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Abstract: The structure of the U.S. financial services industry has been transformed during the past two decades by the combined forces of new technologies, deregulation and financial innovation. Large banks, securities firms and life insurers have responded to these forces by pursuing a twofold consolidation strategy - acquiring direct competitors within their traditional industry sector and making cross-industry acquisitions in other sectors. The Gramm-Leach-Bliley Act of 1999 ratified the ongoing trend toward cross-industry consolidation and facilitated the creation of large financial conglomerates. Based on empirical studies and the experience of the past two decades, it is highly doubtful whether the predicted benefits of financial conglomeration (e.g., greater efficiency, profitability, safety and convenience) will actually be realized. In addition, financial conglomeration has intensified the problem of systemic risk in the financial markets and has increased the probability that the "too big to fail" ("TBTF") doctrine will be applied to major financial holding companies. Current supervisory approaches (including the proposed new Basel capital accord) are inadequate to cure the problems of supervisory forbearance and moral hazard that have been created by the TBTF policy. I propose a new plan for bank regulation and deposit insurance that will (1) insulate the deposit insurance funds from the cost of TBTF bailouts, (2) require financial conglomerates to internalize the costs of such bailouts, and (3) encourage greater market discipline over such institutions.
Abstract: Since the subprime financial crisis began in mid-2007, banks and insurers around the world have reported $1.1 trillion of losses. Seventeen large universal banks account for more than half of those losses, and nine of them either failed, were nationalized, or were placed on government-funded life support. Central banks and governments in the U.S., U.K. and Europe have provided $9 trillion of support to financial institutions to prevent the collapse of global financial markets. Given the massive losses suffered by universal banks, and the extraordinary governmental assistance they have received, they are clearly the epicenter of the global financial crisis. They were also the main private-sector catalysts for the credit boom that precipitated the crisis. During the past two decades, governmental policies in the U.S., U.K. and Europe encouraged consolidation and conglomeration within the financial services industry. Domestic and international mergers among commercial and investment banks produced a dominant group of large, complex financial institutions (LCFIs). By 2007, seventeen LCFIs held leading positions in domestic and global markets for securities underwriting, syndicated lending, asset-backed securities (ABS), over-the-counter (OTC) derivatives, and collateralized debt obligations (CDOs). Universal banks pursued an "originate to distribute" (OTD) strategy, which included (i) originating consumer and corporate loans, (ii) packaging loans into ABS and CDOs, (iii) creating OTC derivatives whose values were derived from loans, and (iv) distributing the resulting securities and other financial instruments to investors, including off-balance-sheet conduits. LCFIs used the OTD strategy to maximize their fee income, reduce their capital charges, and transfer to investors the risks associated with securitized loans. Securitization enabled LCFIs to extend huge volumes of home mortgages and credit card loans to nonprime borrowers. By 2006, LCFIs turned the U.S. housing market into a system of "Ponzi finance," in which nonprime borrowers kept taking out new loans to pay off old ones. When home prices fell in 2007, and nonprime homeowners could no longer refinance their loans, defaults skyrocketed and the subprime financial crisis began. Universal banks also followed reckless lending and securitization policies in the commercial real estate and corporate sectors. LCFIs included many of the same aggressive loan terms (including interest-only provisions and high loan-to-value ratios) in commercial mortgages and leveraged corporate loans that they included in nonprime home mortgages. In all three markets, LCFIs believed that they could (i) originate risky loans without properly screening borrowers and(ii) avoid costly post-loan monitoring of the borrowers' behavior, because the loans were transferred to investors. In addition, LCFIs retained residual risks from their securitization programs due to (1) "warehoused" holdings of loans, ABS and CDOs, and (2) contractual and reputational commitments. Accordingly, when securitization markets collapsed in mid-2007, universal banks were exposed to significant losses. Current regulatory policies - which rely on "market discipline" and LCFIs' internal "risk models" - are plainly inadequate to control the proclivities in universal banks toward destructive conflicts of interest and excessive risk-taking. As shown by repeated government bailouts during the present crisis, universal banks receive enormous subsidies from their status as "too big to fail" (TBTF) institutions. Regulation of financial institutions and financial markets must be urgently reformed in order to eliminate (or greatly reduce) TBTF subsidies and establish effective control over LCFIs.
