I met recently with a member of the House Banking Committee who supports financial modernization legislation. He asked me to respond to the Federal Reserve Board's contention that banks are subsidized by the federal safety net.
The Fed, of course, uses this argument to bootstrap itself into position on the "regulatory turf" issues. Because banks are subsidized, argues the Fed, they should operate their nonbanking activities in holding company subsidiaries to limit any "leakage" of the subsidy. Did I mention that the Fed regulates holding companies?
When it became clear this approach wasn't going to fly, the Fed developed a new argument. It's acceptable to allow nonbanking activities in direct subsidiaries of banks, but we must anoint an "umbrella" regulator to oversee the enterprise. Guess who the Fed says is perfectly suited to handle that job?
It's hard to know where to begin with a response. I guess it's with the observation that banks aren't subsidized.
The Federal Deposit Insurance Corp. is funded by the banks and has taken in $27 billion more than it's spent in the past 63 years. Any subsidies run from strong banks to weak banks, not from taxpayers.
Loans made through the Fed discount window are fully collateralized and bear interest. The Fed is prohibited from lending money to a bank that's not viable. The Fed's check-clearing services are required to be priced at market rates. The only subsidy involved is the one the Fed receives from the sterile reserves banks must keep on deposit.
Even if there were a subsidy, eliminating it would be better public policy than building a convoluted structure to accommodate it. In that vein, the Bankers Roundtable has unveiled a plan to complete the deposit insurance reforms begun a few years ago.
(In the interest of full disclosure, my firm advised the Roundtable on the deposit insurance project. I have also long been a proponent of these reforms.)
The FDIC submitted a report to Congress in 1983 urging deposit insurance reform. We said that deregulating banks while continuing to bail out their creditors when trouble strikes is a prescription for disaster.
Most people would agree that the savings and loan crisis was a disaster. Congress adopted a number of reforms in response-some good, most not so good.
In the good category is interstate banking. President Roosevelt and the American Bankers Association wanted to enact interstate banking, instead of deposit insurance, to resolve the 1930s banking crisis. Strong banks would acquire weak banks and diversify.
Congress also responded to the S&L crisis by making it much more difficult for the FDIC to bail out a bank, enacting a depositor preference law and putting the FDIC on a pay-as-you-go basis. Banks must now cover all of the FDIC's losses each year.
These reforms have significantly reduced the exposure of the FDIC. Banks are less likely to fail, the FDIC is less likely to incur a loss when they do, and the industry must pick up the tab in any event.
The Roundtable proposes to extend these reforms.
It would change the depositor preference law to an insured depositor preference, making it virtually impossible for the FDIC to lose money on a large bank. To ensure that result, the Roundtable would prohibit the FDIC from bailing out any bank.
With these reforms added to those already enacted, it's almost inconceivable the FDIC would ever run short of money. So the Roundtable proposes another logical step: It would remove the government's full-faith- and-credit pledge backing the FDIC and replace the FDIC's line of credit at the Treasury with a private-sector line.
Notwithstanding the Fed's rhetoric, the banking industry isn't getting and doesn't want any handouts. It wants and needs the right to compete for survival in an intensely competitive world.
