Task Force on Regulatory Reform of the Banking law Committee of the American Bar Association. Banking Law Committee Fall Meeting November 2009

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1 Task Force on Regulatory Reform of the Banking law Committee of the American Bar Association Banking Law Committee Fall Meeting November 2009 Materials 1 1. Historic Background a. History and Background of Previous Regulatory Reform and Restructuring Proposals b. Appendix A: Timeline of Regulatory Reform Proposals c. Appendix B: Academic and Scholarly Resources 2. Causes and Circumstances a. The Financial Crisis Of : Causes And Contributing Circumstances b. Background Papers 3. Report on the Financial Crisis of : Recommendations a. Adopted Recommendations b. Recommendations Currently under Task Force Consideration c. Supporting Papers d. Suggested Recommendations Not Yet Adopted 1 These materials are as of October 5, 2009, and are to be used for information purposes only. They have not been approved by the American Bar Association, its Presidential Task Force on Financial Markets Regulatory Reform, or any section or committee of the American Bar Association, including the Business Law Section and the Banking Law Committee.

2 ABA Banking Law Committee Financial Restructuring Task Force GROUP 1: HISTORY AND BACKGROUND OF PREVIOUS REGULATORY REFORM AND RESTRUCTURING PROPOSALS DRAFT as of 7/29/09 This paper was developed by members of the Banking Law Committee s Task Force on Regulatory Reform in their individual capacities and is to be used for information purposes only. The discussion and analysis has not been approved by the American Bar Association, its Presidential Task Force on Financial Markets Regulatory Reform, or any section or committee of the American Bar Association, including the Business Law Section and the Banking Law Committee. Volunteer Members: Maureen A. Young, Chair Michelle Allred Patrick S. Antrim Ken Ehrlich Gregg Killoren Edward McAniff Patrick Murphy Westbrook Murphy Diana Preston Janet Zimmer I. Overview of Previous Regulatory Reform Proposals This Group 1 Report (or the Report ) is intended to provide an overview of the regulatory reform and restructuring models which have been proposed for the U.S. financial services system in previous years, as well as a brief look at other countries models for financial services regulation. The Group 1 Report does not attempt to evaluate or examine in depth the previous proposals or make recommendations for reform of the current U.S. financial services system based on a historical perspective (see, however, the recommendations in the Group 4 Report). An effort was made to summarize the key regulatory reform models proposed for the U.S. financial services system in prior years, but the summaries are by no means comprehensive or based on original or well-documented research; we relied on available secondary sources. Some prior proposals may not have been captured in this Report. The parts of this Report were written by different A/

3 DRAFT 7/29/09 drafters; limited effort was made to conform the writing style or approach of the respective drafters. The intention, however, is that the survey approach of this Report could provide the ABA Banking Law Committee Restructuring Task Force with some, albeit incomplete, historical background for evaluating the current proposals for U.S. regulatory reform. This Report is intended to support the work of the members of the Task Force in identifying causes and contributing factors of the current financial crisis, tracking and analyzing the maze of financial reform legislative proposals, and especially, developing recommendations for specific financial reform proposals. Many of the issues and concepts for regulatory reform being currently discussed by the Obama Administration, Congressional members, regulators, academics, industry analysts and others were considered in previous years. Outlined below are some of the key themes in regulatory reform which have been recently debated: A. Key Issues and Concepts in Regulatory Reform 1. Systemic or Prudential Regulation a. Should firms that could pose a systemic threat to the financial system be subject to different regulatory requirements than other firms? b. If so, what would be the standard(s) for determining which firms could pose a systemic threat (i.e., too big to fail)? c. Should all such firms be regulated the same? Or should they be subject to prudential regulation that is tailored to the individual institution? If there was prudential regulation, would there be oversight to ensure overall regulatory consistency? d. Would such firms have different government protections and/or access to government funding on favorable terms? e. Is a more stable and effective financial services system achieved through a deregulatory v. more highly regulated approach to financial services regulation? How much trust should the system place on market forces correcting risky behaviors? f. Should regulated entities pay fees/assessments to cover the full costs of maintaining their regulatory agencies, or should some or all of the regulatory costs be borne by the federal government? Should the A/

4 DRAFT 7/29/09 assessments be risk-based, with institutions and firms engaged in riskier practices assessed higher fees? 2. Unified Federal Regulator, Functional Regulation, and Agency Consolidation a. Should there be one overall federal regulator responsible for regulating all financial services firms? Or should functional regulation be preserved so that specialized regulators have primary supervisory responsibility depending on the type of business activity conducted? b. If there were one federal regulator for all financial services firms, which government agency should that be? Can a systemic risk consolidated regulator also be responsible for monetary policy, or are there inherent conflicts between those roles? c. If there were one overall federal regulator, would there be a role preserved for specialized functional regulators? If there were functional regulators, how would responsibility be divided? How would the different regulators share information, coordinate activity, and make decisions? Would preserving specialized regulators better enable the regulators to oversee more complex firms and transactions? Or would it lead to regulatory arbitrage? Do multiple competing regulatory entities produce more effective, responsive regulatory regimes or just competition in laxity? Is there value to having the depository institution regulated by a separate agency from the agency which regulates its holding company? d. If a role is preserved for specialized functional regulators, should some agencies be consolidated? If so, which ones? (E.g., OTS into OCC and/or SEC into CFTC) A/