universal banks, financial conglomerates, securitization, subprime financial crisis, too big to fail
Abstract: The re-entry of commercial banks into the securities business transformed U.S. financial markets during the 1990s. The Gramm-Leach-Bliley Act of 1999 (GLBA) removed most of the legal barriers that had separated commercial and investment banking since 1933. GLBA allows commercial banks to become universal banks by affiliating with securities firms and insurance companies. In large part, GLBA ratified the securities underwriting powers that commercial banks gained during the 1990s, based on a series of orders issued by federal regulators and federal courts. By 2000, the top ten global underwriters of securities included three U.S. banks, three foreign banks, and four U.S. securities firms. Competition between commercial banks and securities firms spurred a spectacular growth in the issuance of corporate securities during the late 1990s. The growth in new securities contributed to the stock market boom of 1994-2000, which was comparable to the great bull market of 1923-2029. Unfortunately, as in the 1920s, the stock market boom of the 1990s was followed by a steep decline in stock prices during 2000-2002. The fall in stock prices was especially severe between December 2001 and October 2002, as investors reacted to reports of accounting fraud and self-dealing at new economy firms that had been viewed as stars during the boom. The sudden collapses of Enron and WorldCom - the two largest bankruptcies in U.S. history - were especially shocking to investors. Subsequent investigations and lawsuits revealed that universal banks had played key roles in financing the rapid expansion of Enron and WorldCom and in promoting the sale of their securities. This chapter is part of a larger project that will examine the role of universal banks during the U.S. economy's boom-and-bust cycle of 1994-2002. The evidence presented in this chapter supports several conclusions. First, universal banks arranged dozens of structured-finance transactions for Enron, even though bank officials recognized that the transactions were deceptive and exposed their banks to reputational risk and legal liability. Second, universal banks competed for investment banking mandates by providing extraordinary financial favors to senior executives of Enron and WorldCom, notwithstanding the obvious corruption inherent in those favors. Third, universal banks distributed offering prospectuses and research reports that encouraged investors to buy Enron's and WorldCom's securities, even though bank officials knew or should have known that the banks' promotional documents were materially misleading and failed to disclose significant investment risks. Fourth, universal banks repeatedly extended credit to Enron and WorldCom in order to attract investment banking business, despite serious concerns among bank officials about the financial viability of both companies. During the Enron and WorldCom episodes, universal banks exhibited promotional pressures, conflicts of interest, speculative financing and exploitation of investors that were similar to the perceived abuses that led Congress to separate commercial and investment banking in 1933. Both episodes indicate that GLBA's regulatory framework is not adequate to control the risks posed by universal banking powers. A comprehensive reform of the supervisory system for universal banks should therefore become a top priority for Congress and financial regulators.
corporate governance, conflicts of interest, universal banks, Enron, WorldCom, Gramm-Leach-Bliley
Abstract: Over the past three decades, leading industrial nations and many developing countries have deregulated their financial markets. Financial liberalization has produced major benefits, including more efficient intermediation of financial resources, more rapid economic development and faster growth in trade. At the same time, however, many banking crises have occurred in countries that previously adopted programs of financial deregulation. This essay provides a brief overview of banking crises in international markets since 1973, together with more detailed discussions of Japan's financial crisis that began in 1990, the U.S. banking crises of 1929-33 and 1980-92, and the challenges confronting major U.S. and European banks during 2000-02. This historical evidence indicates that financial liberalization encourages banks to increase their lending commitments and equity investments in the real estate and securities markets. A rapid growth of credit and investment in those markets typically produces an economic "boom," which is fueled by positive feedback between rising asset prices and the willingness of creditors and investors to provide additional financing in the belief that asset values will continue to increase. Under such conditions, asset prices tend to "overshoot" and reach levels that cannot be justified by economic "fundamentals" (e.g., the actual cash flow generated by real estate projects and business ventures). When investors and creditors realize that market prices have diverged significantly from economic fundamentals, they are likely to pursue a rapid liquidation of investments and loans and thereby trigger a "bust." A severe asset bust often gives rise to a systemic banking crisis, because it exposes banks to crippling losses from defaulted loans and depreciated loan collateral and equity investments. Governments have typically responded to such crises by spending massive amounts to protect depositors and recapitalize banks. This apparent correlation between deregulation and banking crises suggests that financial liberalization has a "dark side," because it tends to create a banking system that is more vulnerable to systemic risk. Bank regulators should therefore give greater attention to the potential lending and investment risks created by financial liberalization efforts.
