insurance and that until we straighten out deposit insurance we should not permit banks to be advantaged over nonbanking businesses. As you know from many things I've written, I think this argument of the so-called "safety net subsidy" is silly, as does almost everyone who has looked into it. Then again, John might have been talking about still another matter, so I better not comment further; in arguments with him I was often the loser.

BURSTEIN: But isn't the concern related to expanding the safety net beyond the business of banking? Let's assume, under what we now call a bank holding company ...

GOLEMBE: Or perhaps also, a bank with operating subsidiaries?

BURSTEIN: Okay, and say it goes into the car business, which is going down the tubes. Now it's the XYZ Bank Corp., Automobile Division. Is there a greater temptation, if you will, to argue about the systemic effect when you have a bank involved in this relationship?

GOLEMBE: I think I covered that in my earlier discussion of "too-big-to-fail."

BURSTEIN: How can you contain what's too-big-to-fail?

GOLEMBE: I can't give you a precise answer to your question. Let me try to get at it by going directly to the matter of deposit insurance reform, where I think we are really heading.

I am not in favor of reforming the present deposit insurance system. What I am in favor of is returning to what it was. If you ask, "Has the role of deposit insurance changed since 1933?" My answer would be absolutely not. But the role of the FDIC has changed fantastically; it is a much different agency than it once was. And what it is now doing goes far beyond protecting the rent and grocery money of unsophisticated depositors, which was supposed to be its sole function but has now become almost incidental. Today, the FDIC talks about the safety of the deposit insurance fund, the importance of a stable economy and similar broad objectives. In truth, the matter of "too-big-to-fail" is simply irrelevant to deposit insurance.

Does that mean that there are no banks that should be prohibited from failing? I would think so, but as far as I'm concerned, it doesn't make any difference. In other words, if the Congress, the Treasury or the Federal Reserve—those are the only three that should be involved in this—decide that bank X for good public policy reasons should not be permitted to close, so be it. This would be no different than government's decision a number of years back to shore up Chrysler. Whether the institution that a government decides for some special reason to preserve is a bank or a nonbank has nothing at all to do with deposit insurance.

At least, that's what I've argued for years. In fact, partly with tongue in cheek, I wrote several years ago that the best way to reform the present deposit insurance system was to repass the 1933 act. By doing so, the FDIC would no longer have a conflict of interest because it would not be a bank regulator but simply the government agency in charge of implementing the government's guarantee of deposit, which in 1933 was given the name "insurance" because that sounded much less radical than "guarantee." You may remember that many of the bold initiatives of the New Deal were characterized originally as "insurance" in order to make them more acceptable, such as: "flood insurance," "old age insurance" or "crop insurance." The problem with calling it "deposit insurance" which it clearly is not, is that some bankers and most academics began to believe it!

BURSTEIN: I understand what you're saying about the fundamentals in terms of the grocery and rent money. But it was always my impression that the mission was really twofold. One was protect small depositors, and the other was the stability of the banking system.

GOLEMBE: The argument was that if you took care of the average depositor, an additional benefit would be to introduce a certain amount of stability in the banking system. You would increase public confidence in the banking system. I really think we ought to spend a little time remembering just how "too-big-to-fail" came about. It all began in the post-World War II years, when economists and businessmen alike were predicting that a great depression was in the offing. The people running the FDIC had a vivid recollection of the failure of the Federal Reserve to play its full role as the nation's "lender of last resort" in 1932-33. They were convinced that the Fed would once again permit many otherwise solvent banks to close and this would be the end of the new deposit insurance corporation. So the FDIC went to the Congress and asked for authority to make loans to troubled but presumably solvent banks when the FDIC's board of directors felt it was necessary, and of course the banks they had in mind were particularly large banks.

BURSTEIN: What year was that?

GOLEMBE: During the late 1940s and, specifically, in 1950. The Fed was outraged and rightly so. You don't need two lenders of last resort; you just need one that will do what it is supposed to do. But the FDIC was powerful in Washington then, and got its legislation through Congress. However, by the time this finally happened, in 1950, many people began to think that the great predicted depression was never going to happen, so the FDIC promised, informally, to use its new lending ability sparingly. It did this by interpreting its new authority to apply only if the distressed bank was the only bank in the city.

Thus, aside from one very small instance, the FDIC did not use its new lending power for more than 20 years, until 1972 when the Bank of the Commonwealth in Detroit became involved in difficulties. There was tremendous pressure on the FDIC not to show a bank failure in that year. For one thing it was an election year and Michigan was a key state. And for another thing, it was a state-member bank with about $1 billion in assets. The Fed did not look forward to the honor of being the supervisor of the first billion-dollar bank to fail, preferring, I suppose, that this honor be enjoyed by the Comptroller of the Currency. For these and other reasons, the FDIC decided to use the lending power it had received in 1950.

