INTL FINANCIAL SYSTEM JOINT CLASS FOURTEEN US REGULATORY STRUCTURE Prof. David K. Linnan UI-UGM-USC-UNDIP - USU Univ. of South Carolina Joint Videoconferenced Class School of Law November 7, 2002

RESTRUCTURING REGULATION CAPITAL VS BANKING MARKETS Banking- Central Banking Functions vs Prudential Regulation Capital markets, but also insurance, pension funds & other financial institutions

RESTRUCTURING REGULATION CAPITAL VS BANKING MARKETS US Structures Dual Banking system Securities & Exchange Commission (plus state blue sky agencies) CFTC State insurance regulation Pension regulation (state & federal)

US BANKING REG HISTORY HOW WE GOT HERE National Bank Act of 1864 Pre-existing state banks (free banking tradition since 1838, meaning not a specific charter as business license), so created dual banking system and defined business of banking as to this day deposit-taking & extension of credit

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Federal Reserve Act of 1913 Created Federal Reserve as central bank plus gave prominent role in banking supervision

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Edge Act of 1919 International banking authorization for banks to create special purpose subs (so Citi is not new phenomenon)

US BANKING REG HISTORY HOW WE GOT HERE (Contd) McFadden Act of 1927 Established dominance of state banking laws to determine interstate banking structures, essentially prohibiting interstate branching in theory to preserve community banking

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Banking Acts of 1933 & 1935 As response to 1930s banking crisis, 1.separate commercial from investment banking (so commercial banks could not be universal banks in European model, investment banking being core capital markets activity), 2.established interest ceilings on deposits, 3.established FDIC as insuror with regulatory powers, 4.restricted bank activities particularly interlocking directorates and insider lending, 5.generally broadened supervisory powers

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Federal Home Loan Bank Act of 1932 and Federal Credit Union Act of 1934 Established parallel institutions with special housing & mutual markets covered also by insurance, with own parallel regulatory structure

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Bank Holding Company Act of 1956 & 1970 amendments Federal regulation for bank holding companies under Federal Reserve, in effect upholding longstanding rule that financial & industrial sector ownership separated

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Savings & Loan Holding Company Act of 1967 Parallel S & L regulation like BHCA, but under FHLBB

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Depository Institutions Deregulation & Monetary Control Act of First big deregulatory financial sector statute, 2.phasing out deposit interest rate ceilings, 3.Expansion of permissible S & L activtties 4.Authorizing nationwide NOW accounts (negotiable order of withdrawal, a special check-like instrument) Background of S & Ls suffering asset & liability mismatch & opening up competition in sector more generally

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Garn-St. Germain Depository Institutions Act of Authorised money market deposit accounts (basically, competition from mutual fund industry selling commercial paper destroyed interest rate ceiling & this duplicated competitions product), 2.Strengthening S & L industry again

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Competitive Equality Banking Act of 1987 Targeting so-called non-bank banks as unregulated lenders, given that businesses were trying either to not take deposits (usually), or not make loans going all the way back to 1864 banking activity definition, but grandfathering institutions like consumer finance & industrial lenders (Household Finance, GE Credit, etc.)

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Financial Institutions Reform, Recovery and Enforcement Act of Replaced FHLBB with OTS in Treasury as supervisory authority for S & Ls, 2.Created Resolution Trust Corporation (RTC) for managing failed thrifts & selling assets, 3.Re-regulated much of S & L asset side (investments, meaning lending mostly), cutting back on non-housing loan activities plus commercial real estate lending Functionally, a decent burial for the S & L industry debacle of 1980s

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 Basically undid the McFadden Act in enabling interstate branching and so nationwide branching (in part in response to pressure on S & L side, meaning banks threatened to convert to thrifts, since they did not have the same constraints)

US BANKING REG HISTORY HOW WE GOT HERE (Contd) Gramm-Leach-Bliley Act of 1999 Basically undid formal prohibition in Glass-Steagall Act of commercial banks doing investment banking activity and 1956 BHCA of insurance activity if done through a bank holding company structure, with the result that we now have Citigroup, meaning Citibank- SalomonSmithBarney-Travellers as financial supermarket-- however, there had been regulatory loosening since early 1980s under regulatory interpretation of what was permitted banking business, etc.

US BANKING REG HISTORY HOW WE GOT HERE (Contd) How do you regulate Citigroup realistically as a worldwide financial conglomerate? Instead, drifting under Basel Accord towards what begins to look a little like capital markets SRO self-regulation…. We have gotten here because 1.technology changing the nature of financial services, 2.the sheer size of institutions like Citi (growing concentration), 3.blurring of lines re financial products such as uninsured money market funds as SEC-regulated investment companies investing in commercial paper versus traditional insured bank deposits, and 4.financial engineering practices like securitization and the secondary mortgage market with GNMA guarantee under which for housing we really no longer need S & Ls as real dedicated lenders.

OTHER MODELS? HOW WE GOT HERE (Contd) What are the appropriate regulatory models outside US (consolidated financial sector regulators looking at UK first)? US probably stuck with Fed as central bank vs. Fed Banking Regulators (OCC, FDIC, Fed) vs. State Banking Regulators vs. SEC vs. State Blue Sky vs. CFTC vs. Credit Unions, etc. and federal/state regulatory split on insurance generally as matter of political economy, 1.Unless and until we have a high-enough profile financial institution debacle to trigger another round of regulatory reform. 2.So, was Enron that debacle in waiting or is it really a regulatory success? 3.In what regulated business, if any, was Enron actually engaged?