5 DRAFT 7/29/09 e. Can the regulatory agencies serve both as safety and soundness regulators and as consumer protection agencies, or would the regulatory oversight be more effective if these roles were separated? f. Current federal regulatory oversight responsibilities: Federal Reserve System bank holding companies and state member banks Office of the Comptroller of the Currency national banks Office of Thrift Supervision savings and loan institutions and holding companies Federal Housing Finance Agency i. Savings associations, commercial banks, savings institutions, credit unions, insurance companies, and other institutions that make long-term home mortgage loans ii. iii. Fannie Mae and Freddie Mac Federal Home Loan Bank System National Credit Union Administration federal credit unions Federal Deposit Insurance Corporation insures banks and thrifts, primary federal regulator of state chartered non-member banks Securities and Exchange Commission broker-dealers, investment advisers, mutual funds, independent investment banks, self-regulatory organizations, transfer agents, clearing agencies, nationally recognized statistical rating organizations, securities exchanges, and alternative trading systems Securities Investor Protection Corporation insuring brokerdealers Commodity Futures Trading Commission -- futures commission merchants, commodity trading advisers, A/

6 DRAFT 7/29/09 introducing brokers, commodity pool operators, commodity clearing organizations, and futures markets Municipal Securities Rulemaking Board promulgates rules for dealers in municipal securities, including securities firms and banks Federal Trade Commission, U.S. Department of Justice, other agencies -- pursuing consumer protection and law enforcement objectives 3. Role of Federal and State Supervision a. Whither the dual banking system? Should banks still have the right to be state chartered? Does the dual banking system facilitate states roles as laboratories of experimentation and change, or just regulatory arbitrage, resulting in competition in laxity? If state chartered banks continue, should the state banks be able to choose to be members or non-members of the Federal Reserve System (national banks must be member banks)? Should state supervision be more limited? b. Should federal regulation preempt all comparable state regulation (field preemption) or just conflicting or inconsistent state regulation? Should consistent state regulation which exceeds the federal standards by being more protective of consumer interests be permitted? c. Should state branching restrictions apply to federally chartered institutions with offices with the state? Is it necessary or desirable to retain interstate banking and branching restrictions? d. Should existing state securities regulatory authority be changed, eliminated, or strengthened? If so, how? (e.g., National Securities Markets Improvement Act of 1996) e. Should there be a federal insurance industry regulator? If so, should state supervision be maintained on a more limited basis? f. Current state regulatory oversight responsibilities: State Banking Regulators A/

7 DRAFT 7/29/09 i. State chartered institutions, including commercial banks, trust companies, savings banks, savings and loan associations, and credit unions ii. Licensed lenders, mortgage bankers and brokers, small loan companies, check cashers, money transmitters and other money service businesses, and sales finance and premium finance companies iii. Foreign bank representative offices, branches, and agencies State Securities Regulators securities broker-dealers and investment advisers State Insurance Regulators insurance companies and licensed individuals involved in the insurance business State law enforcement entities, such as the Attorney Generals offices 4. Role of Self Regulatory Organizations a. Current self-regulatory oversight responsibilities: Financial Industry Regulatory Authority securities firms, registered securities representatives, and certain securities exchanges (NASDAQ Stock Market, American Stock Exchange, International Securities Exchange, and Chicago Climate Exchange) Other Securities Self-Regulatory Organizations e.g., Chicago Board of Options Exchange and Chicago Board of Trade National Futures Association firms or individuals that conduct futures trading business with public customers b. Should existing self-regulatory authority be changed, eliminated, or strengthened? If so, how? 5. Regulatory Gaps a. Should the following activities or firms be regulated? A/

8 DRAFT 7/29/09 Over-the-counter derivatives? Credit default swaps? Hedge funds? Mortgage brokers? b. Should the following firms be more robustly regulated: Credit rating agencies? Independent investment banks? Money market funds? Nonbank mortgage lenders? c. If so, which federal and/or state agencies should regulate each of these activities or firms? d. How should any newly regulated activities or firms be regulated? (E.g., licensing/registration, disclosure, recordkeeping, margin, net capital/reserve requirements, etc.) 6. Weak Financial Institutions a. Should there be stronger government authority to intervene if a financial institution and/or financial company of systemic risk importance is in danger of becoming insolvent? Should some institutions and companies be treated as too big to fail? Would a broader too big to fail approach pervert salutary market incentives? b. Which agency or agencies would be empowered to intervene? c. Under what circumstances would the government be allowed or required to intervene? d. Should any authority be limited to firms that could pose a systemic threat? e. Should any government intervention be limited to minimizing impact on the financial system as a whole or should it focus on other goals, too A/

