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Multinationals, The Internet




by Robert A. Spira


The Hypothesis

Since the 1933 passage of the Glass-Steagall act, banks have been attempting to skirt their inability of not being able to own stock in non-financial companies. As the years passed, Congress developed some sympathy for the banks because of what they perceived as an inability of U.S. domiciled financial institutions to compete effectively in the global market place.  Congress began to look at trimming the barriers created by Glass-Steagall and in 1986, the United States did not have a bank listed in the world’s top twenty-five[1].  Eventually, the talk went, American financial institutions were becoming relegated to the role small town lenders by competition from German and Japanese Banks,[2] who by owning shares in their borrowers became a more knowledgeable, more sympathetic and infinitely more profitable.[3]

American banking on the other hand did little to show that it had matured sufficiently to be allowed to come and go as they pleased.  "The last four decades have provided ample evidence of how banks attempt to circumvent regulations.  In general, they either developed new financial products or changed their organizational structure.  Banks avoided deposit-rate ceilings by making implicit interest payments (for example, they offered gifts to depositors when market interest rates rose above the regulatory ceiling).  They attempted to overcome the prohibition on interstate branching by creating bank holding companies (BHCs) with banks in multiple states. 

They circumvented the Glass-Steagall Act by developing new financial products, like MID (market -indexed deposit) accounts…Banks entered into joint-venture-type agreements with investment companies in order to create mutual funds that were bought and sold by these companies, but managed and advertised by banks…The prohibition on interstate banking was introduced to protect small local banks and to limit banks' growth, so banks changed their organizational structure and adjusted the set of activities they undertook. Investment banking was closed to commercial banks because of potential conflicts of interest with their lending activity and its perceived risks, so banks entered into joint-venture type-agreements and developed new financial instruments.  " Glass-Steagall and the Regulatory Dialectic by Joao Cabral dos Santos, February 15, 1996.

In theory at least, foreign banks became better lenders and especially in Japan where the culture mandated that when a new corporate client was taken on, the bank should consider sending one of their lending officers to work for the company for several years in order to glean every nuance of the business.  In Germany, only the best and the brightest need apply for a career in banking, the pay on a relative basis is substantially above relative American standards and banks are regularly engaged in ownership, insurance sales, underwriting, and management of their clients.  In the United States, fledgling bankers are weaned on financial statements and at are most often chosen from the second tier business schools or the lower three-quarters of the graduating class.  Strangely, in American Banks, the better the client fared, the worse the bank would do.  The more successful the borrower the more likely he will require better treatment, usually in the form of lower rates, more aggressive lending, discounts on services and all sorts of other fringe benefits.  In Japan or Germany, should the borrower prosper, the bank’s bottom-line is usually enhanced because it has become a shareholder and thus gains immeasurably from the incident[4].

U.S. Bankers were not only lenders of last resort but also literally the only game in town in the environment that existed shortly after World War II had ended.  They went into a tailspin from that time until the middle to late 1980s, symptomatic of over-regulation on the part of American Banking Regulators.  Banks, clearly seeing the global picture attempted to break out of the mold over the years but their efforts were either ill timed or clumsy as one catastrophe after another mandated that the reforms not be enacted.  The American Banks gave the public every reason not to believe that they were ready for deregulation and Congress sensing this pulse totally concurred. 

Addressing the Problem

The first attempt to get around some of the Glass-Steagall restrictions date back to when several of these institutions formed of holding companies which could theoretically purchase stock in non-financial companies without breaking the law.  Congress was not pleased with this ruse and in 1956 passed the Bank Holding Company Act that barred the bank’s holding companies from owing over 5 percent of a non-financial company.  From 1956 on, numerous attempts were made to liberalize American Banking but in every instance, a bete noire always seems to arise to snatch defeat out of the hands of victory.  Burt Lance who was Jimmy Carter’s budget director set reforms back several decades when it was pointed out that he had used some of Georgia’s financial institutions as his own private piggy bank during in the 1970’s[5]. By the end of the seventies, the S&L Industry was virtually bankrupt. Essentially this was produced by a massive disintermediation, which found the Savings Banks lending long and borrowing short.  The Short-term interest that the S&Ls were allowed to pay to entice new funds were held to a minimum by government ceilings, thus unregulated money market mutual funds were able to offer higher returns and garner those dollars.  Fundamentally, similar problems effected banking, but discrete government intervention prevented the industry from suffering the same fate as the S&Ls.  BCCI’s arrival on the scene in the eighties and the abuses that were found in their policies of payoffs and money laundering set Congressional Action back top the drawing board once again. 

During the same period, Mexico defaulted on major loans to American financial institutions on several occasion, this one event almost single-handedly took down America’s biggest bank at the time, Citibank.  Nevertheless, Mexico was not alone in leaving their debts unpaid to American lenders; defaults in Brazil, Argentina and almost everywhere else in Latin America plagued the banks in the late 80’s and early 90’s[6]. Excessive lending on real estate hit the banks about the same time the Latin American debacle took place and when the smoke cleared, it was rescuing the S & L’s or the banks but not both.  You know who took the hit[7]. In 1991, the FDIC had no reserves in their insurance fund and any further depletions would have required borrowing from the Treasury Department. As time marched on, in 1994, a federal act allowed bank holding companies to acquire subsidiaries wherever and whenever they desired. This was followed on June 1, 1997 with the allowance of interstate branch banking.  Restructuring, fat trimming and a favorable interest rate environment gave the banks a little breathing room and their bottom lines finally got off the dime and improved.

In the late ‘80s and early 90’s, the effects of the “so called Savings and Loan Bailout” were still muddying the waters and thus, for 30 years we have not had a respite from banking problems to make it psychologically convenient to roll back the financial institution’s unencumbered access into banking as it is practiced in much of the rest of the “first” world.  Nevertheless, the call to arms had been issued and in spite of potential negatives, Representative Barnard, then head of the House Banking Committee led the charge over the years for its repeal.  That happened some years after Barnard was no longer a representative, but the movement; once begun, marched on without its founder.

In addition, substantial consideration was given to the fact that as Thomas M. Hoenig President, Federal Reserve Bank of Kansas City put it: "At the domestic level, it is that Glass-Steagall - working against market forces –that prevents corporations, state and local government enterprises, and other borrowers from realizing the cost, efficiency, and other benefits that would result from greater competition among providers of financial services[8].  At the international level, the concern is that U.S. companies, lenders as well as borrowers, are hobbled by restraints that do not inhibit their foreign counterparts. On both counts, Glass-Steagall is ill-suited to the needs of the American economy for productivity and growth."[9] Considering the dominance that the United States displayed in banking shortly after World War II ended and with the rest of the global banking empires shattered, it was felt that our banks were being made to compete with both their hands tied behind their backs[10].

To some degree, the repeal of Glass-Steagall was not as significant an event as many believed it would be.  In reality, it only legitimatised events that had been taking place for many years. In the securities field, foreign subsidiaries of Banks have been active in cross-border capital markets for decades, in line with local regulations, which were not nearly as restrictive as the American, historic separation of securities and banking.  On the other hand, by setting up the what government labels as Section 20 affiliates, banks with the approval of the Federal Reserve were permitted.  With certain restrictions to underwrite and deal in most types of securities[11].  In the insurance field, like inroads have been made for decades especially by state charted banking institutions or by Federal Banks also holding individual state charters in affiliates. The major southern banking institutions in particular have been enmeshed in the insurance business for many years.

The demise of Glass-Steagall fashions an era of incredible opportunity for America's Banking Institutions but as with all great expectations, there is more than a little accompanying risk.[12]  Fortunately or unfortunately, this new era emerges in an environment in which the speed, scope and accessibility of delivery systems is expanding exponentially.  It is just that combination of factors, which will create risks never before perceived in banking history; and could send the industry along with the entire global economy as well, back into the Stone Age[13].  Given the rapid expansion of money and its equivalents, this fall from grace could be faster than its rise, and as central governments increasingly lose more influence, global banking risks will become more magnified every day.

The banks are entering a new era.  Criminal cartels now command an ever-increasing percentage of global electronic money transfers.  The battlefield of future wars may well consist of internet based attacks which are presently capable of terminating literally every infrastructure system in this country and the necessary technology is possessed by almost all technologically advanced nations.  Moreover, teenage hackers routinely make raids into the online credit card vaults of the nation's banks, and use their plunder for fun and profit before their mother brings milk and cookies and puts them to bed.

Deregulation Often Comes At a High Price

While we are strong advocates of free enterprise, in its rush to so-called democratization, the American Government could well be in the process of throwing the baby out with the bath water.  As the end of an era was ushered in, at best we find the in-place systems insufficient for shielding that which already is in place.  As technology advances, multiple layers of opportunities for theft of information and money equivalents will be added.  This has occurred at a time when the FDIC has reduced premiums on bank deposits from 23 cents per $100 to 4.5 cents per $100.[14] These dangers in themselves will generate a much more rapid perception of the problem, thus movement toward solution will take place purely out of necessity. On the other hand, when all is said and done, it appears that the curve will remain seductively near and yet, constantly out of reach.

Has the training of bank examiners kept pace with the nuances of sophisticated product development inherent in today's global financial institution? For many years bank auditing and regulation was a simple process, which consisted of checking the books and going over the loan portfolio in order to analyze its performing status. Today pro-active banking institutions are departmentalizing management of all their products with highly sophisticated, complex tools that have been developed to control or delineate risk[15]. This sounds very nice on the surface, but these products are so sophisticated that their maker often has a difficult time understanding what he has created, thus, how can we expect a bank examiner with substantially less knowledge of the field to evaluate the banks soundness when the portfolios consist of products that are so complex that they literally defy explanation[16]. We are convinced that no less than several very large hiccups await the banking system over the very near future and there can be no assurances that components of the system will not crash before we arrive at a failsafe position on the learning curve. 

The Banking industry in this country has evolved and is now beyond its formative years.  This abrupt departure from the scroll and pen dark ages has already resulted in dislocations.  Contemporary management may not be sufficiently qualified to harness the massive perplexities evidenced by today's technologies.  As a general rule, competitive industries have historically compensated substantially more to hire top employees.  Banking has been considered as exciting as watching corn grow over the last several decades and that combined with limited checkbooks and second-rate employee stock option programs have chased the most qualified MBA’s into the arms of Wall Street’s Investment Bankers along with the new bete noire, Internet oriented venture capital and employment.  Thus, when bank management is thrown, by virtue of cross-industry mergers into a fight for control with top-flight, technologically perceptive management from long-deregulated industries, the latter may have superior resources to win the day.

The Stock Market

Banks are interested in being in the Investment Banking business for the simple reason that it is far more profitable than banking itself.  Statistical comparisons have shown that large investment banks outperform commercial banks by almost 50% when looking at their comparisons from a return on equity point of view.[17] Moreover, after ten years of bull markets, the benefits are now raining down on the Federal, State, and local governments in the form of tax revenues.  Shrinking national and local deficits, once reserved only for the dreams of those economists that were shunned by their associates for alien visions are increasingly becoming a reality.  Historically we are moving from the days when politician’s major concerns were those of saving the inner cities, creating and defending infrastructure, caring for the sick and maintaining and developing transportation.  In today’s surplus era, uncovering methods of cutting taxes and providing additional services are occupying lawmakers’ days. 

Although a vibrant stock market should have been beneficial for banking, historically, new share heights are often met with severe declines.  When the market’s base is eroded even slightly, those debts, which were incurred at the elevated base, soon create a cascading effect, which tends to generate secondary wave of bank loan problems.  The stock market has endured almost a decade of new highs and the banking industry has been on a roll even longer.  At no time in history, have so many people been significantly active in the market, with technological improvements daily making the execution of transactions so convenient that it is as easier to buy a stock than to place a bet on a horse race.  Some people have amazingly discovered that while in any particular race, only one horse is going to win, in today’s stock market, the majority of today’s investors have not really known a down market.  

Speculation has run rampant and many have treated the stock market as an casino alternative rather than a long-term wealth-building mechanism.  Increased margin debt goes along with vital stock markets as bacon goes with eggs.  The more speculating that exists within a system, the higher that the level of borrowing attains and almost by definition, the lower the credit of the borrower becomes.  Currently we are faced with relative excesses the likes of which have never existed in this country including the crash of 1929.  We can only compare it the centuries old and insidious “Tulip Craze” in Holland and the hapless South Sea Bubble of years ago, both of which left their nation’s economies in ruins for decades.  The bursting of both bubbles left their respective countries in financial ruin for countless years.  As a matter of fact, at tulip time, Holland was the center of the financial universe; it has never come within miles of ascending those heights again.

While Internet speculation has played a substantial role in creating the excesses that currently exist, to an increasing degree, it is simultaneously acting as a force for companies to reduce their costs and increase their competitive position.  We are going through a phase of centralization and elimination, as monolithic robotic warehouses take the place of local distribution centers where wages have been kept in check by augmentation of stock options and where retail prices have become embarrassingly transparent.  Nevertheless, in this age of mega mergers, economies of scale have contributed dramatically to increased profit margins and stable prices. 

In spite of the above, there are potential menaces on the near term horizon which could well create stock market alternatives.  We are faced with increasingly more serious balance of payments, problems and unless Japan suddenly begins charging their citizens to buy their government bonds,[18] we will probably be forced to continue to raise our interest rates in the near future.  In addition, we would not be at all surprised if the Federal Reserve selectively lowered the amount that can leveraged through margin borrowing, a rate that has not been tampered with for a score of years.  Another arrow in the Fed’s quiver is its ability to pull money out of circulation while increasing reserve requirements, causing more demand for less dollars and effectively increasing the rates that are paid or the underlying reserves that are required.  Thus, we believe that should rates increase another point or two, many of the funds that have felt that they had no alternative but to remain fully invested in equities will now have a rather pleasant alternative.  On the other hand, we are totally unable to predict the result of a stampede into fixed income securities when at the federal level, the supply could well be plummeting because of the predicted budgetary surplus.  It is very possible that the availability of government issues may dry up leaving fixed income dollars chasing lowering quality.

