Comment: Fed's Arguments Weak In Treasury Turf Fight

The turf battle between the Federal Reserve and the Treasury is clearly the most contentious issue in the financial modernization bill that squeaked through the House.

The Fed wants the legislation to require that new activities be conducted in holding company subsidiaries. This is scarcely a surprise in view of the Fed's role as regulator of bank holding companies.

The Treasury, supported by virtually the entire banking industry, wants new activities to be allowed in either holding company subsidiaries or bank subsidiaries. The Treasury has a turf interest in this issue since it houses the regulator of national banks. Banks, for their part, want the ability to organize in the most efficient manner and the freedom to select the best regulator.

The Fed uses three arguments to justify its position. First, it contends that banks are subsidized by the federal safety net and that the holding company format prevents the transfer of that subsidy to new ventures.

In fact, there is no government subsidy of the banking system. Banks have paid tens of billions of dollars to the Fed and the Federal Deposit Insurance Corp. above the cost of operating those agencies.

Even if there were a subsidy, it couldn't be transferred any more easily to a bank subsidiary than to a holding company subsidiary. If the subsidiary is required to maintain capital and funding separate from the bank's, no subsidy can be transferred. That's true whether the subsidiary is located under the bank or in the holding company.

Suspecting that its subsidy argument was losing "currency," the Fed switched to a safety and soundness argument. It now contends that bank holding company subsidiaries provide better insulation for insured banks against losses from the new activities than do bank operating subsidiaries.

In this respect, there's no difference between bank holding company subsidiaries and bank operating subsidiaries. If both are separately and adequately capitalized, neither is likely to cause major problems for affiliated banks. If either one does cause problems, the other would do so as well.

If forced to put their new ventures in holding company affiliates, banks will be in the worst possible position. They'll be exposed to the risk of loss from unsuccessful ventures, but the profits of successful ventures will accrue to holding companies, not banks.

When the Fed fails to make an impression with its first two arguments, it shifts to another approach. It contends that it must have direct, hands- on knowledge of the banking system in order to carry out its duties as the "lender of last resort" and as the nation's monetary policy authority.

As for the lender of last resort argument, the Fed never makes a loan that is not amply secured by marketable collateral. In the case of Continental Illinois, for example, the central bank had marketable securities equal to 150% of its loans, and it also insisted on a loan guarantee from the FDIC. You don't need extensive knowledge to make riskless loans.

The monetary policy argument is contrary to the experience of most industrial countries. Germany has long been regarded as the best example of a country with a sound monetary policy. The German central bank does not supervise banks. England recently stripped its central bank of supervisory authority.

The Fed has done an outstanding job with monetary policy in the past two decades. Its current chairman will almost certainly go down as one of the best central bankers in history. This performance by the agency and its chairman is clearly not the result of the agency's role in bank supervision.

The turf battle between the Treasury and the Fed has been kicking around almost since the Fed's inception. We need to get beyond these issues so the United States can enter the 21st century with unquestionably the finest financial system in the world.

The Fed supports imposing inefficient and burdensome restrictions. It should be required to present compelling evidence of the need for these restrictions but hasn't come close to doing so.

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