Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, February 23, 1999

Federal Reserve Bulletin, April, 1999 by Alan Greenspan

The committee has asked that, in addition to my report on the economy, I present today the views of the Federal Reserve on the need for legislation to modernize the U.S. financial system. The Federal Reserve continues to support strongly the enactment of such legislation, and I commend the committee for taking up this vital matter so promptly.

NEED FOR FINANCIAL MODERNIZATION

U.S. financial institutions are today among the most innovative and efficient providers of financial services in the world. They compete, however, in a marketplace that is undergoing major and fundamental change driven by a revolution in technology, by dramatic innovations in the capital markets, and by the globalization of the financial markets and the financial services industry.

The technologically driven proliferation of new financial products that enable risk unbundling has created new financial instruments that increasingly combine the characteristics of banking, insurance, and securities products. These changes, which are occurring all over the world, have also dramatically altered the way financial services providers operate and the way they market and deliver their products.

In the United States, our financial institutions have been required to take elaborate steps to develop and deliver new financial products and services in a manner that is consistent with our outdated laws. The costs of these efforts are becoming increasingly burdensome and serve no useful public purpose. Unless soon repealed, the archaic statutory barriers to efficiency could undermine the competitiveness of our financial institutions, their ability to innovate and to provide the best and broadest possible services to U.S. consumers, and ultimately, the global dominance of American finance.

Without congressional action to update our laws, the market will force ad hoc administrative responses that lead to inefficiencies and inconsistencies, expansion of the federal safety net, and potentially increased risk exposure to the federal deposit insurance funds. Such developments will undermine the competitiveness and innovative edge of major segments of our financial services industry. We believe that it is important that the rules for our financial services industry be set by the Congress rather than, as too often has been the case, by banking regulators dealing with our outdated laws. Only the Congress has the ability to fashion rules that are comprehensive and equitable to all participants and that guard the public interest.

For these reasons, we support removal of the legislative barriers that prohibit the straightforward integration of banking, insurance, and securities activities. There is virtual unanimity among all concerned--private and public alike--that these barriers should be removed.

In designing financial modernization legislation, we firmly believe that the Congress should focus on achieving two essential and indivisible objectives: removing outdated, competitively stifling restrictions on financial affiliations and, most important, adopting a framework for this modernization that promotes the safety and soundness of our banking and financial system and prevents the extension of the federal subsidy.

FRAMEWORK FOR FINANCIAL MODERNIZATION

The first objective is achieved by amending the Glass-Steagall Act and the Bank Holding Company Act to permit financial affiliations and broader financial activities.

In our judgment, the other objective of preserving safety and soundness and preventing the spread of the federal subsidy is best achieved by allowing banks, securities firms, and insurance companies to combine in the financial service holding company structure. While we enthusiastically support the new powers granted to financial service holding companies, we just as strongly believe that they should be financed by the marketplace, not by instruments backed by the sovereign credit of the United States. The requirement that the new powers, at least those conducted as principal, be conducted through holding company affiliates minimizes the expansion of the use of the subsidies arising from a safety net backed by the U.S. taxpayer.

The choice of requiring the new powers to be harbored in affiliates of holding companies, not in operating subsidiaries of their banks, will significantly fashion the underlying structure of twenty-first century finance. To inject the substantial new subsidies that would accrue to operating subsidiaries of banks into the currently mushrooming domestic and international financial system could distort capital markets and the efficient allocation of both financial and real resources that has been so central to America's current prosperity.

New affiliations, if allowed through bank subsidiaries, would accord banking organizations an unfair competitive advantage over comparable insurance and securities firms--both those operating independently and those that are bank holding company subsidiaries. By fostering a level playing field within the financial services industry, we contribute to full, open, and fair competition.