Notice & Comment

Chevron and Banking Law: What’s Good for the Goose Isn’t Good for the Gander, by Todd Phillips

As we await the Supreme Court’s decisions in Relentless and Loper Bright, left-leaning scholars and activists have bemoaned the demise of Chevron deference as harmful to progressive values. But this is not true in at least one area of law: banking. Where Congress enacted incredibly progressive statutes, courts granted Chevron deference to regulators’ interpretations in ways that systematically undermined Congress’s intent and ultimately helped cause the 2007–08 Great Financial Crisis.

The Progressive Banking Laws

The National Bank Act of 1864 limits national banks’ activities to those “necessary to carry on the business of banking” and the Banking Act of 1933 (better known as the Glass-Steagall Act) limits commercial banks’ authority to underwrite, deal, or invest in securities (that is, engage in investment banking). Despite reference to Congress’s repeal of Glass-Steagall in 1999, these walls still exist today. These limitations are needed because banks are special. Commercial banks store customers’ money and serve as part of the nation’s payment system, create money by lending out depositors’ cash, provide liquidity to other firms in times of need, and allow the Federal Reserve (Fed) to transmit monetary policy throughout the economy. The government provides them safety nets in the form of deposit insurance, the ability to borrow from the Fed’s “lender of last resort” discount window, and the possibility of bailouts for uninsured depositors of institutions deemed systemically important.

The history of combining commercial and investment banking has proven catastrophic. In the aftermath of the 1929 crash, Senator Glass, for whom the Glass-Steagall Act is named, explained that “one of the greatest contributions to the unprecedented disaster which has caused this almost incurable depression” was combining commercial and investment banking under the same roof. Speculation caused the value of securities to skyrocket, which resulted in significant losses for banks when the value dropped and prevented the banking industry from providing that liquidity backstop. These losses then caused depositors to lose confidence in their institutions, resulting in ruinous bank runs.

The banking laws’ restrictions on commercial banks are a triumph of progressive values. Rather than regulate banks’ securities activities, Congress chose instead to, in the words of one contemporary senator, “surround the banking business with sound rules which recognize the imperfection of human nature that our bankers may not be led into temptation, the evil effect of which is sometimes so subtle as not to be easily recognized by the most honorable man.”

Regulators Used Chevron to Expand “The Business of Banking”

The Supreme Court had long recognized Congress’s intent to keep national banks within the confines of the “business of banking” and policed the boundary between commercial and investment banking for over a century. After Chevron, however, courts allowed regulators to use a “hyper-elastic concept of the ‘business of banking’” to authorize an ever-expanding array” of activities.

In SIA v. Board of Governors, the D.C. Circuit upheld a Fed interpretation that commercial banks may underwrite and place commercial paper (which are securities) so long as that placement does not constitute “underwriting” under the securities laws. The banking laws limit commercial banks’ “dealing in securities … to purchasing and selling such securities and stock without recourse, solely upon the order, and for the account of, customers” and provide that banks “shall not underwrite any issue of securities.” Applying the Chevron Two-Step, the panel first found that “Congress has not clearly addressed the question of whether [underwriting and placing commercial paper] fall within the prohibitions of the Act.” Next, the court found the Fed’s interpretations reasonable. The agency argued that “underwriting” refers only to public offerings under the Securities Act of 1933, which the court found sensible “because the distinction derives support from congressional intent embodied in contemporaneous” enactment of Glass-Steagall and the Securities Act. No matter that commercial paper is exempt from the latter law, making its reference here illogical. Thanks to this application of Chevron, commercial banks may engage in the same types of practices against which Congress legislated so long as they only do so in private markets—which today are bigger than public markets.

In SIA v. Clarke, the Second Circuit approved an Office of the Comptroller of the Currency (OCC) decision permitting banks to sell “mortgage pass-through certificates” that “represent fractional undivided interests in [a] pool of mortgage loans”—better known today as residential mortgage-backed securities (RMBS)—without first attempting to understand Congress’s intentions in limiting commercial banks to the business of banking. In its approval, the OCC reasoned that national banks have long been able to sell mortgages and argued that issuing RMBS was “an ‘incidental power[]’” of the banking business. It argued that RMBS were “a ‘convenient [and] useful’ means for carrying out the express power of selling mortgages” and did not violate Glass-Steagall because these activities were core to “the business of banking,” not “the business of dealing in securities and stock.” Applying Chevron, the court agreed, concluding the interpretation of “incidental powers” here as “reasonable”—no matter that the certificates are securities.