9 DRAFT 7/29/09 (e.g., minimizing cost to taxpayers, preventing greater economic ripple effects, mitigating impacts on non-u.s. financial systems)? f. Should potential government intervention be limited to putting firms into conservatorship/receivership or should it also include financial assistance or other forms of intervention (e.g., purchasing assets)? g. Should this authority be in addition to or in place of the current authority granted to the Federal Deposit Insurance Corporation and the Securities Investor Protection Corporation? h. Do the regulatory authorities have the risk assessment tools they need to understand the potential losses which given sets of activities by banks and companies may pose on themselves and the financial system? Notably, what measures are in place for determining adequate cushions of capital? The foregoing topics are only some of the issues and concerns which have been raised in recent regulatory reform debates. It is a rare Congress or year when restructuring, usually in the form of consolidation, has not been proposed. As you will see, the current regulatory structure for banking in the United States represents an amalgamation of responses to a long history of financial crises and political events, as opposed to a master plan for the future of the banking system. Although there have been many episodes in U.S. regulatory reform movements, we have organized the historic discussion in this Report into periods, largely tracking changes in Presidential administrations and issuances of Presidential reports, covering the following periods: 1930s Through the Carter Administration The Reagan/Bush Years and the 1984 Bush Blueprint for Reform The Clinton Era and Bentsen Testimony, LaWare Proposal and Regulatory Reform and Structure under GLBA The George W. Bush Years, including the Financial Services Roundtable and 2008 Paulson Blueprints A Comparative Look at Non-U.S. Bank Regulatory Reform and Bank Structures A/

10 DRAFT 7/29/09 The Current 2009 Proposals -- Group of Thirty, GAO Reports, EU Recommendations and the Obama Administration Plan We have purposely emphasized the more modern proposals because their recommendations have the most usefulness for considering the reform alternatives being currently debated on Capitol Hill. II. 1930s Through The Carter Administration Apart from the financial climate of , the Great Depression of the 1930s saw the most drastic financial decline in U.S. history. By 1932, one in four banks in the United States had failed. 1 Bank failures accelerated after the stock market crash of 1929 and continued until 1933, as the public lost confidence in banks. It was posited that the 1929 collapse of the stock market was, at least in part, attributable to the incompetence of the Federal Reserve Board (the Federal Reserve ) in not acting to limit speculative activity by commercial banks. 2 In an effort to understand the underlying causes of the depression, President Franklin D. Roosevelt commissioned economists at the Brookings Institution to undertake a large scale study of federal bureaucracy. Among the recommendations was one to reorganize the bank regulatory structure. The study recommended that the Federal Deposit Insurance Corporation (the FDIC ) become the principal federal bank regulator, the abolishment of the Office of the Comptroller of the Currency (the OCC ), and that the Federal Reserve s examination and supervisory responsibilities for state banks be transferred to the FDIC. In 1947, President Harry S. Truman appointed the Hoover Commission, officially named the Commission on Organization of the Executive Branch of Government, to recommend administrative changes in the Federal Government. In 1949, three Hoover Commission task forces recommended the centralization of federal bank regulatory authority. One task force proposed the transfer of the FDIC to the Federal Reserve, the second recommended the transfer of the OCC to the Federal Reserve, and the third wanted to fold both the FDIC and the OCC into the Federal Reserve. The Commission itself opted for a fourth approach, 1 The Bubble Burst, Life, Spring 1992, at 26 (collector s edition). 2 J. Galbraith, The Great Crash 1929, at (1961). A/

11 DRAFT 7/29/09 recommending that the FDIC be transferred to the United States Treasury Department (the Treasury Department ). In 1961, the Commission on Money and Credit, which undertook the first extensive investigation into the U.S. monetary system since the Aldrich Commission of , recommended that the functions of the OCC be transferred to the Federal Reserve. Then, in 1962, in opposition to the recommendation of the Commission on Money and Credit, the Advisory Committee on Banking to the Comptroller of the Currency ( Comptroller s Committee ) proposed eliminating the Federal Reserve s bank supervisory role. Under the Comptroller Committee s proposal, all supervisory authority relating to national banks would have been carried out by the OCC and supervisory authority relating to state banks would have been exercised by the FDIC under the arm of the Treasury Department. The proposal also recommended that the authority of the Federal Reserve Board and the FDIC to regulate branches of state banks be moved to the respective state bank supervisory agencies. The Comptroller Committee further suggested that authority over the formation and expansion of bank holding companies be transferred from the Federal Reserve Board to the OCC, and that the Federal Reserve Board s authority to set margin requirements and deposit interest rates be transferred to the Secretary of the Treasury. In another proposal to bring regulatory bodies under the arm of the Treasury Department, in 1965 the House Banking Committee Chairman Wright Patman proposed consolidating all federal bank regulation, including deposit insurance functions, in the Treasury Department. This proposal took the name of the Patman Bill, H.R Then, in 1971, President Nixon convened the Hunt Commission, formally known as the Presidential Commission on Financial Structure and Regulation, to formulate recommendations to improve the functioning of the private financial system. 3 The intermediate objective of the Hunt Commission was to move as far as possible toward freedom of financial markets and equip all institutions with the powers necessary to compete in such markets. 4 Although the Commission was created in large part as a response to political frustration with the performance of the financial system, the Commission recognized that most of the problems of the financial system in the United States are the result of legislation enacted in 3 The Report of the President s Commission on Financial Structure & Regulation (December 1971), p Id. at 9. A/

