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 industry has experienced significant consolidation in the financial marketplace while the largest 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, Consolidation and Merger Activity Following the Crisis, 100 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 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 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 ona 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 know that their financial institution cares more about maintaining a mutually-beneficial relationship with its consumers than allowing private investors to influence their decisions all in the name of profits.

A modern version of the GSA should be designed to protect consumers against future financial crises, ensure that traditional depositories can continue to thrive in a stable financial marketplace, and reduce the competitive inequalities and moral hazard that arises when large banks take risks on consumer deposits to generate profits. In this regard, Congress should go beyond restoring the repealed provisions of the GSA, which

4 See Arthur E. Wilmarth Jr., The Road to Repeal of the Glass-Steagall Act, 17 Wake Forest J. Bus. & Intell. Prop. L. 441, 545 (Summer 2017). 5 See National Association of Federally-Insured Credit Unions, 2017 NAFCU Report on Credit Unions, 11, (November 2017), available at https://www.nafcu.org/data-tools/nafcu-annual-report-credit-unions; see also FRBSF Economic Letter 2011-28, Credit Union Mergers: Efficiencies and Benefits (September 12, 2011), available at https://www.frbsf.org/ economic-research/files/el2011-28.pdf. 6 See Bill Chappel, “Wells Fargo Hit With $1 Billion in Fines Over Home and Auto Loan Abuses,” National Public Radio (April 20, 2018), available at https://www.npr.org/sections/thetwo-way/2018/04/20/604279604/wells-fargo-hit-with- 1-billion-in-fines-over-consumer-abuses; Bill Chappel, “JPMorgan Chase Will Pay $13 Billion in Record Settlement,” National Public Radio (Nov. 19, 2013); available at https://www.npr.org/sections/thetwo-way/2013/11/19/246143595/j-p- morgan-chase-will-pay-13-billion-in-record-settlement; Jim Zarroli, “Citigroup Agrees to $7 Billion Fine for ‘Egregious’ Misconduct,” National Public Radio (July 14, 2014), available at https://www.npr.org/2014/07/14/331425796/citigroup- agrees-to-7-billion-fine-for-egregious-misconduct. 7 See MarketWatch, “Here’s the staggering amount banks have been fined since the financial crisis,” (Feb. 24, 2018), available at https://www.marketwatch.com/story/banks-have-been-fined-a-staggering-243-billion-since-the-financial- crisis-2018-02-20 (Banks have been fined $243 billion since the financial crisis). 8 See 2016 Democratic Party Platform (“Banks should not be able to gamble with taxpayers’ deposits or pose an undue risk to Main Street. Democrats support a variety of ways to stop this from happening, including an updated and modernized version of Glass-Steagall…”); Republican Platform 2016 (“We support reinstating the Glass-Steagall Act of 1933 which prohibits commercial banks from engaging in high-risk investment).

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 5 had already eroded prior to the passage of the GLBA as the result of deregulatory action taken by the Board of Governors of the Federal Reserve System (Federal Reserve), the Office of the Comptroller of the Currency (OCC), and the Federal courts. To reduce the risk of “too big to fail,” a modern GSA should fundamentally reconsider what constitutes the “business of banking” for Federal Reserve member banks and appropriately limit such business to traditional commercial banking activities.

NAFCU envisions a future state where financial institutions work harmoniously for the benefit of consumers to help propel our economy and nation forward, both domestically and on the international stage. Several of NAFCU’s member credit unions have branches in international locations, and the stronger our financial system and economy, the more competitive and successful this international presence can become. This could provide America with an opportunity to lead others in the movement and demonstrate the importance of putting the interests of consumers ahead of private investors and an increase in rent-seeking behavior. Reforming our financial system and reinstating the GSA to separate commercial and investment activities would allow credit unions and other financial institutions, particularly newly formed institutions, increased opportunities to compete because there would be fewer barriers to entry and more room for growth. A financial services marketplace largely devoid of a credit- granting process influenced by private investors would not only lead to enhanced safety and soundness but also increased liquidity and flexibility in the market overall. A more stable and vibrant economy that captures the confidence of American consumers would be the result. NAFCU urges Congress to be bold: stand up to Wall Street and stand with American consumers.