Abstract: The structure of the U.S. financial services industry has fundamentally changed during the past quarter century. Rapid improvements in information technology and the creation of innovative financial instruments have produced a dramatic increase in competition and spurred deregulation, thereby eroding traditional barriers that separated banks from securities firms and life insurance companies. In response to these trends, major banks, securities broker-dealers and life insurers have aggressively expanded by merging with their direct competitors and by acquiring firms in other financial sectors. The Gramm-Leach-Bliley Act of 1999 has encouraged this consolidation trend by authorizing the creation of financial holding companies that engage in a full range of banking, securities and insurance activities. The Act's proponents claim that the new financial supermarkets will produce favorable economies of scale and scope, offer convenient one-stop shopping to customers, and achieve a safer diversification of risks. This article contends that the motivations for and probable outcomes of financial conglomeration are very different. Managers of large, diversified financial firms have sought growth in order to build personal empires, to increase market power and to secure membership in the exclusive club of too big to fail (TBTF) institutions. By virtue of their TBTF status, major financial holding companies are largely insulated from market discipline and regulatory oversight, and they have perverse incentives to take excessive risks at the expense of the federal safety net for financial institutions. Based on past experience, the new financial megafirms are likely to encounter diseconomies of scale and scope, shrinking profit margins, increased customer dissatisfaction, and greater vulnerability to sudden disruptions in the financial markets. In addition, current policies create a near-certainty that federal regulators will prop up these gigantic financial firms during economic crises. In light of the challenges posed by financial holding companies, federal regulators have tried to strengthen capital regulation and increase market discipline. However, these incremental regulatory initiatives cannot control the potential risks of financial conglomerates, because they do not solve the problems of supervisory forbearance and moral hazard created by the TBTF doctrine. This article calls for more far-reaching reforms to our financial regulatory system in order to compel financial conglomerates to internalize the costs of their risk-taking.
Abstract: During the past three years, a highly-publicized controversy has raged over the question of whether Congress should prohibit acquisitions of industrial loan companies (ILCs) by commercial organizations. The controversy began when Wal-Mart and Home Depot filed applications to acquire ILCs. Those applications triggered strong opposition from a broad coalition that included the Federal Reserve Board (FRB), members of Congress, community banks, labor unions, retail stores, and community activists. From July 2006 to January 2008, the Federal Deposit Insurance Corporation (FDIC) imposed a moratorium on the processing of applications by commercial firms to acquire ILCs. In May 2007, the House of Representatives passed a bill (H.R. 698) that would prohibit further acquisitions of ILCs by commercial firms.
The Senate has not yet acted on legislation similar to H.R. 698 and is not likely to do so during 2008. Wal-Mart and Home Depot have withdrawn their applications, thereby removing the stimulus for much of the public opposition to commercially-owned ILCs. Senator Robert Bennett of Utah, the state with the largest number of ILCs, has strongly opposed any legislation restricting commercial ownership of ILCs. Congress' attention has also been diverted by the subprime lending crisis.
Despite the current legislative impasse, there are three important reasons why Congress should prohibit commercial firms from acquiring ILCs. First, commercial ownership of ILCs conflicts with the well-established U.S. policy of separating banking and commerce. Second, widespread commercial ownership of ILCs will create serious risks for the U.S. financial system and cause significant distortions in the broader economy. As indicated by the FRB's recent rescue of Bear Stearns, large commercial owners of ILCs are likely to receive significant federal subsidies by gaining access to the federal safety net for financial institutions. Such subsidies will encourage other commercial firms to acquire ILCs, thereby promoting extensive commercial-banking links that will increase the U.S. economy's vulnerability to systemic financial crises.
