The Real Lesson of the Asian Meltdown

...Mend It, Don’t End It When all else fails, the fallback argument for fmancia1 consolidation is a time-honored classic used to advocate tossing out everything from gun laws to taxes: The current rules don’t work anyway...

...Hardly the stuff of which Hollywood blockbusters are made...

...And as talk of bailouts by the IMF swirled around Washington and Wall Street, a major stichng point in the deals became whether Asian leaders would accept the requisite financial reforms, includ - ing greater transparency in the region’s financial systems, tighter loan standards, a crackdown on insolvent banks, and improved accounting procedures...

...Regulators reprimanded Continental, but bank executives dismissed the criticism...

...Moreover, despite bankers’ innate desire to do what is right, deregulators argue, limiting banks’ activities actuallyforces them to take greater risks in order to turn a profit on the services they may provide...

...Talk of a global regulatory system was bandied about by heavy hitters ranging from Treasury Secretary Robert Rubin to billionaire currency speculator George Soros, with Soros going so far as to assert that “the private sector is ill-suited to allocate international credit” and proposing an international oversight agency to help stabilize the world’s banking system...

...So before Congress resumes its crusade to make our financial system more competitive, the public would do well to take a close look at the debate...

...Enter H.R...

...But what about keeping banks competitive through new “profit centers...

...The bank took the view, he said, that a loan to one of its subsidiaries wasn’t subject to the lending limit...

...This Year’s Economic Lesson: Japan’s Model Failed,” proclaimed a headline in the Dec...

...At present, the bill would limit the percentage of a banking company’s income that could come from nonfinancial activities...

...Regulation of the insurance industry, on the other hand, is left up to the individual states...

...GAO’s work also indicated that eliminating the current separation could pose a variety of risks to the safety and soundness of the financial system, the deposit insurance finds, and to consumers and taxpayers...

...The development of new financial products and services has indeed blurred the distinction between banks and other financial institutions...

...This, they claim, was the true cause of all those big bank failures in the late ’80s and early ’90s...

...After the Garn-St...

...In a more recent statement he challenged: ‘‘[IIt should be clear there is no public support, no compelling public policy rationale, and-no political necessity for such a breach...

...When the OCC gave the go-ahead in ’96 for national banks to start selling insurance, for example, Florida’s banking commission promptly gave state-chartered banks the OK as well...

...Let’s say Chase Manhattan decides to . buy Merrill Lynch...

...The Real Lesson of the Asian Meltdown Too bad nobody's listening BY MICHELLE COTTLE TRUTH BE TOLD, MOST AMERICANS dislike their bank...

...Such is the case with the recent meltdown in Asia...

...The U.S...

...Over the past decade, regulators have opted to prop up a variety of major banks, at some pretty impressive costs: $4 billion for the 1988 bailout of First Republic, $2 billion for the 1990 MCorp...

...The result was a flurry of prominent bankq-brokerage marriages, including NationsBank‘s $1.2 billion purchase of Montgomery Securities and Bankers Trust’s $1.7 billion buyout of Alex Brown...

...in every one of these countries that opted for a more ‘universal bank,’ the outcome was the same: failed big banks, money-losing nonfinancial subsidiaries, huge bills to the taxpayer . . . and direct government intervention in the businesses these banks had bought and mismanaged...

...In a May 1997 statement to the House Banking Committee, the General Accounting Office’s chief economist, James Bothwell, reported: “GAO found that the potential benefits of mixing banking and commerce generally lacked empirical support or could be realized without removing the current restrictions...

...Damn little, it appears...

...banks‘ competitiveness in the global marketplace...

...newspapers from Boston to Phoenix were awash in articles detailing the economic downfall of the Asian tigers...

...Neither, it seems, are the regulators...

...But just because banks have had their powers expanded an inch does not mean we need to give them a mile...

...First, there is the risk to individual consumers...

...At present, each branch of the financial tree has its own complex set of oversight requirements, resulting in a system that is fragmented, inefficient, and flat-out confusing...

