Timothy T. Taylor Home Page
Journal of Economic Perspectives
Articles and Writing
Economics Textbook
Classroom Teaching
The Teaching Company
High School Pedagogy

Articles and Writing

October 11, 1994
"Next Step That's Needed: 'Universal' Product Line - Quietly, Banks Get Approval to Go Interstate"
San Jose Mercury News
By Timothy Taylor
<< Back to 1994 menu

NOT VERY long ago, it was controversial to suggest that banks should be allowed to set up branches across the country.

But President Clinton has just signed into law a bill permitting interstate banking. The bill received overwhelmingly bipartisan support in Congress. In fact, the news was so bland that Clinton's signing of the bill wasn't even reported in the New York Times, the Washington Post, or the Wall Street Journal.

What happened to make approval possible? For starters, the political timing was right. Congressional Democrats weren't going to let a Republican president take credit for interstate banking, but they were willing to hand Clinton a win on the issue.

It helped that the savings and loan disaster had illustrated a real danger of prohibiting interstate banking. When depository institutions can't diversify broadly, then a regional economic downturn can kill them off, just when the community needs them most.

Treasury Secretary Lloyd Bentsen made this point at the ceremony where Clinton signed the interstate banking bill. Bentsen said that he had opposed interstate banking until he saw how a lack of diversification had weakened the banks in his home state of Texas. "When the economy went into the tank," Bentsen explained, "there was no place for the banks to go. They couldn't branch out, they couldn't expand, they couldn't cross state lines. The only place to go was under. And that's what many of them did."

Finally, allowing interstate banking was easy because, technologically speaking, it had already occurred. Holding companies have been set up to own banks in many states, which is the functional equivalent of interstate banking. When people want to invest their money or take out a loan, they no longer need to turn to a local bank. Instead, they have access to a broad range of financial institutions all over the country -- indeed, all over the world -- available by telephone and computer.

Since the 1920s, when interstate banking was originally prohibited, critics predicted that nationwide banking would lead to a few monopolistic mega-banks, which would drive other banks out of business. They also predicted that such banks would drain capital out of poor areas, while pouring all their loans into middle class and rich areas.

These fears have proved false. The last few years have shown that even with de facto interstate banking, thousands of small banks continue to find niches. And while the number of loans to poor areas are always a public issue, there's no evidence for believing that de facto interstate banking has made the problem worse.

Since interstate financial competition is already fierce, the new law won't have much impact. It will simplify life for businesses that operate across state lines, and for the 65 million Americans who live near a state border.

With interstate banking now officially permitted, the next step for the banking industry is "universal" banking, in which banks are allowed to compete in selling insurance, corporate stock, and any other financial product. This step will raise the same fears as interstate banking, and then some.

For example, there are fears that universal banks might be tempted into financial shenanigans. For example, if a universal bank owns stock in a company, it might be tempted to mislead depositors and encourage them to buy stock in the company, too. Moreover, the failure of a huge universal bank -- one offering banking, insurance, securities advice and much more -- might set off a widespread financial disaster.

These fears are vivid, but the economic evidence is against them. In the September issue of the American Economic Review, Randall Kroszner and Raghuram Rajan of the University of Chicago examine the historical evidence. They find that when U.S. banks were allowed to underwrite securities -- before the passage of the Glass-Steagall Act of 1933 -- they didn't dare try to mislead their customers, because they knew that a reputation for deception would ruin their business.

In the summer issue of the Journal of Economic Perspectives, George Benston of Emory University points out that every other industrialized country allows some form of universal banking, without exhibiting these problems.

Indeed, some observers argue that universal banking has been a great strength for the German and Japanese economies. Banks that invest in companies can offer a long-term source of capital, as well as a mechanism for swiftly reorganizing failing or bankrupt firms.

When Clinton signed the interstate banking bill, two bankers were invited to speak. Both advocated universal banking.

The head of Chase Manhattan, Thomas LeBreque, said: "Regulatory policy should aim at improving financial services, regardless of whether the provider is a commercial bank, an investment bank, broker, or other provider." The head of Norwest, Richard Kovacevich, was more blunt. "This bill gives us geographic freedom," he said. "We now need product freedom, to be allowed to offer all the products our customers need without costly regulations."

The Clinton administration offered supportive hints. Bentsen said, "In a decade or two, you're going to see a major difference in this country because of laws like this one." He said that future bankers would compare the banks of 1994 to the Model T. Clinton added, "Let us all acknowledge that this work is far from over."

The banking industry is far too important to be governed by laws from the Depression. It's time to encourage competition and innovation in the financial services industry by repealing the Glass-Steagall Act and allowing universal banks.

<< Back to 1994 menu