When the message flashes on the ATM screen telling you you're about to be charged $1.50 to take out $20, asking whether you want to proceed with the transaction (YES? NO?), you're made part of a grand experiment in consumer "choice" that banks have been running (despite complaints from municipalities and state attorneys general) for more than a decade. You know it's a rip-off. But you don't know where the next ATM is -- the choice one that your bank owns. And it's cold out. And you're in a hurry.You pay for the convenience, feeling very inconvenienced. You think of switching banks, but, then, they'll charge too, won't they?According to a 1997 study by the U.S. Public Interest Research Group, ordinary people -- that is, not Donald Trump or Sen. Chris Dodd or Sen. Phil Gramm -- pay an average of more than $218 per year for the privilege of having a checking account in a large bank. Fees have risen inexorably regardless of interest rate changes and despite advances in technology that have reduced the bank's incremental cost of having you as a customer to nearly zero, whatever your average daily balance.So you may have been pleased to hear the fanfare last month as politicians and powerful businessmen announced that their long-sought "financial services modernization" had become reality. The new law, for the first time since the Great Depression, allows insurance companies into the banking business, stock brokerages into insurance and banks to sell and manage stock portfolios. Called the Gramm-Leach-Bliley Act of 1999, the new law repeals the 1933 Glass-Steagall Act which, in the interest of safeguarding the nation against depressions fueled by stock market crashes, separated these businesses."By liberating our financial companies from an antiquated regulatory structure, this legislation will unleash the creativity of our industry and insure our global competitiveness," said CitiGroup Co-chairmen Sanford A. Weill and John S. Reed in a press release on Oct. 22, the day the compromise bill was announced in the Senate. "As a result, all Americans -- investors, savers, insureds -- will be better served."Added President Bill Clinton as he signed the bill into law on Friday, Nov. 12: "This will, first of all, save consumers billions of dollars a year through enhanced competition. It will also protect the rights of consumers. It will guarantee that our financial system will continue to meet the needs of underserved communities... which has been largely done through the private sector and honoring the Community Reinvestment Act."Politicians and economists aligned with the financial services industry rushed to praise the legislation and denigrate the old law. With "one-stop shopping" for financial services, consumers will at last be freed from the drudgery of schlepping to their bank for a mortgage, their broker for a mutual fund, their insurer for health and property insurance, they promised. At last, these tiny, feisty American companies -- Chase Manhattan, Fleet, Prudential, CitiGroup -- will be unleashed to compete on the global stage with the powerhouse banks of Europe and Asia.Truly a win-win-win deal.However, among the remarkable ironies about the law are these: Although the money folks had long said the repeal of Glass-Steagall was inevitable as rain, it still took 50 years to happen -- and then in a cliff-hanger, post-midnight arm twisting session involving Senate Banking Commission Chairman Phil Gramm of Texas and Connecticut's Sen. Christopher Dodd. Although the law is claimed to be for the benefit of consumers who will enjoy a financial world teeming with new competitors, the stocks of major banks, investment brokerages and insurance companies shot up the day after the deal was reached -- in expectation of mergers that would logically serve to consolidate market share and diminish competition.Critics call the notion that American financial institutions had been somehow hobbled internationally by a law that kept American commercial lenders from selling insurance and American stock brokerages from buying banks dubious. "They say we need to compete globally? I say who?" says Matthew Lee, director and chief counsel for Inner City Press, a Bronx, New York-based lending watchdog group. "Which countries' banks are beating out American banks for deals in Thailand? The answer is none."On Nov. 12 CitiGroup announced it was extending a $100 million line of credit to the troubled Bank of Thailand.Press coverage of the historic repeal has been, in most cases, positive. Despite mentions of the privacy concerns by some consumer groups, complaints from low-income loan advocates and the shady side deals tucked deep into the law, analysis of the sweeping new law has tended to take at face value the notion that consumers will benefit. After all, if not for consumers' benefit, why would voters' representatives stay up until 2 a.m. on a week night -- and miss a World Series game -- to craft such a law?Holman Jenkins, Jr. writing in the Oct. 27 Wall Street Journal, provides an answer: "This was pure, unpasteurized special interest legislation," he gleefully brags under a column headlined, "Hooray for Soft Money." "It took 20 years to rally commercial bankers, insurance agents and stockbrokers behind a common set of new financial rules. Does anyone think Congress would have gotten off its duff without the continuous and concentrated applications of lobbying and PAC money?"And, indeed, would banks, investment houses and insurance companies have spent an estimated $308 million in federal campaign contributions and lobbying expenses -- nearly a third of a billion dollars -- in the past two years simply for the privilege of competing with one another to give you the best deal on a used car loan?Clearly something else is afoot.What Gramm and Clinton, Weill and Dodd and former Treasury Secretary Robert Rubin and Federal Reserve Chairman Alan Greenspan have created is nothing less than a new world. Rarely before has so much money, power and influence been concentrated into so few hands. Never before has a nation's lawmakers so self-consciously midwifed the birth of private entities potentially richer and stronger than nations themselves -- yet as fragile as a newborn baby.The inevitability factor has been lamented, sometimes from quarters one might not expect."I don't think it is healthy to have this dramatic concentration of financial power," investment banker Felix Rohatyn told the New York Times 11 years ago, near the end of the last great American stock/mergers/acquisitions boom. "But it's just like the nuclear age, you can never uninvent the atomic bomb any more than you can uninvent these astronomical capital markets."These markets have increased in size by 100-fold since then, even as regulation has withered. And that's a good thing, say economists like former Treasury Secretary Robert Rubin, who has said this change could save consumers $15 billion a year in fees paid to banks, brokers and insurance sellers.The financial services companies have for more than a decade been getting into one another's businesses through loopholes. Banks have acquired nearly two dozen regional brokers and investment banks in the past three years, while many banks already sell insurance.Bankers Trust Corp. acquired Alex. Brown & Sons in 1997, BankAmerica bought Robertson Stephens, NationsBank Corp. purchased Montgomery Securities and Travelers Group Inc. bought Salomon Brothers. Recently, Chase Manhattan Corp. agreed to buy technology investment banking boutique Hambrecht & Quist Group.Federal Reserve Chairman Alan Greenspan himself, in testimony before the Senate Banking Committee early this year, explained that "dramatic advances in computer and telecommunications technologies of the past decade have so significantly altered the structure of domestic, indeed, global finance as to render our existing modes of supervision and regulation of financial institutions increasingly obsolescent."The new law concentrates regulatory power in the Federal Reserve, the nation's most powerful and independent regulator (with the responsibility for determining the basic interest rates for American dollars) and historically the regulator with the least direct concern for ordinary consumers. Greenspan's policy -- for which he takes credit for the nation's second longest sustained period of economic growth -- is to raise interest rates at the slightest hint of inflation, which he defines narrowly as increasing wages. For more than two decades the Federal Reserve has sought to hold wages down in deference to people whose income and wealth derive from ownership of stock portfolios and supermarket chains. He also disdains what he calls "outmoded loan file and balance sheet surveillance" -- the bedrock of today's regulatory model. Greenspan prefers to regulate by means of risk management, allowing the best and brightest financial minds to creatively determine the prudence of a given investment strategy.Much of the balance of power to regulate these colossal new corporations is vested with the U.S. Treasury Secretary, who controls the presses that print cash, plus a vast array of auditors and investigators who try to make sure all the banks and brokerages (to say nothing of 1040a-filers) behave honestly.The final bit of oversight -- and one that appears to have been given the least amount of thought -- is of the insurance business. That will continue to be handled by the states. Connecticut State Insurance Commissioner George Reider, who is also president of the National Association of Insurance Commissioners, says he fought hard to maintain the 100-year tradition of state jurisdiction over the insurance business. "In order to compete effectively with the Dutch and the Swiss and so forth, financial modernization can work very well," Reider says, "but not at the expense of consumers."Of course, in a state with some of the highest insurance premiums and some of the most stratified rates for things like auto insurance, protecting consumers is not always perceived to be job one. But at least state legislators have access. "The insurance department has certainly been a very great friend to the industry," says state House member Art Feltman (D-Hartford), who is currently trying to get his urban constituents a break on car insurance. "But we can beat them up, invite them to the committee and yell at them."The varying quality of the state laws and their enforcement, combined with the narrow reach of such agencies, gives the companies an edge that their soon-to-be increased size will leverage mightily.The example of CitiGroup is illustrative. When the Travelers announced it was acquiring CitiBank in the spring of 1998 in a $70 billion stock swap, it was widely interpreted as a death knell for Glass-Steagall. The law forbade the merger, yet analysts assumed -- correctly -- that the companies had received permission from the Federal Reserve and would bull-through legislation to allow it. Worried consumer groups claimed that many larger banks, including CitiBank, have poor records of compliance with Community Reinvestment Act provisions, while they increasingly market "subprime" loans to less wealthy, unsophisticated customers and charge high interest rates