BY NICHOLAS LEMANN
TO A CASUAL READER OF FINANCIAL NEWS, WHAT’S going on in banking today must seem like a series of odd and unconnected upheavals: savings-andloans go broke in Ohio and Maryland, the government virtually takes over Continental Illinois in Chicago, Congress considers closing various arcane loopholes in the banking laws, Argentina can’t pay its debts. But there is a connecting thread. Banking is changing radically after a long period of relative calm; its structure is being altered fundamentally for the first time in fifty years. Almost everyone’s life will be affected a little, and some people ‘s lives will be affected enormously.
From the very beginning of the United States our banking system has been controversial. There were two early problems. First, as a new, rapidly expanding nation, we were prone to an unstable banking system, with frenetic, speculative lending booms followed by bank failures that took people’s life savings. Second, there was, and still is, great hostility between the biggest American banks, in New York and recently also in California, which finance commerce, and the small provincial banks, which are often tied to agriculture. The First and then the Second Bank of the United States were attempts to stabilize banking in a way that also concentrated financial power in a single institution. When Andrew Jackson took the government’s funds out of the Second Bank, in 1833, to the cheers of his agrarian, provincial supporters, he set a different course that would essentially be followed to this day: the government would still act to promote stability, but it would also disperse financial power.
As a result, banking today is the most heavily regulated industry in the country, and one of the most decentralized. All banks are chartered by the federal or a state government, most are inspected by several sets of government examiners, all can be shut down or given orders about important operating procedures. There are three federal agencies primarily concerned with regulating banks: the Office of the Comptroller of the Currency (which regulates national banks), the Federal Reserve Board (which regulates bank holding companies and state banks that are members of the Federal Reserve System), and the Federal Deposit Insurance Corporation (which regulates state banks it insures that are not members of the Fed). And that’s not to mention the fifty state banking agencies, or the federal agencies that regulate the savings-and-loans, which make mostly home-mortgage loans (as opposed to commercial loans—loans to businesses—which is what banks mostly make).
There are about 15,000 banks in this country—at least ten times as many as in any other Western country. Almost all of them are small. The hundred largest bank holding companies—corporations that own banks, usually big ones, and that have not been allowed to own unrelated businesses—control more than half of American banking assets, and the smallest 10,000 banks control only about ten percent. (Of course, in almost any other major industry the hundred biggest businesses control much more than half the assets.) The reason there are so many banks is that the states, with the federal government’s approval, have protected their own banks by not allowing out-of-state banks to come in. Even within states some variant of that principle has often been applied: small rural banks have been protected by restricting big-city banks to operating in one county, one municipality, or even one building. The federal McFadden Act of 1927 in practice banned interstate banking by applying to national banks all the restrictions that the states applied to their banks. In 1956 the Douglas Amendment to the Bank Holding Company Act applied nearly the same restrictions to bank holding companies. (Other corporations can’t own banks.)
The bank failures and other financial horrors of the Depression reinforced the national commitment to a heavily regulated, heavily decentralized system. The Glass-Steagall Act of 1933 added to the McFadden Act’s geographical restriction on national banks a series of restrictions on the services they could offer. Before the Crash, banks had been allowed to underw’rite stock offerings, and one unscrupulous practice, a variety of “self-dealing,” was to lend a flimsy new company enough money to make its prospectus look terrific and then pay back the loans with the proceeds of stock sales made to unsuspecting investors. The GlassSteagall Act separated commerce (such as stock underwriting) from banking, and in effect created the investmentbanking industry.
As the financial world lived under these restrictions for forty years, every group within it, from insurance agents to stock-and-bond salesmen to farm bankers, became a constituency with something to protect. Banking achieved an equilibrium such that any change would offend some powerful interest group. As is usual in such situations, peace among the dukes was achieved at the expense of the unorganized citizenry. The Office of the Comptroller, which grants national bank charters (state banks are chartered by the state banking commissions, though otherwise they differ little from national banks), was stingy with them, approving about half the applications. The tight restrictions on entry into the field protected small bankers from the rigors of unbridled competition, with the result that for years the number of bankers who went broke was negligible. The Fed, through its Regulation Q, restricted the interest rate on bank savings accounts to five and a quarter percent, and federal law prohibited banks from paying interest on demand deposits (checking accounts). Words like prohibit and restrict are misleading about the true nature of Reg. Q, which was a tremendous boon to banks. Their raw material is deposits, and Reg. Q gave it to them at a guaranteed low price.