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 6 BACKGROUND: The Glass-Steagall Act is the modern name given to the Banking Act of 1933, which was enacted in response to the stock market collapse of 1929 and ensuing financial crisis. The purpose of the GSA was to “provide for the safer more effective use of the assets of the Federal Reserve Banks and of national banking associations, to regulate interbank control, to prevent undue diversion of funds into speculative purposes, and for other purposes…” The GSA imposed rules on Federal Reserve member banks to require separation of commercial and investment banking activities.

Today, the GSA is most closely associated with its separation provisions. In its original form, the GSA had four sections which defined the types of activities considered to be the business of banking and restricted the types of institutions that could engage in those activities. Section 16 of the GSA set forth the types of securities national banks could underwrite. Section 20, which was repealed by the GLBA, restricted Federal Reserve member banks from affiliating with businesses “engaged principally” in investment banking. Section 21 applied to securities companies and prohibited them from engaging in deposit taking activities. Section 32—also repealed by the GLBA— prohibited member banks from having interlocking directorates and shared officers with companies “primarily engaged in investment banking.”

The contents of the GSA were informed by Congress’ desire to prevent subsequent financial crises and limit conflicts of interest at traditional depository institutions. In response to the 1929 financial crisis, the Senate authorized the Senate Committee on Banking and Currency (often referred to as the “Pecora Commission”) to conduct an investigation into the “abusive” banking and securities practices that might have fueled financial instability.

The Pecora Commission identified a number of conflicts of interest and other “[a]buses arising out of the interrelationship of commercial and investment banking” that played a role in the crisis.9 Specifically, the Pecora Commission found that commercial banks were “violating their fiduciary duty to depositors seeking disinterested investment counsel by referring such inquiries to their affiliates.”10 Although the Pecora Commission’s official report was not issued until 1934, members of Congress were well aware of the ongoing hearings and investigations when they deliberated on the Banking Act of 1933.

9 U.S. Senate, The Pecora Investigation: Stock Exchange Practices and the Causes of the 1929 Wall Street Crash, 113 (2010). 10 Id. at 163.

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 7 In the years following enactment of the GSA, runs on depository banks were less common, and the financial marketplace enjoyed a period of improved financial stability. Baking conglomerates that had previously maintained commercial and investment banking arms were forced to split up; however, commercial banks and investment banks continued to grow. Credit unions were unaffected by the GSA because of their unique structure and community-based focus. The defining characteristics of a credit union, no matter what the size, remain the same today as they did when the FCU Act was passed in 1934. Credit unions were and continue to be restricted in where they can invest their members’ deposits.

The clear separation of commercial and investment banking activities effectuated by the GSA did not last long. As regulatory interpretations of the “business of banking” evolved, separation between commercial and investment banking activity grew less distinct. With the passage of the (BHC Act) in 1956, the GSA’s four firewall provisions were extended to multi-bank holding companies. However, the BHC Act also authorized the Federal Reserve to determine permissible activities for bank holding companies (BHCs). Throughout the 1970s and 1980s, BHCs and national banks expanded their reach into a broadening category of permissible investment activities. During this era, the OCC and the Federal Reserve interpreted provisions of the GSA and the BHC Act to reduce restrictions on investment banking.

The gradual erosion of the GSA culminated with the passage of the GLBA in 1999. Elimination of the GSA’s anti-affiliation rules was rationalized on the basis that unrestricted affiliations would create a stronger, more diversified financial system and permit more flexible innovation. However, regulators and Congress also acknowledged the hazards associated with extending, implicitly or explicitly, government guarantees to non-banking activities. As the Department of the Treasury observed in a 1991 report to Congress, the “federal safety net cannot be extended to [nonbank affiliates] without eroding market discipline, exposing the taxpayer to additional losses, and unfairly subsidizing the activities of financial affiliates.”11 Despite ample foreshadowing of the problems and moral hazard that would later manifest during the financial crisis, the GLBA faced no serious hurdles in Congress.

