* B.A., University of Iowa, 1992; J.D., Yale Law School, 1995. Mr. Van Der Weide is a senior attorney in the Legal Division of the Federal Reserve Board, Washington, D.C.
** B.A., Colgate University, 1985; J.D., Columbia University School of Law, 1992. Mr. Kini is a counsel at Wilmer, Cutler & Pickering, Washington, D.C. The authors would like to thank Michael Helfer for his comments. The opinions expressed in this Article are exclusively those of the authors and do not reflect the opinions of Wilmer, Cutler & Pickering or the Federal Reserve Board and its staff.
1 See Pub. L. No. 106–102, 113 Stat. 1338 (1999) (codified in scattered sections of 12 U.S.C. and elsewhere).
2 Gramm-Leach-Bliley Act § 108.
3 See id. The Gramm-Leach-Bliley Act defines subordinated debt to mean unsecured debt that:
(A) has an original weighted average maturity of not less than 5 years; (B) is subordinated as to payment of principal and interest to all other indebtedness of the bank, including deposits; (C) is not supported by any form of credit enhancement, including a guarantee or standby letter of credit; and (D) is not held in whole or in part by any affiliate [of the bank].
See id. § 108(c)(3).
4 For example, only a few months prior to the passage of the Gramm-Leach-Bliley Act, Federal Reserve Board Governor Laurence Meyer gave a speech in which he advocated an examination of using marketplace discipline to complement existing bank supervision and regulation. See Fed. Res. Gov. Laurence H. Meyer, Remarks at Conference on Reforming Bank Capital Standards (June 14, 1999) (available at The Federal Reserve Board, Federal Reserve Board Speech from 06/14/99 (visited Feb. 21, 2000) <http://www.federalreserve.gov/ boarddocs/speeches/1999/19990614.htm>) [hereinafter Meyer, Conf. on Reform].
5 See, e.g., Eric J. Gouvin, Shareholder Enforced Market Discipline: How Much is Too Much?, 16 Ann. Rev. Banking L. 311, 331–32 (1997) (suggesting shareholders as source of market discipline); Jonathan R. Macey & Geoffrey P. Miller, Double Liability of Bank Shareholders: History and Implications, 27 Wake Forest L. Rev. 31, 55–58 (1991) (discussing “double liability” of shareholders as means of encouraging shareholder discipline) [hereinafter Macey & Miller, Double Liability]; Krishna G. Mantripragada, Depositors as a Source of Market Discipline, 9 Yale J. on Reg. 543, 552–54 (1992) (suggesting depositors as a source for monitoring and disciplining bank conduct); David G. Oedel, Private Interbank Discipline, 16 Harv. J. L. & Pub. Pol’y 327, 402–05(1993) (exploring interbank transactions as source of market discipline).
6 See Douglas D. Evanoff, Preferred Sources of Market Discipline, 10 Yale J. on Reg. 347, 358–60 (1993); Gary Gorton & Anthony M. Santomero, Market Discipline and Bank Subordinated Debt, 22 J. Money, Credit & Banking 119, 127 (1990); Larry D. Wall, A Plan for Reducing Future Deposit Insurance Losses: Puttable Subordinated Debt, Fed. Res. Bank of Atlanta Econ. Rev., Aug. 1989, at 2; see also Meyer, Conf. on Reform, supra note 4 (noting that requiring banks to issue subordinated debt is “a particularly attractive means” for providing increased market discipline).
7 See, e.g., Helen A. Garten, What Price Bank Failure?, 50 Ohio St. L.J. 1159, 1161 & n.1 (1989) [hereinafter Garten, What Price Bank Failure?]; Helen A. Garten, Still Banking on the Market: A Comment on the Failure of Market Discipline, 5 Yale J. on Reg. 241, 241–42 (1988) [hereinafter Garten, Still Banking on the Market].
8 See, e.g., Gouvin, supra note 5, at 322–23.
9 This Article refers consistently to “banks” as a short form for all federally insured depository institutions, whether organized as national or state banks or federal or state-chartered savings associations. Indeed, with regard to the requirements of the subordinated debt program proposed in this Article, there is no reason why one class of depository institutions (banks) should be treated differently from another (savings associations). The business of banks and thrifts, although historically different, is today quite similar and the failure of both types of institutions gives rise to largely the same systemic risks and exposes the federal safety net to the same potential liability. See, e.g., Ira L. Tannenbaum, The Unitary Thrift Holding Company and the Thrift Charter after the Gramm-Leach-Bliley Act, Banking Pol’y Rep., Dec. 20, 1999, at 13–15.
10 See, e.g., Nicholas Economides et al., The Political Economy of Branching Restrictions and Deposit Insurance: A Model of Monopolistic Competition Among Small and Large Banks, 39 J. L. & Econ. 667, 668 (1996); Daniel R. Fischel et al., The Regulation of Banks and Bank Holding Companies, 73 Va. L. Rev. 301, 303–04 (1987); Helen A. Garten, Regulatory Growing Pains: Perspective on Bank Regulation in a Deregulatory Age, 57 Fordham L. Rev. 501, 506 (1989) [hereinafter Garten, Regulatory Growing Pains].
11 See, e.g., 12 U.S.C. §§ 1817(j) (1994 & Supp. II 1996) & 1842(a) (1994) (providing that no individual, group of individuals or company may acquire control of a bank or bank holding company unless the acquisition has been approved by federal regulators). Federal regulators typically examine such factors as the competence, experience and financial ability of the potential acquirer. See id. In addition, until recently, federal law barred banks from being affiliated with companies principally engaged in the underwriting and dealing of securities. See 12 U.S.C. § 377 (1994). The restrictions on the affiliation of banks and securities underwriters and dealers have been relaxed by the Gramm-Leach-Bliley Act; however, the Act maintains the separation between banks and commercial firms. See Kenneth A. Guenther, The Walls Tumble—Except One, 49 Indep. Banker 20, 31 (Dec. 1, 1999); Dean Anason, Senate Passes Reform Bill; Gramm Calls For a Sequel, Am. Banker, Nov. 5, 1999, at 1.
12 See 12 U.S.C. § 24 (7) (Supp. II 1996) (national banks may engage only in the “business of banking” and may engage only in limited underwriting and dealing of securities); 12 U.S.C. § 1843 (1994 & Supp. II 1996) (bank holding companies may not engage in commercial activities).
13 Banks and bank holding companies must comply with two basic types of capital requirements: risk-based capital ratios and leverage ratios. For a description of these requirements, see, e.g., Michael G. Capatides, A Guide to the Capital Markets Activities of Banks and Bank Holding Companies 318–27 (1993).
14 Financial intermediaries, as a whole, have been regulated differently than industrial companies. Traditionally, the regulation of industrial corporations has been directed principally at ensuring full disclosure of relevant information to investors, while the regulation of financial intermediaries also has sought to limit the risks of investing in those companies. See Robert Charles Clark, The Soundness of Financial Intermediaries, 86 Yale L.J. 1, 3 (1976). More recently, that regulatory strategy has begun to change and, at least to some degree, financial institutions have generally begun to be treated more like their non-financial counterparts. See Garten, Regulatory Growing Pains, supra note 10, at 504–06; see also Gramm-Leach-Bliley Act §§ 101–161, 113 Stat. 1338, 1341–84 (1999) (permitting affiliations between and among banks, insurers, securities firms, mutual funds and other financial intermediaries).
15 There are other explanations for why banking institutions historically have been subject to a unique regulatory treatment. For example, Professor Oedel notes that concentration of banking power has been a concern since the days of the framers. David G. Oedel, Puzzling Banking Law: Its Effects and Purposes, 67 U. Colo. L. Rev. 477, 542–46 (1996) [hereinafter Oedel, Puzzling Banking Law]. Although these explanations for banking regulation offer an important historic or political perspective, they do not adequately explain why, in today’s financial services industry, banks should be treated differently from other financial service purveyors.
16 See Jonathan R. Macey & Geoffrey P. Miller, Bank Failure: The Politicization of a Social Problem, 45 Stan. L. Rev. 289, 290 (1992) (book review); Jonathan R. Macey & Geoffrey P. Miller, Bank Failures, Risk Monitoring, and the Market for Bank Control, 88 Colum. L. Rev. 1153, 1155 (1988) [hereinafter Macey & Miller, Bank Failures].
17 See Helen A. Garten, Whatever Happened to Market Discipline of Banks?, 1991 Ann. Surv. Am. L. 749, 758 (1991) (noting that bank equity levels, which approached 15% of bank assets in 1933, fell to approximately 4% of assets by the 1970s) [hereinafter Garten, Whatever Happened]; Jonathan R. Macey & Geoffrey P. Miller, Deposit Insurance, the Implicit Regulatory Contract, and the Mismatch in the Term Structure of Banks’ Assets and Liabilities, 12 Yale J. on Reg. 1, 3 (1995).
18 By contrast, the debt of most firms comes due at some scheduled time in the future. See, e.g., Jerrie L. Chiu, Note, Introducing Market Discipline into the Federal Deposit Insurance System: O’Melveny & Myers v. FDIC., 1 Conn. Ins. L.J. 197, 204–05 (1995).
19 See, e.g., Macey & Miller, Bank Failures, supra note 16, at 1156; E. Gerald Corrigan, Are Banks Special?, Ann. Rep. Fed. Res. Bank of Minn. (1982) (available via link at Federal Reserve Bank of Minneapolis, Annual Report Essays (visited Feb. 21, 2000) <http://www. woodrow.mpls.frb.fed.us/pubs/ar/>).
20 See Fischel et al., supra note 10, at 306–07. By contrast, mutual funds hold liquid assets and have liquid liabilities; pension funds have illiquid assets and illiquid liabilities. See id. at 306.
21 See, e.g., id. at 307–08; Macey & Miller, Bank Failures, supra note 16, at 1156–57; R. Mark Williamson, Regulatory Theory and Deposit Insurance Reform, 42 Clev. St. L. Rev. 105, 112 (1994).