Another anomaly of our “New Age Stock” economy is the fact that in the last two years, a period in which the market as ascended to unprecedented heights, corporate tax payments have declined.  However, during this same period, these same corporations publicly reported that earnings have dramatically increased.  One has only to look at the strange accounting statements emanating from companies such as AOL, Cendant, Livent and Waste Management and their high priced accountants to wonder what is really going on.  Motorola, Compaq Computer, and WorldCom have all taken eye catching one-time charges of astronomical proportions.  Outright fraud, over-aggressive accounting, and misleading numbers have taken away the time honored practice of requiring that corporate statements reflect how well a company is or is not doing.  Front-loading expenses and taking the “big bath” all at once are tricks that permit corporate earnings management; something that has concerned the Securities and Exchange Commission no end.  The SEC’s chief accountant, Lynn Turner, in a meeting with officials of Big Five Accounting firms among others, states; “If the basic accounting foundation ever loses credibility with investors, then the whole process would fall apart.”  Arthur Levitt Jr., in a speech delivered on September 28, 1998 sounded like he was talking a foreign language when he addressed these issues which were, “Big Bath Charges, Creative Acquisition Accounting, “Cookie Jar Reserves”, Materiality and “Revenue Recognition”.

This magical accounting has been paralleled by very aggressive positions being taken by customers of the Big Five Accounting Firms relative to sheltering income.  Tax shelters are cropping up all over the place and it has reached such substantial proportions that the IRS has indicated that they will be shortly looking at these ploys in a new light.  From here on in, they say, they will refuse to allow any deductions without a business purpose.  The Administration has stated that they want to put on more IRS agents to track down corporate cheating. Between the management of earnings and the sheltering of income, one can certainly see that we have lost track of the transparency so desired by GAAP and the SEC.

Tax collections down with earnings going through the roof is a harrowing example of a dramatically deteriorating quality of earnings, If this is a Witches’ brew, add to the pot, record margin borrowing seasoned with increased credit card debt and home equity bank loans, many of which are solely for the purpose of leveraging the purchase of equities.  In order to keep up with the Joneses, mutual funds on balance have kept themselves almost fully invested, and the amount of money being placed in savings accounts as a percentage of total net income is almost laughable.  There is little or no elasticity of available reserves; they are a taut rubber band that has been expanding for over ten years and is nearly exhausted.  No one seems the least bit concerned about the fact that the top NASDAQ stocks are selling at an average of over 100 times earnings and that those averages are up more than 100% in the last 12 months. 


Despite the pundits' proclamations of "democratization,” this is hardly a democratic market.  The Net and today’s market have become classic anarchies.  Our economic conundrums are bringing our economy ever closer to the creation of an inverse economic pyramid with people able to afford luxuries that cannot be produced fast enough to accommodate their needs. 

The collapse of Long-Term Capital, a steady 40% a year earner, should have sent a serious message to investors because of the ancillary damage that it could have caused to the entire U. S. Economy.  However, that debacle hardly created a ripple.  In reality, had not the New York Federal Reserve broken long-standing rules against meddling in private business, many of us could well be standing in bread lines.  After a short pause, the Bank for International Settlements (hereinafter BIS) now reports that competitive pressures again are leading banks to cut corners. “There are some indications…that competitive and business pressures are starting to reassert themselves and may be influencing credit standards imposed by banks in their dealings with hedge funds.”


During the banking crisis in the Pacific Rim, international bank regulators clearly placed the blame for the fiasco on excessively free lending practices and a lack of supervision.  It was suggested by BIS that the banks formulate standards for more adequate controls on highly leveraged institutions (HLI’s). BIS recommenced that more capital adequacy and good business practices receive more scrutiny. As with all near catastrophes, some progress was made shortly after the near calamity by born-again global bankers, but according to reliable banking reports, not only has the industry regressed in their approach to this type of lending in the face of competitive influences but the hedge funds in particular have “remained reluctant to share sensitive information about their business.”  Both the Basel Committee on Banking Supervision and U. S. Treasury have called on the HLI’s to improve risk management as they note an easing of the constraints that follow Long-Term Credit’s warning salvo.

We are reminded of another disaster that occurred shortly before the demise of Long-Term Capital. In the Pacific Rim, Thailand was flexing its economic muscle. There was not just a car in every garage, there were two shinny Mercedes Benz’s, one for each senior member of the family.  The economy was boiling and the Japanese banks thinking that this territory was part of their manifest destiny, moved into the country “in convoy” to grab their share of the lending pie. As so often happens in the Japanese System, as if in a convoy, all of the major banks descended upon the nascent economy simultaneously and in order to gain a foothold they began to compete by lowering their standards and their rates as inducements. While many foreign lenders heeded the signs of over lending, the Japanese were in a feeding frenzy and were either oblivious to the danger signals or thought that some divine being would save them at the last minute. Thailand ultimately collapsed, not necessarily because their own economic house was not in order, but because foreign bankers were supplying endless torrents of easy money.  The collapse imposed a momentary, forced transparency onto the system showing to those that looked quickly, that the king really had no clothes.  

New Faustian forms of speculation are manufactured systematically in Wall Street financial laboratories daily.  The strangest of these space age instruments is the derivative[19]; a product that often, even its maker does not understand completely.  Derivatives are instruments that are literally a form of economic insurance each of which warrants a particular end result. They are opaque in terms of the writer’s balance sheet and due to that fact, banks' balance sheets today do not nearly reflect the financial health of the institution.  Gary Stern, President of the Federal Reserve Bank of Minneapolis, stated, "Large banks have gone into sophisticated arbitrage transactions that inflate the amount of their capital at risk.  As a result, the banks are in full compliance with regulatory capital standards even though the expected losses of their portfolio exceed the capital that regulations require they hold."

A particularly interesting derivative case history came about during the Pacific Rim Crises when a Korean Corporation purchased a put covering their exposure in Indonesian Currency (Ringit) through a Hong Kong Investment Banking Firm secondarily guaranteed by American Banks.  If anything poses a risk to global banking it is the invisible risk of excessive derivative activity among banks.  Thomas M. Hoenig, President of the Kansas City Federal Reserve said, "…Although moral hazard problems can be continued through traditional regulatory approaches, an alternative is to require those institutions that engage in an expanding array of complex activities to give up direct access to government safety nets in return for reduced regulation and oversight.”  Essentially, what he is saying is that the American Taxpayer should not be obligated to support rampant speculation by certain members of the banking fraternity.  Gary Stern, President of the Federal Reserve Bank of Minneapolis stated, "…fundamental changes taking place in the banking industry (that) exacerbate the tendency of government safeguards to encourage banks to take on too much risk -- the so-called moral hazard problem, This distortion of the risk-reward trade-off was an important factor behind the savings and loan and banking crises of the 1980s and perhaps the recent financial turmoil in Asia as well."

The deep pocketed Americans were going to look to the Hong Kong Investment Banking firm for redress should the transaction go the wrong way.  It turns out that the Korean client buying the insurance made a sensible investment, because everything in Indonesia tanked.  Deeply invested in the Indonesian economy, the Hong Kong firm collapsed into bankruptcy, and the American Banks were left holding an enormous loss that was no place to be found on their books. 

While this may happen every day and be a normal effect of the underwriting business, this transaction, and its brethren differ dramatically from other forms of financial instruments because of the fact that they are entirely off the balance sheet transactions.  Accountants and the Securities and Exchange Commission in the United States have fought a valiant battle in attempting to bring transparency to this trillion-dollar business, but so far without success. The process of unwinding a transaction mid-stream is so complex that should the author vanish and the purchaser go bankrupt, no sensible liquidation can take place until all of the contracts have expired.  The U. S. Government was so concerned about this eventuality that they have written special legislation into the recently enacted bankruptcy code bill that would address this sticky wicket.  


When the exhilaration died down and the cold realities of the day dawned upon the excited banking industry officials learning that Washington had approved a new financial-service law which would allow them to sell, issue and market insurance products, they began to grapple with what they found to be a regulatorily archaic industry[20].  The Texas rule that does not allow non Texans to sell insurance products, the Florida requirement that an in-state agent co-write out of state agent’s insurance sales, glomming onto a sizeable chunk of the commission pie, or the silly New York regulations which require the State’s name to be boldly included in the Insurance Company’s name are only a few of the surprises that greeted the bankers[21].

While the securities industry has evolved into a somewhat homogenous mass when interstate offerings are initiated (mainly because of the powers that reside within the Securities and Exchange Commission), the road to acceptance in the fifty states is rough but travelable.  Insurance, by contrast, is totally amorphous because there is no federal regulator setting the tone for the states to follow.  Each product must therefore be licensed and approved before it can be marketed, and there is literally no way around the rule that agents must travel to the state to take an in-state, locally biased exam in order to sell products within the state.  Contrast this procedure with that of the Securities Industry, where a broker desiring a license can amble down to the local National Association of Securities Dealers Office and by taking an exam know as the “63”, become licensed in every state in about thirty minutes.  SEC Registered Public offerings quickly become indistinguishable from a securities point of view and can for the most part be freely traded in all fifty states.[22]

Both national banking and the securities industry are primarily regulated out of Washington and have some similarities.  Protection is provided  for both bank accounts and brokerage accounts from national mandated funds, which provide a level of safety against the failure of the banking or brokerage company[23].  While many states have funds to protect policyholders, the rules are diverse, funds are often inadequate, and the regulations are obscure and locally biased.[24] 

Recently, a New Jersey sometimes-insurance entrepreneur named Frankel was able to acquire small insurance companies throughout the Southern States because he was able to convince na´ve officials that he was something that he was not.  A total lack of transparency allowed Frankel to grab the cash from these acquisitions, sell off their assets, and live a life style on the ill-gotten funds that even Hugh Hefner would have found enticing.  Frankel took advantage of a combination of name-dropping, payoffs, and fraud to complete these acquisitions instead of using balance sheets provided by ethical accountants and securities filings lodged with the Securities and Exchange Commission.

And how many of use remember the folks at Equity Funding, a West Coast Insurer that was perceived as one of the major growth companies in the United States.  Its management style was cited countless times as being tops in their field and its seven-day a week work ethic was hailed as much of the cause for their success.  Ultimately it was discovered that round the clock work by executives was required to keep the company growing primarily due to the fact that at nights and one weekends, the company’s officers would fuel their growth by creating brand new, totally phony insurance policies.  Regulators within the states that Equity Funding operated never caught on to the racket and it was only by the efforts of a Securities Analyst by the name of Ray Dirks that the plot was uncovered.  Dirks reported his findings to his clients, the SEC and State of California Regulators and was suspended from the securities industry for his efforts.  It would have seemed that cash receipts when weighed against insurance written would have quickly put an end to this sham, but a major accounting firm did not see fit to analyze the company from that point of view and regulators say they relied on the outside accountants.

Banks will find that the Insurance Industry is the equivalent of a regulatory “Wild West” and getting up to speed in an industry where the “old boy” network has governed since inception is not something that can be easily overcome.  Take the example of Cigna insurance where they found that actuarially, policy losses would take a heavy toll on the company in the next few years and that they could even become life threatening.  What they did is logical but not something you see to often outside of the insurance industry.  They spun off the bad policies into another company, put an amount of money into the new company which they said was adequate to cover the future losses and had a good night’s sleep.  They were not alone in this concept.  The venerable Lloyds of London when faced with horrifying actuarial projections that would have sunk their ship, formed a new company, Equitas,  and went merrily on their way.  The Lloyds of London situation, though, had several other elements that had to be swept under the table to complete the subterfuge.  Misleading information provided to their “names” had to be dealt with, massive American Security Fraud had to be forgiven, lawsuits by the “States” had to be dropped, in spite of the probability that their citizens would ultimately suffer massive losses and frauds against state authorized reserve funds had to be winked out of existence.  Cigna saw that what Lloyd’s had done was good and they hastily  followed their sterling example.

If that wasn’t bad enough, many insurance companies have opted for virtually no regulation at all.  This has been accomplished by a movement by “captives” to exotic locales like Bermuda, the Caymans, Nassau, and Barbados.  Who on earth is watching the store in these places and what are their criteria for admitting assets?  How many deserted gold mines are carried in their portfolios at massive amounts of money?  How many American insurance companies are re-insured by these almost totally unregulated companies?  And what of the insurance buyer, is he always aware that when he buys insurance, he must look to the reinsurer for much of his claim and how often does he know to do that?  As banks acquire insurance companies they will also be acquiring the biggest “pig in a poke” in history as try to find out more information on who is reinsuring their policies.

There are no regulation requirements in the banking industry covering any of the above potentially explosive insurance problems.  What will be the impact on insurance and allied financial services industries when our banking/insurance mergers progress further?  What will become, for example of the National Association of Insurance Commissioners hard-fought battle for risk-based capital reporting in the insurance industry? Will insurance companies' statements disappear into the consolidated earnings statements of their banking parents?  Will they put their insurance generated capital at risk to guaranty the derivatives of their bank holding company parents? 

Regulation within the Banking industry is challenging enough, but when you start to add a diversity of hybrid insurance and banking products, it will be troublesome to determine which regulator is in charge of what product.  We believe that because of the fact that most major banks operate through holding companies, the regulators will be faced with a morass of barbed wire, keeping them from the facts. How careful will the bank’s insurance department be when it is designated to underwriting a policy for its parent?  Will the premium be commensurate with the risk involved or can inter-department assets be shuffled into the right spot to control earnings?  What about the difference in reserve requirements between diversely regulated inter-bank departments?  Can they all be swept under the rug by placing a surety bond from their captive on top of the whole morass?

