Unshackling The Troubled Banks

By John Greenwald

It was the most heartening news that America's troubled big banks have had in years. In a bid to strengthen the flagging industry, Treasury Secretary Nicholas Brady last week urged Congress to sweep away laws that have limited bank activities since the Great Depression. Under his proposed reforms, banking companies could easily expand across state lines and become financial supermarkets that offer everything from stocks and bonds to life insurance. Treasury said the plan would also seek to shield taxpayers from any replay of the savings and loan fiasco. "If we expect to exert world economic leadership in the 21st century," Brady said, "we must have a modern, world-class financial-services system in the U.S."

Major banks had long sought a plan like this one to help extricate them from their current crisis. Many banks spent the 1980s chasing long-odds business, such as loans to Third World countries and commercial real estate developers, after their best corporate customers began to borrow more cheaply in money markets. With many of those new customers now in trouble, the banks face more bad debts than ever before. Meanwhile aggressive foreign lenders in Japan and elsewhere, which operate under fewer restrictions, swiftly outpaced their American rivals. While nine U.S. banks were among the world's 30 largest in 1969, only Manhattan-based Citibank made the list in 1989. And it plunged from No. 3 (behind Bank of America and Chase Manhattan) to No. 27.

Critics doubt the wisdom of unleashing U.S. banks to expand into new areas. "This is the same cart-before-the-horse mentality that plagued the deregulation of the savings and loan industry," charged Henry Gonzalez, a Texas Democrat who chairs the House banking committee. "Let's set the speed limits and train the policemen before we open a new superexpressway for financial institutions."

The most bitterly contested part of the Treasury plan would let banks enter new fields that may be unrelated to financial services. Strong banking companies would be permitted to affiliate with anyone from Merrill Lynch to McDonald's. So-called fire walls would prevent banks from risking federally insured deposits in the new ventures. The plan would also let banks create nationwide networks of branches within three years under a law that would replace the current crazy-quilt pattern of state rules that govern interstate banking.

Brady was clearly mindful of the S&L mess when he put forth his proposals. To avoid taxpayers' having to bail out failed banks, the plan would limit depositors to a total of $200,000 of federal insurance per bank. That would include $100,000 in checking and savings accounts and $100,000 in retirement accounts.

Bank customers who wanted to beat the $200,000 ceiling would have to open accounts in several banks. That's just what the Treasury would like, since the rule would dissuade depositors from piling into a struggling institution that was offering impossibly high interest rates in a desperate bid for customers -- as often happened in Texas in the '80s. But the Treasury opened a wide loophole by failing to junk its too-big-to-fail doctrine. Under that policy, which is intended to prevent runs on deposits at large institutions, the government makes good on the entire account -- no matter how sizable -- that a major depositor holds in a large bank. That particularly worries small-town bankers, who fear customers may flee to larger rivals.

The Treasury remained silent on the most pressing issue confronting banks: how to replenish the nearly broke Federal Deposit Insurance Corporation fund, which insures accounts. The beleaguered fund sank to a record low $8.5 billion after 169 banks failed last year. Without fresh cash, it could go bust by the end of 1991 if the current recession lasts all year. The Treasury left the details of rescuing the fund up to the FDIC and the banking industry. FDIC Chairman William Seidman later said that to rescue the fund, the agency might raise banks' insurance premiums 20% to 30% as of June 30 to pay interest on government borrowings of up to $15 billion.

Does the Treasury's reform program stand a chance in Congress? Experts say that limiting deposit-insurance coverage has the brightest prospects in the wake of the S&L bailout. Lawmakers may also look favorably on letting banks expand geographically. The odds are probably longest against permitting banks to diversify into new businesses.

Even if the program passed intact, it would hardly end the troubles of big banks overburdened with poor loans. "There is no magic solution that will fix the banks' problems," says Lawrence White, a New York University economist. "The banks made a whole lot of bad loans, and nothing is going to solve that over the short run." The long run is another matter. While the ambitious plan is certain to stir furious debate, the flexibility it promises just might yield a more profitable and competitive U.S. banking system in the next century.

With reporting by Gisela Bolte/Washington