HR 10, the financial services modernization bill introduced last year by Rep. Jim Leach, R-Iowa, died because it tried to do too much the wrong way.
Though regulatory reform is much needed in the U.S. financial services industry, attempting to revive HR 10 would merely delay reform. Instead, financial services modernization must be rethought in a very fundamental way.
Fortunately last Nov. 8, the day that HR 10 effectively died, Rep. David Dreier, R-Calif., introduced a back-to-basics bill, HR 2940, which should stimulate this rethinking.
HR 10 had substantial flaws. For one thing, it addressed two distinct issues: modernization of the financial services industry and modernization of financial services regulation.
Electronic technology has been blurring distinctions among the three broad product categories of financial services-banking, insurance, and securities. Money market mutual funds and variable annuities are two examples of this blurring. Left to its own devices, the financial marketplace will create many more such products, particularly those that integrate financing with insurance.
Product melding inevitably leads to organizational melding, because a company that is selling melded products cannot be cleanly classified as a bank, insurance company, or securities firm.
The growing inability to neatly classify financial services products and providers renders traditional competitive barriers within the financial services industry meaningless, or worse, anti-competitive. Consequently, these barriers must be demolished to permit financial services providers of various origins to compete on a level playing field.
Instead of doing that, HR 10 would limit what banks could do while locking them into a holding company structure, impede the entry of securities firms and insurance companies into banking, and destroy the thrift charter.
At the same time, HR 10 would preserve the obsolete concept of functional regulation, which is premised on the ability to clearly categorize financial products. To some, functional regulation is the Holy Grail; in reality, it is Humpty Dumpty after his fall.
The genius of Rep. Dreier's bill is that it cuts HR 10's Gordian knot, which would tie industry modernization to regulatory modernization. The four-page legislation addresses only industry modernization, by simply repealing the Glass-Steagall Act and permitting banks and insurers to affiliate.
Though an argument could be made that Rep. Dreier's bill does not go far enough, its objective of separating industry modernization from regulatory modernization is on target. It properly tackles the easier modernization task, because-as is widely agreed in the financial services industry- restrictions on who can compete with whom and who can produce or sell what are obsolete and, worse, counterproductive.
Only after Congress enacts industry modernization should it then tackle the much tougher job of realigning the regulatory structure to meet the needs of a truly modernized financial services industry.
Other countries, notably the United Kingdom and Australia, offer important guidance for regulatory restructuring. Essentially, these countries are scrapping traditional notions of industry regulation because they recognize that two fundamental regulatory concerns span the entire financial services industry: safety-and-soundness, or prudential regulation: and consumer protection, which includes the fair and competitive operation of financial markets.
Although the federal government has six major, well-entrenched financial services regulators, and similar regulators in each state, Congress must move in the direction in which the U.K. and especially Australia are pointing.
First, to permit the delivery of all types of financial services on a uniform basis nationwide, there must be a federal option for insurance regulation.
Congress should then take the admittedly bold step of creating two financial regulatory agencies. One agency must focus on ensuring the prudent operation of those financial firms, whatever their marketing orientation, whose liabilities threaten financial stability. In effect, Congress must address the mother of all financial services issues, deposit insurance, or more broadly, reform of the federal financial safety net.
The other regulator should enforce the broad range of consumer protections that now apply to financial products, while ensuring that financial markets operate fairly.
Properly dividing duties between these two agencies would minimize regulatory turf wars and conflicting regulations that increasingly plague financial services firms.
Though the task is herculean, Congress must enact this regulatory restructuring to bring to the financial services industry the same national regulatory uniformity that it has brought to many other aspects of interstate commerce.
Continuing to wield the outdated notion of functional regulation to preserve the existing regulatory turfs, and invoking states' rights to perpetuate an obsolete regulatory bifurcation, would merely worsen the turf wars while impairing economic performance.
The death of HR 10 and the intent of HR 2940 point Congress in the right direction.