22 See Garten, What Price Bank Failure?, supra note 7, at 1169. Today, the federal government’s support system for banks and their depositors alleviates the danger of runs. See infra text accompanying notes 33–38.
23 See Garten, What Price Bank Failure?, supra note 7, at 1168–69.
24 According to some theory and evidence, accountholders and other market participants have less reliable information about banks and their assets than they do about other firms. See infra Part VI.A. The lack of reliable and easily understandable information about banks may increase the risk of depositor misinformation and the likelihood that misinformation will spread. See Williamson, supra note 21, at 114–16. Information defects of this sort are considered by many as a classic rationale for government regulation and supervision. See id. The system of subordinated debt proposed in this Article will increase the transparency of banks. See infra Part V.C.
25 See Douglas W. Diamond & Philip H. Dybuig, Bank Runs, Deposit Insurance, and Liquidity, 91 J. Pol. Econ. 401, 402 (1983); Garten, What Price Bank Failure?, supra note 7, at 1169, 1186–87.
26 See, e.g., Chiu, supra note 18, at 205.
27 See Fed. Res. Gov. Laurence H. Meyer, Remarks Before the Spring 1998 Banking and Finance Lecture, Widener Univ. (Apr. 16, 1998) (available at The Federal Reserve Board, Federal Reserve Board Speech from 04/16/98 (visited Feb. 21, 2000) <http://www.federalreserve.gov/boarddocs/speeches/1998/199804162.html>) [hereinafter Meyer, Widener Univ.]. Some commentators regard as highly unlikely the potential for systemic contagion. See, e.g., Fischel et al., supra note 10, at 310–11. Professor Fischel and his colleagues argue, for example, that one bank’s troubles due to dishonest management or problem loans made to a particular borrower or sector of the economy will not affect depositors at other institutions, who have no reason to believe their accounts are less secure than before. See id. In the view of Professor Fischel and his colleagues, bank failures can inform depositors of conditions at other banks only if the other banks have similar risk profiles. See id. From this perspective, the likelihood of individual bank failures leading to system-wide contagion is remote. See id.; see also Oedel, Puzzling Banking Law, supra note 15, at 528–29 (describing contagion risk as remote but acknowledging that it is a “nagging possibility”). Other commentators, however, caution against dismissing too lightly the systemic risk of bank failures, especially in a world of imperfect information. See John H. Kareken, Deposit Insurance Reform; or, Deregulation Is the Cart, Not the Horse, Fed. Res. Bank Minn. Q. Rev., Winter 1990, at 6. That caution would seem warranted because bank failures affect large numbers of small depositors, who will not necessarily be well informed and who may start runs at other banks regardless of the risks faced by such institutions. See supra note 24 and accompanying text.
28 See Milton Friedman & Anna Jacobson Schwartz, A Monetary History of the United States, 1867–1960, 108, 157, 355–57 (1963) (describing the nationwide banking panics of 1893, 1907 and the 1930s).
29 Cf. Michael E. Don & Josephine Wang, Stockbroker Liquidations under the Securities Investor Protection Act and their Impact on Securities Transfers, 12 Cardozo L. Rev. 509, 511–13 (1990) (describing the contagion effect of the brokerage industry’s back-office crisis in the 1960s and how this led to the enactment of the Securities Investor Protection Act).
30 See Diamond & Dybuig, supra note 25, at 401–02. Some commentators argue that, in this regard, the effects of the failure of a bank are no different than the effects of the failure of any other firm. See Fischel et al., supra note 10, at 312. These commentators point out that, in the same manner that the failure of a bank disrupts the activities of its borrowers, the failure of a manufacturing firm disrupts the businesses of its suppliers and customers. See id. Furthermore, if there are close substitutes for the failed bank’s credit—either from other banks or from nonbank financial intermediaries—the bank’s borrowers may not experience a significant disruption in their business activities due to the loss of bank credit. See id.
31 See Oedel, Puzzling Banking Law, supra note 15, at 537–42 (arguing that banks no longer serve such a critical macroeconomic role as to warrant special regulatory and supervisory treatment).
32 See Fed. Res. Gov. Laurence H. Meyer, Remarks at the Financial Inst. Center, Univ. of Tenn. (Sept. 18, 1998) (available at The Federal Reserve Board, Federal Reserve Board Speech from 09/18/1998 (visited Feb. 21, 2000) <http://www.federalreserve.gov/boarddocs/ speeches/1998/19980918.html>) [hereinafter Meyer, Univ. of Tenn.]; Meyer, Widener Univ., supra note 27.
33 See, e.g., Macey & Miller, Bank Failures, supra note 16, at 1157–58. For a description of the Federal Reserve’s discount window operations and the payment system, see Federal Reserve System: Purposes & Functions 45–52, 94–107 (8th ed. 1994) [hereinafter Purposes & Functions].
34 Professors Friedman and Schwartz credit federal deposit insurance with virtually eliminating bank runs and contributing greatly to monetary stability. See Friedman & Schwartz, supra note 28, at 440–42. Recent banking panics have occurred in situations where federal deposit insurance did not exist. See Macey & Miller, Bank Failures, supra note 16, at 1158 n.18. For example, in the 1980s, panics occurred among state-chartered, non-federally insured depository institutions in Ohio and Maryland. See id. While federal deposit insurance can be credited with eliminating bank runs, federal insurance also has had the detrimental effect of eliminating depositor monitoring of bank risk taking. See infra text accompanying notes 44–47.
35 See, e.g., Purposes & Functions, supra note 33, at 48; Macey & Miller, Bank Failures, supra note 16, at 1158.
36 During the bank panic of 1907, cash payments were suspended throughout the country as many banks and clearinghouses refused to clear checks drawn on certain other banks, a practice that led to the failure of otherwise solvent banks. See Purposes & Functions, supra note 33, at 93.
37 See, e.g., Macey & Miller, Bank Failures, supra note 16, at 1162.
38 See, e.g., Meyer, Univ. of Tenn., supra note 32.
39 See, e.g., id. The moral hazard concept is a straight-forward one; if a person bears the risk of a loss, that person will take affirmative steps to limit the risk of that loss—either by being more careful or reducing the level of the particular activity to an efficient degree. On the other hand, when a person is insured against the loss, the person lacks incentive to take steps to mitigate the risk of that loss. This lack of incentive to mitigate risks is the moral hazard. See, e.g., Chiu, supra note 18, at 203; William Safire, Moral Hazard, N.Y. Times Mag., Dec. 20, 1998, at 30.
40 See, e.g., Fischel et al., supra note 10, at 314; Williamson, supra note 21, at 120–21; Meyer, Univ. of Tenn., supra note 32. In fact, some commentators have argued that it was expressly for this purpose that the safety net and deposit insurance were designed: to persuade cautious Depression-era bank managers to make risky business and agricultural loans and, thereby, alleviate the severe credit crunch of the 1930s. See Garten, Whatever Happened, supra note 17, at 758–59.
41 For example, in 1991, Congress passed the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), Pub. L. 102–242, 105 Stat. 2236 (1991) (codified in scattered sections of 12 U.S.C.), which substituted a risk-adjusted federal deposit insurance premium for the then-existing flat-rate premium on deposit insurance coverage. Some commentators have noted that the use of risk-based deposit insurance premiums, if accurately priced, would eliminate the moral hazard of deposit insurance and serve as a substitute for forms of market discipline. See Chiu, supra note 18, at 209.
For risk-based deposit insurance to work, the insurance premium must be accurately priced to reflect the riskiness of a bank’s activities. One commentator has cautioned against viewing risk-based premiums as a panacea because the establishment and maintenance of an insurance pricing scheme that accurately reflects an institution’s risk profile is a “formidable task.” Williamson, supra note 21, at 122–23; accord Fischel et al., supra note 10, at 316 (noting that calculation of risk-based premiums requires additional expenditures on information and personnel).
Evidence suggests that, in any event, risk-based premiums are not being used currently to limit the risk-taking activities of banks. For example, for the first half of 1998, virtually no banks were assessed insurance premiums. Similarly, in the second half of 1998, only 577 of over 10,000 (fewer than 6%) FDIC-insured depository institutions paid a risk-based premium. See Scott Barancik, FDIC Premiums to Remain at Zero for Nearly Everyone, Am. Banker, Oct. 28, 1998, at 3.
42 Debtholders typically do not have representation on a corporation’s board of directors. See Oliver Williamson, Corporate Governance, 93 Yale L.J. 1197, 1211–12 (1984). They monitor firm activities through contractual devices and regular oversight of borrower affairs. See id. (describing the manner in which lenders protect their interests); see also infra Part III.C.
43 See Helen A. Garten, Market Discipline Revisited, 14 Ann. Rev. of Banking L. 187, 197 (1995) [hereinafter Garten, Market Discipline Revisited].
44 See, e.g., George G. Triantis & Ronald J. Daniels, The Role of Debt in Interactive Corporate Governance, 83 Cal. L. Rev. 1073, 1085–86 (1995) (describing how creditor exit can create a sense of urgency to motivate bank management and shareholders to take corrective action).
45 See, e.g., Chiu, supra note 18, at 211–12; Macey & Miller, Bank Failures, supra note 16, at 1167. Professor Garten posits that in the past two decades insured deposits have decreased as a percentage of bank assets, and banks have turned to alternative funding sources, including repurchase agreements and Eurodollar and foreign deposits. See Garten, Whatever Happened, supra note 17, at 759–60. The statistics bear out Professor Garten’s theory. See infra note 78. According to Professor Garten, these alternative funding sources are risk sensitive, and the reliance of banks (especially large banks) on such funding sources removes some of their traditional insulation from normal corporate and market disciplinary forces. See Garten, Whatever Happened, supra note 17, at 758. Professor Garten acknowledges, however, that the sensitivity of these uninsured creditors to risk is unclear. See id. at 760. We believe that these interbank and intercorporate creditors are not risk-sensitive, at least not to the degree necessary to monitor bank behavior. See infra Part III.C.
