Viewpoints : Insurance Reform Just Tip of Banking Iceberg

Deposit insurance reform has become a big issue as Congress searches for solutions to the savings and loan crisis and addresses concerns about the financial strength of our nation’s banks. But it would be a mistake to deal with deposit insurance and ignore other fundamental issues.

Here are three simple ideas we ought to keep in mind:

* We need to resist the temptation, as understandable as it may be, to go for the quick fix. It won’t work and most likely will result in even higher costs and higher risks down the road.

We should address not only the condition of our insurance fund but a lot of other pressures that have built up over the past two decades as our financial markets have undergone a jarring transformation. This, to me, calls for a comprehensive plan, one that addresses not only the symptoms but the underlying causes as well.

In this regard, it is useful to note that during the past 12 years we have seen no fewer than eight landmark financial reform acts passed into law. We had two major banking bills in 1978, one in 1980, two more in 1982, one in 1983, another in 1987 and, finally, last year’s Financial Institutions Reform, Recovery and Enforcement Act.

Despite this prodigious range of legislative attention, pressures at the core remain. This is because all the legislation taken together has still not addressed the fundamental structural weaknesses in the system.

The weaknesses stem from the unnatural separation of the securities business from banking under the Glass-Steagall Act. And they arise from the Douglas Amendment and the McFadden Act, which have blocked the emergence of truly national banks that are scaled to the size and diversity of the U.S. economy.

* Second, and along much the same lines, we should work hard to prevent the S&L; crisis from placing on the back burner once again the very pressing challenge of broad and comprehensive structural reform.

As Federal Deposit Insurance Corp. Chairman L. William Seidman noted in recent testimony before the Senate Banking Committee, the S&L; crisis is “a financial disaster of major proportions.” But, as he also pointed out, “the S&L; crisis and the difficulties facing the banking industry should not be confused.”

I heartily agree. Vastly different issues brought on the thrift crisis. A different earnings dynamic. An obsolete concentration on housing finance. Capital standards that were practically non-existent. Extremely permissive accounting standards. Inadequate limits on loans to a single borrower. Very relaxed regulatory supervision.

My concern is that the thrift crisis provides an all too convenient rationale for standing still in terms of broad reform and opting instead for something quick and immediate. That might be fun, but it wouldn’t be constructive.

* Third, we need to do something meaningful about the concept of Too Big to Fail. The costs of continuing this policy are too high. So are the risks.

In this regard, I support an American Bankers Assn. proposal that would provide full deposit insurance coverage for accounts up to $100,000, with higher amounts handled by a rolling scale based on historic recovery rates.

That said, however, I hope that in the United States we can also begin addressing the issue not only in terms of Too Big to Fail but in terms of Too Strong to Fail. We need banks that are large enough, diverse enough and strong enough so that their soundness isn’t an issue.

We need to create an environment in this country that will improve bank profitability, attract new capital, allow for a greater diversification of risk and facilitate orderly and efficient consolidation within the banking industry.

Ron Chernow, author of “The House of Morgan,” recently wrote an op-ed piece in the Wall Street Journal that made a pertinent and provocative point:

“For 20 years now, our commercial banks have courted disaster. Unless we assume that all commercial bankers are dunces, we must suspect some deep, systemic flaw behind this flirtation with danger.”

The title of the essay expresses succinctly the spirit I’ve been trying to convey: “Don’t Punish the Banks, Liberate Them.”

These thoughts add up to a single overriding recommendation: namely, that we not view the issue of deposit insurance reform in isolation.

We need to address the total challenge. We need to link the insurance issue with the equally pressing need to fundamentally reform our entire financial structure.

Unlike in other countries, the very structure of the U.S. banking system does not provide sufficient opportunities for an individual institution to diversify its risks geographically.

One result is that in the past few years we watched as nine of the 10 largest banks in Texas went through some form of supervisory action. A regional economic downturn quickly became a banking disaster.

I can tell you from my experience with it that the one large Texas bank that was acquired without official involvement was in trouble for one reason and one reason alone: It was locked in Texas.

Even if we had a deposit insurance system that imposed market discipline, how could we expect people in that state to impose it when they and their banks are geographically captive? What were their alternatives, other than outside the banking system?

The same thing happened in the Farm Belt, and the same thing is happening in New England.

Our banks are equally stymied when it comes to trying to diversify our sources of revenue. We are inhibited in attempting to follow our corporate clients’ shifting financing patterns into the primary capital market, and we are kept from meeting the full rational array of consumer banking needs.

With this erosion in the value of a commercial banking franchise, how can we expect the banking industry to attract the risk capital so necessary for a sound and stable system? Capital, it is useful to note, imposes the greatest market discipline, and, once obtained, presents the primary protection for depositors as well as the FDIC fund.

Moreover, the discipline of capital has been strengthened by the Basel Accord, the product of multilateral cooperation that could form the model for developing international standards with respect to deposit insurance.

But capital cannot be forced into the banking business; it must be attracted in. More formulas and more speeches about capital only frighten the market and make investors run for cover.

What is needed in this country is a financial structure that will allow banks to diversify risks, serve their customers better and lower their costs by being able to consolidate into larger companies. When banks can do that, capital will be attracted into the industry and our financial system will be truly safe and sound.

In conclusion, I see deposit insurance reform as part of a far larger set of challenges. Perhaps FDIC chief Seidman said it best recently in testimony before the House when he referred to “the structural obstacles to the maintenance of a healthy banking system.”

“To be effective,” he said, “deposit insurance reform must embrace these structural problems. Deposit insurance reforms that do not deal with the structural problems will produce few lasting improvements in the deposit insurance system and will not materially reduce the ultimate exposure of the taxpayer to difficulties among banks and thrifts. The purpose of deposit insurance reform should not be to hold together an antiquated banking industry.”