WASHINGTON Was the Gramm-Leach-Bliley Act effective?
Its a simple question with no easy answers.
Few deny that the 1999 financial reform law helped the government catch up with the market and, in the process, saved banks a bunch of money they had been spending to either abide by outmoded rules or find loopholes around them.
But Gramm-Leach-Bliley has not accomplished its central goal: building a two-way street for banks to enter the securities and insurance businesses and for brokers and insurers to enter banking. Two years after enactment, banks are deeper into securities and insurance, but there hasnt been much traffic in the other direction. Indeed, only five nonbanks have formed a financial holding company the structure created by the law to house banks, brokerages, and insurers. More than 500 financial holding companies have been created.
The fact that less than 1% of the financial holding companies formed have been nonbank driven seems altogether inconsistent with Congress intent in passing the act, former New York congressman Rick Lazio said last week.
Just three words are needed to sum up nonbanks reluctance: Federal Reserve Board.
This is not a revelation, but as another Gramm-Leach-Bliley anniversary rolled around last week, at least some experts were questioning anew the central banks chilling effect on the industrys evolution.
Very few companies have wanted, or will want, to let the Fed determine what businesses they can enter, said Peter Wallison, a former Treasury Department general counsel who is now a resident fellow at the American Enterprise Institute. The acts requirement that companies that control banks engage only in activities that the Fed defines as financial in nature is its fatal flaw.
Under Gramm-Leach-Bliley, brokers and insurers that buy a bank must become a financial holding company supervised by the Fed. Though a companys main lines of business continue to be regulated by its primary regulator, the law gives the Fed broad, but vague, oversight powers. The Fed has promised as light a touch as possible, but executives recognize that the central bank can do most anything, including barring dividend payments, forcing cash infusions to bank units, and even ousting senior managers.
However, regulatory meddling is not the biggest concern. Inaction is.
The law set up a framework to let the financial services business evolve with market changes. Control of this evolution rests primarily with the Fed, which was given the power to define what is financial, what is incidental to financial, and finally what is complementary to financial. (The Treasury Department can reject some Fed decisions.)
In English, this means Congress left it to the Fed to draw the line between finance and commerce, between the products and services that bank-owning companies may and may not offer.
Once a nonbank agrees to become a financial holding company, its business moves from acquisitions to product offerings can be questioned by the Fed. As Samuel J. Baptista, Morgan Stanleys lead lobbyist, put it, becoming a financial holding company is like entering the roach motel.
Once you enter, you cant exit, he said. Once the Fed gets its grip on you, youre stuck.
While the Feds decisions on what is financial, incidental, and complementary will be among its most important, the agency is none too eager to start making them. To wit, the Fed has been agonizing over the simple question whether real estate brokerage is a financial product. The Fed took a year to propose the idea and another to consider all the comments it has received.
To everyone but the National Association of Realtors this is a slam-dunk. Gramm-Leach-Bliley specifically bars banks from developing or investing in real estate, so clearly lawmakers had the opportunity to wall off brokerage if they did not want banks to enter this business. Whats more, half the states already let their banks sell real estate, with little impact because very few banks have bothered.
So though a mad rush into real estate brokerage is not expected, executives are watching closely to see if the Fed will buckle to opposition from Realtors. That would set a bad precedent for calls on what products are financial.
With the Fed reluctant to make even this easy call, few expect the agency to respond promptly to future innovations. And companies developing what they consider to be new financial products do not want to have to wait around for the Feds blessing, which could take years assuming they could even win the Feds approval.
Richard Spillenkothen, the Feds top supervisor, defended the central bank at an American Enterprise Institute roundtable on Gramm-Leach-Bliley that included Mr. Lazio, Mr. Wallison, and Mr. Baptista, among others.
I know everyone wants fast answers, but these are important decisions that are going to guide the future evolution of the financial services industry, Mr. Spillenkothen said.
He acknowledged that the law expects the Fed to create a two-way street that permits brokers and insurers to enter banking. We are working very hard to make this statute work, he said. We are not applying bank-like supervision to financial holding companies.
But Mr. Spillenkothen added, the Fed does feel a responsibility to understand the overall entity and the risks it poses to the bank.
And thats the rub.
Mr. Lazio, who is now the president and chief executive officer of the Financial Services Forum, said he recently polled the groups 21 large diversified financial services firms to see why only one nonbank member MetLife has chosen to become a financial holding company.
The nonbanks surveyed agree that, over the near to medium term, financial holding company status does not offer significant enough benefits, given the associated costs, Mr. Lazio said. Those costs include the prospective burden of additional regulation by the Federal Reserve in particular, onerous capital requirements and risk examinations, a cumbersome rulemaking process, and vague criteria for Fed intervention into nonbank subsidiaries.
Proponents of the law such as Geoffrey P. Gray, a Senate Banking Committee staff member who helped craft it, urge its detractors to be patient. Gramm-Leach-Bliley gives the Fed plenty of flexibility, and it is too soon to judge how well the central bank will use it, he said.
We have expected too much in the short term and not enough in the long term, Mr. Gray said.
But Charles W. Calomiris, a finance professor at Columbia Universitys Graduate School of Business, said its not time the Fed needs, its competition.
Before Gramm-Leach-Bliley, the comptroller of the currency nudged the Fed to expand bank powers, but the law shifted the balance of power to the Fed. The Fed engages in what can only be described as extortion, Mr. Calomiris said. Theres no way out but to go back and decide we were wrong.
Congress, he said, should restore the comptrollers power to define new bank products so well have regulatory competition again.