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Modernizing Financial Services: the Glass-Steagall Act Revisited

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Modernizing Financial Services: the Glass-Steagall Act Revisited MODERNIZING FINANCIAL SERVICES: THE GLASS-STEAGALL ACT REVISITED National Association of Federally-Insured Credit Unions NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 1 INTRODUCTION: Since the financial crisis, the credit union industry has experienced significant consolidation in the financial marketplace while the largest banks have reaped record profits and grown in both size and scope. From 2008 to 2017, the National Credit Union Administration (NCUA) chartered only 29 new federal credit unions while, during that same period, 2,528 credit unions closed or merged out of existence. The post-crisis regulatory environment has contributed to this decade-long trend of consolidation, but credit unions have also faced barriers to growth in the form of field of membership rules, capital requirements, and limits on interest rates, among many other restrictions. Accordingly, while it is essential to promote regulatory relief that reduces compliance burdens, credit unions also need modern rules to evolve and grow. Regulatory burden and the pressure to consolidate affects more than just the credit union industry. Community banks have experienced similar declines.1 The lack of new charters among community institutions illustrates the extent to which complex and poorly tailored regulations have put a stranglehold on growth and, by extension, limited consumer financial services. In recognition of these trends and the need for regulatory relief, Congress recently passed the Economic Growth, Regulatory Relief, and Consumer Protection Act (S. 2155). S. 2155 garnered bipartisan support and helped alleviate some burdens associated with reporting under the Home Mortgage Disclosure Act and the NCUA’s member business lending rules, and provided new safe harbors for compliance with federal consumer financial protection laws. Although many of S. 2155’s provisions afford regulatory relief to small financial institutions, much more needs to be done to ensure that credit unions 1 See Michael Kowalik, et. al, Bank Consolidation and Merger Activity Following the Crisis, 100 Federal Reserve Bank of Kansas Economic Review 31 (2015). NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 2 of all sizes are able to succeed. Unfortunately, recent measures aimed at granting credit unions additional regulatory flexibility have been attacked by various banking coalitions, who view any measure of relief afforded to credit unions as a competitive threat. NAFCU continues to advocate for meaningful relief for credit unions, but modernizing credit union-specific rules may not be enough to guarantee a vibrant and competitive marketplace for community financial institutions of all types and sizes. This paper explores other solutions to creating a healthy and competitive banking system. One solution worth consideration is the creation of a modern Glass-Steagall Act (GSA), which would alleviate competitive inequalities and improve overall financial stability in times of stress by separating commercial and investment banking activities. NAFCU supports a bipartisan effort to create a modern GSA because, as many on both sides of the aisle, including former Speaker of the House of Representatives, Newt Gingrich (R-GA), have recognized: “[R]epealing the Glass-Steagall Act was probably a mistake. We should reestablish dividing up the big banks into a banking function and an investment function and separating them out again.”2 During the financial crisis, the shadow banking system came under severe strain, revealing the inherent risks associated with ending the traditional separation of commercial and investment banking. In 2011, the bipartisan Financial Crisis Inquiry Commission reported that between the passage of the Gramm-Leach-Bliley Act (GLBA) and the financial crisis, “regulation and supervision of traditional banking had been weakened significantly, allowing commercial banks and thrifts to operate with fewer constraints and to engage in a wider range of financial activities, including activities in the shadow banking system.”3 In that same timeframe, credit unions focused their efforts on improving traditional banking products and services, consistent with their role as depository institutions. As member-owned, not-for-profit cooperatives led by volunteer boards of directors, credit unions exist to serve their membership, a prerogative that has insulated the credit union industry from the speculative, risk-taking activities that large banks have embraced. Credit unions do not abuse their members’ trust by taking large, illiquid positions in opaque investments through affiliates. In addition, no credit union is “too big to fail,” which eliminates the moral hazard that occurs when a large financial institution exploits implicit or explicit government guarantees to subsidize high-risk activities outside of the core business of banking. 2 Pat Garofalo, “Gingrich Admits Deregulation of Wall Street in the ‘90s Was ‘Probably A Mistake,’” Think Progress (Nov. 8, 2011), available at https://thinkprogress.org/gingrich-admits-deregulation-of-wall-street-in-the-90s-was-probably-a- mistake-4bb53f03793d/. 3 U.S. Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report (Jan. 2011), available at https://www.gpo. gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf. NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 3 NAFCU believes that the lack of appropriate separation between commercial and investment banking activities presents risks that are worth legislative consideration. A significant aspect of this risk involves reliance by nonbank financial firms on deposit accepting banks to secure liquidity in times of financial stress or crisis. NAFCU believes that such dependency undermines financial stability in the long term, which puts both credit unions and their members at risk. Consequently, NAFCU recommends that Congress consider the creation of a modern GSA to address bipartisan concerns related to the increasingly interconnected and interdependent shadow banking system. EXECUTIVE SUMMARY: The Federal Credit Union Act (FCU Act) established the credit union system with the mission of extending credit for provident purposes to consumers. This underlying principle has dictated the approach credit unions have taken in the delivery of financial services: measured, safe, and community-driven. Credit unions have always put consumers first. Large banks, on the other hand, have historically taken a much different approach with the ultimate goal of accumulating massive profits. As banks continued to exponentially grow their branches and investment activities, Congress began to take notice. In 1933, Congress enacted the GSA to separate commercial and investment banking activities, but the range of securities activities that banks were permitted to engage in continued to expand. This culminated in the repeal of the GSA by the GLBA in 1999. After the passage of the GLBA in 1999, large banks exploited their size by leveraging networks of affiliated non-bank entities to achieve liquidity transformation on a global scale. The largest banks had already blurred the lines between commercial and investment banking activity in the 1970s and 1980s, but the repeal of sections 21 and 32 of the GSA after the passage of the GLBA permitted unprecedented interlock and affiliation between investment banking entities, such as private equity firms and hedge funds. The GLBA marked a turning point in the U.S. financial system, whereby the largest banks grew even more complex to accommodate what economists call “shadow banking:” a process of credit intermediation that relies on deposits held at commercial banks to fund illiquid, long-term investments. This repeal of portions of the GSA only benefited large banks by incentivizing megamergers and the creation of institutions that can engage in virtually unlimited activities, oftentimes outside the reach of federal and state regulators. The financial NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 4 industry has also seen immense consolidation along with the rise of large, complex conglomerates.4 The credit union industry, in particular, has been facing rising rates of consolidation, which will likely continue without more opportunities to compete.5 Since the repeal of the GSA and especially after the 2008 financial crisis, there has been much discussion of reinstating a modern version of the GSA to reign in Wall Street excesses and encourage a more competitive and safe financial system for institutions of all sizes. Massive fines levied against the largest banks have called into question whether these institutions are capable of preserving the public’s trust.6 Furthermore, the staggering amount of civil penalties paid by the largest financial institutions reveals the extent to which megabanks overshadow the regulatory landscape itself, especially when penalties are compared with those levied against smaller institutions.7 In this context of uncertainty regarding the role and ethical standards of the largest banks, the 2016 presidential election brought to light a rare moment of consensus among both the Republican and Democratic parties. Both sides of the aisle agreed in their 2016 party platforms that reinstating the GSA could bring much-needed security and stability to our economy and help protect consumers.8 Federal deposit insurance should not be used to subsidize big banks’ reckless gambles with their consumers’ deposits. Consumers should have confidence in the system and
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