10 Years On, GLB Reform Was Wasted Opportunity

Professor Richard Carnell in Insurance Networking News, November 10, 2009

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When the Gramm-Leach-Bliley Act was enacted in 1999, its architects promised the financial services world would be a lot different in a decade.

They were right, but not in the way they intended.

Proponents billed the act as a landmark law that would spur financial supermarkets and lower consumer costs, but even some of them are viewing GLB as a lost opportunity as it hits the 10-year mark on Thursday.

Though few say it directly caused the financial crisis, major players who made the law happen acknowledge it could have done more to prevent the meltdown by toughening supervision of the bigger-is-better system it encouraged. That shortfall irreversibly opened the door to "too big to fail" firms that were difficult for the government to regulate and resolve.

"The failure of Gramm-Leach-Bliley is that it failed to produce a coherent regulatory mechanism that was up to the new powers it created," said Eugene Ludwig, the chief executive of Promontory Financial Group and the comptroller of the currency leading up to GLB.

Gramm-Leach-Bliley gave the Federal Reserve Board more power to serve as an "umbrella" supervisor, but questions remain over whether its restrictions on that power were too strict. It also allowed banking firms to diversify into securities and insurance, but did not impose tougher regulatory requirements in exchange for being allowed to take on more risk.

GLB allowed "the bulking-up of the holding company, there's no question," said Professor Lawrence White, of the Stern School of business at New York University.

Some lawmakers say they saw it coming. "I thought then, and I know now, that it would create more risk for our banks," said Sen. Richard Shelby, the senior Republican on the Senate Banking Committee — the only GOP senator to vote against the bill.

"You've got investment banks, which are highly leveraged businesses — big risks, big rewards, as opposed to commercial banks, which are more structured, more regulated. You've got this marriage, in a sense, of these big banks, and I thought it created a dangerous combination."

HOLES IN THE UMBRELLA

The most pervasive criticism about GLB is that it left room for too much risky activity to go unchecked at the holding company level. Authors of the act said it would wall off commercial bank subsidiaries from any excessive risks.

The law gave the Fed the power to act as the umbrella supervisor for holding companies, but the central bank says it was hamstrung because the law required it defer to primary regulators on most matters concerning subsidiaries.

"If there were one error, GLBA, like is so often the case, involved an element of political compromise, and instead of having a single regulator, which could regulate the entire entity, it did leave compartmentalized or siloed regulation," said H. Rodgin Cohen, the chairman of Sullivan & Cromwell LLP and a specialist in bank acquisition, corporate governance, regulatory and securities law matters. "It certainly is and was a problem and I think is something the administration is trying to correct in a single systemic-risk regulator for financial institutions."

Many observers said policymakers were well aware at the time that they were making politically expedient choices.

"The securities, and insurance and banking regulators didn't have to talk to one another and that was reassuring to the different parties but we knew that was sort of artificial," said Wayne Abernathy, who was Senate Banking's staff director in 1999 and is now the American Bankers Association's executive vice president of financial institutions policy. "One of the things that is being looked at now, and needs to be, is improving the regulatory sharing of information and breaking down the walls to sharing the information."

Overall, Ludwig said the problem was that financial holding companies had vast new powers but there was no corresponding increase in regulators' ability to monitor the use of them.

"The fact that the grant of powers was not accompanied by an equivalently sophisticated regulatory mechanism … was a recipe for trouble," he said. "Instead we just allowed these activities to be placed in the holding company structure on the theory that the structure would wall them off from the bank and that would solve the problem. Relying on that structure instead of a modernized regulatory mechanism did not work. … The issue is treating the enterprise as a whole and then regulating it in a coherent fashion."

Richard Carnell, an associate law professor at Fordham University School of Law, the Treasury Department's assistant secretary for financial institutions during the last six years leading up to GLB, agreed the structure itself was flawed as a result of political deals.

"GLB forced an unproductive bank holding company regime on firms — a legal regime that has markedly failed to live up to the promises that the Fed made for it," Carnell said.

He criticized "the dominance of special-interest politics, the complacency about real risk, the perpetuation of regulatory fragmentation and with it the tendency to put turf concerns ahead of foresight and sound policy."

To be sure, the forces driving financial reform today could not be more different from those of a decade ago. When President Clinton signed GLB into law after more than 20 years of intraindustry dueling over the bill, banks were enjoying a streak of record profits, the stock market was booming and unemployment and inflation were negligible.

