Arthur F. Burns Fellow Peter J. Wallison

The House of Representatives has passed HR 698, legislation that is intended to prevent companies that receive more than 15% of their revenue from "commercial activities" from owning a Utah industrial loan company. ILCs have many of the powers of banks, including the ability to take deposits backed by the Federal Deposit Insurance Corp.

This act demonstrates beyond any reasonable doubt the hollowness of congressional pretensions to be protectors of U.S. consumers in general, or of the "American family" in particular.

While claiming that the legislation is based on the principle of separating banking and commerce, the sponsors have made clear that they are protecting the banking industry against competition that might bring down financing costs for ordinary Americans. In the end, the legislation is not good either for working American families or the banking industry.

To push this bill through the House, the sponsors endlessly invoked the so-called principle that banking should be separated from commerce. This notion rests on the proposition that banks, as federally backed lenders, must be protected against exploitation by commercial firms in two different ways.

A commercial firm, it is argued, could abuse a bank it controls by forcing the bank to lend on favorable terms to the parent or by preventing it from lending to the parent's competitors.

In addition, a commercial firm might be able to exploit the bank's connection to the banking safety net by using the bank for a bailout if the parent gets into financial trouble.

Following out this idea, the bill's sponsors drafted legislation that would allow the FDIC to deny applications by any firm that was engaged to a substantial degree in commercial activities. Up to this point, there is a surface consistency to the legislation. If one really believed that affiliation with a commercial firm would indeed be a threat to the federal safety net--a very doubtful proposition, by the way, since it depends on several different violations of law--limiting connections between banks and commercial firms would make sense.

However, once the bill was passed, it became clear that it was nothing more than another weakly disguised effort to protect a favored industry.

Thus, the bill's principal sponsor--House Financial Services Committee chairman Barney Frank--let it be known that, if necessary to obtain Senate approval, automobile companies might be allowed to acquire ILCs. Huh? Aren't automobile companies commercial firms? And wouldn't their acquisition of ILCs violate the so-called separation of banking and commerce?

Surely, if you believe that commercial firms will misuse their banking subsidiaries, there's no reason to assume auto companies will be different.

But if opening ILC ownership to auto companies raises questions about the bona fides of this legislation, the reason for doing so removes any doubt. U.S. auto companies, as is well known, have been taking a competitive beating from foreign manufacturers and are financially--even worryingly--weak. The industry was singled out for a special exemption because Rep. Frank knows that a concern for the welfare of this industry can bring in some votes in the Senate.

The notion that financial weakness is a reason for owning an ILC, of course, completely undermines the idea that the separation of banking and commerce is intended to prevent the exploitation of the federal safety net. For decades, the Federal Reserve Board has justified its regulation of bank holding companies as necessary to ensure they will remain sources of strength for their subsidiary banks.

Now an important member of Congress is suggesting that a parent company's weakness will be a source of strength in its application to acquire an ILC.

Obviously, allowing weak companies to acquire ILCs is an open invitation to extend the federal safety net to commercial firms.

The offer to allow auto companies to acquire ILCs exposes the disingenuous posturing that underlies HR 698. The purpose of the bill was not what its sponsors told the House it was. Far from continuing the separation of banking and commerce, the real purpose was to protect the banking industry from competition from retailers and others who might offer America's working families a better financial deal.

Now that the sponsors of HR 698 are willing to offer special exemptions to others, the separation of banking and commerce is revealed for what it has always been: a way to protect the banking industry from competition.

But ironically, the exploited class will ultimately include the banks themselves. As was true of the railroads, AT&T, and other protected industries, the government's shelter will only weaken their incentives to innovate and make themselves relevant to consumers. The economic rents they earn today by keeping the Wal-Marts at bay through government action will attract potential competitors from outside the industry, and these competitors will develop and deploy new technology and marketing techniques that will eventually supplant deposit banking. It's only a matter of time.

Peter J. Wallison is the Arthur F. Burns fellow in Financial Market Studies at AEI.