When Rep. Jim Leach steps down from his
post as chairman of the U.S. House Committee on Banking and Financial
Services at the end of this year, he will do so knowing that his
name will be forever linked with one of the most important pieces
of banking legislation enacted during the preceding century.
The Financial Services Modernization Act (or Gramm-Leach-Bliley),
signed into law at the close of last year, not only overturned
Depression-era legislation that
had so shaped the industry throughout the century, but also established
rules that will greatly affect the future of the financial services
The Iowa congressman first began pushing for a financial modernization
bill in 1995, when he assumed the chairmanship of the House Banking
Committee, and as he notes in the following interview, his intentions
were more than to revamp old laws: He wanted the bill to establish
certain ground rules for banking's evolution. From defining which
financial institution can sell what type of financial product,
to answering questions surrounding privacy and community reinvestment,
the Act has changed the rules for years to come.
Rep. Leach recently discussed those new rules, and many other
issues, in a conversation with Gary Stern, Minneapolis Fed president.
The following discussion reveals, among other things, that Leach
does not see the need for immediate follow-up legislation to address
a "corrections agenda," that privacy issues have been well addressed
in the bill, and the notion of merging commerce and banking is
easy to advocate "until the public finds out about it."
STERN: When you took the reins of the House Banking Committee
in 1995, you introduced the initial modernization bill. What led to your
interest in that legislation and what did you hope to accomplish?
LEACH: My sense was that the Congress in the 1930s introduced
arbitrary and uncompetitive elements into the landscape of finance
and that the American financial system could be made more competitive
internally as well as externally. The original Glass-Steagall Act
had been precipitated by conflicts of interest that were perceived
to have existed at the time of the Great Depression, but subsequent
analysis indicated that those conflicts were not as pervasive as
was assumed at the time. Indeed, in retrospect, it would appear
that Glass-Steagall was rooted more in resentment than need and
that with each passing decade the barriers to competition it introduced
into the delivery of financial services increasingly skewed and
misserved the market.
As products that bankers were precluded from offering found favor,
commercial banks inevitably lost market share. Particularly in the
last three decades of the 20th century, American savers moved markedly
away from making commercial bank deposits to preferring other types
of savings and investment instruments. The question for bankers
became one of whether they preferred staying in a market niche that
was partially sheltered, but diminishing in size, or whether they
could accept becoming less sheltered competitors in a broader financial
Aspects of the debate about the wall that was erected between
commercial and investment banking began immediately on passage of
Glass-Steagall; but nuances developed with a changing market environment.
For instance, one of the changes that occurred over the decades
was that Glass-Steagall reform, which had originally been considered
principally an issue of competitive concern to large institutions
such as Morgan Stanley and J.P. Morgan, came to have increased implications
for smaller institutions and the customers they serve.
If you take the great Middle West, for example, arbitrary barriers
in finance made modern financial products less accessible to consumers.
The average Midwestern manufacturing company has excellent relationships
with its commercial bank, but virtually no relationship with an
investment bank. By allowing institutions to combine commercial
and investment banking services, Midwestern businesses will have
more access to more financial products.
STERN: What other issues did you hope to address through
LEACH: There are other kinds of issues that came into play
in legislation of this nature. For instance, I've always believed
in expanding the realm of competition within finance, but have not
been one who favored merging banking and commerce. This issue involved
differing judgments as the bill went forward, both with regard to
putting constraints on new powers, as well as reconsidering existing
charter arrangements. That is, loopholes in the current law existed
which allowed the expansion of commerce and banking through the
so-called unitary thrift provision. The final modernization legislation
not only refrained from authorizing the expansion of commerce and
banking, but closed the most significant existing aspect of law
that allowed it. The Gramm-Leach-Bliley Act was designed to increase
competition within finance and at the same time preclude an excessive
expansion of bank powers outside of finance. While the Glass-Steagall
wall was breached, a unitary thrift barrier was erected.