Are the insurance companies adequately reserved for what they are writing and during times when the market is falling and bank loans are going bad, does not this time, also bode ill for the insurance business?  Are we not evolving a bigger and bigger house of cards that will collapse at the first sign of a downturn? We will not belabor this issue but would like to point out that, the United States Government, selectively determined that the; Savings and Loan industry should be allowed to collapse when in reality both the banking and savings industries were in equally dire straits. The Federal Government only had the resources to deal with one catastrophe at a time and thus, the S & L’s went. How, during a time of future crises will we be able to disintermediate the problem of who to save?  That luxury has seemingly gone the way of all flesh. 

Money Laundering

Every day of the week, over a trillion dollars a day is transferred between banks electronically every day of the week.  Jimmy Burns, reporting for the Financial Times stated, “Government and law enforcement agencies are in danger of losing the fight against economic crime because of inadequate regulation, excessive banking secrecy and poor co-operation between jurisdictions.  Jonathan Winer, U.S. Deputy Secretary of State, added his concerns: “Over the past year, a series of international financial scandals have highlighted significant gaps in the global system which seeks to regulate and enforce global norms to protect the integrity of financial markets and service.”  Essentially he blamed something he called “disappearing electronic money” and the inability of governments, regulators, law enforcement agencies and international organizations to trace it when “something goes radically wrong”. Such an instance happened at the Bank of New York when they became the conduit for questionable transactions emanating in the former Soviet Union.  What was so particularly frightening about that story was the fact that the players were not experts at anything, let alone electronic money transfers.  It appears that what they did know how to do was what criminals since the birth of time have been adept at, offering something of substantial value in exchange for the morality of the person that gets the job done. Thus, as long as the human element is part and parcel of the banking system, it will suffer the occasional hiccup. Some of these hiccups will be bigger than others

William Baity, Director for financial crime enforcement at the U.S. Treasury, indicated that money-laundering legislation is not keeping up with the sophistication of organized crime legally or from the point of view of enforcement.  The White House’s Special Adviser on Terrorism, Richard Clark added fuel to the fire, when he said; “Where once our opponents relied exclusively on bombs and bullets, hostile powers and terrorists can now turn a laptop computer into a potent weapon capable of doing enormous damage. There is giant tsunami about to crash down behind us. I would rather we respond before an electronic Pearl Harbor.”

So the government guys got together and put together something they called the Federal Intrusion Detection Network, or FIDNET. FIDNET would link with its counterpart in the Defense Department, the Joint Task Force/Computer Network Defense.  The plan was that these two systems would constantly monitor the electronic horizon looking for anomalies; breaches or intrusions and making short work of them. The system was designed to protect the “critical Infrastructures” such as banking, energy, telecommunications, transportation services, and the government itself. At the top of this Star Wars concept would be the FBI, which would have oversight over the project and be responsible for correlating the data, which resulted. This structure was named the National Infrastructure Protection Center and would roll out around 2003 having an open-ended checkbook to get it up and running.

Of course, this was all before the civil libertarians got wind of what was going on. The Electronic Privacy Information Center started the ball rolling with the statement, “These proposals are more of a threat to our system of ordered liberty than any single attack on our infrastructure could ever be.” Next up was The Center for Democracy and Technology and they chimed in, “It’s a Trojan horse for law enforcement and the FBI in particular. Underneath the fašade of wanting to protect ourselves from potential terrorists and hackers is a plan to collect information on every citizen in the United States.”  These and other highly critical statements have temporarily mothballed the project and for the moment, there is little direction.


The Bank of International Settlements is the institution that has been handed the gold ring to conduct international oversight on globally financial dealings. It is truly fitting that this antiquity, created to oversee World War I reparations has gotten the nod.  How on earth this invaluable training qualified this bank to determine international capital adequacy is beyond comprehension.

So soon after the calamities of the 1987 crash, the savings and loan crisis, the Mexican collapse and the Pacific Rim fiasco we are once again in a na´ve world in which many feel that the game will last forever and everyone is blithely attending the Mad Hatter's Tea Party.  When the market collapse and the bailout comes, it will be the public that ultimately picks up the tab and the fanciful vision of a debtless government will go to the same part of heaven that houses the Dodo bird.  Free lunch went out with the Wild West but somehow or other everyone is still standing in line at the bar.  And those who know better are the worst offenders; the banks, in a herd-like response lend willy-nilly to hedge funds, allowing them to borrow ever-increasing percentages of their assets.


Low Tech Crime


Low-tech crime has burgeoned while we have focused sophisticated Internet based theft. For example, lockbox fraud has increased recently. Historically, the lockbox department was an area where new employees worked. On average, these employees were at the lower paid and less educated end of the spectrum. Criminals are now paying $50 a copy for checks which list the account-holder’s name, the bank's name, the account number, the bank routing number, the check number and a copy of the accepted signature.  The lure of turning over 100 checks a day and bringing home $5,000 is almost impossible to resist.


If lockbox thieves keep their thefts below the banks' checkpoints, detection is almost impossible until the monthly account is mailed out. If the withdrawals are kept small, the theft may not be caught by the owner for a matter of months. Modern day scanning equipment creates a literally perfect copy of the owner's signature and even close examination of the check with the signature on file will not disclose a discernable difference. Even if one account is found to have been compromised, there is no direct link from this account to another, thus these transactions must be addressed on an individual basis. Knowing that the theft is going on has nothing to do with stopping it while the blood bath continues. Making the judgment that the crime is lockbox oriented is not a natural It is not always clear that the crime is lockbox-oriented, and even if it is, it may be hard to find the perpetrator. Currently there is no way to really combat this type of crime.


Bank Failures During a booming Economy

Under the damned if you do and damned it you don’t department, future years will see a lot more rate shopping because of the ability of banks and potential clients to climb into the ether and look for the best deal.  This may well bring about loans in geographic areas that are unfamiliar to bankers, but worse if solid loans become to easy to place, it well could hamper the efforts of the inner cities to get much needed funding for their infrastructure as well. While cyberspace lending has not yet become “new age,” there were failures of eight banks in 1999.  This has caused no undue concern to regulators because theoretically, if you couldn’t make money in the kind of economy last year provided, when will you ever make a profit.  Thus, the regulators are talking about tightening the reins a bit. Of the 11 banks that collapsed in the last year and a half, six were active in sub prime loans.  Thus, the FDIC has proposed doubling the minimum required funding for banks specializing in that arena.

The definition placed by the FDIC on sub prime loans is; “those (borrowers) who have made two payments 30 or more days late or one payment 60 or more days late”[25] Under this definition, we would see a return to red-lining.  The Fed is clearly worried about the fact that the robust economy that we presently enjoy is not going to continue forever and when the downtrend occurs many of those lending institutions will collapse.  The FDIC has identified over 150 banks and thrifts specializing in sub-standard lending that it has indirectly put on a watch list because when cumulated, these institutions represent 5% of the total banking industry assets.

On the other hand, the FDIC’s insurance fund is at record levels of almost $30 billion so that the banking industry is well equipped to weather most storms.  In the meantime, if improved dialogue can be created between the Federal Deposit Insurance Corporation and the Comptroller of the Currency it may be possible not to drastically change the rules at this time according to Chairman of the House Banking Committee, Representative Jim Leach of Iowa.  On the other hand, it was Leach who had stated when referring to the banking industry, “Seldom is a wake-up call as loud and clear as the one emanating from the tiny town of Keystone, West Virginia.”[26]


According to Ira Winkler, Technology Director for the National Computer Security Association in Carlisle, Pa. misrouted transactions, usually criminally instigated, account for an estimated $2 to $3 billion a year in losses to banks.  This type of bank heist was pulled off as early as 1994 by Russian programmers who cracked Citibank's system and launched $10 million into their own accounts.  Although the bank indicates that a substantial amount of these funds were recovered, Citibank's admission of the break in became fodder for their competition to use in ads indicating the Bank's security systems left quit a lot to be desired. According to Time Magazine,[27] this plays havoc with law enforcement. "Most companies that have been electronically attacked won't talk to the press. A big concern is loss of public trust and image, not to mention the fear of encouraging copycat hackers…Almost all attacks go undetected-as many as 60% according to security experts. What's more, of the attacks that are exposed, maybe 15% are reported to law enforcement agencies.  "


While many banks such as Chase use the more difficult to break, 128-bit encryption technology, others attempt to appeal to the majority of users that don't have this high level encryption installed on their machines. For some time, for example, Nations-Bank used 40-bit encryption, security that can be breached by run of the mill hackers in less than 4 hours.[28] The theory of using low level encryption in spite of the obvious security problems related to it is obvious. The bank was appealing to the majority of people that did not have higher levels of security. Thus, the bank was creating a compromise between maximizing its business and potentially incurring a substantial financial hit. A somewhat unique compromise.


Moreover, let us say that you are a criminal and the bank is fairly diligent. Even the conscientious bank is comfortable with automatic bill paying features. So let us assume that you set up a fictitious utility account in the victim's name at his online bank. Let us say that it is a phone system now has direct payment at their own American Bank, which in turn is acting for a foreign bank where the account really resides. Although the amounts that can be taken are not humongous, there is currently no defense for this type of Internet based crime. That is exactly the reason that the crime is so successful, the victim sees a charge by, let us say, Consolidated Electric for $18,75 on his account and confuses that with Consolidated Edison. It is only after several months that it dawns upon the victim that it is not one and the same.


A corollary to this type of crime is the theft of massive amounts of money from AT&T by enterprising hackers in Moldova, who transferred telephone calls to porn lines from the U.S. to a 900 number in that country. People found that even when they disconnected from the net, the phone line continued to charge their account and in some cases, person-to-person charges to Moldova continued for several days. More recently, AT&T, GTE, and ""Sprint, among others, were broken into by hackers-for-hire and hit them for over $2 million."[29]



Hungry brokerage firms that house day traders are usurping Federal Reserve Margin Requirements continuously[30].  In these businesses, greater leverage is directly tied to increased trading and more substantial commissions for the house.  Friendly bankers are always willing to provide money to these brokers should the need arise because of the fact that by the end of the day most accounts are back in the friendly confines of 50% margin mandated by the Federal Reserve Board.  During the day though, millions of dollars may have been spent without a dollar to back them up.  This reminds us of the story of the Kuwaiti stock exchange that arose like a Phoenix in the desert and went back to its maker almost as suddenly. 


In Kuwait, a person's credit was his bond, so this stock market operated on a system of uncashed checks, which were to be retained by the sellers until the transactions were concluded.  The checks became a game of musical chairs as they were literally always in motion.  When an “investor” sold a particular stock, he would nearly always immediately purchase another for the same approximate value.  This the uncancelled checks were propelled from seller to seller and acted as the ballast for the Kuwait Stock Exchange’s Clearing operation.  It was regarded as an affront not to trust the credit of fellow citizens until one day; a seller requiring funds for his business did the unthinkable and cashed a check.  This breach of social ethics caused a chain reaction when the check bounced higher than a kite and billions of dollars went up the smokestack.  As soon as the news started circulating that a check had bounced, everyone tried to get out the exit door first. Unfortunately, most of the checks that people held were no better than the one that was the first to come back market not sufficient funds.  The losses incurred by the Kuwait Stock Exchange and its members dwarf almost all other financial events in history and yet how many of you have heard the story and are aware of the gigantic amounts of money that were required to restabilize the country?  Today, there is desert where the exchange once stood and there is not even a marker to depict the scene of one of the greatest economic debacles of all time.


The Net


Stage left, roll the drums and into the complex equation comes the Internet. This of course is the wave of the future and no one is able to predict with any conviction exactly where it is headed because all estimates of its growth have been hopelessly under-predicted. Smart people have given us sage advice as to winning Internet strategies to be proven hopeless wrong within months and even days. This young toddler is being nurtured in most of the world, while in the United States, it is getting ultra-VIP treatment. This baby is persona non grata with the regulators because of fears that its growth could become impaired. Not only that, it has special citizenship because it pays no taxes. Interestingly enough, on the net, we have ticket-less tickets and we have bank less banking, we have SEC-less securities and cashless money.  Barter has become the vogue and regulation has vanished. 


An array of banking instruments is being hawked on-line; credit cards, deposits and faceless borrowing are just a few of the cyberspace products that hip lending institutions have gravitated too. Last year, for the first time, bankers made more from fee income than from loans or investments. As bankers increasingly rely on the web to attract customers and increase business, additional prospects for catastrophe loom on the near term horizon.


In Romania recently, hackers broke into the Finance Ministry’s Web site and changed the exchange rate of the nation's currency. A U.S., Latvian and/or Russian hacker invaded a credit card site, made off with 300,000 names, and then threatened to release them if he wasn’t paid $100,000. Just to show his seriousness, he dumped 25,000 of the cards onto the web on Christmas day for any remaining skeptics to observe.  This guy even gave us chapter and verse on what he had done;  “In 1998 I hacked into a chain of shops and got ICVerify (Cybercash) program with necessary configuration files for transferring money.”  By using this program he was not only able to make credit card purchases but was able to do charge backs refunds.  An offshore credit card account and access to an automatic teller where he could download either credit or money were literally all the tools he needed to perform his surgery.  The FBI, The White House, Congress, the Pentagon, and the National Security Agency have been visited recently along with the Japanese Government’s supposedly impenetrable site, which was recently penetrated in January and the last we heard moment is still down for the count. 


Possibly even more scary was the computer break-in that occurred at Visa International in London. The incident was so serious that while it occurred in July of 1999, the information of the incident was withheld for almost six months.  The reason for withholding the news was the fact that the site that was broken into was directly connected to 21,000 of Visa's member financial institutions and a ransom of $16.3 million was requested.  At the time, Visa was literally not certain whether they were in business or not.