...Alternatively, an umbrella agency could be formed to monitor the system as a whole, as was proposed early in Clinton’s first term...

...Here again, Congress doesn’t need hypothetical models to foresee potential problems...

...4 article in The Washington Post criticized the lack of government oversight of Thailand’s banks as part of a “deregulated financial system run amok...

...media joined in the call for reform...

...Not surprisingly, this proposal is embraced by neither the regulators, who don’t want to risk their current powers, nor the banks, who stand to benefit from their overseers’ war of concessions...

...31 piece in The New York Timec “Inadequate oversight, not over-regdation, caused these problems...

...Because whatever combination of factors ultimately led to Asia’s implosion, its freewheeling banking style did not do good things for the region...

...Everyone clear on that...

...bailout, $2.3 billion for the Bank of New England in 1991...

...In other words, we don’t want a handful of powerful financial conglomerates holding the rest of the economy hostage, nor do we want banks takmg stupid risks with federally insured funds for the benefit of their business affiliates Even as South Korea & Co...

...Stiglitz was, of course, referring to the banking crisis in Asia, but if the shoe fits . . . Sadly, deregulators’ optimism knows no bounds, and financial consolidation is only Step 1 on the agenda...

...Opponents of Glass-Steagall point to studies indicating that, contrary to prior belief, the 1929 crash had little to do with banks’ involvement in the securities business, and they insist that the law serves only to undermine U.S...

...Certainly we want U.S...

...House Banking Committee Chairman James Leach is somewhat more emphatic: ‘‘MMng commerce and banking simply doesn’t fit our kind of democracy,” Leach told fellow committee members last March...

...If Microsoft owns a bank, for example, and a competing software developer applies for a business loan, who can say for certain that the parent company’s interests won’t color the bank‘s lending judgment...

...That’s right, closer...

...Largely because of squabbling between the banking and insurance industries - both of which have a considerable stake in the fine print of a deregulation bill - the Commerce Committee failed to reconcile its version of H.R...

...As a result, the Clinton administration dropped the issue early on, explains Treasury Undersecretary John Hawke, out of concern that further debate would only impede “the cause of modernization...

...There are plenty of more immediate, less dramatic ways the American people (and economy) could suffer, some of which can already be seen across Europe in countries that have “modernized” their banks...

...In fact, GAO data indicate that it’s the regulators we should be pushing to consolidate, rather than the financial sector...

...We found during the bankin, g crisis [of the late OS] that the firewalls tended to get ‘squishy’ when significant problems were raised in the banking organization...

...Consequently, our emphasis should not be on deregulation, but on finding the right regulatory regime to re-establish stability and confidence...

...But commercial banks hold a unique place in our economy...

...And no matter how close to success the “modernization” effort came in 1997, 1998 is an election year, and members of Congress - including Senator D’Amato, who’s up for re-election in November - are loath to risk losing the financial largesse of either the American Bankers Association or the American Insurance Association...

...10, Congress has tried to pass similar legislation at least a half dozen times in the last 10 years - and failed in as many tries...

...financial sector should be approached with caution...

...Germain Act of 1982 cleared the way for the thrift industry to expand its services beyond the basic home-loan business, it took all of seven years for such well-intentioned folks as Charlie Keating to make the industry so “modern” and “competitive” it required a $130 billion (and counting) bailout from t a p ayers...

...With an unshakable faith in the better angels of human nature, they maintain that such laws are unnecessary and that, if only government would keep its meddlesome mitts off the nation’s financial institutions (or telecommunications firms or public utilities or . . .), the upstanding, ultrarational professionals who run these industries could usher in a new era of perfect competition, efficiency, and productivity...

...10 with the one approved earlier by the Banking Committee in time for a floor vote...

...Among other advantages, giving each arm of the financial sector one chief overseer might put an end to the ongoing turf wars, especially those among the banking regulators...