STERN: On the unitary thrift question, I can understand
from the bankers' point of view, particularly the independent bankers'
point of view, why that legislation was very important. On the other
hand, how should consumers feel about it? I can see where consumers
might have liked the idea of being able to bank at Wal-Mart.
LEACH: Well, first of all, let me stress that the issue
isn't whether you can bank at Wal-Mart; the question is whether
or not Wal-Mart is your bank. Those are separable questions.
STERN: Fair enough.
LEACH: I don't see any case for merging banking and commerce
in this country. I am for a healthy, vibrant, competitive model
within finance, but not a system which would inevitably lead to
an uncalled-for concentration of asset ownership in America.
If you believe in allowing anyone to do anything, you have to
look at the models in finance and commerce that have existed around
the world. The places that have allowed it have experienced great
losses to the public treasury as well as great conflicts of interest
within their own financial systems. I see no economies of scale
and no consumerist case to be made, for example, for Citigroup to
merge with General Motors and Wal-Mart, whereas there are economies
of scale that can be put on the table when a commercial bank is
allowed to offer investment banking and insurance services, and
Gramm-Leach-Bliley is a three-way street for competition within
finance, but a closing of the barriers to the Keiretsu model of
Japan, and the banking and commerce model that has developed on
parts of the Continent, which has stultified aspects of the German
economy and cost the Spanish and French taxpayers billions of dollars
to rescue banks which imprudently thought they could invest in and
manage well commercial enterprises.
While the public did not follow the commerce and banking issue,
I cannot overstate its importance to me and how close the Congress
came to making what I believe would have been one of the gravest
legislative errors of the century. After all, the modernization
approach I introduced five years ago was opposed by the Treasury,
powerful parts of the banking system and key congressional leaders
of both parties because it didn't sanction the integration of commerce
and banking. Secretary Rubin and the Treasury pushed strongly for
the merging of commerce and banking and the Fed initially acquiesced
to a so-called basket approach, which represented a partial merging
which inevitably would have been extended further. But, as time
evolved, the Treasury reversed its position and the Federal Reserve
modified its stance and both eventually came out against any modernization
approach that would allow the merging of commerce and banking. Of
all the things I am proud of in my tenure as House Banking Committee
chairman it is that in the end the world's two greatest governmental
institutions of finance revised their initial positions and not
only ended up concurring with my position on this issue, but established
unequivocal positions in favor of an independent financial sector.
My concerns on this subject relate far more than to past experiences
in other societies where taxpayer resources were jeopardized when
explicit and implicit deposit safety nets expanded to activities
beyond the banking system. My paramount concern is that modern finance
has gotten so sophisticated in its ability to leverage ownership
relationships that asset concentrations could be precipitated in
short order throughout society if the financial industry becomes
a handmaiden to commercial interest.
The first modernization bill that I passed out of committee five
years ago did not have a commerce and banking provision, but the
Republican leadership objected because it wasn't perceived to be
sensitive enough, in their view, to a combination of small insurance
agent, large bank and unitary thrift interests. In the next Congress,
the committee moved in the direction of banking and commerce. I
considered this a fatal legislative error and prevailed on the House
floor in knocking the banking and commerce "basket" provision out
of the bill at the time, but unfortunately the final product couldn't
muster Senate support to become law.
But, fortunately, just as the House, the executive branch and
the Fed shifted on the commerce and banking issue, so did many of
our large banks. You are correct to note that small banks have been
against the commerce and banking model for a long time while many
large banks embraced and argued for it. But two years ago I put
out a statistical analysis, which indicated, based upon market capitalizations
of various kinds of companies, that pointed to the near certitude
that if the banking and commerce model were adopted, banks would
become the acquired, not the acquirers. And by "banks," I mean all banks. Even, or perhaps particularly, the independence of Chase
Manhattan and Citigroup would have been immediately in doubt.
