FROM THE OFFICE OF PUBLIC AFFAIRS

I. INTRODUCTION

I always welcome an opportunity to speak with Women in Housing and Finance -- a group that includes so many of my friends and colleagues. But the opportunity to speak here as a pinch-hitter for Speaker Gingrich -- that was irresistible. I took it in a flash.

Today I'd like to talk to you about some of the challenges we face in financial services. I'm going to focus on Glass-Steagall reform, but I'll also have a word or two to say about SAIF, community development financial institutions, and regulatory burden relief.

Strengths of Our Financial System

I'd like to begin by talking about the strengths of our nation's financial system. Let me name five of those strengths.

First, we have the broadest, deepest capital markets in the world -- capable of financing innovation and growth at relatively low cost.

Second, our financial workforce is highly-skilled, from the backroom to the boardroom. They are a tremendous -- and often under-appreciated -- resource.

Third, the nation's consumers are knowledgeable and demanding -- which, in turn, encourages financial institutions to compete, innovate, and be responsive.

Fourth, our system has, to a very large degree, democratized credit. Most people in this country have access to some form of credit. Credit is not, as it once was, the preserve of the affluent. That's not to say the system works perfectly. It doesn't. But compared to a century ago or to many other countries, consumers in the United States generally have very good access.

And fifth, our financial system is remarkably innovative and adaptable. (Of course, given our legal and regulatory structure, it has to be.) Americans remain the Thomas Edisons -- even the Michelangelos -- of the financial world.

Against the backdrop of these strengths, our financial system does have some very real shortcomings. One of these shortcomings is a set of outmoded and overly restrictive bank structure laws. I'd like to focus on this a bit because it's relevant to the ongoing debate over modernizing our financial system.

Laws such as the Glass-Steagall Act and the Bank Holding Company Act impose needless costs and dampen innovation.

That's a bit ironic because, as I've indicated, innovation and adaptability are hallmarks of our financial services sector. Naturally, financial institutions put this same innovation to work inventing their way around outmoded legal constraints. They do this successfully. But they also do this at the cost of diverting resources that could better be used elsewhere.

Expertise of this kind has much more limited utility than other financial innovation. If you develop electronic money or home-banking software, you could potentially market it worldwide. But you'd sure have trouble exporting Glass-Steagall avoidance techniques, or the latest strategies for coping with Regulation Y. Since other countries don't inflict similar constraints on themselves, they have little use for these innovations.

The fact that our bank structure laws are out of date is not for lack of trying. And we can take satisfaction that the Riegle-Neal Interstate Banking and Branching Efficiency Act largely resolved a debate over interstate banking that goes back 60, 70, even 200 years -- perhaps the longest-running battle in American banking law.

Changes Occurring in Our Financial System

Nonetheless, the failure of our bank structure laws to keep pace with the changes over the past several decades becomes all the more glaringly apparent when we consider the profound changes now occurring in our financial system.

Let me just give you a few examples, first by being a bit retrospective.

If you look back about 30 or 40 years, you find the financial services industry neatly segmented into specific, regulated markets. Commercial banks take deposits, offer checking accounts, and make loans. Thrifts offer savings accounts and home mortgages. You go to your stock broker to buy securities, and visit your neighborhood insurance agent for your insurance needs.

Now fast forward to the present. Despite the legal and regulatory barriers that created that balkanized system of several decades ago, financial services have begun to converge. Commercial banks and their affiliates engage in a wide range of investment banking activities. Securities firms make bridge loans. Indeed, distinctions between loans and securities, and between securities and financial futures, have become increasingly tenuous and artificial.

The fact is, the financial services industry looks different today because there are some very powerful forces changing it.

I want to talk about three in particular: technology, financial innovation, and globalization. This list is by no means exclusive, but it illustrates some of the key issues. So let me walk through them with you.

Technology

The first -- and perhaps most significant -- force for change is technology. It has a remarkably broad reach. Technology has connected global markets, driven down the cost of backroom operations, brought us ATMs. It's at the forefront of electronic money and electronic banking. And technology may well be creating economies of scale that could drive consolidation within the industry for many years to come. My descriptions here don't even scratch the surface of a CD.