Its annual report for 1972 is fascinating. It could not say that Bank of the Commonwealth was the only bank in Detroit, so it claimed that it was the only bank readily available to minorities in Detroit. Second, it argued that to have allowed the Bank of the Commonwealth to go under would have had strong, adverse systemic consequences for the entire banking system—a questionable conclusion I think. That was the inauguration of "too-big-to-fail," in its present sense. As you know, it was then followed by other major banking cases such as First Pennsylvania and culminating with the problems of the eighth largest bank in the United States in 1984, Continental Illinois.

BURSTEIN: But as it turns out, it didn't take this extraordinary power of the FDIC to lend because the Fed was an active participant in all this.

GOLEMBE: I agree—I do not think the FDIC should ever have been given such "lender-of-last-resort" powers even though, in 1950, the concerns of FDIC officials may have been quite reasonable. It is awfully easy to second-guess the FDIC on Continental and I suppose that I am as guilty as others. My recollection is that the corporation was under great pressure from the Federal Reserve and probably others to protect everyone fully, lest several other major money center banks be threatened. I have often said that if I had been FDIC chairman at that time, receiving that opinion, I would have done exactly what the chairman of the FDIC did. But I have also argued that the proper policy in fact would have been to pay off the depositors of Continental Illinois only to the insurance maximum, and the proper policy for the Federal Reserve would have been to make it clear that it stood ready to provide all of the funds necessary to assure that no other major bank would go down—something that Walter Bagehot told us a long time ago in Lombard Street was the basic justification for a central bank.

BURSTEIN: Well, let me just come back to deposit insurance and your observations about what we consider the roots of the situation, if you will. As you know, the Federal Reserve Bank of Minneapolis has been a long-time proponent of deposit insurance reform. More recently we've proposed that FDICIA be amended to say that if a bank is saved because it's too big to fail, then there should be a loss to the depositors or creditors with more than $100,000 in one account.

GOLEMBE: They have to take a haircut.

BURSTEIN: They have to take some haircut, and the question is: Do you see this as a viable way to address too-big-to-fail?

GOLEMBE: Logically, it is an important step in the right direction. My only concern would be whether one could really hold the line politically. In other words, how do we make certain, push come to shove, that the haircut will apply? If we can accomplish this, I think it would be a great improvement over our current system.

BURSTEIN: There are several proposals to privatize deposit insurance as a way to bring about reform. What's your sense of that as an option?

GOLEMBE: By privatize I assume you mean that the government would not be involved either directly or on a standby basis.

BURSTEIN: Ostensibly that's what it means.

GOLEMBE: Historically, nongovernment arrangements have worked very well. The most successful depositor protection plans we ever had in this country were in Ohio, Indiana and Iowa, prior to the Civil War. In those systems all of the banks were guarantors; there was no government monetary involvement. As a matter of fact, in Indiana the system worked so well that no bank failed during its 30-year history. And the head of that system became the first Comptroller of the Currency in 1863. The cross-guaranty proposals today, such as those by Bert Ely, often point back to that experience.

The other kind of privatization proposal is essentially that the banking industry take over the function of the FDIC. I think that could be done and I think it might work. But I'm not sure that the federal government would be kept out of it completely, at least in terms of providing a backup guarantee. And in that case, I wonder whether if it could really be successful. For example, there would be the same concern that, in a crisis, a very large bank would have all of its deposits covered. Frankly, I much prefer my proposal for deposit insurance reform, which is simply to return the corporation to what it was on Jan. 1, 1934.

BURSTEIN: In your most recent Golembe Reports, you reprinted a piece by David Holland that questions why we even need a deposit insurance fund. Just forget about going through that process and just have the government guarantee deposits.

GOLEMBE: I agree with his position completely. The deposit insurance fund is a fiction; it's a harmless fiction, generally speaking, at least until bankers start talking about getting paid back from the insurance fund.

BURSTEIN: Like Social Security?

GOLEMBE: No, I think David's point was something different and really quite important. He was arguing that the role of the deposit insurance corporation is to contribute to the maintenance of a smoothly functioning, stable banking system through proper supervision and regulation. His concern was that the FDIC, at times, seems to think that its proper mission is to protect itself (i.e., the deposit insurance fund) and, indeed, he pointed out that one can find at least some suggestion of that in recent statements by the FDIC. This, he fears, might cause the FDIC to assign excessive importance to short-term considerations and the aversion of bank failures. In other words, the deposit insurance fund becomes more than just a harmless fiction but something that at times may result in poor policy decisions. The fund, he said, is essentially no more than an accounting entity on government's books, but at times it seems to become an end in itself rather than a means to an end. His is a good, thought provoking, analysis.