This system tended to help the rich and the poor and to hurt the middle class. Because banks could acquire their deposit base without having to pay much for it, they could afford to offer uneconomically generous treatment to very small depositors: free checking, many branches, many tellers, no service charges for bounced checks, elaborate monthly statements that included canceled checks. A poor person had at least some access to a banking system that would treat him decently—more than he has today. The rich were able to buy certificates of deposit for $100,000 or more, on which banks were allowed to pay market interest rates (that is, well above five and a quarter percent). Everybody in between was subsidizing the system.
A subtle difference between the past and the present at the great majority of banks—something that can’t be proved, but that people talk about—is that banking was a business run as much to exercise power as to make money. Traditionally a small bank is owned by a family or by a group of families that also ow n the prominent businesses in town. In most places the ability to control credit is extremely important, perhaps even more important than political power; the bank controls the flow of capital, both to the leading local businesses (whose owners are often directors of the bank as well as its biggest customers) and to small and new businesses. In this way the bank’s directors might do better in their other businesses, but it is often also important to them just to be able to run things, whether or not there’s money in it—to be able to decide which businesses prosper and which ones die.
The owners of a small bank don’t always expect high dividends and profits. Small, independent banks tend not, to be aggressive, entrepreneurial lenders; they’re conservative and they keep generous capital reserves. It’s worth remembering that the farmers who are having the most-
publicized loan-repayment problems usually did their risky borrowing from a federal agency (such as the Farmers Home Administration or the Farm Credit Administration), not the kindly local banker. Bank directors and owners — at least 150,000 people—are the clearest beneficiaries of a decentralized banking system, more than small borrowers. In a centralized system they would be less powerful, and their loans might not be processed with the same friendship and respect. These burghers were the most important opponents of the Second Bank in 1833, and they are the most important opponents of the big New York and California banks today.
WHAT DID MORE than anything else to crack the foundation of the old order was the Organization of Petroleum Exporting Countries’ dramatic oil-price increases in 1973 and 1979. When inflation is higher than five and a quarter percent, people with their money deposited in banks at Reg. Q rates are losing money, and they will either stop saving or look for a place that might pay a higher interest rate on deposits. In 1973 several investment firms began offering money-market mutual funds, which were able to pay market-rate interest on deposits by investing them in safe, high-interest federal securities and certificates of deposit (the money-market funds themselves are not insured). In 1977 there was $3.9 billion in money-market funds; in 1979, $45.2 billion; in 1981, $181.9 billion. This money was coming out of banks, and the flow would continue as long as market interest rates stayed high and bank interest rates stayed low. The banks began to worry.
One option for the banks was to try to persuade Congress or the state legislatures to outlaw money-market funds, but after some years of trying they found this political lv impossible—the middle class realized what a raw deal it had been getting before, and would not stand for a return to the status quo ante. The only other choice was for the banks to join the game by raising the interest rates they paid small and middling depositors, and with some reluctance they settled on doing that. Deregulation seemed to be having its moment in every field anyway. In 1980 Congress, with the banks’ consent, passed the Depository Institutions Deregulation and Monetary Control Act, which ordered that Reg. Q be abolished by 1986. In December of 1982 the first major step of the process took effect—banks were allowed to offer money-market deposit accounts, which were federally insured. In 1983 the amount of money in nonbank money-market mutual funds dropped for the first time (from $207 billion to $163 billion), while bank money-market accounts went from zero to $375 billion. By the end of last year there was still nearly $250 billion in non-interest-bearing checking accounts and more than $288 billion in savings accounts—but there was $210 billion in money-market funds, $415 billion in money-market accounts in banks, and $885 billion in certificates of deposit for less than $100,000, which were deregulated in 1983. Price deregulation had suddenly arrived.
A fundamental concept in banking is the “interest-rate spread”—the difference between the price a bank pays its depositors and the price it charges its borrowers. The abolition of Reg. Q was a Pyrrhic victory for banks, because although it stopped the outward flow of deposits, it sharply narrowed the spread. Interest rates on loans had to be high because interest rates on deposits were high. Operations had to be streamlined and unprofitable activities pruned.
Over the course of a generation the biggest banks had formed holding companies and gone public. Now they were majority-owned by Wall Street institutional investors, who raptly watched the banks’ quarterly financial reports. Declines in such numbers as “return on average assets” led quickly to declines in stock prices and to dissatisfaction with management. For small banks the end of Reg. Q meant that they had to think hard about profitability for the first time, both for the sake of staying in business and because small bankers know that if they want to sell, the price they will get is based on the size of their profits, not their assets—and many are expecting to sell within the next ten years, as interstate banking arrives.
