FROM THE OFFICE OF PUBLIC AFFAIRS

While the organizers of this impressive program could not possibly have anticipated it, this week could not be a more appropriate -- or perhaps inappropriate, depending on your point of view -- time to talk about Financial Modernization. Just two days ago an effort to bring a long debated and delicately balanced Financial Modernization bill to the Floor of the House of Representatives failed. While supporters of the bill gamely announced that the effort was not over, and that they would return to the drawing board after the Recess, the prospects for legislation in this Congress look exceedingly dim.

Why did the effort fail -- an effort that had unprecedented momentum behind it in the House, with the Republican leadership mobilizing forcefully to craft a compromise package and take it to the Floor?

There is, of course, one narrow and easy answer that some would offer: it was a tactical miscalculation to link Financial Modernization with another bill intended to overturn the Supreme Court's recent decision in the credit union case.

The Banking Committee, in a model bipartisan effort, had voted out a credit union bill, and Members were anxious to vote on that bill before they went home for the Recess. While there was an element of controversy to the bill, the Committee had crafted a reasonable and balanced proposal, and the banking industry had largely resigned itself to a losing fight against the bill.

On the other hand, the great preponderance of Members did not want to vote on H.R. 10, the Financial Modernization bill. H.R. 10, despite the Leadership efforts to design a compromise (some would say because of the compromise that was designed) was riddled with controversy. Members were being besieged on all sides, and any vote they might make was likely to offend some significant portion of their constituency.

Driven by the Leadership, the Rules Committee combined the two bills and sent them to the Floor under a narrowly tailored rule that permitted only a few selected amendments to be presented for a Floor vote, and that held out the prospect of forcing Members to vote for the controversial Financial Modernization provisions as the price of getting to vote on the credit union measure.

Members on both sides of the aisle were upset by this procedure, and hardly had debate started on adoption of the rule, when the Chairman of the Rules Committee, in a surprise statement that reminded me of Lyndon Johnson's announcement that he was not going to run again, withdrew the rule from further consideration. Yesterday the credit union bill was split apart and brought separately to the Floor, where it passed by a vote of 411 to 8 -- a vote that speaks volumes about the wisdom of the original tactic.

But that is the easy explanation. What was it that really brought the Financial Modernization train to a halt? It is tempting to say that those who fashioned the compromise bill leaned too far in one direction or the other, and thereby created strong opposition. But the fact is that virtually any movement toward the position of a disaffected interest would have created a countervailing problem on the other side. Does this mean that it is impossible to draft a Financial Modernization bill that would command a strong consensus of support among the various interested parties? I would like to think not, but I must say that the recent experience does not hold out great cause for optimism.

Just consider the major conflicts presented:

In the area of insurance, banking organizations were seeking an unqualified right to sell and underwrite insurance, free from state laws that might discriminate against bank-related insurance activities. Independent insurance agents wanted to retain the protections they have under many state laws, and to that end wanted to curtail the Comptroller of the Currency's ability to deem discriminatory state laws to be preempted. The agents also wanted to protect their franchises against de novo expansion of the agency activities of national banks, while banks wanted the ability to expand without the need to buy out an existing agency.

Underwriting companies wanted assurance that banks would not be able to offer insurance-like products in the bank itself, where they might be deemed to be immune from state insurance regulation, while the banks wanted the ability to offer what they deemed to be traditional banking products, even though they might partake of some aspects of insurance.

This confrontation led to unending efforts to define what constitutes insurance, how disputes over that issue should be resolved, and what deference, if any, should be given to the Comptroller of the Currency in the process.

A similar kind of debate was carried on in the area of securities activities. Banks wanted the freedom to continue to offer products in the bank that they had traditionally offered, even though they might be considered be some to be securities. Securities firms and the SEC wanted to limit direct bank securities activities to assure a level competitive playing field and comparable functional regulation.

The thrift charter became a major focal point for debate. The banking industry lobbied hard for an elimination of the thrift charter, while the thrift industry understandably wanted to continue as is. The unitary thrift holding company became a major target of attack from a number of quarters. Those opposed to any mixing of banking and commerce wanted the unitary holding company -- which enjoys the right to engage in any activity it chooses, financial or nonfinancial, significantly curtailed. As nonbank financial services firms began to focus more attention on the flexibility of the thrift charter as a possible vehicle for their own expansion into the business of accepting insured deposits, even the commercial banking industry became concerned about the unitary format -- which has, of course, existed for decades with no apparent concern from the banking industry.

The "banking and commerce" issue was also a focus of controversy in the consideration of whether companies owning banks should be permitted to engage in any nonfinancial activities. Some said absolutely none; others -- particularly those nonbank financial services firms that already had some nonfinancial activities -- argued for a reasonable "basket" leeway to be able to continue some level of nonfinancial business.