Within weeks of adoption of a commerce and banking principle,
companies such as Microsoft, AOL-Time Warner, BP-Amoco or GE would
knock off every major bank in the country. Although they naturally
don't prefer to advertise their vulnerability, the top leadership
in the major banks now fully recognize this circumstance and their
advocacy of mixing banking and commerce is, for the time at least,
In sum, on this seminal issue, an evolution in judgment in the
Treasury, a partial reconsideration at the Fed and an enormous reversal
of thought in the larger banks has occurred, and I am extremely
thankful. I stress this commerce and banking issue because I believe
it alone to be more significant than the entirety of change wrought
by the Gramm-Leach-Bliley Act. If Congress would have reached another
judgment on commerce and banking, I would have done everything in
my power to pull the plug on the bill.
STERN: Let's talk about the financial services business
per se for a minute. Do you think that we're going to see most of
the action on new delivery of financial services, or on a new range
of products and services that are delivered? And then, which institutions
are going to wind up as the major players in the financial arena
when all is said and done?
LEACH: The answer to the first question is going to be
both. You're going to have new arrangements as well as new products,
and the only certitude in finance is that there's going to be continual
change. In terms of winners and losers, I think a counterintuitive
circumstance could develop. Those most on top of technology will
have advantages, also those most in touch with their customers.
The delivery of financial services is, in many ways, no different
than that of soap. A company must have a good product, but also
market strategies that reach people to make a sales approach work.
The circumstance in American banking that has been missed by many
is that the big have gotten bigger from the top down through mergers,
but at the local level, market share has been eroded for the large
and increased for the small. Community banks and credit unions are
doing quite nicely. I believe that community banks, including de
novo institutions, have a very strong future for a number of reasons.
One is that in this world of brand names, there is no better brand
name than the State Bank of Hometown. Community banks that are on
top of technology and have good ties to customers and good market-mix
strategies may be best positioned to do well in the new financial
order. And, based upon the phenomenon that market capitalization
for banks is well above book value, enormous incentives exist for
de novo institutions to be formed. In theory, if an investor can
put x capital into a new institution, and it becomes viable and
valued as other banks at double or more of book, a lot of entrepreneurs
will be incentivized to establish de novo institutions. In addition,
the negligible cost of deposit insurance due to the fact that the
insurance fund has reached its statutory 1.25 percent of assets
reserve level means that new institutions will hold as an asset
a claim on an insurance system that their older institution competitors
In terms of winners and losers in the financial landscape in the
next generation, the primary reason one institution will do well
or less well relative to another will relate to technology and customer
service rather than changes in law. While the law has just been
changed dramatically in relationship to prior law, the change in
legal framework that has occurred is more modest in relationship
to market practice. The markets got ahead of the law and Gramm-Leach-Bliley
simply represents a partial catch-up. What it principally has added
is legal certainty, competitive equality and a more flexible regulatory
approach designed to adapt more pragmatically in the increasingly
competitive global financial system.
STERN: Let me shift gears and get to a public policy issue
that we at the Minneapolis Fed have been concerned about for probably
20 years or so, and that's the so-called moral hazard problem. The
problem is that if you grant banks new powers before you provide
the proper incentivesthat is, curb the moral hazard that's
inherent in deposit insurancethat's akin to putting the cart
before the horse, and is likely to not work very well from the taxpayer's
perspective. Do you share those concerns?
LEACH: Well, it would appear that there have been banking
mistakes of some size about every generation, and some, but not
all, have related to moral hazard issues. That's one reason attention
must by necessity be placed on prudential regulation. In this regard,
it's of importance to stress that deposit insurance is designed
to protect depositors, not owners. Nobody wants any institution
to be considered too-big-to-fail, but if government, for whatever
reason, finds compelling rationale to intervene in a market economy,
it must be with private sector as well as public accountability.
The system may require stabilizing acts, but owners and managers
must be held accountable for market misjudgments. I support deposit
insurance because, as we learned in the '30s, an average family's
savings should not be at risk due to a downturn in the economy or
a bank manager's error. This is an issue of compassion for the family
that in the aggregate can have enormous confidence implications
for the banking system. That is why I remain a strong advocate for
the maintenance of deposit insurance.
