Revisions in Banking Law Not Likely This Year

Efforts to dismantle the legal barrier that keeps banks out of the securities business have been delayed, possibly even derailed, by political infighting, the stock market crash, a court ruling and lobbyists with pit bull temperaments.

The nation’s big banks expected 1988 to be the year that Congress repealed parts of the Glass-Steagall Act, which prohibits them from owning securities firms and underwriting corporate debt.

It would open the door to a lucrative field for banks, which recently completed their worst year since the Depression. And it would be the first step in what many see as an inevitable upheaval in financial services that will alter the way billions of dollars are invested and will affect virtually every consumer in the United States.

‘Not End of Road’

But a variety of forces have combined to dim prospects for even the first increment of the restructuring. While bankers and their lobbyists maintain publicly that they still expect Glass-Steagall reform, many concede privately that it is unlikely this year.

“I had hoped that the Senate Banking Committee would at least get out something that I would characterize as progressive legislation, but I don’t think we are on that schedule now,” the top lobbyist for a major banking company said in an interview. “It’s not the end of the road, but I’m not optimistic.”

The banks had reason for optimism just months ago, for they had gained a powerful and surprising ally.

Sen. William Proxmire (D-Wis.) is chairman of the Senate Banking Committee and a longtime critic of big banks. But last summer he reversed himself and joined their side on the critical issue of reforming Glass-Steagall. Proxmire announced hearings on the subject, with the aim of drafting legislation to alter the Depression-era bank regulations.

Glass-Steagall was passed in 1933 to separate securities and banking activities after the 1929 market crash and the subsequent collapse of the banking system. Before then, banks had owned securities firms and critics blamed that integration for contributing to the economic catastrophe by risking bank assets and fostering conflicts of interest.

In the more than half a century since the law was passed, however, the financial industry has undergone enormous changes. Technology transformed money into blips on a computer screen and linked the world’s financial centers. Innovative products, such as mutual funds and Eurobonds, were introduced.

Banks complained that the outmoded restrictions of Glass-Steagall forced them to remain on the sidelines, watching profits shrink and business go to foreign banks and domestic non-bank competitors, such as the investment firm of Merrill Lynch. The banks wanted the right to compete by owning securities affiliates.

“The changes have been so great in the banking system that you can do this without the threat and danger we had before,” Proxmire said the day before he introduced legislation last November to repeal the section of Glass-Steagall prohibiting banks from engaging in securities transactions.

Proxmire is pivotal to any chance for success. He is respected as a legislator of intellect and integrity, and many view this legislation as his last hurrah before retirement at the end of 1988. He added to his luster by persuading Sen. Jake Garn (R-Utah), the ranking Republican on the banking committee, to co-sponsor the legislation.

A central feature of the Proxmire-Garn bill would require that securities activities be restricted to an affiliate of the bank holding company, establishing what are generally called “fire walls” to insulate the bank from potential losses of the securities affiliate.

But the concept was called into question after the Oct. 19 stock market crash, when it was disclosed that Continental Illinois National Bank lost $90 million after making excessive loans to an affiliated options-clearing company. The subsidiary is not a securities firm, and Continental Illinois had assured regulators that it was risk free.

That event was outside Proxmire’s control, but Washington insiders say the senator has made a couple of mistakes that also damaged prospects for his bill’s success.

One was underestimating the impact of the market crash. Proxmire said the crash showed that the banking system had the strength to endure its biggest test since 1929. But the event raised long-buried fears in the national psyche and provided opponents with an emotional argument for keeping banks out of the securities business.

Banking regulators have supported the Proxmire bill and, as recently as Wednesday, H. Robert Heller, a member of the Federal Reserve Board, urged Congress to repeal the sections of Glass-Steagall separating commercial and investment banking. He said it would benefit the financial industry without undue risk to the banking system.

Three segments of the financial services industry are leading the fight against changing Glass-Steagall: securities houses, insurance firms and real estate companies. All three are fighting tenaciously, although with different degrees of unity, to protect their turfs.

Garn Rips Lobbyists

“What you have had is a piecemeal, zero-sum, pit bull contest in which industry types oppose one another, and the result is legislative gridlock,” said James D. Robinson III, chief executive of American Express, the nation’s largest financial services company.

Robinson wears several hats, for his firm’s holdings include a bank in Switzerland and the largest brokerage in the United States, Shearson Lehman Hutton, in addition to its credit card and other businesses.

He is a member of the Financial Services Council, a coalition of major companies in the fields of banking, securities and insurance. These big firms favor sweeping aside all restrictions on competition and letting the market govern, in the belief that they will pick up their share of the marbles in an open system.

The basic concept is contained in legislation introduced in the Senate by Sens. Alan Cranston (D-Calif.) and Alfonse M. D’Amato (R-N.Y.) and in the House by Rep. Doug Barnard Jr.(D-Ga.). Some council members concede that the idea is too revolutionary for Congress to swallow at once. So they have generally supported reform of Glass-Steagall as a first step.

