Fed, Treasury Feud Hampering Financial Reform Legislation

Until the Federal Reserve Board and the Treasury Department can resolve their turf war, legislation restructuring the financial services industry is unlikely to be enacted.

Last week the House approved, by a single vote, a financial reform bill that would topple the legal barriers separating the banking, insurance, and securities industries.

Even if the Senate defied expectations and passed a similar bill by yearend, the Clinton administration has threatened a veto to win its embittered policy dispute with the Fed.

At issue is where new powers such as insurance underwriting may be housed: in direct subsidiaries of a bank or walled off in holding company units. The Treasury argues banking companies should be permitted to choose how they are structured while the Fed insists direct powers would give banks a risky competitive advantage over rivals.

The House agreed to require banks to enter most new businesses through holding companies. Fed Chairman Alan Greenspan, whose agency supervises holding companies, has publicly campaigned for this approach.

Though House lawmakers roundly defeated two amendments that would have expanded operating subsidiary powers, Treasury Under Secretary John D. Hawke Jr. remains undaunted. Indeed, the presidential veto threat remains Treasury's equalizer.

"It seems to me a perfectly appropriate thing for the administration to do in the face of a threat of legislation that would significantly diminish the role of the executive branch," Mr. Hawke said in an interview Tuesday. "I haven't seen the votes to override a veto."

Confirming that the battle has only begun, this week Mr. Greenspan and Mr. Hawke defended their positions.

In a meeting with community bankers Monday, Mr. Greenspan said limiting operating subsidiary powers to sales activities would protect the deposit insurance funds.

"The federal safety net was intended to support only bank operations and should not be extended directly or indirectly to cover losses from the operating subsidiaries of banks that conduct securities or insurance underwriting or other activities as principal," he reiterated in a May 19 letter to the Independent Bankers Association of America.

The two agencies have also laid out the guts of their arguments in separate documents sent to Congress this month.

In a May 4 package, Mr. Greenspan bluntly summed up the Fed's argument: operating subsidiaries pose "serious risks" because they are part of the bank and in the event of collapse could drag down the bank's parent, too.

But the Treasury, which charters national banks through the Office of the Comptroller of the Currency, countered in a May 12 paper that operating subsidiaries could be made just as safe as holding company affiliates. A bank could be barred from lending more than 10% of its capital to any operating subsidiary. Loans to subsidiaries could be capped at 20% of capital.

However, the Fed noted a bank's equity investments in subsidiaries would not count toward these limits.

The Treasury's answer is to require a bank to deduct its entire investment in a subsidiary from regulatory capital. In other words, if the subsidiary folded, the bank could lose its entire stake and remain well capitalized.

To correct the competitive advantage that the Fed claims banks enjoy over holding companies because of the federal safety net, the Treasury would limit a bank's investments in a subsidiary to the dividends a bank can pay to the holding company.

The Fed insists that operating subsidiaries still would benefit from a cheaper cost of capital and that banks would abandon the holding company structure if operating subsidiaries were granted equivalent powers. That would diminish the Fed's oversight of the banking system and weaken its ability to prevent financial crises.

The Treasury counters that banks of "any significant size" would retain their holding company structure to avoid the paperwork needed to convert.

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