Monster Banks

Commercial banks in the United States have been on a wild ride over the last 25 years. They have seen record profits, vastly expanded powers and a new post-Depression record for bank failures. Today the industry is still in the midst of a massive concentration of financial resources.

As President Reagan’s first term came to a end in 1984, there were 15,084 commercial banks and thrift institutions in the 50 states. By the end of 2003, the number had dropped to 7,842 — almost a 50 percent reduction. The majority of the decline from 1984 to 2003 was among banks of $1 billion or less in assets, many them swallowed up in mergers and acquisitions by the mega institutions.

But the decline was also the result of the massive failures among both banks and thrifts in the mid 1980s and early 1990s. Between 1984 and 2003, 2,700 banks and thrifts failed. Nearly three-fourths of the failures came in a five-year period, 1987 to 1991.

As a result, the deposit insurance fund for savings and loan institutions collapsed and ultimately required a half trillion dollars of tax funds to cover the losses and restore deposit insurance. The bank deposit insurance fund itself dipped into the red in 1991, requiring Congress to vote a $30 billion contingency fund to back up the insurance.

While the number of financial institutions continued to decline in the 1984-2003 period, banking assets were increasing. During this period, banking industry assets more than doubled — totaling $9.1 trillion at the beginning of 2004. And the rapidly increasing level of concentration began to show dramatically.

The share of assets in institutions with more than $10 billion rose from 42 percent in 1984 to 73 percent by 2003. Meanwhile, the share of industry assets in community banks — defined as institutions of less than a billion dollars — plunged from 28 percent to 14 percent in the same period. The truly small banks with 8 percent of the nation’s assets in 1984 saw their share drop to only 2 percent by 2003.

Measuring concentration by deposits produces equally stark evidence of a banking industry already controlled by a relatively small handful of dominant players. The top four bank holding companies — Bank of America-Fleet, Citigroup, J. P. Morgan-Bank One and Wells Fargo — control nearly one fourth of all domestic deposits, and the top 25 banking institutions have nearly half of all U.S. deposits. In fact, Bank of America, after its merger with Fleet, is now bucking up against a 1994 law which prohibits any one institution from controlling more than 10 percent of domestic deposits. So Bank of America may have to shed some of its deposits or seek a liberalization of the statute — certainly not an impossibility for an institution with its economic and political clout.

Banking marries finance

But just becoming big wasn’t enough. The mega institutions wanted a broader financial role by moving into insurance and securities. That meant repeal of the Glass-Steagall Act, passed in the wake of the stock market crash of 1929 — a measure designed to firmly separate banking from securities activities. For years, these and other efforts to expand the economic role of banks was blocked by Representative Wright Patman, the Texas populist who served as chair of the House of Representatives Banking Committee.

After Patman’s death, the legislative calendar was dotted with a variety of proposals to deregulate the banks and let them roam across the financial landscape. Often these proposals failed because of intramural fights involving banking, insurance and securities industries — each jealously guarding their special niches.

The collapse of the savings and loan industry at a cost of $500 billion to the taxpayers in the 1980s and early 1990s — plus a post-Depression record number of commercial bank failures — scared the Congress and temporarily cooled the more radical deregulation proposals. Nonetheless, in 1994, Congress passed the Interstate Banking and Branching Act, which allowed banks to branch nationwide. As a result, institutions like Bank of America today stretch from coast to coast.

But the big prize of deregulation — expanded powers — was still out of reach. Major deregulation legislation was introduced in 1982, 1988, 1991, 1995 and 1998. It was like a never ending series of summer television reruns. The legislation was designed to allow the formation of giant financial conglomerates composed of banks, insurance companies.

In 1999, the deregulatory stars were in alignment. By this time, the legislation had a new and deceptive name, “Financial Modernization.” Senator Phil Gramm, R-Texas, the truest of true believers in deregulation, was chair of the Senate Banking Committee. In the House, the Financial Services Committee was headed by Republican Representative Jim Leach of Iowa, who had only one big concern — that deregulation not go so far as to allow financial institutions and non-financial companies to combine — the long-standing issue of banking and commerce. Once that was settled, Leach was on board. The House Commerce Committee shared jurisdiction with the financial services committee, and its chair, Tom Bliley, R-Virginia, was a cheerleader for deregulation.

