Reform Fiasco Presages a Bleak Future for Banks

Among the many lessons that emerge from the failure to pass significant banking reform legislation this year, four seem to be particularly relevant:

* Current leaders, whether in Congress or the Treasury, lack the ability to formulate a universal solution to the financial industry's dilemmas.

* The banking industry itself is unable to define financial issues clearly (beyond the limited needs of a series of special-interest groups) and therefore, has not created a compelling case for Congress to act upon.

* The primary objective - development of a sound system that delivers financial resources to multiple economic sectors - is not even being thought about, let alone discussed.

* Banks will increasingly find themselves shunted into smaller roles in the financial industry, while nonbanks enjoy accelerated growth at the traditional banks' expense.

Thus, banks must focus more than ever on discovering those businesses at which they can do the best job. Concentration of resources in high-profit sectors is critical to survival over the long term.

The Political Issue

Congress understands neither banking nor the interplay between banks and nonbanks that has reshaped the financial system - nor should it be expected to. However, because of negative developments in the thrift and banking businesses, Congress is being forced to decide about the nature and direction of this poorly understood business.

To make these judgments, legislators are relying on guidance from leaders designated to understand banking. And in this regard, Congress is poorly served.

The nation requires a broad-based solution to its financial dilemma, one that will serve a variety of interests and yet maintain safety in the system. Instead, plans are being offered that serve very narrowly based clienteles - plans that have very little hope of meeting the universal need.

Selfish Interests

Congressional leaders have aligned themselves closely with self-serving positions. So much so that they are incapable of convincing others either that they understand key banking issues or that they will fashion solutions to meet the broader need.

Everyone knows what the position of House Banking Committee Chairman Henry Gonzales, D-Tex., will be on any issue.

Rep. Gonzales views banks as huge, profitable, capitalist organizations that get government subsidies through the Federal Deposit Insurance Corp. and the Federal Reserve Board. Therefore, he feels, they can be forced to redirect lending toward minority sectors of the business community. For him, the Community Reinvestment Act is the only relevant banking issue.

Moreover, he wants to limit the subsidy that banks get from the government by forcing structural change that would inhibit banks' growth.

Out of His Depth

Rep. Gonzales may be totally beyond his range of comprehension when looking at issues that go beyond this narrow scope; he has no feel for what nonbanking companies do, nor does he care. Finally, he seems unaware that, by restricting banks, he reduces their ability to serve the clientele he favors.

Rep. John Dingell, D-Mich., chairman of the Energy and Commerce Committee, seems prone to "shoot from the hip" in order to advance his causes. Thus, he is willing to argue that the nation's largest bank is insolvent, without having facts or understanding the statement's consequence for his constituents.

The motivation of Rep. Dingell for asserting his role on banking legislation may be to increase his political clout in Congress, to use "bank bashing" as a political tool to expand his populist support, or to assist Detroit's industrial-banking-auto companies.

He certainly did not intervene with any thought of building a national consensus for a solution to the financial industry's problems, and he has not done so.

It seems evident that neither Rep. Dingell nor Rep. Gonzalez has the motivation to develop a broad solution for financial problems.

Chairmen Repudiated

Clearly, their fellow Democrats in the House of Representatives perceive this to be the case. They voted overwhelmingly to repudiate the compromise forged by these two men who often seemed most interested in feuding with each other over control of banking legislation.

The Republican approach to banking issues is much better focused than the Democrats' highly politicized approach. In a well-written, clearly thought out report to Congress, titled "Modernizing the Financial System," the Treasury presented a view that would have supported its constituency - the large corporation.

The problem with this report was that it espoused a philosophy soundly and continuously rejected by the American people for at least the past 100 years. Republicans want a return to the "robber baron" era, when a few very large, multidisciplinary corporations controlled major financial flows in the economy.

The Republican position is so extreme that it frightens and repels populists. Moreover, the constituency for this approach is so narrow that it has no chance to attract the votes needed for acceptance.

Cacophonous Voices

Failure of broad banking legislation can therefore be blamed on the fact that no minority group proclaiming its self-interest could redefine its position broadly enough to capture majority approval. The cacophony of differing positions in Congress was magnified by the diverse groups clamoring to realize their desires.