Third, no federal regulator currently has authority to exercise consolidated supervision over corporate owners of ILCs. The Bear Stearns rescue has shown that the FRB must be given consolidated supervisory powers over the parent company of any financial institution that has access to the FRB's liquidity support facilities. However, it would not be desirable to authorize either the FRB or the FDIC to supervise commercial firms that own ILCs. Consolidated supervision of commercial parent companies of ILCs would significantly increase the amount of governmental intrusion in the commercial sector of our economy, and it would cause financial markets to expect federal support for large commercial owners of ILCs. The subprime crisis confirms the need for Congress to close the ILC loophole in order to forestall even greater threats to the stability of our financial system and the broader economy.
subprime lending crisis, separation of banking and commerce, deposit insurance, federal safety net, industrial loan companies, systemic risk
Abstract: Commercial banks were leading participants in the U.S. securities markets during the great bull markets of the 1920's and the 1990's. Those stock market booms and the crashes that followed were extraordinary events. Is it merely a coincidence that the two most dramatic stock market booms and crashes in U.S. history occurred during periods when commercial banks played major roles in our securities markets? Or did the exercise of universal banking powers contribute to the financial and economic conditions that produced both episodes? This essay is the first installment of a larger project that seeks to answer these questions. This essay offers a preliminary assessment of the role played by universal banks in the economic boom-and-bust cycle of 1921-33. Part I reviews the reasons for Congress' decision to prohibit universal banking in 1933. Senator Carter Glass and other proponents of the Glass-Steagall Act (GSA) maintained that banks and their securities affiliates encouraged speculative behavior and helped to promote unsustainable booms in the securities markets and the broader economy. Glass and his colleagues also contended that universal banking powers created conflicts of interest that prevented commercial banks from acting as impartial lenders or objective investment advisors. Part II examines the role of commercial banks during the economic boom of the 1920's. In response to a relaxation of legal rules governing bank powers, banks greatly expanded their financing of business firms and consumers through five channels - loans on securities, securities investments, public offerings of securities, real estate mortgages, and consumer credit. This surge of new financing enabled business firms and consumers to assume heavy debt burdens and to make risky investments that proved to be unviable when the U.S. economy entered a sharp recession in the summer of 1929. In addition, the entry of commercial banks into the securities markets created competitive pressures that caused commercial banks and traditional investment banks to abandon prudential standards and promote speculative domestic and foreign ventures. Commercial banks re-entered the securities markets during the 1990's as a result of court decisions and administrative rulings that opened loopholes in the GSA. In 1999, Congress enacted the Gramm-Leach-Bliley Act (GLBA), which effectively repealed the GSA and authorized the creation of financial holding companies. GLBA reflected a widely-shared view among modern scholars that the 1933 legislation was misguided from the outset. However, due to the bursting of the stock market bubble in 2000 and the revelation of scandals involving universal banks (e.g., Enron and WorldCom), some commentators have begun to reconsider the benefits and risks of universal banking. Part III of the essay offers a preliminary response to the modern scholarly critique of the GSA. First, contrary to the claims of some scholars, Congress did not adopt the 1933 legislation for the purpose of protecting investment banks from competition with commercial banks. Instead, Congress separated commercial and investment banking in order to prevent speculative booms and to ensure that banks acted impartially in making loans and providing investment advice. Second, there was substantial evidence for Congress' belief that universal banks posed serious risks to the banking system. Universal banks undermined the soundness of smaller correspondent banks by encouraging them to purchase speculative securities during the 1920's. Losses on securities were a major cause of bank failures during the 1930's. In addition, several large universal banks failed between 1930 and 1933, due in part to risky investments and loans they made to support their own stock prices and to prop up affiliates. Those failures triggered regional banking panics and also contributed to the widespread loss of depositor confidence in the banking system. Third, modern scholars have attacked the conclusions reached by the Pecora investigation of 1933-34. However, earlier scholars concluded that the Pecora hearings produced credible evidence of conflicts of interest and other abuses involving universal banks during the 1920's. Given recent episodes of similar misconduct by universal banks during the 1990's, further research is needed to evaluate the risks created by universal banks during both periods.