The Clinton administration had no problems with pushing for deregulation. Its Secretary of the Treasury, Robert Rubin, who had been a major player on Wall Street, enthusiastically promoted the legislation. At times, the Clinton administration even toyed with the idea of allowing a total blurring of the lines between banking and commerce, but was forced to back away from this radical move after fire from former Federal Reserve Chair Paul Volcker, Leach and the ranking Democratic member of the Senate Banking Committee, Paul Sarbanes of Maryland.

The banking, securities and insurance corporations — the big ones at least — were beginning to see mutual advantages and new roads to big bucks in the deregulation scheme. And they saw little to be gained by a prolonged fight over banking and commerce and everything to be gained by passage of financial modernization.

In 1998, the end of Clinton’s second term as President was on the horizon and financial lobbyists were anxious that the bill get to the President’s desk before the national political campaign was in full swing. But the bill was floundering. Predictions of still another in a long tale of failures were beginning to appear.

The upturn in the fortunes of the legislation can be traced to many reasons and many personalities. At the forefront were John Reed of Citicorp, Sanford Weill of Travelers Insurance Group (who later was to succeed Reed at Citigroup, after Citi and Travelers merged) and David Komansky of Merrill Lynch. They became familiar figures in the halls of the Senate and House office buildings.

Big banks, securities firms and insurance companies spent lavishly in support of the legislation in the late 1990s.

During the 1997-1998 Congress, the three industries spent $58 million in the form of campaign contributions, along with $87 million in soft money contributions to the Democratic and Republican parties and an estimated $163 million in various lobbying efforts.

While the money certainly helped grease the wheels of the legislative bulldozer, two individuals — Senator Phil Gramm, the Senate Banking Chair and Federal Reserve Chair Alan Greenspan — were the key to the ultimate passage of “financial modernization.” Greenspan, a conservative anti-regulation Republican, had no philosophical problems with wiping out statutory safeguards. More important, he saw an opportunity to strengthen his and the Federal Reserve’s role as the major overseer of the financial industry. He wanted the role of the Office of the Comptroller of the Currency — which regulated national banks — diminished and the Federal Reserve firmly installed as the dominant regulator.

To accomplish the goal, Greenspan became a one-man cheerleader for Senator Gramm’s legislation. When the legislation became snagged on controversial provisions, Greenspan would invariably draft a letter or present testimony supporting Gramm’s position on the volatile points. It was a classic back-scratching deal that satisfied both players — Greenspan got the dominant regulatory role and Gramm used Greenspan’s wise words of support to mute opposition and to help assure a friendly press would grease passage. Deregulation became law in 1999.

Consumers be damned

Proponents of financial modernization had the chutzpah to attempt to sell the legislation as a boon to consumers. Press releases and testimony were filled with claims that consumers who were supposedly clamoring for large conglomerates which would be “one stop” financial centers where customers could dabble in a variety of expensive and esoteric financial transactions. Through the years of hearings, no one ever produced the consumers who were supposedly yearning for one-stop money shops.

The legislation did nothing to build on the consumer protections which started coming on the scene in the late 1960s. These efforts produced laws like Truth in Lending — which require that consumers be fully informed of the costs when they borrow money — along with the Community Reinvestment Act, Home Mortgage Disclosure Act, Equal Credit Opportunity Act, Fair Housing Act, Fair Credit Reporting Act, Truth in Savings and more recently legislation to protect the privacy of consumers’ bank records.

The titles of the various consumer protection statutes are impressive. In the real world, the protections have been diminished by a financial regulatory system which traditionally has been focused on the “care and feeding” of banks, not on enforcement of protections for bank customers. The saving grace, in some cases, has been the willingness of the Federal Trade Commission (FTC) to enforce consumer protections while the bank regulatory agencies looked the other way.

The 1977 Community Reinvestment Act, which requires banks to help meet the credit needs in all areas of its communities, was weakened as part of the modernization scheme. Small banks under $250 million will be subject to CRA examinations only every four to five years.