The GLBA eliminated sections 20 and 32 of the GSA, which contained firewall provisions related to interlock and affiliation with investment banking entities. The GLBA permitted—among other things—BHCs to convert to Financial Holding Companies

11 U.S. Department of the Treasury, Modernizing the Financial System: Recommendations for Safer, More Competitive Banks, 58 (1991).

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 8 (FHCs), which were allowed to take controlling interests in both commercial and investment banking firms. In addition, the GLBA granted FHCs the authority to engage in various non-banking activities permitted under the BHC Act and its regulations.

In response to the passage of the GLBA, the financial marketplace changed rapidly. The GLBA’s accommodation of “universal banking” strategies coincided with a series of mergers between investment banks and commercial banks, which resulted in the current landscape of megabanks. In addition, the GLBA allowed large banks to convert existing securities dealing subsidiaries into more complex broker-dealer firms. At the same time, large securities firms sought to acquire FDIC-insured thrifts and industrial banks. The rapid consolidation of commercial and investment banks into large financial conglomerates gave rise to the current ensemble of “too big to fail” institutions, whose losses during the financial crisis accounted for three-fifths of worldwide losses recorded from mid-2007 to the spring of 2010. As recent scholarship observes, these massive financial conglomerates had become deeply embedded in shadow banking networks leading up to the financial crisis, a factor which contributed to the deep losses in capital markets. Some economists have argued that losses during the financial crisis would have been less severe if GSA-style separation of commercial and investment banking activities had still been in place.

In the aftermath of the financial crisis, Congress acknowledged that a degree of separation between commercial and investment banks should exist to promote financial stability. The Volcker Rule recognized that proprietary trading poses a significant risk of commercial and investment bank affiliation. In the aftermath of the financial crisis, the Senate Permanent Subcommittee on Investigations Report, titled “JPMorgan Chase Whale Trades: A Case History of Derivatives Risks and Abuses,” revealed the extent to which large banks continued to take risks in order to maximize profitability.12 The report found that JPMorgan Chase’s Chief Investment Officer used bank deposits, including some that were federally insured, to construct a $157 billion portfolio of synthetic credit derivatives, engaged in high-risk, complex, short term trading strategies, and disclosed the extent and high-risk nature of the portfolio to its regulators only after it attracted media attention. The losses JPMorgan Chase incurred in 2012 as a result of its poorly supervised proprietary trading strategies revealed the extent to which commercial and investment banking affiliation could drive risk and cause severe losses.13 As a result, supporters of GSA-style reforms have argued that the Volcker Rule does not go far enough.

12 S. Rep. No. 113-96, Vol. 1, (2013), available at https://assets.documentcloud.org/documents/623882/jpmorgan-chase- whale-trades-a-case-history-of.pdf. 13 Id. at 9.

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 9 POLITICAL LANDSCAPE: In the aftermath of the 2008 financial crisis, both sides of the aisle were quick to assign blame for the circumstances that led to the massive housing bubble. Many concluded that deregulation in the years between the passage of the GLBA and the financial crisis allowed banks to operate with fewer restrictions and therefore engage in riskier behaviors, which made the entire financial system more vulnerable to the crisis and made its effects that much worse. Others argued that legislative overreach and high corporate tax rates hurt banks and other businesses, forcing them to look for other revenue streams, including high-risk investments. Many Democrats banded together to begin working on what came to be the Dodd-Frank and Consumer Protection Act (Dodd-Frank Act). To this day, many Republicans disagree with the approach taken by the Dodd-Frank Act and have worked to roll back some of its major provisions and continue to try to dismantle the federal banking regulator created by the act: the Bureau of Consumer Financial Protection. However, both parties agree that credit unions had no part in the crisis and the financial system should be structured to foster competition and growth among institutions of all sizes.