12 DRAFT 7/29/09 response to financial crises, such as that of the 1930s. 5 The Hunt Commission went the opposite direction of the previous proposals recommending that all agencies be merged into the Federal Reserve and proposed that the Federal Reserve be taken out of bank regulation and supervision altogether. The Commission recommended the establishment of three new independent agencies. The Commission proposed that the OCC be converted into an Office of the National Bank Administrator, which would act as an independent agency separate from the Treasury Department. 6 The proposed Administrator of State Banks would have assumed the supervisory functions of the FDIC and the Federal Reserve, and the Federal Deposit Guarantee Administration would have consolidated the FDIC, the former Federal Savings and Loan Insurance Corporation ( FSLIC ), and the credit union insurance agency into one regulatory body. Not surprisingly, the Federal Reserve did not agree with some of the recommendations of the Hunt Commission. In response to these proposals, the Federal Reserve asserted that because it is the central bank of the United States, it must be closely involved in the processes of bank regulation and supervision. In testimony before the House of Representatives, Federal Reserve Board Chairman Arthur F. Burns argued that if the Federal Reserve played no part in the processes of bank regulation and supervision, there would be a danger that monetary policies and regulatory policies would not be sufficiently aligned and separating the two functions would weaken effectiveness. 7 The Hunt Commission was actually a little ahead of its time, as the structure it proposed forms what much of the industrialized world has followed since -- namely, removing regulatory and supervision powers from the central bank and allowing the central bank to concentrate on central-bank issues like monetary policy. In 1975, the Senate Banking Committee commissioned a series of papers on issues of structural reform from non-governmental experts. As part of what was titled Compendium of Major Issues in Bank Regulation, several papers recommended that the FDIC become the primary federal bank supervisor, primarily because the deposit insurer was viewed as having ultimate responsibility for all bank supervisory activities. The papers further recommended the creation 5 The Hunt Commission Report - An Economic View, Clifton B. Luttrell, Assistant Vice President, Federal Reserve Bank of St. Louis, Remarks to the Management Group of the Federal Reserve Bank of St. Louis (Apr. 14, 1972). 6 Kushmeider, Rose Marie, The U.S. Federal Financial Regulatory System: Restructuring Federal Bank Regulation, at 7 Statement by Arthur F. Burns, Chairman, Board of Governors of the Federal Reserve System before the Subcommittee on Financial Institutions Supervision, Regulation and Insurance Committee on Banking, Currency and Housing, House of Representatives (Jan. 21, 1976). A/

13 DRAFT 7/29/09 of a Federal Banking Commission, which would be responsible for all regulatory and supervisory activities and contain a separate division to carry out insurance procedures. This proposal reflected the customary arguments of efficiency and consistency, but was also a response to the concern of lax supervision under the existing supervisory arrangement. 8 During the preceding year, two of the largest banks in the United States - Franklin National Bank and U.S. National Bank of San Diego - had failed. 9 In testimony before Congress in 1975, FDIC Chairman Frank Wille proposed the creation of a five-member Federal Banking Board to administer the deposit insurance system. In the Willie Proposal, Chairman Willie also called for a Federal Supervisor of State Banks to assume the combined supervisory functions of the FDIC and the Federal Reserve vis-à-vis state banks. 10 In 1975, the House Banking Committee held a series of hearings on regulatory structure. The product of the hearings was a four-volume work titled Financial Institutions and the Nation s Economy Discussion Principles (the FINE study ). The FINE study was the first to recommend that all of the federal banking and thrift industry regulatory bodies be consolidated into a single new agency. 11 The FINE study recommended the establishment of a Federal Depository Institutions Commission to administer all supervisory functions of the FDIC, the Federal Reserve, the OCC, the former Federal Home Loan Bank Board (the FHLBB ), and the NCUA. Insurance functions would be handled by a subsidiary agency within the commission. An alternative to the FINE study, which involved functional realignment of existing agencies, was also proposed. Under this proposal, the Comptroller would be responsible for optimizing individual bank performance and defining permissible activities for banks; the FDIC would be in charge of the safety and soundness of banks and have sole authority to conduct bank examinations and declare banks insolvent; and the Federal Reserve System would maintain the competitive structure of the banking system and would have jurisdiction over mergers. 12 This latter proposal was intended to avoid concentration of power and assure that conflicts among goals intrinsic to different functions would be debated openly, with Congress as the final arbiter. 8 Carron, Andrew S., Banking on Change: The Reorganization of Financial Regulation, The Brookings Review, at (Spring 1984). 9 Id. 10 Kushmeider, supra, at Appendix. 11 Id. 12 Id. A/

