When I became inside counsel for a commercial bank in 1977, I never imagined the changes coming to the industry or that it would be front and center 30 years later in the most serious economic crisis since the Great Depression. I have been thinking about how regulatory changes over these three decades may have contributed to our current predicament, and what lessons can be learned.
Commercial banking was fairly simple in the 1970s. Banks were generally hemmed in by the Douglas Amendment of the Bank Holding Company Act to branching in a single state. On the product side, they were regulated most notably by the Depression-era Glass-Steagall Act. Banks made bread-and-butter loans to consumers and businesses and offered deposits subject to mandated maximum rates of interest.
But bankers weren't happy in those seemingly halcyon days. Large, comparatively unregulated investment banks were peeling off their most profitable customers, offering deposit-type instruments without rate caps, and underwriting debt for the best corporate customers.
And so began what I consider the two major trends of these past three decades. At first the assault was not direct, but more nuanced. With respect to geography, banks attempted to work within the language of existing federal law. A number of state legislatures, particularly in New England, passed bills allowing regional bank holding company mergers.
The so-called New England Compact was immediately subject to a legal challenge that worked its way up to the U.S. Supreme Court, which validated the compact in 1985. What followed was a spate of mergers in New England. States in other regions were passing legislation allowing their own compacts. Congress had to face facts on the ground, and in the early 1990s passed the Riegle-Neal Act, which essentially opened up nationwide interstate banking.
Simultaneously, product diversification was also moving along. In this case bank regulators played a role in helping commercial banks compete with their less-regulated Wall Street cousins. Competitive money market accounts were permitted by the Federal Reserve, the Office of the Comptroller of the Currency became more liberal in its definition of "banking," and in 1987 the Fed permitted bank holding companies limited rights to engage in investment banking activities.
Once again Congress was forced to recognize facts on the ground, and the passage of the Gramm-Leach-Bliley Act in 1999 allowed bank holding companies, through affiliates, to engage in most activities held to be financial in nature. Investments banks could do the same and own commercial banks; however, it was not until the current crisis that they were willing to accept this status and the heavy supervision and capital requirement it entails. Thus commercial bankers had largely achieved their long-standing goal of being more like investment bankers.
What insight can be gleaned from this very compressed history of two secular banking trends of the past 30 years? It is my feeling that geographical growth worked quite well. Combined with leaps in technology, large banks have been able to offer more innovative products (in some cases maybe too innovative) and remote banking facilities are now ubiquitous, greatly adding to customer convenience. While community banks will continue to survive, today the larger borrowing customers have more options than just money-center banks. Of course the creation of trillion-dollar institutions has also exacerbated the issue of "too big to fail."
The history of product diversification is more checkered. Commercial banks did get into investment banking and made some of the same bad bets that laid low such venerable institutions as Lehman Brothers, Bear Sterns and even Merrill Lynch. Yet in the end it was the commercial banks, troubled though they were, that had the wherewithal to rescue Merrill and Bear Stearns. And the only two remaining large investment banks — Goldman Sachs and Morgan Stanley — voluntarily submitted to bank holding company regulation. Therefore, I disagree with those who say that the passage of Gramm-Leach-Bliley is the cause of all our current problems, though failures of regulatory oversight were an important part of the equation.
So what now? We are not going back to Glass-Steagall or limited interstate branching. Clearly some regulatory consolidation is in order, and the proposed merger of the Office of Thrift Supervision into the Office of the Comptroller of the Currency is a good first step. On the other hand, the replacement of one agency with another devoted to consumer protection is probably not necessary. The regulators just need to put a higher priority on the consumer and make sure that like products are all governed by the same rules.
The current crisis did not occur because we had too many regulators; but rather, because none of them appreciated the accident waiting to happen in the subprime mortgage arena. So the creation of a systemic risk council or bestowing these powers on the Fed is generally a good idea. Hopefully this will enable regulators to recognize and circumvent the next crisis before it occurs.
As for bankers (or bank lawyers), a little more humility please. Just because you are a great commercial banker does not automatically qualify you to be an investment banking guru. Better to strive to be best at what you are than to try to be something that you are not.