Banking Panics,Glass-Steagall,Great Depression,Universal Banks
Abstract: During 2005-2006, Wal-Mart, Home Depot, and several other commercial firms applied to the Federal Deposit Insurance Corporation (FDIC) for permission to acquire FDIC-insured industrial loan companies (ILCs). Those applications were opposed by business groups, labor unions, community activists, and members of Congress. In January 2007, the FDIC imposed a one-year moratorium on all acquisitions of ILCs by commercial firms and asked Congress to determine whether such acquisitions should be prohibited. As the FDIC noted, acquisitions of ILCs by commercial firms raise three important policy issues, which are addressed in this Article. First, commercial ownership of ILCs conflicts with the policy of separating banking and commerce, which has been generally followed in the United States since 1787 and has gained strength over time. Banks have frequently tried to engage in commercial activities, and commercial firms have often attempted to gain control of banks. However, federal and state legislators have repeatedly passed laws to separate banking and commerce whenever it appeared that either (i) the involvement of banks in commercial activities threatened their safety and soundness, or (ii) commercial firms were acquiring large numbers of banks. ILCs represent the last remaining exception to the policy of prohibiting commercial ownership of banks. Second, acquisitions of ILCs by commercial firms will produce serious risks for our nation's financial system and economy. Commercially-owned ILCs will extend federal safety net subsidies to the commercial sector, and ILCs will have strong incentives to make loans and investments that benefit their commercial affiliates. Commercial ownership of ILCs therefore creates a competitive imbalance between commercial firms that own ILCs and those that do not. Commercially-owned ILCs are also vulnerable to contagious losses of confidence resulting from problems at their parent companies. Accordingly, federal regulators may feel compelled to arrange too big to fail bailouts of large troubled parent companies of ILCs. Third, the FDIC currently does not have authority to exercise consolidated supervision over commercial owners of ILCs. Any grant of such authority to the FDIC would have adverse consequences. The FDIC does not have the expertise or resources to identify and control the risks presented by commercial owners of ILCs. In addition, mandating FDIC supervision of commercial parent companies would significantly increase the federal government's interference in the general economy. FDIC supervision of commercial owners could also impair market discipline by causing market participants to expect FDIC support for such owners during financial crises. For all these reasons, Congress should prohibit further acquisitions of ILCs by commercial firms.
Separation of banking and commerce, industrial banks, consolidated supervision, federal safety net subsidies
Abstract: In January 2004, the Office of the Comptroller of the Currency (OCC) issued new regulations that are intended to preempt a broad range of state laws from applying to national banks and their operating subsidiaries. The OCC's rules declare that state laws are preempted if they obstruct, impair, or condition a national bank's ability to fully exercise its federally-authorized powers, either directly or through operating subsidiaries. According to the OCC, state laws apply to national banks only to the extent that state laws provide the legal infrastructure that makes it practicable for national banks to do business. The OCC's new rules are also designed to prevent state officials from suing in federal or state courts to enforce state laws against national banks or their operating subsidiaries. The practical effect of the OCC's new rules is to create a regime of de facto field preemption for national banks and their operating subsidiaries. This article contends that the OCC's rules are contrary to decisions of the Supreme Court and the intent of Congress. The Supreme Court and Congress have generally upheld the application of state laws to national banks, except in situations where state laws prevent or significantly interfere with the exercise of congressionally-authorized powers by national banks. During the past century, Congress has preserved the dual banking system by maintaining a competitive equilibrium between national and state banks in the most important areas of banking operations. The OCC's new rules conflict with congressional intent and threaten to disrupt the competitive balance that has long existed between national and state banks. The OCC has declared that national banks are exempt from state laws dealing with consumer protection, fair lending, and other areas regulated by the states under their historic police powers. Unless the OCC's rules are overturned by Congress or the courts, large state-chartered banks with interstate branches are likely to convert to national charters so that they, too, can obtain the blanket immunity