When Is Bank Regulation Really Bank Protectionism?

The simmering controversy over American Express' (AXP) Bluebird card typifies a classic debate: When do regulations that ostensibly protect the public from shady operators really just protect incumbent businesses from competition?

The card, sold at Walmart (WMT) stores, has features that arguably make it competitive with checking accounts (including paper checks), but it is not FDIC-insured. Amex issues the product through its Travel Related Services unit, which is licensed by the states as a money transmitter – not through either of its federally supervised depositories.

Some suggest Amex is going out on a limb, offering a product that is a checking account in all but name without the usual safeguards for depositors. "Can Amex operate as an uninsured bank under the laws of 50 states, selling checking accounts untouched by bank regulation? I doubt it," wrote BankThink's resident curmudgeon, the veteran industry consultant Andrew Kahr, in his column last week.

The knock on Bluebird is that if something were to happen to American Express, customers could lose money. For its part, Amex points out that under the state money transmitter laws, it must hold assets to back up 100% of the funds on the Bluebird card at all times. As if on cue, company officials reply to questions about the product with the same response: Amex has been issuing travelers checks out of the TRS unit for more than a century. For whatever it's worth, American Express and the TRS unit carry investment-grade ratings from all the major credit agencies (and TRS' ratings are higher than the holding company's).

As my colleague Joe Adler reports, there's a broader debate going on about whether prepaid cards in general should be required to carry FDIC insurance. Unsurprisingly, those in favor of such backing include bankers.

To some, this smacks of cartelism. "Is there no end to the tyranny of the banking industry?" reader Jim Wells wrote in a comment thread. "First banking sycophants criticized prepaid cards as second class products and no substitute for bank relationships. Now that consumers have ignored this nonsense and embraced prepaid cards over predatory bank accounts, bank apologists are invoking the argument of requiring FDIC insurance. What's wrong with a little honest competition in the financial services industry?"

From this perspective, the Bluebird card might be viewed as what the tech entrepreneur and investor Chris Dixon calls a "regulatory hack."

"Many regulations are created by incumbents to protect their market position," Dixon wrote in a recent blog post. But "startups don't have the resources to change regulations through lobbying. Instead, they need to start with regulatory hacks: 'back door' experiments that demonstrate the benefits of their ideas. With luck, regulators are forced to follow."

For example, Dixon writes, in the early days of cell phones, when the FCC limited the market to two operators per city, the company that later became Nextel got around this barrier "by acquiring local (e.g. taxi, pizza truck) dispatch radio companies, which they then connected to create a nationwide (non-dispatch) cell phone service. Predictably, the cellular incumbents tried to regulate Nextel out of existence." Among other claims, "the incumbents argued that Nextel's service would interfere with public safety frequencies and therefore endanger the public."

The FCC ultimately permitted Nextel's service, which flourished, without harm to consumers. "The only thing endangered [was] the incumbents' profits," Dixon writes.

For some observers, such protectionism is the sole or main purpose of most or all regulation. Mitt Romney's statement during the first presidential debate that "you couldn't have people opening up banks … in their garage and making loans" angered these laissez-faire advocates. "There's no reason that the same kind of garage-style innovation that brought growth and dynamism to the technology, toy, and bagel businesses can't also penetrate into lending," wrote Ira Stoll in Time magazine.

Yet Dixon also acknowledges that "regulations that truly protect the public interest are necessary." And I know I used the following line while discussing this theme in American Banker's Morning Scan a few weeks ago, but it bears repeating: "You wouldn't want to use an unlicensed brain surgeon, would you?" Well?

Not all lines are so bright, however. How do we know when a regulation is "truly protecting the public interest," and when it's merely protecting a cartel? What are some examples of the latter in financial services? Even if Amex's Bluebird pushes the legal envelope, is anyone really getting hurt? And why shouldn't people be allowed to open banks in their garages – provided they put a "NO FDIC GUARANTEE" sign on the door? Let us know your thoughts in the Comments section below.

Marc Hochstein is the Executive Editor of American Banker. The views expressed are his own.