Federal Reserve Board Chairman Alan Greenspan, lining the Fed up with other federal bank regulators, yesterday called on Congress to repeal a 54-year-old law that separates commercial banking from securities underwriting.
Warning that banks will become the dinosaurs of financial services if the Depression-era law is not repealed, Greenspan said that the Fed believes banking can be tied to securities underwriting without subjecting federally insured deposits at banks to the risks inherent in the stock market.
"The risks can never be fully eliminated, but they can be sufficiently contained to be acceptable," Greenspan said during testimony before the House Banking Committee.
As to potential conflicts of interest between those who lend to companies -- commercial banks -- and those who raise money for those companies in the stock and bond markets -- securities firms -- Greenspan said, "We're never going to make everybody honest, but the number of safeguards we would put in the system are adequate."
The Fed favors allowing a parent holding company to own both banks and securities firms rather than allowing banks and securities firms to buy and own each other directly, Greenspan said. The holding company structure would be the best way to ensure that, if a securities firm fails, a court would not try to "pierce the corporate veil" by seeking to get at federally insured deposits in the bank subsidiary, he said.
He said the Fed does not believe that allowing banks and securities firms under the same corporate roof would lead to improper concentrations of power. He said the nation's largest banks and securities firms would not be interested in merging with each other because such marriages would prove "unprofitable and uneconomical."
Greenspan's comments were the most detailed he has made on banking since becoming Fed chairman last summer and since the stock market collapse last month.
He said the Fed reached its conclusions before the stock market's spectacular fall on Oct. 19, but "the events since have not altered our view that it is both necessary to proceed to modernize our financial system and that it is possible to do so in a way that will maintain the safety and soundness" of banks.
Greenspan said that he personally favors even more radical bank deregulation -- namely, the repeal of laws that bar companies unrelated to financial services from owning banks -- but said the Fed was not yet ready to make such a recommendation and that he does not think Congress is ready to take such a step.
The Fed's endorsement of allowing banks and securities firms to be linked means that all federal banking regulators have lined up behind growing efforts in Congress to repeal the Glass-Steagall Act of 1933, which separates commercial banking from securities underwriting.
Congress passed Glass-Steagall in the belief that a mixture of the two industries contributed to the crash of 1929 that preceded the Great Depression, but few economists now blame the crash on the banking-securities link.
Greenspan said the Fed is not yet ready to recommend how far banks should be allowed to expand into insurance and real estate. Instead, he said, he would welcome legislation from Congress that would give the Fed guidelines.
Greenspan said that changes in electronics and competition have eliminated many sources of income for banks, forcing them to try to compete in securities and other financial markets.
For that reason, he said, Congress should let a temporary ban on allowing banks to expand into new financial powers expire on March 1, with or without repealing Glass-Steagall.
Congress imposed the freeze last summer in an effort to halt the bank deregulation that was taking place in the marketplace, largely through rulings by courts and regulators. Congress wanted extra time to consider what permanent law should be passed governing bank deregulation.
House Banking Chairman Fernand J. St Germain (D-R.I.) said he was skeptical about whether there are enough safeguards to protect against concentrations of power. "You and I both know that even though it isn't economically advisable, there's that certain greed of some type, that desire to be the biggest, that overcomes and overshadows the economics of it," St Germain said.
Stephen J. Verdier of the Independent Bankers Association of America, a trade group for smaller community banks, expressed similar fears. "We don't want the concentration of power that would result" from repealing Glass-Steagall, he said.
But Kirk Willison, spokesman for the American Bankers Association, the largest trade group for the banking industry, said, "The chief banking regulators are on record and unanimous in agreeing that the best way to insure the safety and soundness of the banking system is to modernize our outdated laws."