Centre for Economic Policy Research

Endnotes 109

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total assets of all financial subsidiaries of the national bank, however, cannot exceed
45% of the parent bank’s total consolidated assets, or $50 billion, whichever is 
greater. An operating subsidiary cannot engage in insurance underwriting, real 
estate development, merchant banking, or insurance company portfolio investing.
The Act empowers the Federal Reserve Board to define additional activities as 
‘financial in nature, or incidental or complementary to’ financial activities. All 
insurance, banking and securities activities will be functionally regulated. The Act 
significantly narrows the broad exemptions from broker-dealer registration that 
banks enjoyed. The authority of the Board is limited to regulate, examine and 
require reports from functionally regulated subsidiaries, establishing a streamlined 
supervisory system for FHCs.
48
Commercial banks were the predominant intermediaries, holding two-thirds of the
financial system’s assets (White, 2000). 
49
The Mutual and the New York Life were mutual companies while the Equitable was
a stock company. 
50
Although linked to specific investment banks, insurance companies often 
participated in other firms’ syndicates. In addition, there were close ties with banks, 
trust companies and title insurance companies through ownership, large deposits or 
other affiliations. This group of institutions assisted with syndicate operations by 
providing collateral loans.
51
Affiliates or subsidiaries were a new and untested corporate form. The earliest trust
affiliate was established in 1903 and the first known securities affiliate in 1908 (see
Peach, 1941).
52
Henry Clews quoted in Carosso (1970 p. 113).
53
Markets were pummelled by an even more severe crisis in 1907 when sliding stock
prices were joined by a banking crisis and sharp recession. Over the course of the 
1907 crisis, stock prices, as measured by the Dow Jones index, plummeted 40%.
54
This structure was similar to the arrangement in German universal banks where 
investment and commercial banking activities are in separate departments within 
the bank. 
55
This organizational form is similar to Section 20 securities subsidiaries permitted 
under the Glass-Steagall Act. See Macey and Miller (1992).
56
It should be noted that the new issue bond market shrank from $5.9 billion in 1927 
to $4.2 billion in 1928 and finally $2.9 billion in 1929. At the same time, new 
equity issues were booming. Unfortunately, there appears to be no data on the
underwriting institutions for stocks, although securities affiliates garnered a large 
share of the business. 
57
One of the most prominent security affiliates, the First National Old Colony 
Corporation of Boston (the affiliate of the First National Old Colony Bank) had an 
investment supervision department with over $1 billion of funds for clients that 
included 600 banks and many manufacturing and insurance companies. It was 
highly respected by state bank regulators, for the investment advice it gave its client 
banks. It won the grudging respect of Senator Glass in the 1932 hearings, as a 
‘virtuous affiliate’ (US Senate, Committee on Banking and Currency, 1932).
58
See Peach (1941) for a detailed list of ‘abuses and defects’.
59
For example, the Metropolitan Securities Corporation, a wholly owned subsidiary of 
Chase Securities Corporation operated several pools in Chase National Bank stock 
between 1927 and 1931. Drawing in other investment companies, the pool bought
and sold Chase stock, turning large profits until the market collapsed. One purpose
claimed by the banks for these affiliates was to gain a wider distribution of the stock.
60
The three largest netted a profit of $10 million, while the bank affiliates’ pools had 
profits of only $159,000. Wiggin argued that his family corporations gave 
sub-participations to officers of the affiliate because they were valuable employees 
and they should make money in additional to their salaries. Wiggin’s successor,
Winthrop W Aldrich denounced the pools and vowed that Chase would no longer
engage in such activities.
61
Huertas and Silverman (1986) have argued that this fund was an appropriately 
designed incentive-compatible scheme, helping to solve the problem of the divorce 
110 Conflicts of Interest in the Financial Services Industry

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of ownership from management. 
62
Similarly, Representative Henry B Steagall insisted that the New Deal legislation 
include deposit insurance even though the White House, the Federal Reserve and 
the larger banks were firmly opposed (Calomiris and White, 1994). 
63
Banks that had affiliates were larger and more diversified, with the combined 
earnings from commercial and investment banking smoothing total fluctuations.
64
Banks were permitted to underwrite and deal in US state and local bonds.
65
The Bank Holding Company Act of 1956 closed a loophole in the Banking Act of 
1933 by prohibiting bank holding companies from owning shares in subsidiaries 
that were not engaged in approved banking-related activities (see Santos, 1998).
66
As National City Company and Chase Securities Corporation were singled out by 
the Pecora hearings for their conflicts of interest, it is possible that they alone 
exploited the conflicts. Ang and Richardson (1994) discovered, however, that while 
the bonds issued by these affiliates were lower quality than the average for affiliates,
they were no worse than those for investment banks. 
67
In a study of pre-World War II Japan, before commercial and investment banking 
were separated, Konishi (2002) found that there was no significant difference in the 
initial yields in bonds underwritten by commercial banks, trust firms, the Industrial 
Bank of Japan or investment houses. Although the market did not price the bonds 
to indicate an apprehension of conflicts of interest or certification, issues under-
written by commercial bank performed better with lower mortality rates 
(age-adjusted default rates).
68
Krozner and Rajan (1997) point out that the shift to affiliate form was not driven by
the new issue equity boom that surged in 1928. National banks, which had no 
powers to underwrite stocks in bond departments, created securities affiliates before 
the surge in equities when bonds were still the dominant new issue.
69
The strict separation of commercial banking, investment banking and insurance 
made it necessary to define and restrict the activities of each type of intermediary 
carefully. When banks seemed to find a means to circumvent limitations through 
bank holding companies, the gap was quickly closed. The 1970 amendments to the 
Bank Holding Company of 1956 specified the permissible activities for bank 
holding companies, requiring that they be ‘so closely related to banking or 
managing or controlling banks as to be a proper incident thereto’. The Board of 
Governors has the power to determine the scope of banking under the 1970 
amendments. The test whether an activity was acceptable was whether it could 
‘reasonably be expected to produce benefits to the public, such as greater 
convenience, increased competition, or gains in efficiency, that outweigh possible 
adverse effects, such as undue concentration of resources, decreased or unfair 
competition, conflicts of interests or unsound banking practices’.
70
In 1984, the FDIC allowed insured non-member banks to offer securities services 
through subsidiaries (Santos, 1998). 
71
Defining a small issue as less than $75 million, 31% of subsidiaries’ underwriting is 
for small issues, while it constitutes only 8% for investment banks.
72
Stefanadis (2003) offers a theoretical treatment of tying and universal banking 
where universal banks have an advantage vis-à-vis independent investment banks 
when they bundle together services (e.g. tie loans to the provision of investment 
banking services). He finds that tying may ultimately reduce competition between 
banks and lower social welfare.
73
There are few studies that examine other potential conflicts of interest for universal 
banks. Allen et al. (2001) look at the potential conflict of interest for banks acting as 
both lenders and financial advisers, using the cumulative abnormal returns of the 
target and acquiring firms for a sample of mergers from 1995 to 2000. When a 
target firm uses its commercial bank as an adviser, the abnormal return is positive, 
implying that the certification effect dominates the conflict of interest effect. When 
the acquirer is advised by its bank, however, there is no abnormal return which 
suggests that the conflict of interest dominates the effect of certification.
74
For lower rated bonds (BBB, BB and unrated), there is no difference in the yields, it 
exists only for bonds rates AA or A. Thus, unlike the United States, there is no