The immediate losers from the new emphasis on profitability have been small depositors. Banks now regularly charge them for each check and penalize them when their balances drop below certain minimums. Computerized statements have already replaced canceled checks in many states. Service charges and fees have risen in a dozen categories. Worst of all, many poor people have simply lost their toehold in the banking system. In the inner-cityneighborhoods of cities like New York and Chicago a bank has become a rare sight. Instead there are storefront check-cashing operations that charge at least a dollar—and as much as ten dollars—per check. Many banks have set up special divisions to serve large depositors, leaving the small ones to wait in long, long lines if they want to see a teller.
So far, the rest of the public seems to have done well by interest-rate deregulation. People who can afford to keep $1,000—the legal minimum balance for high-interest accounts—in a bank are now getting a much higher return on their savings than five years ago, with the same federal protection. Borrowers have had to suffer from high interest rates, but banks have been eager to lend because commercial loans are where the profits are. Though it would seem that deregulation, by driving interest rates up, would cause lending to wither, in practice the pressure on banks, especially big banks, has been the other way, toward highrisk, high-return lending. Small entrepreneurs can borrow money, though often at a rate that makes slow, sensible growth difficult. Big corporations, traditionally the best bank customers, had begun before deregulation to turn away from bank debt and toward “commercial paper”—notes their brokerage firms sell to investors—as a source of capital. Also they were abandoning the old gentlemanly banking practice of maintaining interest-free “compensating balances” on deposit at their banks as a condition of their loan agreements. The evaporation of the corporate market was one of several kinds of pressure that made big banks so eager to lend in Argentina and Mexico during the seventies—the loans that have become the foreign-debt crisis of the eighties.
THE BIG BANKS FEEL HEMMED IN. ON THE DEPOSIT side, the money-market funds are going after them and compensating balances are disappearing. On the loan side, it’s commercial paper. Their stockholders want more profits. The banks themselves are large corporations with strong drives to expand. Meanwhile, big national companies outside of banking have been trying to get into the business of financial services—that is, handling consumers’ money, which is what banks used to have almost to themselves.
Sears, Roebuck, one of the most aggressive financialservices companies, has been offering credit, consumer loans (loans to individuals for household purchases), and insurance for years. In 1981 it bought a brokerage firm. Dean Witter Reynolds, and a real-estate firm, Coldwell Banker. These are fields that real banks have traditionally been prohibited from entering. Sears also owns a savingsand-loan in California and a bank in Delaware, through which it is offering a new national credit card—and it would like explicit government permission to enter banking. Merrill Lynch has made clear its desire to enter banking, and it has a state bank charter in New Jersey. Other, hyphenated giants of the financial-services world—Shearson (brokers and underwriters)—American Express (credit cards and cash machines), Prudential (insurance)-Bache (brokers and underwriters)—want to be in banking too. In all, about a dozen securities firms own some bastard form of bank somewhere in the country. Unlike banks, these firms can operate nationwide under their own heavily advertised names—which would give them a tremendous head start on banks if they were allowed truly to get into banking.
All these pressures have led the big banks to put pressure of their own on the McFadden and Glass-Steagall acts. Interstate banking could theoretically get them millions of consumer depositors and commercial borrowers, and being able to enter commerce would bring them new profit-producers like selling insurance and underwriting stocks and bonds. With bank deregulation by price in place, the big banks badly want deregulation by geography and by product — they think that price deregulation has increased their risks, which other kinds of deregulation would spread and reduce.
The biggest of the big banks, and the most aggressive, is Citicorp, whose name is invoked by anti-bigbank interest groups as a synonym for big-bank voraciousness. In attacking the McFadden and Glass-Steagall acts, it has followed a dictum of the Chinese strategist Sun Tzu, hero to the current American militaryreform movement: instead of engaging the enemy in a grand, formal battle on a single front (such as a bill in Congress to repeal the old banking laws), use the swarm technique, gaining ground by creating confusion.
A federal banking law passed by Congress in 1982 contained a provision that bank holding companies could buy failing savings-and-loans. (The savings-and-loan industry, with most of its assets in home-mortgage loans, was devastated by the inflation of the seventies—many savings-andloans are today getting sixand seven-percent fixed-rate returns on their existing loans, while by necessity paying eight percent to depositors for the money to make new loans.) Just before the law was passed, Citicorp bought a failing savings-and-loan in California, which it renamed Citicorp Savings, and began taking deposits in California.
Since then it has added savings-and-loans in Florida and Illinois.