46 Depositors may use a variety of methods to obtain more than $100,000 of insurance coverage at a particular institution. For example, a husband and wife may secure up to $300,000 of insurance for deposits held at one bank by maintaining one account in the husband’s name, one account in the wife’s name and one joint account in both names. See FDIC, Your Insured Deposit (visited Feb. 22, 2000) <http://www.fdic.gov/deposit/deposits/insured/index.html>.
47 Chiu, supra note 18, at 211; see also Macey & Miller, Bank Failures, supra note 16, at 1179 (noting how the FDIC’s practices exacerbate the disincentives for depositors to monitor banks). In the 1980s, the FDIC developed a preference for resolving bank failures in a manner that ensured payment to both insured and uninsured depositors. See, e.g., David A. Skeel, Jr., The Law and Finance of Bank and Insurance Insolvency Regulation, 76 Tex. L. Rev. 723, 769 (1998). Congress attempted to curb this practice with the passage of FDICIA. See id. at 739–40, 770–71; infra Part VI.B.
48 If deposit insurance were priced to reflect the riskiness of a bank’s activities, shareholders and managers would likely be more concerned about the institution’s risks. Riskier banks would be assessed higher premiums and, consequently, would have less money for stockholder dividends and management bonuses. See Chiu, supra note 18, at 212–23. As noted above, however, over 94% of banks are not assessed any insurance premium. See discussion in supra note 41.
49 For example, the federal banking agencies have broad powers to require “prompt corrective action” when a depository institution is undercapitalized. In addition, bank regulators may commence “cease and desist” proceedings against banks, their parent holding companies or certain of their affiliates if regulators determine that these institutions are engaging in unsafe or unsound practices. For a description of some of the enforcement tools available to bank regulators, see Pauline B. Heller & Melanie Fein, Federal Bank Holding Company Law §§ 5.09–.13 (rev. ed. 1999).
50 Many commentators have argued that depositors would be poor disciplinarians. See Garten, Still Banking on the Market, supra note 7, at 242–44. This Article discusses the relative merits of depositor discipline versus other forms of market-based discipline in Part III, infra.
51 See Macey & Miller, Bank Failures, supra note 16, at 1167–68.
52 The U.S. bank regulatory structure is extraordinarily complex, with shared and overlapping jurisdictions for various federal and state authorities. This system creates the potential that a single bank holding company with multiple bank subsidiaries may need to deal with three federal bank regulatory agencies (the Federal Reserve, the Office of the Comptroller of the Currency (“OCC”) and the FDIC) and an equal number of state regulators. For an example of how this system functions, see U.S. General Accounting Office, Report to the Chairman, Comm. on Banking, Housing and Urban affairs, U.S. Senate, Interstate Banking: Benefits and Risks of Removing Regulatory Restrictions 187–94 (1993). These overlaps can lead to comical results: Former Treasury Secretary Lloyd Bentsen was fond of telling an apocryphal tale that members of Congress often repeated about twenty-six examiners converging at a single bank location at one time so that their cars filled the parking lot and left no place for the bank’s customers. See Hearings on Interstate Banking and Branching before Subcomm. on Fin. Inst. Supervision, Regulation and Deposit Ins. of the House Comm. on Banking, Fiduciary and Urban Affairs, 103d Cong. 15 (1993) (statement of Rep. Sam Johnson). For a discussion of how this intricate “Balkanized” system came to be, see sources cited in infra note 162; see also Meyer, Widener Univ., supra note 27.
53 Insufficient government monitoring may be the result of inadequate or misallocated resources. See Macey & Miller, Bank Failures, supra note 16, at 1169 (citing a former Chairman of the FDIC regarding the shortage of bank examiners and the serious threat to the safety and soundness of the banking system posed by this shortage).
54 See Fischel et al., supra note 10, at 315.
55 Cf. Oedel, supra note 15, at 490–92 (noting the limitations of political capture theory).
56 The recent failure of the First National Bank of Keystone, West Virginia highlights this problem. In this failure, which may cost the federal deposit insurance fund over $750 million, the OCC, the bank’s chartering authority, reportedly prevented the FDIC, the bank’s insurance examiner, from gaining access to the bank. See Marcy Gordon, Bank Failure Prompts Bid for Greater FDIC Power, Chicago Tribune, Nov. 17, 1999, at B3.
57 See Macey & Miller, Bank Failures, supra note 16, at 1170–71.
58 See Garten, Regulatory Growing Pains, supra note 10, at 512–13; see also J. Virgil Mattingly & Kieran J. Fallon, Understanding the Issues Raised by Financial Modernization, 2 N.C. Banking Inst. 25, 37 (1998) (noting “general consensus” regarding the need to permit banking firms to engage in securities and insurance activities). Although this was the predominant view, there were a few dissenters. See Don More, Note, The Virtues of Glass-Steagall: An Argument Against Legislative Repeal, 1991 Colum. Bus. L. Rev. 433, 439 (taking a different approach from the “almost unanimous[] call . . . to replace Glass-Steagall”).
59 For example, in the recent failure of the First National Bank of Keystone, there is evidence that bank examiners did not understand the complex activities of the bank. See Gordon, supra note 56.
60 See, e.g., Mantripragada, supra note 5, at 550 (noting that the “bank examination system has not kept pace with banking practices”); Meyer, Widener Univ., supra note 27 (“Technological change, financial innovation, the acquisition of new powers by banking organizations, the increasing geographic scope of banks, and the globalization of financial markets all challenge our ability to examine and assess the safety and soundness of individual banking firms.”).
61 To cite one example, UBS AG, a Swiss bank, engages in the United States in leasing activities, trust company functions, providing financial and investment advisory services, securities brokerage and futures commission merchant services, securities underwriting and dealing, buying and trading bullion and related instruments, engaging in community development activities and acting as general partner for various investment limited partnerships. See UBS AG, Order Approving Acquisition of Nonbanking Companies and Establishment of U.S. Branches, 84 Fed. Res. Bull. 684 (1998).
62 To the extent that the government is less effective than private-sector parties in monitoring bank activities, banks are able to externalize some of the costs of their risky activities. See Fischel et al., supra note 10, at 315. Using market forces to complement the government regulatory and supervisory system will force banks to internalize the costs of their risky activities.
63 The secondary market is the market in which existing securities are traded. The primary market is the market in which new securities are offered by a firm to investors for the first time.
64 Prospective providers of capital in the primary securities market are particularly adept reviewers of a company’s behavior. When a company issues a new class of securities, new potential investors or investment banking concerns representing the new investors will scrutinize carefully the affairs of the issuer. As a consequence, a bank that must periodically enter the capital markets to obtain financing can be expected to behave prudently to obtain the approval of potential future investors. See Frank H. Easterbrook, Two Agency-Cost Explanations of Dividends, 74 Am. Econ. Rev. 650, 653–55 (1984). Market participants corroborate this view. See BOARD OF GOV. OF FED. RES. SYST., STAFF STUDY NO. 172, USING SUBORDINATED DEBT AS AN INSTRUMENT OF MARKET DISCIPLINE 16 (1999) [hereinafter, USING SUBORDINATED DEBT].
65 See Gramm-Leach-Bliley Act, Pub. L. No. 106–102, §§ 101–161, 113 Stat. 1338, 1341–84 (1999) (permitting banking firms to engage freely in activities that are “financial” in nature and to engage, upon a determination from regulators, in activities that are “incidental” to and “complementary” to financial activities).
66 See 15 U.S.C. § 79n(a) (1994); DEL. CODE ANN. tit. 8, § 220 (1991 & Supp. 1998); 17 C.F.R. § 240.14a (1999); 12 C.F.R. §§ 11.2, 208.16 & 335.401 (1999).
67 See Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 360 (Del. 1993); Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985); Guth v. Loft, Inc., 5 A.2d 503, 510 (Del. 1939). But see Mark E. Van Der Weide, Against Fiduciary Duties to Corporate Stakeholders, 21 Del. J. Corp. L. 27, 32–33 (1996) (discussing state laws that require corporate managers to consider the interests of other firm stakeholders in certain decisional contexts).
68 See supra text accompanying notes 43–44.
69 Professors Macey and Miller point out that, prior to the advent of deposit insurance, a system of “double liability” was imposed on bank shareholders to force them to better monitor bank risks. See Macey & Miller, Double Liability, supra note 5, at 31. Under this system, if a bank failed, the institution’s receiver would assess its shareholders an amount up to the par value of their stock so that shareholders would not only lose their initial investment in the stock but also lose a further sum out-of-pocket. See id.
The use of double liability to spur shareholder monitoring of bank risk would be unworkable in today’s world, which Macey and Miller implicitly recognize. To begin with, double liability schemes would face numerous administrative problems: who is liable, how is the assessment to be enforced, what if the shareholder is outside the jurisdiction. Perhaps more importantly, imposing double liability on bank stockholders would increase the cost of capital to U.S. banks, placing them at a significant competitive disadvantage to their foreign counterparts and their non-bank competitors.
70 See Richard A. Brealey & Stewart C. Myers, Principles of Corporate Finance 59–62 (5th ed. 1996); see also John R. Hall et al., Do Equity Markets and Regulators View Bank Holding Company Risk Similarly? A Comparison of Market-Based Risk Measures and Regulators’ BOPEC Scores (Dec. 1997) (unpublished manuscript, on file with the authors) (finding that equity market participants focus on risk-return trade-off, not on probability of failure of institutions in which they invest).
71 See Chiu, supra note 18, at 210; Triantis & Daniels, supra note 44, at 1111.
72 Most banks, and certainly most large banks, are subsidiaries of holding companies. One commentator has argued that holding company shareholders can serve as market disciplinarians of their subsidiary banks. See Gouvin, supra note 5, at 333–34. Bank holding companies—including new financial holding companies that were created by the Gramm-Leach-Bliley Act—are required by federal regulation to be a source of strength for their subsidiary banks and, as controlling shareholders of their subsidiary banks, can easily control bank behavior. See 12 C.F.R. § 225.4 (1998).