14 DRAFT 7/29/09 In 1977, the Senate Governmental Affairs Committee proposed the consolidation of the commercial bank regulatory agencies into a single agency. The recommendation was driven by a desire to eliminate the perceived inconsistencies among the OCC, the Federal Reserve and the FDIC concerning bank merger and bank holding company regulation. The Consolidated Banking Regulation Act of 1979 would have merged supervisory functions into a fivemember Federal Bank Commission. III. The Reagan/Bush Years and the 1984 Bush Blueprint for Reform A. Background The central theme of bank regulatory reforms in the early 1980s was deregulation. The Depository Institutions Deregulation and Monetary Control Act of 1980, 13 among other reforms, phased out deposit interest rate ceilings to address the problem of disintermediation and expanded the powers of thrift institutions. 14 The Garn-St Germain Depository Institutions Act of 1982, 15 among other reforms, authorized depository institutions to offer money market deposit accounts to further combat disintermediation, expanded the power of thrift institutions to make commercial loans, eliminated statutory restrictions on real estate lending by national banks, and loosened per-borrower lending limits. 16 In this context, the Task Group on Regulation of Financial Services ( Task Group ) was formed in December 1982 to comprehensively review the federal financial services regulatory system and propose legislation to improve it. The Task Group was chaired by then Vice President George H. W. Bush, with then Secretary of the Treasury Donald T. Regan as Vice Chairman Pub. L. No , 94 Stat An Examination of the Banking Crises of the 1980s and Early 1990s (FDIC 1997) ( Examination of the Banking Crises ) Pub. L. No , 96 Stat Examination of the Banking Crises at The Task Group s other members included the Attorney General, the Director of the Office of Management and Budget, the Assistant to the President for Policy Development, the Chairman of the Council of Economic Advisors, the Chairmen of the Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Federal Home Loan Bank Board, Securities and Exchange Commission, Commodity Futures Trading Commission and National Credit Union Administration, and the Comptroller of the Currency. Richard C. Breeden, then Deputy Counsel to the Vice President, was Staff Director for the Task Group. A/

15 DRAFT 7/29/09 B Task Group Report System a Product of Piecemeal Steps The Report of the Task Group issued in 1984 ( Task Group Report ) concluded that the financial services regulatory regime in the United States was in need of significant reform. In contrast to a carefully planned system crafted through a single piece of comprehensive legislation, the financial services regulatory regime in the U.S. evolved over a long period of time in a series of piecemeal steps responding to various specific problems. 18 In some cases, this evolution resulted in the creation of new agencies, while in other cases it resulted in expansion of the responsibilities of an existing agency. As a result, the regulatory structure can really only be explained as a result of its evolution, and the system has never been comprehensively overhauled to ensure that the various constituent parts work both coherently and efficiently. 19 Differential Treatment and Lack of Coordination Among Federal Agencies The report noted that differences in approach among regulatory agencies with common or overlapping jurisdiction caused financial services companies to comply with conflicting governmental policies or obtain multiple approvals from different agencies for the same transaction. Differential regulation resulted in inequitable treatment of firms competing in the same market, as well as in differing levels of protection of the public. 20 For example, the Task Group Report concluded that it is fundamentally unfair to banks to permit community groups or competitors to protest the opening of a new bank office, a bank merger or a new type of holding company activity, while securities firms, insurance companies and other direct bank competitors were immune from any such proceedings. 21 On the other hand, permitting banks or thrifts to offer securities for sale to the public without registration with the SEC under the securities laws, as required 18 Blueprint for Reform: The Report of the Task Group on Regulation of Financial Services (July 2, 1984) ( Task Group Report ) Id. 20 Task Group Report at Id. A/

16 DRAFT 7/29/09 for other types of issuing companies, might result in unfair treatment of the unsuspecting investor not aware of this potential gap in regulatory protection. 22 At the same time, the allocation of regulatory responsibilities required that multiple agencies cooperate when addressing various issues. Problems of failing institutions, the supervision of bank holding companies and their subsidiaries, mergers and acquisitions, efforts to develop inter-agency uniformity in examinations and the deregulation of interest rate controls were all cited in the report as cases in point. 23 Problems of inter-agency coordination delayed resolution of issues, imposing costs on the institutions involved and their customers or undermining confidence in the system. The current division of supervision for banks and their holding company affiliates between two separate agencies may result in inadequate coordination in supervisory cases, as well as a certain degree of duplication in regulatory effort. 24 Benefits of the Dual Banking System The Task Group Report noted that the States chartered banks and thrifts before the national government did. 25 Except for limited periods, the federal government did not begin chartering banks until the formation of the OCC as part of the Treasury Department under President Lincoln. Even after creation of a federal chartering authority, however, the States continued their role in tandem with the new federal chartering authority. 26 The existence of this dual federal and state system for chartering, regulating and supervising depository institutions has provided a safety valve against out-dated or inflexible regulatory controls being imposed by either federal or state authorities. 27 Acting as laboratories for change, the States have frequently developed new forms of financial services, which then spread nationally through federal action Id. 23 Task Group Report at Id. 25 Task Group Report at Id. 27 Id. 28 Id. A/