STERN: We haven't advocated its removal or even its reduction,
but we have tried to think of ways that would bring more market
discipline to bear on insured institutions, to banks in particular.
But the legislation does seem to at least acknowledge, maybe more
than acknowledge, the issue. Explicitly, it ties the powers available
to the subsidiaries of the 100 largest banks to their bond rating.
There's a study mandated for the Treasury and the Federal Reserve
to look at the use of subordinated debt to further enhance market
discipline. It seems there is at least an implicit concern in the
bill because institutions aren't given carte blanche, and because,
as I'm sure you know, the subordinated debt proposal has some advocates
at the Fed and elsewhere.
LEACH: Well, there is a technique of using subordinated
debt as a measure of a company's ability to access the capital markets.
There are other techniques that can be used, too. I'm for any reasonable
approach to getting as much market accountability as possible, and
certainly there are some techniques we use that other countries
don't. We take some things for granted such as bookkeeping transparency
that other societies don't. A country like New Zealand has largely
diminished regulation of its financial system based upon new transparency
rules for banks. That added transparency apparently has caused financial
companies to seek prudential levels of capital because they found
that good capital levels have been rewarded in the stock market.
This emphasis on transparency instead of intrusive regulation fits
New Zealand society. Whether it fits our society or any other as
well is quite another matter.
Counterintuitive, for instance, to past models, a number of publicly
traded banks have found that the less capital they have relative
to assets, the more they are rewarded by investors who like leveraging.
Hence stock market strength may, in some cases, be in inverse proportion
to capital strength for particular institutions. There are, of course,
limits to how stretched a bank can prudently become and this is
a reason for responsible regulation. Regulators simply cannot assume
that a bank's strength relates to its market capitalization rather
than to its actual capitalization because if a bank errs or the
economy turns sour, market value can quickly plummet. Hence, I've
always been one who favors solid capital cushions, though I recognize
that an increasing number of institutions have been rewarded in
the market by diluting their capital.
STERN: That's counterintuitive?
LEACH: There are examples in all directions. J.P. Morgan
has found that customers and credit providers appreciate its higher
level of capital. Other banks are finding it more productive and
beneficial to stockholders to increase dividends or buy back stock
with what they perceive to be excess capital. And, the stock market
in recent years rewarded these strategies. This is yet another reason
why it is important for the taxpayer and the system as a whole to
have reasonable regulatory rules as well as reasonable regulation.
STERN: I would certainly agree with that. Let me ask you
to expand upon this: You recently said, "I doubt we will have combined
oversight until there is some shakeout in the financial sector from
the legislation." What shakeout might we expect?
LEACH: Well, I don't recall that quote [laughter], but
I don't view a shakeout occurring related to legislation. The main
changes that are occurring in finance relate to technology, but
the main reason for consolidation in banking in most of the country,
rural areas in particular, relates to one phenomenon alone: estate
planning. When a community banker reaches an age at which he wants
to retire, his options are to sell, usually over time with enormous
tax liabilities, to a subordinate or exchange stock, at a premium
with no tax consequence, to a regional bank. The president usually
owns 10 percent to 50 percent of the stock and board members much
of the rest. The only people happier than the banker to sell for
stock are those on the board. Consolidation of financial institutions
in the Midwest has been led, for the most part, by those who spent
their lives committed to community banking arrangements. But the
rural phenomenon that is growing is that when a community bank sells
to a regional one, individuals in the town or banks in nearby communities
look at the sale as a market opportunity and consider moving in
or chartering a new bank. Community banks have found it easier to
compete against the big than their brethren.
In any regard, the consolidation that has occurred to date in
banking has thus related to prior, not new, law.
STERN: You mean through interstate banking?
LEACH: Yes, largely through the interstate banking provisions
of the Bank Holding Company Act, but also through statutes that
pertain to thrifts.
