CONGRESS BRACES FOR BATTLE OVER BANKING Financial system facing overhaul

WASHINGTON — Washington -- Nothing motivates like fear and desperation. Thus, after years of hemming and hawing, Congress seems ready to change the face of banking in this country, overhauling laws that have governed financial services for more than a half-century.

"We're scared," said Sen. Jake Garn of Utah, the top-ranking Republican on the Senate Banking Committee. "We know that business as usual is no answer."


Confronted by severe strains on the fund that insures bank deposits -- it could be insolvent by year's end -- lawmakers have reason enough to move quickly when they return in September from a five-week recess.

But the battered condition of many commercial banks, starved for capital and reeling from loan losses, has alerted lawmakers to new problem: Encroaching competition from securities firms and insurance companies for such lucrative services as loans and credit cards. Banks have been unable to fight back, thwarted from diversifying into selling stock or insurance by a Depression-era law.


Meanwhile, profits have slid. Banks' return on assets has fallen from 84 cents on the dollar in 1970 to 50 cents on the dollar in 1990, the American Bankers Association says.

Many lawmakers believe banks will go the way of savings and loans -- and that taxpayers will have to pay for another massive bailout -- unless they can halt a half-decade slide that has triggered hundreds of bank failures.

So, last month, banking committees in the Senate and House responded to the Bush administration's call and endorsed sweeping reform packages.

Proposed legislation would open the door to affiliations between banks and securities firms. To bolster the strength of existing banks, both bills would permit interstate banking, allowing banks to buy or open branches in any state. The House bill would go even further, allowing commercial companies, such as Sears or General Motors, to own banks -- yet another tactic to enhance the banks' ability to attract capital.

Those proposals have triggered bitter denunciations. Critics fear banks will be tempted to speculate with federally insured deposits -- a move that could trigger a debacle dwarfing the S&L; crisis. They also worry that widespread interstate banking, designed to help banks lower costs and boost profits, will allow financial conglomerates to siphon credit from one region to another, intensifying gyrations in local economies.

"This bill is the seeds of our destruction," said Sen. Paul S. Sarbanes, D-Md., after he voted against the Senate committee's package. "It is an assault on safety and soundness . . . that will come back to haunt us in the years ahead."

Mr. Sarbanes and his allies promise to put up a fight when the bill comes to the Senate floor next month.

A similar struggle is likely in the House, where proposed legislation must first clear the House Energy and Commerce Committee and its powerful chairman, Representative John D. Dingell, D-Mich., a brazen skeptic about many proposed reforms.


Mr. Dingell and other critics are concerned about proposals permitting industrial concerns to own banks through diversified holding corporations. They worry about the national security implications of a law allowing foreigners -- the Soviets, the Japanese -- to own U.S. banks.

Beyond that, however, their greatest fears come from distant memories of a national nightmare: the Great Depression.

Bank abuses of the 1920s are usually listed as a prime reason for the nation's most severe economic collapse. Those abuses inspired laws that separated banking and commerce, established federal insurance on bank deposits and created a system of small banks to guard against the concentration of economic power.

Today, Mr. Dingell speaks of the "hideous abuses" that occurred in the '20s, when banking and securities were intermingled.

Mr. Dingell's father "lost every penny in a bank that folded," the the congressman recalled, evoking memories of his grandfather's eviction from his farm.

But history teaches other lessons as well. Scholars note that the commercial banks maintaining securities affiliates were not among those that actually failed.


Furthermore, some economists contend that the depression was triggered, not by bank abuses, but by the tight-money policies of the Federal Reserve. The banks, they said, simply were a convenient target for populist fury.

When considering the banks' plight, some banking industry leaders reflect on the decline of the once-mighty railroads. That was triggered, they say, by federal regulations that prevented railroads from diversifying into newer forms of transportation.

"It's an accurate analogy," said Mark Burneko of the American Bankers Association. "We're locked in a regulatory environment that is not allowing banks to adapt to consumer demands and the changing marketplace."

At first glance, traditional banks seem to be surrendering in much the fashion of the old railroads.

Last year, banks accounted for just 15 percent of all loans in the United States, nearly half the level of a decade ago. And they held a bit more than 30 percent of the nation's financial assets -- compared with more than half in 1950.

Meanwhile, car loans from the "Big Three" automakers and credit cards from the likes of Sears, Roebuck and Co. and AT&T; have eaten away at the banks' traditional home turf.


Wall Street investment houses have captured another big chunk of traditional bank business with money-market funds invested in U.S. Treasury bills and home mortgages packaged into tradable securities sought by pension funds and other institutional investors.

That raises another crucial question: Should the government grant banks new powers if their economic significance is diminishing?

One skeptic is Herbert Stein, the Nixon administration's chief economic adviser.

He argued in a Wall Street Journal op-ed piece that banks' scope ought to be narrowed rather than broadened, their lending restricted to such steady instruments as Treasury bonds and their services limited to providing a safe haven for small savers.

The bankers' appeal for relief, Mr. Stein argued, should be

discounted as nothing more than a special-interest plea. "The demand for banking reform does not come from non-financial business or from homebuyers or consumers or depositors who claim that they are inadequately served by the present system," he said.


Arguments over the macroeconomic ramifications of that idea quickly become dizzyingly complex. In the current context of the banking reform debate, they also are irrelevant.

Right or not, the political establishment has fallen in line with the Bush administration's assessment that banking is a "key industry" and that the economy's health is clearly influenced by its profitability and competitiveness.

Add the president's influence to Friday's General Accounting Office report -- which predicted that the banking insurance fund "will likely be insolvent" by year-end -- and it's clear that the banking industry is poised for some dramatic changes.

Comparing the banking bills

Banking reform bills moving through the House and Senate are designed to restore financial integrity to a weakened system, in part by overhauling a host of federal laws considered out-of-date.

Although banking committees in both chambers have endorsed


similar bills, many legislators still argue over which laws are antiquated, and how they should be reformed. These disagreements will be thrashed out in further committee -- and floor -- action after lawmakers return in September.

1) Both bills would replenish the nearly depleted deposit insurance fund and overhaul the insurance system so taxpayers don't have to foot the bill for future bank failures.

2) Both bills would direct the Federal Deposit Insurance Corp. to continue insuring individual accounts up to $100,000.

3) Both bills would allow the FDIC to borrow up to $30 billion from the U.S. Treasury, to be paid for by increasing premiums on the Bank Insurance Fund.

4) Both bills would grant banks broad new powers to affiliate with securities firms and to open branch offices nationwide, shattering the federal law that has been the cornerstone of modern banking for the last 58 years.

5) Both bills would open the door to interstate banking, allowing financial holding companies to buy or to start banks in any state, subject to that state's regulations.


6) The House bill would, for the first time in 35 years, remove federal bans on bank ownership by non-banking companies, allowing companies such as McDonald's or IBM to buy banks. The Senate panel rejected a similar proposal.

7) The Senate bill would prevent banks from underwriting insurance policies, reversing a recent appeals court decision that would permit state-chartered banks to underwrite insurance nationwide. The House bill, meanwhile, would allow diversified holding companies to own both banking and insurance firms in separate subsidiaries.