from state regulation offered by the OCC. Over time, the state banking system will probably be reduced to a group composed primarily of smaller, community-oriented banks, and the national banking system will be increasingly dominated by large multistate banks. Even if the state system can survive as a chartering authority for community banks, there will no longer be a meaningful chartering option for most banks. Such an outcome will destroy, or at least severely weaken, the dual banking system's current incentives for regulatory innovation, responsiveness and flexibility. Federal and state courts have upheld the authority of state officials (i) to obtain judicial remedies to stop violations of state laws by national banks, and (ii) to bring administrative or judicial proceedings to enforce state laws against state-chartered providers of financial services. State enforcement has proven to be an effective and necessary supplement to federal efforts to protect consumers against illegal, fraudulent or unfair conduct by consumer lenders, securities firms, and mutual funds. Large national banks and their affiliates have been involved in abusive practices in all three areas. The OCC's rules, however, bar the states from continuing to license, examine or otherwise regulate state-chartered corporations that are operating subsidiaries of national banks. In doing so, the OCC's rules ignore fundamental principles of corporate separation and vastly expand federal control over state-chartered corporations, thereby eroding the states' historic primacy in corporate regulation. Public policy does not favor entrusting the OCC with sole authority to enforce fair lending statutes and other consumer protection laws against national banks and their operating subsidiaries. Large national banks and their affiliates have become dominant competitors in today's financial marketplace. Virtually the entire OCC budget is funded by fees and assessments paid by national banks. The OCC therefore acted with an obvious self-interest in issuing preemption rules that encourage large multistate banks to operate under national charters. During the past decade, the OCC has not initiated a single public prosecution of a major national bank for violating a consumer protection law. The OCC's unimpressive enforcement record is, unfortunately, consistent with its strong budgetary interest in maintaining the loyalty of leading national banks. Because the OCC issued its preemption rules to build its regulatory empire and please its largest regulated constituents, the courts should refuse to give deference to the rules and Congress should override them.
Consumer Protection, Dual Banking System, National Banks, Preemption
Abstract: This comment letter was submitted to the U.S. Treasury Department in connection with that Department's review of proposals for changes in the regulatory structure for financial institutions. The comment letter presents the following policy recommendations: (1) the thrift charter should be eliminated, existing thrifts should be required to convert into banks, and the Office of Thrift Supervision should be merged with the Office of the Comptroller of the Currency (OCC); (2) the dual banking system should be preserved and strengthened in order to promote innovation in banking regulation and to support the community bank sector; (3) at least one federal agency that is separate and independent from the OCC should be designated as the primary federal regulator for state-chartered banks; (4) the existing statutory limits on bank mergers and acquisitions should be maintained, including the 10% nationwide deposit cap and the 30% statewide deposit cap; (5) greater scrutiny and special conditions should be required for large bank mergers; (6) Congress should establish federal consumer protection standards for all home mortgage lenders, credit card lenders, and other providers of consumer credit; (7) Congress should prohibit the OCC from issuing regulations that preempt state law, except in specific areas where Congress has given the OCC explicit authority to adopt preemptive rules; (8) Congress should establish a separate and independent federal authority to enforce federal consumer protection laws against all providers of financial services, including national banks; (9) Congress should recognize the authority of state attorneys general to enforce applicable state laws against all financial service providers, including national banks, (10) Congress should provide the Federal Reserve Board (FRB) with direct oversight over all significant financial conglomerates that control FDIC-insured banks; (11) Congress should prohibit the FDIC's deposit insurance fund from making any payments to uninsured depositors or other uninsured claimants; and (12) all responsibility for protecting uninsured creditors of too big to fail (TBTF) financial institutions should be assigned to the FRB, and the FRB should impose assessments on significant financial conglomerates to recover the FRB's cost of providing financial assistance to TBTF institutions.
