Real Estate Brokerage and Management Regulation

Real Estate Brokerage and Management Regulation

Office of Financial Institution Policy

May 1, 2001

Page 1

May 1, 2001

Real Estate Brokerage and Management Regulation

Office of Financial Institution Policy

U.S. Department of the Treasury

1500 Pennsylvania Avenue, NW

Room SC 37

Washington, D.C. 20220

Re:RIN 1505-AA84

Ladies and Gentlemen:

On behalf of more than 760,000 members of the NATIONAL ASSOCIATION OF REALTORS®, we are writing to comment upon the rule proposed by the Department of the Treasury (the “Department”)[1] which would amend Part 1501 of the Department’s regulations to add real estate brokerage and real estate management to the list of activities that the Secretary of the Treasury (the “Secretary”) has determined to be financial or financial in nature, and therefore permissible for financial subsidiaries of national banks. The NATIONAL ASSOCIATION OF REALTORS®, for the reasons stated below, vigorously and strongly opposes this unprecedented expansion of bank powers to permit national banks to engage in these activities, which are commercial activities, not financial activities, and therefore are beyond the scope of the authority conferred upon the Secretary by the Congress.

Any consideration of this proposal must begin by taking into account the magnitude of the real estate brokerage industry and its role in the national economy, in order to appreciate the breadth of the effects that likely would follow from the dramatic structural changes in the industry that the Department proposes to authorize. Resales of approximately five million existing single-family homes, and sales of approximately 900,000 new single-family homes, are conducted annually through real estate brokers, generating a total sales volume in excess of one trillion dollars.

Approximately twenty percent of home purchases are made without any financing, and, thus, in those transactions, there is no “financial activity” associated with the transaction. There is, however, a very substantial volume of financial activity in home-financing that occurs every year, without any participation or involvement whatsoever by real estate brokers, when homeowners refinance their existing mortgages.

The NATIONAL ASSOCIATION OF REALTORS® is also submitting comments to the Board of Governors of the Federal Reserve System (the “Board”) with respect to its proposal to amend its Regulation Y to permit financial holding companies (“FHCs”) to engage in real estate brokerage and management. In this regard, the NATIONAL ASSOCIATION OF REALTORS® notes that, during the debates in Congress over the Gramm-Leach-Bliley Act (the “GLB Act”), both Secretary Rubin and Chairman Greenspan were outspoken in their opposition to the mixing of banking and commerce.[2]

The Mixing of Banking and Commerce

For the past two centuries, the Congress has mandated the separation of banking and commerce. When Congress created the national banking system, during the Civil War, it limited the activities permitted for institutions holding the new federal bank charter so that national banks could not engage in commerce.[3] During the Great Depression, Congress moved to further limit the possibility of banks’ being involved, even tangentially, in commerce, by enacting the Glass-Steagall Act,[4] which prohibited a company from carrying on both commercial banking and investment banking businesses.

With the accelerating growth of bank holding companies, Congress gave further legislative form to its concern over the mixing of banking and commerce with the enactment of the Bank Holding Company Act of 1956 (the “BHCA”), and again in 1966 with amendments to the BHCA which tightened the restrictions imposed by it.[5] The Senate Report to the 1966 amendments stated that Congress intended “to prevent unduly extensive connections between banking and other businesses.”[6]

In 1970, Congress again amended the BHCA, to bring within its coverage, for the first time, bank holding companies that own or control only a single bank, and the Senate Report prepared in connection with those amendments stated that Congress believed it “desirable to continue our longstanding policy of separating banking from commerce.”[7] The 1970 amendments provided that the Board of Governors, in order to permit bank holding companies to engage in any nonbanking activity, would have to find both that the activity is “so closely related to banking . . . as to be a proper incident thereto,” and that permitting bank holding companies to engage in it “can reasonably be expected to produce benefits to the public . . . that outweigh possible adverse effects” of doing so.[8]

When Congress adopted the GLB Act in 1999, it debated extensively the mixing of banking and commerce before adopting provisions to curtail the growth of thrift holding companies and to prohibit commercial firms from owning thrifts.

One of the policy bases for erecting a wall between banking and commerce was succinctly stated by former Chairman of the Board of Governors William M. Martin in testimony before the Senate Banking Committee in 1969. We urge the Department to note the close parallel between the present proposal to permit national banks to own financial subsidiaries engaged in real estate brokerage and the example given by Chairman Martin in his testimony.

If a holding company combines a bank with a typical business firm, there is a strong possibility that the bank’s credit will be more readily available to the customers of the affiliated business than to customers of other businesses not so affiliated. Since credit has become increasingly essential to merchandising, the business firm that can offer an assured line of credit to finance its sales has a very real competitive advantage over one that cannot. . . . [I]f we allow the line between banking and commerce to be eased, we run the risk of cartelizing our economy. Just as we have seen the country’s largest banks join the new wave of one-bank holding companies, we could later see the country’s business firms clustering about banks in holding company systems in the belief that such affiliation would be advantageous, or perhaps even necessary to their survival.[9]

As discussed further below, the “firewalls” cited in the notice of the proposed rule existed when Chairman Martin gave the quoted testimony. For the reasons stated hereinafter, they were inadequate then, and they remain inadequate to address the serious concerns that he expressed in 1969 and that are directly implicated in the current proposal.

