After congratulating Richard Herring and Anthony Santomero on a fine article, I will focus my comments mainly on regulatory and legal aspects of the issues they discuss.
The authors point out that if legal separateness is meaningful--defning "meaningful" to mean that subsidiaries or affiliates are permitted to fail without precipitating the collapse of the related institutions--then prudential supervision may be quite selective, and full examination of the consolidated unit is unnecessary. On the other hand, they argue, if the market views the conglomerate as indissoluble, then the insulation provided by legal separateness is illusory, and prudential supervision must take place on a consolidated level. As I thought about that argument, it occurred to me that we have a situation in which the market's view of the effectiveness of legal separation will turn in very large part on regulatory actions, both historical and predicted, concerning whether legal separateness, in fact, will be enforced in times of crisis. If that is right, then regulatory actions, statements, and policies will, in effect, create their own reality in the marketplace in determining what level of supervision is warranted or required.
We have not had a reasoned regulatory view in this country on the issue of legal separation and how it should work, particularly in times of crisis. The Federal Reserve has said in the past, particularly under Chairman Volcker, that holding company supervision-capital requirements and supervisory actions at the holding company level--was necessary, because in times of crisis neither the market nor management would act, or expect the regulators to act, in a way that fully respected corporate separateness. At the same time, the Fed has tried to implement corporate separateness in numerous ways, the best example probably being the firewalls in the Section 20 approvals that permit affiliates of banks to conduct securities activities through a separately incorporated, registered broker-dealer, but subject to a long list of very cumbersome and difficult firewalls. The Fed implemented these firewalls, but at the same time in other contexts, it expressed serious questions about whether legal separation by these firewalls could effectively insulate the bank in times of crisis.
Recent developments seem to me to be moving in a somewhat different direction. The FDIC's "Mandate for Change" certainly indicates that, in its view, holding company separateness can be maintained and that holding company regulation is not essential. Of course, the court in the recent M-Corp decision found that the Fed was without statutory authority to enforce its "source-of-strength" doctrine. This doctrine would have required