Consumer groups and community organizations weighed in heavily against H.R. 10, arguing for stronger consumer protections, for mandated "lifeline" banking, and for extension of the Community Reinvestment Act to the nonbank affiliates of banks in the new world of expanded activities under Financial Modernization. Banks, on the other hand, opposed the imposition of such new requirements.

There were even strong differences of view among the various federal agencies having an interest in the subject. The Comptroller of the Currency and the Treasury Department argued that all banks should be permitted the option of engaging in any newly authorized financial activities either through holding company affiliates or through operating subsidiaries of the bank, in either case subject to strong and equivalent safety-and-soundness protections for the bank. The Federal Reserve contended that new financial activities should be conducted only in holding company affiliates, under their jurisdiction, because only in that way could the spread of an alleged "safety net subsidy" be contained.

These are imposing confrontations -- and there are many more contentious issues I have not described. Will it ever be possible to achieve real progress toward Financial Modernization in the face of such controversy.

I continue to be hopeful, but it will require some changes of attitude and approach on almost everyone's part.

First and foremost, we cannot hope to have real Financial Modernization unless that subject is approached with a universal commitment to eliminate barriers to full competition. Participants in the financial services marketplace have to come to the realization that the broad, long term interests of all providers can only be served by letting go of special interest protections intended to segment markets. Consumers are demanding the convenience of one-stop shopping and the benefits of increased competition, and the force of the marketplace cannot be held back by corralling providers into separate pens.

Second, the principle of functional regulation has to be accepted as a governing precept. Similar activities should be subject to the same regulatory regimes. To be sure, there will be definitional difficulties at the margin, and due consideration should be given to the grandfathering of activities that have historically been conducted in a different mode. However, these issues must be approached not from the perspective of maintaining particular competitive advantages, but with a view toward achieving broad functional regulation.

Third, the issues being raised by consumer and community groups cannot be dismissed. Financial Modernization legislation must assure that in bringing the benefits of increased competition to consumers -- which is really what this effort is all about -- we are not subjecting consumers to greater abuses and that we are not weakening the benefits of the Community Reinvestment Act.

Fourth, we must assure that the safety and soundness of our financial system is not impaired as we expand business opportunities for financial services firms.

Finally, we must assure that we do not, in the name of serving other purposes, upset the balance we presently have in the dual banking system, or effect fundamental shifts in the roles of the agencies involved in the process of regulating and supervising our financial industry.

I do not by any means suggest that our objective should be to preserve a regulatory status quo or to protect the turf of particular agencies, any more than we should preserve those barriers that inhibit competition among financial institutions. The subject of regulatory restructuring is unquestionably an appropriate topic for Congress -- as painful as it seems to be every time it comes up. More specifically, the subject of what the appropriate regulatory structure should be in the brave new world of Financial Modernization is a topic of great importance. My point is simply that such far reaching issues should be addressed directly and openly, on the merits, with due consideration for the implications of proposed changes. They should not be subsumed, as the compromise bill unfortunately does, in discriminatory treatment of particular charters or formats, or clothed in arcane argument that covers their real implications.

It may be that these preconditions can never be satisfied; it may be that the marketplace must evolve further before we can achieve the kind of consensus that Congress needs to act comfortably. One is reminded that Congress avoided the subject of interstate banking for many years, and only addressed it after the states had made it largely academic through the innovations that started in the mid-1980s.

Surely, much more work is needed on H.R. 10 before it can come close to commanding a consensus. The Statement of Administration Policy transmitted to the Congress on Tuesday affirmed that the Secretary of the Treasury would recommend that the bill be vetoed if it were presented to the President in its present form. This strong statement was based on our conviction that the bill would:

• stifle innovation and efficiency in the national banking system;
• undermine the Community Reinvestment Act by forcing financial innovation to occur in
• holding company affiliates rather than in bank subsidiaries;
• diminish the ability of communities and consumers to benefit from the financial system;
• eliminate advantageous features of the present thrift charter; and
• impose needless costs on small banks.

The Chairman of the Senate Banking Committee has made clear in the past that he will only take up a Financial Modernization bill if it passes the House with a strong bipartisan majority. While the House Leadership deserves credit for the strength of the drive they mounted to move this bill to the Floor, the events of this week seem to make clear that any further effort to push the bill in its current form will confront continued conflict and opposition. Whether it is possible to accomplish the kinds of repairs that are necessary in the time remaining in this Congress is problematic, but it seems clear that in its present form the bill simply cannot command the kind of support needed to achieve a strong bipartisan majority. No constructive purpose can be served by a continued push for the present proposal.

Perhaps the best we can hope for is that by maintaining things as they are, the normal drive of market participants in seeking out ways to compete more effectively, aided by a commitment on the part of regulators to experiment and innovate, we will move toward the kind of environment that will make it easy for Congress simply to ratify what the marketplace presents it with.