Bank On Change

By Daniel Kadlec

Last year the deal-a-day CEO of financial-services giant Travelers Group, Sanford I. Weill, called then Treasury Secretary Robert Rubin to impart important news. "You're buying the government?" Rubin quipped. Well, no. But the remark was more on the money than either could have known.

Weill was proposing to merge Travelers, deeply ensconced in insurance and stock brokerages, with the nation's second largest bank, Citicorp, in a deal that would tread all over Depression-era legislation prohibiting such an expansive combination. He would need bank regulators, immediately, and Congress, in short order, to clear a path. No surprise to Weill watchers, "Sandy" got what he needed, and more.

The Federal Reserve, the main bank regulator, quickly granted Weill and his new partner, co-CEO John Reed from Citi, a grace period to sort things out. Long before they would have to do any actual sorting, though, Congress is now fixing things for good. President Clinton is expected to soon sign a bill repealing the decades-old restrictions that have divided brokerage and banking into infusible industries. The bill sweeps aside the Glass-Steagall Act and blesses the brave new banking world embodied in Weill's $689 billion behemoth, Citigroup. Lest there be doubt as to how fully Weill routed the regulators: Rubin, who left government this summer, joined Citigroup last week as a co-chairman.

In theory, there's plenty in the Financial Services Modernization Act for everyone. Individuals should end up getting faster answers and better rates on things like home mortgages and insurance, and corporate clients will be able to issue stock and buy directors' insurance with a single call. One-stop shopping for financial services up and down the customer ladder is mainly what this bill is about. Yes, you've heard it before, and, yes, it failed miserably in the 1980s. (Remember Sears, which added another dimension--buy stocks where you buy socks?) But with the government's stamp of approval on Citigroup's no-limit money enterprise, that model is sure to get another, more thorough test.

The model has devout believers. "I'm absolutely thrilled," comments James D. Robinson, who as CEO of American Express in the 1980s tried to marry banking, credit cards and other products with brokerage services in a financial supermarket. His plan dissolved amid corporate infighting and data-sharing nightmares that are now easily remedied with more powerful computers and better software. Another booster is Congressman Jim Leach, chairman of the House Banking Committee. He predicts that the bill will save consumers $15 billion a year in lower rates and fees.

Be advised, though, that even if it all works, financial services could get more confusing in the short run as the industry adjusts. If the model ultimately fails--and make no mistake, the jury is still out--shareholders in these newfangled financial companies may feel a sharp sting.

Among the certain winners are dealmakers like Weill and countless others who earn their living swimming in the deal flow. By tearing down barriers between banking, insurance and brokerage, Congress practically erected a billboard on Wall Street reading MORE SALAD DAYS AHEAD. Few financial companies will want to brave the world of financial conglomerates with only one weapon. Anticipating a torrent of consolidation, speculators have been driving up shares of potential target banks, such as Chase, and brokerages, such as PaineWebber.

But many believe that the speculation is unwarranted. "This bill doesn't materially change the products or activities that banks are interested in getting into," says George Bicher, bank analyst at Deutsche Bank Alex. Brown (speaking of mergers). As a practical matter, Bicher notes, Glass-Steagall lost its teeth long ago. Exploiting loopholes and a remarkably tolerant Fed, banks and insurers and brokerages have been invading one another's turf for two decades. Still, some new combinations are inevitable. Says David Stumpf, senior bank analyst at A.G. Edwards: "We will see some consolidation among banks and insurance companies, with banks doing the buying."

The new bill is also about making financial-services firms in the U.S. big enough to compete with universal banks in Europe and Japan. Banks there have long been free from the kind of separation that has ruled in the U.S. since Senator Carter Glass and Representative Henry Steagall bonded in 1933 to draft the defining financial legislation of the 20th century. Born in tough times, Glass-Steagall expanded the powers of the Fed in controlling credit. It established the Federal Deposit Insurance Corporation, which insured bank deposits. Most important, the act required banks to choose between being a simple lender (a bank) or an underwriter (a brokerage).

For decades, few challenged the wisdom of separating risky underwriting activities from federally insured bank savings deposits. But by the 1970s the financial world had become more muddled. Merrill Lynch, for example, began to offer money-market accounts with a check-writing feature. As the lines between banks and brokers blurred, Glass-Steagall came under repeated attack, starting in the 1980s. "I spent a lot of time lobbying Congress to convince them that we needed to look beyond the parochial interests of banks, brokerages, insurance companies and mutual funds," says former AmEx boss Robinson, now investing in tech start-ups. "We needed to view them as one industry. I was just a little ahead of my time."

Glass-Steagall lost all its teeth this decade, starting in 1990 with a Fed decision allowing J.P. Morgan to begin underwriting securities. In 1997, Bankers Trust (now owned by Deutsche Bank) bought the investment bank Alex. Brown and officially married two businesses divided since the Depression. Meanwhile, banks had begun marketing annuities and mutual funds, and brokers had begun offering CDs and loans. Leaders in all corners had come to agree that Glass-Steagall was obsolete. They just couldn't compromise and find a solution.

Now that they have and lawmakers have hopped on board (barring last-minute bickering), not everyone is happy. "This is horrible legislation," says bank analyst Lawrence Cohn at Ryan, Beck & Co. "It creates a huge potential obligation for U.S. taxpayers." How's that? Cohn says the new bill will encourage concentration of financial power in a few hands, any one of which could topple the system if it failed--forcing a government bailout. He has strong support from the likes of consumer activist Ralph Nader.

But the yelping over firms getting too big to fail is nothing compared with the wailings of privacy activists. They fear that companies engaging in a broad range of financial services will have carte blanche to, say, check bank records before granting health insurance. "This will legalize unprecedented and Orwellian surveillance of the daily lives of bank customers," asserts the U.S. Public Interest Research Group in Washington, one of many consumer groups demanding that Congress kill--or Clinton veto--the bill. The industry says this is all overblown, and lawmakers behind the bill note that specific points in the legislation require full disclosure of any information sharing that will go on.

Either way, there's no derailing the train at this point. And if the end of Glass-Steagall heralds a world in which one phone call will enable you to buy a house, get a mortgage and insurance too--and at lower rates than in the past--maybe the risk is worthwhile.

--With reporting by Bernard Baumohl and Aixa M. Pascual/New York and Adam Zagorin/Washington

With reporting by Bernard Baumohl and Aixa M. Pascual/New York and Adam Zagorin/Washington