Ask Martin Mayer about the newly enacted financial modernization law, and his response will be typically caustic: "More players doing more things they understand less."

Ask him about the rescue last year of the Long Term Capital Management hedge fund, and you will get no speech about wise bankers meeting secretly in oak-paneled boardrooms. "The Fed is now living in a world where the demand is unknown and the supply is unlimited," he says.

Ask him about financial services consolidation as a force for efficiency, and he will tell you, essentially, that less is less: less talent, less competition, less safety and soundness.

At 71, Mr. Mayer has lost neither his righteous anger nor his killer wit. The man who took on the banking industry and the legal profession in entertaining - and sometimes best-selling - tomes is still producing books and essays by the dozen and railing against unnecessary risk in the financial system whenever he gets the chance.

During a recent interview at the Century Club in New York, Mr. Mayer, now a guest scholar at the Brookings Institution, talked about his upcoming book, "The Fed and the Markets" (due out in fall 2000 from Free Press, a division of Simon & Schuster), and how risk management has changed for banks in the era of financial reform. Scheduled for publication at a time when Fed-watching - and, in some cases, Fed-worship - has pretty much become the national pastime, the book may well cause more than a ripple.

For Mr. Mayer, the movement to repeal the Glass-Steagall prohibitions on the merger of banks, brokerages, and insurers is, at best, an example of government finally catching up with the marketplace. Technology has brought vast changes to the banking industry, not all of them positive, he said.

"Banks used to develop large pools of knowledge about their borrowers," said Mr. Mayer. "Now what the banks want to do is make the loan and securitize. They want to score commercial loans the way they score auto loans."

The result has been the commoditization of lending and a know-nothing approach to banking, he said. Stabbing the air with a finger and waggling his prodigious eyebrows, Mr. Mayer declared: "Michael Milken was right! Loan participations and junk bonds are indistinguishable. They are functionally equal for trading and investment purposes."

Paraphrasing former Securities and Exchange commissioner Joseph Grundfest, now a law professor at Stanford University, he continued: "A term loan is nothing but an illiquid junk bond."

The near failure last year of Long Term Capital Management proved, if the real estate crisis of the 1980s had not already, that banks do not enforce collateral requirements on large and important customers. And the regulators "are not willing to force people to buy fire insurance," Mr. Mayer said. "In recent years, bankers have come to think that when worse comes to worst, the Fed will provide liquidity. But liquidity goes away very quickly."

The solutions, Mr. Mayer said, are to ensure that financial institutions have larger cushions of capital to protect against failure and for regulators to put banks through stress tests and worst-case scenarios to see whether they can survive.

But banks have been very reluctant to let the regulators do this, he said, partly because the banks want to write the scenarios themselves.

Mr. Mayer also said he believes that banking companies need to give regulators more information about their derivative positions. The Office of the Comptroller of the Currency and the New York State Department of Banking both have jurisdiction over many of the banks that use derivatives extensively.

The problem is that regulators, in general, have become too interested in the banks' profitability, Mr. Mayer said, and not as concerned as they should be with issues of safety and soundness.

"Regulators believe that bank managers, who make more money than they do, are smarter than they are, that they should trust institutions to know their own risk. But all the short-term incentives for bank executives are to increase risk in order to boost earnings, stock prices, and their own bonuses," he said.

Mr. Mayer is not the only industry commentator who sees changes in the banking industry as perhaps accelerating financial risk. Consultant George Davis, the president of Scarborough Partners and a former Citicorp executive, said he, too, is worried. "The problem is raw size," he said. "The companies are getting so big, they've become very difficult to manage. I think it's very hard for one person to sit on top of the risk management pile at a Citigroup or a Bank One Corp. and do a good job."

Mr. Davis suggested that the new entities created by financial reform be managed as portfolios, instead of amalgamations. "You need separate silos," he said. "The mortgage company, the brokerage company, the credit card business, and the banking company should all be run autonomously, each with its own risk managers. Then the chairman and the policy committee can look at portfolio performance and not at any one business in detail."

Both Mr. Davis and Mr. Mayer also said that the financial services work force has changed substantially in the last 10 years - and in a way that is likely to be negative for the industry's risk management profile. Mr. Mayer said experienced credit officers, who were sloughed off by banks in the recession of 1990 and 1991, have never been replaced. And Mr. Davis pointed out that, generally, the people managing financial services companies today are younger than their predecessors in the same posts.

"Downsizing and acquisitions have pushed out a whole lot of experienced people," he said. "When I was a young man in banking, there was always somebody around with gray hair. Now that's not true anymore. The average age is 50, and if you go into an investment bank, it's even younger." The industry needs people who have experienced several turns of the credit cycle, Mr. Davis said.

Edward Furash, another longtime financial industry consultant, said the new environment also demands that banks think of risk in terms of a budget. Financial managers need to ask themselves: "What is the maximum amount of risk that an institution's capital can stand? How do we divide that risk among our businesses to create an optimum situation?"

"What the law makes clear is that comprehensive risk management will become more and more important," he said. "These holding companies are in multiple businesses, and they have to measure the total risk of all these businesses combined."

Kevin Blakely, the executive vice president responsible for risk management at Cleveland's KeyCorp and chairman of the credit industry trade group Robert Morris Associates, said he finds the brave new world of financial reform both "thrilling and scary."

"We all sort of coveted each other's businesses," he said. "But now that we're getting into each other's backyards we're saying, 'Yipes! You guys do that?' "

"It's been an interesting process," he continued. "Some of the stuff they do in the investment banking business makes us scratch our heads. But we have to go into it with an open mind and learn from our new partners."

One risk manager at a financial institution with a long history in commercial and investment banking insisted that, in some ways, reform makes these issues easier to deal with. Mark Brickell, a managing director at J.P. Morgan & Co., said his company found a great deal of commonality among apparently different financial businesses. Morgan, for example, uses similar technology to manage interest rates in its swaps portfolio and its deposit accounts.

"All things being equal, the diversification that comes from financial modernization makes the business less risky and the revenue streams more stable, just like interstate branching made banks safer because of geographic diversification," he said.

"Finding a way to measure what the differences in risk are is one of the things that we're doing and benefiting from doing," Mr. Brickell added. "We're increasingly confident that we can manage them well."

Mr. Mayer, however, was not so easily reassured. His new book, "The Fed and the Markets," will call on central bankers to encourage financial institutions to again cultivate what he calls "information-rich" lending. "There will be a time when banks won't be so important because everything will be securitized," he said. But until then, "we still need banks very, very badly. And there is a role for the Fed to encourage banks not to get too post-modernized."

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