More recently, a company that designs security systems was browsing financial sites and discovered seven internet locations at which credit card numbers and related sensitive personal information, including names, addresses, and employee social security numbers were exposed to public view on Internet servers.  Without password protection, this information was accessible to everyone who had an SQL server and was familiar with the nuances of opening a connection to the particular web site.  Strategy LLC, a Russian software company that discovered this problem immediately tried to contact some of the companies that were displaying this private information.  According to CEO Anatoliy Prokhorov, hew tried to contact these companies to inform them of what had transpired and received no response.  At this time, obviously seeing public relations material here, Anatoliy contacted MSNBC who investigated the incident announced:  "These basic security flaws were found by a legitimate Russian software company named Strategy LLC, and shared with MSNBC.    This is just a hole we passed by, an open door.  Our people were amazed.” — Anatoliy Prokhorov


During the Kosovo conflict, it appears that U. S. Intelligence agencies were able to tinker with the accounts of Yugoslav President Slobodan Milosevic in an attempt to throw the country’s banking system into chaos. “Three days after NATO began bombing Yugoslavia, Belgrade hackers inundated the alliance’s computer in Brussels with e-mails, transporting a hitchhiking virus intended to disable NATO's online operations.  The attack was a screaming success and NATO was forced to take its headquarters computer offline overnight.  Not content, other Serb sympathizers hacked their way onto the White House’s official Web site, and after U.S. warplanes mistakenly bombed the Chinese Embassy, vengeful Chinese hackers posted graffiti on the home pages of the U.S. Departments of the Interior and Energy, calling all who could perceive,  “Nazis.” The Defense Department documented over 100 attempted break-ins on its computers daily, and a U.S. Navy airbase involved in support of NATO air operations briefly let e-mails from Belgrade get onto its network in view of the fact that they were able to successfully mimic a Navy E-mail address.”[31] Authorities have pointed out that the United States currently possess the capacity to disable enemy air defense systems, infect software and disrupt logistics through its recently organized cyber-defense complex at Colorado Springs.


Kosovo is not the only hot spot in the world where hackers give the impression of being able to penetrate sites at will. As we speak, an undeclared cyber-war is raging between Portuguese and Indonesian sympathizers over the desperate situation in East Timor. Sites are ravaged on a recurring basis with various slogans left behind for all to consider. An even more serious cyber-conflict has been boiling over between Taiwan and Mainland China. In spite of the fact that China has an overwhelming population advantage, Taiwan is more technically proficient with Web Interdictions and has been a recurring visitor at all of China’s most strategic sites. By sheer dominance of numbers, the mainland has been capable of striking back systematically. China is fighting a two front war; they are attacking the Taiwanese on one hand while they are also on the offensive against the so-called rebellious religious fanatics that having been drummed out of China, their leadership has domiciled in the United States.  The sites on both sides of the Pacific Ocean are being zapped on a daily basis. 


During the Gulf War, Dutch hackers lifted classified information with reference to U.S. troop movements and made contact with the Iraqis eager to strike a lucrative deal. Fortunately, the paranoid Iraqi leadership was convinced that this was only an American ploy to throw them off-guard and thus, rejected the proposal out of hand. In February of 1999, a group of hackers seized control of a British military communications satellite and demanded compensation in return for control of the satellite. CNN reported in January of 1999 that U.S. Intelligence Agency computers were hit by a coordinated attack, which appeared to be originating in Russia. CIA Director George Tenet announced that the United States had fabricated a computer program that could attack the infrastructure of unfriendly nations, “That’s nothing new, but it’s the first time it was publicly announced. If a country tries to destroy our infrastructure, we want to be able to do it back. It’s the same approach we’ve taken with nuclear weapons, the prudent approach.” The U. S. Government Accounting Office has estimated that over 120 countries or factions have or are in the process of developing the necessary technology to conduct information or disinformation warfare. Designated, as countries already possessing highly developed systems in the cyberwarfare arena were China, Israel, and France.


This form of assault will become substantially more pervasive as computerized delivery sophistication evolves. The New York Times leaked a document evidencing the fact that the National Security Council is evolving a "Big Brother-like" electronic monitoring system called the Federal Intrusion Detection Network.” The EIDN director instead of denying the newspaper story, retorted,  “We have good reason to believe that terrorists may be developing similar capabilities.”


Plain Vanilla Computer Crime


In March of 1998, the Computer Security Institute[32] went public with results of their "Computer Crime and Security Survey, a joint undertaking with the Federal Bureau of Investigation. The survey is based upon responses of 520 security personnel in U. S. corporations, government agencies, financial institutions and universities. The findings suggest that computer crime and information security breaches are still on the rise and that the cost to U. S. Corporations and the Government is escalating. While we will not belabor the issue, it is sufficient to say, 64% of the respondents reported computer security breaches within the last twelve months and of these 72% acknowledged suffering financial losses incurred by those breaches.  Of those violations, 44% were committed by employees. Those transgressions incorporated the theft of proprietary information, telecommunications fraud and financial fraud. A startling 54% of that total occurred through Internet.


Time magazine reported that, "…the FBI estimates computer losses at up to $10 billion a year. As grim as the security picture may appear today, it could actually get worse as broadband connections catch on. Then, the Web will go from being the occasional dial-up service to being "always on," much as the phone is.  That concept may be nirvana to e-tailers, but could pose a real danger to consumers if cyber crooks can come and go into their computer systems at will. "[33] Time goes on to point out that if you are "always on" the Internet address remains constant, but with a modem hook-up, that address is altered each time you sign on.  Thus, there is the ability to go back to the site numerous times once you have made entry on system connected by cable or other comparable methods.  


Patrice Rapalus, Computer Security Institute director suggested that organizations pay more attention to information security staffing and training. "While companies may think that they are spending the requisite amount on information security, the dramatic increase in quantified dollar losses indicates otherwise. In addition to hardware and software (for example, firewall), organization must ensure that training staffing levels are adequate and that end users are made aware of the seriousness of the situation."     Robert Walsh, Special Agent in Charge of the FBI's San Francisco office agreed that the dollar losses as reflected in this year's survey are a matter of grave concern. "But what is of equal concern is the seeming reluctance of organizations, for the third year in a row, to report computer intrusions to law enforcement. It is understandable that negative publicity is cited as the principal reason for this; however, the FBI has successfully investigated, and resolved many cases in which computer crimes are alleged with minimal or no public exposure to the victim company."[34]


Well, that’s very interesting but what the heck does it have to do with banking?  It seems that there is a Cyber-Banking institution by the name of X.Com Bank, a division of First Western National Bank, which determined to interconnect its online application form with the Banking Automated Clearing House Network. Thus, someone having another person’s account information was able to move money from his or her account at another bank into the X.Com Bank cyberspace facility and from there, simply walk off with a substantial amount of money.  William Harris of X.Com stated after the horse had already gotten out of the barn, “We’ve done thousands of transfers, and 5 or 10 that have been problematic. We have had people attempt to beat our systems in a number of ways and now we think that we’ve identified and addressed these problems.”


Elias Levy, who runs, an Internet security information service was appalled at the ease in which the swindle was pulled off.  “What’s most appalling is they said it ‘was a designed feature,’ ” Levy said. The company wanted to make online banking as simple as possible, so it allowed depositors to skip a step like sending in a voided check to verify their identity. “It was a calculated risk. Obviously they calculated wrong.” Nothing seems sacred on the net, apparently as soon as the first money was heisted; news of it appeared on the net describing the address and how it was done.  Undoubtedly others joined in the fun, but for now the bank is keeping a lid on what its damages were. It seems that none of the net denizens thought of calling or e-mailing X.Com about what was appearing regularly on the Net's chat rooms.


Venture Capital


Venture Capital is another arena that while new to banking has literally exploded in popularity and in a short time has become de rigueur. As an example of how serious this thrust has been, Chase Manhattan’s, Chase Capital Partners accounted for in excess of 15% of the Banks overall earnings in 1999 while only employing 3% of Chase’s assets.  Its return over the past 15 years has averaged 42%, almost double the industry norm. Chase has begun selling pooled investments in a roll-up of its venture deals. Chase is offering the investors a pretty good deal, a chance to buy into the deal after Chase has already sunk their money, and at the same price. Chase's return is generated by spreading the risk and receiving a backend payment of 20% if the deal goes public. There is absolutely nothing to criticize in the way the people at Chase have structured the transaction, but it is a toe in the water of the pools that existed before Glass-Steagall. With the other banks envious of Chase’s position, watch them all try to get into the act at once, simultaneously diminishing the pool of available transactions that would qualify as a reasonable businessman’s risk.  Thus, we will soon be looking at the age-old problem of more and more money chasing a diminishing pool of available investments.  As quality begins to suffer, people will stampede out of these investment as quickly as they got in.  There are just so many good deals around and you cannot force these kinds of investments.  Wells Fargo and FleetBoston Financial Corporation have already announced that they are joining the fray so you can soon expect a lot of bloodied bodies.


Very Different Point of View


In addition, as the Banks get cozier and cozier within the securities markets, regulation becomes more of an issue.  Historically, while the SEC was concerned with the financial security of the investor, at the same time, the Federal Reserve and the Department of the Treasury have been concerned with the financial security of the bank. Thus, we have a clash of historical perspective. The SEC was always willing to let the brokerage firms fail if it meant that one less investor would get fleeced or lose money. The banking regulators would try to save the bank at almost any cost, even if it was at the expense of depositors.


These two very different philosophies were expressed best by SEC Commissioner Hunt, who stated “There is some concern whether banking regulators will be concerned when we, or other securities regulators, try to regulate the securities function of say a bank holding company, or whether the banking regulators will let us continue to do it as we do now with the securities firms, or whether there will be some resistance from the banking regulators as to how much we can get into their holding companies. I don’t think we know, Bank regulators, as I understand what they do, care about the sanctity and stability of the bank as an entity, Securities regulators, are concerned about protecting investors and protecting the function of the market but the sanctity of the entity itself-the brokerage firm itself-is not our primary concern.”  We would express the same concerns considering the diametrically differing approaches to regulation and hope that the philosophy of investor protection is somehow maintained within the framework of a Glass-Steagall-less world. [35]


The Central Banks & Digital Cash

Between the Internet’s corruption of regulation and the Central Bank’s ultimate demise, the global banking system is sitting in a very precarious situation.  Nevertheless, wait, the banks are now in the insurance business and the brokerage business and the data-mining business and in every bodies business all at once.



We have made great strides as a society and today many of us have the capability of carrying these miniscule debit cards that are capable of containing unlimited  amounts of money embedded within there obsequious framework.  The smuggling of diamonds or gold has become passÚ’ because no longer will fleeing dictators or money launderers have to ship currencies from one location enjoy its value.  Smart or debit  cards can retain billions or even trillions if need be and they pass through the high-tech metal detectors and low-tech custom agents like a hot knife cutting through butter.  In Europe and the Pacific, these little devils have taken a firm hold on the populous. As this plague gains momentum, it will totally subjugate any control that our global central banks were able to enforce.  As central banking gradually loses the ability of controlling anything, those that have the fullest cards will become Cyberspace kings.


The Federal Reserve was not sleeping on the job and foresaw many differing unpleasant scenarios that could potential upset its control of money and banking in the United States. The Federal Reserve in a joint venture with the banking industry developed the Automated Clearing House (ACH) which, when it was conceived took into account many aspects of the issues we are now dealing with. In its over two decades of development, the Federal Reserve along with the banks continued hoping that consumers would gravitate to its use. Unfortunately, as with all innovations, predictability sometimes works in indirect proportion to our vision and that has been the case with ACH.  Alan Greenspan in speaking for the Federal Reserve stated, "In the case of electronic money and banking, the lesson from the ACH is that consumers and merchants, not governments, will ultimately determine what new products are successful in the marketplace. Government action can retard progress, but almost certainly cannot ensure it."


According to G10[36], a precise definition of (digital) money is difficult to provide (as) a number of official bodies have described and categorized these products in different ways."  Its use is evolving by trial and error, a basic function of consumer acceptance. What form it will take is yet to be determined, but the fact that some form of debit card that will contain your critical information and your assets is certainly a part of all of our futures’.  The issues are only when and in what form will today's smart cards, electronic wallets, debit cards or stored value cards become tomorrows alternative bank.


It seems literally without question that increasingly substantial amounts of cash will be stored on these cards with total anonymity and that they will soon be replacing the movement of gold, currency and diamonds as the underworld’s favored method of money laundering. No sooner had the global community begun working together in tracking funds stolen by national leaders such as Congo’s Mobutu and the Philippines’ Marcos, then a new method of concealment rears its ugly head.  No longer will it be feasible to think that in the future, stolen funds can be gloomed onto by the Marshall attaching a bank account. 


Thus, we will be entering an era of what we may call “trusted money.” The American Dollar, the Japanese Yen and the Euro will probably be in great demand as trusted currencies. However, why not the Visa Electronic Dollar, The Master Charge Internet Currency or the American Express Internet Travelers Check?  Each one of the forgoing will create havoc on the ability of the Central Bank to track currencies. This creation will not be anything singular in the annals of money as private currencies were the order of the day in the early days of the United States[37].  The potential profits to be generated by signorage will in some way parallel that of the float on today's travelers checks and money orders. Yet these potential rewards are astronomical and offer such unlimited potential that we would envision, not only the above companies but a plethora of others to jump on the money issuing band wagon. The only trick to be in the money issuing business will be a better mousetrap. Certainly a good start would be a basket of currencies approach once favored by the United Nations and the International Monetary Fund.  By backing a new currency with a combination of Dollars, Yen, and Euros organizations such as the United Nations could become a successful currency issuer overnight.


Moreover, we should be prepared for the day when every bank is a money issuer and in their new found relationship with insurance companies they will soon be issuing surety bonds covered by “in house” insurance companies guarantying themselves, not to healthy state of affairs to say the least. [38]


Thus, ultimately we will be driven back to a time when the quality of the institution was constantly under scrutiny and issuers money had a tendency to fluctuate as the perception of the underlying worth changed. If we think that we the currency of today's world offer a mind bending number of alternatives, visualize what tomorrow’s world will be like.  