17 DRAFT 7/29/09 The Task Group Report noted, for example, that the States originated checking accounts and branch banking. 29 The States also began chartering credit unions and invented the NOW account. 30 In all of these cases, Congress subsequently implemented these programs on a national basis, although without the prior experience of the States to rely on Congress might never have acted, or at least not for several additional years. 31 Because it has served the financial needs of the nation so well over time, state participation in the chartering and regulation of financial institutions can genuinely be regarded as one of the finest examples of cooperative federalism in the nation s history, the Task Group Report concluded. 32 Because the balance of state and federal regulatory participation helps promote the public interest in a safe and competitive financial system, the dual system of chartering financial institutions should be maintained and strengthened wherever possible. 33 Task Group Report Recommendations One of the key components of the Task Group Report s recommendations was a proposal to eliminate the FDIC s role in regulating, supervising and examining state chartered non-member banks. 34 The Task Group Report recommended that a new Federal Banking Agency be created within the Treasury Department, incorporating and upgrading the OCC. 35 This new agency would regulate all national banks while the Federal Reserve would be responsible for federal regulation of all state-chartered banks. 36 The Task Group Report recommended that the regulation of bank holding companies be substantially revised. Under the proposal, the agency that regulated a bank would, in general, also regulate and supervise its parent holding company. This would make it possible for most banking organizations to have a single federal regulator instead of two Id. 30 Id. 31 Id. at Id. at Id. (emphasis supplied). 34 See also text accompanying Note 47, infra. 35 Task Group Report at Id. 37 Id. A/

18 DRAFT 7/29/09 The Task Group Report recommended that the Federal Reserve transfer its authority to establish the permissible activities of bank holding companies to the new Federal Banking Agency, with the Federal Reserve retaining a limited veto right over new activities. The Federal Reserve would continue to supervise the holding companies of very large domestic banks, as well as those with significant international activities and foreign-owned institutions. 38 The FDIC, with no further role regulating, supervising and examining state chartered non-member banks, would be refocused exclusively on providing deposit insurance and administering the deposit insurance system. 39 All of the FDIC s responsibilities for environmental, consumer, antitrust and other areas of law not directly related to the solvency of insured banks would be transferred to other agencies, as would responsibilities for routine examination, supervision and regulation of state chartered non-member banks. 40 The Task Group Report recommended that the FDIC be given new authority to review the issuance of insurance to all institutions, examine all troubled institutions, review healthy institutions in coordination with the institutions primary regulators, and take enforcement action in response to violations of federal law involving unsafe banking practices at any bank where the primary regulator failed to take action after a request by the FDIC. 41 Consistent with the Task Group Report s conclusion that the dual system of chartering financial institutions should be maintained and strengthened wherever possible, 42 the Report recommended that the current federal supervision of many state-chartered banks and thrifts and their holding companies be transferred to state regulatory agencies, creating new incentives for states to assume a stronger role in supervision. 43 Other recommendations included proposals to require the FDIC and the FSLIC to establish common minimum capital requirements and accounting standards for insurance purposes, treat institutions as thrifts only if they actually compete as thrifts regardless of whether they are chartered as thrifts, and combine 38 Task Group Report at Id.; see also text accompanying Note 22, supra, and text accompanying Note 47, infra. 40 Id. 41 Id. 42 Task Group Report at Task Group Report at 12. A/

19 DRAFT 7/29/09 authority over antitrust and securities matters into a single agency rather than five different agencies. 44 C. Modernizing the Financial System: 1991 Treasury Report The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ( FIRREA ), 45 among other provisions, directed the Treasury Department to conduct a study of federal deposit insurance and related issues in consultation with the OCC, the Federal Reserve, the OTS, the FDIC, the NCUA, and the Office of Management and Budget. The Council of Economic Advisors and the Office of Policy Development within the Executive Office of the President also participated. The 1991 report, entitled Modernizing the Financial System: Recommendations for Safer, More Competitive Banks (the 1991 Treasury Report ), recommended four fundamental reforms. First, to increase bank competitiveness, the 1991 Treasury Report recommended nationwide banking, new financial activities, and commercial ownership of banking organizations. 46 Second, to reduce taxpayer exposure and address the loss of market discipline, the proposal recommended curtailing the over-expanded scope of deposit insurance, strengthening the role of capital, and assessing risk-based premiums. 47 Third, the report recommended that the fragmented regulatory system be streamlined. 48 Finally, the report recommended using industry funds to recapitalize the Bank Insurance Fund administered by the FDIC. 49 Nationwide banking and branching would make banks safer through diversification and more efficient through substantially reduced operating costs. 50 At the same time, banking organizations must also be allowed to use their 44 Id. 45 Pub. L , 103 Stat Modernizing the Financial System: Recommendations for Safer, More Competitive Banks (U.S. Dept. of the Treasury 1991), reprinted in (CCH) Fed. Banking L. Rpt. No. 1377, Pt II, 10 (Feb. 14, 1991) ( 1991 Treasury Report ). 47 Id. 48 Id. 49 Id. 50 Id. A/

