The regulatory restructuring blueprint the Treasury Department released last week is another reminder that the Gramm-Leach-Bliley Act was never the landmark legislation it was hailed to be.
The 1999 law, decades in the making, was billed as tearing down the wall between commercial and investment banking put in place by the Glass-Steagall Act. In reality, it was a backward-looking imprimatur for business activities that markets, regulators, and companies had staked out years before its passage, most notably in a Federal Reserve Board 1996 rule change that launched a slew of commercial and investment banking mergers.
As the Treasury advances substantive and structural changes in financial services regulation, Gramm-Leach-Bliley continues to be less than meets the eye. It accommodated financial convergence without setting up a framework for effective regulation of companies and markets in a post-Glass-Steagall world.
The law "did not resolve the regulatory structure — it made it worse," said Cantwell F. Muckenfuss 3rd, a partner in the Washington office of Gibson, Dunn & Crutcher LLP. "It resolved the question about insurance affiliation, expanded bank holding company powers, and kicked every other hard question down the road."
It did not establish a consolidated regulator for complex organizations, nor did it resolve the responsibilities of the state and federal government. These failures loom large as policymakers consider the causes of the current credit crisis, including the growth of a huge financial industry largely beyond regulatory auspices.
The Treasury's March 31 plan offers an ambitious vision that would tie up many of Gramm-Leach-Bliley's loose ends. It is also hazy and theoretical, with short-term, intermediate, and long-term steps that are sometimes incongruous and occasionally contradictory. Treasury Secretary Henry Paulson has acknowledged that the plan would require lengthy deliberations before it could be put into action.
"This administration is leaving office in less than a year. They have done some thinking about it, and they want to lay down a marker as part of their legacy," said Rick Carnell, a former Treasury assistant secretary and now a professor at Fordham University School of Law. "If this was the beginning of the administration, you would have a different kind of fight."
But as the crisis lengthens and deepens, the price of inaction increases. Longtime Washington watchers have concluded that the shock of the crisis may be enough to force a shake-up. The form of that shake-up — and whether it proves to be regulatory or deregulatory — remains to be seen.
"Right now it's all primordial soup, and the new universe has not yet been birthed, but something is going to come out of this," said Robert Litan, a senior fellow in economic studies at the Brookings Institution. "In the broad sweep of history, we recognized commercial and investment banks were in the same business, and so we gave them the necessary authority. The next stage of history, almost 10 years later, they are in a crisis together, so now we realize we have to regulate them alike, but we still haven't figured out the model of regulation that we're going to apply."
Whatever emerges from the soup will have one defining ingredient: crisis.
Gramm-Leach-Bliley has been referred to as interest-group legislation that emerged from a relatively benign banking environment. Its passage required navigating the competing constituencies of trade groups for bankers, insurers, real estate agents, brokers, and investment banks, not to mention regulators.
"One of the things that really hamstrung honest debate during the process of the Gramm-Leach-Bliley Act was that a lot of things became shadow plays about regulatory power fought out in the guise of other things," Prof. Carnell said. "By destabilizing the regulatory and private-interest forces, a crisis makes it possible to make more fundamental changes."
The history of banking legislation rising from crisis is about as long as the history of the country itself, going back to the Second Bank of the United States in 1816. Others in the rich tradition: the National Bank Act of 1863, the Federal Reserve Act of 1913, Glass-Steagall, the Financial Institutions Reform Recovery and Enforcement Act of 1989, the Federal Deposit Insurance Corporation Improvement Act of 1991, and the Sarbanes-Oxley Act of 2002.
The Treasury blueprint, of course, was not conceived as a putative structure for crisis legislation. It was initiated a year ago as part of a process the agency began after concluding that U.S. financial markets and companies were facing regulatory burdens that threatened their global competitiveness.
"The addition of new regulators over many years, and the tendency of these regulators to adapt to the changing market by expanding, as opposed to focusing on the broader objective of regulatory efficiency, is a trend we should examine," Mr. Paulson said at the Treasury's March 2007 conference that presaged the report. "We should assess how the current system works and where it can be improved, with a particular eye toward more rigorous cost-benefit analysis of new regulation."
