A major bank's excessive loans to a subsidiary that lost $90 million during last month's stock market plunge was evidence that banking companies should not be allowed to expand into securities trading, a securities industry executive said Monday.
John W. Bachmann, a St. Louis securities executive and chairman of the Securities Industry Assn., used Continental Illinois Bank & Trust's bailout of its options-clearing subsidiary as ammunition in the fight to stop banks from expanding into the securities business.
Big banks are trying to change the Glass-Steagall Act, a 54-year-old federal law that bars them from entering the securities business in the United States, although subsidiaries may do so abroad. Much of the opposition comes from the securities industry, which would compete with the bank subsidiaries.
The stock market crash stirred skepticism over the proposed changes and caused Sen. William Proxmire (D-Wis.) to delay plans to introduce legislation amending the law, which was approved as a result of the 1929 market crash to keep banks off Wall Street.
Critics argue that banking companies must remain free of the risks of the stock market in order to keep the nation's banking system safe. Top federal regulators and the banks, who say that they need new powers to remain competitive, contend that banking and securities functions could be separated safely. But events related to the crash illustrated the potential effect on banking companies and fueled the debate.
Security Pacific, a Los Angeles-based banking company, may lose money as a result of a small role played by its British securities subsidiary, Hoare Govett, in underwriting an offering of shares in British Petroleum. The value of BP shares went into a tailspin when the markets fell and some U.S. investment banks face losses of up to $500 million. However, Security Pacific said its losses, if any, would be minor.
Another bank was spared a potential loss simply because a deal had not closed. First Chicago Corp., parent company of First National Bank of Chicago, said last week that it would reassess plans to acquire a $200-million stake in Wood Gundy Corp. after the Canadian securities firm lost up to $45 million in the BP offering.
But the incident singled out by Bachmann involved Continental Illinois, which just three years ago was rescued from collapse by the biggest federal bank bailout ever.
Federal regulators said the big Chicago-based bank violated federal banking rules by lending too much money to its First Options subsidiary after the market crashed Oct. 19. First Options matches buyers and sellers of stock and commodity options and had to borrow heavily from its parent to cover trading losses.
After regulators questioned the size of the loans, First Options returned an estimated $25 million to the bank within 24 hours and borrowed the same amount from the holding company. Last week, Continental Illinois Bank signed an agreement with regulators promising not to exceed its lending limit again. The holding company also announced that it expects a loss for the last quarter of the year as a result of First Option's losses.
First Options processes trades and lends money to futures and options traders, using securities as collateral. The losses occurred when the stock prices crashed and traders could not make up the price difference.
In a New York speech, Bachmann questioned whether safeguards could actually separate a bank from an affiliated trading entity. But an official in the federal Office of the Comptroller of the Currency said Monday that the Continental incident demonstrates that regulatory safeguards can ensure the separation of banks and trading subsidiaries since the office spotted the transaction.
Debra Whitefield reported from New York and Douglas Frantz from Los Angeles.