Over the last two decades the Federal Reserve Board has been evolving into a Ministry of Finance, an overseeing generalized policy regulator for all facets of the financial services industry. This has been done with the consent and authorization, albeit sometimes after the fact, of Congress.

Oversight of nonfinancial companies offering banking services may well be the next great empowerment of the Fed.

With the legislative demise of the Glass-Steagall Act, the last major banking-structure regulations remaining to be addressed by Congress are the elimination of barriers between banking and commerce in the Bank Holding Company Act.

The Gramm-Leach-Bliley Act of 1999 laid the foundation for banking and commerce regulation by expanding the Federal Reserve’s authority over merchant banking. The act protects and expandsÊthe Fed’s continuing role as the gatekeeper that maintains the barriers between banks and commercial companies.

Regulators have chosen to interpret this new authority as restrictive — that is, that their job is to maintain the barriers between banking and commerce. Another interpretation is very possible; Congress probably foresees Fed regulation of merchant banking as a basis for ultimately eliminating the restrictions in some future legislation.

The revocation of the long-standing separation of commercial and investment banking sets the stage.

Gramm-Leach-Bliley was relatively modest in what it did initially, but it is an enormous grant of authority to the Fed to do more in the future. Essentially, the Fed gets to define the limits of its own powers because the law permits the Fed to define what activities are “financial in nature” or “complementary” to a financial activity.

Although some Fed determinations are subject to “consultation” with the Treasury Department, that obligation is not much of a real restriction. The Fed has been slugging it out with Treasury and its Office of the Comptroller of the Currency for years, and the Fed almost always has come out the winner.

There is no more clear example of this sparring than the conclusion of years of debate over whether banks could carry on securities and insurance activities from inside the bank or would be required to form a holding company and do such business in a subsidiary.

The comptroller argued and ruled in favor of the former, the Fed the latter — and Gramm-Leach-Bliley gave the victory to the Fed and its holding company authority.

New merchant banking powers are the first erosion of prohibitions against the mixing of banking and commerce that underlie the Bank Holding Company Act. Like all statutory provisions, the new “complementary” powers are subject to interpretation by regulators.

We suspect we will see the same pattern develop in the Fed’s interpretation of merchant banking regulations that we saw last in the Fed’s incremental elimination of Glass-Steagall’s prohibition of bank association with companies that underwrite securities.

Glass-Steagall prohibited a bank from being affiliated with a company “principally engaged” in underwriting securities. But the Fed interpreted the term “principally engaged” to mean an ever higher percentage of business: 10%, 15%, and ultimately 25% of the gross revenues of the subsidiary. That set off a feeding frenzy of acquisitions of investment banks by commercial banks that has left very few independent investment banks still standing.

By the time Congress passed the Gramm-Leach-Bliley Act, it was memorializing the decision made by the Fed to eliminate Glass-Steagall restrictions on banks. It was also correcting a problem the Fed was only too happy to have exist: the fact that Fed regulations had established a one-way street in which banks could buy brokers but brokers could not buy banks.

Some critics of the Fed’s first proposals for merchant banking regulations saw them as disincentives to brokers buying banks even after Gramm-Leach-Bliley authorized them to do so. The Fed is, after all, a bank regulator and it is in the institutional interests of the Fed for banks to be the dominant players in the financial services industry.

The price the Fed demanded for allowing the two-way street was that brokers that wanted to buy a bank had to form a holding company subject to Fed regulation; hence the financial services holding company of Gramm-Leach-Bliley.

When the comptroller tried to get into the same game by allowing expanded securities activities in a bank subsidiary rather than a Fed regulated holding company, the Fed objected. Working with its friends in Congress, the Fed defeated the comptroller and occupied the field.

Game, set, match: Fed.

As the Fed gradually eroded the barriers of Glass-Steagall, it empowered bank holding companies and itself. As the Fed expands its regulation of merchant banking to gradually erode the barriers to mixing banking and commerce, it will further empower itself as the regulator of holding companies and ultimately could use that authority to regulate the financial businesses of commercial companies.

Gramm-Leach-Bliley is an empowering step in this process of establishing the Fed as the regulator of nonbank financial institutions. Ultimately, the Fed may be the regulator of financial entities regardless of the nature of the organization, establishing policy for participation of an entity in the financial markets, leaving the day-to-day regulation to functional regulators.

As an ever higher percentage of revenues for companies like General Electric come from its financial businesses, it will be interesting to see how the Fed maneuvers its authority under Gramm-Leach-Bliley.

Mr. Blumenthal analyzes financial services policy at Schwab Capital Markets in Washington.

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