The Fed’s Point of View


In a speech before the Federal Reserve Board on 9/19/96 by Fed Chairman Alan Greenspan, he attempted to make an analysis between the frontier banking days before the Civil War and what we are facing today.  "In the pre-Civil War period, when the general ethos of laissez faire severely discouraged government intervention in the market economy, private regulations arose in the form of a variety of institution which accomplished much of what we endeavor to do today with our elaborate system of government rule making and supervision.  In particular, scholars have noted that the period saw the development of private measures to help holders of bank notes protect themselves from risk.  As the notes were not legal tender, there was no obligation to accept the currency of a suspect bank, or to accept it at par value; accordingly, notes often were accepted and cleared at less than par. As a result, publications--bank note reporters--were established to provide current information on market rates for notes of different banks based on their credit worthiness, reputation, and location, as well as to identify counterfeit notes.  Bank note brokers created a ready market for notes of different credit quality. In some areas, private clearinghouses were established, which provided incentives for self-regulation."


"Banks competed for reputation, and advertised high capital ratios to attract depositors. Capital to asset ratios in those days often exceeded one-third. One must keep in mind that then, as now, a significant part of safety and soundness regulation came from market forces and institutions. Government regulation is an add-on that tries to identify presumed market failures and, accordingly, substitute official rules to fill in the gaps."[39]


"To be sure, much of what developed in that earlier period was primitive and often ineffectual. But the financial system itself was just beginning to evolve." [40] Greenspan later goes on to make a startling statement; "I am especially concerned that we not attempt to impede unduly our newest innovation, electronic money, or more generally, our increasingly broad electronic payment system." Having convinced us that this early form of American Banking was evolutionary in nature and was well left alone, he concludes that today's situation is analogous and should remain equally independent.



Although we are great admirers of Chairman Greenspan and have been for some period of time, we believe that this speech will not hold up well when viewed by future economic historians. We are hardly in the same sort of environment that existed then. Each bank was an entity upon itself and the collapse of an individual bank had little overall bearing on the survival of the system as a whole.  Today we live in a globally interconnected society and each and every bank in each and every country has some bearing on the health of the whole, be it only a small ripple, on their global counterparts[41]. We would ask Mr. Greenspan, What about a renegade bank or worse yet a renegade nation, what effect may that have on our society[42]?  In not to recent history, we are all well aware what the over lending of Japanese Banks did in Thailand. A panic spread throughout the Pacific Rim and effected Russia, Latin America as well as all of Asia before fast action by the IMF brought the virus to a halt.


What about the hypothetical case of a very large depositor in a major bank who has his funds stored on a cyber-cash card that who suddenly determines to change banks?  The hypothetical transfer occurs at a time when the bank cannot make arrangements to borrow from the federal reserve or other member banks.


We are reminded of a time when a similar problem occurred at Bank of New York and the entire system almost crashed taking Wall Street with it.  Very few people are aware of the details but what occurred is not complex. Bank of New York’s (BONY) computer system failed for a day and a half and as a result, a $30 billion overdraft occurred. If not promptly settled, this overdraft would have sent the entire system into convulsions. The New York Federal Reserve, without a second thought, lent BONY the equivalent of 22 times their capital, or $23 billion.  The Fed was fully cognizant of the fact that any delay in allowing Bank of New York to settle its transactions would cause a system wide crash effecting both the securities and banking industries.       


Are The Central Banks Getting Long in the Tooth?


Without the Fed’s nimble action, the economic world could have come crashing down.  In the world of the future, we envision a Fed that may well be toothless, this transaction although certainly not the fault of the bank would have affected the integrity of the entire system.  What would happen under similar circumstances if the largest cyber-bank becomes unable to settle their accounts because a twelve-year-old hacker shut down the system?  Who is it that comes in and keeps the system from crashing?  The United Nations doesn’t have enough money to pay their employees’ salaries, the World Bank and the IMF would not be allowed to do it by the nature of their charters, because the bank has is domiciled in Antigua, there is not enough money in the nation’s treasury to pay the wire charges and the world’s central banks are paralyzed.  Our only hope under this scenario may be someone like Bill Gates stepping up to the place and backing the bank with Microsoft Cyber-Money.  The Bank of New York’s computer going down is more or less an act of God, but these days, God seems to be active.


Three trillion dollars per day are settled at the New York Federal Reserve, the most important money center financial institution on earth. How many of us realize how close the world came to financial meltdown when a unpretentious fire occurred in a Con Ed facility in New York?  It didn’t really even make the news, but it did close the New York Fed for a week.  Only the redundancies available in lower Manhattan could have warded off the disaster that lurked just a hair away from Wall Street every minute for that long week in August of 1990.  The world barely escaped calamity, and yet how many people realize that the global trading game was almost shut down?


How The Group of Ten Sees Deregulation and Technology


We will not go into the additional problems created by our hypothetical situation such as reserve requirements and other ratios, but suffice to say, the banking world will never be the same again.[43] The Group of Ten continues with a rather bleak picture: "Issuers may bear risks of fraud or operational failure or of redeeming counterfeit electronic money accepted by merchants or consumers for which no corresponding payment has been received.  Issuers will also have to address a range of traditional risks, including strategic and reputational risks, compliance risks, and risks associated with outsourcing of operations." [44] 


We see no regulation on the horizon and as matter of fact, a ”let's see how things develop” mode seems be the order of the day in G-10 countries.  "A survey of policies across G-10 countries indicates that, at this stage, G-10 countries have generally not seen the need to develop new anti-crime laws or regulations specifically pertaining to electronic money.  Nevertheless, because of the potential for money laundering and other criminal activities, and because of rapidly changing technologies and commercial environments, law enforcement authorities will need to continue to monitor the development of electronic money products…"[45]

The Effects of a Renegade Banking System


Why not add to this thesis the hypothetical, First National Bank of Antigua, theoretically a member of MasterCard where money is stored by drug cartels throughout Central and South American. The simple two step process of a bank wire from say Citibank in Columbia, to our First National Bank of Antigua and from there into our electronic money account (digital cash) in our digital Master Card has literally rendered the money invisible to bank regulators.  It can reappear with equal ease to make payment for desired items or to be used to attract currencies around the world with abandon.[46] 


The First National Bank of Antigua is fictitious but what about something that the regulators call "Regulatory Arbitrage"? Let's use Morgan Guarantee as an example. Now everyone knows how solid Morgan is. On the other hand, we envision the time when countries will start appealing to banks to set up overseas operations based on the stringency or leniency of their digital cash regulations.  Thus, a traveler buying a digital card from Morgan may think that the card represents the full faith and credit of this prestigious institution. On the other hand, those that read the fine print see a different reality; it is a non-guaranteed subsidiary of Morgan set up in another country whose banking laws are skewed toward the bank's benefit.  Can you imagine the consternation of the card-carrying traveler when confronted with a problem that can only be solved by applying in person to Moldavian Supreme Court, which only convenes on alternative leap years?    


As digital cash becomes universal, the University of California is quick to point out: "The institutions’ close relationship with individual customers and their transactions’ changes.  Financial data is no longer warehoused in bank servers. Records pertaining to the spending and borrowing habits of customers can no longer be traced. This anonymity encourages the commission of crimes that rely on faulty currency authentication, such as money laundering and counterfeiting."[47] 


Ultimately the loss of signorage will begin making a significant reduction in the operations of countries that rely on the issuance of currency to support their treasury functions.  The G10 countries in their April 1997 Report on Electronic Money express fears that a dramatic upsurge in the usage of this form of tender could threaten the stability of financial markets, undermine confidence in the payment system, create a breeding ground for fraud, unfair practices, financial loss or unnecessary intrusion on personal privacy, erode the central bank's ability to conduct monetary policy and hinder the ability of law enforcement authorities to prevent and detect movement of funds associated with criminal activity. The only way to prevent this catastrophe from occurring is an anathema to the basic tenets of electronic commerce, rigorous controls.  The fact that there are no regulations in this arena is only hastening the day when the system may plunge utterly out of control.


We also have the "between the rock and the hard place issue" of privacy. Should these electronic cards be truly anonymous, criminal elements and unfriendly foreign governments will have a field day as tracing the ebb and flow of weapons, contraband, and narcotics becomes almost impossible.  On the other hand, should they be transparent, a cookie trail will divulge facts about the card’s owner that would even make the ACLU rush for cover.  Like vultures riding the rising air in the savannah looking for carrion, the criminal element can take it either way and find limitless opportunities.


Yet, the Government wants to know what is going on without criminals being able to have access to what that information.  From the Government’s point of view, too much encryption will hurt the efforts of regulatory agencies from policing their turf, two little encryption will level the playing field to a degree where everyone will get a equal opportunity to see the landscape.  A vote for privacy and a high degree of encryption takes away the government’s ability to police, lowering the barrier riles the civil libertarians and aids criminals, thus we seem damned if we do and damned if we don’t. 


As if that wasn’t a big enough problem digital funds will probably have to be double counted in order to balance the books the central bank’s books, as they will literally reside at two locations simultaneously.  Under this scenario, the Federal Reserve could lose control of the money supply if it did not enter into a system of controlling the issuance of digital cash by financial institutions in the United States.  This would be of little value when we address the friendly First National Bank of Antigua, which could become a recipient of massive inflows under that scenario. Without the United States retaining full control of the issuance of digital cash, we believe that the government's ability to control anything monetary will gradually be eroded. Ultimately as digital cash gains, even that will be of little or no help.

Bank Mergers and Computer Compatibility

Bank mergers have been an item lately.  When you consider the fact that the average department in a bank can’t communicate  through their computers to another department in the same bank, you can get some idea of the prodigious effort it takes to merge two of these monoliths and have them function as a single unit. It will be years if ever, before Chase has finished digested Chemical or the other way around, depending upon where you happen to be sitting and yet the talk is that they are going after a major brokerage house, possibly even Merrill Lynch.  Citicorp’s/Travelers draconian two headed management team is fairing no better in getting the glitches out of their system.  These ragged spots have not surfaced in recent times because the bank’s fee income segments have been growing so quickly that they have been glossed over, but they are there like an accident waiting to happen[48]. This problems will become more transparent when the economy begins to back up which it ultimately will.


As a generalization, bank mergers have not achieved anything near what they have promised.  A recent article by Amy Kover in Fortune Magazine, entitled article, “Big Banks Debunked for Over Ten years, waves of mergers, each seemingly bigger than the last, rolled through the banking world.  Now the hype is ebbing, and only the numbers remain.  They’re not pretty.”  After that, kind of beginning you can just imagine what the remainder of the article had to say.  Without beating on a dead horse, it mostly concerns itself with the comings and goings of Bank One, First Union and Bank of America and goes into some detail relative to the fact that earnings projections made before acquisitions did not even come close to the mark, the only thing that got bigger was the CEO’s salary and the price earnings paid for succeeding acquisitions.  Miss Kover inserts the quote of the day when she talks about the relationship between a bank’s size and its performance.  She uses a line from Tom Brown of who stated, “Basically, when banks get bigger, it’s just the shareholder who gets screwed.”


Miss Kover charges the banking industry with acquisitions for their own sake and illustrates the magic accounting that is used within the industry to cover the tracks of a really bad deal.  She additionally points out chapter and verse of how CEO’s salaries go up literally in inverse proportion to the bank’s stock market performance.  Not satisfied in bringing to our attention the dismal performance of the “big three”, she goes on to point out the ineptitude of the “old boy” board’s of directors that in many cases seem to do the chief’s bidding without looking too deeply into the implications.  Things have apparently gotten so bad that FASB is taking another look at bank accounting and is talking about a major overhaul in 2001.  


It’s A New World Charlie Brown


It is certainly not difficult to convince even the staunchest critic of deregulation that this is not the same world in which the Glass-Steagall came into being[49].  It was created during the depths of the Great Depression and although it did little or nothing in a constructive sense, it did restore people’s perception of the banking industry and funds that had been secreted under mattresses slowly found there way back to the local bank.  Technology had nothing really to do with the act being created, the banks were just being made the whipping boys for joining into the revelry that caused the crash of 1929. An interesting example of the witch-hunt the created the Glass-Steagall Act is the simple statistic that during the 1930s only 15 of the 207 nationally charted banks with securities affiliates failed[50]. The entire reason for its being flies in the face of this one statistic. For punishment, the banks were to only do banking and they were forced to leave things like insurance and securities to professionals.  On Thursday, November 4, 1999, the Gramm-Leach Bliley Act was passed, highly trumpeted as the single most import step in bringing banking out of the Stone Age and into modern times after almost seven decades.

Essentially, the Gramm-Leach-Bliley Act allows the banks to go into the insurance and securities industries and regulates them from the banking side of the ledger.  It reins in public use of banks' customers' sensitive personal information. It creates an economic wall of safety between the new products and customer guaranteed deposits and eliminates burdensome regulation of community lending. In spite of these beneficial aspects of the Act, in a competition-free environment, fees will escalate rapidly and the privacy of bank clients is still at risk. More importantly, the economic power that these institutions will be able to wield will be immense and a formerly level playing field may fall victim to free enterprise.  

The Glass-Steagall Law was also known as the Bank Act of 1933. By the time the Bill had become law, 11,000 banks had failed or merged, diminishing their number by over 40%. Roosevelt had actually declared a moratorium or in a more civilized manner of speaking, a bank holiday on the banks.  Take a break, take an aspirin and let things chill out was the order of the day. Roosevelt’s moves had no real effect on things, as the depression grew continued to increase in intensity.[51] It was not until the country began to prepare for war that any kind of turnaround occurred.  By taking the banks’ ability to speculate away, Roosevelt was to some degree calming the waters[52]. 

