A Time for Cautious Optimism

Until a month or so ago, most political experts were betting that there was almost no chance Congress would enact broad-based banking reform this year.

To the chagrin of some and the utter amazement of almost everyone, the financial institutions subcommittee of the House Banking Committee has spent the past couple of weeks marking up what could become the most significant banking reform measure in more than 50 years.

Ironically, an important reason for the success thus far is that almost no one expected anything of consequence to happen. The special-interest groups had been lulled to sleep and were not geared up to orchestrate their usual high-powered lobbying campaigns.

Another irony is that the S&L crisis and the much-publicized problems confronting the Bank Insurance Fund, are providing momentum to the reform effort.

Congress Gets Smarter

Many observers had assumed these problems would stand in the way of reform. It now appears that many members of Congress realize the S&L and banking problems are, to a significant degree, the result of out-moded laws that have prevented banks and thrifts from keeping pace with the rapidly changing market for financial services.

Much of the credit for the early success must be given to the administration; to a cadre of progressive members of the Banking Committee led by Rep. Doug Barnard Jr., D-Ga.; and to House Speaker Thomas S. Foley, D-Mass. The President has made it clear that banking reform is a priority and has joined forces with the speaker to give activist members of the Banking Committee from both parties an opportunity to work their will.

As gratifying as the progress has been, it's much too soon to rejoice. There is still plenty of opportunity for the reform effort to fail - and even more opportunity for mischief. Though the special-interest groups were dozing at the start of this proceeding, they are now wide-awake.

The Money Broker Problem

Take the money brokers, for example.

The better part of a decade has passed since the Federal Deposit Insurance Corp. and the Federal Savings and Loan Insurance Corp. tried without success to eliminate deposit insurance on brokered funds. In the meantime, the money brokers have caused tens of billions of dollars in losses to the bank and thrift insurance funds and the taxpayers.

The administration has bravely proposed to remove deposit insurance coverage from brokered funds. The subcommittee has responded by capitulating once again to the money brokers, letting them keep their taxpayer subsidy so long as they do not put the money in institutions that are already in trouble.

Contrast this vote with the subcommittee's decision to terminate deposit insurance coverage on bank investment contracts, or BICs. It appears that deposit insurance coverage is a bad thing when banks are using it to their advantage against insurance companies, but a good thing when Wall Street is using it to earn enormous fees.

Special-interest politics aside, there is considerable potential for harm in the current legislative proceeding.

For example, there is Congress' fixation on "early intervention" schemes based on a rigid and arbitrary measure of a bank's health (its nominal capital ratio).

There are other scary notions floating around the Hill that could spell trouble.

Rep. Charles Schumer, D-N.Y., who is one of the more able members, is flirting with a scheme that would sharply constrict the activities of insured banks and subject them to extremely onerous regulation, including reintroduction of deposit interest rate controls. Even the author of this plan concedes that insured banks and thrifts would shrink by $1 trillion if it were implemented - not a happy thought for a struggling industry already finding it difficult to fuel an economic recovery.

|Too Big to Fail'

Moreover, though Congress seems to want to reform the deposit insurance system to eliminate the "too big to fail" policy, it hasn't figured out how to do it.

The policy will never be eliminated so long as banks have access to fully insured brokered funds and fully secured advances from the Fed.

Nor will it happen so long as the government's only choice is to put all depositors above the $100,000 insurance limit totally at risk when a large bank gets into trouble. There needs to be a less draconian alternative, such as applying a "haircut" to the deposit balances above the base insurance limit.

We should all take heart from the fact that the reform effort is moving along much faster than almost anyone thought possible just a few weeks ago. Moreover, some courageous stands have been taken with respect to interstate branching and other reforms favoring competition.

But this is no time for complacency. The ball hasn't yet crossed midfield and could easily be fumbled.

Mr. William M. Isaac, a former chairman of the Federal Deposit Insurance Corp., is managing director and CEO of the Secura Group, a Washington-based financial services consulting firm.

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