In 1980 Citicorp persuaded economically depressed South Dakota to let it start a bank there and began nationally marketing its MasterCard and Visa cards out of Sioux Falls, where it was free of New York’s ceiling on credit-card interest rates. (Alaska, Maine, Nebraska, and Nevada, among others, also allow out-of-state banks to set up credit-card operations.) This year Citicorp persuaded the Maryland legislature to grant it full banking privileges in return for promising to hire 1,000 people for a new cardprocessing operation in Hagerstown, another depressed area. Citicorp has started selling life insurance in England, and through various legal quirks and loopholes it also has a smattering of insurance operations in the United States.
And there is plenty more demolition of the walls going on. Automatic-teller machines, which dispense cash twenty-four hours a day and can be placed in all sorts of locations other than a bank building, have been allowed to creep across state lines in several places. Though banks can’t open interstate branches, they can set up offices in other states to solicit commercial loans (which are made through the home office) or to process overseas loans, Though these loanproduction offices aren’t a very good way to penetrate new markets, because they lack an imposing presence and an established customer base, a 1982 study by the Federal Reserve Bank of Atlanta found 345 of them in operation across the country. The 1982 law that allowed financial companies to buy failing savings-and-loans in other states also allowed savings-and-loans to engage in commercial lending on a modest scale. BankAmerica Corp., of San Francisco, was allowed to buy Charles Schwab, a discount stock brokerage, and Seafirst, a big, failing bank in Seattle. Several New England states and several southeastern states allow interstate banking, but only among themselves, in arrangements called “regional compacts.” The list of such encroachments goes on and on; overall, it’s an indication that in American banking the old and durable arrangement has been falling apart since the early eighties, in the manner of Europe in the early teens.
THE SARAJEVO IN THIS CASE IS A MINOR INSTITUTION called the nonbank bank. In 1970 Congress amended the Bank Holding Company Act of 1956, which forbade bank holding companies to operate across state lines. Lobbyists for the Boston Safe Deposit and Trust Company were able to add one clause to the amendment’s definition of a bank so that a “bank" became an institution that accepts demand deposits and makes commercial loans (Boston Safe Deposit, which doesn’t make commercial loans, wanted out of regulation by the Fed). Thus a loophole was born: an institution that took deposits but didn’t make commercial loans, or vice versa, was no longer officially a bank and therefore could be owned by an out-of-state bank holding company, or even by a company that wasn’t a bank.
Gulf + Western, the conglomerate, set up the first nonbank bank in 1980, and over the next few years several securities firms, such as Merrill Lynch and Dreyfus, opened nonbank banks as part of their strategy of getting into diversified financial services. The big bank holding companies got the idea of using the loophole as a way into interstate banking. The Federal Reserve Board, which must approve applications by bank holding companies to start nonbank banks, was inclined to block the way, but in March of 1984 it decided that it couldn’t legally turn down the U.S. Trust Company’s application to open a nonbank bank in Palm Beach, Florida. More than 300 applications to start nonbank banks were instantly filed. Most of the nonbank banks would take deposits and would not make commercial loans; none of them would be of any great size. Their importance to their owners was strategic, not financial. But they created a crisis in the parts of the federal government that regulate banking.
To understand what happened next, it is necessary to consider the powerful interests involved, both in business and in government.
There are the big, nationally important banks in New York and California, which have a majority of bank assets but a tiny minority of banks. They are in favor of both kinds of bank deregulation left to come after price deregulation: product deregulation, which will allow them to enter other businesses, and geographic deregulation, which will allow them to go interstate. Many of them were tempted by the nonbank-bank loophole. Organizations like the Association of Reserve City Bankers, the Association of Bank Holding Companies, and, sometimes, the American Bankers Association, represent their interests.
There are big banks in cities of regional but not national importance in banking—Boston, Houston, Pittsburgh, Atlanta, and so on—represented by the Coalition for Regional Banking and Economic Development. They want interstate banking up to a point: the point beyond which the New York and California banks could compete with them. To this end they have invented a concept by which legislation would be passed enabling them to bank with their neighbors and no one else. These regional compacts are established in parts of New England and the South, and are under consideration by state legislatures in the West, the Southwest, and a group of states with Ohio at its center. (This last region is known as the Reality Belt, because of the rigid journalistic convention that all stories about the Real America must be done from there.)
