ALANGREENSPAN'S LEGACY: AN EARLYLOOK

The RegulatoryRecord of the GreenspanFed

By CHARLESW. CALOMIRIS*

Alan Greenspanplayed an importantrole in Fed's regulatory advocacy. To understand it, shaping majorchanges in the structureand rules one must consider the Fed as a political player of financialregulation. Indeed, it is in this realm in the Washingtondrama; as a creatureof Con- that ChairmanGreenspan has made his most im- gress subject to its oversight; as a competitor portantcontributions as an institutionalinnovator. with other regulators for influence within the Just describing how the Federal Reserve financial services industry and within the polit- made possible the expansion of commercial ical realm;and as a prioritizingagent that had to banks' powers to permit them to engage in decide which battles (monetaryor regulatory)to investment banking could occupy this entire fight-when, and how hard. essay. That change occurred in several stages, One lesson of this overview of Fed regulatory beginning with the Fed's decision in 1987 to advocacy duringthe Greenspanyears is that the allow small inroads by banks into investment algorithm of Fed advocacy (the decision proc- banking. Those changes created a favorable ess that decides which position the Fed will trackrecord, which laid the groundworkfor the advocate) has not changed, although some of Administration'sand Congress's willingness to the specific policy advocacy has. John Hawke eliminate restrictionsentirely in 1999 (a policy (1988) wrote an evaluation of ChairmanPaul the Fed advocated in the 1990s). The growth in Volcker's regulatorypolicy during his years at commercial banks' market share in investment the Fed, which was presentedat the 1988 ASSA banking has been dramatic. In 1992, only 10 Annual Meeting, and which describes an ap- percentof corporatedebt and less than 1 percent proach to Fed policy that is similar to the one of corporateequity flotationswere underwritten suggested here. In that sense, ChairmanGreen- solely or jointly by commercialbanks. By 2002, span did not change the Fed; indeed, it is prob- that share had grown to 66 percent of debt and ably more accurate to say that his personal 36 percent of equity (Calomirisand Thanavut advocacy was changed by being at the Fed. But Pornrojnangkool,2006). that does not imply an irrelevance to his lead- Can one identify a "philosophyof regulation" ership. What emerges from a review of Green- that underlies the regulatory advocacy of the span's regulatory record is an appreciationof Fed under ChairmanGreenspan? Although the his skill as a Beltway warrior,particularly with Fed's advocacy on various mattersmay appear respectto his success in facilitatingthe geograph- somewhat contradictoryor, at least, philosoph- ical expansionof banks,broadening bank powers, ically heterodox, the Fed has behaved in a man- and securinga prominentrole for the Fed under ner that is remarkably predictable, once one the Gramm-Leach-BlileyAct of 1999. takes account of the political arena in which both regulatoryand monetary policy are made. There is fairly straightforwardlogic to the I. The Fed's RegulatoryAdvocacy Algorithm: Ten Examples

* Graduate School of Business, Columbia University, In Table 1, I list ten of the main regulatory 3022 Broadway, Uris Hall 601, New York, NY 10027, issues with which the GreenspanFed has grap- American EnterpriseInstitute, and NBER (e-mail: cc374@ pled. I categorize financial regulatory issues columbia.edu). into four to I thankBenjamin Hamlin and GordonGray for excellent categories, according my interpre- researchassistance, and JerryHawke and PeterWallison for tation of the Fed's actions and the dominant comments on an earlier draft. motives for those actions. The first category is 170 VOL.96 NO. 2 ALAN GREENSPAN'SLEGACY: AN EARLYLOOK 171

