Vol. 2001-3

Readers may recall that when writing about the enactment of financial modernization legislation (the Gramm-Leach-Bliley Act), I pointed out that if the Act were to be truly effective it would have to be supplemented, as early as possible, by "regulatory reform, deposit insurance reform, and elimination of the near theological belief that a line must be drawn between banking and commerce" ("Financial Modernization Legislation: The End of the Beginning," Vol. 1999-9, p. 10). Of the three, I concluded, as have many others, that the first, regulatory reform, was most urgently needed. I dealt with that subject in a lengthy, double report, "Reform of the Financial Regulatory Structure" (Vol. 2000-2&3, March 20, 2000). The present report, the first of two and coming just about one-year later, is not nearly as lengthy, for which many readers will doubtless be thankful.

For the authors of the Gramm-Leach-Bliley Act, financial modernization essentially meant lowering or eliminating the barriers between or among the various financial services industries. They dealt only incidentally with regulatory agency structure and responsibilities, and even then not very clearly. Which is to say that the Act did not fully recognize that: "The combination of integrated financial markets and fragmented national regulation raises major public policy issues," (Michigan Journal of International Law, Summer 1999, Vol. 20, No. 4, p. 596). One such issue is the need to assure that financial regulation does not become stultifying or counter-productive as the number of agencies involved in regulation increases. Dramatically reducing the number of agencies, along with provision for centralized direction, is the obvious answer, but how to do this is far from easy, particularly in this country.

Perhaps the most difficult public policy question posed by regulatory structure reform involves the role of the central bank. The question is clear: should the regulation of an expanding banking and financial services industry have as its primary objective the soundness and vitality of the system, or should supervision and regulation play a subsidiary role, designed to help the central bank achieve its national macroeconomic goals? It is a question being addressed with increasing frequency by other advanced nations in recent years. In the United States, there are strong and powerful advocates of each position. However, the Congress, along with the banking and financial industry, continues to ignore it officially, even though it is impossible to be unaware of its significance. These two issues – agency consolidation and the role of the central bank -- are dealt with in the present report, with the focus only on developments during the past year. Extensive background information is available in earlier reports, copies of which we would be happy to make available to readers at no charge.

Another, quite different, issue centers on the extent to which the United States banking structure is supported (or even improved) by the fragmentation of regulatory authority at the federal level. For those persons – and I am one – who believe that, notwithstanding its faults, the record of the U.S. banking and financial system over two centuries has proven to be far superior to that of any other advanced nation, this issue is particularly tough to handle. And it has special relevance only to this country. The problem is not that the subject is ignored by Congress and others, as is the case with the conflict between system goals on the one hand and macroeconomic goals on the other. Rather, it is an issue of which most people are unaware. This subject is covered in the next report (Scorecard on Regulatory Structure Reform: II), which should be published within the month, barring any unforeseen developments. As with the present report, it will focus on recent events, and includes some aspects of deposit insurance reform that have implications for changes in agency structure.