Perhaps the most egregious of the cases allowing commercial banks to expand into other areas via Chevron is Inv. Co. Inst. v. Ludwig. In an opinion spanning all of two pages, the district court granted Chevron deference to an OCC determination that banks may offer the economic equivalent of S&P 500 index funds.

Of course, there are instances in which courts have rebuffed the agency’s efforts to expand what is incidental to the business of banking, just as there are instances in which courts permit new activities without using Chevron. Nevertheless, regulators’ assertion of Chevron deference to expand the banking perimeter allowed national banks to engage in activities once thought strictly outside their authorities.

Perhaps the most significant of those newly permitted activities is the dealing of derivatives and associated practices. Between the mid-1980s and 2008, the OCC “gradually and deliberately expand[ed] the ability of large U.S. commercial banks to engage in trading and dealing in complex over-the-counter derivatives.” Derivatives are financial instruments with prices derived from the value of underlying assets; a stockholder might, for example, enter into a derivative to hedge the stock’s value, with a dealer offering what is essentially insurance. Although the OCC’s expansion was initially closely tied to the activities Congress expressly authorized in statute, such as permitting banks to hedge their own lending risks, the agency soon permitted activities much more attenuated; for example, allowing banks to take the other side of clients’ derivatives—a far cry from Congress’s intention that “[t]he banker ought to be regarded as the financial confidant and mentor of his” customers. As a result, the OCC allowed banks to engage in activities that Congress never would have imagined as being permissible—such as banks owning warehouses in order to take physical delivery of aluminum after commodity derivatives expire.

Banks’ expanded activities, permitted by courts under Chevron deference, helped cause the 2007–08 Great Financial Crisis and realize Congress’s fears of combining commercial and investment banking. Whereas the OCC reasoned in SIA v. Clarke that banks would “not be tempted to make unsound loans to customers in order to influence the success of” their RMBS sales or “remarket[] them to uninformed purchasers,” that is exactly what happened. Banks earned “enormous fees” by “originat[ing] huge volumes of poorly-underwritten, high-risk subprime and ‘Alt-A’ mortgages,” that caused them “to disregard sound underwriting principles and due diligence standards.” These mortgages were then packaged into RMBS and sold to investors. The decline in underwriting practices occurred simultaneously with commercial banks’ expansion into derivatives; in 2007, the top commercial banks held $14 trillion in derivates insuring securities.

Lower underwriting standards led to mortgage defaults, which led to RMBS defaults, which required derivatives dealers to pay. Several top commercial banks, investment banks, and insurers failed. The U.S. government committed approximately $182 billion to bail out AIG, $187 billion to bail out Fannie Mae and Freddie Mac, $40 billion to Bank of America and Citigroup, and an additional $30 billion to incentive JP Morgan Chase to buy Bear Sterns. The U.S. Government Accountability Office estimated that the crisis reduced GDP output by more than $13 trillion and resulted in paper losses for homeowners of $9.1 trillion. The unemployment rate did not reach pre-crisis levels until nearly a decade after the crisis began.

Concluding Thoughts

What is discussed here is just the tip of the iceberg when it comes to Chevron and banking. For example, courts routinely deferred to OCC regulations permitting national banks to egregiously evade state consumer protection laws, causing Congress to ultimately ban Chevron deference to such interpretations. (This ban is at the heart of Cantero v. Bank of America, currently before the Supreme Court.)

This post is not meant to cheer Chevron’s potential undoing, but rather to highlight that courts’ deference to agencies is not an unqualified good for progressive values—what’s good for the progressive goose may not always be what’s good for the progressive gander. When statutory aims are already progressive, like those of the banking laws, Chevron deference can be used by agency officials to undermine them. Hopefully the doctrine will survive, but in a form that requires courts to truly wrestle with Congress’s statutory goals. Though that may be more work to defend progressive values in some issue areas, it would certainly help protect those in others.

Todd Phillips is an Assistant Professor at the J. Mack Robinson College of Business.

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