The Financial Modernization Legislation: An Assessment
Published March 1, 2000 | March 2000 issue
ON THE GRAMM-LEACH-BLILEY ACT:
Why my lukewarm enthusiasm for the Act? There are several reasons. First, it was only of help in dealing with the barriers between banking and insurance. The barriers between investment banking and commercial banking had long since been largely obliterated Glass-Steagall was essentially a nullity by 1999. Second, there are some bothersome demodernization provisions in the Act, such as prohibiting the creation of new unitary thrift holding companies. This was a setback to attaining a more competitive financial system, a setback I hope will be rectified soon.
ON BANKING AND COMMERCE:
Admittedly, there are some who believe, with almost theological fervor, that the separation of banking and commerce is deeply rooted in U. S. banking history and, indeed, is a part of natural law. As a matter of historical fact they are simply wrong. Not so long ago, the General Counsel of the Treasury Department summarized the historical evidence and record succinctly and accurately: "There has never been a national policy of separating banking and commerce."
On Nov. 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley (GLB) Act, an attempt at financial modernization almost two decades in the making. As the draft legislation gathered momentum, particularly in its later years, it became what Washington describes as "Christmas tree" legislation, which means that a variety of legislative "bulbs" were hung on it as it went by. As a result, evaluating the new law is difficult because so many of the provisions, however important or unimportant, and however worthy or unworthy, have little or nothing to do with financial modernization as that term is usually understood.
It is important to note that the GLB Act is not a deregulation measure. Indeed, if the Act were to be judged on its success in achieving significant deregulation of financial institutions it would have to be counted as an abysmal failure. If anything, the federal regulatory structure for banks and other financial institutions was left in worse shape than it already was. The Act does embrace such important matters as the role to be played in the future by the Community Reinvestment Act, as well as consumer privacy issues. However, these were not central to the legislation; in fact, privacy issues only arose rather late in the game.
Probably the most reasonable and fairest way of judging the new Act is to focus on the objectives of its principal architects. Financial modernization in their eyes meant that it was necessary to recognize and deal with the fact that, because of technological change and market forces, the old lines separating commercial banking, investment banking and insurance companies were no longer sustainable. The principal authors of the legislation sought the reduction or elimination of government-constructed barriers to affiliations among institutions in the three industries. Accordingly, two questions can be posed. First, did the Act achieve the objectives of its champions? And second, what still remains to be done? On these terms, the Act, in my opinion, must be judged to be only a modest success.
Why my lukewarm enthusiasm for the Act? There are several reasons. First, it was only of help in dealing with the barriers between banking and insurance. The barriers between investment banking and commercial banking had long since been largely obliteratedGlass-Steagall was essentially a nullity by 1999although the Act did some useful mopping up. Second, there are some bothersome demodernization provisions in the Act, such as prohibiting the creation of new unitary thrift holding companies. This was a setback to attaining a more competitive financial system, a setback that I hope will be rectified soon. Third, on balanceand not without taking a few steps backwardthe Act made a useful contribution to eliminating the barriers between insurance and banking, but the erosion of such barriers had been under way for some time prior to the Act. It is interesting that even the example cited most often as typical of the problem caused by existing lawthe need for Citigroup to divest itself of insurance operations unless the new legislation was enactedhad been dismissed almost casually by the Wall Street Journal. That journal identified several options already available to Citigroup under existing law.1 To be sure, passage of the Act was probably a more desirable option, but not the only option, and I suspect that this was also the case in many other situations. The GLB Act's contribution was not so much the granting of permission as it was simply that of getting government out of the way.
Finally, the new Act will not be of any lasting importance to financial modernization unless it is soon accompanied by other legislation. If financial modernization is truly the objective, then the GLB Act is, at best, "the end of the beginning." Probably most urgently required are regulatory reform, deposit insurance reform and elimination of the near-theological belief that a line must be drawn between banking and commerce. There is neither time nor space for a full discussion of any of these subjects, let alone all three (to say nothing of still others that could be mentioned, such as universal banking). Only a few brief comments on each of the first three can be made here.
Even while the financial modernization legislation was being debated, The Economist characterized the U.S. regulatory system as "hopelessly fragmented and costly" (Oct. 30, 1999). It is now even more so. The almost unbelievable complexity of the U.S. bank regulatory structure is due largely, but not entirely, to the decision made in the Bank Holding Company Act Amendments of 1970 to leave the oversight of holding companies solely with the Federal Reserve. This decision meant that, effectively, bank holding company regulation was separated from bank regulation, placing each on separate tracks and thereby creating overlap, duplication and conflicts of purpose (if not of interest). Not only has the GLB Act exacerbated the problem by creating still another set of overlaps with divided authoritythe new "financial subsidiary" arrangementbut it has also extended the system to embrace important aspects of investment banking and insurance. It is truly a bizarre arrangement found, I believe, only in the United States. That it can work at all is because of the practical accommodations made by professional career administrators.
There is no point to extending this discussion unduly, but I cannot resist an item recently called to my attention: The Board of Governors of the Federal Reserve, under the GLB Act (Sec. 205), may take exception to certain proposed regulations by the Securities Exchange Commission and request that a regulation be set aside. Any proceeding to challenge the rule would be handled by the U.S. Court of Appeals for the District of Columbia. Admittedly, it has been many years since I studied Administrative Law, but I do not recall a provision enabling one named federal agency to bring an action against another named federal agency. It is, at the very least, highly unusual. It is also indicative of the regulatory morass we have created in this country.