In the past, the Board of Governors has reflected the concerns expressed by Chairman Martin in its rulings upon proposals to authorize bank holding companies to engage in nonbanking activities. In First Commerce Corp.,[10] the Board rejected an application by a bank holding company for approval to acquire a business that provided real-estate consulting services to developers, on the grounds that the business was not closely related to banking and that the public benefits that could be expected from permitting such activity would not outweigh the potential adverse effects. The Board specifically stated that it was concerned by the conflicts of interest which could arise from combining banking and real-estate consulting activities.

Although the current notice of the proposed regulation attempts to distinguish the longstanding policy of the Board of Governors, as reflected in the First Commerce decision, on the grounds that the GLB Act broadened the standard by which the Board is to evaluate proposals seeking authority to engage in new nonbanking activities (by requiring that the Board find that the proposed activity, rather than being “closely related to banking,” is, instead, “financial in nature” or “incidental to a financial activity”), this ignores the fact that the Board’s longstanding policy was not derived solely from application of the “closely related” standard. That policy, it is important to recognize, also is grounded in the Board’s determination that actual or potential conflicts of interest and other factors make the mixing of banking and real estate activities adverse to the public interest.[11]

Under the GLB Act, the Department and the Board, in determining whether to permit a proposed activity under the rubric of its being either “financial in nature” or “incidental to a financial activity,”[12] are required to consider, among other things, the Congressional purposes of, respectively, the National Bank Act and the BHCA. In its published decisions, the Board repeatedly has emphasized that among the intended purposes of the BHCA is to prevent the mixing of banking and commerce, as well as to “prevent the undue concentration of economic resources.”[13]

The Board, similarly, has observed that the BHCA reflects the intent of Congress to prevent situations in which a bank that has nonbanking affiliates “might deny justified credit to competitors or prospective competitors of such affiliates,” or in some fashion seek to coerce or influence bank customers to use the services of the bank’s nonbank affiliates out of fear of retaliation by the bank.[14] The GLB Act did not change the requirement that the Board determine whether proposed new nonbanking activities, even if they are “financial in nature” or “incidental to a financial activity,” may nevertheless contravene the purposes of the BHCA by mixing commerce and banking, with attendant adverse consequences to the public.

If the Department and the Board were to adopt the proposed regulation, such action would represent a reversal of many years of Federal Reserve policy that has been based upon the Board’s considered judgment that the public interest would be disserved by permitting affiliations between commercial enterprises and financial-services companies, thereby allowing credit decisions to be impermissibly affected by commercial relationships, and creating the risk that banks’ customers would be subject to real or perceived pressures to transact their nonbanking business with the affiliates of their respective banks.

For the same reasons, the Department’s proposal to allow financial subsidiaries of national banks to engage in the commercial activities of real estate brokerage and management should be withdrawn, because permitting such activities would be contrary to the public interest, would enable bank-owned real estate brokerage firms to benefit unfairly from the government subsidies provided to the banking industry, and would distort the marketplace through the public’s unavoidable perception that any bank having a real estate brokerage subsidiary would more readily provide financing to acquirers of real property who contract their purchases through a broker affiliated with the Bank.

In assessing whether any proposed expansion of nonbanking activities would erode the barrier between banking and commerce, one of the factors to be considered is the fact that all banks, whether they operate independently or as part of a holding company, receive a very substantial subsidy from the federal government.[15] As a result of the protection provided by federal deposit insurance, bank depositors are willing to accept a lower rate of return on the funds that they place on deposit in banks than they otherwise would find acceptable. This significantly reduces the cost of funds for insured depository institutions. Additionally, banks enjoy special access to credit at the Federal Reserve discount window and at Federal Home Loan Banks, where they can borrow at below-market rates that are not available to other businesses.

Closely related to the subsidy that banks receive through deposit insurance is the indirect subsidization of larger banks that results from federal regulators’ implicit determination that some banking institutions are “too big to fail.” When any such institution experiences severe capital impairment or a liquidity crisis, regulators will intervene in the market, or arrange or facilitate intervention and/or assistance by healthy banks, to avoid permitting such an institution to reach insolvency, and thereby avoid the widespread -- and often unpredictable -- disruption of markets and economies that authorities fear would result from the failure of such an institution.

All of these benefits and advantages that are enjoyed directly by insured banks, and indirectly by their affiliates, unmistakably would work to the advantage of bank-affiliated real estate brokerage and real estate management firms, and would provide them substantial competitive advantages over companies engaged in real estate brokerage and management that cannot match the low costs of funding available to banks, cannot borrow at the Fed discount window or the Federal Home Loan Banks, and do not benefit from being part of an organization that the government regards as too big to be allowed to fail.

