Finance VI

Most conservatives, and especially conservative lawyers, are federalists--meaning fidelity to state law except where the Constitution specifies a Federal role. Though you wouldn't know it from leftist references to white sheets and burning crosses, states' rights is good law: it's even in the Constitution.

It's also good theory, reflecting political "subsidiarity": devolving decisions to the smallest practical unit of government, so maximizing citizen participation, while minimizing state power coercion. Moreover, because there rarely is a single "right" regulation, Federalism turns states into oversight laboratories, where one jurisdiction's superior experience over time becomes a model for reform elsewhere. Hence my hesitancy in embracing Federal centralization of insurance regulation, though I have no doubt cross-state competition dramatically would reduce consumer rates (and, per force, nullify states' ability to set the mandates, guaranteed issue and community rating schemes favored by local voters).

I've taken a different position on banking regulation, opposing the Democrat proposal to subject national banks to state oversight. Superficially, this might appear inconsistent. Actually, it's not.

First, the present system is already Federal: National Banks cover multiple states and are federally regulated; state-chartered banks operate in a single state and are regulated by that state. Banks can choose national or state charters. Thus preserving the opportunity for trying various regulatory schemes and observing successes and failures.

Second, as compared with consumer needs in the 19th Century, modern commerce demands interstate banking--if, for no other reason than that bank customers transplant, travel and trade across state boundaries. And the Constitution recognizes "interstate commerce" as the proper province of Federal regulation (see Art I, § 8, cl. 3). Federal bank charters having been available for almost 150 years (13 Stat. 104-05 (1864)), national banking has become the poster-child for interstate commerce. Insurance regulation, by contrast, has always been almost exclusively a state prerogative.

Third, and relatedly, Federal regulation is the only practical approach to interstate banking, as a September 25th Wall Street Journal editorial explained:

[T]he Frank-Obama proposal still contains the Treasury's not-so-bright idea to require all banks to comply with national rules, plus a different set of regulations in each state where they operate. The regulatory possibilities are endless, starting with the fact that each state could impose different rules for pricing, product features, repayment schedules, bank capital requirements, consumer disclosure, regulatory reporting requirements, and so on. If each state can set its own rules, expect endless legal confusion over which law prevails when a bank in one state serves a customer in another.

If a particular product is legal in New York, but illegal in New Jersey, can it be advertised in the New York media market? Will a family moving from Washington, D.C. to the Virginia suburbs be required to change all of the financial products they use? Comptroller of the Currency John Dugan warned in a speech yesterday of the chaos to come: "This radical change is fundamentally at odds with the concept of efficient national standards for national products and services offered across state lines."

The framers created the Commerce Clause of the Constitution precisely to prevent local and state governments from strangling free trade among the states. But the framers left it up to Congress to decide when to pre-empt state authority. Therefore the Frank-Obama plan is probably not unconstitutional. It merely overturns an 1864 judgment made by Abraham Lincoln and Congress that has allowed a national market in banking to flourish ever since.

The Frank-Obama rewrite of the National Bank Act would give state AGs the kind of enforcement power that even Mr. Spitzer, the former New York enforcer, probably never imagined. Not only could 50 attorneys general sue to enforce their new state laws; they would also gain the power to enforce federal laws. So even a practice deemed legal under federal law by federal authorities would still be open to 50 other interpretations, with the inevitable cost and confusion that would result.

A lawyer assault on interstate banking may sound like an assault on just the biggest national banks, but hundreds of banks have business in more than one state. If this is intended to be populist payback against Citigroup and the other big banks that had to be saved by the taxpayer, it misses the mark. The big banks are fighting the proposal, but they will learn to love it, as it impedes upstarts seeking to compete with the too big to fail crowd. Anyone starting an Internet bank, for example, would need to throw out the old business plan and contemplate the compliance costs inflicted by 51 separate regulators--52 if a customer logs on from Washington, D.C.

This would effectively end national banking. I might be convinced that insurance has become sufficiently "inter-state" to warrant national oversight. But, surely, it makes no sense to make banks or insurers subject to dual, overlapping and potentially inconsistent regulation.

Fourth and finally, additional state-by-state oversight of National Banks wouldn't have prevented the financial meltdown. Most of the worst sub-prime originators (14 out of 20) were state, not Federally, regulated. Indeed, as MaxedOutMama has discussed, state banking law often utterly failed. (Fannie and Freddie fell under a regulatory scheme different than national banks, one seemingly more tailored to Congressional re-election than coherent regulation.)

And this Washington Post story isn't to the contrary. The problem there was subsidiaries of bank holding companies that were not regulated by the Federal Reserve Board; affiliates of federally chartered banks would have been regulated (by the OCC). I would have no objection to closing that loophole, albeit not by subjecting holding company affiliates to state regulation. Nor would I oppose eliminating the FHA, and consolidating its functions into Treasury.

Conclusion: The WSJ is right--state oversight of national banks wouldn't be illegal, just inane. Slapping Citibank isn't worth sacrificing consumer costs and convenience. So, bravo for the big banks.

Federalism doesn't demand that each marketplace exchange serve multiple masters. States control transactions within their borders but, unless Congress specifically defers to states (and has on some issues), inter-state commerce falls within Federal control. Either/or makes sense--but redundant sovereign bank supervision would spawn inefficient operations subject to potentially inconsistent outcomes, the costs of which will be borne by bank customers: you and me. In this situation, states' rights is neither logically compelled nor legally conservative.

If systemic financial reform is required, why not make insurance law more like national banking, with Federal and state charter companies competing to drive down health insurance premiums?