There are the thousands of small banks, represented by the Independent Bankers Association of America. Atavistically fearful of the New York banks, their first priority is to close the nonbank-bank loophole and prevent nationwide interstate banking, in order to preserve their markets. A usually reliable ally of theirs is the Association of State Bank Supervisors, which is worried that the demise of small state-chartered banks would leave its members without anything to supervise. The system by which banks can be either state or federally chartered is called the dual banking system, as in the ringing cry made in speeches at small-bank conventions: We must above all preserve the dual banking system!
There are the money-market funds, represented by the Investment Companies Institute, which want to keep banks from being able to offer no-minimum-balance, unlimited-checking money-market accounts (as banks will be able to do next year); the independent insurance agencies, represented by the American Insurance Association, which want to keep banks from being allowed to sell insurance; and the stock brokerages, represented by the Securities Industry Association, which want to keep banks from being allowed to underwrite stocks. These groups are opposed to product deregulation, because it would open them to direct competition from banks. They don’t much object to nonbank banks except insofar as nonbank banking might begin a rush to deregulate products along with geography.
And then there are the government organizations concerned with banking, which view each other just as suspiciously.
The Comptroller of the Currency is a political appointee who reports to the secretary of the Treasury. President Jimmy Carter’s comptroller, John Heimann, changed the office’s national bank-chartering policy so that it began to approve more than 90 percent of applicants in order to promote competition. President Reagan’s first comptroller, C. Todd Conover, was the great government champion of nonbank banks until he resigned, in May, saying that he had become fed up with the impossibility of getting anything done in Washington. He was not a Wall Street pro like Heimann but a California consultant and a free-market conservative. The independent banks resented Conover, because of their feelings about nonbank banks, and often called for his resignation. The Fed didn’t like him much either, because he was for a less tightly regulated banking system. A theory about Conover popular in independent banking circles was that he was a pawn of Donald Regan, the former Treasury secretary, who in turn was a pawn of his old company, Merrill Lynch, which wants to get into interstate banking and wreak havoc on the small banks. The acting comptroller is H. Joe Selby, a career bureaucrat.
The Federal Reserve is a classic regulatory agency that believes in regulation as a noble cause and that, being relatively immune from politics, hasn’t been affected by the anti-regulatory spirit of the times. It wants to keep its strong power over bank holding companies (for reasons of bank safety and as a way of controlling the money supply) and to keep out of banking new players over whom it doesn’t have power. Thus the Fed is unsympathetic to nonbank banks’ entering into banking, because they are kinds of institutions that it doesn’t regulate, but it isn’t especially hostile to interstate banking, through which the turf of the banks owned by holding companies, and hence of the Fed, could only expand.
The Reagan White House plays almost no visible role in banking issues (though in this year’s State of the Union message there was a brief, vague reference to continued deregulation of the financial system), except in one minor respect.
There is a Task Group on Regulation of Financial Services, chaired by Vice President Bush and run by Richard Breeden, a former Wall Street lawyer. It wants to consolidate bank regulation under the Fed and a new Federal Banking Agency, which would essentially be the Comptroller with many new powers. Under the Task Group’s initial plans, the Fed would have become much less important, because the Federal Banking Agency would have had regulatory power over the big national bank holding companies. But when Paul Volcker, the chairman of the Federal Reserve’s board of governors, got wind of this, last year, he was able to use his influence to change it: the Task Group revised its recommendations in favor of allowing the Fed to keep regulating the largest bank holding companies. Conover looked on helplessly as the prospect of control over a third of the bank assets in the country slipped away from his agency. The recommendations are nowhere near being enacted or even considered by Congress.
The Senate Committee on Banking, Housing and Urban Affairs is headed by Jake Garn, of Utah, a Republican who came to the Senate on one of the early waves of seventies conservatism. Garn is a former insurance agent, but he tends to be sympathetic to the big boys in deregulation—both the largest banks, which want to expand their reach, and the Fed, which wants to regulate them as they do so.
The House Committee on Banking, Finance, and Urban Affairs is a stronghold of small-bank populism. It was chaired for eleven years by the late Wright Patman, of Texas, who as a very junior congressman in 1932 proposed the impeachment of Andrew Mellon, the secretary of the Treasury and an embodiment of eastern money power. Its current chairman is Fernand St Germain, of Rhode Island, an old-fashioned liberal Democrat, first elected in 1960, who is hard to figure out—he is autocratic and unpredictable, and though he frequently delivers emotional diatribes against deregulation, he has pushed several important deregulation bills through the House.