Finally, the NATIONAL ASSOCIATION OF REALTORS® urges the Department to carefully consider the fact that, in the GLB Act, Congress enumerated those current activities that it deemed to be “financial in nature,” and in so doing specifically omitted real estate brokerage and management. See 12 U.S.C. § 1843 (k)(4) (made applicable to financial subsidiaries of national banks by 12 U.S.C. §§ 24a(a)(2)(A)(i) and 24a(b)(1)(A)(i)). The enumerated list is extensive, and Congress easily could have added real estate activities if it had deemed them to be financial in nature. It chose not to do so.[16]

The legislative record reflects that the purpose of Congress in giving the Secretary and the Board authority to expand the list of financial activities was to allow the range of permitted activities to evolve as new technological developments occur and the marketplace itself evolves. No reasonable observer would suggest that there has been any significant change in the relevant technology, or in the business of real estate brokerage or management, since enactment of the GLB Act in 1999. The businesses of real estate brokerage and real estate management remain, for all practical intents and purposes, the same today as they were in 1999.

The limited nature of the Secretary’s authority to designate additional activities as “financial in nature” or “incidental to such financial activity” is underscored by reference to the factors which Congress mandated that the Board take into account in making such determinations. Those factors include the following:

-“changes or reasonably expected changes in the marketplace in which banks compete;

-“changes or reasonably expected changes in the technology for delivering financial services; and

-“whether [a proposed new] activity is necessary or appropriate to allow a bank and the subsidiaries of a bank to --

“(i) compete effectively with any company seeking to provide financial services in the United States;[17]

“(ii) efficiently deliver information and services that are financial in nature through the use of technological means, . . .; and

“(iii) offer customers any available or emerging technological means for using financial services or for the document imaging of data.”

12 U.S.C. § 24a(b)(2)(B)-(D).

Thus, the factors enumerated by Congress for use by the Secretary show that the legislature obviously contemplated that additional financial activities would be authorized for financial holding companies as a result of changes that can be expected over time in the marketplace and in technology, but none of the sort of changes that were contemplated by Congress have occurred since enactment of the GLB Act in late 1999.[18]

Real Estate Activities Are Inherently Commercial in Nature

Under the GLB Act, the Secretary cannot authorize financial subsidiaries of national banks to engage in any nonbanking activity unless such activity has been determined to be “financial in nature” or “incidental to such financial activity.” The Secretary has no authority to permit financial subsidiaries to engage in commercial activities and, therefore, the proposed regulation is not authorized by the GLB Act.

The proposed regulation defines real estate brokerage as “the business of bringing together parties interested in consummating a real estate purchase, sale, exchange, lease, or rental transaction and negotiating on behalf of such parties a contract relating to the transaction.” 66 Fed. Reg. at 308. In proposing that this activity be determined to be “financial in nature” or “incidental to a financial activity,” the notice cites virtually every remotely similar activity that presently is permissible for financial institutions, but it completely ignores those aspects of the real estate brokerage function that are clearly commercial in nature, and not financial. As a result, we respectfully ask that the Department begin its analysis at the ground level.

The first and most fundamental question is not whether some of the aspects of real estate brokerage, or real estate management, may be analogous to particular activities that presently are permissible for banks or their affiliates. The first and most fundamental question should be: “What is a financial activity, as opposed to a commercial activity?” Any discussion or consideration of the proposed regulation must begin at this level.

The NATIONAL ASSOCIATION OF REALTORS® submits that financial activities are those that relate to transactions in intangible assets. Commercial activities, on the other hand, are those that relate to transactions in tangible assets. Financial activities are based on the concept of notional value. For example, the value of money is solely notional, as is the value of stocks and bonds. Similarly, insurance represents a commitment to transfer something of notional value on the occurrence of some event. On the other hand, commerce involves the transfer of tangible assets (such as cars, property, televisions, etc.), the value of which derives from the uses to which they can be put.

While commerce, other than through barter, inevitably entails the use of financial assets such as money, this does not transform commercial activity into an activity that is “financial in nature” or “incidental to such financial activity.” If it were otherwise, the GLB Act would have to be interpreted as wholly abolishing the distinction between finance and commerce, meaning that banks and their subsidiaries would be free to engage in any activity that involves the use of financial assets, including the manufacture and sale of automobiles, television sets, or any other product that is bought and sold in commerce.

Understandably, since the proposed regulation must rest on the proposition that real estate brokerage and real estate management are “financial in nature” or “incidental to such financial activity,” the notice wholly fails to address how financial activities, and activities incidental to financial activities, are distinct from commercial activities. Any effort to do so would serve only to demonstrate the commercial nature of the purchase and sale of real estate, the brokering of such transactions, and the management of real estate.