...As James Bothwell told the House Banking Committee: “Our work on past financial institution failures has shown the-importance of having an umbrella supervisory authority to assess how risks to insured institutions may be affected by risks in the other components of a holding company structure...

...The U.S...

...financial pundits, although acknowledging the gravity of the situation, seemed positively gleeful that “the Asian miracle” had at last collapsed, offering definitive proof that Western capitalism is lung...

...banking system closer to that of South Korea and Japan...

...This helps explain how Citicorp racked up $188 million in pretax trading losses in late 1997, thanks largely to the Asian upheaval...

...Advocates of financial consolidation argue that safeguards already exist to prevent such conflicts of interest...

...When asked about such concerns, however, Undersecretary of the Treasury John Hawke - a veteran advocate of banking deregulation - dismisses the comparisons...

...media were celebrating the coming westernization of East Asia’s economies...

...Thus when Kia Motors collapsed last July, for example, it took the Korea First Bank down with it...

...As a matter of fact, right up until Congress’ winter recess - even as South Korea & Co...

...has a totally different kind of system,” he insists...

...Stories in the press, usually buried on page 12 of the business section, positively ooze with steamy talk of prime rates, loan portfolios, and capital requirements...

...The two chief banking regulators - the Federal Reserve and the Office of the Comptroller of the Currency (OCC) - have used a variety of legal loopholes to let banks and bank holding companies into areas such as bond underwriting...

...Federal Reserve system in an effort to “learn the lessons from Southeast Asia and adopt a more cautious approach,” explained the governor of the People’s Bank of China...

...policy makers...

...As for the securities business, although guidelines for fair trading practices are set and monitored by the Securities and Exchange Commission, the health of individual firms is not regulated...

...Under the present system, some activities and firms get double or triple oversight, while others slip through the cracks...

...Congress also aims to do away with prohibitions on banks’ owning, or being owned by, nonfinancial commercial firms...

...Just how squishy is “squishy...

...When the stock market crashed in 1987, then-megabank Continental Illinois (which had already undergone a $4.5 billion government bailout in ’84) breached internal firewalls to prop up a securities subsidiary it operated by special permission from regulators...

...But taking a step toward the South Korean or Japanese system seems a peculiar way to maintain these different traditions...

...A Jan...

...Besides, a system-wide meltdown is merely the worst-case outcome of the “modernization” plan wending its way through Congress...

...banking sector...

...Already, this “too big to fail” phenomenon characterizes the U.S...

...Customer deposits are guaranteed by a government insurance f u i to preserve consumer confidence in - and reduce the danger of a run on - the banks during an economic downturn...

...Ignoring restrictions on the amount banks may loan to subsidiaries, Continental extended $240 million to securities dealer First Options, to cover $90 million in trading losses...

...10, aka the Financial Services Competition Act of 1997 It seems that, in order to keep up with foreign banks, as well as with rival domestic institutions such as stock brokerages, US...

...So, with all this excitement on the international financial scene, what have U.S...

...Similarly, South Korea’s economy is characterized by close ties between its banks and its chaebol, the handful of giant conglomerates that dominate the economy...

...were being told to westernize their financial systems ASAP - members of the House were working fast and furiously to pass a bill that would move the U.S...

...Take the case of the failed Bank of New England: The OCC was responsible for the lead bank, while the Fed was responsible for the bank‘s holding company and the major expansion program it undertook in the late ’80s...

...Under Japan’s keiretsu system, for instance, banks, trading companies, and industrial firms share common stock holdings, an arrangement that lends itself to preferential - and often unwise - financial dealings...

...Lost in this happy world of pure market capitalism, deiegulators seem oblivious to the irony that, as the Associated Press recently noted, Japan is hoping to make its financial sector more competitive with a “Big Bang” reform package aimed at “scrapping regulations . . . that have fostered cozy ties between banks, brokers, and insurance companies...

...But starting in early July, when the value of the Thai currency, the baht, fell through the floor - triggering financial shock waves that soon brought down the Philippines, Indonesia, Malaysia, and South Korea - U.S...

