Dear Mr. and Mrs. Taxpayer:
This is the report on the midterm exam of your scion, U. S. "Bill" Treasury, in his course on banking reform. Of the six questions, the first two were quite easy and Treasury handled them well. On the four that required deeper thought, however, Treasury showed limited creativity and questionable judgment. Overall, its performance was only passable. Herewith, a brief rundown.
-- Should interstate banking be permitted? This question was a "gimme," and we are happy to report that Treasury got it right. Virtually every economist and banking expert agrees that America's restrictions on interstate banking are an absurd anachronism that fosters inefficiency. The only arguments on the other side are thinly disguised excuses for protecting local pockets of monopoly.
Efficient local bankers should be able to use their superior knowledge of the territory to compete successfully with behemoths from distant New York or San Francisco. If they cannot, they probably deserve to fold.
-- Should there be fewer regulators? Treasury once more said "yes," which is, again, the obviously correct answer. Anyone with a lick of sense can see that regulatory supervision is now dispersed among too many agencies: the Federal Reserve System, the Comptroller of the Currency, the Federal Deposit Insurance Corp., and state banking commissions. This not only creates a maze of overlapping jurisdictions with partially conflicting rules but also invites bankers to shop around for the most lenient treatment.
-- Who should regulate the banks and how? On this much harder question, Treasury's answer was satisfactory at best. The effect of its recommendation to consolidate federal regulators into two agencies--the Fed and a new agency created by merging the Comptroller with the Office of Thrift Supervision--was to emasculate the FDIC. We gave part credit here because two is better than four. But why reduce the FDIC to the role of bookkeeper? We would have thought that the FDIC would be a vigilant regulator since it is left holding the deposit-insurance bag whenever a bank fails.
Treasury did, however, score significant points for one creative innovation. It recommended subjecting banks to tighter regulation as their capital declines, just as regulators often do now on an informal basis. Under the Treasury plan, well-capitalized banks would face a more permissive regulatory environment--and lower deposit-insurance premiums--than their less well-capitalized brethren. Since banks with thicker capital cushions are inherently safer, this proposal shows a real understanding of basic economic concepts.
-- Should banks be brokerages? This was a tough question, with good arguments on both sides. On the one hand, we are skeptical that anyone can build a "firewall" between a bank and its related securities firm that will remain impregnable in a real blaze. So allowing banks to sell and underwrite securities would probably make banking riskier. Furthermore, neither history nor the current state of Wall Street gives any reason to think that banks will make money in these new lines of business. Finally, we doubt that costs will be greatly reduced by merging banking and securities operations into a single company.
On the other hand, banks must now compete with brokerage houses and mutual-fund companies in the lending and deposit-taking businesses but are barred from invading the home turfs of their adversaries. This seems patently unfair and is progressively weakening the banks. So, on balance, we think Treasury was right to say that banks should be allowed into the securities business. However, we question the wisdom of taking this step without reforming deposit insurance (see final question).
-- Should industrial companies own banks? Treasury answered "yes," as a way to attract much-needed capital into banking. We understand the argument but believe it is a weak one. Little new capital will flow into banking in its currently unprofitable state, and plenty of new capital will become available when and if bank profitability is restored. We wonder if Treasury thought through what might have happened in the past had there been a Chrysler Bank or an Eastern Air Lines Bank. Allowing nonfinancial corporations to hold controlling interests in banks has the potential to create monumental conflicts of interest while making the banking system more vulnerable to disruption--surely a losing combination.
-- How to fix the deposit-insurance system? Despite a wide consensus that basic reform is necessary and many creative suggestions, Treasury proposed a grin without a cat. Poor show! Limiting each person to two accounts at any one bank does nothing but force people of means to hold accounts in many banks. This is no more than a bookkeeping nuisance. We would like to have seen some attention given to restricting banks' ability to use insured deposits to fund risky ventures.
As you can see, while the simple questions were answered correctly, few of the difficult ones were. Treasury needs to focus more clearly on the issues at hand before the final exam. A few stern words from you might help.
The University of Hard Knocks