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The Day Of The Regulator Dawns But For How Long?

Special Report


The 1980s, in many ways, was almost as much a regulatory debacle as a financial one. Regulators were not the main cause of the collapse of hundreds of savings and loans, banks, insurance companies, and brokerage houses. But few observers would dispute that regulators often were lax in supervising these institutions, slow in spotting problems, and ineffectual in trying to get them to take remedial actions. Regulators also were asleep at the switch in spotting wrongdoing, which was graphically demonstrated by the Bank of Credit & Commerce International fraud and the Salomon Brothers Treasury manipulation scandal.

Regulators now are moving aggressively to mend their ways. In abject testimony before Congress, regulators have been admitting misjudgments, promising vigorous enforcement of existing regulations, and proposing new rules. Bank regulators in the field have sharply tightened their oversight.

It's tempting, but still premature, to label the '90s as a decade of regulatory rigor, for there are as many regulatory doves as hawks in Washington these days. Dovish Bush Administration officials are at odds with hawkish congressional leaders and regulators over the crackdown on banks. With an eye toward next year's election, officials want regulators to ease up in the hope that banks will lend more to help the sluggish economy.

All of this has helped produce a raging debate in Washington over the tone and direction of regulation of financial institutions in the years ahead. Adding confusion to the rancor are the Administration's mixed signals, with some officials encouraging forbearance and others promoting discipline. The resolution of the debate will demonstrate whether we have learned from the abuses of the '80s. More important, it will go a long way toward determining whether financial institutions prosper or languish during the '90s.

MERGER FRENZY. The moves toward a stricter approach are most apparent in banking, which remains beset by billions in bad loans. The Federal Reserve, for instance, vows to enforce stiff capital requirements on the institutions it regulates. Banks that want to participate in new businesses or the current merger frenzy will have to toe the capital line to get a green light from the Fed.

And despite squawking from some banks--and some senior Administration officials--the U. S. Office of the Comptroller of the Currency doesn't seem

inclined to back off its strict handling of questionable bank loans. The Bush Administration has signaled its approval for the tough line by putting Fed official William Taylor in charge of the Federal Deposit Insurance Corp. and by renominating hard-liner Robert L. Clarke to another term as Comptroller.

There also is increasing talk of a new wave of regulation in other sectors. Growing concern about the solvency of the insurance industry is behind a move on Capitol Hill to federalize insurance regulation. "If we have one more important insurance company failure, the pressure will be on Congress to do something," says Georgia State University business Professor Harold Skipper.

There's a suggestion that Congress might adopt a model state insurance code that would set minimum capital requirements and limit the kinds of investments insurers could make. Among other ideas under discussion: creating a self-regulatory organization similar to the National Association of Securities Dealers, which polices Wall Street; making insurance fraud a federal crime; and repealing the industry's historic exemption from federal antitrust laws.

The Securities & Exchange Commission's ambitious chairman, Richard C. Breeden, wants more power over the government securities market so that the SEC can more effectively deal with abuses uncovered by the Salomon Brothers Inc. scandal. Currently, the SEC's authority extends only to prosecuting fraud. Under a bill proposed by Representative Edward J. Markey (D-Mass.), Wall Street dealers would be required to report large trades in government bonds to the SEC. The dealers also would have to implement adequate internal systems to comply with the law.

CLOUT. It's not certain, though, how long all of this tough regulatory talk will endure. Some policymakers are advancing the argument that expensive new regulatory burdens could quash innovation and put U. S. companies at a competitive disadvantage as capital markets become more global. The SEC, for instance, is under pressure to ease reporting requirements for publicly held companies and investment houses in order to preserve U. S. preeminence in stock trading. If the economy continues to sputter, regulatory doves will have even more clout in forcing hard-line regulators to back down.

Similarly, the Administration would fight any regulatory intrusions in the government securities market that might boost the cost of financing Washington's budget deficit. Says one senior Fed official: "We need to look for efficient ways to zero in on abuses without a heavy layer of regulations."

