Congress Wary of White House Plan for Banks

The nation’s banking system may be in the midst of its biggest crisis since the Great Depression, but the odds are that Washington won’t do much about it this year.

Apart from some stop-gap measures to ensure that the federal fund protecting bank deposits doesn’t go broke, Congress seems bent on postponing major banking reform until another day.

But the White House doesn’t think the banking crisis will go away quite so easily. And so the Bush Administration will be pushing hard this spring for its sweeping reform package that would tear down 50-year-old legal barriers that have limited the scope of traditional banks and made it impossible for them to compete in a wide array of modern financial markets.

“We have stopped banks from going to the next generation of services, because we have a set of archaic laws that look back to the 1920s and 1930s,” Treasury Secretary Nicholas F. Brady insists.

Yet Congress, still smarting from the hail of criticism it received for its handling of the savings and loan debacle, is clearly reluctant to take on another big headache in yet another financial industry gone sour. Many congressional leaders believe that the Bush plan to give banks more freedom sounds suspiciously similar to the disastrous campaign in the early 1980s to deregulate the S&Ls.;

“We will have to move cautiously to avoid mistakes that could prove very costly,” warns Senate Banking Committee Chairman Donald W. Riegle Jr. (D-Mich.). “And we need to make sure we have reformed the deposit insurance system and the supervisory system in ways that guarantee new powers do not mean new risk to the taxpayers.”

Expanding Services

To rescue the industry, the Bush Administration proposes a dramatic restructuring of the banking industry designed to let the banks grow their way out of their troubles.

Banks would be permitted to move across state lines and open new branches without restrictions, and enter fully into the businesses of trading and underwriting stocks and bonds, and selling and writing insurance.

Big industrial companies such as IBM and DuPont would also be permitted to buy banks.

The White House also wants to reform the deposit insurance system that backs the deposits of bank customers up to $100,000 per account, while providing more money to keep the fund that backs deposits solvent.

In addition, the Bush plan would streamline the federal regulatory process, reducing the number of agencies involved in bank examinations, but would also give regulators new authority to intervene earlier when banks appear to be getting into trouble.

However, the banking industry itself is increasingly divided over banking reform, reducing the effectiveness of the industry’s lobbying campaign as the banking package moves through Congress.

Bigger banks, notably some of the most powerful international institutions in New York and Los Angeles, want an unfettered hand to move across state lines, and also to market insurance and securities.

But community bankers, representing the vast majority of the nation’s 12,000 commercial banks, don’t want their turf invaded by outsiders from the big cities.

So a cautious Congress is likely to confine its efforts this year to the rescue of the federal insurance fund for bank deposits, which is virtually exhausted, and to the creation of an early warning system to prevent a future wave of bank failures.

“I think we’re looking at a core package this year, something for Congress to say we’ve improved the system this year and made the system safer,” notes Alfred A. Pollard, Washington lobbyist for Los Angeles-based Security Pacific Corp.

“What we ought to do is pass sweeping reform that allows the selling of different products by banks, but Congress is likely to take a go-slow attitude,” says Joseph Belew, president of the Consumer Bankers Assn.

Fears of Bailout

Clearly the most pressing issue, government officials and industry lobbyists agree, is the refinancing of the depleted insurance fund, which is run by the Federal Deposit Insurance Corp. and protects deposits up to $100,000.

The banking industry and federal regulators insist the fund can be bolstered by additional premium payments from the banks themselves, without resorting to a painful taxpayer bailout.

But Congress is fearful that a taxpayer bailout is becoming ever more likely; that’s a key reason congressional leaders believe this isn’t the time to deregulate the banking industry.

Their fears were heightened in March when Federal Deposit Insurance Corp. Chairman L. William Seidman revealed that the deposit insurance system may need as much as $70 billion in new resources and borrowing authority from the government--including both the U.S. Treasury and the Federal Reserve--to avoid becoming insolvent.

And if the FDIC can’t repay the loans from those government agencies from insurance premiums paid by commercial banks, the taxpayers will be on the hook.

