Access provided by Virginia Polytechnic Institute & State University

Book Review

Two Radically Different Approaches to Analyzing Banking Policy

Jean Reith Schroedel

Jeffrey Worsham. Other People's Money: Policy Change, Congress, and Bank Regulation. (Boulder, Colo.: Westview Press, 1997). Pp. xi, 164. $55.00 cloth. $21.50 paper.

The recent announcement of a proposed merger between Citicorp and Travelers, which will result in the creation of a bank with more than $700 billion in assets is only the latest evidence that the financial sector is in the midst of a fundamental restructuring as ever larger and more diverse conglomerations compete to offer customers a wide array of new financial products and services. Even though the banking industry of the twenty-first century will be radically different from that of the1970s and 1980s, the need to maintain a safe and sound system will not have changed. If anything, the prospect of $1 trillion banks makes it even more crucial for the country to have a system of effective banking regulation and supervision. Given these concerns, it is not surprising that policy researchers have a renewed interest in the study of banking regulation.

In this review, I will consider two extremely different approaches to analyzing bank regulatory policymaking. In Checking on Banks, Anne Khademain focuses on how the cultures within the three regulatory agencies with primary responsibility for supervising commercial banks affects the examination process, while Worsham uses subsystem theory to analyze the passage of banking legislation within Congress over the past one hundred years. [End Page 323]

Khademian begins with the general question of whether consolidation and downsizing to standardize procedures and eliminate overlap would result in more effective government bureaucracies. In 1992 and 1993 she conducted a series of open-ended interviews with bank examiners, supervisors, and administrators at the three federal agencies responsible for the regulation and supervision of commercial banks. She discovered that although officials at the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board (Fed), and the Federal Deposit Insurance Corporation (FDIC) have the same general mandate--to supervise the commercial banking industry--each has somewhat different supervisory responsibilities and very different conceptions of the best way to carry out the task. She also found differences in the agencies' organizational structures and their relationships with political overseers; much of which she traced to differences in the degree of autonomy accorded them.

Khademian discovered that the OCC, which is responsible for supervising all banks with federal charters, has an ambiguous mandate. It is expected to promote aggressively the interests of national banks as opposed to state-chartered banks while simultaneously promoting stability within the system to ensure that the federal government can meet its financing needs. The OCC is generally recognized as the most innovative of the agencies, but as Khademian shows this is not an unmixed blessing. For example, in the 1980s the OCC developed a hierarchy of risk approach to regulation. Rather than scheduling regular on-site inspections of all nationally chartered banks, it focused on banks and banking activities that posed the greatest risk to the industry as a whole. This approach meant that small banks not deemed to pose a systemic threat were not closely supervised and they ended up comprising a disproportionate number of the bank failures in the 1980s.

The Fed, which is responsible for the supervision of all state-chartered banks within the Federal Reserve System and bank holding companies, defines its primary mission as crafting monetary policy to stabilize economic performance. Because the Fed must consider the effects of its policies on a wide range of competing economic and political interests, its mandate is far broader than the other two regulatory agencies. According to Khademian, the Fed is the most autonomous of the three and its staff has the highest level of expertise. In contrast, the FDIC, which is responsible for supervising state banks that have deposit insurance but do not belong to the Federal Reserve System, has a far more limited mandate--defend the deposit insurance fund. Success is measured by the health of the insurance deposit fund. A supervisor at one of the other agencies complained to Khademian that regulators at the FDIC have an excessively narrow viewpoint. "I think they (FDIC) have a statue in the lobby and every day they bow down to the fund" (79). [End Page 324]

Khademian argues that until a consensus is reached over the goals of banking regulatory policy, there can be no single best way to supervise the industry and that the current system of overlapping responsibilities allows for a balancing of goals. A single regulatory agency wound find it nearly impossible to encourage bank innovation and competitiveness while at the same time ensuring stability and minimizing depositor risk. Khademian does an excellent job of providing a framework for understanding the current examination process within agencies and their respective strengths and weaknesses.

The book could be improved by the inclusion of an appendix that would provide a few more details about the methodology, such as how many interviews were conducted at each of the three agencies as well as a copy of the interview questions. I also would recommend placing the discussion of banking supervision within the broader framework of current debates over the efficacy of different approaches to regulation, such as whether "police patrol" or "fire alarm" oversight is better.

