A Subsidiarity Angle on the Banking Crisis

One aspect of the financial crisis not receiving much attention is the relative soundness of the smaller community banks that constitute a large part of our nation's banking system.  Of course, a worsening recession could drag them down, too, and about two dozen community banks have failed this year, but they are generally fairly sound.  Recent articles in a banking industry daily that I follow, The American Banker  (available only by subscription) have noted out that about 1/3 of the banking industry (3,100 banks -- mostly smaller, community banks) has opted out of the Federal Deposit Insurance Corporation's offer of extra deposit insurance (for a price) until the end of 2009.  Another article in today's American Banker  ("Big Bank Troubles, Small-Bank Opportunity") discusses how "many smaller banking companies are well positioned to take advantage of market disruption by beefing up their staffs and entering into new lines of business.  They also can capitalize on customer runoff, and the strongest ones are even scouting for branches or banks to buy."

I worry that the dramatic attention being given to the rescue of the financial institutions that are "too big to fail" is obscuring our appreciation of the value of our truly unique "dual banking system", in which a system of typically smaller, community-based state-chartered banks historically has provided a counterweight to the typically larger, increasingly regional or nation-wide federally-chartered banks.  Significant federal regulation of the banking industry in response to the current crisis that is not sensitive to the position of state-chartered banks could significantly endanger the ongoing vitality of the dual banking system.

I recently published an article on the effect of a recent Supreme Court decision, Watters v. Wachovia on the delicate balance of federal versus state authority over consumer protection in banking services.  Most of the article is an analysis of the evolution of federal preemption of state banking law, but the last section raises arguments of subsidiarity.  Following is the abstract; you can find the article here.

Damming Watters: Channeling the Power of Federal Preemption of State Consumer Banking Laws, 35 Fla. St. U. L. Rev. 893 (2008)

Abstract:     
In Watters v. Wachovia, 127 S. Ct. 1559 (2007), the Supreme Court reversed two presumptions about federal preemption of state law that historically have guided the delicate balance between state and federal authority over consumer protection in banking services - the presumption that issues involving consumer protection are quintessentially matters of state rather than federal prerogative and the presumption that national banks are subject to nondiscriminatory laws of the states where they are located, except where federal law expressly preempts such law.

This article analyzes the dramatic impact of Watters' reversal on two different areas - consumer protection in banking services and the continued vitality of the uniquely American dual banking system. The first part of the article traces the evolution of consumer protection law in the banking industry through three stages. The first was the gradual expansion of the preemptive effect of a particular federal usury statute for national banks through a combination of action by federal banking agencies and case law. The second stage was the assertion by federal banking regulators of a broad theoretical framework for federal preemption of state banking law based not on any particular federal statute, but rather on a theory of congressional intent to permit national banks to provide consistent banking services nationwide. The third stage was the validation of that broad conflict preemption theory by the Supreme Court in Watters. The article demonstrates how the reversal of the historic presumption has recently played itself out in the preemption of state laws governing bank-issued gift cards, culminating in the first citation of Watters in SPGGC, LLC v. Ayotte, 488 F.3d 525 (2nd Cir. 2007).

While challenging the proposition reflected in most recent scholarship in this area that federalization of consumer protection law necessarily entails deregulation, in this article I nevertheless conclude that Watters will have a significant adverse effect on the continued vitality of the dual banking system. Arguments for preserving the "dual banking system" arise out of our nation's fundamentally federalist sensibilities. From that perspective, a recent shift in the tenor of arguments for the preserving the dual banking system from the benefits of competition (states as laboratories of reform) to arguments based on the principle of subsidiarity (states as more responsive units of government where democratic ideals are more fully realized) can be observed. I argue that the subsidiarity arguments are likely to be more persuasive in convincing Congress to intervene to address the imbalance between the state and national banking system exacerbated by the Watters decision. I conclude by proposing that Congress partially reverse Watters by validating a recent proposal by the primary federal regulator of state banks to extend preemption authority to state banks, thus preserving to states the authority to offer a meaningful alternative to the national banking system on the level of consumer protection.