Nonetheless, holding companies are equityholders in their bank subsidiaries and therefore suffer from the same incentive misalignments described above. Holding companies probably suffer even more severe incentive misalignments than other bank shareholders because holding companies typically control other nonbanking companies and may have motivations to benefit their nonbank subsidiaries at the expense of their bank subsidiaries. See, e.g., Bevis Longstreth & Ivan E. Mattei, Organizational Freedom for Banks: The Case in Support, 97 Colum. L. Rev. 1895, 1896 (1997).
73 See Brealey & Myers, supra note 70, at 360–61.
74 See infra Part III.C.
75 See BREALEY & Myers, supra note 70, at 360–61.
76 See USING SUBORDINATED DEBT, supra note 64, at 45.
77 The lack of popularity of preferred stock stems, in large part, from the fact that it is not a tax-efficient capital instrument. A bank is not permitted to deduct preferred stock dividends from its taxable income, while a bank is permitted to deduct interest payments to its depositors or other debtholders. See BREALEY & MYERS, supra note 70, at 360–61; 26 U.S.C. § 163(a) (1994).
78 See Mantripragada, supra note 5, at 553. Deposits are shrinking, however, as a source of funding for U.S. commercial banks. See Louis Whiteman, Agriculture: Deposits Bogging Down, Bankers Push Bill to Widen Home Loan Bank System, Am. Banker, April 12, 1999, at 7 (noting that bank deposits grew only 1.9% from 1987 to year-end 1998); see also FDIC, Statistics on Banking Third Quarter 1999,Table RC-1, Assets and Liabilities of FDIC-Insured Commercial Banks, (visited April 3, 2000) <http://www.fdic.gov/bank/statistical/statistics/ 9909/cbrc01.html>; FDIC, Statistics on Banking Fourth Quarter 1994,Table RC-1, Assets and Liabilities of FDIC-Insured Commercial Banks (visited April 3, 2000) <http://www.fdic. gov/bank/statistical/statistics/9412/cbrc01.html> (indicating that deposits as a percentage of assets for insured commercial banks in the United States shrunk from 72% to 67% between December 31, 1994 and September 30, 1999).
79 See 12 U.S.C. §§ 1813, 1817, 1821 (1994 & Supp. II 1996); see also supra Part I.C. (describing deposit insurance and other features of the federal safety net for banks).
80 See Helen A. Garten, Banking on the Market: Relying on Depositors to Control Bank Risks, 4 YALE J. ON REG. 129, 134–36 (1986) [hereinafter Garten, Banking on the Market]. Macey and Garrett argue that, in the absence of federal deposit insurance, riskiness will be one of the factors that depositors use in determining where to place their deposits. See Jonathan R. Macey & Elizabeth H. Garrett, Market Discipline by Depositors: A Summary of the Theoretical and Empirical Arguments, 5 Yale J. on Reg. 215, 223–24 (1988) [hereinafter Macey & Garrett, Market Discipline]. Nevertheless, the thrust of the argument remains: risk will be a secondary or tertiary concern of these depositors and their decisions will seldom actually turn on the riskiness of the bank’s investments and activities. See id.; see also Yvette D. Kantrow, Surprising Rivals Challenge British Bank Giants: Grocers, Am. Banker, Jan. 14, 1999, at 1 (discussing how grocery stores in England are seizing deposits from banks).
81 See supra Part I. Professor Mantripragada has proposed that deposit insurance coverage limits should be based on the maturity of the deposits rather than the size of deposits. See Mantripragada, supra note 5, at 571–73. Because long-term deposits are generally investments and are generally made by more wealthy and financially sophisticated individuals who are better capable of monitoring the relevant depository institutions, his proposal provides disciplining incentives to the depositors most capable of accomplishing the task. Also, because all short-term and transaction deposits would be insured, Mantripragada’s proposal theoretically would not increase the risk of bank runs. While this proposal would be an improvement over the existing deposit insurance scheme, it would not mitigate most of the concerns set forth in the textual paragraph. Most important among these is that even long-term depositors have a short time horizon as compared with the bank’s other stakeholders: stockholders and long-term debtholders.
82 See 12 U.S.C. § 1821(d)(11) (1994).
83 As of September 30, 1999, time deposits of $100,000 or more represented only 12% of U.S. insured commercial bank deposits, and 83% of such time deposits matured within one year. See FDIC, Statistics on Banking Third Quarter 1999, Table RC-5, Deposit Liabilities of FDIC-Insured Commercial Banks, (visited April 3, 2000) <http://www.fdic.gov/bank/statistical/statistics/9909/cbrc05.html>.
Macey and Garrett argue that, for some large depositors, pressuring bankers to reduce the risk profile of the bank or raise deposit rates would be cheaper than withdrawing their funds and finding another bank in which to invest. See Macey & Garrett, Market Discipline, supra note 80, at 230–31. This sort of influence is rarely attempted, however, because in most cases the costs of negotiating and monitoring are high and the costs of withdrawal and reinvesting elsewhere are low. See Garten, Banking on the Market, supra note 80, at 154–55.
84 See Skeel, supra note 47, at 169 (noting the FDIC’s past practice of paying both insured and uninsured depositors); see also Charles W. Calamiris & Robert E. Litan, Federal Regulation in a Global Marketplace (unpublished paper presented at the Brookings Institute, on file with authors) (noting that, as consolidation in the financial services industry increases, more institutions will be deemed “too big to fail” and regulators will be “compelled” to bail out both insured and uninsured depositors should an institution run into financial difficulties).
85 See Garten, Banking on the Market, supra note 80, at 136–37, 153–55. Macey and Garrett argue that bank runs are not the only form of market discipline that depositors can employ. See Macey & Garrett, Market Discipline, supra note 80, at 229. They believe that banks, faced with the prospect of paying risk-adjusted interest rates to uninsured depositors, will hire risk management teams and adopt risk-aversion strategies to reduce the interest rates that they otherwise would be required to pay. See id. Banks may even agree to contractual commitments to uninsured depositors to reduce such rates. See id.
These ex ante benefits of depositor discipline, however, may be illusory. Risk policies and personnel can be changed at any time, and contractual commitments to avoid risk would likely be cost inefficient for a bank to negotiate with each depositor and cost inefficient for each depositor to enforce. This reality is highlighted by the fact that brokered certificates of deposit (“CDs”), which are almost always large and uninsured, are not purchased pursuant to any kind of contract containing commitments by the bank as to activity or investment policies. Professor Garten points out that short-term debt like commercial paper and CDs is not issued with covenants; the short-term nature of the instrument provides the protection, along with an active secondary trading market. See Garten, Still Banking on the Market, supra note 7, at 245–46.
Macey and Garrett also suggest that banks could contractually prevent bank runs by limiting depositors’ right to withdraw their monies on demand. See Macey & Garrett, Market Discipline, supra note 80, at 231. Customers put much of their money in banks, however, for the sole purpose of having transaction accounts with complete liquidity. Moreover, to the extent some depositors would permit time limits on their withdrawals for certain higher-rate savings or money-market accounts, the time limits would be short—days or weeks—thus only slightly delaying the prospects of a bank run.
86 See Oedel, supra note 5, at 402–09.
87 Interest rate swaps and securities repurchase agreements are examples. An interest rate swap is an agreement between two parties to exchange over time interest cash flows, based on a notional principal amount, calculated according to a fixed formula. See Federal Reserve Trading and Capital-Markets Activities Manual § 4325.1 (Feb. 1998). For example, Bank A might agree to pay to Bank B annually 8% of $1 million, while Bank B agrees to pay Bank A annually LIBOR plus 3% of $1 million. A repurchase agreement is an agreement between two parties where one party agrees to sell a security to the other party and agrees to repurchase the security from the other party at a fixed price at a specific date in the future. See id. § 4015.1.
88 See id. § 4325.1.
89 For example, the conservatorship and receivership provisions of the Federal Deposit Insurance Act provide for special treatment for “qualified financial contracts,” which term includes securities, commodities and forwards contracts, and repurchase and swap agreements. See 12 U.S.C. § 1821(e)(8) (1994).
90 Eighty percent of repurchase agreements, for example, are overnight transactions. See Federal Reserve Trading and Capital-Markets Activities Manual § 4015.1 (Feb. 1998).
91 The price of a securities repurchase agreement will, for example, depend more on the nature of the securities subject to the agreement and the relevant collateral arrangements than on the creditworthiness of the bank counterparty. Similarly, the price of a derivatives contract will depend principally on the nature, value and volatility of the underlying instrument.
92 The classic work on debtholder covenants and the economic theory behind them is Smith & Warner, On Financial Contracting: An Analysis of Bond Covenants, 7. J. Fin. Econ. 117 (1979). Other works on debtholder covenants include Brealey & Myers, supra note 70, at 690–93; Anthony C. Gooch & Linda B. Klein, Documentation for Loans, Assignments & Participations (3d ed. 1996); and Morey W. McDaniel, Bondholders and Corporate Governance, 41 Bus. Law. 413 (1986).
93 Like equityholders, holders of a corporation’s public debt generally have the right and ability to sell their debt in the secondary market and, thus, express their views as to the bank’s riskiness.
94 A well-established and reasonably liquid market for corporate subordinated debt securities exists, but few banks have issued debt securities to third parties. See Meyer, Conf. on Reform, supra note 4. As of June 30, 1999, subordinated notes and debentures represented only 1.3% of the total liabilities of U.S. insured depository institutions. See FDIC, Statistics on Banking Second Quarter 1999, Table RC-1, Assets and Liabilities of FDIC-Insured Commercial Banks (visited April 3, 2000) <http://www. fdic.gov/bank/statistical/statistics/9906/ cbrc01.html>.