In the spring of 1984 one of the few issues that Garn and St Germain agreed about was the nonbankbank loophole, which they were both against; it therefore appeared that the loophole would quickly be closed. Garn put together a comprehensive deregulation bill that closed the loophole and also gave banks the power to begin underwriting and selling some securities, though not corporate stocks and bonds. Through the spring and summer he kept a fragile peace among the interest groups—only the Securities Industry Association was strongly against the bill—and nurtured the bill until it finally came to the floor in September. It passed the Senate by a vote of 89 to 5.
But St Germain didn’t like it. He wanted to close the nonbank-bank loophole, period, and he was unalterably opposed to granting new securities powers to banks at the same time. He dropped the banking bill he had proposed. In October the Ninety-eighth Congress adjourned. Conover, who had stopped approving nonbank-bank applications on the assumption that Congress would pass a bill before it adjourned, began approving them again. The day Congress convened this year, St Germain introduced a simple loophole-closing bill, which during the winter and spring moved at a stately pace through his committee.
Garn’s attention during the winter and spring was on his trip aboard the space shuttle, not banking deregulation.
But the action continued, in the federal courts. In March a Florida district court, ruling on a lawsuit by the Independent Bankers Association of America, issued a preliminary injunction to prevent Conover from granting any more nonbank-bank charters. The Fed, having approved twenty-two nonbank-bank applications in the year since its U.S. Trust decision, announced with pleasure that it would stop processing them pending the outcome of the Florida case. (In May a federal circuit court decided that U.S. Trust didn’t have the right to open a nonbank bank in Florida after all, putting in jeopardy the twentytwo other nonbank banks whose applications the Fed had approved.) In April the Supreme Court agreed to hear a suit involving the Fed and a Kansas company that had applied to open thirty-one nonbank banks, which would be immune to regulation by the Fed because they wouldn’t be part of a bank holding company. In June the Court unanimously ruled against a challenge by Citicorp to the constitutionality of the New England regional compact—a tremendous victory for the big regional banks, which will expand aggressively within their territories.
Typically in banking the world changes and the government rushes to catch up with it, in order to be able to continue to exercise control. This has become true of interstate banking during the past year of the government’s arguing about nonbank banks. Somehow, everyone now regards interstate banking as inevitable. The clearest sign of this came when Paul Volcker, testifying before St Germain’s committee late in April, endorsed nationwide interstate banking, to be phased in after three years of existing and planned regional compacts. Even the regional banks see the regional compacts as a temporary phase, though three years is much too temporary for them.
TO THOSE NOT IN THE FINANCIAL BUSINESS OR IN financial regulation, what difference will deregulation make? Arguments about the public interest in banking come mostly from the self-interested, so they deserve not to be taken at face value. But here are the worries: Deregulation will make the banking system less stable, with potentially disastrous results for small depositors and for the world economy. Deregulation, and especially interstate banking, will cause whole industries and areas of the country to lose the ability to borrow money, and hence they will wither and die. Product deregulation will lead to corrupt, incestuous dealings by banks which will hurt consumers. Deregulation will hurt poor people. Deregulation will lead to excessive concentration of financial power, and in turn to predatory pricing and many other ills.
Of these, by far the most serious problem would be instability, and there seems to be strong evidence that it already exists. The Federal Deposit Insurance Corporation was founded in 1933. Through 1980 it processed $9 billion worth of bank failures; from 1981 through 1984 it processed $30 billion worth, which doesn’t count Continental Illinois, with its $40 billion in assets, because it wasn’t allowed to fail. In 1981 ten banks failed; in 1984 seventynine failed; the FDIC expects the number this year to be even higher. It makes intuitive sense that deregulation brings higher risk to any industry. From almost the moment the 1980 deregulation bill passed, the rate of bank failure began to zoom far beyond what it had been at any time since the Depression. What more dramatic proof could anyone want that deregulation is damaging the stability of the banking system?
Bank stability is an odd issue. No big bank keeps much more than a twentieth of its deposits on the premises in cash; there is no bank that could not be badly hurt by a run on its deposits, though any solvent bank could survive one. The system depends on confidence, so a lack of confidence in itself can cause instability. Thus bank regulators both don’t believe that deregulation is responsible for the rash of bank failures and would be loath to say so if they did believe it, because for the government to send out signals that the whole banking system had become unstable would be inherently destabilizing. The alternative explanation for the bank failures is that they were caused by an extraordinary set of circumstances in the economy. The recession of 1981-1982 brought the highest rate of business failure we have seen since the Depression. The farm crisis devastated the agricultural banks, by leaving them with virtually no good loan customers. The Fed’s tightening of the money supply, beginning in 1979, made inflation low but interest rates high, which lessened the economic attractiveness of borrowing money and so depressed loan demand. Just one factor—the giddy boom and bust in oil prices from 1979 to 1982—was responsible for virtually all of the most famous bank problems of the past few years: Penn Square; Seafirst and Continental Illinois (both dragged down by bad loans they had bought from Penn Square); and, in 1983, First National Bank of Midland, in Texas—the second largest U.S. bank failure. (The largest was Franklin National Bank of New York, in 1974.)