Banks Have Stockholders Too

Many banks are public and certainly all of the big ones are.  In order to rank among the movers and shakers in the securities markets, all corporations (other than some on Internet) are forced to show consistent improved earnings so that their stock will keep pace with the averages.  As the stocks rise, the corporate bank officials that have large positions or a healthy serving of options become richer and richer. In an effort to keep the ball in play, enormous pressure is exerted on bank officials to produce continually improving results.  The Federal Reserve believes that the quality of loans has eroded. This is borne out by the fact that in the second quarter of 1998 non-performing loans stood at $15.4 billion or .72% of loans, while in at the end of the second quarter of 1999, non-performing loans were $18.5 billion or .82% of loan portfolios. Comptroller of the Currency John D. Hawke Jr. noted that “even though many of these loans are currently performing, we are beginning to see rising levels of missed payments, defaults and bankruptcies among corporate borrowers.” Robert Bostrom, head of the Financial-institutions practice at law firm Winston & Strawn in New York stated, “It’s the age-old conflict between regulators’ desire for banks to be sound and the market’s demand for profits and return on equity. There continue to be a lot of banks chasing a limited number of deals, so people start to structure them to meet their income numbers and their bonus numbers.”

The regulators that passed the bill eliminating Glass-Steagall certainly not only meant well but also had an enormous push from the banking lobby. We would remind these folks of how Nick Leeson destroyed one of the oldest banks in the world by a system that almost predates modern banking, simply by taking over the back office function and making his illegal transactions conform to those that would balance the books[53].  We are further reminded of Yasuo Hamanaka’s copper transactions that were hidden from Sumitomo Company officials for almost a decade and that almost caused a the demise of one of the largest banking complexes in the world.  Yasuo was able to conceal his actions by having access to the bank’s “back office” where he made up documents that justified his trading from an internal accounting point of view.  Losses racked up by Hamanaka totaled almost $3 billion and if Sumitomo had not been one of the largest banks in the world, they would no longer be with use.  The effect if this on copper markets and world copper prices that has still not been fully analyzed but there is little question that the market has never recovered.[54]. 

I am sure that the people at the Federal Reserve remember the creative accounting of Toshihide Iguchi, who in Leeson’s role as chief trader and bookkeeper managed to rack up mind boggling loses and then hide them from officials in his own company as well as regulators from both the Japanese and American Government.  For some inexplicable reason, the Japanese Government delayed informing the U.S. of what had happened giving everyone involved a warm and cuddly feeling relative to the morality of Japanese Bankers.  Charles Keating who rhetorically speaking, had a good portion of the U.S. Senate on his payroll and many of those cronies took his side with the Federal Home Loan Bank Board when they explained why his unethical practices should be overlooked.  Mr. Keating cost American taxpayers over $3 billion and last we heard was free as a bird.  Last of all; let us not forget our friend at Kidder Peabody, Mr. Jet, who was able to make a shambles of General Electric's world-renowned, reporting systems and ended the existence of his direct employer.  No one could question his trades because there were so complex that the auditors assumed that they were all right.  His superiors who shared a bonus pool with Jet did not protest too much because they were drawing down in the seven figures a year and things never looked better.  The problem with these types of transactions is the fact that in order to keep the plot from unraveling, the transaction size must be continually increased to show ongoing performance.  Ultimately, there is a point at which can see that the game is about to end.

A Bank of a Different Color


And, in the how quickly we forget department, Bank of Credit and Commerce deserves special mention, as it was probably the first perpetrator of a bank organized on a multinational basis, totally designed to commit fraud and structured in such a way as to evade the regulators.  BCCI was able to establish footholds in regions that historically were totally closed to outside companies ([55]). The bank was financed by Middle-Eastern interests and at its height was domiciled in over 70 countries. 


Their mode of operation was ruthlessly uncomplicated; bribe the highest-ranking credible official within the target country, install him, as a senior officer of the bank and success would be assured.  ([56]) Friends were accorded loans in the tens of millions of dollars with virtually no collateral and no discernable businesses ([57]).  Officials plundered the bank’s treasury at will and government officials became millionaires by turning their heads while the bank’s regulators shared the spoils as well.


At one time or another, BCCI’s payroll included the following distinguished names:  Sheik Zayed of Abu Dhabi, Lord Callaghan, former Prime Minister of Britain and Javier Perez de Cuellar, then secretary-general of the United Nations.  De Cuellar was a regular passenger in the bank’s luxurious 727, which he flew on official business. Jimmy Carter, ex-President of the United States, was also a regular user of the plane and his Presidential Library was a substantial recipient of the Bank’s largesse. Indira Gandhi was the presenter of BCCI’s established, “Third World” prize and Clark Clifford, who was at the time America’s true elder statesman was a senior official of an undisclosed affiliated bank.  Andrew Young, when Mayor of Atlanta, was on a $50,000 per year retainer from BCCI, which was paid into a company the Mayor owned ([58]).  Adnan Khashoggi founded the Monte Carlo branch of BCCI, which was most convenient for funding his multi-million dollar arms transactions[59]. 


They were able to operate almost at will during period of substantial regulation. I absolutely shudder to think of letting these people loose on the electronic systems in use today. You can be certain that every drug cartel, Mafia family, religious fanatic, revolutionary and unfriendly country would gravitate to their banking services like a duck to water.

We are of two minds here.  The first is that today's systems are easy marks for internal thieves like those listed above; the second is that with the easy access now provided by Internet or other electronic processes, it is clear that another or a series of thefts has already taken place that is at least the size of the ones listed above.  When they are announced, what effect will they have on global banking? We can only pray that we garner controls over the system before we are once again forced to use wampum as a method of payment.  




Global banking as a rule has not been as safe as the industry would have us believe. We tend to forget yesterday’s failures and concentrate on today’s successes. But then again, that is human nature. The Economist  in their April 12, 1997 issue put it well:


“…Since 1980, more than 100 developing countries have suffered some kind of serious banking-sector crises. In some of them, reckless lending has left banks with unrecoverable loans that far outstrip their shareholders’ capital. In others, banks have been sculptured by a sudden loss of confidence that led to runs by depositors.


“Many bank-watchers worry that, on the evidence of the past few years, things are getting worse. In Africa, banking systems have been going down the tubes at the rate of two a year. According to the World Bank, between 1988 and 1996, systemic banking crises struck in 20 African countries, five of which had to spend more than a tenth of their GDP to mend the damage…..


“In Eastern Europe, banks in almost every country have run into trouble as they swapped communism for capitalism. Hungary’s government has thrice had to bailout state banks that  had been sliced off from its communist-era Central Bank, taking with them huge portfolios of bad loans to smokestack industries. Over the past five years, the financial systems of all three Baltic States have been rocked by explosions among the new breed of private banks. The Czech Republic, one of the region’s star economic performers, blotted its copybook with a series of banking scandals and bust-ups that last year threatened a systemic collapse. In Bulgaria, a failure to reform state industry and banking supervision has left banks with a collective negative net worth of over $1 billion.


“Banks in Latin America have been just as accident-prone. Chile suffered a devastating banking crisis in the early 1980s. The currency turmoil in Mexico at the end of 1994 came on top of banks’ over-expansion and careless lending binges that had stored up trouble. Mexico’s problems also tripped up Argentina’s already-wobbly banks as panicky customers drew out 40% of their deposits in early 1995. Venezuela’s banks were brought to their knees by a combination of incompetence and fraud. Several billion dollars-worth of bail-outs later, they are only just learning to stand again.”


“Banking crises are not confined to emerging countries. Over the past decade or so, the rich world too, has had to deal with various financial traumas, including a property-lending fiasco in Scandinavia, America’s $150 billion savings-and-loan disaster and Japan’s current bad-debt mountain. But, except in Japan, these problems have long since been fixed.  In the past five years, the most serious problems in rich countries have cropped up at individual banks, such as Britain’s Barings, which collapsed under the weight of ill-advised derivatives deals, and France’s Credit Lyonnais, which ran up $4 billion ([60]) of loan losses. In emerging markets, by contrast, banking troubles have more of a habit of spilling over into the economy at large.


“Moreover, such crises have growing international implications. The “tequila effect” produced by the Mexican debacle, not only spread south to Argentina, but briefly reverberated in financial markets, as far away as Thailand. The risk of contagion, economists now say, may be growing as emerging markets forge stronger links with each other – for example, through increased cross-border trade, investment and lending – an become part of global markets. The financial ties between rich and poor countries are also strengthening all the time. Private capital flows, from all sources, to emerging markets have risen steadily, despite the peso crisis. Last year, they reached $239 billion, more than four times higher than flows of international aid.


“This has caused fears that banks, which provide much of the plumbing to carry these flows, will become ever more vulnerable, without a concerted international effort to avert such crises. Multilateral officials have become preoccupied with this fragility. James Wolfensohn, the President of the World Bank, says that banks are the “Achilles heel” of emerging economies, and that one in five of these economies faces a banking crisis. His counterpart at the IMF, Michel Camdessus, has said that the next mishap of the Mexican kind is likely to start with a banking crisis, and has promised that the IMF will concentrate harder on bank supervision. America’s Treasury and central bankers’ committee of the Group of Ten (G10) have joined the chorus of concern.  ([61])


GE Capital, A great Example

If U.S. banks were permitted to engage in equity investing and other activities with a higher degree of risk, the risks involved in non-traditional banking activities would need to be carved out of the deposit insurance safety net to avoid placing an enormous burden on the American taxpayer, who ultimately has to fund bailouts. The so-called safety net has eliminated one of the great equalizers in the banking industry. A "run" on an offending bank. The fact that the bank may be ready to go under tomorrow morning is currently not a good enough reason for depositors to line the streets in front of the bank to yank their funds. These bank customers are comfortably aware that their funds (up to defined limit) are totally protected by "the safety net funds." This causes banks to become items of convenience for depositors as opposed to competitively vigilant institutions who are not interested in gambling on their future. As the taxpayer is the ultimate loser in a failed bank, this policy has more holes than Swiss cheese.  Along with its big-brother, the bank that is too big too fail, these policies should be on the way out, instead they are more important than ever.

A good example of Non-banking financial institutions that for most purposes look like banks but are not protected by a safety net while conforming to the current global banking standards is GE Capital.  GE Capital is unregulated and is not covered by the Federal Deposit Insurance Corporation. It is one of only two lending institutions with an AAA credit rating, and it is among the most profitable and best-managed financial institutions in the country. With $155 billion in assets, GE Capital has experienced more rapid internal growth than any major bank in recent years. Its ties to an industrial company are invaluable. One of its units, which leases more commercial aircraft than anyone else, is staffed with salespeople who are licensed pilots. GE’s truck leasing operation runs a 24-hour hot line manned by mechanics that assist customers with breakdowns. Moreover, one of the keys to its success during the leveraged buyout era was the fact that GE Capital frequently funded all capital categories involved in a transaction, holding senior debt, subordinated debt, and equity in the same company. By doing so, it evaluated the risk/return profile of the company’s entire capital structure, rather than taking a narrow perspective. It is no coincidence that arguably the most successful lending institution in America operates outside the umbrella of the country’s burdensome financial services regulation.[62]

Interstate Banking and the Regulatory Dialectic

Or A Case History of One Industry's Attempt to Circumvent Legislation

"Banks' efforts to circumvent the regulations that prohibit interstate banking--and regulators' subsequent reactions--are a classic example of the regulatory dialectic. Since the 1950s, banks have tried to exploit the loopholes in these regulations by changing their organizational structure or by altering their portfolio of activities. Regulators, on the other hand have adjusted the regulations in reaction to each innovation."

Branching conditions for state banks have always been a matter of state discretion. Passage of the McFadden Act in 1927, and its amendment in 1933, gave national banks capabilities identical to those of state banks. But because no states allowed interstate branching for state banks, the McFadden Act effectively imposed the same restriction on national banks."[63]

During the two decades following passage of the McFadden Act, banks seemed to lack the incentive to profitably circumvent the prohibition on interstate branching. That changed in the 1950s, perhaps because of a perceived increase in economies of scale, additional competition from other U.S. financial institutions and foreign banks, and improvements in technology, all of which encouraged banks to find profitable ways around the branching prohibition."

Bankers first attempted to overcome the interstate branching restrictions by developing multibank holding companies with banks located in various states. Once lawmakers recognized bankers' intent they responded with the Douglas Amendment to the Bank Holding Company Act, which prohibited BHCs from acquiring banks in other states without the home state's authorization. This provision passed in 1956, effectively stopped the interstate banking movement, because no states permitted out-of-state acquisitions. "

Banks' next step was to expand their activities across state lines by forming one-bank holding companies. These were parent corporations that owned a single bank plus other bank subsidiaries, which could be located in one or more states. This organizational structure allowed banks to circumvent the revised Bank Holding Company Act, which defined BHCs as corporations that controlled two or more banks.  Again, Congress stepped in and closed this loophole in 1970 by revising the Act to cover one-bank holding companies."

The government's actions did not stop banks from further attempts to engage in interstate banking. The 1970 amendment to the Bank Holding Company Act defined a bank as any firm that accepted demand deposits and made commercial loans. The industry's answer was to develop "nonbank" banks--institutions that offered only one of these services. Some nonbanks chose to offer money market deposit accounts instead of transaction deposits. Others continued to offer transaction deposits, but restricted the extension of credit to the purchase of money market instruments, like commercial paper, or to consumer credit. Not surprisingly, Congress went into action again, closing this loophole in 1987 by redefining a bank as any institution that had deposit insurance or that offered demand or transaction deposits and engaged in commercial lending."

Banks' continuing attempts to expand their services across state lines finally met with some success in the early 1980s, when the regulatory barriers to interstate banking began to be dismantled. The first step in this movement was taken by a few states that state except Hawaii has passed legislation allowing either nationwide entry or regional entry. However, interstate branching was still forbidden to most banks because states generally did not allow acquired banks to be converted into branches, and only a few states permitted entrance through a de novo branch."[64]

Another important development came in 1994, when Congress passed the Interstate Banking and Branching Efficiency Act. This legislation defined nationwide standards for BHCs' acquisition of a bank in any state, implying that state laws governing out-of-state acquisitions were no longer applicable. Furthermore, beginning on June 1, 1997, BHCs will be allowed to convert their bank subsidiaries into a single network of branches, provided that their home states have not enacted legislation opting out of the Act's branching provision."[65]

This latest regulatory change, though welcome among the nation's bankers, has left intact one potentially important barrier to the development of a full nationwide banking system: It does not provide for de novo branching across state lines. That is, in a state where a bank has no branches, it can set up a new branch only if the host state has passed legislation specifically allowing for de novo branching."