20 DRAFT 7/29/09 expertise to participate in the full range of financial services but to do so outside the bank and outside the federal safety net. 51 The report stated that while appropriate safety and soundness limitations will be needed, the taxpayer can no longer afford the artificial restrictions that constrain a bank s ability to make maximum use of its resources and expertise in serving customers. 52 The report recommended allowing financial and commercial firms to affiliate with banks to create a strong, diversified financial services system that can compete head-to-head with diversified financial firms around the world. 53 The 1991 Treasury Report recommended fewer agencies and fewer sources of rulemaking, which would eliminate the overlap and duplication of activities among the several agencies, enhancing operating efficiencies as a result. 54 Repeating themes of the 1984 Task Group Report, the 1991 Treasury Report noted that depository institutions should not, in general, need to satisfy different sets of rules. 55 Taking aim at the FDIC, the 1991 Treasury Report noted that there is an inherent conflict in having a single regulatory agency simultaneously promote and protect an industry. 56 The regulator or supervisor is, in general, often receptive to innovation for the institutions it oversees. Even though new powers and activities could entail risk, they might well allow the institutions to better adapt over the long run to evolving demands for financial services. 57 On the other hand, the insurer has an immediate goal of ensuring a high level of solvency of the insurance fund, and minimizing bank failures. As a result, the regulator that is also an insurer would be expected to have internal conflicts because new powers and activities, despite their promise, could cause an increase in calls on the insurance fund. 58 Like the 1984 Task Group Report, the report 51 Id. (emphasis in original). 52 Id. 53 Id Treasury Report, Discussion Chapter XIX, p. XIX Id Treasury Report, Discussion Chapter XIX, p. XIX Id. 58 Id. A/

21 DRAFT 7/29/09 recommended separating the regulation and supervision functions from the insurance function in order to eliminate the conflict of interest. 59 IV. The Clinton Era and Bentsen Testimony, LaWare Proposal and Regulatory Reform and Structure under GLBA On March 7, 1994, Senator Riegle introduced S. 1895, 103rd Congress, 2nd session (the Bill ) which set forth the Clinton Administration proposal with respect to reorganizing bank regulation in the United States. The Bill established a Federal Banking Commission (the FBC ) to which would be transferred the powers and duties of the Office of the Comptroller of the Currency and of the Office of Thrift Supervision. Some reasonable period after the transfer, those bureaus of the Treasury would be abolished. In addition, there would be transferred to the FBC the functions of the Federal Deposit Insurance Corporation (the FDIC ) relating to the supervision and regulation of State nonmember banks and insured branches. All functions relating to deposit insurance, conservatorship, or receivership would remain with the FDIC. Finally, there would be transferred to the FBC all functions of the Federal Reserve relating to the supervision and regulation of... (i) National member banks and State member banks, (ii) bank holding companies and their affiliates... (iii) foreign bank branches, agencies and representative offices... (v) Edge Act companies and (vi) companies subject to Federal Reserve supervision under any title of the Consumer Protection Act or any other consumer protection act. No function relating to monetary policy and open market operations, administration of the payment system, and discount window operations would be transferred. The proposal, then was to establish a single Federal regulator for banks and thrifts and their affiliates including bank holding companies. As explained below, the Bill contained significant exceptions to this straightforward proposal. From that, one might gather that the structure of the Bill reflected a contentious political process. This is explicable in light of the fact that Senator Riegle and Senator D Amato had introduced in November 1993 a bill which outlined the basic intent of the Administration Proposal. A similar bill was introduced in the House by Representative Gonzalez, who was at that time the Chairman of the House Banking Commitee. Negotiations between the Treasury and the Federal Reserve ensued. 59 Id.; see also text accompanying Note 22, supra. A/

22 DRAFT 7/29/09 On January 4, 1994, Governor LaWare published in the American Banker a Federal Reserve counterproposal (the LaWare Proposal ). With respect to rulemaking and supervision, the Federal Reserve would have authority with respect to bank holding companies, foreign banks and all State banks, while the FBC would have such authority with respect to national banks and apparently all thrifts, whether federal or state. As to examinations, the LaWare proposal would have given the Federal Reserve examination authority over all entities affiliated with an organization whose lead depository institution was a State bank, while the FBC would have such authority with respect to organizations whose lead depository institution is a national bank and apparently all thrifts. As to the FBC examination authority, however, the LaWare proposal would grant to the Federal Reserve examination authority over the holding company and nondepository institution subsidiaries of the, presumably, twenty largest organizations if the lead depository institution were a national bank or a thrift. The LaWare newspaper article and other testimony given during hearings in March of 1994 made it clear that the Federal Reserve was on a continuous basis staking out its position with members of Congress, as well as with the public. If the Treasury had anticipated being able to conduct quiet negotiations, that expectation was doomed. It is at this point that we turn our attention to details of the Bill designed specifically to make it more palatable to adherents of the Dual Banking System and of the Federal Reserve. Turning first to exceptions in the Bill relating to the Dual Banking System, it was proposed that the FBC would consist of five Commissioners who may be removed only for cause. The Secretary of the Treasury and a governor from the Federal Reserve Board would be two of the five Commissioners. The remaining three would be appointed by the President, subject to the advice and consent of the Senate. The Chair would be the CEO and appointed by the President for a term expiring four years after the end of the predecessor s term, apparently for the purpose of allowing an incoming President to appoint a new Chair if so desired. The other two appointed Commissioners would each serve five-year terms which would continue until a successor has been appointed and qualified. At least one of those other two Commissioners must have demonstrated knowledge of and competence in State supervision and regulation of depository institutions. Not more than two of the appointed Commissioners may be members of the same political party. Thus, the makeup of the Commission would include the Federal Reserve, the Treasury and a State regulator or someone with State regulatory experience. A/