and bundled, expensive loan insurance.Martin Lee, a New York lawyer and CRA watchdog, complained futilely to the Fed about these issues before taking his case to the state insurance departments. On June 4, 1998, he arrived at the offices of the Delaware Department of Insurance, in Dover. He met Rashmi Rangan, director of the Delaware Community Reinvestment Action Council, and Mary Harris, a Delaware resident who said she had been ripped off by a Travelers' subsidiary called Commercial Credit.Harris testified that she had responded to an advertisement from Commercial Credit and went to consolidate her family's car payments, mortgage and some consumer loans.According to a complaint filed with the Office of Thrift Supervision, Harris went to Commercial Credit for a $7,000 loan, and ended up with total payments, including points, interest and insurance, of more than $72,000.Her testimony was ignored by the insurance commissioner.Under state law, the only question at the hearing was whether Travelers Group could acquire Citicorp Assurance Co., an internal reinsurance agency that covers risks for the bank. By narrowing the question under study, the state regulator sidestepped the larger questions raised by the merger and comments like Harris'. Those were the Fed's responsibility, Hearing Officer Tony Meisenheimer told Lee and Rangan.Rangan and Lee are part of a small community of consumer activists who monitor the lending patterns of banks under the 1977 Community Reinvestment Act. The law, which has been weakened several times since its passage but remains in force even now, requires banks to lend money in the geographical area where they have branches, and to lend to historically underserved communities. The law also requires the banks to report this lending to regulators. It is an upshot of the studies of bank "redlining" that were done in the 1960s and '70s, when it was discovered that banks would refuse to lend money to African-Americans and to anyone with a home or business in a predominantly minority area. Some loan officers had maps with red lines drawn around the forbidden zones.The new law almost did not come to a vote because its main architect, Texas senator Gramm, hates the CRA. Gramm wanted the CRA completely repealed. Some Democrats, responding to pressure from folks like Lee, refused. When the House bill was being drafted, Rep. Luis Gutierrez (D-IL) and Rep. Tom Barrett (D-WI) tried to introduce amendments that would have applied CRA to all the lending and basic banking activities of a financial holding company. This means that mortgage companies, insurance company affiliates, and security company affiliates that make loans and offer other checking/savings accounts would have been covered by CRA. Those amendments were killed, and CRA requirements were reduced for smaller institutions.Meanwhile, a provision of the law added by Gramm was designed to punish watchdogs like Lee's group by requiring them to divulge any agreements such as loans that they have with banks. It's no problem to do so, says Lee, but when other community groups call for help when a bank is closing branches in poor neighborhoods, he has to tell them that if they file a complaint with the Fed, they have to open their books to an extraordinary degree.Many of the groups, who don't have full-time lawyers or accountants, aren't staffed to do such reporting, Lee says: "It couldn't be more clear that the intent and the effect of that is to discourage CRA commenting."CRA has been the only effective lever consumer and community groups had over large financial institutions. By attacking their community lending records during merger hearings, groups like Lee's and Rangan's could delay regulatory approval, costing the banks money. To avoid delays the banks would often offer the community groups loans and grants, or offer to partner them in a loan fund to serve the poor."Now the Fed is going to be regulating community groups," Lee notes, "the very community groups who are trying to say, look at the banks' lending records" which the Fed has traditionally ignored.Big banks miss opportunities to lend to the corner store proprietor partly because their eyes are focused on more lucrative customers, like former Mexican President Carlos Salinas' brother, Raul.As lawmakers on congressional banking committees crafted the financial services reform bill this fall, the Senate Select Subcommittee on Investigations examined the lack of oversight of so-called "private banks," highly selective, secretive institutions central to vast money-laundering schemes. One of them is Citibank, which the subcommittee found engaged in a "pattern of poor account management," according to its report."There never was a pattern," CitiGroup co-CEO John Reed said in Nov. 9 testimony before the subcommittee. "We have to admit that in some of our businesses, some of our activities, we've had failures."According to the committee's investigation, a General Accounting Office report and internal Citibank audits, the failures, which involved stolen national treasuries, bribes and possibly drug money, stretched over years and continued despite internal bank warnings. A 1995 audit of the Monaco private bank office found that "80 percent of the Unit's client base [is classified] 'high risk' using the Legal Affairs Office criteria for money laundering."Although the unit has established 'Know Your Customer' policies, there is no effective transaction profile monitoring for high risk clients," the report continues.A 1996 audit of private bank offices handling Latin American clients found four "major deficiencies" which "increase[d] the exposure to money laundering schemes and internal fraud." The audit stated that it "seems the Unit's priority was to focus on customer service, even when it meant that internal controls would be compromised," according to the committee report. Citibank handled more than $85 million for Raul Salinas, referring to him only as "Confidential Customer 2," or "CC-2" to protect his privacy. Salinas is now in prison for murder.But he was far from the largest -- or weirdest -- Citibank account.President El Hadj Omar Bongo, who has ruled Gabon for more than 30 years and been a Citibank client since 1970, has moved more than $130 million through private-bank accounts since 1985, according to records reviewed by the subcommittee staff. Citibank collected more than $1 million a year in fees from this account, the subcommittee report states.When Citibank was asked by regulators in 1996 to document the source of one $52 million Bongo deposit, Alain Ober, the Citibank officer handling the account, sent an e-mail to a colleague stating: "Neither Bill nor myself ever asked our client where this money came from. My guess, as well as Bill's, is that...The French government/French oil companies...made 'donations' to him [very much like we give to PACs in the U.S.!]."The account was closed this year.While these customers asked for and received extraordinary privacy, the laws governing the privacy of your financial transactions -- and probably your medical records as well -- have been loosened under the new law.At the last minute, lobbyists for GE Capital Services Corp., the giant defense conglomerate's credit card subsidiary, got a provision slipped into the law that allows financial service companies to share your personal data not only within their own subsidiaries, but also with outside companies, like GE Capital, with which they have a business relationship. GE Capital services about 70 million credit cards for retailers like Home Depot and Wal-Mart."We had to make strong policy arguments," said Kate Fulton, a GE Capital lobbyist. "We take privacy very seriously."So, of course, do money managers. And while deregulation has encouraged price competition for such things as on-line stock trading, it has also broadened and hidden much of the business that used to be done on regulated trading floors. The result has been an explosion of financial activity, much of it secret, with which existing regulators cannot hope to keep up."It's what I call nonpublic markets, and there are a lot of them already," says Jane D'Arista, an analyst with the Financial Markets Center, a think tank. "They're going to take the last few public markets we have, and disappear them."D'Arista studies debt ratios and the total capitalization of markets -- a kind of systems analysis for the whole financial world -- and the trends disturb her. "The big guys don't care," she says. "They want to be as invisible in their trading as they are on the foreign exchange market, where $1.5 trillion is traded each day. That's compared to $35 billion on the [relatively transparent and regulated] US stock exchange."Secrecy is power, but it's also danger. And the trend in the 1990s has been a quiet concentration of unregulated and highly-leveraged trading, most of it done in the name of risk management -- insurance.Derivatives, for example, are contracts that derive value from an underlying asset such as U.S. Treasury Bills or Japanese yen. You might buy yen today and hold them at the prevailing Japanese interest rate, and agree to sell them tomorrow night at 9 -- or three months from now -- for a fixed price. If the interest rates do what you guess they'll do, you win. If they go the opposite way you thought they would, you lose. A derivative amounts to a futures option for money. A sophisticated institutional investor might make a derivatives play in order to balance another risky venture. The current notional amount (total level of the money traded) in derivatives is $80 trillion, D'Arista says. In 1995 it was $35 billion -- more than 2,000 times less.What do derivatives do to promote productivity? "Absolutely nothing," D'Arista says.The leveraging can be breathtaking. Long Term Capital Management, a Greenwich-based hedge fund founded in 1994 by two Nobel Laureates and the former deputy of the Federal Reserve, took about $4 billion in real assets to put $100 billion "at risk" in international currency, swap and options markets by the summer of 1998. On that $100 billion rested between $1 trillion and $2 trillion in notional assets.Then the Russian government devalued the ruble.The best and brightest financial minds fundamentally miscalculated their risk, by failing to account for volatility.The hedge fund's collapse threatened to bring down America's largest banks and some of the best known public pension systems in the United States. The Fed could not give money to the fund, so in late September New York Fed President William McDonough arranged for 14 of the banks and securities firms he regulates (including Citibank) to lend the money -- knowing full well the loans could never be repaid."Although no public money was involved, this is the first time the too-big-to-fail doctrine has ever been applied beyond insured depository institutions," Rep. Jim Leach (R-IA) said in introducing hearings on the matter last October. "This intervention is also the first one in my memory that involved a commitment of funds by those summoned to the elegant quarters of the New York Fed."In the world of high finance, such too-big-to-fail institutions and their bailouts are known as "moral hazard." A new study of