Notice & Comment

The Continuing Importance of State Banking Law

The Business History Review has a new article that should interest our readers. In Citibank, Credit Cards, and the Local Politics of National Consumer Finance, 1968-1991, Sean Vanatta (PhD candidate in history at Princeton) tells us the story of how Sioux Falls, South Dakota became a global financial center in 1981. Well, global financial center may be an exaggeration, but only barely. Since 1981, it has been the headquarters of Citi’s credit card business. In Vanatta’s telling, we get the background for one of banking law’s most important principles: that state law can make federal law through the creative combination of state usury laws and federal banking practice.

Vanatta outlines how “states . . . became ‘on-shore’ financial havens where banks connected far-flung consumers directly with volatile capital markets” that led to an explosion of credit card borrowing in the late 20th century, an explosion that traditional usury limits could not provide. This focus on states—both on state regulation and state legislation—is useful and interesting for banking and administrative law scholars so much more accustomed to assuming away the significance of state-level restrictions given the regulatory behemoths at the federal level, including and especially the Federal Reserve. But state financial regulation continues to matter today, and, in Vanatta’s account, we get a sense of how decisive state regulatory and legislative decisions—with the firm support of the federal judiciary—have been for decades.

The economic historical problem that Citi faced in its decision to relocate from New York to South Dakota is a familiar one. As Vanatta puts it, by the 1960s the luxuries of the postwar boom in banking—almost effortless for that generation’s financiers—was coming to an end. To counter the loss in profits that Citi and its competitors were facing, the banks needed to dramatically expand their customer base to make more and different loans than their tapped out efforts had already yielded. The problem: “while Citi’s corporate clients shopped for loans nationally, consumers borrowed where they lived, and Citibank was geographically confined by state and federal law to New York City and its surrounding counties.”

This restriction was problematic because it constrained the cards’ profitability. Credit cards were a profitable business when limited to the states where the banks did traditional business, but usury limits put a hard cap on those profits, making the margins even tighter (when they were positive at all). The banks had a few options. In the time-honored history of evading usury limits by calling interest rates by another name, Marquette National Bank—yes, that Marquette, of Supreme Court fame, of which more in a moment—began charging an annual fee on top of its state maximum of 12%. Even though, as Vanatta tells us, almost half of its card users jumped ship, the fee did the trick and Marquette started turning a profit.

But other banks weren’t on board with usury-by-another-name, and some states even forbid the practice entirely. For example, First of Omaha, a Nebraska bank, started poaching customers in nearby Iowa and Minnesota but still charged interest rates under Nebraska’s more permissive laws. Marquette National Bank was losing customers to the out-of-stater, even though Marquette was charging the Minnesota-required lower interest rate. Marquette sued, and eventually this state-law dispute became a federal case through the interpretation of the 1863 National Bank Act. (Incidentally, how Marquette could lose customers in this economic setting confused the Justices, too, but arose because of Marquette’s annual fees; first Omaha didn’t charge the fees, even as it made more money off of higher interest.)

The legal argument that Marquette carried to the U.S. Supreme Court was whether the National Bank Act permitted First of Omaha to follow Nebraska’s laxer usury laws, even though it was transacting in Minnesota with Minnesotans. Robert Bork, First of Omaha’s lawyer, insisted with adverbs: “as a legal matter [the Act] is quite clear, that absolutely and clearly applies, I think beyond doubt.” The justices, non-plussed by the assertion of states’ rights to assert control of their own interest rate climate for consumer lending, unanimously agreed and First of Omaha got a powerful imprimatur to keep eating Marquette’s lunch.

As Vanatta tells us, the case was a regional conflict that might have stayed that way. But the idea—apparently uncontroversial among the bar—that a single state could permit a single bank to expand into a national fortress of consumer lending, usury laws be damned, was a startling proposition. And Citi wasted little time in shopping its Marquette-sanctioned proposal to the highest (meaning, lowest) bidder. South Dakota won the auction, and your credit card statement likely comes from that state or ones that later joined the incorporation game following Citi and South Dakota’s lead.

Vanatta’s article is a fascinating history about the mélange of institutional pressures shaping the development of modern finance. But the bottom line is one that can be forgotten in a post-Dodd-Frank world where federal and even international regulatory juggernauts dominate the landscape. In banking as in so much else, states—state courts, state laws, state regulators—matter enormously.

UPDATE: It seems that Sean’s article is gated and not yet widely available. If you would like a copy of it and lack JSTOR access, email me or Sean directly (emails at our home pages).