Since the passage of the Dodd-Frank Act, Senator Elizabeth Warren (D-MA), Senator John McCain (R-AZ), and others have introduced a bill on several occasions (in 2013, 2015, and most recently 2017) to reinstate a modern version of the GSA. The House of Representatives has also had bipartisan legislation introduced both as a companion to the Warren-McCain legislation and as an alternative version to restore aspects of the GSA. During the 2016 presidential election, both the Republican and Democratic parties put together platforms that called for the restoration of the GSA.14 The Republican

14 2016 Democratic Party Platform; Republican Platform 2016.

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 10 Party platform also called for a rollback of the 2010 Dodd-Frank Act; a position many Democrats criticized as impossible to reconcile with reinstatement of the GSA and overall consumer protection efforts. Nonetheless, through this rare instance of party alignment, it became clear that the public was still angry with Wall Street and felt victimized by its greed.

The Trump Administration has continued its campaign trail message. In May 2017, President Trump implicitly referenced the GSA in response to a question about breaking up the banks: “There’s some people that want to go back to the old system, right? So we’re going to look at that.”15 Others from the Trump Administration have also voiced their support. During his confirmation hearing, Treasury Secretary Steven Mnuchin said he supports a “21st century Glass-Steagall,” although he later clarified that does not mean he is in favor of breaking up the banks.16 The Trump Administration has yet to enact any regulatory changes effectuating a modern GSA.

Congress, on the other hand, has made some considerable efforts. The 2017 iteration of Senators Warren and McCain’s bill, entitled the “21st Century Glass-Steagall Act,” demonstrated a bipartisan effort at reform.17 Speaking in support of the bill in 2017, Senator John McCain said, “Since core provisions of the [GSA] were repealed in 1999, a culture of excessive risk-taking has taken root in the banking world, placing the financial security of millions of hardworking American taxpayers at18 risk.” Such bipartisan support of this bill, coupled with potentially strong White House support, could mean the nation is on the brink of the most dramatic rewrite of financial banking laws in about 150 years.

Others have also come out in support of a bipartisan effort. In June 2017, Representative Walter Jones (R-NC) said “I have full faith that with bipartisan support, we can reinstate Glass-Steagall protections for the good of the American people.”19 Continued bipartisan efforts and support provide an avenue for successfully reviving the GSA. Lawmakers must rally around the idea that banks should only engage in socially valuable banking activities that promote consumers’ best interests while protecting the American taxpayer from funding large government bailouts. Lawmakers should agree that

15 Akane Otani & Ryan Tracy, “President Trump Says He’s Looking Into Breaking Up Wall Street Banks,” The Wall Street Journal (May 1, 2017), available at https://www.wsj.com/articles/president-trump-says-hes-looking-into-breaking-up- wall-street-banks-1493660319. 16 Id. 17 See 21st Century Glass-Steagall Act of 2017, S.881 115th Congress (2017). 18 “Senators Warren, McCain, Cantwell and King Introduce 21st Century Glass-Steagall Act,” Senator Elizabeth Warren Newsroom (Apr. 6, 2017), available at https://www.warren.senate.gov/newsroom/press-releases/senators-warren- mccain-cantwell-and-king-introduce-21st-century-glass-steagall-act. 19 “Bipartisan effort has 50 cosponsors and will break up the big banks,” U.S. Congresswoman Marcy Kaptur Newsroom (June 6, 2017), available at https://kaptur.house.gov/media-center/press-releases/kaptur-jones-vow-keep-fighting- reinstate-glass-steagall.

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 11 extremely risky behaviors aimed at producing short-term profits at the expense of consumers endanger the stability of the entire financial system. These behaviors could lead to yet another financial crisis in the near future, so it is time to make significant changes to permissible banking authorities and activities and get big banks back to the true business of banking. A bipartisan solution is the best path toward such reform.

