Manufacturing giants aim to protect industrial banks from financial reform

Business giants General Electric, Toyota and dozens of others are on the verge of a major victory over President Barack Obama’s push to rein in their financial arms.

As part of its overhaul of the financial system, the Obama administration originally wanted to close what it considered a regulatory loophole. Federal laws do not typically allow banking and commerce to mix, with a notable exception: roughly 40 industrial loan companies (ILCs) chartered in a handful of states, primarily Utah and Nevada.

{mosads}The White House wanted to regulate the industrial loan companies just the same as big banks. The administration argued ILCs had access to a federal safety net in the form of federal deposit insurance without having to comply with the regulations a regular bank faced. Several companies with ILCs also received billions of dollars in federal aid during the worst of the financial crisis.

The administration’s proposal prompted a multimillion-dollar lobbying effort by some of the biggest names in corporate America, which feared new regulations would hurt their bottom line and choke off credit to their customers.

The companies were joined by powerful senators like Bob Bennett (R-Utah) and Majority Leader Harry Reid (D-Nev.), who argued Obama’s proposal would cost jobs in their states.

“Nearly 300 employees work at ILCs headquartered in Nevada, and thousands more work for ILCs in neighboring states,” Reid wrote to the Senate Banking Committee last year. “While I appreciate some of the concerns raised by critics of the ILC charter, the evidence is overwhelming that these institutions have been managed in a safe and sound manner.”

A year after Obama pitched his plan, Congress appears ready to hand the industry a big win. A bill crafted by Senate Banking Committee Chairman Chris Dodd (D-Conn.) includes a temporary moratorium on new ILCs and a requirement to study the issue, but stops short of imposing sweeping new oversight on the industry.

Reid is happy with the change.

“He is content with Sen. Dodd’s bill. ILCs have been important to expanding credit to consumers and businesses and the bill addresses them responsibly,” said Jon Summers, spokesman for Reid.

The Senate is eyeing a May vote on its financial overhaul package, and the loan company issue is just one of scores in a bill that spans more than 1,000 pages. But the lobbying and parochial nature of the issue underscores the complexity of building support for the bill, even on the heels of the worst financial crisis since the Great Depression.

Industrial loan companies were first formed in the early 1900s. For most of the time since then, they represented only a small share of the total banking industry. Their assets, however, have ballooned in recent years.

Between 1995 and 2006, total ILC assets grew nearly seventeenfold, from $12 billion to $213 billion, according to a study by two economists at the Federal Reserve Bank of Kansas City.

The companies allow commercial and manufacturing firms to extend credit and offer customers a way to finance purchases. Industrial loan companies have state charters but also access to deposit insurance from the Federal Deposit Insurance Corporation (FDIC).

Critics argue manufacturers aren’t alone in benefiting from the loan companies. According to the Cambridge Winter Center for Financial Institutions Policy, which supports new restrictions, ILCs became a boon to Wall Street. The center attributed 90 percent of the growth in the ILC market since 1987 to Wall Street.

And while few critics, including the Cambridge center, allege the companies spurred the financial crisis, some firms have required federal intervention.
GMAC Bank, once an industrial loan company, faced mounting losses and in November 2008 moved to transform itself into a bank holding company in order to receive a bailout, according to the Congressional Oversight Panel over the $700 billion financial rescue package. Regulators approved the request in December 2008, and GMAC got billions of dollars in aid.

CIT Group, which had roughly $9 billion in assets in its loan company, made a similar conversion in 2008 and benefited from federal bailout efforts.

In mid-March, Utah banking authorities took over Advanta Bank Corp., which had $1.5 billion in assets, after finding it was insolvent and was not able to raise sufficient capital. The FDIC took receivership of the bank.

In its white paper on new financial regulations, the Obama administration wanted to transform existing ILCs into more conventional bank holding companies. The loan companies would then face the same type of regulations as bigger commercial banks.

The companies, lobbyists and state-based interests immediately went to work. Over the past year, the firms spent millions of dollars on K Street and flexed their muscle with members of Congress.

The American Financial Services Association (AFSA), a trade association with 350 consumer and commercial finance companies, opposed the president’s plan.

Toyota hired Arnold & Porter and American Continental Group and spent $140,000 with the two firms on financial issues in the last three months of 2009.

The Alliance for Consumer Credit sprang up out of the Eris lobbying shop, which employs Doyle Bartlett, former Republican staffer on House banking issues, and Jennifer Bendall, who worked for Sen. Richard Shelby (R-Ala.), the ranking member on the Senate Banking Committee. The alliance supports preserving industrial loan companies, among other issues, and spent $210,000 lobbying last year.

Foxley & Pignanelli, a Utah-based government relations and law firm, headed to Washington and began lobbying on Capitol Hill.

“The industrial bank model really could be part of the future in getting private credit into the American economy,” said Frank Pignanelli.

The House bill bans new industrial loan companies and requires existing ones to set up a special intermediary subject to the Federal Reserve. Companies with pending applications for ILCs, including Ford Motor Co., lobbied successfully to be placed under the grandfather clause.

Obama’s plan met a much chillier reception in the Senate. Last June, Bennett sharply criticized the administration’s plan at a congressional hearing.

“You’re engaged in overkill, in my view, here. I know that the Fed has been after regulation of the ILCs for as long as they’ve been around,” Bennett told Treasury Secretary Timothy Geithner. “The Fed seems offended somehow that the regulation of ILCs is left to people like Utah and the FDIC.”

Dodd’s bill would impose a temporary three-year moratorium on new ILCs. The bill would prohibit a change of ownership during the three years. And during that time, the government would be required to study the effects of subjecting the loan companies to new federal regulations.

“This is an area in which [Dodd] has perhaps deviated strongly from the administration’s point of view,” said Arthur Wilmarth, law professor at George Washington University and critic of loan companies. “I think that would indicate there are powerful interests in the Senate he knows he has to deal with and could potentially block the entire bill.”

Bennett is seeking further changes to the bill that would benefit ILCs. He wants to shorten the moratorium to two years instead of three, and he wants it to take effect after pending applications are reviewed, said Andrea Candrian, a spokeswoman for the senator.

Howard Headlee, head of the Utah Bankers Association, said Washington should be looking to expand the role of ILCs to help the economy recover.

“When you have lost the amount of credit we have lost to the destruction of the secondary markets, we have to be looking at viable safe sound fully regulated alternatives and the industrial bank charter just screams out as perhaps the best alternative and you’ve got people talking about shutting it down or just leaving it on life support. Is that acceptable? No,” he said.