the international financial system by the Council on Foreign Relations expends much ink and thought on ways to reduce such instances. It even calls the influx of speculative money into Russia several years ago, when anyone who looked realized corruption and fundamental weakness made for an unsustainable economy -- but that a bailout was guaranteed -- "the moral hazard play."The Gramm-Leach-Bliley Act of 1999 further frees American financial institutions to make such plays. Leach's authorship of the law may one day be seen as an ironic affront to concerns he expressed just the year before."Federally-insured institutions are subject to well-understood regulation which, among other things, places a premium on prudence and disclosure," Leach said during his hearings on the Long Term Capital affair. "In this case, however, some of the country's largest and most sophisticated banking institutions provided loans -- and, according to a Long-Term Capital officer, fought for the privilege for doing so -- to an institution that shielded its operations in secrecy, denying lenders and the regulators any data about its positions or its liabilities to other lenders. The rationale was that sharing information was competitively disadvantageous to the fund. Implicitly, however, this practice made lenders to the fund responsible for a kind of blind-eyed banking practice that no community bank I know would countenance, and complicit in speculative actions that might in some cases prove destabilizing for the very financial system upon which banks and the public rely."D'Arista says such plays are likely to continue -- and worsen -- because despite the Long Term Capital fiasco (or maybe because of the bailout), institutions we think of as creditors are piling up unprecedented levels of debt, almost all of it undertaken in order to bet on currencies and bonds using derivatives.The regulated market in derivatives is open and subject to rules about how much of a given bet a player can borrow, D'Arista says. But the over-the-counter market has no margin rules. "They make it up as they go along," she says. "It's seven times the size of the [regulated] market."Ninety-five percent of market is controlled by eight banks," D'Arista says. "CitiGroup is one... Chase is another." The Fed keeps the list secret.D'Arista spends all her time studying this debt, trying to understand what it means. She says the amount of direct borrowing by financial institutions plus securitized lending held by investors has risen from $2.4 trillion in 1989 to $7 trillion today -- bigger than household debt and almost double the size of non-financial corporate debt.This at a time when, despite a supposedly booming economy, consumer debt in the U.S. has risen to a staggering 98 percent of income.In short, the current prosperity rests on a thin bubble, and the consolidation of large financial institutions all chasing the same highly leveraged investments will leave all of them swamped the next time a currency is unexpectedly devalued or a stock market crashes. The looming possibility is that no bucket will be large enough to bail them out."There are a number of us out there who really believe there's an Armageddon waiting, and there are not a lot of options for deflecting it," D'Arista says. "And the few options there might be out there, they aren't going to take."***SIDEBAR ONE: How Uncle Sam Will Get You!The Gramm Leach Bliley Act of 1999 is hailed as a boon to consumers, who will hence forth enjoy lower prices for loans and stock trades and insurance. U.S. Financial Institutions will also get stronger, proponents say, because they will be able to combine into even larger corporations with even more diversified assets. But on three key counts the new law fails to deliver:Privacy: Central to the strategy of CitiGroup and others who will merge in the wake of this law is "cross marketing," the ability of the company to, when you're sitting in a loan office, sell you insurance and mutual funds and such. To do this, the companies will merge their existing databases into one big one with all your financial history, your jobs, taste in consumer goods (ever buy anything with a credit card?) and perhaps even your medical records. This will give them tremendous power over not just individual customers, but potentially whole geographic areas. "The banks have been engaged in a major ongoing project to develop a demographic and transactional database on customers to market products and services more efficiently," reads a letter from a Travelers lawyer to the lawyer for the Federal Reserve a few days before the CitiGroup merger was announced. "The Banks and the Insurance Companies would expect to share such information on customers..." The new law allows such data sharing even with outside corporations.Fees: As banks have become larger and more efficient, fees have increased. According to a 1997 study by the U.S. Public Interest Research Group, folks pay an average of more than $218 per year for the privilege of having a checking account in a large bank.Too-big-to-fail Doctrine: For decades, the largest U.S. banks have gotten into deep trouble making risky investments, only to be bailed out by taxpayers. The larger the financial institution, the more likely its bankruptcy will be viewed as destabalizing to the financial system as a whole. The bankers know this and can't help but act on it; economists call the concept "moral hazard." Policy analysts are stumped by the looming specter of 20 to 50 giant financial services companies -- all too big to fail -- comprising the entire financial world.
Edward Ericson Jr.