Much of the technological revolution has centered on information technology. In his book, The Road Ahead, Bill Gates writes: "What characterizes this period in history is the completely new ways in which information can be changed and manipulated, and the increasing speeds at which we can handle it." Additionally, Gates argues, we are approaching frictionless capitalism in which buyers and sellers -- aided by information and low-cost communication -- are closely linked.

This information revolution has profound implications for financial services. Think of how banking originally came to be. People who had money to lend weren't in a position to assess the credit of people who needed to borrow. But they knew the bank's credit -- represented by its reputation for meeting all its obligations. And the bank knew (or could learn about) potential borrowers' credit. That informational advantage was its stock in trade.

What does it mean for banking, then, if information and communication improve to the point that investors, and borrowers, and other participants in financial markets can link up with one another much more readily than in the past? Of course, that happened with commercial borrowing by large corporations -- which turned from commercial loans to commercial paper. But it does appear that this process -- this disintermediation -- will spread into new areas. If market participants can communicate directly with one another, share information, buy and sell almost effortlessly in a virtual marketplace, then we have to expect that the pace of disintermediation will accelerate.

Financial Innovation

Technology has also played an important role in facilitating financial innovation, which I consider to be the second major force. Let me use one example. Thirty years ago, Americans couldn't legally own monetary gold. Today, you can own Eurobonds, floating rate bonds, strips, futures, options on futures, options on indexes, income warrants, CMOs, MBS's, currency swaps, floor-ceiling swaps and, yes, even a Libor-squared turbo swap.

It's a dizzying array of financial products -- but they play an important role. Financial innovation has meant lower costs, greater flexibility for users, increased liquidity and better risk allocation. But, at the same time, many of these financial products have perplexed regulators -- for example, distinctions between certain futures and securities have become blurred. This presents enormous challenges for regulators and our regulatory system.

Globalization

Globalization is another force transforming our financial system. Financial markets are increasingly integrated, with large volumes and ranges of financial instruments being traded across borders. Firms today can "pass the book" and engage in 24 hour trading in markets around the globe. Large multinational offering of stock are commonplace and mutual funds have strong international components as investors chase the higher returns of riskier emerging markets or seek to invest in equities on the London or Tokyo exchanges.

Of course, this increased globalization carries with it many risks, just as it does opportunities. Many financial services providers today are players in an enormous, unpredictable market -- surely there will be more with the passage of time. But, as financial markets become even more integrated, and even more globalized, numerous questions arise: Could there be new challenges to systemic stability? What is an appropriate regulatory scheme? We must think through these and other issues very carefully.

What are the implications?

The implications of these changes are dramatic. So, I would like to draw some general conclusions about the implications of the changes to the financial system.

Disintermediation is virtually certain to continue, reducing the role of traditional financial intermediation and increasing the role of informational intermediation. In short, knowledge is power, and those who deal in information -- for example, non-financial firms such as developers of computer software -- will be important participants.

The convergence of different types of financial services and financial institutions will continue, thereby undercutting the existing regulatory structure.

This still leaves us with a specific problem: Markets have changed, and customer needs have changed, but financial intermediaries remain constrained by antiquated laws designed for different circumstances. Of course, this has lead to calls for financial modernization -- which is typically assumed to mean repeal of the Glass-Steagall law.

In Glass-Steagall we have an easily identifiable target -- the separation of commercial and investment banking. And we want to remedy the problem.

But we still need to ask the following question: Is this what we need for the next century? Is Glass-Steagall reform responsive to the changes in the financial services industry? I think there are really two ways of answering that question.

The first answer is: Yes. Glass-Steagall is an unnecessary, artificial constraint imposed under dramatically different circumstances. It never made sense to begin with. And it's long overdue for the regulatory scrap-heap. Maybe some day, when you peruse through an economics textbook on CD ROM, you might just click on the words "misallocated resources" and get pictures of Carter Glass and Henry Steagall.

The second answer is that Glass-Steagall reform -- in the form of scores of statutory pages of restrictions and requirements -- is a short-term fix, making incremental advances on what several decades of regulatory and legal rulings have already put in place.