23 DRAFT 7/29/09 Another provision in the Bill designed to mute opposition by State bank adherents related to bank examinations. The Bill provided that the FBC may certify a State bank supervisor as qualified to examine State depository institutions on behalf of the Commission. Such certification could be revoked at any time and must be periodically reviewed. The standards for certification would be established by the FBC. The FBC could accept an examination by a federally certified State bank supervisor for State depository institutions which are well capitalized and have total assets not more than $250,000, including the assets of the institution s bank holding company. As might be expected, the Commission could participate in any such examination. Another State institution-focused provision in the Bill related to examination fees. First, the FDIC was required to collect semiannually from all insured depository institutions an amount equal to one-half basis point of each insured institution s domestic deposits and remit that amount to the FBC. Second, the Bill required the Federal Reserve to pay to the FBC an identified savings amount, which was not specified in the Bill but was to be so specified prior to enactment. The Bill as introduced estimated that the amount would be in excess of $300 million, the amount of expenditures saved by the Federal Reserve as a result of transferring its examination responsibilities to the FBC. The Bill provided that the Federal Reserve would pay the identified savings amount annually for an initial five year period and that thereafter, the amount would be reduced by ten percent each of the next nine calendar years. All other costs of the FBC would be covered by fees paid by examined institutions. Fees would be based on asset size. National institutions would pay fees on the full amount of their assets, while State chartered institutions, whether member banks or not, would pay no fees on the first $1 billion in assets and at one-half a national institution s fee on assets exceeding $1 billion. Such assets include commonly controlled institutions. The Bill specifically provided that both the Federal Reserve and the FDIC would have full access to all data in the hands of the FBC. The most interesting aspect of the Bill are the modifications of the Bill s basic structure which were made to mollify the Federal Reserve. Those modifications related to Federal Reserve participation in FBC examinations and the Fed s right to initiate enforcement proceedings. The FBC and the Federal Reserve would jointly determine the twenty largest banking organizations annually, based upon total assets of each organization s depository institution subsidiaries. Each year, the Federal Reserve could select ten of those twenty organizations for joint examination so long as the aggregate total assets of the depository institution subsidiaries selected would not exceed twenty-five percent of A/

24 DRAFT 7/29/09 the total assets of all insured depository institutions. The Federal Reserve could elect to be the lead examiner of an organization, included in the twenty, which has a majority of the total assets of its insured depository institution subsidiaries in State member banks so long as the total assets of all insured depository institution subsidiaries of that, or those, selected organization(s) do not exceed ten percent of the total assets of all insured depository institutions. Otherwise, the FBC would be the lead examiner. Hearings on the Bill were held on March 1 through 4 and on March 9, 1994 before the Senate Committee on Banking, Housing and Urban Affairs. Testimony during the hearings made clear the political flashpoints, as well as the blocking position of the Federal Reserve. Repeatedly, Chairman Riegle and other senators called upon Treasury Secretary Bentsen and Chairman Greenspan to get together and to resolve their differences so that the Bill could move forward. Thus, it was clear that the Administration would have to coax the Federal Reserve into agreeing with a Bill of which it approved or there would be no legislation. That was not the outcome and the Bill joined the death march of restructuring efforts which fell afoul of Washington s favorite sport, turf wars. The Gramm-Leach-Bliley Act ( GLBA ) What was different about GLBA that enabled it to be enacted? After all, it was not an insignificant statute. It made so many significant changes that it might be viewed as a regulatory constitution for financial institutions. In fact, GLBA actually got enacted because of fortuitous settlements of a number of regulatory conflicts. Because GLBA embodied those settlements, we should preliminarily examine what GLBA actually did. First, it repealed the affiliation provisions of Glass-Steagall so that a specialized bank holding company called a financial holding company (an FHC ) might engage in securities underwriting and other non-banking activities such as insurance, mutual funds and merchant banking activities. Next, GLBA amended the Bank Holding Company Act (the BHCA ) to permit FHCs to engage in an activity that is financial in nature or incidental to such financial activity or complementary to a financial activity [if it does] not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Included in the term financial activities were insurance and securities underwriting and a number of other activities which had not previously been available to bank holding companies or their affiliates, much less depository institutions. A/