Believe It Not, Bank Reform May Happen

It’s understandable that Americans sometimes see Washington as a taxpayer-financed fantasyland.

Take last week, when the Bush Administration sent to Congress a 316-page package of proposed laws on banking reform that Treasury Secretary Nicholas F. Brady called “an enormously high priority.”

Most people know that matters are urgent. Regulators expect 180 more banks to fail this year. The Federal Deposit Insurance fund has dwindled alarmingly and will need $10 billion in new funds this year plus perhaps $30 billion more in the next three years, according to FDIC Chairman L. William Seidman.


Yet Washington’s immediate response to bank reform was scorn. One group denounced the Treasury proposals as bad for “Main Street America.” Others predicted that nothing would come of them. The system would limp on, and Washington would preserve its image of expensive inertia: Congress costs taxpayers more than $700 million a year in salaries and expenses, and the Executive Office of the President costs tens of millions more.

But don’t be misled. In its own way, the system is working in Washington and may very well produce substantial bank reforms by year-end. However, to understand that you have to appreciate how Washington works.

It works by politics and compromise and bargaining among interest groups, especially when confronted with sweeping, comprehensive legislation such as the bank reform package. Then a great number of interests are affected. And Washington is the town where everybody’s interests come together.

There are 12,696 banks in the United States and more than a dozen banking organizations lobbying in Washington. And that’s not counting groups such as the American Assn. of Retired Persons, which wants to make sure deposit insurance isn’t trifled with because many elderly Americans have their life savings in banks.

Call that lobbying or call it democracy. “This government doesn’t govern; it resolves disputes among interests,” Seidman says. “Therefore, there is a huge amount of bargaining and compromising going on at all times--which is the only way you could ever run a country like this.”

So, if you want an inkling of what’s coming on bank reform, think politics as much as economics. Right now, Congress fears, as does the public, that bank troubles could become another savings and loan debacle. The first order of business will be to reduce the risk.

Under the Treasury proposals sent to Congress on Wednesday, as well as other bills put forward in Congress, steps would be taken to restrict deposit insurance for the first time in almost 60 years. Insurance would be banned for deposits of most institutional and pension fund investors and for multiple accounts at the same bank. The thinking is that by covering multiple bank accounts at $100,000 each, when average family savings are only $8,000, deposit insurance has departed from its original purpose of protecting small savers.

Congress is also more than ready to beef up the insurance fund. And Congress wants the banks to build up their equity capital--from less than 5% of assets to 8% or more--so they will be less vulnerable to collapse from a loan loss or two.

But here’s the trick. Congress doesn’t want bank reform costs to hit the taxpayers. Rather, it wants banks to pay higher insurance premiums to fund FDIC and to earn more profits to build up capital.

That means that Washington will have to help banks make that profit and come up with that insurance money--while encouraging banks to continue lending to small business. Proposals to allow interstate branches will have appeal because they would slash costs for many banks that now operate separately incorporated offices in several states.

If banks are well capitalized, they may be allowed to get into other businesses. Banks could set up money funds, for example, paying higher rates on uninsured deposits. Insured deposits would earn lower interest rates--you want safety, you pay for it.

And, banks might well be able to provide insurance at lower rates than the insurance companies now do. Competition generally lowers prices.

Ironically, many of today’s hot ideas on bank reform reflect the thinking of Amadeo Peter Giannini, founder of Bank of America, whose nationwide expansion was stopped cold years ago by a political knockout in Washington.

Giannini was to banking what Joe Montana is to football and Michael Jordan to basketball: a natural. He started his bank in 1904 in San Francisco, lending to Italian fishermen who wanted to buy their fishing boats. Established banks saw the fishermen as poor credit risks, but Giannini saw prime customers--hard-working people in business for themselves. Giannini’s bank flourished.

He had other good ideas. He reached across the nation, setting up branches in numerous states and formed Transamerica Corp. to run the branches and to go into other business such as insurance. Giannini saw it as spreading his risk and increasing his opportunity. Competitors saw it as invasion.

So the competitors went to Washington, lobbied Congress and the Federal Reserve and stopped Giannini’s interstate march. Although President Roosevelt thought that interstate banking was a good idea, deposit insurance--with strong support for local banks--was the principal salvation of the banking system in the 1930s.

That was then; this is now. Banking is in crisis again, and reforms being pushed in Washington this year reflect a lot of Giannini’s thinking. As a result, the banking system could be changed significantly.

And again, that depends on politics. Major reforms will win, say Washington experts, only if President Bush gets involved in pushing them. If he doesn’t, legislation will get chewed up by special interests.

In other words, the system will get done what we really want done. It’s politics--and business--as usual in Washington.