Republicans are usually very suspicious of government regulation and they should be. I am a champion of the free enterprise system and as a businessman I consistently voted against additional regulations on business when I served in the U.S. Congress. But, Republicans, and everybody else, need to keep in mind that financial intermediaries are fundamentally different from manufacturing, retail, or other service types of industries in important respects when it comes to applying reasonable governmental regulation. The difference is that most businesses are managing their own or their stockholders' money or resources while financial intermediaries are managing other people's money or resources. Remember the adage, "banks don't ever lend out their own money, they lend out everybody else's money!"
Banks, insurance companies, and investment banking companies are financial intermediaries that all, in one way or another, face moral hazards that are at a much higher consequence than what other businesses face. Moral hazard is the likelihood that an individual or an institution that does not have to face the full consequences of its actions will behave irresponsibly. In most cases people and institutions putting their own money at risk are more careful than people and institutions putting other people's money at risk. Just being a financial intermediary creates moral hazard because of this reality, even though people and institutions do exist where integrity and responsibility makes them more careful with other people's money than their own. When we create law we usually consider where most people and institutions are on the "bell curve" of honesty and integrity.
One of the historically proven best ways to lower the moral hazard of financial intermediaries is to keep separate, by creating strict "fire walls", banks, insurance companies, and investment banks. It is more important today than when the 1933 Banking Act was passed because, only after that law was passed, depositors' cash in banks has essentially all been insured by the U.S. taxpayer through the FDIC. Without strict "fire walls" or total separations, insurance companies, or more importantly, securities or rather investment banking companies can put taxpayer insured cash at greater risk than traditional commercial banks would put that cash to. Putting that money into complex derivatives and credit default swaps is not what the American people expected with their commercial bank deposits and what the taxpayers assumed when they agreed to insure those deposits with the creation of the FDIC.
According to the Library of Congress the Prudent Banking Act of 2011, initially sponsored by two good friends of mine in the Congress, Walter Jones and Marcy Kaptur, H.R. 1489, will amend the Federal Deposit Insurance Act (FDIA) to prohibit an insured depository institution from being an affiliate of any broker or dealer, investment adviser, investment company, or any other person or entity engaged principally in the issue, flotation, underwriting, public sale, or distribution of stocks, bonds, debentures, notes, or other securities.
It prohibits officers, directors and employees of securities firms from simultaneous service on the boards of depository institutions, except in specified circumstances.
It requires any such individual serving as an officer, director, employee, or other institution-affiliated party of any insured depository institution to terminate such service as soon as practicable after enactment of this Act. Requires an insured depository institution to wind-down in an orderly manner and terminate any affiliation prohibited by this Act.
It amends the Banking Act of 1933 (Glass-Steagall Act) to expand its prohibition against the transaction of banking activities by securities firms, and it requires the Board of Governors of the Federal Reserve System, the Comptroller of the Currency, or another appropriate federal banking agency to report to Congress a detailed description of the basis for its decision each time it makes a determination or grants an extension concerning an affiliation between insured depository institutions and investment banks or securities firms.
The reaction to America's recent meltdown in our major financial institutions and in our economy has been for the U.S. government to launch unprecedented bailouts and stimulus plans. These bailouts and stimulus plans have already created vastly new moral hazards. It is getting more obvious every day that the plans set in motion since the middle of 2008 to counter our current economic problems will not only fail, but will create such a new level of moral hazard that for years to come Americans will lose, not only their prosperity, but more importantly, their liberty. Enacting the Prudent Banking Act of 2011, H.R. 1489, will be a step back, but in the right direction for a change.
Former U.S. Congressman Merrill Cook lives in Salt Lake City