BANKRUPT: RESTORING THE HEALTH AND PROFITABILITY OF OUR BANKING SYSTEM
By Lowell L. Bryan
HarperBusiness 315pp $22.95
THE FUTURE OF BANKING
By James L. Pierce
Yale University Press 163pp $25
Every day, it seems, we are bombarded by bad news from the world of banking. Even as Congress tries to fashion reforms to cure the industry's ills, one banking giant after another agrees to merge with a rival, declares huge losses, or otherwise teeters toward insolvency. Meanwhile, taxpayers are wondering whether they'll get stuck paying to clean up the banks--the way they must pay to restructure the savings and loan industry.
For those who yearn for a systematic understanding of this crisis, two experts--Lowell L. Bryan, a director at McKinsey & Co., and James L. Pierce, an economics professor at the University of California at Berkeley--have written books to provide just that. Of the two, Pierce's The Future of Banking is briefer and easier to follow. It takes a historical approach, while Bryan's Bankrupt follows the more abstract lines of economic analysis. Yet Bryan offers fresher, more profound thinking about solving the industry's problems. Indeed, his chief proposal--to break banks up into relatively safe, federally insured units and riskier, uninsured units--is gaining currency among lawmakers.
In exploring the roots of the crisis, Bryan and Pierce both acknowledge the tension that arises from banks' role as private businesses with a public purpose. While banks are profitmaking enterprises, they also have a duty to provide a safe haven for deposits and thus ensure some stability in the financial system. Throughout the industry's history, the two roles have vied for supremacy.
Both authors trace the banking system's current weakness to reforms enacted after the massive bank failures of the Depression. The regulatory framework established then effectively ended bank panics, which had long plagued the system. The new rules included federal deposit insurance, the separation of banking from other financial businesses, and such efforts to limit competition as ceilings on interest paid on deposits and restrictions on interstate branching. For more than three decades the reforms worked, protecting the public and guaranteeing profits for the banks.
But by the mid-1960s, Pierce writes, inflation and technological changes undermined the arrangement. When restrictive monetary policy drove interest rates up, depositors left banks for higher-yielding, unregulated money-market accounts. But after Congress finally deregulated bank deposit rates in the early 1980s, high interest rates and recession squeezed profits.
Meanwhile, companies that would normally use banks were turning to the securities markets. At the same time, computers began to enable banks to raise deposits around the world. Flush with deposits but prohibited from venturing beyond the loan business, banks sought better returns through high-risk lending--including loans to the Third World and commercial real estate. They suffered humiliating losses.
Bryan's solution is a fundamental change in the structure of banking. He would separate banks' business lines into three new entities. The safe businesses of taking deposits and lending to small enterprises would be carried out by federally insured "core banks." More hazardous businesses would be the province of two types of uninsured entities--money-market investment banks to engage in investment-banking activities and finance companies to make loans for real estate and other risky activities.
Core banks would pay Treasury rates on deposits, and the size of the loans they make would be limited. Since deposits probably would exceed the demand for small business loans, they could invest the excess in AA-rated securities, such as Treasuries and mortgage-backed securities. Bryan contends that, despite their mundane business, core banks could attain a healthy return on assets of more than 1%, since deposit rates would be low and returns would not be eaten up by losses on risky loans. (In a brief final chapter, Pierce endorses a similar remedy. Under his plan, the insured entities could not make loans.)
Bryan envisions 10 to 20 large, multiregional core banks with assets of $50 billion to $200 billion or more operating from such centers as Detroit, San Francisco, and Charlotte, N. C. They would be formed through mergers of what are now the 120 biggest bank holding companies, with two-thirds of the nation's deposits. Of the $2.6 trillion now in bank deposits, Bryan calculates, about $600 billion might leave core banks for higher yields offered elsewhere. Ultimately, he envisions thousands of small, independent core banks across the country and a handful of large money-market investment banks and finance companies.
Although Bryan's vision is radical, lawmakers seem increasingly intrigued by the idea. Representative Charles E. Schumer (D-N. Y.) plans to introduce the core bank concept in an amendment to pending legislation when it comes to a House vote. For now, however, Congress is more likely to settle for dismantling some Depression-era regulations.
Together, Pierce, with his discussion of the origins of the banking crisis, and Bryan, with his proposal for a way out, provide a primer on a subject that deserves urgent attention. Notes Bryan: "As a nation, we only have one banking system and one economy. . . . If we try to muddle through this mess, we will suffer collectively."