Not only does Jeffrey Worsham's book cover a far broader time period, but the institutional locus is Congress rather than the bank regulatory agencies. Worsham argues that congressional committees play a central role in subsystem politics and that changes within the configuration of power in subsystems can be traced by studying committees. He uses banking as a case study to show how changes within the balance of power in a subsystem affect policy outcomes. Given the author's focus, it is not surprising that the sections on subsystem theory and his extensions of that theory are the strongest parts of the book. Worsham argues that because endogenous and exogenous environmental factors constantly threaten to disrupt politics within subsystems, it is more appropriate to conceptualize them as achieving a "wavering equilibrium" rather than a general equilibrium (17). The purpose of the study is to answer three interrelated questions: (1) What have been the major patterns of political participation in the financial subsystem? (2) How do you explain changes from one pattern to another? and (3) How do the types of subsystem politics affect policy outcomes?

The use of both quantitative and qualitative methodologies in Worsham's study is commendable. Few scholars recognize that a combination of methodologies has the advantage of allowing one to use quantitative data to trace broad patterns of behavior and more qualitative research to show the detailed interactions that occur when particular policies are being developed. Unfortunately, the author has only a limited understanding of the history of financial institutions in the United States and of the dynamics of congressional bank policymaking. A few examples will be used to illustrate how this weakness undercuts the effectiveness of an otherwise credible study. [End Page 325]

Because he only traced banking bill introductions through the Congressional Record and did not systematically read through all banking bills introduced into the House and Senate, Worsham gives credit to House Banking Chair Henry Fowler for the origination of the idea of deposit insurance at the turn of the century (37). In fact the first deposit insurance bill was introduced by William Price (R-Wis.) in 1886, and quite a few House and Senate Banking Committee members introduced bills to create deposit insurance funds before the idea was taken up by Fowler. Although this is a relatively minor factual error, it makes knowledgeable readers question the thoroughness of the scholarship.

The second example has far more serious implications. Although Worsham mentions in passing that the United States has a dual banking system and briefly describes savings and loans and credit unions, he fails to consider the policy implications of a system where financial regulation is split among different levels of government and according to the type of financial institution. In the period covered by this study, the most significant disputes over banking policy either pitted state banks and national banks against one another (i.e., a function of dual banking) or pitted different types of financial intermediaries against one another, such as conflicts between commercial banks and savings and loans. The author's superficial understanding of the substantive policy area led to his making a serious error in his choice of how to code the data used in the book's quantitative sections. A key component of all subsystem scholarship is the ability to differentiate between interests that are part of a dominant coalition and those that are outside that coalition. Worsham classifies all commercial banks and other financial institutions as part of a single banking-policy block. He then compares the proportion of banking committee members with "a background in or connection to the financial industry" to their numbers in the chamber as a whole (50), but this approach fails to distinguish between different factions within the financial industry. Witnesses at committee hearings are similarly broken down into those representing the banking sector and those representing other interests, but again individuals from banks and other financial institutions are treated as part of a single block. He then uses changes in the proportions of committee members and hearing witnesses from the banking sectors to identify three different types of subsystem politics: dominant coalitions, transitory coalitions, and competitive coalitions. However, because the unit of analysis (proportions from the banking sector) does not measure the most important divisions over banking policy, the typology cannot be used to distinguish between periods when a dominant coalition controls the policy process and more conflictual eras. [End Page 326]

Despite the weaknesses in Worsham's book, I would recommend it to those interested in the topic of subsystem politics. The author's general approach has merit; the problems are in execution. I also strongly recommend Khademian's book. It is likely to become the definitive work on the culture and functioning of the bureaucrats within financial regulatory agencies. The author has a remarkable grasp of the internal dynamics of these institutions.

Jean Reith Schroedel is an Associate Professor in the Department of Politics and Policy at the Claremont Graduate University. She is the author of Congress, the President, and Policymaking: A Historical Analysis (M. E. Sharpe, 1994), which examines the roles of Congress and the President in developing banking policy over the past 160 years, and numerous articles on banking policy. Her most recent article is "Senate Voting and Social Construction of Target Populations: A Study of AIDS Policy Making, 1987-1992." Journal of Health Politics, Policy and Law 23.1 (February 1998): 107-32. Schroedel is currently completing a historical study of fetal policymaking entitled Beyond Conception: Is the Fetus a Person? (Ithaca, N.Y., forthcoming 2000).