ECONOMIC POLICY: Although the Dodd-Frank Act was a necessary response to the financial crisis of 2008, it did not cure all of our nation’s problems and many weaknesses still remain. Credit unions center on relationship banking, and regulations implementing the Dodd-Frank Act have made it more difficult for credit unions to focus on their relationships as they have had to instead allocate immense resources to compliance. But for the Dodd- Frank Act, credit unions would not have incurred many of the regulatory compliance burdens they face today. According to NAFCU’s 2017 Federal Reserve Survey, members reported that compliance expenses have increased 289 percent since 2010 and the number of full-time equivalent (FTE) staff devoted to “total compliance activities” has increased 114 percent since 2010. Additionally, 87 percent of respondents expect it will be necessary to increase the number of compliance FTEs even more in the years to come. These alarming statistics highlight the difficult regulatory environment facing smaller financial institutions. This regulatory burden simply makes it harder for credit unions to compete.

Generally, credit unions increase competition in the financial services marketplace by offering better loan and deposit rates. Lower loan and higher deposit rates place more money in the member-consumer’s hands, thus increasing consumer consumption and injecting more capital into the economy. Competition in the marketplace increases product innovation and incentivizes banks to set more competitive rates due to substitute product availability. Unfortunately, the rise of large, complex financial institutions has made it even harder for credit unions to compete and to continue to help their local communities achieve financial success.

Large, complex financial institutions generally started forming after the repeal of the GSA through the passage of the GLBA in 1999. Banks grew to have an even larger national footprint and become “one-stop” shops for all of the financial service needs of their consumers. The largest four U.S. banks (Wells Fargo, , Bank of America, and JPMorgan Chase) grew more rapidly prior to the financial crisis and recession due to deregulation, particularly through the passage of the GLBA. The industry saw the emergence of mega-financial institutions that were considered “too big to fail” and

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 12 thus perceived by the markets as having an implicit government guarantee to bail them out should they undergo an extreme stress scenario and have insufficient capital reserves. These “too big to fail” financial institutions created an implicit safety net that all other banks and credit unions did not have, although they still had to adhere to industry regulations and enforcement, therefore giving “too big to fail” entities a competitive advantage.

The removal of previous barriers allowed for the emergence of “shadow banking,” which largely fell out of the FDIC process for resolving failed insured financial institutions through receivership. According to the aforementioned Senate Investigations Report, a prime example of a large, complex financial institution utilizing excess deposits to make risky investments was JPMorgan Chase investing excess liquidity of $350 billion in synthetic credit derivatives that were supposed to yield higher returns, but instead lost $6.2 billion.20 A portion of these excess deposits were FDIC insured. Excess deposits were smaller pre-recession as financial institutions did not want surplus cash sitting in reserves. Reserves were put to work and, in some instances, were placed in increasingly riskier investments in order to yield a higher return. Historically, from the 1950s to the early 2000s (prior to the recession), the percentage of excess reserves in relation to required reserves had been less than 10 percent. The repeal of the GSA made it more difficult for regulations to distinguish between banking activities that aimed to benefit customers versus those that were simply meant to benefit the financial institution itself.

The notion that an institution is “too big to fail” has led to unintended consequences, including lower funding costs for larger financial institutions versus smaller financial institutions. For example, a July 2014 Government Accountability Office report indicated that from 2007 to 2009, bank holding companies with $1 trillion in assets and average credit risk had lower bond funding costs, equating to a 17 to 630 basis point difference, compared to a similar bank holding company with $10 billion in assets.21 Funding cost differences can be attributed to investors’ belief in the likelihood of a government bailout if a failure occurs.22 Accordingly, although the Dodd-Frank Act intended to end “too big to fail,” the perception of certain institutions as “too big to fail” remains.

In recent years, the industry has seen reduced competition due to a concentration of financial power as a result of consolidation. Collectively, the consolidations that occurred after the financial crisis significantly affected the distribution of market share inthe banking sector. Several major mergers occurred due to forced consolidation of failing large

20 S. Rep. No. 113-96, Vol. 1, at 4 (2013), available at https://assets.documentcloud.org/documents/623882/jpmorgan- chase-whale-trades-a-case-history-of.pdf. 21 U.S. Gov’t. Accountability Office, GAO-14-621,Large Bank Holding Companies Expectations of Government Support (2014). 22 Id.

