As the federal government considers imposing new regulations on financial entities, Connecticut”™s banking commissioner said sweeping deregulation a decade ago has had little impact on the state”™s finance and insurance industry.
Enacted in 1999, the Financial Services Modernization Act repealed many elements of the Glass-Steagall Act, which the federal government passed in 1933 in response to the 1929 stock market crash and the Great Depression. Glass-Steagall restricted banks to their core business of taking deposits and making loans, limiting the damage bank failures could have on the overall economy.
Popularly called Gramm-Leach-Bliley for its authors in the U.S. Senate, the Financial Services Modernization Act relaxed some of those limitations, allowing banks, securities dealers and insurance companies to compete against one another.
The law”™s passage legitimized the 1998 merger of Hartford insurance carrier Travelers Group and New York City-based Citicorp, with the combined company becoming today”™s Citigroup Inc.
The merger and new regulatory environment failed to spark additional mega mergers in Connecticut, however, despite some speculation that carriers like Aetna Inc. and Hartford Financial Services Group Inc. might be in a position to benefit. Fairfield conglomerate General Electric Co. has undergone perhaps the most fundamental change, exponentially increasing the size of its GE Commercial Finance and GE Money operations under the current rules.
“There are different cultures between insurance, banking and securities (companies),” said Howard Pitkin, Connecticut”™s commissioner of banking. “They are more different than they are alike. The (Citigroup) model just never caught on.”
According to the Federal Reserve, more than 50 bank- or financial-holding companies operate in Connecticut today. While several large banks added insurance agencies, including Bridgeport-based People”™s United Financial Inc. and Waterbury-based Webster Financial Inc., they shied away from the riskier underwriting side of the business that has produced strong insurance profits since 2001.
The risk-averse culture may have stemmed from both the banking crisis of the early 1990s and Hurricane Andrew in 1992.
Banks and insurers shed jobs throughout the decade, and the sector did not experience a recovery until 1997, when UBS AG established a major office in Stamford to supplement its New York City operations.
Already the home to a significant cluster of reinsurance companies, which assume some of the catastrophic risks underwritten by traditional carriers, the UBS decision helped legitimize Stamford as a locale for a broader array of financial services companies, including Royal Bank of Scotland which is building a new office there for its RBS Greenwich Capital affiliate.
According to the most recent estimates by the U.S. Census Bureau, approximately 150,000 Connecticut residents work in the financial sector, with insurance carriers accounting for half that number. State economists have reckoned that Fairfield County”™s hedge funds employ more than 10,000 people.
Pitkin said Gramm-Leach-Bliley has had no impact on the rapid proliferation of hedge funds in Fairfield County, noting the burgeoning sector owes its existence to a regulatory void that allows managers wide latitude in how they handle investor funds.
U.S. Treasury Secretary Henry Paulson last week urged hedge funds to adopt “best practices” in the areas of disclosure, asset valuation, risk management, business operations, compliance and conflicts of interest.
At the time Gramm-Leach-Bliley was enacted, Pitkin”™s predecessor commissioner John Burke was largely willing to let the markets determine their own course.
“My sense is that any regulatory agency, state or federal, should not only attempt to make doing business less bureaucratic but at the same time should not expect to become a profit center by creating a prohibitive fee structure,” Burke wrote in an opinion piece published by the Hartford Business Journal. “Instead, a regulator”™s primary role should be to protect consumers from poor management, or even mismanagement, of the regulated industry and to provide for a consistent and convenient means for addressing problems.”
Economists like Paul Krugman and Robert Kuttner have theorized that Gramm-Leach-Bliley is at least partly responsible for the collapse of the mortgage market, saying the law created an incentive for banks to securitize subprime mortgages, creating a market that in turn encouraged brokers to sell such mortgages to homeowners who could not afford them after they reset to higher rates.
In an April 10 speech in Virginia, Federal Reserve Chairman Ben Bernanke said the current problems arose from an “originate-to-distribute” model that has evolved in financial services, in which the lending process is broken down into production stages not unlike a manufacturer.
“The incentive structures often tied (mortgage) originator revenue to loan volume, rather than to the quality of the loans being passed up the chain,” Bernanke said. “Some originators had little capital at stake, reducing their exposure to the risk that the loans would perform poorly.”
U.S. Sen. Christopher Dodd, who heads the Senate banking committee, is now assessing what legislation is needed to stitch together perceived tears in the financial industry fabric, affecting banks and possibly other types of financial institutions. In early April Dodd initiated hearings examining the bailout of Bear Stearns, and last week held additional hearings on the mortgage market and its impact on other credit markets such as student loans.
“When your neighbor”™s house is burning, you don”™t charge him for the use of your garden hose ”“ you simply lend it to him,” Dodd said last week at a federal hearing. “Today, hundreds of thousands of our neighbors”™ homes are figuratively burning, and like any fire, the damage threatens to spread ”“ every home that goes into foreclosure lowers the value of the other homes on that block by $5,000 ”¦ The ripple effects are severe and widespread.”