TABLE 1--EXAMPLES OF FED REGULATORY ADVOCACY

Fed Advocacy of Beneficial Regulation Interstatebranching The GreenspanFed has been a much more vocal advocate of interstate branchingthan the Volcker Fed, owing to changes in the political landscape that allowed the Fed to supportbranching with little political risk, and with strong supportfrom large banks. Mergers and acquisitions The Fed has supportedlarge bank mergers. Although this has largely been beneficial, the merger of Fleet Bank and BankBoston Corp. shows that the Fed may be too willing to permit undesirableconcentration of power to occur. Fannie and Freddie post 2000 Once the political climate had become less risky, in cooperationwith reform leadershipby CongressmanRichard Baker and the White House, the GreenspanFed became a vocal proponentof reform, with strong support from large banks. Investment banking powers The Fed led the efforts to expand banking powers, particularlyin the area of underwritingof corporatesecurities. This was done gradually, and at a time when large banks' internationalcompetitiveness was threatened, both of which limited the risk of a political backlash. This was strongly supportedby the large banks. Not in the Interest of the Big Banks Banking and commerce The Fed opposes permittingnonbank firms (e.g., WalMart)to compete with banks, a position that supportsthe interests of large banks, and also limits regulatorycompetition with the Fed. Minimum subordinateddebt Despite widespreadevidence supportingthe view that such a requirement requirementfor large banks would boost prudentialregulatory and supervisorydiscipline, some of which was produced by Fed staff, the Fed killed this initiative, due to opposition from the large banks. Too Politically Hot to Handle Fannie and Freddie pre 2000 Fed officials and researcherswere silent during the early phase of the reform efforts involving these GovernmentSponsored Enterprises because of the perceived political risks. Community ReinvestmentAct Not an effective or efficient policy, yet the Fed does not oppose it because of the perceived political risks of doing so. Real estate brokerage Under Gramm-Leach-Bliley,the Fed shares with the TreasuryDepartment authorityto decide which activities qualify as permissible "financial" activities for financial holding companies. This places the Fed in a difficult position when there is strong political opposition to permitting entry. Despite the absence of any economic argumentagainst permitting banks to act as real estate brokers, the Fed seeks to avoid the political fallout from supportingthe effort. Fed Regulatory Power Play Investmentbanking subsidiariesversus The Fed sought to limit the ability of banks to operate securities affiliates subsidiariesand other subsidiariesof banks, as opposed to affiliates, in a largely unsuccessful power play against the Office of the Comptroller of the Currency. Umbrella financial supervision by the The Fed succeeded in having itself appointed as an umbrella supervisor of Fed financial holding companies under Gramm-Leach-Bliley.