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 13 financial institutions. These major consolidations included: JPMorgan Chase acquiring Bear Stearns, Bank of America acquiring Merrill Lynch and Countrywide Financial, and Wells Fargo acquiring Wachovia. In 2003, the largest four U.S. banks made up roughly 35 percent of the total banking assets. In 2008, these big four banks rose to 52.2 percent of market share but then, post-recession (2008-2013), dropped to 45.2 percent because Goldman Sachs and Morgan Stanley became bank holding companies.

The share of total banking assets held by large bank holding companies dwarfs the combined total assets held by credit unions, small bank holding companies, and banking assets not held by bank holding companies. Large bank holding companies hold about 80 percent of the total assets held by banking organizations, whereas credit unions share of total assets hovers under 10 percent. This dramatic difference demonstrates the extent of massive concentration and consolidation in the financial industry and just how difficult it is for credit unions to compete in such an environment.

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 14 The repeal of the GSA’s protections coupled with the influx of Dodd-Frank Act regulatory requirements has also led to massive consolidation in the credit union industry. Since 2008, the industry has lost over 1,500 credit unions either through a closing or merger. Industry consolidation has also accelerated in recent years as the number of credit unions continues to decline at a rate of nearly one per day. The existing framework is likely to lead to further consolidation in the credit union industry as institutions are inclined to seek economies of scale.

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 15 In the current environment, competition is fierce. According to NAFCU’s 2017 Annual Report on Credit Unions, the median credit union has just $30 million in assets, yet respondents to the survey indicated that you need $250 million to survive. Also in 2017, NAFCU commissioned an independent study, entitled “Economic Benefits of the Credit Union Tax Exemption to Consumers, Businesses, and the U.S. Economy.”23 A portion of the study determined that a consolidating credit union industry has several consequences for the economy, including increased interest rates for all loan products, a reduction in personal income to consumers, loss in consumer consumption, and a reduction in GDP. That same study also estimated the value of credit unions to consumers at $16 billion per year and the resulting increase in economic activity at 90,000 jobs annually. Therefore, credit unions not only have a large impact on the communities they serve, but also provide clear benefits to the American economy. A modern GSA would amplify these benefits because more credit unions could emerge and compete in the marketplace. Increased competition would provide American consumers with more options and increased access to financial services, thereby exponentially increasing the overall benefits to our nation’s economy.

23 Robert M. Feinberg & Douglas Meade, Economic Benefits of the Credit Union Tax Exemption to Consumers, Businesses, and the U.S. Economy (Jan. 2017), available at https://www.nafcu.org/data-tools/credit-union-federal-tax-exemption-study.

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 16 FUTURE STATE: Competition, confidence, liquidity, and stability are the hallmarks of a strong future American financial system. NAFCU and its member credit unions are confident that the proper division of investment and commercial activity through implementation of a modern GSA would help foster these principles. The unregulated, non-depository entities that make up much of the “shadow banking” industry would have to evolve and find new ways to contribute to the market, separate and apart from large banks. Big banks must be encouraged to discover more innovative, yet honest, ways of accessing liquidity that do not put the American taxpayer at risk. Activities outside of those traditionally considered to be part of the “business of banking,” especially through unregulated non-depository institutions, should be subject to closer scrutiny and approval from the appropriate financial regulator. Accountability and transparency is the best way to truly understand and demystify the “shadow banking” industry so that consumers are fully protected and institutions of all sizes can flourish.

These principles would also further encourage banks to step away from harmful activities such as redlining and instead focus on helping their local communities. Every American deserves a chance to accumulate wealth and build opportunities for their family. Shifting the focus of our banking system from acquiring profits to helping local communities is the first step.

NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 17 National Association of Federally-Insured Credit Unions NATIONAL ASSOCIATION OF FEDERALLY-INSURED CREDIT UNIONS | NAFCU.ORG | 18