What can’t be denied, though, is that interest-rate deregulation, by cutting the banks’ spreads, put pressure on banks to lend as much money at as high a rate as possible. In that situation bad loans are chickens coming home to roost. Savings-and-loans, which can’t make many commercial loans, have run into trouble with high-flying investments made for the same reason—the need to restore the spread. It’s impossible to spend any time as a reporter around the banking world without hearing rumors that several very big New York banks are teetering on the brink. There’s a secret list of eight banks, the story goes, that the Fed is keeping alive by secretly channeling funds to them, or a secret list of eleven banks that the Comptroller won’t let die. Last year the Comptroller filed an official proceeding to force the Bank of America—the second-largest bank in the country—to increase its capital reserves as a precaution against loans going bad. That nationwide disaster hasn’t struck yet shows that the rumors aren’t true, or that we’ve been lucky, or that the regulators and examiners are doing a wonderful job.
Because of deposit insurance, unless there is an utter collapse of the banking system these are the problems of bankers and bank stockholders, not depositors. It is extremely unlikely that bank failures today could bring thirties-styfe losses of life’s savings to individuals; the FDIC insures deposits of up to $100,000, and its de facto policy is to cover larger ones, too. The big problem in deposit insurance is the Federal Savings and Loan Insurance Corporation, which experts think is sure to go bankrupt over the next few years and will need some sort of federal bailout. (The FDIC wants to solve the FSLIC’s problems by taking it over.)
The fear that big national banks will drain capital from regions is a venerable one—it’s the policy argument, if not the real reason, underlying the long history of laws against interstate banking. The idea is that Citicorp would soak up all the deposits in Nebraska by offering enticing interest rates and then lend them out in New York or even Argentina, leaving small-business borrowers in Nebraska to go broke. Many Americans resent New York and believe that it’s too powerful to begin with, so this argument strikes an emotional chord. But it’s very difficult to substantiate. The big New York banks were allowed to branch upstate in the seventies, but they weren’t able to make significant inroads on the banks already there. California, which has a long tradition of statewide branch banking, vigorously continues to generate new banks. If an area is truly a poor loan risk, then the local banks are not likely to plunge in with loans that Citicorp would be afraid of; typically, because of high reserve requirements and small bankers’ predilections, independent banks lend out much less of their deposits than huge banks lend of theirs.
There is some basis for saying that the small banker’s vaunted loyalty to his community is best seen in the loans he makes to his board members—they’re the people who really would get a worse deal from Citicorp. The FDIC says that at nearly half of the failed banks of the eighties there have been insider loans that went bad. Even Texas Commerce Bancshares of Houston, probably the most widely respected of the big regional banks and a strong advocate of regional compacts, announced earlier this year that its profits were down because a big loan to one of its directors had gone sour. Anyway, it is possible to guard against capital drain by legislating against it, rather than by banning interstate banking. Most interstate-banking proposals contain a requirement for making some proportion of loans in the places where money has been deposited.
The problem of what is called self-dealing by banks is the strongest argument against allowing them to diversify into other financial services. At worst, banks would unload worthless stock on consumers, as they did in the twenties. Or a bank diversified into financial services might require a customer to buy from its line of collision insurance before it would approve a car loan. Sears inspires the most elaborate fears: Representative Timothy Wirth, of Colorado, at a hearing last year imagined Sears selling a customer who came into the store to buy a hammer a house and a mortgage before he could get out the door, and a stock portfolio later. But Sears, as part of its bid to be allowed into banking, has proposed strict rules against the tying together of its financial services. There is legitimate cause for concern, especially regarding banks’selling insurance, but again, better safeguards can probably be created through legislation and regulation that would prohibit the tying of one bank service to another than through the elaborate partitioning of the financial-services industry that prevails today. Those who disagree most vehemently with that are the people w-ho rule the parts.
The detrimental effects of deregulation on the poor aren’t conjecture, they’re demonstrated fact—a matter that’s a secondary issue in the politics of banking only because it offends no powerful interest group. A study last year by the Comptroller of the Currency showed that banks’ total service charges on deposits more than doubled between 1978 and 1982 (the figure went from $2 billion to $4.6 billion). These charges encompass everything from monthly fees to big bounced-check charges to per-use charges at automatic-teller machines and even to fees charged to retirees for cashing their Social Security checks. Big depositors are largely immune.