labeled "Fed advocacy of beneficial deregula- beneficial deregulationso long as doing so does tion." The remaining three categories include not (a) stir up significantpolitical opposition to cases where the Fed has opposed beneficial the Fed within Congress or the Administration, regulatory policies, which I attribute to three which might threatenits monetarypolicy inde- reasons: "too politically hot to handle," "not in pendence, (b) harm the large commercialbanks the interest of the big banks," or a "Fed regu- (which are key allies of the Fed in its political latory power play" to boost its own political battles in Washington), or (c) undermine the influence. Fed's competitive position vis-a-vis other regu- My proposed regulatoryadvocacy algorithm lators. Furthermore,these three constraints(op- for the Fed is fairly simple. The Fed supports position by politicians, opposition by big banks, 172 AEA PAPERSAND PROCEEDINGS MAY2006 and erosion of Fed regulatorypower) may lead TABLE2--FINANCIAL REGULATIONWITHIN OR OUTSIDETHE the Fed not only to fail to support beneficial MONETARY AUTHORITY but also to harm- deregulation actively support Countriesfor which Countries for which ful or in the case of antitrust regulation, regu- financial regulation financial regulation lation, fail to enforce beneficial regulation (i.e., authoritylies authoritylies against undesirable anticompetitivemergers). outside the within the Underlyingthis categorizationare two sets of monetary authority monetary authority substantive claims on my part: first, claims Australia Argentina aboutwhat constitutesbeneficial regulation, and Austria Brazil second, claims about the interests that are Belgium Czech Republic Canada Egypt served by supportingor opposing regulation.In Chile Indonesia the longer version of this paper (available from China Israel the author on request), I review in detail both Colombia Jordan sets of claims for the ten regulatoryexamples in Denmark Kenya Finland New Zealand Table 1 (interstatebranching; mergers and ac- France Nigeria quisitions; Fannie and Freddie; investment Germany Pakistan bankingpowers; permittinginvestment banking Greece Russia subsidiariesversus affiliates; umbrella supervi- Hungary Saudi Arabia sion the Fed; and India South Africa by banking commerce;requir- Ireland banks to issue subordinated the United States ing large debt; Italy Community Reinvestment Act; and real estate Japan brokerage). Luxembourg Two other aspects of ChairmanGreenspan's Mexico record as a advocate warrantmen- Netherlands regulatory Norway tion. First, he was a first-raterhetorician. One of Peru ChairmanGreenspan's great skills was to shift Poland the burdenof proof to suit his argument.When Portugal South Korea he advocated deregulation (as in the case of Spain expanding underwritingpowers via affiliates), Sweden he argued that there was no clear evidence that United Kingdom deregulation would cause harm. When he op- Venezuela posed deregulation,he arguedthat there was no clear evidence that deregulation would not cause harm.In the case of permittingunderwrit- ing, he used gradualism to compromise with powers, securing umbrella supervisory author- worrisome critics, and build a record of perfor- ity, giving the Fed an ongoing role in deciding mance on which to base further relaxation of which activities would be permissible in finan- constraints.But he did not advocate gradualism cial holding companies, and limiting competi- and experimentationas a means to overcome tion in banking from nonbanks (benefiting his uncertainties on the part of policymakers in big bank allies, while also limiting competition other areas (notably with respect to permitting with the Fed in the regulationof banks). On the underwritingin subsidiaries,or with respect to other hand, the Fed's new authority to deter- allowing commercial firms to provide financial mine permissible financial activities places it services). Chairman Greenspan knew how to more squarelyin the middle of political disputes overcomecongressional fears of change when he that it does not really want to decide, because of wanted to. He also knew how to use Congress's the political risks of having to do so. fear of change as a tool to limit deregulation. Second, the Gramm-Leach Bliley Act of II. The Case for Endingthe Fed's Role as a 1999--the Chairman'smoment of greatest tri- FinancialRegulator umph-was a double-edged triumph. On the one hand, Chairman Greenspan succeeded in During the 1980s and 1990s, the Fed's advo- his advocacy in the areas of broadening bank cacy role was largelybenign. Despite the fact that VOL.96 NO. 2 ALAN GREENSPAN'SLEGACY: AN EARLYLOOK 173 the Fed was often on the wrong side in the ten rest of the financially developed world, as areasreviewed in Table 1, it was on the rightside shown in Table2). Althoughremoving regulatory of the most importantcontroversies; and it made a powers from the Fed has little political support differencein helping to win some importantreg- today, ChairmanGreenspan's departure may fa- ulatorychanges, most notablythe consolidationof cilitate the renewed discussion of the need to the bankingindustry and the expansionof bank separatemonetary policy from regulatorypolicy, powers into otherfinancial areas. now that the Fed will be deprivedof his personal In the future, the Fed is likely not to play a stature, which has been used as a powerful helpful role in resolving the most important weapon to defeat opponentsof the Fed's agenda, regulatoryissues. The most importantdesirable and sometimesto preventbeneficial reform. changes of the next decade will involve permit- ting the entry of nonbanks into banking, and developing stronger regulatory oversight to REFERENCES limit excessive concentrationwithin the finan- cial sector (not just for banks, but for ratings Calomiris, Charles W. and Pornrojnangkool, agencies, accounting firms, and other financial Thanavut. "Relationship Banking and the intermediaries).The Fed's political objectives Pricing of Financial Services." Unpublished and its alliance with large banks will limit its Paper, Columbia Business School, 2006. future effectiveness. Looking forward, there is Hawke,John D. "PaulA. Volcker and Domestic an increasing benefit derived from removing Bank RegulatoryPolicy." Presentedat ASSA regulatoryauthority from the Fed (a change that Annual Meeting, New York, December 28- would align U.S. regulatory practice with the 30, 1988.