If you're confused about the impact the financial modernization legislation that just squeaked through the House will have on the deposit insurance system, you're not alone. It would be difficult not to be confused by the remarks on the subject by Federal Reserve Chairman Alan Greenspan.
In a May 19 letter to the Independent Bankers Association, the chairman argued that HR 10 contains important safeguards for the deposit insurance system:
"HR 10 would prohibit operating subsidiaries from engaging as principal in activities that are not permissible for the parent national bank, primarily insurance underwriting, securities underwriting and dealing, merchant banking, and real estate investment and development activities.... HR 10 provides important protection to the deposit insurance funds from the risk of loss from these activities by requiring that these activities be conducted in a holding company rather than in a bank subsidiary."
Now let's look at the chairman's remarks on June 3, 1997, before the House Banking Committee.
Mr. Greenspan, when asked by Rep. Ken Bentsen, D-Tex., about the nature of his concerns about bank operating subsidiaries, responded:
"My concerns are not safety and soundness. It is the issue of creating subsidies for individual institutions, which their competitors do not have. It is a level playing field issue. Nonbank holding companies or other institutions do not have access to that subsidy, and it creates an unlevel playing field. It is not a safety and soundness issue."
Neither the chairman's May 1998 letter nor his June 1997 testimony has it right. The subsidy issue doesn't hold water, and the safety-and- soundness concern is misdirected.
First, there is no subsidy. Banks pay billions of dollars each year to support the Federal Reserve System and the Federal Deposit Insurance Corp.
To date, banks have paid some $30 billion into the FDIC, over and above its losses and expenses. Banks' payments to the Federal Reserve have been even greater.
Moreover, even if there were a subsidy, it wouldn't be transferred any more easily to a separately capitalized and funded bank subsidiary than it would to a holding company subsidiary.
There is a safety-and-soundness issue, but the chairman has it backward in his May 19 letter. If an affiliate of a bank engages unsuccessfully in some activity, such as insurance underwriting, it might cause some problems for the bank. These potential problems would be equally troublesome whether coming from a holding company affiliate or from a bank subsidiary.
When I was chairman of the FDIC, we went over these structural issues very carefully. We concluded that bank operating subsidiaries were clearly preferable to the holding company structure, from the standpoint of the deposit insurer.
The risks to the banks are similar in either case. But if the activities are forced into holding company subsidiaries, the profits of successful ventures will not accrue to the insured banks. Our nightmare scenario was to have banks suffer the consequences of unsuccessful ventures by affiliates while not reaping the benefits of successful ventures.
The FDIC had no regulatory turf at stake in the operating subsidiary versus holding company affiliate issue.
The FDIC can examine and exercise enforcement authority over any insured bank and its affiliates. In favoring bank operating subsidiaries over holding company affiliates, the FDIC's sole concern was with the strength of the banking system and the FDIC fund.
HR 10 clearly poses a greater risk to the deposit insurance system than if the bill were to allow all financially related activities to be conducted in separately capitalized and funded bank subsidiaries. HR 10, as adopted by the House, is in the best interests of neither the banking system nor the FDIC.