Ten years after the Berlin wall crumbled, ending the division between much of Eastern and Western Europe, the “regulatory wall” came down on the U.S. financial services industry. Nov. 12, 2009, will mark the 10-year anniversary of the signing of the Gramm-Leach-Bliley Act (GLBA) by President Clinton.
Widely regarded as the most significant piece of financial services regulation to be enacted since the Great Depression, the GLBA — also referred to as the Financial Modernization Act — broke down the barriers that separated cross-sector ownership of, and marketing between, banks, insurance companies, investment banks and securities firms.
Was the tearing down of financial regulatory walls a good thing for the U.S. insurance industry and other members of the financial sector? Did the deregulation facilitate competition and innovation as its authors intended? Networks Financial Institute at Indiana State University will present a conference (see sidebar below) regarding the Act’s impact 10 years after its signing.
Just as the “fall of the wall” in Eastern Europe reflected decades of change on the continent and throughout the world, the enactment of the GLBA reflected decades of change and modernization in the U.S. financial services industry. The GLBA turned back some very restrictive regulatory policies that were enacted during the Great Depression, specifically portions of the Glass-Steagall Act of 1933, which prohibited a bank-holding company from owning other financial companies.
The GLBA was not the first legislation to repeal portions of the Glass-Steagall Act. Regulation Q, which allowed the Federal Reserve to regulate interest rates in savings accounts, was repealed by the Depository Institutions Deregulation and Monetary Control Act of 1980. In 1987, the Congressional Research Service submitted a report presenting the arguments for and against preserving the Glass-Steagall Act.
The emergence of technology as well as the competitive threat from the European banking structure helped to create an interest in further deregulating the U.S. financial services industry. By the mid-1990s, geography was less relevant in determining where a customer banked and Internet-based financial firms began to compete with traditional “brick and mortar” firms. Likewise, the development of data mining and other marketing technologies made it easier for financial institutions to identify and “match” particular products with customers based on their life stage and “customer profile.” In Europe, many customers were enjoying “one-stop-shop” banking through the “universal banking” system.
Rush to form holding companies never materialized
With President Clinton’s signing of the GLBA on Nov. 12, 1999, insurance agencies, banks, investment banks and securities firms were able to form holding companies offering services outside of their traditional portfolios. For example, an insurance company could form a financial holding company that would enable it to offer banking products to its customers. Likewise, a bank could form a financial holding company and market insurance products to its customer base. Advocates of the GLBA saw an opportunity for holding companies to offer “one-stop-shop” convenience for customers across a spectrum of financial services.
Despite enthusiasm for one-stop financial centers, a large scale trend towards financial institutions forming holding companies did not materialize. As of July 1, 2009, there were fewer than 600 financial holding companies authorized by the Federal Reserve. However, a few very large institutions used GLBA to develop holding companies, most notably Citigroup and Travelers, and JP Morgan and Chase.
Diversified delivery channels
Within the insurance sector, the GLBA allowed insurance agencies to cultivate new revenue streams by offering bank products to their customers. Over the past decade, MetLife has emerged as the largest insurance carrier and one of the largest financial holding companies. Allstate Insurance’s interstate bank has engaged its agent network to emerge as a large competitor in the retail banking industry. Beyond retail banking products, the GLBA also permits insurance companies to underwrite other types of products including securities.
Many advocates cited innovation as a key reason for GLBA. However, the real innovation appears to have arisen primarily through product delivery channels versus the creation of new products. Many financial institutions found that it was more efficient to offer their customers the products of outside competing firms instead of creating their own products in a separate business unit. For example, through the holding company structure, banks could offer their customers a variety of insurance products without incurring the expense of developing the products in-house. Similarly, an insurance company could offer its customers securities services ultimately supplied by others. Thus, the GLBA appears to have been effective at generating new customers for financial institutions as a result of their products being marketed by other businesses.
Just as GLBA has not transformed the majority of financial services firms into one-stop-shops, it has not created the type of product integration across insurance, banking and securities, that some expected. Indeed, there has been some reduction in the level of diversification at Citigroup. However, the opportunities to diversify and cross-sell additional products seem to have made the GLBA successful in opening up new cross-sell opportunities and helping to increase products per household.
While consumers may express a desire for “specialists” and experts, the financial services industry has long observed that the more products and services a customer household establishes with an organization, the less likely the customer is to leave. Therefore, GLBA could be seen as a customer retention asset if the institution aggressively works to cross-sell a number of services at the beginning of a new customer relationship.
Kudos and criticism
In the wake of the financial crisis and concerns about the role of new and controversial products contributing to the crisis, GLBA has attracted its share of criticism. Earlier this year, President Obama stated in the Wall Street Journal that the GLBA helped create the 2007 subprime crisis. Nobel Laureates Joseph Stiglitz and Paul Krugman have also criticized the Act. In fact, Paul Krugman (New York Times, March 29, 2008) referred to co-author former Senator Phil Gramm as the “Father of the Financial Crisis.”
However, the controversial products that have been recognized as the primary “villains” in the crisis — collateralized debt obligations, mortgage-backed securities, and credit default swaps among others — were primarily created and marketed by the largely unregulated mortgage brokerage industry and investment banks.
Analysts such as Peter Wallison, who testified before the Senate Banking Committee in May 2009, have noted that GLBA has helped to insulate investors from larger losses. In fact, the only two large investment banks that were not affiliated with financial holding companies when the crisis arose and that have survived, have since established a holding company structure. Three others that failed (Bear Stearns, Merrill Lynch and Lehman) and that were not part of a financial holding company were able to be purchased and operated by banks rather than being completely dissolved with larger losses to other firms and investors.
Just as the fall of the Berlin wall did not erase all of the geo-political tensions in Europe, the GLBA has not solved all of the challenges that U.S. financial institutions face in a global marketplace. However, the GLBA has opened up new avenues of competition and appears to have broadened the distribution of products across the marketplace.
GLBA at Ten: Reform, Expand or Repeal
On November 12, 2009, Networks Financial Institute at Indiana State University (the outreach that also presents the annual Insurance Reform Summit) will present GLBA at Ten: Reform, Expand or Repeal in Washington, D.C. The conference will examine the intentions of the GLBA and evaluate its performance against the Act’s original objectives. Former Senator Phil Gramm, a co-author of the GLBA, will deliver the keynote address. Other speakers and panelists scheduled to speak include Peter J. Wallison, co-director of the American Enterprise Institute’s Program on Financial Market Deregulation; Edward Kane, professor of finance at Boston College and a senior fellow at Networks Financial Institute; Wayne Abernathy, executive vice president, financial institutions policy and regulatory affairs, American Bankers Association; and Martin Mayer, guest scholar, Brookings Institute. Details regarding the conference are available at www.networksfinancialinstitute.org.
John A. Tatom is the Director of Research at Networks Financial Institute at Indiana State University and Associate Professor of Finance at Indiana State University. He has published widely on international and domestic monetary and fiscal policy issues, especially inflation, capital formation, productivity and growth; the macroeconomics of supply; the relationship of exchange rate movements to international competitiveness, capital flows, trade and international economic policy; and on financial innovations and their effects on monetary policy and the economy, among other areas. He holds a Ph.D. in economics from Texas A&M University.