…As the history of the movement to interstate banking shows, the cost-benefit analysis of a regulation is incomplete unless it considers the costs of the regulatory cat-and-mouse game it might engender. This is a timely issue given the ongoing debate over reforming the Glass-Stegall Act. Its importance is further enhanced by the continuous increase in financial market competition and the constant progress in information technology, which together make innovation easier and more attractive."[66]

How Banks Got Into Securities

"Prior to passage of the 1933 Glass-Steagall Act, state banks that were not members of the Federal Reserve System were permitted to underwrite securities and bonds. The McFadden Act of 1927 allowed national banks to underwrite bonds, and they were later allowed to underwrite certain equity issues. But even before 1927, national banks engaged in securities activities by organizing state bank affiliates.[67] So by the early 1920s, many commercial banks were heavily involved in the underwriting and distribution of securities.[68] The number peaked in 1928 when 591 commercial banks were engaged in securities activities either directly or through securities affiliates; of these 235 were national banks and 356 were state-chartered.[69]"

The background against which the Glass-Steagall Act was passed was one of tumult in financial markets. The economy was in depression; there was a record number of bank failures. To the average person, it appeared the stock market crash had caused the Great Depression, and banks had a large role in the stock markets. This perception, coupled with widespread bank failures, led Congress to begin a series of investigations into market abuses and ways to reform the banking system, including the famous Pecora hearing of the U.S. Senate in 1933-34.[70]"

…James Ang and Terry Richardson (1994) studied a sample of 669 domestic and foreign corporate and foreign government bonds underwritten from 1926-34 and obtained results similar to those of Puri. (Another study) They studied the default experience of these issues from the time of issue until 1939 and found that commercial bank underwriting significantly outperformed those of investment banks: about 40 percent defaults compared with more than 48 percent defaults for the investment bank issues; commercial bank issues outperformed investment bank issues for each type of security examined. They also found that the issues underwritten by Kuhn, Loeb and Co. and J.P. Morgan, which were difficult to classify as either commercial or investment banks, outperformed both commercial bank and investment bank issues, with a default rat of only 30 percent. But even including these two institution among investment banks does not change the result that commercial bank underwritings defaulted less often than investment bank underwritings. In their study, National City and Chase did worse than other commercial banks but they seem to have been on a par with investment banks"

…Congress has been debating whether to repeal the Glass-Steagall Act, which was passed in 1933 in the aftermath of the large number of bank failure that occurred during the Great Depression. One of the problems the act sought to address was the potential conflict of interest when a commercial bank that lends to a firm also underwrites that firm's securities. Empirical evidence based on the pre-Glass-Steagall days and on commercial banks' recent experience in debt underwriting suggests that, on balance, conflicts of interest have not been a problem: the data support the repeal of Glass-Steagall."[71]



If the Banks Didn't Do All Those Terrible Things That We are Told They Did, Why On Earth Was Glass-Steagall Passed In The First Place?

"The Glass-Steagall Act passed anyway, for several reason. First, Sen. Carter Glass believed strongly in the "real bills doctrine." He had long argued for legislation limiting banks to making short-term "self-liquidating" business loans that used inventory as collateral. Senator Glass thought that banks' engaging in securities activities reduced the effectiveness of the Federal Reserve and was contrary to sound banking laws. With the collapse of the stock market and widespread failures among bangs, Senator Glass was the man with the plan when his congressional colleagues were ready to do something or anything. "

The Glass-Steagall Act passed because Congress wanted to blame some specific, identifiable group of villains for the financial crisis and the economy's troubles. With banks failing in large numbers, bankers were a convenient group to blame. Furthermore, during the 1930s many observers believed that the nation's economic ills resulted from "excessive competition." Legislation affecting several industries during the 1930sw was designed to reduce competition and allow for more coordination among producers. In short, much legislation promoted government-sanctioned cartels. In the financial markets, as elsewhere, Congress took steps to provide individual financial institution with well-defined, protected markets. Restrictions against geographic expansion were reinforced for banks and savings and loan associations. The business of banking, the activities of thrifts, the purview of investment banks and insurance companies were all defined in ways designed to limit interindustry competition."

Finally, policy analysts during the 1930s clearly understood "moral hazard." The Congress that passed the Banking Act of 1933 and created the deposit insurance system was amply warned that federal guarantees for all bank deposits would relieve banks of the need to compete for customers on the basis of their financial strength and stability. By making deposits in all banks equally safe, feral deposit insurance freed bankers to take on more risk in pursuit of higher profits. By strictly circumscribing the range of services banks could provide, 1930s policymakers no doubt hoped to limit the risk embodied in bank portfolios."[72]






[1] Public Meeting Regarding Citicorp and Travelers Group Friday, June 26, 1998.  Transcript of Panel Twenty-Three, Rev. Floyd Flake



[2] Japan also had Glass-Steagall like legislation, which it had repealed decades ago it was believed to hamper the ability of Japan's banks to compete globally.

[3] In addition to those legislated restrictions, there are serious legal liabilities assumed when a lender takes a stock position in the United States.  In the event of a bankruptcy, a senior lender can be stripped of its claims to collateral if the other creditors can show that the lender exercised some degree of control over the borrower.  This principle, which is known as equitable subordination, is much more likely to be raised in the event that the lender owned an equity stake in the company.  Consequently, the senior credit officers of most major banks uniformly prohibit, as a matter of policy, the bank from holding an equity position in a customer.  How U.S. Financial Regulations Reduce the Time Horizons for U.S. Investment Michael T. Jacobs, 1991, CATO Institute


[4] "This (American) banking structure is very different from that of other industrialized nations--for example, there are less than 500 banks incorporated in England, Germany, and Canada combined.  To be sure, the very largest U.S. banking organizations account for the lion’s share of banking assets.  Still, no one institution controls more that 6 percent of total domestic banking assets in the United States.”  Remarks by Chairman Alan Greenspan, Federal Reserve Board, Convention of the Independent Bankers Association of America, Phoenix, Arizona, March 22, 1997

[5] Bankers Won’t face Stiff Legislation in ’79; Last Year’s Stiff Measures In Banking Unlikely For 1979, John F. Berry, Washington Post Staff Writer, Monday, January 1

[6] "To be sure, the effects of the banking crisis, as well as the ongoing pace of consolidation within the industry, have reduced the total number of banking organizations by more than a third since 1980.  Nevertheless, we remain a nation characterized by a large number of smaller community banks -- just as we are a nation characterized by a diversity and small average size of our non-financial businesses." Remarks by Chairman Alan Greenspan, Federal Reserve Board, Convention of the Independent Bankers Association of America, Phoenix, Arizona, March 22, 1997


[7] The current mood in Congress is to further limit the capabilities of lending institutions that have consistently been in trouble from lending to third world countries, over funding real estate, and over leveraging companies. Little consideration has been given to the fact that banks might not have ventured into such unfamiliar territories if they had been able to achieve adequate returns from their original mandate: funding commercial enterprises. As long as banks are unable to hold equity stakes in client companies and to offer investment-banking services, they will be unable to consistently achieve competitive returns from their core business and will become increasingly irrelevant to U.S. corporations. The recent upsurge in bank profits is largely the product of investing in Treasury securities using low-cost funds. This practice does not fund technology development. How U.S. Financial Regulations Reduce the Time Horizons for U.S. Investment Michael T. Jacobs, 1991, CATO Institute


[8] "As banks expand their activities, it is at least possible that the exposure of the safety net will rise.  The concern for policymakers is that the additional costs associated with an expansion of the safety net will be greater than the additional benefits. Indeed, some believe the costs of the safety net as it is currently structured are already greater than the benefits."  Thomas M. Hoenig President, Federal Reserve Bank of Kansas City, Kansas City, Missouri, January 29, 1998, Conference on Deposit Insurance.


[9] J.P Morgan, Glass-Steagall: Overdue for repeal, April 1995.

[10] "Consumers of financial services are denied the lower prices, increased access, and higher quality services that would accompany the increased competition associated with permitting banking companies to expand their activities. We cannot afford to be complacent regarding the future of the U. S. banking industry The issues are too important for the future growth of our economy and the welfare of our citizens." Alan Greenspan, at Federal Reserve conference in Chicago, 1993

[11] J.P Morgan, Glass-Steagall: Overdue for repeal, April 1995.

[12] "…Thus, it is possible that allowing banks to directly engage in new activities will reduce their overall risk through greater diversification. On the cost side, allowing banks to directly conduct new activities expands the costs associated with safety nets that I noted earlier. To the extent that banks do not bear the full social costs of their activities, they may make loans or engage in other activities that might not otherwise be viable. In addition, this increase in moral hazard makes it necessary to extend regulation and prudential supervision to new activities. For example, new activities would have to be regulated under a safety and soundness criterion rather than the less extensive fraud and disclosure requirements for market-based activities. Thus, as activities are expanded with the bank, there is a greater regulatory burden for banks, greater costs for bank regulators, and perhaps less efficient decision-making by the banks."  Thomas M. Hoenig President, Federal Reserve Bank of Kansas City, Kansas City, Missouri, January 29, 1998, Conference on Deposit Insurance.


[13] "Among the most significant of the new activities (of the banks) are trading and market-making in money markets, capital markets, foreign exchange, and derivatives. The rise in proprietary trading, market-making and active portfolio management has also dramatically altered the risk profiles of financial institutions. If used properly for portfolio management, new financial instruments can certainly reduce an institution's risk exposure and raise its profitability and viability in the financial marketplace.  If used improperly, however, they expose the institution to sudden, extraordinary losses, raising the likelihood of failure. Moreover, the risks and opportunities for failure are often exacerbated by the leverage associated with the new activities and the larger numbers of players and greater degree of anonymity in financial markets." Thomas M. Hoenig, President Federal Reserve Bank Of Kansas City, World Economic Forum 1996 Annual Meeting, Session on Rogue Traders, Risk and Regulation in the International Financial System, Davis Switzerland, February 2, 1996


[14] As ABA term ends, McMillan sounds off on banking issues; Technology, annuities, mergers, and regulations highlight tenure. By Nita Chilton McCann MBJ Staff Writer.




[15] Derivatives and associated synthetic products.

[16] "This difficulty is not meant as a criticism of the capabilities of bank examiners; rather, the point is that the private sector has significantly more resources--both human and financial--than the regulators for keeping pace with the changes in financial markets. For example, consider the Basle Committee's recent revision to the capital adequacy standards to incorporate market risk. The Committee's capital standards allow banks to use their own value-at-risk models to determine the amount of capital necessary to protect them from market risk. To effectively supervise banks that use their own models, however, examiners need to have the expertise to judge the adequacy of the models and the risk management practices. At a minimum, this requires understanding the quantitative aspects of the model, such as its statistical structure, its accuracy in valuing assets, and the adequacy of the stress tests used to determine the financial consequences of large movements in interest rates and asset prices. In addition, examiners must understand the qualitative aspects of a risk management strategy, such as how management uses the model's information and ensures compliance with this risk management strategy. Indeed, the Barings and Daiwa episodes are prime examples of the importance of these qualitative aspects. The lack of internal controls that monitor compliance with management's risk strategy is the reason that these institutions' exposure to market risk was able to rise to extreme levels. Overall, then, examiners have to know as much about a bank, its model, and control procedures as the rocket scientists who built the model and the management team who designed the risk management strategy. Thomas M. Hoenig, President Federal Reserve Bank Of Kansas City, World Economic Forum 1996 Annual Meeting, Session on Rogue Traders, Risk and Regulation in the International Financial System, Davos Switzerland, February 2, 1996

[17] Repealing Glass-Steagall: The Past Points The Way To The Future, Loretta J. Mester, Assistant V.P. and head of the Banking and Financial Markets section in the Research Department of the Philadelphia Fed.


[18] Japanese interest rates are hovering around levels so low that they cannot be reduced any further without people having to pay for the privilege of owning government securities.  Believe it or not, this happened at the height of the American Depression when the flight to quality become so great and so many banks had failed that people were willing to accept negative returns just to insure that they would get their money back upon the instrument's maturity.

[19] "In New York, the Federal Reserve Bank approved a code of conduct in derivatives trading that permits a bank to cite a price to a customer without any commitment to do business at that price, an action for which a non-bank securities dealer subject to NASD rules could lose his license." Financial Services Reform: Consolidation in the Brokerage Industry. Testimony to the Subcommittee on Finance and Hazardous Materials of the House Commerce Committee -- May 14, 1997, Martin Mayer, The Brookings Institution, Washington, D. C.

[20] In reality, “The landmark 1996 U.S. Supreme Court case Barnett Bank of Marion County N.A. v. Nelson, in which the high court ruled that the National Bank Act of 1916 gave national banks the power to sell insurance under certain conditions…” BANKS-IN-INSURANCE: An Industry in Transition by Jack Hoile


[21] Examples, courtesy of The Wall Street Journal, Dawn Kopecki, Tuesday February 22, 2000

[22] There are some unusual exceptions to this rule and in the case of smaller non-public securities transactions, more often than not; state “Blue Sky” regulations take precedence over federal law.

[23] "Congress in FDICIA mandated prompt closure for troubled banks by the regulators themselves, but it is no secret that the regulators do not intend to be bound by that law. Internal memos resisting the law leaked from the Fed soon after its passage, and this year we have the spectacle of some monoline banks being kept afloat by kind hands in Washington despite the violence of their losses from default by consumers who weren't creditworthy from the start and were thus willing to borrow on usurious terms. In any event, support or closure of troubled institutions by regulatory decision is the antithesis of market discipline" Financial Services Reform: Consolidation in the Brokerage Industry. Testimony to the Subcommittee on Finance and Hazardous Materials of the House Commerce Committee -- May 14, 1997, Martin Mayer, The Brookings Institution, Washington, D. C.