...As Comptroller of the Currency Eugene Ludwig told Congress in 1994, “it is never entirely clear which agency is responsible for problems created by a faulty or overly burdensome or late regulation...

...In late October, the House Commerce Committee put its stamp of approval on H.R...

...And just think of the exciting bailout possibilities there will be once a few dozen mammoth banking-insurance-securities conglomerates rule our economy...

...The US...

...In addition to the crisis in Asia, the mixture of banking and commerce has caused trouble in France (Credit LYOM~~S), Spain (Banesto), and Germany (Deutsche Bank...

...At that point, all hell breaks loose and everybody wants some answers...

...Don’t feel bad...

...Similarly, Brookings Institution banking expert Martin Mayer noted in a March ’97 Wail Street Journal piece on banking deregulation in France, Spain, Sweden, and Finland that...

...10, a comprehensive deregulation bill that would not only tear down the legal walls now separating the banking, securities, and insurance branches of our financial sector, but would also undercut laws barring banks from owning, or being owed by, nonfinancerelated businesses (e.g., currently, Bill Gates and Microsoft cannot own NationsBank...

...Under such a system, in which banks have an understandably tough time maintaining their objectivity and independence, Korean banks lent too much money to their industrial partners during good economic times, only to be left holding the bag when many of their ventures failed...

...The aim of this compartmentalization is to protect the “safety and soundness” of our economy by limiting undue consolidation of resources and preventing conflicts of interests between banks and non-banking affiliates...

...Also in ’96, a Supreme Court ruling dismantled many of the barriers keeping banks out of the insurance field...

...Hardly a glowing recommendation...

...Asia Miracle Fades: Sun sets on crony capitalism,” crowed the Nov...

...Under such an open system, Bill Gates could buy himself a couple of federally insured banks and go into the lending business...

...What’s more, any legislation approved by the House would then pass through the kingdom of Senate Banking Chairman and deregulation cowboy Alfonse D’Amato, whose own “modernization” bill aims to do away with all restrictions on mixing banking and commerce...

...If Merrill Lynch later loses a bundle on pork bellies, how long before Chase feels compelled to bail out its subsidiary, using insured deposits...

...After all, why not take risks in the market if you have a guaranteed source of government funds available to save your bacon when you screw up...

...italics added]) Whatever the origins of our compartmentalized system, the potential dangers of dismantling it remain...

...financial system can, for the most part, be divided into three major categories: insurance, securities, and banking (which typically includes the savings-and-loan industry...

...Rehashing the collapse of Japan’s bubble economy in the early OS, financial pundits traced the roots of the recent crisis to Southeast Asia’s having emulated the Japanese model, with its “cozy” relationships between government, banking, and industry...

...Most recently, a November 1996 decision by the OCC cleared the way for its banks to run subsidiaries engaged in securities underwriting and other services closed to banks themselves...

...As is so often the case, this statement has some truth to it - but entirely misses the point...

...What’s more, as mega-mergers yield conglomerates too economically important for the government to allow to fold, regulators will become increasingly less inclined to interfere in such shenanigans and this type of big-ticket rescue will likely become increasingly common...

...One by one, with varymg degrees of resistance, the ailing nations accepted the IMF‘s conditions, and soon the U.S...

...Now, fans of deregulation tend to be more optimistic than the average shmoe...

...Each focusing on its own regulatory realm, neither the OCC nor the Fed took action to control the combination of risky loans and toorapid growth that ultimately overwhelmed the bank...

...Long lines, surly tellers, obscene ATM fees, and a wait of anywhere from three days to 30 years for a check to clear have combined to make banks a source of minor irritation for most consumers...

...WasKington, however, is not known for its longterm memory, which is precisely why Asia’s current woes should be of intense interest to U.S...

...So much for those fabulous firewalls...

...Not to be outdone, one month later the Fed ruled that bank holding companies may control f m s that earn as much as 25 percent of their revenues from the securities business...