In my own writings, I have called attention repeatedly to the fact that calls for modernization of financial law are occurring in other countries as well. In fact, there is under way a worldwide movement to reform bank regulatory structures in order to cope with new market pressures and rapid technological change, something the United States has yet to address. The result in the rest of the world has been the creation of new regulatory structures and, in almost all cases, the separation of the central bank from the supervision and regulation of financial institutions (largely because of fears of conflict of interest problems and a loss of political independence by the central bank). Sweeping changes have recently been made, or are under consideration, in the United Kingdom, Japan, Korea, Australia, Canada, Luxembourg, Ireland, Israel and South Africa, according to an official of the Financial Services Authority (FSA), the new British agency created to handle this matter.2 Even earlier, Belgium, Canada and Switzerland had separated their central banks from bank supervision and regulation. When the chairman of the FSA recently reviewed the current situation he could only add that: "It is fair to say that the U.S. system is not now typical of international practice."3 Strangest of all is the fact that the proponents of the GLB Act, and the Congress as a whole, have resolutely ignored, at least thus far, what is happening in the rest of the world.
Several years ago in an article written for Banking Policy Report (Jan. 20, 1997), I said that "deposit insurance, in its present form, may be the last and most formidable roadblock to the modernization of banking." I had in mind, as just one example, the fact that we have today, because of the Federal Deposit Insurance Corp. Improvement Act, a complex system of capital regulation, the stated purpose of which is to protect the federal government against loss when fulfilling its deposit insurance commitment. In other words, the present system of deposit insurance goes to the very core of laws and regulations affecting banking.
Readers are familiar, I am sure, with the long-running debate over the so-called "safety net" subsidy allegedly enjoyed by insured depository institutions. The safety net subsidy refers essentially to deposit insurance, and it is that subsidy, assuming it exists or is relevant, that accounts for the new life given to the bank holding company structure (geographic restrictions on banking having disappeared several years ago).
The case for deposit insurance reform has many facets. The literature dealing with the need for reform is impressive, as is the stature of many of the proponents who, incidentally, include important officials within the Federal Reserve System. It is difficult for me to believe that there can be lasting and meaningful financial modernization without a thorough examination of the proposals for deposit insurance reform that are presently on the table.
The continued separation of banking and commerce is likely to be reexamined again. Sen. Gramm, chairman of the Senate Banking Committee, made this point rather forcefully when agreement had been reached on the new Act: "There will be another banking bill within ten years and it will deal with commerce. ... This bill is a pause, and it is only a pause, and it is not going to last very long."4
Admittedly, there are some who believe, with almost theological fervor, that the separation of banking and commerce is deeply rooted in U.S. banking history and, indeed, is a part of natural law. As a matter of historical fact they are simply wrong. Not so long ago, the General Counsel of the Treasury Department summarized the historical evidence and record succinctly and accurately: "There has never been a national policy of separating banking and commerce."5
More is involved, however, than a dispute among historians. Banking is a live, vibrant, ever-changing business. Efforts to constrain it are either doomed to failure or, more likely, doomed to destroy the business itself, to force it into other channels. This has been recognized clearly whenever there have been attempts to devise rigid rules to define what is, and what is not, the banking business.
Never has this been more persuasively argued than by a New York court about a century and a half ago. In 1857, the New York Court of Appeals was called upon to interpret a section of New York law that included among banking powers "such incidental powers as may be necessary to carry out the business of banking," a section later borrowed by the federal Congress and placed in what became the National Bank Act. The Court's words still resonate:
The implied powers [of a bank] exist by virtue of the grant [to do the business of banking], and are not enumerated and defined; because no human sagacity can foresee what implied powers may in the progress of time, the discovery and perfection of better methods of doing business, and the ever varying attitude of human relations, be required to give effect to the express powers. They are, therefore, left to implication.6
In my view, no more serious error could be made in modernizing financial law than to attempt to confine the powers of banks to their 1999 boundaries.
Note: This article draws heavily upon a more comprehensive analysis of the GLB Act prepared by the author, and published as Vol. 1999-9 in The Golembe Reports under the title "Financial Modernization Legislation: The End of the Beginning," Dec. 1, 1999.
Carter Golembe is president of CHG Consulting in Delray Beach, Fla. From 1966 to 1989, he managed Golembe Associates, a Washington-based banking consulting firm. Golembe is the author of many articles, columns and analyses and is the principal author of the Golembe Reports, a long-running review of major policy issues relating to banking. Golembe began his banking career nearly 50 years ago with the Federal Deposit Insurance Corp. and has worked for Congress, major banking organizations and their trade groups.
For Carter Golembe's thoughts on other financial services issues, see his interview in The Region, June 1998.
1 Wall Street Journal, "Financial Firms Already Know How to Avoid Barrier Rules," Oct. 22, 1999.
2 FSA Occasional Paper, May 1999.
3 Howard Davies, Travers Lecture, London, March 11, 1999.
4 American Banker, Nov. 5, 1999.
5 Felsenfeld, Villanova Law Review, Vol. 38, no. 1, 1993.
6 Curtis v. Leavitt, New York Court of Appeals, 1857.