Bank Regulation: Rolling Backwards

Are you clinging to the hope that the 2008/09 crash of the global economy was the last one that we’ll experience in our lifetimes? Do you believe that our political leaders learned much from the events that almost destroyed the world’s financial system?

If you remain optimistic about our economic future, you might wish to ponder legislation that was approved by the United States Congress last week. Legislators easily passed a bipartisan federal budget that funded the operating activities of the United States and avoided any possibility of another imminent government shutdown.

That sounds very promising, doesn’t it? After all, any bipartisan activity in Washington can be a cause for celebration. And any budget process that avoids a federal government shutdown can represent a step in the right direction.

But before you permit yourself to feel optimistic about the future, you might wish to read the “fine print” of the budget bill. If you do, you’ll notice that an important component of regulatory oversight, one that was instituted by the Dodd Frank Act just a short time ago to prevent a future government bail-out of the “too big to fail” banks, is being dismantled.

Lobbyists from the global bank Citigroup reportedly helped write the provision that repeals restrictions on the riskiest investment activities of federally insured banks. On a go-forward basis, the new law “will allow banks covered by the Federal Deposit Insurance Corporation to directly engage in derivatives trading.”

In other words, as a result of this law, the world’s largest American banks will again be empowered to trade in the very derivatives that Warren Buffet once called “financial weapons of mass destruction.” And the institutions that engage in these trades will retain the benefit of insurance coverage by the taxpayer supported FDIC.

Will this new law encourage riskier behavior by America’s banking giants? And will it again create the very conditions that might lead to the next global economic collapse? The sudden roll-back of the derivative regulations that were first passed only four years ago makes it difficult to be optimistic about the future stability of the global financial system.

MetLife and Deutsche Bank: Playing Hide And Seek

Undoubtedly, you’ve heard of the Metropolitan Life Insurance Company, i.e. MetLife. According to the Fortune 500 rankings, they’re the largest life insurance company in the United States. And certainly, you’ve heard of Deutsche Bank AG as well. According to Banker’s Almanac, they’re the second largest bank in the world.

So here’s a question for you: according to the federal government of the United States, which one of these organizations is an insurance company? And which one is a bank?

A rational person might respond “the insurance company is an insurance company and the bank is a bank.” But in the world of federal banking regulations, a rational answer is often a wrong answer. So please guess again!

MetLife: From Insurer to Bank and Back

The Metropolitan Life Insurance Company was founded in 1863 as the National Union Life and Limb Insurance Company, an issuer of policies to military personnel fighting the American Civil War. For almost 150 years, it has been perceived as a quintessential American insurer; in fact, it even utilizes the Peanuts beagle Snoopy as its corporate logo.

But in the year 2000, MetLife purchased a small bank called Grand Bank N.A. of Kingston, New Jersey. Although it renamed the entity MetLife Bank and has been operating it since that time, the division has never grown to become a significant component of its operating activities. And recently, on December 27,  2011, it decided to sell the division’s entire depository business to GE Capital.

Considering the relatively inconsequential size of MetLife’s banking operations, why does the Federal Reserve Bank of the United States list MetLife, Inc. as the sixth largest bank in the nation? It’s because MetLife utilized its tiny bank to reorganize itself as a diversified bank holding company. That helped the firm boost its profits during the bubble economy era prior to the 2008 market crash, but is now proving a hindrance in the new era of Dodd Frank regulations and Federal Reserve stress tests, one of which MetLife recently failed.

So MetLife is now shedding its banking persona, selling off its MetLife Bank operations in a piecemeal fashion. Last year, when it decided to sell its deposits to GE Capital, it declared that “a diversified bank holding company structure was no longer appropriate” for it.

Deutsche Bank: From American Bank to American Subsidiary

Deutsche Bank AG has been operating as a global banking company since its founding in 1870. In 1999, one year before MetLife purchased Grand Bank N.A., Deutsche Bank created a corporate entity called Taunus Corporation (named after a mountain range in Germany) to serve as a bank holding company for its American assets.

Until late last month, there was never any question that Taunus represented a major American banking operation. That’s why the Federal Reserve Bank still lists Taunus as the eighth largest bank in the United States.

So what happened last month? Like MetLife, Deutsche Bank decided that its American operations should try to avoid the necessity of compliance with the new regulations that are being imposed by federal regulators. So it decided to transform itself from: (a) an American bank that is owned by a German bank, to (b) a German bank’s American subsidiary. At first glance, that distinction might appear to be a relatively arcane one, but under American law it will permit Deutsche Bank’s Taunus Corporation to side-step the new regulatory requirements.

Now You See Me, Now You Don’t

As if playing a game of hide and seek, MetLife and Deutsche Bank have each decided to disappear from the watchful gaze of federal oversight. MetLife plans to accomplish this feat by selling off a minor operation that enabled them (while it was beneficial to do so) to classify their entire firm as a bank. And Deutsche Bank plans to achieve the same goal without selling any of their American operations at all.

Are there any other organizations that have slid in and out of the regulatory classification of a banking institution? You bet! Major American corporations such as Harley-Davidson, Caterpillar, and McDonald’s relied on their corporate treasury operations to borrow billions of dollars from the Federal Reserve Bank at the height of the financial crisis. And pension plan entities of all sizes, ranging from the California State Teachers Retirement System to the City of Bristol (Connecticut) General City Retirement Fund, did so too.

Clearly, the conveniences of the reclassification process have permitted many banking organizations (like Deutsche Bank’s Taunus division) to avoid the disadvantages of being regulated as a bank. And clearly, they’ve also permitted many non-banking organizations (like McDonald’s) to enjoy the advantages of such a classification.

So when can a bank call itself a bank? And a non-bank a non-bank? Apparently, in the United States, the answer to these questions is a simple one: whenever the bank (or non-bank) decides it is beneficial to do so.