...policy makers learned from the upheaval...

...What’s more, despite Congress’ inability to deregulate the industry, administrative and judicial rulings in recent years have allowed banks to circumvent existing limits on their activities...

...Until recently, rapid growth, coupled with lax accounting and disclosure policies, helped hide the tigers’ bad lending practices, overextended banks, and the general lack of oversight of the region’s financial institutions...

...Then there are the more systemic concerns...

...Otherwise, the next economic crisis to hit the front page of The Wall StreetJoumal may have its roots in New York rather than Bangkok...

...For instance, money market accounts offered by securities firms can function much like checking accounts...

...Moreover, the piecemeal approach to deregulation being taken by the Fed and the OCC only makes things worse, resulting in “overlaps, anomalies, and even some gaps” in oversight, according to James Bothwell’s May ’97 testimony...

...As such, most of us never think about the business of banking at all...

...Until something goes wrong...

...Divided We Stand First, a bit of groundwork...

...Even China, which escaped the storm this time around, announced plans to restructure its banks more along the lines of the US...

...Which, incidentally, is Congress’ major objection to bailing out Asian banks and their foreign creditors...

...If laws such as Glass-Steagall were repealed, so the logic goes, commercial banks could move smoothly - and cautiously - down the path toward providing customers with one-shop -stopping for their financial services needs...

...confused deregulation with supervision, and the same thing happened in Asia.,’ Just something to chew on the next time you’re waiting in line at the ATM...

...Prior to last summer, few Americans could have told you what continent Thailand is on, much less what the country’s financial system looks like...

...If NationsBank and Travelers insurance merge, for example, how can we prevent a system under which the resulting conglomerate, or some of its more enterprising employees, can subtly suggest that a loan is more likely to be approved if the applicant also buys her homeowners insurance from the firm...

...banking system closer to that of South Korea or Japan...

...The Trouble With Inaction There is some good news in all of this: It probably ain’t gonna happen - at least not this year...

...Whether or not Continental had done anything wrong was simply “a matter of interpretation,” the bank‘s chairman and CEO, Thomas Theobald, told the Chicago Tribune shortly after the bailout...

...Under the Glass-Steagall Act of 1933, passed in the wake of the 1929 stock market crash, banks are not allowed to engage in the securities business and vice-versa...

...Suggested the Post, ‘Ks with the savings and loan scandal in the United States, which led to a shakeout of the American fin’ance sector and greater regulation, so too Asia might retool by cleaning up its banking mess...

...Currently, the desire to keep banks happy and prevent “charter swapping” can lead to what has been elegantly termed “a competition in laxity,” whereby one agency extends certain freedoms to the institutions it oversees, prompting other agencies to counter with similar, or even more liberal, allowances...

...In exchange for access to this safety net, banks’ activities are circumscribed by law to minimize financial risk to the taxpayer...

...In recent years, reviews by the GAO found that the current financial regulatory system isn’t really equipped to deal with existing institutions, much less “modernized” ones...

...Unlike the stock and bond markets, with their risk and drama and potential for big returns, the banking industry is decidedly less glamorous...

...were being told to westernize their financial systems, the House was working to move the U.S...

...With fallout from Asia rattling markets from Moscow to Sao Paolo, the international financial community launched discussions on how to prevent future meltdowns...

...Unfortunately for Chairman Leach, who introduced H.R...

...Perhaps...

...The banking yxtem, however, is another matter entirely...

...Despite all of the cheerleading over H.R...

...Since then,” reported The American Banker this January, “negotiations for mergers and joint ventures between banks and insurers have skyrocketed...

...Already, D’Amato has tried to distance himself from the issue, announcing that he won’t waste any more time hawking comprehensive reform until the House manages to pass a bill...

...26 USA Today...

...You know the situation is serious when the Ubercapitalists start sounding like World Federalists...

...Not only does this expose the bank‘s shareholders and depositors to serious losses, it gives Merrill Lynch less incentive to follow cautious investment policy...