Looking ahead, what we really need is a regulatory and legal structure that will bring us into the 21st century -- that will support the institutions and products that comprise the future financial services industry in such a way as to promote efficiency, stability, and equity. Globalization and disintermediation are realities. But is the regulatory and legal system equipped to meet their challenges?

I can't tell you what the financial services industry of the next century will look like. I don't have a crystal ball. But I can tell you it must, by and large, be shaped by the market -- not the government. Certainly, the government will continue to address issues of safety and soundness, fairness of access, and significant market failures. But the government also needs to create a legal and regulatory structure that enhances free-market competition.

Financial modernization in that respect is an issue for the long-term, but we should be addressing it right now. If we wait too long, we run the risk of falling behind our competitors around the globe who do not operate with the same restrictions, but who do operate in the same global marketplace as us.

I believe it's important that we remove the outdated barriers to competition that were put in place by the Depression-era banking laws. And I have spent a good part of my professional life to advance that objective. At the same time, however, I continue to have some concerns about current proposals.

My concern is that the Glass-Steagall reform proposal being considered on the Hill would have the effect of locking the financial services industry in the 1980s or early 1990s. And I find it to be rather ironic that the premise of current legislation is the separation of deposit-taking and securities activities -- and the separation of banking and insurance -- when in fact the reality is that financial products and financial institutions are converging.

Yes, I want to see financial modernization. But, let's not do it at the cost of impeding future change. The cost of taking a few steps forward should not be having our feet nailed to the floor.

Other Concerns

Now let me take just a few minutes to talk about some other important items that deserve attention. I know this is 1996, and in years that end with an even number, less tends to happen in Washington than some might like. Still, there is time to make a difference.

First, I want to send a clear message about the importance of resolving the problems of the Savings Association Insurance Fund.

As most of you are aware, the recapitalization of the SAIF was included in the budget reconciliation bill which was vetoed last year. Since the time that the bipartisan SAIF solution passed -- and I want to thank Chairmen D'Amato and Leach, Senator Sarbanes and Congressman Gonzalez for their hard work and leadership on this matter -- the FDIC has lowered premiums for banks (who have fully recapitalized the BIF), and a large premium differential between most banks and thrifts has opened up.

If we don't take steps soon to recapitalize the SAIF, the incentive for thrifts to get out may be too strong to overcome. Ingenious attorneys who have had a year to work on this problem will find ways for thrifts to lessen their reliance on SAIF-insured deposits. Deposits will migrate elsewhere and, as the deposit base shrinks, we will come closer and closer to the possibility of a FICO default and a seriously weakened SAIF. That shouldn't be allowed to happen. The solution doesn't rely on anything magical. Congress needs to act soon to pass again the bipartisan solution that we all agreed upon just a few short months ago. Second, let's provide full funding for the Community Development Financial Institutions Fund. As I am sure many of you are aware, the CDFI Fund has gotten off the ground in the Treasury Department. The round that made available $30 million for CDFI and $15 million for Bank Enterprise Act activities has just closed and the review for that competitive process is now beginning. The Fund's programs will help distressed urban and rural communities to restore neighborhoods, start new businesses and grow their local economies. This is an approach to community lending that virtually everyone can agree upon and it deserves the chance to work.

And third, I am hopeful that the Congress will still find a way to pass meaningful regulatory burden relief legislation. The Administration has worked very hard these past three years to eliminate unnecessary regulatory burdens wherever possible. For example, the OCC and OTS have been doing a comprehensive review of every regulation on the books. If a regulation isn't needed, it's being eliminated. But there is only so much you can accomplish administratively -- we need to work on it legislatively as well.

Regulatory burden relief legislation will have a much better chance if it is not encumbered by needlessly divisive provisions, like CRA-gutting amendments, or connected with the extraneous controversy over bank insurance powers. In short, we have to be careful about loading up the bill with items that give just about everyone something to shoot at. Because when that happens, we have that old staple phenomenon of federal banking legislation, the circular firing squad -- in which everyone hits his or her target, but no one comes out ahead. Thank you, and I'll be glad to take questions now.