Congress made more progress this year toward enacting financial modernization legislation than many thought possible. When the clock ran out, the major interest groups had pretty much settled their long-standing differences.
The bill stalled at the end due in part to concerns about the Community Reinvestment Act. The inclusion of new CRA civil money penalties for officers and directors was particularly irksome.
It's just as well the legislation didn't pass.
Congress had given short shrift to an overwhelmingly important issue-the manner in which newly authorized financial activities should be organized and regulated.
The Federal Reserve argued that the new activities should be organized in holding company affiliates regulated by the Fed. The Treasury Department wanted the activities to be permitted in bank subsidiaries regulated by the Comptroller's Office or state banking departments, with oversight by the Fed and Federal Deposit Insurance Corp.
The Fed got on top of the issue early and-due almost entirely to the stature of its chairman-dominated what little debate there was.
The central bank first argued that banks are subsidized by the federal safety net-the FDIC and the Fed's discount window-and that forcing the new activities into holding company affiliates is necessary to prevent "leakage" of that subsidy. The theory holds that if the subsidy "leaks" from the bank, its affiliates gain a competitive advantage.
The argument makes no sense. Banks bear the entire cost of the safety net, so there is no subsidy. Moreover, it has never been demonstrated how a holding company is any more likely to prevent "leakage" to its affiliates than a bank is, to its subsidiaries.
After testifying early in the process that this was not a "safety and soundness" issue, the Fed changed its mind when the subsidy argument began losing steam.
The Fed decided that holding company affiliates were indeed necessary to protect banks.
The problem with this argument is that the FDIC-which picks up all losses whenever any bank fails-disagrees completely.
The agency's staff and its current and three past chairmen have been urging for nearly two decades that new activities be placed in bank subsidiaries.
Banks can be protected against downside risks equally well either way. The advantage of the bank subsidiary structure is that the bank (or the FDIC, if the bank fails) gets the benefit from successful ventures.
The bank doesn't get these benefits if the activities are conducted in holding company affiliates.
The Fed would impose a highly inefficient structure that essentially eliminates the freedom banks have to be regulated by either the Fed or the Comptroller's Office.
The Fed is seeking a virtual monopoly in the regulation of banks and their affiliates.
Placing this much additional power in arguably the most powerful agency in the world ought to be profoundly disturbing to anyone who believes in limited government, as Republicans purport to do.
It should be even more troubling when one considers that the Fed is largely immune to political direction.
The United States is noted for its distrust of concentrations of power, particularly in the federal government.
If the Fed gets its way, the United States would vest far more power in its central bank than any other major country has done.
With Sen. Alfonse D'Amato's defeat in the New York Senate race, Sen. Phil Gramm is in line to become chairman of the Senate Banking Committee.
It's conjectural at this stage, but the prospects for a bill the industry can rally behind are probably enhanced should Sen. Gramm take over the committee.
He helped lead the charge against the CRA provisions, so it seems likely that these provisions will be tempered. Since Sen. Gramm has consistently opposed concentrating more power in Washington, it's also a decent bet that the bank subsidiary issue will be approached more thoughtfully.
And the threat to impose limits on automated teller machine fees-one of Sen. D'Amato's pet projects-should be dead as a doornail. So things may be looking up.