[24] "One notes in passing that all financial instruments held by investment banks must be valued every day at their market price that day, according to Generally Accepted Accounting Principles while banking regulators permit banks to carry both loans and bonds at their face value so long as the bank has an intention to hold the paper to maturity. In times of rising interest rates, when compelling banks to recognize the reduced value of loans and bonds could impair their reported profitability and even their solvency, bank examiners are instructed to be very kind in deciding which instruments are part of a trading inventory that must be marked and which are part of an investment portfolio that can be carried at higher values." Financial Services Reform: Consolidation in the Brokerage Industry. Testimony to the Subcommittee on Finance and Hazardous Materials of the House Commerce Committee -- May 14, 1997, Martin Mayer, The Brookings Institution, Washington, D. C.


[25] Associated Press, 2/8/2000 Marcy Gordon, Washington

[26] Referring to First National Bank of Keystone, Based in Keystone, W. Virginia, which cost the FDIC $800 million, one of the ten most expensive in banking history.

[27] Cyber Crime Business Week February 21,2000, p37, Ira Sager, Steve Hamm, Neil Gross, John Carey and Robert D. Hof.

[28] From Information contained in, Rob Pegoraro Why you shouldn't worry -- That much-- About Banking Online.  (No date)

[29] Cyber Crime Business Week February 21,2000, p37, Ira Sager, Steve Hamm, Neil Gross, John Carey and Robert D. Hof.

[30] Federal securities regulators, taking aim at the controversial lending practices of day-trading firms, accused All-Tech Direct Inc., Investment Street Co. and nine individuals of making loans to clients exceeding federal margin-lending limits.  The two civil administrative proceedings filed by the Securities and Exchange Commission represent its first regulatory salvo against the lending activities of day-trading firms, which cater to rapid-fire traders who may make scores or even hundreds of trades each day.  The Wall Street Journal, 2/23/2000, Ruth Simon, P c13

[31] Rod Nordland, Newsweek International Tuesday, 2 November 1999, The New Wired World.

[32] CSI, established in 1974, is a San Francisco-based association of information security professionals.  It has thousands of members worldwide and provides a wide variety of information and education programs to assist practitioners in protecting the information assets of corporations and government organizations. 

[33] [33] Cyber Crime Business Week February 21,2000, p37, Ira Sager, Steve Hamm, Neil Gross, John Carey and Robert D. Hof.

[34] From an article published by 3/11/98

[35] "The larger issue is the clash of cultures between banking the securities markets. Banks are run to a large extent in secret --indeed, Congress has passed secrecy laws to protect the confidentiality of bank investment portfolios. Nor is this demand for secrecy with justification. Borrowers have reason not wish the fact or terms of their borrowings to be known (especially as these terms may and do change from time to time, and knowledge of the changes could give both competitors and business partners information the business has valid reasons to consider privileged). And given the danger of contagious runs that could damage the economy, banking regulators fear that information reducing confidence in any one well-known bank could harm the banking system and the economy as a whole. Both of these arguments incidentally are of diminishing validity. As the banks' portfolios become increasingly securitized, there will be less reason to keep their contents secret, and as payment move toward real time gross settlement the danger of contagious runs will diminish." Financial Services Reform: Consolidation in the Brokerage Industry. Testimony to the Subcommittee on Finance and Hazardous Materials of the House Commerce Committee -- May 14, 1997, Martin Mayer, The Brookings Institution, Washington, D. C.



[36] Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, The United Kingdom and the United States

[37] "Throughout much of the 19th century, privately issued bank notes were an important form of money in our economy.  In the pre-Civil War period, in particular, the federal government did not supply a significant portion of the nation's currency.  The charter of the Bank of the United States had not been renewed, and there was no central banking organization to help regulate the supply of currency.  Notes issued by state-chartered banks were a major part of the money supply.  This was a result, in large part, of the "free banking" movement, a period when state chartering restriction on banks were significantly loosened.  Free banking dominated the landscape in most of the states in the Union starting in the 1830's and lasted until the National Banking Act was adopted in 1863.”  Remarks by Chairman Alan Greenspan, at the U. S. Treasury Conference on Electronic Money and Banking: The Role of Government, Washington DC, September 19, 1996, Federal Reserve Board.

[38] "We could envisage proposals in the near future for issuers of electronic payment obligations, such as stored-value cards or "digital cash", to set up specialized issuing corporations with strong balance sheets and public credit ratings.  Such Structures have been common in other areas, for example, in the derivatives and commercial paper markets.  " Ibid

[39] "The most often mentioned problem (with banks) is the moral hazard that banks will take excessive risks to the extent that explicit government guarantees remove the incentive for depositors and other creditors to monitor banks. In particular, the guarantees and reduced private sector monitoring mean that the coast of risk taking is lower for banks than for other financial institutions. To the extent they are allowed to do so, some banks will fund investment projects that might not otherwise be viable in the sense that the expected returns on the projects are too low. As a result, the moral hazard problem leads to a misallocation of credit, which is costly for the economy as a whole because it reduces economic efficiency." Thomas M. Hoenig President, Federal Reserve Bank of Kansas City, Kansas City, Missouri, January 29, 1998, Conference on Deposit Insurance.

[40] Remarks by Chairman Alan Greenspan, Federal Reserve Board At the U.S. Treasury Conference on Electronic Money and Banking: The Role of Government, Washington DC September 19, 1996

[41] "The suggestion that banks will police each other is theoretically sound but historically wrong, and especially dangerous now, when the Fed is encouraging bilateral netting, which permits unexamined build-up of exposure in institutions that deal separately with all their counter-parties. The Chairman's (Greenspan) feeble suggestion of a regulator-approved form for expressing gross derivatives exposure is clearly by the need to counter the SEC's already announced and much more revealing disclosure standards for such instruments." Financial Services Reform: Consolidation in the Brokerage Industry. Testimony to the Subcommittee on Finance and Hazardous Materials of the House Commerce Committee -- May 14, 1997, Martin Mayer, The Brookings Institution, Washington, D. C.



[42] "Globalization means that a domestic crisis can become international or that a foreign crisis can become a domestic concern." Alan Greenspan, Federal Reserve Board Chairman, Convention of the Independent Bankers Association, Phoenix, Arizona, March 22, 1997.

[43]   Issuance of electronic money implies the creation of liabilities on the balance sheet of the issuer that are generally payable (or redeemable) at face value to those entities accepting electronic money as payment.  This entails both operational and liquidity risks for the issuer.  Issuers could also face credit and market risks in the assets, depending on their policies for investing the proceeds from electronic money issuance.  Other financial risks related to electronic money issuance could include those arising from participation in loss- sharing or guarantee arrangements between issuers that are planned for some systems, as well as potential clearing and settlement and foreign exchange risks, in some schemes.  Group of Ten Electronic Money, Consumer protection, law enforcement, supervisory and cross border issues, April 1997, Report of working party on electronic money.

[44] IBID

[45] Group of Ten Electronic Money, Consumer protection, law enforcement, supervisory and cross border issues, April 1997, Report of the working party on electronic money

[46] Another school of thought on the subject could say that the money in the card is still in the bank and thus is at two places at the same time.  In this instance, do the Central Banks count the money twice, once, or not at all?  Then again which Central Bank is responsible, the Central Bank of Antigua or the Central Bank where the card resides and if so how does one know where that is?

[47] Exploring Digital Cash, Information Systems 204, Fall 1997.  U.C. Berkeley

[48] "In the United States, for example, banks have lost market share in the short-term lending market to commercial paper and finance company loans. Over the past 25 years, bank loans as a share of short-term debt on the books of non-financial corporations have fallen from about 80 percent to about 50 percent. In addition, corporations have greater access to other sources of finance, such as medium-term note facilities and junk bonds." Thomas M. Hoenig, President Federal Reserve Bank Of Kansas City, World Economic Forum 1996 Annual Meeting, Session on Rogue Traders, Risk and Regulation in the International Financial System, Davos Switzerland, February 2, 1996

[49] The Glass-Steagall legislation was a product of the so-called Pecora Commission, which was charged with determining the cause of the crash of 1929. In a unsubstantiated decision they determined in 1931 that the banks had single-handedly brought about the catastrophe by their securities activities.

[50] Regulation, The Cato Review of Business & Government, Banking on Free Markets, Catherine England.

[51] "Mistakes in lending, after all, are not generally made during recession but when the economic outlook appears benevolent. Recent evidence of thin margins and increased non-bank competition in portions of the syndicated loan market, as well as other indicators, suggest some modest underwriting laxity has a tendency to emerge during good times." Alan Greenspan, Chairman, Federal Reserve Board, Independent Bankers Association of America, Phoenix Arizona, March 22, 1997

[52] "Congressional hearings on the securities practices of banks disclosed that bank affiliates had underwritten and sold unsound and speculative securities, published deliberately misleading prospectuses, manipulated the price of particular securities, misappropriated corporate opportunities to bank officers, engaged in insider lending practices and unsound transactions with affiliates. Evidence also pointed to cases where banks had made unsound loans to assist their affiliates and to protect the securities underwritten by the affiliates." Paul Volcker "The problem is that none of that is true. Banks were certainly accused of all those things, but during three different sets of congressional hearings held over four years during the 1930s, none of the accusations of conflicts of interest, improper banking activities, or excessive risk attached to banks' securities activities was proved. George Benston, in researching his book The Separation of Commercial and Investment Banking: The Glass-Steagall Act Revisited and Reconsidered, returned to the original hearing records and the reports written during the 1930s and found there was never any evidence to support the charges brought against the banking industry." Regulation, The Cato Review of Business & Government, Banking on Free Markets, Catherine England

[53] "The Barings failure is a prime example of how quickly a large exposure to market risk can cause an institution to fail--the bulk of its net losses occurred over a two-week period, with one-fourth of the losses occurring in a single day. Thomas M. Hoenig, President Federal Reserve Bank Of Kansas City, World Economic Forum 1996 Annual Meeting, Session on Rogue Traders, Risk and Regulation in the International Financial System, Davos Switzerland, February 2, 1996


[54] Because of the activities of Sumitomo in the cooper markets, those exchanges that trade futures in the metal have seen their business all but disappear.

[55] At the time the bank was closed in July of 1991, it had 430 branches in 73 countries. 

[56] In the  United States, that was Clark Clifford, Influential power broker, advisor to presidents and secretary of Defense under Lyndon Johnson.  He was the president of BCCI’s American affiliate, First American, as well as their attorney.  His associate, Robert Altman was also a president of First American.   

[57] The problems said Price Waterhouse, centered on insider loans to shareholders and others with close affiliations to the bank.  Payments had not been made on many of these loans for years.  Some of the borrowers denied ever receiving the loans.  As much as $2 billion had been loaned to associates of the bank and major customers, often with little or no documentation or security.

[58] “During his two terms as Atlanta mayor, he was on a $50,000 annual retainer from BCCI that was to be paid into his small trading company through a line of credit that the company opened with Ghaith Pharaon’s National Bank of Georgia in 1982, the year that Young became mayor.  The loan rose to $175,000 and was transferred to BCCI in about 1985.  Eventually, BCCI forgave the loan after Young’s business partner informed that bank that he and Young had done enough consulting work to equal the amount of the loan.  The BCCI Scandal: An American Secret, James Ring Adams and Douglas Frantz, Chapter 13.

[59] "The complexity of the new activities is not the only reason it is more difficult to extend traditional regulation--another reason is the erasure of national borders. With the globalization of fiancÚ, uncertainty about regulatory responsibility and the difficulty of coordinating regulatory policies across international agencies have made it easier for problems to go undetected or undisciplined. In the Unite States, for example, steps were taken after the BCCI failure to prevent global institutions from slipping through the regulatory cracks. The recent Daiwa incident, however, indicates the difficulty of solving these problems." Thomas M. Hoenig, President Federal Reserve Bank Of Kansas City, World Economic Forum 1996 Annual Meeting, Session on Rogue Traders, Risk and Regulation in the International Financial System, Davos Switzerland, February 2, 1996

[60] At least!

[61] The Economist, Banking Survey, Fragile, handle with care 4/12/1997

[62] How U.S. Financial Regulations Reduce the Time Horizons for U.S. Investment Michael T. Jacobs, 1991, CATO Institute

[63] "The fundamental reasons why the interstate branching prohibitions were introduced remain unclear. Some believe that these restrictions were intended to protect small local banks from competition with out-of-state banks, while others point to the public's distrust of large banks" Glass-Steagall and the Regulatory Dialectic by Joao Cabral do Santos, February 15, 1996


[64] See Donald T. Savage. "Interstate Banking: A Status Report, "Federal Reserve Bulletin, vol. 79, no. 2 (December 1993), pp 1075-89.


[65] "As of December 1995, only Texas had opted out of the branching provision, while 25 other states had opted in. Of the latter group, only eight have opted into the de novo branching provision." Joao Cabral dos Santos, Glass-Steagall and the Regulatory Dialectic, 2/15/1996

[66] Glass-Steagall and the Regulatory Dialectic by Joao Cabral do Santos, February 15, 1996

[67] Ang, James S., and Terry Richardson, "Underwriting Experience of Commercial Bank Affiliates Prior to the Glass-Steagall Act: A Re-examination of Evidence for Passage of the Act," Journal of Banking and Finance 18 (January 1994), pp. 351-95.

[68] Benston, George J. "Origins and Justification for the Glass-Steagall Act," in Universal Banking: Financial System Design Reconsidered. Homewood, Il: Irwin (1996), pp 31-69

[69] Benston, George J. "The Separation of Commercial and Investment Banking, New York: Oxford University Press, 1990.

[70] Board of Governors of the Federal Reserve System. Banking and Monetary Statistics 1914-1941. Washington, D. C., November 1943.

[71] Repealing Glass-Steagall: The Past Points The Way To The Future, Loretta J. Mester, Assistant V.P. and head of the Banking and Financial Markets section in the Research Department of the Philadelphia Fed.

[72] Regulation, The Cato Review of Business and Government, Banking On Free Markets, Catherine England




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