Who's Guarding the Bank?

Financial deregulation offers the public some neat opportunities. it also offers the potential for disaster.
March 2000
By Jonathan Walters  |  Senior Editor
A Senior Editor of Governing, Jonathan has been covering state and local public policy and administration for more than 30 years.

Last fall, when Congress passed sweeping legislation to deregulate the financial services business, there was quite a bit of discussion about how meaningful the new law was going to be for consumers. There wasn't much talk, understandably enough, about how it would change state government. But if the states don't pay close attention to the new financial world that has been created, many of the consumer benefits may not come to pass.

The new Gramm-Leach-Bliley Act, as it's known, is billed as a venture in "financial modernization." It essentially repealed the Glass- Steagall Act of 1933, passed during the Depression to prevent any single company from offering multiple financial and insurance services, i.e., banking, life insurance and stock brokerage. The thinking behind Glass-Steagall was that given the financial industry's propensity for dropping the ball, single companies should only be allowed to carry one ball at a time.

There is no question that a law passed in 1933 couldn't deal effectively with financial services and financial planning in the current age of global commerce--an age, not incidentally, in which businesses had already figured out ways around Glass-Steagall. Companies and combinations of companies have been offering a wide range of integrated banking, securities and insurance services for years. It seemed obvious that consumers could benefit from an opportunity to do even more one-stop financial shopping. So, after years of stalemate, Glass-Steagall has finally been repealed.

Still, consumers can't be blamed if they find the phalanx of banking, insurance and securities industries that joined forces behind last year's legislation to be a bit disquieting. These are not three industries well known for their determination to cut consumers a break. The inclination of rational consumers upon seeing this triad locking arms could reasonably be to put both hands over their wallets.

After all, those with even short memories will recall the last major deregulation that took place in financial services--the last time a significant portion of the financial world coalesced behind "reform." It was in support of legislation allowing savings and loans to step away from their traditional lending base--home loans--and into the high-stakes world of serious commercial lending. What did the industry do with that new-found freedom? It squandered, laundered and binged its way into a half-a-trillion dollar hole, out of which American taxpayers had to pull the industry, picking up a tab of record proportions in the process.

At least it is hoped that the S&L bailout will remain the record- setter when it comes to financial fiasco. Because with companies now allowed to offer a virtually unlimited array of financial services, any of these one-stop financial service outfits has a chance to dig itself a much greater hole than the S&L's did before anyone figures out what happened. And in this case, a collapsing company could take down much more than a group of hapless investors and some paper plot to pepper an Arkansas riverside with resort homes. It could send homeowners, their personal financial portfolios and their life insurance policies all plummeting in one swift, painful crash.

Of course, all three sectors--insurance, banking and securities--are what business people would characterize as already "heavily regulated." They are regulated by both the federal government and state governments. What's worrisome is that the savings and loan industry was "heavily regulated," too. The question begged by the S&L debacle was always who was more soundly asleep at the switch--federal or state banking regulators? The answer is proffered by a top state lobbyist in Washington. "Looking back," he says, "it's hard to say that state regulators behaved any differently than federal regulators." In other words, all concerned were catching a pretty expensive nap.

And so an obvious question in the newly freed financial world is whether the feds and states are going to step up to the plate and pay real attention here. For things to work out, a heightened degree of cooperation among state and federal government regulators is going to be required. To date, the feds have not evinced any real willingness to share such a job.

State regulators seem confident that, for their part, at least, the challenge can be met. Richard Dean, Secretary of Wisconsin's Department of Financial Institutions, says the new law "creates a very unique opportunity for state regulators to be more vigilant." Dean's agency places state banking and securities regulators in the same agency for the first time--an obvious response to the new law, but not one all states have taken.

Texas Insurance Commissioner Jose Montemayor is equally optimistic. "This is going to be a watershed year for state regulation and the modernization of the financial and insurance industries," he says. "These are exciting times to be a state regulator."

Certainly consumers won't begrudge state regulators a little excitement. What they'd be happy to forgo, however, is the sort of excitement the country witnessed a decade ago, when it watched an entire industry collapse while state and federal regulators caught up on their sleep.