...or the Federal Reserve...

...I don’t think you can look at whatever happened over [in Asia] and say this proves the case for the U.S., where we have an entirely different set of regulatory laws and traditions...

...But as Ricki Helfer, then-chairwoman of the Federal Deposit Insurance Corp., told a congressional subcommittee last March, “In times of stress, firewalls tend to weaken...

...No one seems particularly interested in improving the existing regulatory system, so much as loosening it up in the name of competitiveness...

...In a March 1994 statement to the House Banking Committee, the GAO’s then-comptroller general, Charles Bowsher, reported that banks were receiving contradictory advice from regulators concerning lending practices and that “[a]Ithough the regulators try to coordinate their supervision and examination functions, this effort is not always successful and questions of accountability arise...

...When the bubble burst, however, the banks (and the financial experts) were caught with their proverbial pants down...

...But it may be that the modernization “cause” should be impeded...

...If anything, the fact that the old laws are widely considered inadequate to deal with the changing financial landscape suggests that what we need are better regulations, not weaker ones...

...10 as a pure financial consolidation bill, both versions under consideration were amended to allow for the commingling of banking and commerce...

...In such a case, would we really want to bank on Bill “thumb your nose at the federal anti-trust suit” Gates’ respect for healthy competition...

...Nor, according to both federal and state laws, may banks enter the insurance industry...

...Now back to the bad news: Something really should be done to address the onping evolution of our financial sector...

...It seems that, as is the case with so many legislative matters, the devil is in the details: Although most of the major players agree on the broad outlines of a bill, conflict among the bankers, brokers, insurers, and even regulators over the particulars (and Congress’ unwillingness to alienate any of these influential groups) promises to drag out the process a while longer...

...A] consultant at wsk Management Services] said he expects half of all banks to be selling insurance by year-end...

...Otherwise, we may soon find ourselves choking on the words of Joseph Stiglitz, senior vice president and chief economist of the World Bank, in his Oct...

...And don’t think it coincidence that the Fed’s December ’96 decision to loosen the reins on bank holding companies came so close on the heels of the OCC‘s November ruling...

...Banks can choose to operate under either a national charter (regulated by the OCC) or a state charter (issued by state banking commissions and overseen by either the Federal Deposit Insurance COT...

...And the people busy poohpoohing the potential risks of “modernization” should consider the recent comments of former GAO chief Charles Bowsher to The New York Timex “In the early 1980s the U.S...

...30 Wall StreetJoumal...

...banks to remain strong both abroad and at home, but there is no impending crisis to justify deregulation before a solid, updated oversight system can also be put into place...

...The Fed also regulates bank holding companies, umbrella corporations that operate banks, while the Office of Thrift Supervision oversees the S&Ls...

...Of course, as banks establish ties to unrelated and unfamiliar industries, the risk to the economy is compounded and the possibility for conflicts of interest explodes...

...Indeed, the Congress would risk public scorn if it were to endorse a policy which would lead to conglomeration of ownership of assets in America, as well as an expansion of the deposit insurance safety net to commercial activities...

...But such limits have a way of expanding over time...

...Which regulator should have stepped in to prevent the crash...

...In February 1997, the Congressional Research Service reported: “Once viewed as a growth mechanism, German universal banking seems to be troubled by characteristics of private-insider transaction...

...Undaunted, Banhng Committee Chairman James Leach has pledged that “financial modernization” - that’s code for banking deregulation - “will be among the first major issues taken up by the House next year.’’ Now, East Asia aside, those who recall the S&L debacle of the ’80s can probably think of one or two reasons why efforts to deregulate the U.S...

...In the months leading up to the storm, everyone from Money magazine to the International Monetary Fund was touting Southeast Asia’s investment potential and economic fundamentals...

...In fact, 1996 marked the banking industry’s fifth consecutive year of record earnings...

...banks want to expand their “profit centers” beyond the traditional check cashing/money lending business...