Because millions of Americans depend on the government to protect their savings, Congress must act on this issue, even if it does nothing else about the banking industry this year.

“The major thing that Congress has interest in dealing with is recapitalizing the insurance fund,” says Sam Leamon, a banking specialist with Washington Analysis Corp., a consulting firm owned by County/National Westminster Bank.

Yet Seidman’s new $70-billion plan represents a dramatic increase over his earlier proposals. And it marked a big step away from his firm pledges, made earlier this year, that the FDIC wouldn’t have to turn to the government for help, and would need only $10 billion in additional help from the banking industry to keep the deposit fund afloat.

Now, Seidman’s plan to give the FDIC a line of credit at the Federal Reserve and the Treasury is prompting an outcry from critics in Congress and elsewhere who charge that the proposal represents an attempt to go through the back door to give the banking industry a hidden taxpayer bailout.

“There is great reluctance to admit that taxpayer funds will be required . . . it may be politically convenient to avoid the appearance that public funds will have to be tapped,” complains Lee Hoskins, the president of the Federal Reserve Bank of Cleveland and an opponent of the plan to tap the Fed. “But this will be costly because it will delay recognition of the problem and, as the thrift crisis taught us, allow the problem to worsen,” he says.

Combined with the insurance fund’s rescue, the Bush Administration and Congress largely agree on the need to reform the way that Washington guarantees bank deposits.

“People in Congress want to feel like they are not pouring money down the drain, so they will want some deposit insurance reform to come with the recapitalization of the fund,” noted one senior Senate staffer familiar with banking issues.

The Administration plan would limit deposit insurance to $100,000 per person per bank, plus another $100,000 per person per bank for retirement savings. However, individuals would still not be limited in the number of insured accounts they had, as long as they were held in separate banks. The plan would replace a system which insures an unlimited number of accounts per bank.

Some congressional leaders are upset with the Administration for not taking more aggressive steps to reduce the burden on the fund for protecting deposits in failed banks beyond the $100,000 legal limit. This is the controversial doctrine known as “too big to fail.” It has given banking regulators wide latitude to extend federal insurance coverage to all of the deposits in a failed bank--even those that exceed the $100,000 insurance limit--when the regulators believe that doing less would lead to a panic among depositors and a disruption to the nation’s financial system.

The frequent use of the policy when a big bank gets in trouble has cost the insurance fund billions of dollars in losses.

Riegle and others in Congress want to impose a complete ban on the use of “too big to fail,” while the Bush Administration wants to restrict its use to special occasions with the top regulators deciding when a bailout is needed.

But critics point to the decision to protect depositors with more than $100,000 at risk in the collapse of the Bank of New England in January as a sign that the Administration is not serious about getting rid of “too big to fail.”

“I think the Treasury plan is not a big enough step to solve the problem,” says Allen Meltzer, an economist at Carnegie Mellon University in Pittsburgh, Pa.

As a result, the debate between the Administration and Congress over “too big to fail” could become the most rancorous aspect of the banking battle this year.

Separately, both the Administration and Congress agree that some new guidelines should be established to allow government regulators to intervene and take action earlier when it appears that a bank is in trouble.

Such early intervention, coupled with a streamlined structure that would consolidate bank regulatory authority at the Fed and the Treasury, would be designed to head off the need for a government bailout by helping to keep a bank from collapsing.

Michigan’s Riegle wants to install a “trip-wire” to alert regulators, depositors and shareholders to problems in a given bank while there is still time to fix them. “It would end the incentive that rewards excessive risk-taking,” he says.

But prospects are highly uncertain this year in Congress for anything beyond fixing the fund and tightening regulations.

Security Pacific’s Pollard says anything else should be viewed as an “add-on,” with uncertain chances of passage. “Interstate branching has the highest possibility among the add-ons,” he says.

Interstate Banking

Already, most states allow some form of interstate banking, and most major banks now have cross-state affiliations. Both congressional leaders and banking industry executives say a move by Washington to repeal all the remaining restrictions would complete the process.

“I think interstate banking is going to be on the table this year,” says Ken Guenther, executive director of the Independent Bankers Assn., a Washington-based trade group.