BURSTEIN: FDICIA has a provision for risk-based deposit insurance premiums.

GOLEMBE: I have never understood the argument for so called risk-based deposit insurance premiums—I think it is one of the traps academics fell into because they really think there is an insurance system. The risk in banking cannot be measured in the same way that one can estimate with considerable precision the life spans of individuals. So what these premiums are really based on is the past. Banks that have transgressed and therefore have suffered losses are then fined for these transgressions. Some argue that this makes sense because such penalties will deter others from taking similar risks. Perhaps so, but surely the FDIC has enough authority to punish banks that have strayed from the path of righteousness without adding a monetary fine to the FDIC's arsenal of enforcement powers.

BURSTEIN: Would you make the same observation about risk-based capital?

GOLEMBE: I am afraid that this is a subject that could keep us here for another several hours. Let me put it this way. I have long held a decidedly dim view of using capital as a regulatory tool. It can be an immensely powerful tool, but useful only if those charged with formulating the regulations and devising the rules are blessed with infinite wisdom. Unfortunately, they are not. Capital is essentially an accounting convention—useful as a buffer or cushion to absorb unexpected losses but of decidedly secondary importance in the prudential supervision of banking. Management of course is the crucial element, as are such things as asset quality, liquidity and earnings.

BURSTEIN: Let me ask you about monetary union in Europe.

GOLEMBE: I have been skeptical about monetary union for a long time and, obviously, I have been wrong. By that I mean I doubted that we would ever see it take place but now it seems almost certain to happen.

I don't think that there is any question that the real objective of the architects of monetary union is full political union. One could argue that they are going about it backwards—that the logical way to achieve monetary union is first to have political union. The United States provides an excellent illustration: We did not have a single currency in this country until 1863, accomplishing it when we were engaged in a Civil War to achieve true political union.

I don't know if this present European effort will be successful or not. I tend to agree with those who have suggested that it will inevitably break down because the problem of melding together 15 or 20 nations into one true political union.

Perhaps it will not fail, at least for a time, and if so I am impressed by Martin Feldstein's concern over the foreign policy implications for the United States. I saw a piece of his recently in, I believe, the New York Times and another last year, in the November/December issue of Foreign Affairs. Dr. Feldstein argues that if Great Britain is ultimately drawn in fully, as seems to be likely, the United States faces the loss of its major ally in Europe. Other writers have pointed to the likelihood that when full political union comes, it is likely to be one that is protectionist rather than favoring free trade.

BURSTEIN: What are you working on right now?

GOLEMBE: I have been spending a great deal of time recently on the battle over modernizing banking law. There are a great many issues and a great many players—banks, insurance companies, thrifts, investment banks—but the most fascinating to me has been the battle between the Treasury and the Federal Reserve. The fact that the two are battling is not very surprising, this has been true throughout all U.S. history, beginning with the struggle between the Bank of the United States and the federal treasury during the administration of Andrew Jackson.

The current battle, as I am sure you know, focuses on the effort by the Treasury through the Comptroller of the Currency to replace the Federal Reserve in the affections of the banking industry by offering bank operating subsidiaries as a more efficient and less cumbersome vehicle for bank organizations than the holding company, and the Fed's determination to see that this does not happen since its present eminence in banking regulation stems largely from the Bank Holding Company Act.

For many this is regarded simply as a "turf war," with the Fed seeking to hold on to the turf it captured from the Comptroller of the Currency in 1970 in the Bank Holding Company Act amendments that year and the Comptroller seeking to recapture its historic position as the leading bank regulatory agency at the federal government level. Debate has focused in considerable part on the contention that there is a subsidy that banks receive from the so-called "federal safety net," which really means deposit insurance, essentially, which subsidy is better managed and better controlled through the bank holding company than the operating subsidiary arrangement.

Unfortunately, the most important issue of all is not being addressed. I refer to the crucial question of the role of the central bank—the Federal Reserve of course—in the nation's bank regulatory system. It is a question that calls urgently for deep and thoughtful attention. I suppose it is no secret that I have long believed in and argued for a minimum role by the central bank in the supervision and regulation of banks, but I am also conscious of the fact that an excellent case can be made for having the central bank occupy a major position in bank supervision and regulation. It is becoming increasingly clear to me—and I am sure this is true for a great many others as well—that there is room for reasonable compromise between these two extreme positions. It is truly unfortunate that we have been spending so much time over the past year or two on extraneous, indeed irrelevant, matters such as the so-called "safety-net subsidy" for commercial banks. Instead, we should focus on the central issue.

BURSTEIN: Thank you, Mr. Golembe.

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