There were rampant fears that the country's banks would be supplanted by foreign competitors that were not saddled by Depression-era laws creating walls between banking, insurance and securities.

Today the fears are running in the opposite direction, with Europe and the U.S. competing to see which can write more stringent regulations. Lawmakers, far from wanting to help banks have new powers and keep pace in the global economy, are badly shaken by the financial collapse.

"Then we were concerned about foreign banks and institutions in effect eating our lunch, putting our banking system at a distinct disadvantage, so that was one of the motivating things that moved the bill," said former Rep. Thomas Bliley, now a senior government affairs adviser for Steptoe & Johnson. "Of course what's happened since, we had the institutions buying these mortgages that were not properly backed. People were buying mortgages that they couldn't afford."

Ken Guenther, former CEO of the Independent Community Bankers of America, agreed that "the climate was totally different."

"It was deregulation-is-good, the-faster-the-better, the-bigger-the-better," he said. "Risk will be diversified. That religion has failed."

TURN BACK THE CLOCK?

What is still a subject of debate is whether the Obama administration's plan will adequately address the shortcomings of GLB. Though President Obama sharply criticized the law during his campaign, his plan does not attempt to do what some of his advisers, like former Fed Chairman Paul Volcker, have recommended: restoring the walls between banking, securities and insurance.

Instead, it largely builds off of GLB. The Obama plan would eliminate so-called "functional regulation," allowing the Fed to dive into all subsidiaries of a holding company. Although Frank initially pushed to allow the central bank the power to override other regulators, he backed off of that plan last week. Still, the central bank would stand to gain significant power as an umbrella supervisor.

That is ironic to former Sen. Phil Gramm, who was a target last year as an adviser to Republican presidential candidate Sen. John McCain in part because he was an architect of the financial reform law.

"When the president submitted his reform package, he used the structure of GLB to make the Fed the regulator of systemically significant companies," said Gramm, who is now a vice chairman with UBS AG's investment bank division. "No part of GLB does the administration propose to repeal, and I think it's interesting they used its structure to create the systemic-risk regulator. I think that says about all you need to say."

For his part, like other architects of the law, Gramm defends its legacy, and argues it accomplished some of its goals. "The objective of GLB was to promote competition to lower the price of banking services and to provide an increase in products that would be available to consumers. I think it succeeded in all of those areas," Gramm said in an interview.

John D. Hawke Jr., a Treasury under secretary a decade ago and later comptroller of the currency, acknowledged the law was useful in creating a legal basis for moves made by the government during the crisis. During the past year, Bank of America acquired Merrill Lynch & Co. and JPMorgan Chase & Co. acquired Bear Stearns. The remaining big investment banks — Goldman Sachs and Morgan Stanley — became holding companies.

"The great paradox is that it wasn't until the last year or so that GLB really became useful, because it permitted the investment banks to become bank holding companies, which they couldn't have done before GLB," Hawke said.

HUMAN-ERROR FACTOR

But there are lingering concerns that the Obama regulatory reform plan is building too much on Gramm-Leach-Bliley. Many fear it is not doing enough to curb the growth of "too big to fail" banks.

Shelby says that Volcker's recommendation to restore the barriers of GLB would help. "Paul Volcker is a very wise man," he said. "I've listened to him, because he's been there, and I hope some other people will begin."

But Bliley said Volcker's call to reinstate the separations of the 1933 Glass-Steagall Act is impractical. "That's like trying to put the egg back together after the shell is broken," he said.

For Senate Banking Committee Chairman Chris Dodd, repealing Gramm-Leach-Bliley isn't the point. He acknowledges that the firewalls in GLB were weak and that they gave an opening for loosely regulated holding companies. "The walls never worked quite as well as the architects wanted them to," he said. "There was creative manipulation of things that were never part of the debate."

Still, Dodd said the critical factor was not the law itself, but the regulators who oversaw its implementation. They were the ones who should have done more to act to prevent the current crisis, he said.

"What has been suggested is that somehow because of what we did, every regulator, member of the Federal Reserve Board, everyone else, all the other people were incapable of responding to what was happening," Dodd said. But "they encouraged it. They welcomed it. They applauded it. … You can point to Gramm-Leach-Bliley, but it's what happened afterwards that is far more injurious and far more culpable to the events that unfolded."