95 The Federal Reserve Board’s Capital Guidelines permit bank holding companies and state member banks to count debt in tier 2 capital if the debt has an original weighted average maturity of at least five years and is subordinated to general creditors and depositors. See 12 C.F.R. §§ 208 (1999) & 225 app. A, § I.A.2.d (1998). The Capital Guidelines also require bank holding companies and banks to exclude from tier 2 capital 20% of the principal amount of the debt in each of the security’s last five years. See id. § 255 app. A, § I.A.2.e. The requirements of the Capital Guidelines are set forth in infra note 109.
96 As noted above, one of the superior characteristics of debtholder monitoring versus depositor monitoring is that debtholders generally cannot make a run on the bank. See supra text accompanying notes 93–94.
97 The government, naturally, has an interest in preventing bank insolvency at all times. A holder of a very long-term debt instrument (say, a 100–year bond) has a similar interest because that creditor will only receive its principal investment back from the bank if the institution remains solvent for the next 100 years. In addition, the price of the bank’s 100–year debt security will reflect the market’s assessment of the bank’s risk of insolvency prior to maturity of the bond (that is, for the full 100 years). The price of a long-term bond will reflect its issuer’s insolvency risk over a longer term than would a short-term bond’s price.
98 See supra note 64 and accompanying text.
99 Imposing a regulatory maximum maturity would not be beneficial. A bank theoretically could issue thirty-year debt securities, and thereby reduce its short-term exposure to the discipline of the capital markets by reducing the amount of debt it would have to roll over in the short-term. A bank issuing thirty-year debt would have to roll over one-fifteenth of its subordinated debt every two years, whereas a bank issuing ten–year debt would have to roll over one-fifth of its subordinated debt every two years. Moreover, by issuing fifteen tranches of thirty-year debt, rather than five tranches of ten-year debt, a bank would be permitted to count much more of its subordinated debt as tier 2 capital. See 12 C.F.R. §§ 208 (1999) & 225 app. A, §§ I.A.2.d & I.A.2.e (1998).
Despite these incentives, there are reasons to think that banks would not issue such very long-term debt. Banks would find longer-term debt securities to be a more expensive form of financing. Investors require, ceteris paribus, a higher return to lock up their money for a longer period. Investors also require, ceteris paribus, a higher return on small, less liquid tranches of debt (which would be engendered by the longer-term debt approach). Even if some banks were to issue thirty-year debt, it is not clear that the longer-term loss absorption capacity of the debt and the longer-term incentive horizons of the holders of the debt would not outweigh the costs of less frequent tappings of the capital markets.
100 A portion of this debt would count as tier 2 capital under the Capital Guidelines. Assuming a bank issues six-year debt and rolls over one-third of its outstanding debt every two years, immediately prior to rolling over a tranche, the bank would be permitted to count one-third of its outstanding subordinated debt as tier 2 capital; immediately after rolling over a tranche, the bank would be permitted to count two-thirds of its outstanding subordinated debt as tier 2 capital. See 12 C.F.R. § 208 app. A, § II.A.2.e (1999). Assuming a bank issues ten-year debt and rolls over 10% every year, the corresponding percentages would be 70% immediately before rolling over a tranche and 80% immediately after rolling over a tranche. See id.
101 See USING SUBORDINATED DEBT, supra note 64, at 34–35.
102 See id. at 46.
103 See Wall, supra note 6, at 9–11.
104 See id. at 4–6.
105 While investment professionals are less subject to irrational bandwagon behavior than individual investors, no institutional investor wants to be one of the only debtholders who failed to jump ship when all the other debtholders in a bank did jump. Moreover, the prisoner’s dilemma faced by the creditors of a bank approaching insolvency suggests that even fully informed and rational creditors should exit at the first sign of trouble, even if the sign of trouble is chimerical. See supra text accompanying notes 21–25. A run on a large bank’s puttable debt could have serious systemic repercussions. See Garten, Banking on the Market, supra note 80, at 162–63; see also supra Part I.B. (describing the systemic risks of bank failures).
106 See Wall, supra note 6, at 3. The puttable debt would have to be floating-rate because investors would put puttable fixed-rate debt back to the issuers as soon as general interest rates increased. See id.; see also Brealey & Myers, supra note 70, at 360 (describing the mechanics of floating rates).
107 Wall suggests that the bank could avoid this eventuality by originally issuing their bonds at prices above par. See Wall, supra note 6, at 12. To the extent that banks are permitted to issue their bonds at prices above par, banks themselves obtain control over how much discipline the put mechanism will have.
108 Bank holding companies that have greater than $10 billion in assets and issue subordinated debt currently have subordinated debt outstanding equal to 2.9% of their risk-weighted assests. See USING SUBORDINATED DEBT, supra note 64, at 27.
109 The Capital Guidelines require banks to hold tier 1 capital in an amount at least equal to 4% of risk-adjusted assets and total capital (tier 1 plus tier 2 capital) in an amount at least equal to 8% of risk-adjusted assets. See 12 C.F.R. §§ 208 app. A, § IV.A (2000) & 225 app. A, § IV.A (1998).
110 Evanoff advocated amending the Capital Guidelines to replace the 8% total capital requirement with a 4% equity and 4% subordinated debt requirement. See Evanoff, supra note 6, at 355–56. We see no reason to alter the Capital Guidelines to effect our proposal. Moreover, adjusting the Capital Guidelines in such a fashion would be inconsistent with the requirements of the Basle Capital Accord, which is an internationally agreed upon framework for measuring the capital adequacy of banks. A U.S. departure from the Basle standards would have adverse international repercussions.
111 As discussed above, immediately prior to rolling over a tranche of ten-year subordinated debt securities, a bank would only be permitted to count 70% of its subordinated debt as tier 2 capital. See § 208 app. A, § II.A.2.e (1999). Consequently, a Subject Bank would need to maintain additional permanent capital in an amount equal to 0.6% of its risk-weighted assets if such bank intended to maintain its reported capital ratios. See id.
112 Argentina, the only country that requires its banks to issue subordinated debt, requires banks to issue subordinated debt in an amount equal to 2% of their deposits. See USING SUBORDINATED DEBT, supra note 64, at 68. Although use of insured deposit denominators rather than risk-based asset denominators may advance more precisely the goal of minimizing losses to the insurance funds, the systemic risks posed by a banking organization are more likely proportional to its risk-based assets than its deposit liabilities.
113 As of year-end 1984, bank holding companies issued more than ten times the amount of debt issued by banks. See Robert B. Avery et al., Market Discipline in Regulating Bank Risk: New Evidence from the Capital Markets, 20 J. Money, Credit, & Banking 597, 599 (1988). In contrast to our proposal, which focuses exclusively on bank-issued subordinated debt, the subordinated debt study required by the Gramm-Leach-Bliley Act mandates that the Federal Reserve and Treasury Department investigate the appropriateness of requiring both large banks and their holding companies to issue subordinated debt. See Gramm-Leach-Bliley Act, Pub. L. No. 106–102, § 108(a)(1), 113 Stat. 1338, 1361 (1999).
114 Most banks, and certainly all of the largest banks, are subsidiaries of holding companies. These holding companies may engage in a broad range of financial activities in which their subsidiary banks may not directly engage. See 12 U.S.C. § 1843 (Supp. II 1996). The Gramm-Leach-Bliley Act has expanded the types of activities that holding companies with “well-managed” and “well-capitalized” bank subsidiaries may engage. Such activities include insurance and securities underwriting and other activities deemed “financial in nature.” See Gramm-Leach-Bliley Act §§ 101–161.
115 Inter-corporate transactions are a principal concern of bank regulators. Congress and federal regulators have long feared that, especially in times of severe financial stress, bank holding companies will be tempted to divert resources from banks to their nonbanking affiliates. See, e.g., Garten, Market Discipline Revisited, supra note 43, at 204–05; Satish M. Kini, New Fed. Letter Eases Limits on Use of Affiliate Securities as Loans, Banking Pol’y Rep., May 17, 1999, at 12. Sections 23A and 23B of the Federal Reserve Act seek to safeguard against such conduct by imposing restrictions on transactions involving banks and their affiliates. See 12 U.S.C. §§ 371c & 371c–1 (1994).
116 Indeed, federal regulators’ principal interest in the parent holding companies of banks stems from how the activities of the parents may endanger their subsidiary banks. Cf. HELLER & FEIN, supra note 49, § 17.01 (noting that, historically, regulation of bank holding companies was aimed at reducing concentration in the banking industry).
117 For example, one of the first true financial holding companies under the Gramm-Leach-Bliley Act is Citigroup. Citigroup engages in securities activities through Salomon Smith Barney and a broad array of insurance activities through the former Travelers Group of insurance companies. The bank assets of the firm represent approximately one-third of the total assets of Citigroup. See USING SUBORDINATED DEBT, supra note 64, at 31.
118 See Mattingly & Fallon, supra note 58, at 41.
119 See Julapa Jagtiani, George Kaufman & Catharine Lemieux, Do Markets Discipline Banks and Bank Holding Companies? Evidence from Debt Pricing, EMERGING Issues Series, Fed. Res. Bank of Chicago, June 1999, at 15. Because some empirical evidence also has shown that the debt capital markets are equally able to perceive the riskiness of banks and bank holding companies, the price differential most likely arises from the federal subsidy discussed supra Part I.C. See id.
120 In determining whether one company has control over another for purposes of the Bank Holding Company Act, the Federal Reserve has long considered not only the size of the acquirer’s equity stake but also the amount of subordinated debt held by that stakeholder. See, e.g., Wells Fargo & Co., Order Approving Notice to Engage in Certain Lending Activities, 82 Fed. Res. Bull. 165, 165 n.2 (1996).
121 Federal regulators should be authorized to develop an indexing mechanism to adjust over time the asset thresholds for each tier. See, e.g., Gramm-Leach-Bliley Act, Pub. L. No. 106–102, § 121(a), 113 Stat. 1338, 1373–81 (1999) (requiring the Federal Reserve Board and the Treasury Department to establish jointly an indexing mechanism for adjusting the $50 billion asset limit for financial subsidiaries of national banks).
