House panel to vote on subjecting national banks to state rules

By Binyamin Appelbaum
Monday, October 19, 2009

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Large banks are on the verge of losing a key legislative battle over the shape of financial reform, an unusual setback that reflects the continued political backlash over their role in creating the financial crisis.

The House Financial Services Committee is expected to vote Tuesday to let state governments protect bank customers by imposing restrictions that go beyond existing federal laws, according to congressional and industry sources.

The move would roll back a doctrine called preemption that has allowed big banks to answer solely to federal regulators. The banks argue that operating under a single set of rules is more efficient and results in lower prices for customers. But the Obama administration, which is pushing for the change, regards preemption as a cause of the crisis because it prevented state regulators from quashing obvious abuses.

The change essentially would unleash 50 additional regulators on the largest banks.

Large banks have fought bitterly against the proposal, which they regard as one of the most problematic components of the administration’s financial reform plan, but they have been unable to sway House Democrats.

By contrast, the committee last week granted a major concession to smaller, community banks, agreeing that they would not be directly supervised by a new federal agency devoted to protecting consumers of financial products.

“The big banks don’t have much political power, and the big banks are the ones that care about preemption because they operate in so many states,” said Rep. Barney Frank (D-Mass.), the committee chairman. “The community banks were worried about examinations, and that’s why we compromised, appropriately, on the examinations. They have political clout. . . . They’re respected members of the community in everybody’s district.”

The Obama administration has proposed eliminating the ability of federal regulators to override state laws, but Frank said he supported a compromise under which federal regulators would retain a limited amount of override authority.

The version approved by the committee also is likely to pass the House, but it faces an uncertain future in the Senate, where financial lobbyists regard some moderate Democrats as more sympathetic to their concerns.

A bit of background

The federal government started chartering and regulating banks during the Civil War. These national banks were subject to state laws unless they got an exemption from the federal regulator, the Office of the Comptroller of the Currency. Beginning in the 1980s, as the government allowed national banks to expand across state lines, the banks started pressing the government for exemptions more often.

The point of expansion was efficiency, which was supposed to result in lower prices for customers.

The rise of federal preemption was gradual. In 1999, the OCC said national banks did not need to comply with a California law limiting the fees banks could charge for ATM withdrawals. In 2000, it lifted a Rhode Island law limiting changes in the interest rates on credit cards. In 2002, it overrode a Texas law that barred banks from charging check-cashing fees. Finally, in 2004, the OCC issued a blanket exemption, asserting sole authority to police national banks. That stance has since been upheld by federal courts.

John C. Dugan, the head of the OCC, has defended the value of the current policy for banks and consumers. He noted in a recent speech that without preemption, a bank operating in the Washington area could be required to disclose different information to borrowers in Maryland, Virginia and the District, complicating even the simple task of advertising.

“Consumers benefit from an efficient financial services system where you can operate under uniform rules wherever you go,” Dugan said in an interview Friday. “It’s important to have strong rules to protect consumers, but what we don’t need is 50 different rules.”

A divisive issue

But the policy has come under fierce attack from state regulators and consumer advocates. They noted that in many cases, federal regulators failed to impose comparable restrictions on national banks after clearing away the state laws. And they charged that during the financial boom, the OCC and other federal regulators failed to police mortgage lending abuses even when state regulators offered specific warnings.

The question of what should be done about that failure has divided Democrats.

A group of moderates organized as “new Democrats,” led by Rep. Melissa Bean (D.-Ill.), argued that the idea of preemption was sound and that the single national standard benefited consumers. Problems had arisen because regulators were too lax, they said, but the appropriate solution was the creation of a strong new federal agency, not a rollback of preemption.

The Obama administration and state regulators, however, argued that the best solution to insufficient regulation is to empower more regulators. The administration proposed that the new agency would set a minimum standard, ensuring that residents of every state enjoyed basic protections, but allowing states the ability to go further.

“Washington doesn’t always know what’s best,” Michael Barr, an assistant secretary in the Treasury Department, said on a conference call Thursday. He said the administration wanted to restore the right of states “to protect their citizens with the rules that they think make sense.”

The debate came to a head last week. Bean’s group said it would propose an amendment to retain the current law. Liberals warned that if the amendment drew enough Republican support to pass, they would oppose the broader legislation to create the new agency. House leaders and the White House pressured Bean and the moderates to fall in line.

Despite tremendous pressure from the banking industry, Bean ultimately agreed.

In a piece of political theater, Bean now plans to introduce the amendment and then to withdraw it, according to people familiar with the matter. She then plans to engage in a scripted conversation with Frank, in which both are to affirm the importance of further discussions about the issue. Bean can then reintroduce the amendment once the bill comes before the full House, but lobbyists on both sides say they regard the battle as over.