That provision has now prompted regulators to propose limiting full CRA examinations to institutions of $1 billion or more in assets. This means only 428 out of 7,263 banks will be subject to complete exams.

CRA requirements for public hearings of merger applications have given community organizations opportunity to reveal and protest poor lending performance by banks and gain future commitments. The requirements for hearings are sharply reduced under financial modernization. The legislation provided no improvement in the ratings of bank CRA performance, leaving in place a system under which 98 percent of all banks receive satisfactory or outstanding ratings. Presumably if these ratings were accurate, housing and community development needs would be met fully. Any survey of inner city housing and depressed rural areas would establish the inflated CRA ratings as gross frauds.

The financial conglomerates created under financial modernization have access to a marketing gold mine in the information gathered and shared by banks, securities firms and insurance companies. Consumer groups and privacy advocates fought to ensure that personal records, including medical data, would not become open secrets.

But, in the end, privacy was the loser. All that was left as a protection was a weak “opt out” provision which gave the conglomerates the right to use and misuse personal data unless consumers took affirmative steps to “opt out” of the scheme.

In notifying consumers of their rights to opt out of the information sharing, the financial firms set a new record for obfuscation. Mandatory notices of consumer rights to opt out were often buried among a welter of other enclosures in billing envelopes and obscured by legal verbiage that only served to confuse.

Regulatory impotence

Even more absurd is the fact that the deregulatory bill was titled “Financial Modernization,” when the financial regulatory system was left as a disjointed, fragmented and overlapping creature — anything but modern. Four federal banking agencies and 50 state regulators have jurisdiction over banks. And now the securities powers of the banks also involve the Securities and Exchange Commission (SEC). As part of this jumbled system, the nation’s monetary policy machinery is housed in the Federal Reserve, which also serves as a bank regulator.

A study by the Federal Deposit Insurance Corporation (FDIC) pointed to the growing international trend toward a coordinated regulatory system with monetary policy and bank regulation clearly separated:

“At a time when questions are increasingly being raised in the United States about our fragmented piecemeal system of financial regulation, in many other countries functional regulation has given way to consolidated supervision by a single regulator. Although many countries continue to regulate and supervise their financial institutions through multiple entities, in nation after nation, serious study and thought have been given to devising regulatory arrangements to deal with a new, more integrated financial world. The trend has been to bring together in one agency financial supervision and regulation of the major types of financial institutions (banks, securities firms and insurance companies). ... Many nations are achieving this consolidation by moving the regulatory and supervisory functions outside the central bank.”

But under the rubric of financial modernization, the United States took another step backward into the morass of overlapping agencies. Instead of moving bank regulation out of the central bank, the Congress anointed the Fed as the “umbrella” regulator.

The problems created by the regulatory gaps under the present system are not academic. They are illustrated by the celebrated shenanigans engineered by banks like Citicorp, J. P, Morgan Chase and Merrill Lynch. In the Enron scandal and in other cases, these banks engaged in various kinds of fraudulent activity in one part of their financial empires in order to generate profit in another. The breach of the wall between banking, investment banking and insurance led directly to these abuses.

Senator Carl Levin, D-Michigan, then-chair of the Senate Permanent Subcommittee on Investigations, in 2002 described the banks’ role this way:

“The evidence shows that Citigroup and Chase actively aided Enron in these transactions, despite knowing they employed deceptive accounting or tax strategies and were being used by Enron to manipulate its financial statements or deceptively reduce its tax obligations. Citigroup and Chase received substantial fees for their actions or favorable considerations in other business dealings.”

Both banks loaned billions of dollars to finance Enron’s deals. And, as Senator Levin bluntly remarked, Merrill Lynch “assisted Enron in cooking the books.”

All three corporations were major lobbyists for the financial modernization legislation.

At the conclusion of the hearing, Senator Levin stated the obvious:

“There is a regulatory gap right now.”

Yet only three years earlier, Congress and the national media had proclaimed financial regulation” modernized.”

Jake Lewis, a former professional staff member of the Banking, Finance and Urban Affiars Committee of the U.S. House of Representatives is on staff at the Center for the Study of Responsive Law.