122 It is worth exploring, however, whether a subordinated debt requirement should be imposed upon the subsidiary banks of a financial holding company that engages in merchant banking, insurance underwriting or real estate investment and development. In the Gramm-Leach-Bliley Act, Congress recently expressed its view as to the riskiness of these activities by forbidding them to national bank operating subsidiaries. See id. This sort of unambiguous activity threshold would be clearly preferable to a threshold based on a regulatory determination of complexity or risk profile.
123 See infra text accompany notes 125-27.
124 Such novel poolings are currently being explored by bank holding companies. See generally John J. Madden, Financing Small Bank Holding Companies: Securitization of Capital Securities, 54 Bus. Law. 93 (1998).
125 As of June 30, 1999, approximately 9800 banks fell within our Tier III category. These banks had total consolidated assets of approximately $1.3 trillion, which represents about 19% of the U.S. banking system’s total assets. See FDIC, Statistics on Banking Second Quarter, 1999, Table 104, Number and Total Assets of FDIC-Insured Depository Institutions (visited April 4, 2000) <http://www.fdic.gov/bank/statistical/statistics/9906/allstru.html>) [hereinafter FDIC Statistics].
126 For example, a bank with $1 billion in total consolidated assets—the largest Tier III bank—would be required to issue only approximately $20 million in subordinated debt.
127 In advancing a proposal for puttable subordinated debt, economist Larry Wall also exempted small banks for many of the same reasons outlined above. See Wall, supra note 6, at 4. Mr. Wall, however, noted that the expense to debtholders of monitoring small banks could be reduced through the use of professional monitors. For example, he suggested that private insurers could issue insurance contracts covering the debt and serve as delegated monitors for investors. See id. at 5. It seems that such professional monitors would face the same problem, however, in that they would receive a small fee for protecting the interests of small debtholders.
128 Small banks may voluntarily choose to opt-in to the subordinated debt scheme if, as we propose below, they are subject to reduced government supervision and regulation and have lower examination expenses upon issuing the required amount of debt or if their corporate parents are permitted to engage in expanded activities once the bank has issued the necessary debt. See infra Parts V.A. and V.E.
129 As of June 30, 1999, approximately 440 banks, with total consolidated assets of approximately $1.2 trillion, fell within our Tier II category. The assets of these banks represent about 18% of total U.S. banking assets. See FDIC Statistics, supra note 125.
130 For a complete description of the requirements of a valid private placement under the Securities Act of 1933, see, e.g., Larry D. Soderquist, Understanding the Securities Laws § 6.2. (3d ed. 1996).
131 Companies generally find it difficult to raise less than a few hundred million dollars in a public debt issuance. See, e.g., Laura Mandaro, Credit Suisse, B of A Eye Placing Tech Debt Privately, Am. Banker, Nov. 10, 1999, at 5.
132 As of June 30, 1999, ninety-four banks, with total consolidated assets of approximately $4.1 trillion, fell within our Tier I category. The assets held by Tier I banks represent approximately 63% of all the assets held by banks in the United States. See FDIC Statistics, supra note 125.
133 This aspect of the proposal mirrors, to some extent, the subordinated debt proposal advanced by Douglas Evanoff. See Evanoff, supra note 6, at 357.
The Gramm-Leach-Bliley Act allows national banks to engage in various non-banking financial activities through subsidiaries. Under the Act, national banks may control such subsidiaries only if they meet certain conditions. Among the conditions is a requirement that if the national bank is one of the fifty largest banks in the United States, it must issue long-term, unsecured debt rated in the top three investment grades; if the national bank is between the 51st and 100th largest banks in the United States, it must either have debt in the top three investment grades or meet other criteria imposed by the Federal Reserve and Treasury Department. See Gramm-Leach-Bliley Act, Pub. L. No. 106–102, § 121, 113 Stat. 1338, 1341–84 (1999).
134 The top fifty U.S. insured commercial banks already finance over 2% of their risk-weighted assets with subordinated debt. See USING SUBORDINATED DEBT, supra note 64, at 27. Most of this subordinated debt is held by the banks’ holding companies. See id. at 30.
135 For another federal financial institution transition rule, see generally 17 C.F.R. § 275.203A–1 (1999)(establishing transition rules for investment advisers who cross the $25 million asset threshold and thus become subject to SEC registration requirements).
136 United States regulators have long recognized these differences and have not required foreign banks active in the United States to comply with all of the capital requirements that apply to domestic banking institutions. For example, nearly a decade ago, the Federal Reserve and the Treasury Department expressly rejected applying to foreign banks active in the United States a “leverage ratio” (a ratio of tier 1 capital to total assets), such as the one that applies to U.S. banks and bank holding companies. See BOARD OF GOVERNORS OF FED. RES. SYST. AND SECRETARY OF DEPT. OF TREAS., CAPITAL EQUIVALENCY REPORT 41 (June 19, 1992) (noting that different standards are necessary to “accommodate[] the significant differences in asset structures of banks from different countries and take[] into account off-balance sheet activities”).
More recently, the Federal Reserve has departed from this precedent and has proposed a leverage requirement for foreign banks that have U.S. branches or agencies that wish to engage in expanded financial activities in the United States under the Gramm-Leach-Bliley Act. Nevertheless, that leverage requirement would still be more lenient than the requirement that applies to U.S. banking firms. See Bank Holding Companies and Change in Bank Control, 65 Fed. Reg. 3785, 3785 (2000)(to be codified at 12 C.F.R. § 225). European Commission officials have raised the possibility of taking action against the United States in the World Trade Organization to protest the Federal Reserve’s imposition of U.S. capital standards abroad. See Rob Garver, Foreign Banks Say U.S. Reforms Leave Them at a Disadvantage, Am. Banker, Mar. 16, 2000, at 1.
137 As of June 1999, only twenty-two U.S. branches of foreign banks held FDIC-insured deposits, totaling approximately $3 billion. That sum represents less than 1% of the $3.7 trillion of total federally insured deposits. See FDIC, Deposits of all FDIC-Insured Institutions (visited April 3, 2000)<http://www2.fdic.gov/sod/newtable1frame_main.cfm> (using June 30, 1999 in date field). In addition, foreign bank branches in the United States are limited in their ability to accept retail deposits. See 12 U.S.C. § 3104 (1994).
138 See supra text accompanying notes 37–38 on why we regulate banks. Of course, foreign bank failures could pose systemic risks to the United States, but these systemic risks are nearly identical to the risks posed by non-bank financial intermediaries, which also are not subject to a subordinated debt requirement.
139 To this end, one of the “three pillars” of the new capital framework proposed by the Basle Committee on Banking Supervision is market discipline. See Basle Committee on Banking Supervision, A New Capital Adequacy Framework: Pillar 3 Market Discipline (visited April 3, 2000) <http://www.bis.org/publ/bcbs65.htm> (consultative paper). The other two pillars are minimum capital requirements and supervisory review processes. See id.
140 Larry Wall recognized similar concerns and proposed, as well, that bank insiders be permitted to purchase only limited quantities of the bank’s subordinated debt. See Wall, supra note 6, at 8.
By insiders we mean to include any shareholder of the bank or affiliate that owns or controls more than 5% of any class of voting securities of the bank or affiliate. Such a 5% threshold corresponds with the threshold contained in the reporting requirement of sections 13(d) and 13(g) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78m(d) & 78m(g), and therefore should be relatively easy for publicly owned bank holding companies and regulators to monitor.
141 Regulations would be required to determine what constitutes a business relationship of sufficient significance to require the exclusion of the debtholder.
142 The FDIC is the primary federal supervisor of state banks that are not members of the Federal Reserve System and, because of its role in running the federal deposit insurance program, it is the backup supervisor over all federally insured depository institutions. See, e.g., Christian A. Johnson, Wild Card Statutes, Parity, and National Banks—The Renascence of State Banking Powers, 26 Loyola Univ. Chicago L. Rev. 351, 360 (1995).
143By contrast, the OCC is charged with supervising national banks, and it often sees its mission as promoting the national bank charter over state bank charters. See, e.g., Johnson, supra note 142, at 363–65; see also Rob Garver, Visit from Hawke Kept ‘National’ in Bank’s Name, Am. Banker, Feb. 11, 2000, at 1 (detailing the efforts of the Comptroller of the Currency to keep a national bank from switching to a state charter). The Federal Reserve is principally responsible for supervising at the holding company level and its role often puts its interests at odds with those of the OCC. See infra note 164 and accompanying text.
144 See infra Part V.A. regarding how this system should actually reduce regulatory burden.
145 The FDIC possesses similar authority to take actions against banks and their managers when they are engaged in unsafe and unsound banking practices that place the federal deposit insurance funds at risk. See, e.g., 12 U.S.C. § 1818(b) (1994).
146 The value of a leveraged firm is generally equal to the sum of three elements: (i) the value of the firm if financed completely with equity; (ii) the present value of the tax benefit of the firm’s debt; and (iii) the present value of the costs of financial distress posed by the firm’s debt. See Brealey & Myers, supra note 70, at 485.
147 See Meyer, Conf. on Reform, supra note 4.
148 See USING SUBORDINATED DEBT, supra note 64, at 35.
149 Participants in the existing market for bank and bank holding company subordinated debt have indicated that the lack of standardization across such debt instruments does not make it difficult to compare the credit quality of various issuers within a peer group. See id. at 45.
150 See, e.g., 12 C.F.R. § 208, app. A, § II. (2000).
151 In general, national and state banks must be examined every twelve months. See, e.g., 12 U.S.C. § 1820(d)(1) (1994). For example, in some cases banks may be examined on an eighteen-month cycle. See id. § 1820(d)(4).
152 Each federal bank regulatory agency is authorized to conduct a “thorough examination of the affairs” of a bank. See 12 U.S.C. § 481 (1994). The size and scope of the examination depends on a variety of factors, including the regulatory agency conducting the examination and the size, activities and reputation of the bank to be examined. Examinations focus on the capital adequacy, asset quality, management ability, earnings and liquidity of a bank. See Alfred Dennis Mathewson, From Confidential Supervision to Market Discipline: The Role of Disclosure in the Regulation of Commercial Banks, 11 J. Corp. L. 139, 143 (1986).