We will, of course, see further changes based upon the increased
ease by which banks will be allowed to unite with securities companies
and insurance companies. But this trend has evidenced itself without
modernization legislation. After all, we have the Citigroup model
which includes not only Citicorp and Travelers, but also Salomon.
So you have that model in existence, and now we will see other examples
of this model come into play with greater regulatory ease. But most
importantly the modernization legislation puts in place a functionally
regulated framework that provides a finely tuned balance with regulatory
flexibility to adjust rules to changing circumstances.
STERN: You mentioned regulatory frameworkdo you think
that there are going to be turf problems as that framework is developed?
Or, on the other hand, do you think that maybe this regulationor
the supervisionwill wind up being too specialized, and so
if you have an institution that gets into trouble, you'll have a
very serious coordination problem simply because of the number of
LEACH: The nature of regulatory bodies is surprisingly
more competitive than people would surmise. While in the private
sector issues often relate to the maximization of profit, in the
pubic sector maximization of power concerns too often came to the
fore. Indeed, at every point in the road this legislation traveled
upon turf battles were underestimated, between the Fed, the Treasury,
and the Securities and Exchange Commission (SEC), as well as with
state banking, insurance and securities regulators. What the legislation
established was the definitization of relationships. There will
always be some tension. Unresolved issues, for example, exist now
in the derivatives oversight area. Congress is going to have to
take a hard look at this particular issue, as it relates to the
proper locus of governmental oversight over product offerings, as
contrasted with issues related to the right of parties to enter
certain markets. The exact relationship of the CFTC [Commodities
Futures Trading Commission], the SEC and banking regulators with
regard to derivative products and exchange markets will necessitate
further legislative action. But, for the first time, we have certain
models for resolution in place on these issues, and the intent of
the Gramm-Leach-Bliley Act was to press regulators toward a more
cooperative and coordinative stance, as well as a recognition of
STERN: Let's talk about consumers a little bit. Some people
have expressed concern about what they think are the implications
of the legislation for consumers on the privacy front and on CRA.
How do you feel about those things?
LEACH: First, the privacy issue: This legislation has the
strongest privacy provisions of any modern statute. A largely unnoted
feature of the bill is that the privacy provisions come into play
with all activities defined as financial in nature, both for those
activities conducted by a bank as well as for those conducted by
a nonbank. For instance, if a bank offers travel services, the privacy
features apply not only for the bank's travel services function,
but also for all travel agents in America. With regard to the "financial
in nature" definition, which is a signature part of this bill, as
it provides for expansion of future financial activities of banks
and financial holding companies, the privacy features apply to each
new activity that will come into being for the financial institution
as well as for nonfinancial companies that offer similar services
In theory, for instance, and this is not a credible example, if
the Fed approved a bank getting into funeral services as a "financial
in nature" activity, the privacy provisions would come into play
for the funeral services of the bank as well as for the general
funeral services industry. The privacy provisions of the bill are
not only strong, but because of the new powers adaptations that
will occur over time, they will inevitably get stronger even if
no future legislation on this subject is adopted.
On CRA, the bill basically maintains the CRA obligation without
dramatic change. However, several nuances were advanced: (1) CRA
recipients will be subject to greater "sunshine" in how they use
funds; (2) banks will be subject to CRA review if and when they
seek to become a financial holding company; (3) community banks
with satisfactory ratings will be reviewed every four, instead of
STERN: Do you think there will be further legislation addressing
financial services coming forward in the next year or two? And if
so, what type? What is out there that still needs to be addressed?
LEACH: First, I don't visualize a corrections agenda for
this bill in the next year, and possibly longer, for several reasons.
One is that this bill took a long time in development and most of
the subtleties were dealt with during this lengthy review. Secondly,
the hallmark of the bill is flexibility, particularly for the regulators,
where nuances can be expected to be resolved. There is still some
support among a few on Capitol Hill for the extraordinary issue
of mixing commerce with banking. As I indicated, I believe a great
strength of this bill is the number of causes such as this that
it didn't include. But, I would note that mixing commerce and banking
is an easy thing for any member to advocate until the public finds
out about it. There is simply no support in the American public
for concentration of ownership, and I am convinced it would be a
liability for any political party or any individual to identify
strenuously with that principle if it was ever thought that it might
become a reality. Up to that point in time, it's kind of an esoteric
"freebie" advocacy issue, but if the public ever thought it would
pass, woe be to the advocate.