The major political opposition to full interstate branching comes from small rural banks--which fear they may be overrun by their big city rivals--and from state banking regulators, who fear a loss of control over banks in their jurisdictions.

The banking industry itself also is divided over the desirability of selling and underwriting insurance and securities.

While the provisions to allow banks to expand into securities are supported by the major international banks, many regional banks, which are now in better financial shape than the big New York institutions, have not been willing to push for them. Instead, the regional banks are putting all their weight behind the drive for interstate banking and reform of the deposit insurance fund.

“We do not want to underwrite securities or sell insurance, or provide mutual funds,” says Thomas Jeffs, vice chairman of National Bank of Detroit, one of the strongest regional banks in the nation. “The New York money center banks want different things than the strong regionals do.”

The politically potent insurance industry also stands ready to fight any significant expansion of bank powers. “We were frankly surprised by how far the Administration went in understanding some of our issues,” says Paul A. Equale, senior vice president for government affairs at the Independent Insurance Agents of America, with 220,000 members.

“While we have no great love for a comprehensive bill, we will not oppose the bill as a whole,” he says. “But as it moves through Congress we will educate, beat up and let Congress know what we want.”

The insurance industry “will take rifle shots at insurance aspects, not take a shotgun to kill the whole bill,” according to Equale. “There will be a tremendous uphill battle for the plan to get through this year. They really do have their work cut out for them.”

The bankers realize the effort to get new powers is a struggle. The insurance and securities industries will offer “a few critical amendments likely to giveth with one hand and taketh away with a much larger hand,” says Security Pacific’s Pollard. In other words, if the banks appear to be winning, the insurance and securities people will rush in with amendments to block them and to roll back the limited rights banks already have in these areas.

Plan Unlikely to Die

Despite the pessimistic prospects, the Administration is determined to persist, and will be back again next year seeking the expanded powers if this year’s effort, as expected, falls short.

However, economist Herbert Stein argues that the White House is going in the wrong direction--that the government should reduce, rather than broaden bank powers. Banks should be kept from using federal deposit insurance to enter risky businesses, he contends. Instead, other financial institutions, such as consumer loan and mortgage companies, mutual funds, and brokerage firms can supply the cash and savings needs of individuals and corporations without any government guarantees.

“If these other institutions are going to provide these services, I say we should let them do it,” says Stein, the chief presidential economic adviser during the Richard M. Nixon Administration.

Stein’s views are provocative, but even many of those who disagree with them acknowledge that the banking industry is too bloated.

After all, there are now about as many bank branches in America as gas stations.

OVERHAULING THE NATION’S BANKING SYSTEM

President Bush has unveiled a sweeping new banking reform plan that would tear down the 50-year-old legal barriers that have limited the scope of traditional banks and would make it possible for them to compete in a wide array of modern financial markets.

Here are the major elements of that package: * Complete the move begun by states to allow banks to open branches in more than one state. The measure would eliminate all existing restrictions on interstate banking.

* Repeal the Depression-era laws that currently prohibit mergers and cross-ownership between commercial banks and industrial corporations, such as General Motors or General Electric, in an effort to help bring new capital to banks. Many of these industrial firms provide financial services themselves.

* Allow banks to sell and underwrite securities and insurance. They currently are prohibited from that by the Glass-Steagall Act.

* Strengthen the federal deposit insurance system by limiting the amount that the government will guarantee for any one person to $100,000 in deposits in one account per bank, plus another $100,000 coverage in retirement for each person per bank. Currently, there are no such restrictions.

* Replenish the federal deposit insurance fund with an infusion of $70 billion in new resources--partly through a controversial plan to borrow $25 billion from the Federal Reserve, which the banking industry eventually would repay through higher insurance premiums.

* Streamline the federal bank regulatory process by consolidating the current authority to examine and regulate banks into the Treasury and the Federal Reserve, eliminating the role of the Comptroller of the Currency.

* Give regulators the power to intervene and take control of banks earlier than they may under current law--in time to keep the institutions from failing and becoming a burden on taxpayers.