The outlook for financial modernization legislation has taken a decided turn for the worse.

Federal Reserve Chairman Alan Greenspan dealt a blow to the reform bill with his recent testimony before a subcommittee of the House Commerce Committee.

He threw down the gauntlet, declaring "the long-term stability of U.S. financial markets and the interests of the American taxpayer would be better served by no financial modernization bill rather than one that allows the proposed new activities to be conducted by the bank."

In so doing, Mr. Greenspan expressly rejected Treasury Secretary Robert Rubin's compromise proposal that had been overwhelmingly approved by the House Banking Committee.

Many champions of financial modernization, myself included, believed Mr. Rubin had gone too far in his attempts to mollify Mr. Greenspan by restricting the activities of bank subsidiaries.

For more than two decades the House Commerce Committee has been a stumbling block to obtaining a decent reform bill. The committee is poised to conduct its mischief again, particularly on the issue of bank subsidiaries.

If Chairman Greenspan had supported the measure approved by the Banking Committee, the Commerce Committee might have gone along. Now it seems almost certain the Commerce Committee will approve a bill the administration has vowed the President will veto, as well he should.

Mr. Greenspan advanced the same arguments he has made previously. Banks, he asserts, are subsidized by the federal safety net (i.e., deposit insurance and the Fed window).

New activities must be conducted in holding company subsidiaries to prevent "leakage" of the subsidy from the bank to the new activity. Moreover, holding company subsidiaries provide more protection to the Federal Deposit Insurance Corp. than do bank subsidiaries, according to Mr. Greenspan.

Most experts reject these arguments. There clearly is no taxpayer subsidy of banks. The FDIC is sitting on nearly $40 billion accumulated from banks during the past 65 years. The Fed rakes in billions of dollars in profits every year courtesy of the banks.

The subsidy runs from strong banks to weak banks and from all banks to the government.

Even if there were a subsidy running to the banks, it would not "leak" from a bank to a separately capitalized and funded bank subsidiary any more easily than to a holding company subsidiary.

The current and three former chairmen of the FDIC, myself included, flatly reject Mr. Greenspan's assertion that holding company subsidiaries will better protect the deposit insurance fund.

The FDIC has consistently urged since 1982 that Congress allow expanded activities to be conducted in bank subsidiaries. The FDIC has no turf involved in this debate, only tens of billions of dollars of added exposure to losses if Congress fails to allow the expanded activities in bank subsidiaries.

Nearly every issue in the financial modernization debate has been resolved or appears susceptible of resolution, a notable exception being the bank subsidiary issue. For a long time it seemed that neither the Treasury nor the Fed would give any ground.

Then Secretary Rubin broke the logjam, and the bill sailed through the House Banking Committee with strong bipartisan support.

The House leadership needs to get behind the compromise bill approved by the Banking Committee.

If it fails to do so, yet another year will likely pass without financial modernization legislation.

Legislation that forces expanded activities into holding company subsidiaries does not deserve the "modernization" label. Its enactment would be harmful to the financial system, consumers, the FDIC, and potentially the taxpayers. Mr. Isaac, former chairman of the Federal Deposit Insurance Corp., is chairman of Secura Group in Washington.

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