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 monetarizationand
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
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 levelwith
the final decision lying with the Comptroller, the FDIC or the Fedbut
this still means you can pick your federal supervisor, or switch
from one federal supervisor to another. And the statesthe
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 systemand
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
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
bankingits great historic valuewas 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
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 systema situation that has existed
almost since the republic began and at one time gave us as many
as 30,000 commercial banksour 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
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 myselfprobably
as an irreverent conservative who takes a particular delight in
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 bankssay a few thousandplus
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
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
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
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
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
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 Reservethose are the only three that
should be involved in thisdecide 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 systema 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 agreeI 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 downsomething
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
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
GOLEMBE: I have never understood the argument for so called
risk-based deposit insurance premiumsI 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
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 conventionuseful 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 backwardsthat 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
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 playersbanks, insurance companies,
thrifts, investment banksbut 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 bankthe
Federal Reserve of coursein 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 meand I am sure this is true for a great many others
as wellthat 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.