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Fed Lite and the Industrial Loan Company Loophole

MAY 30, 2003


Banker Update: Fed Lite and the Industrial Loan Company Loophole

No, this isn't the brand name of a new beer. It is terminology widely used to describe a new regulatory concept originating from the Gramm-Leach-Bliley (GLB) Act. Recall that as the bill was being put together there was a major political battle over the appropriate regulatory structure authorizing new financial conglomerates. The Board of Governors of the Federal Reserve System was accorded umbrella regulatory authority over financial conglomerates. These conglomerates (like Citigroup) were christened large complex banking organizations by the Fed. Early in this century, Federal Reserve Governor Larry Meyer had noted that such organizations carried the potential of substantial systemic risk for our economy.

In a recent New York Law Journal article, Clyde Mitchell defined Fed Lite: "The board [of governors of the Federal Reserve System] is to work closely with each functional regulator [e.g., banking agency, SEC, insurance regulator, etc.]; it is to rely on the functional regulator's auditing and examination and not duplicate such regulatory work; it is to rely on information furnished to the functional regulator and, if it feels it requires more information, the board must do so through the functional regulator; and it may not impose capital or other similar requirements on the functionally regulated entity. However, in the event that, notwithstanding the above, the board is concerned that certain activities of the functionally regulated entity may have a material adverse effect on one or more insured depository institutions in the system or may violate any laws which the board is empowered to enforce, then the board is free to take whatever actions are required to prevent such a result. … To date, the board appears to have gone to great lengths to show a spirit of cooperation and willingness to follow closely the proscriptions of GLB to do so."

But apparently for Merrill Lynch, Morgan Stanley and other large financial conglomerates who are exploiting the Utah industrial loan company (ILC) charter, the Fed has not done enough. Merrill Lynch, one of the lead "free rider" horses, uses its Utah ILC as one of the vehicles to offer $200,000 in individual deposit insurance coverage levels. Now Merrill wants a lighter regulatory jockey, to the further detriment of all banks and thrifts.

Wal-Mart attempted to buy an ILC in California; Toyota is well advanced in its attempt to purchase an ILC in Nevada. UBS, which former Senate Banking Committee chairman Phil Gramm recently joined, has just purchased a Utah ILC. Citigroup owns three ILCs. Citigroup and UBS are under Federal Reserve regulation.

ILC owners Merrill Lynch and Morgan Stanley are on point with their powerful trade group, the Securities Industry Association (SIA), in trying to 1) expand the ILC charter to include new powers and de novo interstate branching, and 2) make sure they remain out from under Fed regulation.

Chairman Greenspan and the Board of Governors don't like it one bit. In a letter to House Financial Services Committee chairman Mike Oxley (R-OH), Chairman Greenspan warned that this ILC expansion would be contrary to assuring "that companies that own insured banks operate in a safe and sound manner."

Unfortunately, the Congress is not listening to the Federal Reserve. And in the banking arena, the U.S. Treasury apparently is doing little except worry about increased insurance coverage levels for retired folks. A parallel and weaker regulatory structure is being crafted to the benefit of the same firms that were just heavily fined by the SEC for misleading tens of millions of investors. The regulatory structure put in place by GLB is being undermined by stealth bombers and their congressional allies. If the House of Representatives doesn't come to its senses, the Senate must. One Enron and one WorldCom were enough.