WASHINGTON -- The unfolding government securities scandal ensnaring Salomon Brothers Inc. could help derail pending bank reform legislation and may sidetrack lawmakers, at least for the moment, from considering further regulation of municipal securities, industry sources said yesterday.
Bank lobbyists said the Salomon situation could throw more cold water on measures to overhaul the financial industry, which faced an uphill battle in both the House and the Senate even before the alleged skulduggery by Salomon traders.
Among other reforms, bills pending on both sides of Capitol Hill are aimed at gutting the 1933 Glass-Steagall Act. But bank lobbyists expect House Energy and Commerce Committee Chairman John Dingell, D-Mich., a strong opponent of bank entry into the securities business, to use the Salomon situation to help retain the act's barriers between investment and commercial banks.
"Dingell can say there's a danger in underwriting [or wrongdoing], so banking and securities shouldn't be mixed," a bank lobbyist said.
"All of this would play into Dingell's hand, I would think," said Fritz Elmendorf, a spokesman for the Consumer Bankers Association. Rep. Dingell's views are considered important because his panel is reviewing a reform bill approved in June by the House Banking Committee that would allow banks to affiliate with securities firms.
They said Rep. Dingell's hand could be strengthened by concerns about the Bank Insurance Fund, which is expected to go broke by year's end. Some of Salomon's competitors allegedly lost millions of dollars when the firm cornered the market in Treasury securities. Had those losses been absorbed by a bank affiliate, they could have strained the institution's resources and caused it to fail, the lobbyists said.
But Mr. Elmendorf said commercial banks have never been excluded from the government securities market because Glass-Steagall allows banks to underwrite and deal in general obligation bonds of the federal and municipal governments.
"So there's no real connection [between the Salomon situation and the Glass-Steagall debate], but it is a scandal," he said. "Anything like that can be used as an excuse not to act on banking legislation."
According to one lobbyist, the scandal could weaken Rep. Dingell's sway in the reform debate. "All in all, I think this is positive because it shows members of the House that Dingell spends too much time on trying to expand his [committee's] jurisdiction rather than on stuff that clearly is within his jurisdiction, like the Treasury market," he said.
"It shows that there are problems in Dingell's domain that he's not tending to because he's too busy trying to mind everyone else's business," the lobbyist added.
In the Senate, the reform bill faces an equally uncertain future. Approved by the Senate Banking Committee earlier this month on a narrow 12-9 vote, the legislation may be amended by disgruntled senators who believe there is a need to require stricter separation between banks and securities affiliates. But overhaul proponents complain that such restrictions would so burden banks that any advantages of opening securities affiliates would evaporate.
Another impact of the Salomon scandal may be to shave back air time Congress may give on issues facing the municipal bond market in upcoming Capitol Hill hearings over reauthorization of the Government Securities Act of 1986, government and industry sources say.
"A lot of attention may be diverted to Salomon" during the House's debate of the 1986 law, said a government source who asked not to be identified.
A Senate Banking Committee panel chaired by Sen. Christopher Dodd, D-Conn., has already held two hearings on the condition of the municipal bond market and the need for improved disclosure. But it is unclear whether Sen. Dodd's securities subcommittee will conduct a third in the series, as planned.
The Senate cleared legislation July 30 reauthorizing the government securities law without amendments affecting the municipal market.
In the meantime, the House Energy and Commerce Committee's subcommittee on telecommunications and finance will conduct a hearing Sept. 4 on Salomon's problems and will probably hold hearings on the Government Securities Act reauthorization later that month.
Full committee Chairman Dingell has written the SEC three times in the last year expressing concerns about the quality of disclosure in the municipal bond market, adding that the reauthorization of the government securities law may be an appropriate vehicle for an amendment on the subject.
But neither Rep. Dingell nor subcommittee Chairman Edward Markey, D-Mass., have signaled recently that they plan amendments touching on municipal bonds in the government securities legislation.
Some industry sources, however, warn that municipal bonds cannot help being drawn into the debate over government securities in the near future. "The Salomon problem adds fuel to the concern that there should be more regulation in unregulated markets," said one top Wall Street official.
"I think it could have a big impact on the municipal side. If there are abuses in the most efficient market in the world, what about other markets," he said, saying poor secondary-market disclosure and the lack of price dissemination in the municipal market could be the targets of congressional scrutiny.
SEC member Richard Roberts hinted earlier this month that Congress may get involved in municipals soon, particularly if the market does not move quickly to improve secondary-market disclosure. He said the Municipal Securities Rulemaking Board's proposed secondary-market repository, if eventually approved by the SEC, will improve the situation. But the board's efforts alone "may not carry us all the way to our destination," he said.
"Further commitment will need to come from other segments of the industry, including lawyers, and perhaps the SEC and Congress may also have a role to play," he said at an American Bar Association conference in Atlanta.
But another industry source said, "I don't think that the Salomon situation is at all related to the municipal market. The municipal market is a lot more mature than the government securities market.
"The municipal market went through in 1975 what the government securities market is going through now," he added, referring to enactment of amendments that established sales practice rules and suitability standards for the municipal market. Their situations are "totally unrelated" now, he said.
Sources say that Salomon situation could put pressure on Congress to give primary regulatory authority over sales practice standards for the government securities arena to the SEC, rather than the Treasury. The Senate bill gives the National Association of Securities Dealers the ability to write sales practice rules for its members -- subject to SEC approval -- but the Treasury could veto rules it thinks impair market liquidity or create competition problems.
A draft House version would give the SEC, which is considered a stronger regulator, more authority in regulating sales practices, while Treasury and the Federal Reserve would provide input.