Treasury Department, Federal Reserve Board, financial institutions, banking regulation, dual banking system, financial conglomerates, too big to fail, deposit insurance
Abstract: This essay criticizes OCC v. Spitzer (S.D.N.Y. 2005), a recent federal court decision dealing with the application of state laws to national banks. The court upheld a regulation issued by the Office of the Comptroller of the Currency ("OCC"), the federal agency that supervises national banks. The OCC's regulation preempts the authority of state officials to file suit in state or federal courts to enforce state laws against national banks. The OCC's regulation asserts that any decision about whether to enforce state laws against national banks is a matter "within the OCC's exclusive purview." Based on the OCC's regulation, the court barred New York Attorney General Eliot Spitzer from using judicial process to enforce New York's fair lending laws against national banks. The court concluded that the OCC's regulation was entitled to deference under the "Chevron doctrine," in part because the National Bank Act did not "unambiguously" prohibit the OCC from adopting the regulation. I contend that the court's decision is erroneous and should be reversed. The OCC's regulation is inconsistent with the plain language of the National Bank Act, which recognizes that "the courts of justice" possess enforcement authority over national banks. Until the OCC issued its regulation in 2004, state officials had successfully filed suits in state and federal courts for more than a century to enforce state laws against national banks. Accordingly, the OCC's regulation infringes upon the states' sovereign authority to enforce their laws without any clear indication that Congress intended such a result. In addition, the OCC was motivated by a powerful self-interest when it adopted the regulation. The regulation was one of a series of preemption rules issued by the OCC in 2004. Those rules were designed to shield national banks from the application of state laws, a result that encouraged large, multistate banks to operate under national charters, thereby increasing the OCC's assessment revenues and budgetary resources. In two recent court decisions - Gonzalez v. Oregon (U.S. Sup. Ct. 2006) and American Bar Association v. Federal Trade Commission (D.C. Cir. 2005) - the courts refused to grant Chevron deference to agency regulations after finding that the regulations exceeded the authority granted to the agencies by Congress. Both courts declared that ambiguity or silence in a federal statute is not sufficient to demonstrate an implicit delegation of rulemaking power, particularly when an agency seeks to expand its jurisdiction or to intrude upon an area traditionally regulated by the states. Both decisions indicate the emergence of a new precondition for judicial deference - a precondition I call "Chevron step 2.1." This step requires a reviewing court to examine the text and structure of the governing statute to determine whether it reveals a congressional intent to delegate the full extent of the rulemaking power claimed by the agency. I contend that proper application of "Chevron step 2.1" would mandate a reversal of OCC v. Spitzer. In addition, I suggest that "Chevron step 2.1" is needed to preserve what I believe is the most important principle of administrative law. That principle, as declared by the Supreme Court in 1977, provides that the rulemaking authority of an administrative agency "is not the power to make law" but, rather, is only "the power to carry into effect the will of Congress as expressed in the [governing] statute."
Chevron, Deference, National Banks, Preemption
Abstract: Chief Justice John Marshall's opinion in Marbury v. Madison is generally regarded as the cornerstone of American judicial review. Marshall's opinion in Marbury skillfully invoked the distinctive American concept of popular sovereignty and linked that concept to the written Constitution. Marshall argued that judicial review provided the best means for enforcing the people's will, as declared in the written Constitution, without resort to the drastic remedy of revolution. Marshall warned that, without judicial review, the legislative branch would enjoy a practical and real omnipotence and would reduce to nothing what we have deemed the greatest improvement on political institutions - a written constitution. In Marbury and subsequent cases, Marshall based his constitutional decisions on the supreme authority of the Constitution's text. Marshall used interpretive canons drawn from the common law and natural law as helpful tools for defining the meaning of the Constitution's terms, but he avoided any direct reliance on unwritten principles of natural law. By portraying the Supreme Court as a faithful agent of the people's will embodied in the Constitution's text, Marshall sought to encourage popular acceptance of the Court as the principal interpreter and guardian of the Constitution. In developing his theories of popular sovereignty and judicial review, Marshall drew upon the ideas of other Founders, including James Wilson. During the ratification of the Constitution, Wilson declared that the Constitution's principles of popular consent represented the great panacea of human politics. By affirming the right of the people to mold [their government] into any shape they please, the Constitution provided a remedy for every distemper in government. While Wilson's concept of popular sovereignty was similar to Marshall's, Wilson advocated a far more ambitious role for the courts in the new federal republic. Wilson called upon American judges and lawyers to develop a new science of law based on principles of natural law and psychological insights furnished by the Scottish Enlightenment theories of moral sense and common sense. Wilson believed that this new legal science would enable judges to work in concert with jurors and elected officials in bringing society closer to the perfection intended by humankind's divine Creator. As judges performed their function of judicial review, Wilson contended that they must enforce applicable principles of natural law as well as the text and purposes of the Constitution. Thus, as Professor Robert McCloskey has observed, Wilson envisioned a grand moral consensus that would reconcile the venerable Western idea of a binding higher law with the relatively new idea of the will of the people. Wilson tried to persuade the public to accept his methodology for harmonizing natural law and popular sovereignty on three occasions - in defending the Framers' decision to omit a bill of rights from the original Constitution, in deciding Chisholm v. Georgia, and in instructing the grand and petit juries in Henfield's Case. On all three occasions Wilson's efforts were rejected, and he was accused of undermining the Constitution, threatening the residuary sovereignty of the states, and subverting the liberties of the people. This article suggests several reasons why Wilson failed, and why Marshall rather than Wilson is remembered today as the principal founder of the American doctrine of judicial review.