A recent special supplement to the American Banker was titled "Does the banking industry need 201 trade groups?" The newspaper's answer was that the industry does not. The associations are far too costly. (Many of their top executives are paid more than $250,000 annually.) However, far more importantly, these interest groups tend to nullify each other's message.

I would add that, if a questionnaire were submitted to the 201 banking trade groups listed in the American Banker special report, asking their views on any banking issue, at least 201 different answers would come back.

The point is that banks are spending millions of dollars to confuse, weaken, and obscure their positions in Washington. They have recreated the Tower of Babel.

5 Essential Qualities

The nation wants from its financial system the following qualities:

* Safety - money put in this structure cannot be at risk.

* Impartiality - funds should flow to the areas of highest return.

* Availability - the structure must be such that no geographic or business sector has difficulty obtaining needed funds.

* Regulation - a mechanism that insures the system functions properly.

* Subsidies - methods of paying market returns on investments in geographic or economic sectors that need help to attract funds.

Free-market advocates may find themselves at odds with the last two qualities, but they are just as critical as the first three. There is no evidence that unregulated banking systems perform well, and even the Japanese subsidize the development of high-technology and other businesses that they believe are important to their nation's well-being.

We've Had This System

What may surprise is that the system described above is exactly the one that has functioned in the U.S. financial sector for the past 55 years. Moreover, it is the only system that has ever worked that long in this country.

The argument that Depression-era banking philosophy no longer works is specious. The problem with Depression-era laws is not that they don't work but that only banks must obey them.

Consider the following: Rep. Dingell now wants to offer banking legislation that would curtail the Federal Reserve's ability to make rulings that contradict provisions of the Glass-Steagall Act. Presumably, this means that Rep. Dingell wants to defend that law's precepts. Not so.

General Motors Corp. and Ford Motor Co., for example, which are headquartered in Rep. Dingell's home state, regularly violate almost every provision of the Glass-Steagall Act. That is because these are industrial corporations that function through subsidiaries as banks, something that Rep. Dingell supposedly abhors.

Could it be that Rep. Dingell's real interest is to pass legislation that would inhibit banks and give his patrons in the Motor City freer reign to take away banking business?

The point of this example is not that Rep. Dingell is protecting the interests of the large corporations in his state (which he probably is) but that nonbanks are not being considered when issues of legal restrictions on banks are discussed.

Washington has accepted a two-tiered financial system that forces companies getting FDIC insurance to obey the law, while those that appear not to have such insurance are freed. (However, Ford regularly accepts insured deposits, as do General Electric Co. and Sears, Roebuck and Co.).

The Economic Costs

Sensible banking reform will not happen, and this shortsightedness is foolish because, by not taking a comprehensive view, Congress erodes the five essential financial-system qualities:

* The system's safety is negatively affected as unregulated nonbank banks increase their share of financial assets. The safety net is being shrunk.

* Funds are not flowing to the sectors of highest return because large nonbanks divert this flow to sectors that benefit them to the exclusion of others.

* Fund availability is being crippled by Washington's continuous and irrational demands for more capital in the banking system.

* Regulators are not regulating to keep the system functioning properly but to shut the system down.

* The concept of subsidizing weak economic sectors or weak industries so that they can attract funds is dead. Look at monthly housing starts and the economic recovery(?) in New England.

To recap, the only fashion in which a comprehensive banking or financial industry bill should pass Congress and avoid a Presidential veto is if it reverses erosion of the five qualities and if it offers a universal solution to the nation's financial needs, not just a bonanza for special-interest groups.

To create such a bill would require objective and fair-minded committee chairmen in Congress and a Treasury secretary who places the nation's needs over those of special-interest groups. It would also require a coordinated lobbying effort by trade groups seeking a solution to the needs of the whole body politic.

In short, it is an impossible dream, since none of the basic requirements are fact.

Coming Attractions

This being the case, it is important for bankers to understand what Washington will impose upon them:

* Tough regulation. (Mr. Clarke, the comptroller of the currency, was not fired by Congress for helping banks meet the economy's needs.)

* A constant curtailment of cash flows. (The recent request by the Fed for fees on overdrafts is another government move to curtail money flows in the economy.)

* An unwillingness to impose strictures of any nature on the banks' main competitors who, therefore, will maintain substantial cost advantages over banks selling the same products.

This means that banks must solve their problems through internal action. They must restrict product offerings. Banks must now provide only items that are profitable and sell into markets that can be dominated.

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