The glaring disconnect between the circumstances behind the study's launch and the market conditions that greet its completion has not gone unnoticed.
"This has nothing to do with the problems of the last year," said Jim Leach, the former congressman who is the 'L' in GLB and is now a professor at Harvard University. "It is the typical Treasury position of trying to concentrate banking regulation within the Treasury."
The blueprint is similar to a 1991 Treasury study directed by John Dugan, now the comptroller of the currency. That study, known as the Green Book for its cover, advocated a simplification of the regulatory structure — also in the interest of competitiveness of U.S. companies.
The Treasury blueprint promises to revive its power struggle with the Fed — a fight that also served as a Gramm-Leach-Bliley backdrop. Some observers say the plan, consistent with the Bush administration's guiding principles, would be deregulatory and would concentrate power in the executive branch.
The financial holding company structure established in Gramm-Leach-Bliley was little enticement to big investment banks. Goldman Sachs Group Inc., Bear Stearns, Lehman Brothers, Merrill Lynch & Co. Inc., and Morgan Stanley are not among the 648 financial holding companies that the Fed listed as of February of this year.
Whether they can avoid such scrutiny after the Bear Stearns rescue is the locus of the biggest fight between the regulatory and deregulatory forces. The Gramm-Leach-Bliley functional-regulation model preserved the interests of several regulators, but it is looking increasingly archaic.
"In the wake of the Bear Stearns bailout, what is the justification for Gramm-Leach-Bliley's splitting off commercial banking, investment banking, and insurance into separate subsidiaries within the financial holding company?" asked Jonathan Macey, a professor at Yale Law School who teaches bank regulation. "There is none. They are all subject to a government bailout, apparently."
Mr. Leach remains a passionate supporter of the Fed, arguing it has the greatest economic wherewithal and market sophistication to regulate complex companies. He sees a gap in investment bank regulation in the Treasury's plan.
"The question is whether anyone is going to be responsible for investment banks to a greater extent than currently, and whether it will have an overlay of banking regulation," he said. "With the infusion of Fed money, it's hard to suggest that the Fed should not have some oversight."
Mr. Litan calls Fed oversight of investment banks a near certainty.
"If the government is going to bail people out and put taxpayers on the hook in one form or another, the quid pro quo is some form of governmental regulation," he said. "Even if we don't do it very well, we're still going to do it, because to not do it would be unthinkable."
The plan would consolidate federal supervision of state-chartered banks and eliminate the thrift charter — along with the Office of Thrift Supervision. In the longer term, it espouses a single prudential regulator for institutions that carry a federal guarantee, raising the question of whether states would have any authority over banks.
To some, even the long-term plan promises little more than structural changes — or "bureaucratic office-shuffling," as Prof. Macey puts it.
"It's as if you went to the doctor, and instead of giving you medicine, he said, 'We're redecorating the hospital,' " he said. "This is just cosmetic from the standpoint of meaningful reform."
And the entire debate is infused with healthy skepticism about whether any of the long-term propositions — including recasting the Securities and Exchange Commission's role as markets regulator — will come to pass.
"The idea that we are going to wake up and reorganize financial services regulation by taking the SEC's investor protection role, all the necessary consumer protection, including insurance and mutual funds, in a new business practices regulator is interesting, innovative, and maybe right," Mr. Muckenfuss said. "But anyone, even with almost unlimited resources, would take five years to get something functioning."
The backdrop for the Treasury blueprint is collisions: between short- and long-term goals, between the Fed and the Treasury, between the Fed and the Federal Deposit Insurance Corp., between the OTS and the Office of the Comptroller of the Currency, and, perhaps most importantly, between a financial crisis that has amplified the cry for intervention and an administration that wears its free-market ideology proudly.
As history has shown, crisis usually trumps all other considerations, provided it is severe enough. But there is no guarantee that a restructuring would satisfy its advocates or produce sound policy.
"Reform legislation is much easier to do with crisis," Prof. Carnell said. "But of course, you can enact reform legislation in a crisis, too, where you have an overreaction or piling on or latching on to a bad idea, like Glass-Steagall."
