Don’t Bank on Reform

With the Treasury Department about to announce its proposals for banking deregulation, Sen. Alfonse D’Amato (R., N.Y.) and the Clinton administration seem likely to join forces to push for what would be in the end the greatest extension of government intervention in the private sector since the Great Society. Their mechanism is the new banking reform bill, which would permit banks to own nonfinancial corporations and nonfinancial corporations to own banks.

This “bank-industry” combination was all the rage a dozen years ago, when Ford and Sears owned savings and loans, and Merrill Lynch and Citicorp were talking about “financial supermarkets.” A joining of banking and commerce was at the heart of 1980s privatization and banking deregulation in France, Spain, Sweden and Finland. Since those days, however, Ford and Sears have sold their S&Ls, and Merrill and Citicorp have pulled back to their core businesses. And in every one of the countries that opted for a more “universal” bank, the outcome was the same: failed big banks, money-losing nonfinancial subsidiaries, huge bills to the taxpayer (the French government has already put up more than $14 billion to keep Credit Lyonnais barely afloat)—and direct government intervention in the businesses those banks had bought and mismanaged.

For if you’re not prepared to let big banks fail—and because everybody worries about contagious runs, there is no exit strategy for insolvent big banks—then the government can’t escape direct involvement in a busted bank-industry combination. Because it was their money that had to be allocated, only French bureaucrats could decide what steps should be taken to make Metro-Goldwyn-Mayer salable so Credit Lyonnais could unload it. Likewise, the department stores owned by Spain’s Banesto had to be managed and then sold off in fire sales by the Spanish government, like the real estate properties U.S. S&Ls had acquired after Congress loosened their leash.

In the 1990s, trouble has plagued both the German “universal banks” and the Japanese keiretsu, the latter an arrangement by which industrial groups are formed around a bank. The Germans and the Swiss worry that their securities markets lack the depth and resilience their world financial status warrants. But in an economy where banks and nonfinancial corporations are linked together, the culture of secrecy that pervades the banking world blocks the diffusion of information about the corporate world that markets require before participants can feel confident about bidding.

Proponents object that industrial corporations own S&Ls and finance companies, and that has done no harm. Indeed, GE Capital has a larger portfolio of commercial loans and leases than any bank in the country, and First Data handles more payments than the four biggest banks combined. But GE Capital has to borrow its funds competitively in the open market, and First Data has to deliver good service at a good price. In contrast, banks as a group create the money they lend and can count on an electronically challenged Federal Reserve System to protect inefficiencies in their payment services.

We almost lucked into the right answer to these dilemmas a dozen years ago, when various companies wanted to get into different parts of the banking business through the device of a “nonbank bank.” Our law then defined a bank as an institution that both took deposits and made commercial loans, and permitted a company without a banking charter to set up in one of these businesses so long as it stayed out of the other. The banking regulators were offended and upset, and the “loophole” was closed. But this industry is now technology driven, and technology is in fact separating the payments business from the lending business, whether the regulators like it or not.

The preamble to the D’Amato bill announces “findings” that “restrictions on ownership of depository institutions and affiliations with other business organizations interfere with their ability to attract and retain capital” and that “current laws inhibit the ability of domestic financial markets and intermediaries to respond to the serious competitive challenges presented by foreign intermediaries.”

These “findings” would have been plausible 10 years ago, but today they are indisputably wrong. The larger U.S. banks now have too much capital and are buying back their stock. Most of the “foreign intermediaries” that were most active in our banking markets—Barclay’s and NatWest, the huge Japanese banks and the ever-present Credit Lyonnais—have shrunk their American presence and now fit comfortably into minor niches. Lending, which is what banks are for, is a business in which you have to know the territory.

Nobody doubts the inadequacy of our existing banking legislation, or the need to add value to the banking charter in an age when the whole computerized world has information once known only to banks. Public convenience and necessity argue strongly for allowing banks to do insurance brokerage and some underwriting. In an age when smaller loans are securitized for sale in the market and larger loans are “participated out” to big investors, the restrictions on banks’ securities activities are meaningless.

But the forces of changing technology will mold the industry regardless of what Congress does, simply because the new cost efficiencies are so great. There is no urgent need for legislation now—all sectors of the industry are profitable, and the engines of change are rolling on to destinations still unknown. The lawyers, lobbyists and political tacticians are offering solutions to yesterday’s problems. That’s no way to get organized for the 21st century.