STERN: That doesn't sound like it has much of a future.
Is there anything else you'd like to mention as we wrap this up?
LEACH: Well, I believe it deserves stressing that the role
of the Federal Reserve as an independent regulator has been preserved.
It is my view that if you take political science in the 20th century,
the greatest institutional model contributed by America was the
decision made by Congress in 1913 to establish an independent Federal
Reserve. That decision has made this country stronger and contributed
significantly to global economic stability. The role of the Fed
in regulation, as opposed to monetary policy, can in theoretical
terms always be challenged, as it has been on the Continent. On
the other hand, one of the aspects of the Fed that I appreciate
is a professionalism and an independence that has served the country
well. We change institutional balances at great risk, particularly
if change includes a greater prospect of politicizing regulation.
In this regard, it should be noted that in an emergency the U.S.
Treasury is a misnomer: It has no treasury unless Congress acts.
The Fed, on the other hand, has the capacity to liquefy the world
at its own discretion, based on existing statute. Hence the Fed,
as a regulator, is particularly important in difficult times. Alan
Greenspan is properly getting a great deal of credit for his stewardship
of macroeconomic policy, but care should be taken to recognize that
the strength of the Fed is its independent authority not any particular
head. This may be "The Age of Greenspan" and Alan surely is the
strongest and most important Fed chairman ever, but the world depends
more on the existence of an independent Federal Reserve than the
wisdom of its chairman, as great as it currently is.
And that relates to the importance of the Fed in its financial
regulation role, as well as to the formulation of monetary policy.
STERN: We certainly understand that.
LEACH: Here the quality and professionalism of the staff
at the regional Federal Reserve banks, such as your own, is greatly
STERN: And we appreciate the kind words. One further item
before we go: In the Federal Deposit Insurance Corp. Improvement
Act, depending on circumstances, of course, when the Fed needs to
act in, say, large-bank problem situations that might have systemic
implications, the Fed does need the approval of the Secretary of
Treasury and the administration, as well.
LEACH: What has occurred in this bill, as a balancing powers
compromise between the Fed and the Treasury, is that the Fed's regulatory
turf has been protected, but the policy involvement of the Secretary
of the Treasury has been somewhat enhanced in recognition that the
Treasury reflects electoral accountability as an important arm of
the executive branch. The Fed and the Office of the Comptroller
of the Currency will split regulatory roles, but the Secretary of
the Treasury will come to share certain policy accountability with
the chairman of the Fed.
STERN: Thank you very much, Congressman Leach.
More About Jim Leach
Republican Congressman, First District of Iowa
Elected to the 95th Congress November 1976 and each succeeding
Chairman, Committee on Banking and Financial Services since
Member, Committee on International Relations,
on Asian and Pacific Affairs
The Constitutional Forum, Co-Chairman
The Century Fund, Vice Chairman
Republican Education Caucus, Co-Chairman, 1997-Present
Congressional Arts Caucus, Secretary, 1983-1994
The Cosmos Club
Flamegas Companies Inc., Bettendorf, Iowa, President, 1973-1976
Federal Home Loan Bank Board, Director,
U.S. Advisory Commission on International Education and
Cultural Affairs, Member, 1975-1976
Foreign Service Officer assigned to Arms Control and Disarmament
United Nations General Assembly, Delegate
Geneva Disarmament Conference, Delegate
London School of Economics, Research student in Economics
and Soviet Politics, 1966-1968
School of Advanced International Studies,
Johns Hopkins University, 1964-1966
Master of Arts Degree in Soviet Politics
Princeton University, 1960-1964
Bachelor of Arts Degree (cum laude) in Political Science
Born and resides in Davenport, Iowa