153 This is not to imply that regulators would abandon traditional bank examinations. On occasion, but with less frequency than is currently the case, regulators would conduct a full-scope examination of an institution.
154 The cost of regular federal bank examinations is assessed against the examined bank. See 12 U.S.C. § 1820(e)(1) (1994).
155 See 12 U.S.C. § 1817(b)(1)(A) (1994). FDICIA defines a risk-based assessment system as one in which the depository institution’s insurance assessments are calculated on the basis of (i) the probability that the deposit insurance fund will incur a loss with respect to the institution; (ii) the likely amount of the loss if it occurs; and (iii) the revenue needs of the deposit insurance funds. See id. § 1817(b)(1)(C).
156 See 12 C.F.R. §§ 327.4, 327.9 (1999).
157 See 12 U.S.C. § 1831o (1994 & Supp. II 1996).
158 See Fed. Res. Gov. Roger W. Ferguson, Jr., Remarks at the College of Management, Univ. of Mass. (Oct. 27, 1998) (available at The Federal Reserve Board, Federal Reserve Board Speech from 10/27/98 (visited February 22, 2000) <http:// www.federalreserve.gov/ boarddocs/speeches/1998/19981027.html>); infra Part VI.A.
159 See Ferguson, supra note 158. To this end, it is worth noting that the Gramm-Leach-Bliley Act requires Federal Reserve examiners to make increased use of publicly available information. See Gramm-Leach-Bliley Act, Pub. L. No. 106–103, § 111, 113 Stat. 1338, 1362–66 (1999).
160 See CALAMIRIS & LITAN, supra note 84, at 43–44.
161 See Murray A. Indick & Satish M. Kini, The Interstate Banking and Branching Efficiency Act: New Options, New Problems, 112 Banking L.J. 100, 102 (1995). All federally insured banks also are subject to supervision by the FDIC. In addition, state banks that are members of the Federal Reserve System are subject to Federal Reserve examination and supervision. For a discussion of the complex system of overlapping jurisdictions of federal and state bank regulatory authorities, see supra note 52 and sources cited therein.
162 This complex scheme of shared regulatory authority has historical roots that date back to the Civil War. See Charlotte L. Tart, Comment, Expansion of the Banking Industry Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994: Is the Banking Industry Headed in the Right Direction?, 30 Wake Forest L. Rev. 915, 919–23 (1995); Fed. Res. Chairman Alan Greenspan, Remarks before the Annual Meeting and Conf. of State Bank Supervisors (May 2, 1998) (available at The Federal Reserve Board, Federal Reserve Board Speech from 05/02/98 (visited Feb. 22, 2000) <http://www.federalreserve.gov/boarddocs/ speeches/1998/19980502.html>). The virtues and vices of this system have been the subject of much academic debate. See generally Johnson, supra note 142; Geoffrey P. Miller, The Future of the Dual Banking System, 53 Brook. L. Rev. 1 (1987); Arthur E. Wilmarth, Jr., The Expansion of State Bank Powers, The Federal Response, and the Case for Preserving the Dual Banking System, 58 Fordham L. Rev. 1133 (1990).
163 Banks may switch charters for other reasons as well, including lower examination fees and easier access to regulators. In 1999, twenty state banks switched to federal charters; twenty-two national banks switched to state charters. See Alan Kline, Bank in Memphis Plans to Switch to State Charter, Am. Banker, Dec. 30, 1999, at 2.
164 Regulatory competition and turf fights between the Federal Reserve and the Treasury Department hindered congressional financial modernization efforts. The Federal Reserve sought to have new financial activities conducted exclusively in holding company affiliates, whereas the Treasury Department (on behalf of the OCC) argued that new financial activities should be permitted for banks and bank subsidiaries. See, e.g., Laura J. Cox, Note, The Impact of the Citicorp-Travelers Group Merger on Financial Modernization and the Repeal of Glass-Steagall, 23 Nova L. Rev. 899, 920–21 (1999). The compromise crafted by Congress in the Gramm-Leach-Bliley Act allows most (but not all) financial activities to be conducted at either the holding company or bank subsidiary level. See Gramm-Leach-Bliley Act, §§ 101–161, 113 Stat. 1338, 1341–84 (1999).
165 There are powerful arguments that the benefits of regulatory competition outweigh the risks. For example, vesting all regulatory power with a single regulator could lead to ossification and the stifling of change, which is particularly important in the dynamic financial services industry. See CALAMIRIS & LITAN, supra note 84, at 25.
166 This argument has also been advanced by CALAMIRIS & LITAN, supra note 84, at 25–26.
167 See supra text accompanying notes 53–55 regarding the singleness of purpose of investors, as opposed to government regulators.
168 Although Congress has just passed the Gramm-Leach-Bliley Act, at least some policy makers believe that further liberalization of restrictions in the financial services industry is warranted. See, e.g., Anason, supra note 11, at 1 (noting Senate Banking Committee Chairman Gramm’s appetite for further reform).
169 The history and merits of the separation of banking and commerce have been the subject of much academic writing. See, e.g., Carl Felsenfeld, The Bank Holding Company Act: Has It Lived Its Life?, 38 Villanova L. Rev. 1, 34–86 (1993); Peter J. Ferrara, The Regulatory Separation of Banking from Securities and Commerce in the Modern Financial Marketplace, 33 Ariz. L. Rev. 583, 617–27 (1991); Carter H. Golembe, Separation of Banking and Commerce: A Myth that’s Ripe for Debate, Banking Pol’y Rep., Jan. 20, 1997, at 12–17.
170 See, e.g., Felsenfeld, supra note 169, at 35–52; Mattingly & Fallon, supra note 58, at 32. Undue concentration of resources is another common concern voiced by opponents of mixing banking and commerce. Admittedly, to the extent that this mixture would have adverse macroeconomic or antitrust repercussions, a subordinated debt requirement does not address all of the problems of combining banks with nonfinancial businesses.
171 See generally Donald P. Morgan, Judging the Risk of Banks: What Makes Banks Opaque? (Fed. Res. Bank of N.Y. Research Paper No. 9805, 1998) (available at Federal Reserve Bank of New York, Federal Reserve Bank of New York—Research Papers (visited March 19, 2000) <http://www.ny.frb.org/rmaghome/rsch_pap/9805.html>); Manuel A. Utset, The Discipline of Institutions and the Disciplining of Banks, 14 Ann. Rev. of Banking L. 211, 215–17 (1995). Professor Utset contends that bank opacity also stems from structural contingencies—for example, that banks are generally controlled by bank holding companies, which can shift assets and liabilities in and out of their bank subsidiaries in order to subsidize the operations of their nonbank subsidiaries. See Utset, supra at 215–17. Federal banking law, however, places substantial restrictions on these sorts of asset and liability transfers. See 12 U.S.C. § 371c (1994) (limiting the aggregate amount of a bank’s loans to, investments in and asset purchases from affiliates); § 371c–1 (requiring generally that a bank’s transactions with affiliates be on fair market terms).
172 One study found that loan quality problems developed over a period of three to five years before market observers could see them. See Richard E. Randall, Can the Market Evaluate Asset Quality Exposure in Banks?, Fed. Res. Bank. New Eng. Econ. Rev., July/Aug. 1989, at 3.
173 See, e.g., Melanie L. Fein, Securities Activities of Banks § 13.01 (2d ed. 1998); Robert L. Tortoriello, Guide to Bank Underwriting, Dealing and Brokerage Activities X-3 (4th ed. 2000).
174 There is some evidence, however, that smaller banks are more opaque to the market. Morgan found that the probability of a ratings split between Moody’s and S&P decreases up to some level of bank assets. See Morgan, supra note 171, at 15. Morgan also found, however, that the probability of a ratings split begins to increase again at some level of assets. The probability of a ratings split increases as a bank substitutes loans and leases for securities and as a bank moves securities into its trading account. See id. at 16.
175 See generally Richard Cantor & Frank Packer, The Credit Rating Industry, Fed. Res. Bank of N. Y. Q. Rev., Summer/Fall 1994, at 1–26; Morgan, supra note 171. Cantor and Packer found that Moody’s and S&P split over only 37% of the general sample of firms but over 63% of the banks. See Cantor & Packer, supra at 1–26. Morgan found that, controlling for risk and asset size, Moody’s and S&P are about 12% more likely to split over banks than over non-financial firms. See Morgan, supra note 171, at 12.
176 See Avery et al., supra note 113, at 608.
177 See Gorton & Santomero, supra note 6, at 123–27.
178 Market participants generally believe that prices of existing bank subordinated debt reflect risk differentials across organizations. See USING SUBORDINATED DEBT, supra note 64, at 16.
179 See Jagtiani et al., supra note 119, at 21–22.
180 See Mark J. Flannery & Sorin Sorescu, Evidence of Bank Market Discipline in Subordinated Debenture Yields: 1983–1991, 51 J. Fin. 1347, 1373–74 (1996).
181 See Thomas F. Cargill, CAMEL Ratings and the CD Market, 3 J. Fin. Serv. Res. 347, 353–55 (1989). CAMELS stands for Capital adequacy, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risks. See Federal Reserve Commercial Bank Examination Manual § 1020.1 (May 1997).
182 See Herbert Baer & Elijah Brewer, Uninsured Deposits as a Source of Market Discipline: Some New Evidence, Econ. Perspectives, Fed. Res. Bank of Chicago, Sept./Oct. 1986, at 23–29.
183 See, e.g., Brealey & Myers, supra note 70, at 179–83. To avoid paying an “opacity premium,” banks issuing subordinated debt in our proposal will be expected to increase the quality and quantity of their disclosure. See supra Part V.C. The current price for opacity, however, is low. One study estimated that yields on investment grade bonds with split ratings, for example, are only 6 basis points higher than the yields predicted by the average rating of the bond. See Morgan, supra note 171, at 8.