The problem of service charges could be handled through requirements that fees be disclosed when customers open accounts and legal exemptions for certain income groups from certain fees—a series of reforms that usually go under the name of “lifeline” banking. The Consumer Federation of America, in Washington, and the state banking commissioners of New York and Massachusetts have been pushing these reforms, and Representative Cardiss Collins, of the West Side ghetto in Chicago, has proposed a lifeline-banking bill. But the issue is always the first to be put off for another day by legislators and lobbyists.
Reg. Q was one solution to all these problems. St Germain sometimes speaks about it nostalgically, though he helped kill it, and the few genuine banking populists who remain, including Representative Byron Dorgan. of North Dakota, openly long for a return to Reg. Q. That is inconceivable now. Whether the excesses of deregulated banking can be effectively curbed through legislation will be a good test of who’s right in the battle between traditional liberals and neo-liberals. The traditional New Deal liberal position is that in order to protect a noble social goal it is necessary to build a politically powerful constituency for it. Social Security recipients must be kept happy in order to protect welfare recipients; in banking it is worth giving thousands of rich small-town bankers government price controls (by means of Reg. Q) if this will protect the poor. The bankers give money to their congressmen, the congressmen protect Reg. Q, and the poor are helped. The new generation of liberals is impatient with such elaborate arrangements—they’re inefficient, they favor certain groups, they stifle the market’s creativity—and it wants to help the poor just by making excessive charges illegal and to forget about the thousands of small-town bankers. Ah, the traditional liberals would say, but then the efforts to help the poor will always be subverted, because they lack a constituency. We’ll soon see who is right.
Concentration of power is the vaguest of the putative dangers of bank deregulation—the objections to it are based on principle more than on specific bad effects it might have. The path to concentration would probably be mergers rather than all-out war between the big and the small banks. In the seventies a few states—for example, New York and Texas—let their big-city banks operate statewide. The banks found that starting branches or new banks as a way of entering new markets didn’t work well, and that buying banks in new territory was a much better way to acquire depositors and borrowers. Because the big-city banks paid generous premiums for local-bank stock that had previously had limited market value, the financial enticement for the local banks’ shareholders to sell was irresistible.
It is probable that the same thing would happen nationally, at a pace made frenzied by the merger professionals on Wall Street. The scenario runs like this: During the heyday of regional compacts, which is just beginning, Atlanta’s banks will buy up Birmingham’s, and Dallas’s will buy up Tulsa’s, just as Boston’s banks have been buying up Hartford’s. Then, in a few more years, the barriers to nationwide interstate banking will begin to come down, and there will be another wave of mergers, this time with Citicorp and Bank of America moving into Denver and St. Louis and Chicago. Though most of the interstate-banking proposals allow individual states or even regions not to participate, in practice it will be very difficult for anyone to resist once it becomes clear what a killing bank shareholders can make.
The system that emerges wall not be truly centralized banking (in all of Canada there are only seventy-one banks). Citicorp doesn’t want to own 4,000 rural banks. But it will be significantly less decentralized than banking is today. If you live in a city or a suburb, this is one change in banking law whose effects will be instantly visible as you drive down a major thoroughfare, or watch television, or read your newspaper. For most people, it will make life more convenient.
But another effect of a concentrated financial system is something that isn’t visible. Local banks are the seat of authority for a significant group that might be called the local big-shot class. Its members are lawyers, auto dealers, furniture-store owners, doctors, and hundreds of thousands of others—people who are important in the place where they live but who are not part of the fabric of national institutions like corporations, the government, unions, and universities. In almost any place but a metropolis the bank is the symbol of the order by which these people live. They are engaged in small-scale commerce, which depends on credit, which the bank controls. That’s why the banker in a town is the person most likely to know about, and to influence, everything that’s going on in it. It is a mistake to think that if 10,000 small banks matter less, no one will care but 10,000 small bankers, many of whom will have the proceeds of a sale to console them. Their loss of influence wall affect the whole local system, to which the bank is like the sun fixed in the sky. The accountants who do the bank’s and its allies’ books, the agents who write its insurance, the feedlots that live on its loans, and all of their employees—together they form an extensive matrix of acquaintance and outlook that doesn’t matter to bank holding companies. The local big-shot class has been declining in power for two generations, as the national institutions have grown. Interstate banking will be its latest step down. □