Already there are signs that some parts of the Administration are backing off from its stiff stance on bank regulation. The most telling examples are the Administration's proposal to overhaul Depression-era banking laws and its Oct. 8 package of measures to combat an alleged credit crunch. Both seem eerily reminiscent of Washington's handling of the savings-and-loan industry. A decade ago, Congress permitted S&Ls to seek profits in risky new ventures -- moves that often led to their undoing. Now, many lawmakers support the Administration proposal to give banks greater powers to sell stocks, bonds, and insurance. The legislation, though, is likely to be scaled back because of opposition from some Democrats who fear a repeat of the '80s.

The Treasury Dept.'s credit-crunch proposals stand a better chance of becoming policy. On the surface, the blueprint to encourage more bank lending and give the economy a jump start seems technical and innocuous. Among other

things, it would encourage banks to make new loans--and roll over existing loans--to real estate developers, cable-TV franchises, and other highly leveraged borrowers. But critics worry that this could set the stage for another wave of troubled loans. To one Wall Street analyst, the plan appears aimed at "getting the marginal lender to lend to a marginal borrower." Robert B. Reich, a public policy lecturer at Harvard University, worries that the Administration is sending "a message that the government is not really serious about reforming the financial markets."

The proposals also would allow bankers to appeal confidentially what they consider onerous reviews by field examiners to regional higher-ups. For some banks, that would mean the president of the local Federal Reserve Bank, who is appointed by bankers from within the region. Critics fret that bankers may now feel freer to use their political pull to tone down bad reports--much as former thrift executive Charles H. Keating Jr. did to forestall a regulatory attack on his Lincoln Savings & Loan Assn. Treasury's proposals could sow the seeds for "more bank scandals, taxpayer bailouts, and general chaos in the banking industry," worries Representative Frank Annunzio (D-Ill.), chairman of a key House banking subcommittee.

Some bankers had no qualms about going over examiners' heads even before these proposals were announced. In a move one ex-regulator deemed "extraordinarily unusual," top officials at the Comptroller's office in August overruled examiners who had told Wells Fargo & Co. to write off an $85 million high-risk loan to Revco D. S. Inc. The examiners' reasoning: The Ohio-based drugstore chain has been mired in bankruptcy since 1988, two years after a leveraged buyout.

But Wells Fargo CEO Carl E. Reichardt flew to Washington to argue--successfully--that with Revco's junk bonds still trading at roughly 50~ on the dollar, the bank shouldn't have to write off the entire debt, particularly since the chain had not missed an interest payment. Whatever the merits of the dispute, Wall Street analysts worry that the episode sends a troubling signal to examiners: Ease up, or else. That's especially true given that Wells Fargo, whose portfolio of highly leveraged loans totals $3.5 billion, hasn't written off anywhere near the share of such loans other banks have.

In sum, financial regulators in the '90s will have to walk a fine line: They must be sensitive to the need to bolster a struggling economy and maintain U. S. competitiveness. But they also must be strict enough to prevent another round of '80s-style abuses. The $500 billion S&L bailout is a grim reminder of what can happen if regulators can't strike a balance. "The last thing anyone like me wants after 2 1/2 years of the S&L debacle is to get on the wrong side of forbearance river," says Treasury Deputy Secretary John E. Robson. "There's no profit in that." A $500 billion hit can wipe out a lot of economic growth.



-- Bank regulators have raised capital requirements and forced huge

write-downs of problem loans. Critics claim that could impede the


-- Congress is mulling federal insurance regulation. Lawmakers are

considering a model state insurance code setting minimum capital

requirements and limiting investment options

-- The SEC wants broader authority over the government debt market. Now, it

can only bring fraud cases


-- The Bush Administration is pressing Congress to repeal limits on the

ability of banks to sell stocks, bonds, and insurance. Opponents argue

that similar deregulation helped create the thrift industry disaster

-- The Administration wants more leniency by bank examiners on loans to

real-estate and other highly leveraged borrowers. Some analysts say

this could encourage riskier loans

-- The SEC may exempt foreign companies that issue stock here from some

reporting requirements. The agency has already reduced disclosure for

securities offered solely to institutional investors. And it has

relaxed reporting rules for stock trading outside normal exchange

hours. Critics claim these moves could hurt investors

DATA: BWDean Foust in Washington

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