184 See Macey & Garrett, supra note 80, at 233–36 (citing examples).
185 See discussion in supra note 47; see also infra Part VI.B.
186 See 15 U.S.C. §§ 78m(a), 78n(a) & 78n(d) (1994).
187 See 12 U.S.C. § 161 (1994) (national banks); § 324 (1994) (state member banks); § 1817(a) (1994) (state nonmember banks).
188 See 12 U.S.C. § 3906 (1994) (foreign loan concentration); 12 C.F.R. § 304.4 (1999) (insider loans).
189 See, e.g., Basle Committee on Banking Supervision, Enhancing Bank Transparency (visited Feb. 22, 2000) <http://www.bis.org/publ/bcbs41.html>.
190 See Ferguson, supra note 158, at 4.
191 See Basle Comm. on Banking Supervision, supra note 189, at 5; see also Macey & Garrett, Market Discipline, supra note 80, at 226–27 (arguing that banks have a strong incentive voluntarily to disclose relevant financial information to depositors). A recent study by PriceWaterhouseCoopers also concluded that banks could raise their equity prices by disclosing more information. See Barbara A. Rehm, Fuller Disclosure Could Aid Bank Stocks, Study Says, Am. Banker, Dec. 2, 1999, at 2.
There are also inherent limitations, however, on the amount and timeliness of public disclosure that banks can make: the quality of a bank’s risk management system may be difficult to convey; comparing financial information across countries is a difficult task; a bank has an obvious need to preserve the confidentiality of certain business plans and certain information provided to it by its customers; and producing information is costly. See Basle Comm. on Banking Supervision, supra note 189, at 7–8.
192 See Basle Comm. on Banking Supervision, supra note 189, at 7; supra Part V.C. Even Professor Garten, perhaps the most prolific critic of market discipline approaches to bank regulation, admits that banks publicly disclose sufficient information to permit market participants to assess the riskiness of bank assets and activities. See Garten, Banking on the Market, supra note 80, at 131, 144–45. Professor Garten argues that the opacity problem does not relate to an investor’s inability to assess the probability of a bank insolvency, but rather to the uncertain consequences to an investor of a bank insolvency. See id. at 148–50. This aspect of the opacity problem was powerfully addressed by FDICIA. See infra Part VI.B.
193 See James P. McCollom, The Continental Affair: The Rise and Fall of The Continental Illinois Bank (1987); Jonathan R. Macey & Geoffrey Miller, Banking Law and Regulation 629 (2d ed. 1997).
194 12 U.S.C. § 1823(c)(4) (1994). FDICIA preserves the federal bank regulators’ ability to apply the too-big-to-fail doctrine, but only in connection with failures that would impose excessive systemic risks on the banking system. The FDIC may dispense with the “least-cost rule” only if two-thirds of the directors of the FDIC and two-thirds of the governors of the Federal Reserve Board so recommend in writing, and the Secretary of the Treasury agrees with the recommendation. See id. § 1823(c)(4)(G).
195 See 12 U.S.C. § 1823(c)(4)(E)(i) (1994). FDICIA also provides, however, that federal bank regulators may protect uninsured deposits in purchase and assumption transactions that are no more expensive than liquidations. See id. § 1823(c)(4)(E)(iii).
196 See Mantripragada, supra note 5, at 563–65 (arguing that FDICIA has not really removed the too-big-to-fail doctrine). Although the Federal Reserve Bank of New York’s (“FRBNY”) brokering of the bail-out of Long-Term Capital Management did not involve the use of public funds to save private creditors from losses, the FRBNY’s actions indicate that the Federal Reserve remains concerned about the systemic risks resulting from the failure of a large financial institution. See Paul S. Nadler, Long Term Lessons from Long-Term Capital Management, Secured Lender, Jan./Feb. 1999, at 14; Financial Markets: Shadow Regulatory Panel Calls on Fed to Explain Role in Hedge Fund Bail Out, BNA Banking Daily, Sept. 29, 1998, at D2.
197 But see Garten, What Price Bank Failure?, supra note 7, at 1166–67 (arguing that failure policy should not be automatic and inflexible because the failure process is costly and failures may create systemic adverse effects on the FDIC and healthy banks); Richard E. Randall, The Need to Protect Depositors of Large Banks, and the Implications for Bank Powers and Ownership, New England Econ. Rev., Sept./Oct. 1990, at 63, 67–69 (arguing that removal of the federal government’s implied support of uninsured bank creditors may destabilize the payments system and reduce the availability of short-term credit in the economy).
Professor Garten argues that bank failure policy should not be designed exclusively to focus on facilitation of market discipline of healthy banks. See Garten, What Price Bank Failure?, supra note 7, at 1176. Rather, minimizing losses to the bank insurance funds must be the primary goal. Garten’s argument assumes that what the FDIC saves in the short-term by managing each failure to save the bank insurance fund is not outweighed in the long-term by the costs of bank failures caused by the decreased market discipline of investors. This Article demonstrates that market discipline by subordinated debtholders can work and that, therefore, these long-term costs will be high.
198 See generally Gorton & Santomero, supra note 6; Flannery & Sorescu, supra note 180. Although the FRBNY’s actions in the fall of 1998 with respect to Long-Term Capital Management evidence a continuing federal government interest in preventing the failure of large financial firms, it is important to note that the Federal Reserve never offered to bail out LTCM’s creditors with taxpayer money.
199 See William J. Baumol, The Stock Market and Economic Efficiency 69–70 (1965); Gordon Donaldson, Managing Corporate Wealth (1984); Garten, What Price Bank Failure?, supra note 7, at 1177–78.
200 See supra notes 62–63 and accompanying text.
201 As of December 31, 1998, deposits represented 67.6% of the assets of FDIC-insured commercial banks in the United States; as of December 31, 1991, deposits represented 78.4% of such assets. Among Tier I banks, as of December 31, 1998, deposits represented 62.9% of assets; as of December 31, 1991, deposits represented 72.5% of assets. See FDIC, Statistics on Banking Fourth Quarter 1998, Table 105A, Number, Assets and Deposits of FDIC-Insured Commercial Banks (visited April 4, 2000) <http://www.fdic.gov/bank/statistical/ statistics/9812/cbstru.html>; FDIC, Statistics on Banking Fourth Quarter 1991, Table 105A, Number, Assets and Deposits of FDIC-Insured Commercial Banks (visited April 4, 2000) <http:// www.fdic.gov/bank/statistical/statistics/9112/cbstru.html>.
202 But see Van Der Weide, supra note 67, at 69–71 (arguing that despite constraints managers still have room to engage in self-dealing and not decrease risk-taking activities). Because banks are usually wholly owned by a holding company and bank shares are typically not publicly traded, bank managers will act to protect the interests of bank holding company shareholders. Bank managers are often also managers at the holding company level. Moreover, in most cases dangerous activity at the bank level will be reflected by a decline in the share price of the parent bank holding company.
203 See Brealey & Myers, supra note 70, at 148–66.
204 See Garten, What Price Bank Failure?, supra note 7, at 1179.
205 See Brealey & Myers, supra note 70, at 148–56.
206 See Garten, What Price Bank Failure?, supra note 7, at 1180; Garten, Market Discipline Revisited, supra note 43, at 201.
207 See supra notes 92–94 and accompanying text.
208 See Garten, Market Discipline Revisited, supra note 43, at 204.
209 See Van Der Weide, supra note 67, at 61–62.
210 See Gouvin, supra note 5, at 322–23. On the exit/voice dichotomy, see generally Albert O. Hirschman, Exit, Voice and Loyalty (1970); John C. Coffee, Jr., Liquidity Versus Control: The Institutional Investor as Corporate Monitor, 91 Colum. L. Rev. 1277 (1991).
211 See 17 C.F.R. § 230.144 (1999).
212 See Gouvin, supra note 5, at 323; Garten, Market Discipline Revisited, supra note 43, at 208.
213 See Brealey & Myers, supra note 70, at 684.
214 See, e.g., GOOCH & KLEIN, supra note 92, at 131–207.
215 See also Macey & Garrett, Market Discipline, supra note 80, at 232.
216 See Garten, What Price Bank Failure?, supra note 7, at 1181–83. Although Garten supports her argument by pointing out that deposit contracts rarely include such covenants, the position of depositors with respect to a bank is very different from a debtholder: deposits are liquid, short-term investments; depositors are covered by insurance; and depositors generally are not investing enough to make negotiating for covenants worthwhile.
217 See Garten, What Price Bank Failure?, supra note 7, at 1183.
218 See 12 U.S.C. §§ 1831o(h)(1) & 1831o(h)(2) (1994).
219 See Garten, Market Discipline Revisited, supra note 43, at 200–01.
220 See Using Subordinated Debt, supra note 64, at 44.
221 See id. at 25.
222 See id. at 49.
223 Two examples of these new Web sites, investinginbonds.com and tradebonds.com, can be used to find information on bond prices.
224 See, e.g., Jeanne Dugan, Bond Giants Battle Upstarts in Rush to Internet, Wash. Post, Feb. 15, 2000, at A1; Jonathan Fuerbringer, Market Place, The Bondmarket Refuge of the Instinctually Stodgy is Being Wired for E-Commerce Dealing, N.Y. Times, Jan. 13, 2000, at C1; Gregory Zuckerman, Bond Auction Goes Online, Then Off-Line, Wall St. J., Dec. 16, 1999, at C10.
225 See supra text and accompanying notes 109–114.
226 See Garten, Banking on the Market, supra note 80, at 153–56, 162.
227 See Garten, Whatever Happened, supra note 17, at 782–83.
228 See Purposes & Functions, supra note 33, at 5.
229 See Katharine Fraser, Fed Mandates Tough Stance on Lax Lending, Am. Banker, Sept. 29, 1999, at 1; Rob Garver, OCC Says Big Commercial Loans Suffering from Lax Underwriting, Am. Banker, Oct. 6, 1999, at 1; James Toedtman, Greenspan Remarks Trigger Jitters, Newsday, Oct. 16, 1999, at A7.