Robinson contends that the securities industry must be willing to accommodate changes in the restrictions through legislation, rather than have them imposed bit by bit through the courts and regulatory agencies.

But the lobbying has remained so fierce that Garn launched a tirade late last year during hearings on the bill.

“Frankly, ladies and gentlemen, I’m getting sick of all of you,” he said, criticizing the lobbyists for pursuing parochial interests. “The whole game . . . it’s a disgrace. My patience is growing very, very thin. I’m at the point where I don’t care what’s done as long as we do something.”

Perhaps in response to such criticism, the securities industry modified its opposition. John W. Bachmann, chairman of the Securities Industry Assn., told a House subcommittee Feb. 2 that the industry is no longer unified in opposition to reform. But he said the industry would insist that banks’ entry into its business be linked to allowing securities firms to buy banks.

Said Robinson of the securities industry’s softer position: “Some members are out of the foxhole, and some are merely peering over the foxhole. At least that’s progress.”

Bachmann’s insistence on quid pro quo may have support from Garn. A financial industry executive said the Utah Republican told him recently that he no longer supports the Proxmire-Garn bill because it contains nothing for the securities industry.

“He called it a ‘one-way street’ and said he wouldn’t even second it without changes,” the executive recalled.

The incident raises what some lobbyists view as another Proxmire mistake. They say that he failed to consult with other Democrats on the committee to obtain their approval, or at least their opinions, of his legislation.

The result is that Proxmire lacks enough support to gain committee approval of his legislation, and he has twice delayed a vote.

Donald Crawford, chief lobbyist for the securities industry, said, “Proxmire’s bill was DOA,” dead on arrival.

Proxmire has delayed the vote in an attempt to strike bargains for support, which would probably require altering the legislation to accommodate other interests.

Bank lobbyists worry that the changes would constitute “killer amendments,” either allowing securities firms to own banks or further restricting the ability of banks to enter insurance and real estate. They are prepared to walk away from any bill containing those changes.

The situation in the House is even more uncertain. Rep. Fernand J. St Germain (D-R.I.), chairman of the House Banking Committee, has expressed little enthusiasm for expanding bank powers. He is holding hearings on the subject, and many believe that he will draft a bill that adds severe restrictions to any new powers.

The picture is further complicated because House legislation must also go through the Energy and Commerce Committee. Its chairman, Rep. John D. Dingell (D-Mich.), is regarded as a securities industry supporter.

The possibility that the banks will abandon the process was enhanced two weeks ago when a federal appeals court upheld the right of seven banks to underwrite a variety of debt securities. The ruling applies to powers granted last spring by the Federal Reserve Board that pretty much mirror the authority contained in the Proxmire legislation--without the potential restrictions.

The Securities Industry Assn. plans to appeal the ruling to the U.S. Supreme Court, and it is unlikely that the banks could begin acting on the powers until the court decides the case or refuses it.

But if banks smell a killer amendment, they will choose to withdraw support for legislative reform and await a court decision.

Congress was angered last year when the Fed chose to grant new powers to banks under its own interpretation of Glass-Steagall. So the legislators passed a moratorium on expanding bank powers.

The moratorium runs out March 1, and there is little chance that it will be extended. But many lobbyists doubt that the regulators will rush to approve broad new powers for banks.

Most believe that the Fed and the Comptroller of the Currency will proceed slowly, or perhaps not at all, until Congress either approves new legislation or shows itself incapable of reaching a consensus on such a controversial issue.

“There’s probably a 70% chance we’ll have to kill any legislation by walking away,” said a veteran lobbyist for the banking industry.

OPENING THE DOOR: PRO AND CON

Here are some of the arguments for and against allowing banks into the securities business:

Arguments For

Corporations and governments will benefit from lower fees for underwriting bonds as a result of increased competition from banking companies in an area now dominated by a few Wall Street firms.

Customers will have access to a wider ranger of investment opportunities, such as mutual funds, at even small banks. Consumers could also save up to $1,000 on a $100,000 mortgage loan if banks package them into securities for resale.

The stock markets, long dominated by five major investment houses, will become more stable because the number of major participants will increase.

Bank companies will become more profitable overall, with income from more diverse operations and a broader risk base. Banks will regain business from blue chip corporate customers, who have transferred much of their borrowing to the securities markets.

U.S. banking companies will be larger and better able to compete internationally with rivals from other countries with less restrictive laws.

Arguments Against

Banks have a special mandate of trust, and they should not risk the public confidence by participating in speculative ventures, regardless of the safeguards installed to separate affiliates within the bank holding company.

Even if federally insured deposits are not used in speculative ventures, customers might be confused and believe that their investments were insured by the FDIC.

There is no evidence to support the notion that fees will go down in an area because banks get involved. When banks opened discount brokerages, fees did not drop below existing levels.

Banks might link access to credit to buying other services from affiliates, such as requiring big commercial borrowers to use the bank’s securities arm to underwrite the company’s bond issues if they want loans.

Low-income customers might be ignored as banking companies focus on more profitable businesses. Consumer groups already complain that banks ignore poor neighborhoods and want to link expanded bank powers to community investments.