legal history
Abstract: In Cuomo v. Clearing House Ass’n, L.L.C., the United States Supreme Court struck down a regulation issued by the Office of the Comptroller of the Currency (OCC), which barred state officials from filing lawsuits to enforce applicable state laws against national banks. In upholding the New York Attorney General’s authority to seek judicial enforcement of New York’s fair lending laws against national banks, Cuomo revealed a perspective on banking regulation that was significantly different from the Court’s approach only two years earlier in Watters v. Wachovia Bank, N.A. In Watters, the Court upheld another OCC regulation, which preempted the application of state laws to nonbank mortgage lending subsidiaries of national banks. Watters took a broad view of the preemptive reach of the National Bank Act and indicated that national banks would not benefit from supplemental regulation by the states. In Cuomo, however, the Court took great pains to limit the scope and precedential force of Watters. Three members of the Supreme Court (Justices Breyer, Ginsburg and Souter) switched from supporting the OCC in Watters to opposing the OCC in Cuomo. Evidently those Justices changed their views about the merits of the OCC’s preemptive regime and the value of state regulation between April 2007, when Watters was decided, and June 2009, when Cuomo was issued. The most plausible explanation for the three Justices’ change in perspective is that they were influenced by the outbreak of the subprime financial crisis in August 2007 and subsequent federal bailouts involving several major national banks. Amicus briefs filed in support of New York Attorney General Andrew Cuomo included numerous references to the financial crisis. In addition, the briefs sharply criticized the OCC for its sweeping preemption of state laws and for its weak record of protecting consumers from abusive lending practices. Statements made by Justice Ginsburg and Justice Souter during oral argument in Cuomo, and by Justice Stevens in his dissenting opinion in Watters, indicate that the Court was aware of the mortgage crisis and the growing controversy over the OCC’s preemptive actions. Cuomo represents a much-needed victory for consumers and for the principles of regulatory federalism inherent in the dual banking system. In addition, Cuomo supports current legislative proposals by the Obama administration, which seek to strengthen consumer protection and preserve the states’ longstanding role in regulating financial services. During the past decade, the states have been far more proactive than the OCC and other federal agencies in enacting laws and bringing enforcement proceedings to protect consumers against predatory lending and other abusive financial practices. The subprime financial crisis has demonstrated that effective consumer protection is closely linked to the safety and soundness of financial institutions. The states’ positive record of legislation and enforcement over the past decade demonstrates the wisdom of preserving a federalist system of financial regulation, which includes not only a federal component but also a supplemental state role in enacting and enforcing consumer protection laws. The only disappointing aspect of Cuomo for the states is that the Supreme Court failed to resolve a recurring issue about the appropriate level of judicial deference that federal agencies should receive when they claim authority to preempt state laws. Cuomo did not apply a four-part test for judicial review of agency preemption claims that was indicated by Justice Stevens’ opinion for the Court in Wyeth v. Levine. That test would strike an appropriate balance between (i) the expectation that administrative agencies should receive some deference based on their specialized expertise and (ii) the judiciary’s responsibility to ensure that preemption issues are resolved in accordance with the Constitution’s allocation of federal and state powers. Instead of following Wyeth, Cuomo left open the possibility that future preemption claims by federal agencies could receive a more accommodating level of judicial deference known as “Chevron deference.” However, the Court in Cuomo refused to defer to the OCC’s preemptive regulation, based on the Court’s conclusion that Congress did not delegate the preemptive authority asserted by the OCC. Cuomo may indicate that, even if the Supreme Court chooses to apply Chevron in future cases involving agency claims of preemptive authority, the Court will apply a heightened level of scrutiny in answering the question of whether Congress has actually delegated the preemptive power claimed by the agency.
Chevron deference, consumer protection, Cuomo v. Clearing House; dual banking system; National Bank Act; national banks; preemption; state regulation; subprime financial crisis; subprime mortgages; Watters v. Wachovia Bank; Wyeth v. Levine
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