Congress Revisits the Issue of Banks Selling and Managing Real Estate
In December 2001, the U.S. Congress introduced the Community Choice in Real Estate Act, which would prohibit banks and financial companies from engaging in real estate brokerage and property management. A coalition of real estate organizations, including the National Association of Realtors and the CCIM Institute, lobbied intensely for the introduction of the act, which was published in response to a proposed U.S. Department of Treasury and Federal Reserve Board rule that would open real estate brokerage and property management to financial holdings companies and national banks' financial subsidiaries.
While the act did not move during the 107th Congress, it has been reintroduced this year as H.R. 111/S. 98 and enjoys significant support in the 108th Congress. In addition, Congress brokered a stay on the issue by barring either the Treasury Department or Federal Reserve from using any of their current budget dollars to promulgate the joint proposal. This stay remains in effect until October.
Banks and financial institutions lobbied for entry in real estate as a result of the Gramm-Leach-Bliley Act, signed into law in November 1999, which already permits financial holdings companies and national bank subsidiaries to engage in insurance and securities underwriting, merchant banking, and insurance company portfolio investment activities. While some sections of the law detail the precise financial activities in which banks may engage, other sections are broad enough to allow agencies the authority to define other commercial activities as financial in nature. This ripe regulatory environment opened the door for banks and financial institutions to request entry into yet another profit-making commercial industry — real estate brokerage and property management.
Background on Banks in Real Estate
Historically, the federal government has maintained that banking and commerce should be separate, thereby limiting the range of banks' permissible activities. The government's intent was to protect consumers from potential banking/commerce monopolies that could adversely affect competition, foster unsound banking practices, and create conflicts of interest. Also, it was feared that banks could expose themselves to extraordinary risk via their commercial operations while benefiting from regulatory safety nets not available to their commercial competitors.
To discourage a monopoly of financial or commercial markets, the federal government passed the McFadden Act of 1927, which prohibited banks from branching across state lines. The Glass-Steagall Act of 1933 formally separated commercial and investment banking.
In 1989, after the savings and loan crisis stemming from extensive federal deregulation of the banking industry, the government signed into law the Financial Institutions Reform, Recovery, and Enforcement Act, or FIRREA, to buy and sell failed savings and loans associations, as well as to identify failing institutions before they became insolvent. With somewhat restored confidence in the banking industry, the Riegle-Neal Interstate Banking and Branching Efficiency Act passed in 1994 to allow interstate banking and branching.
Five years later, the Gramm-Leach-Bliley Act eliminated the barriers between commercial banking, investment banking, and insurance and allowed banks to bundle insurance and investment products into their offerings. This act established certain factors for defining permissible banking activities, but left the agencies with significant discretion and little guidance regarding the definition of financial activity. Before the act's passage, banks were permitted to engage only in activities that the Federal Reserve Board determined to be “closely related to banking.” However, the parameters set in the act's language noncommittally allowed banks to engage in activities that were “financial in nature,” “incidental to a financial activity,” and those the Federal Reserve determined “complementary” to a financial activity.
The Government Proposal
The Treasury Department and Federal Reserve's joint proposal requested commentary to determine, by rule, if real estate brokerage and property management are activities that are financial in nature or incidental to a financial activity. Due to the unresolved aspect of the language and the billions of dollars and thousands of jobs at stake, the agencies received tens of thousands of letters from the banking and real estate industries in response to this proposed rule and, as a result, extended the time period for submitting comments.
Banks and financial institution trade associations presented a variety of arguments. First, bank commentators argue that some depository institutions, including thrifts (through service corporations), and some state banks already legally engage in real estate brokerage. Second, banks allege that they have expertise in real estate activities because they broker real estate assets that are acquired through foreclosure or part of trust estates. Third, banks argue that they engage in virtually every other aspect of real estate transactions, such as mortgage lending, community development real estate investments, real estate appraisals, and settlement and escrow services, as well as mortgage and homeowners insurance.
The Real Estate Industry Response
As expected, the real estate industry disagrees with the banking industry's conclusions and actually identifies some of those conclusions as reasons why banks should not be allowed to enter the real estate brokerage and management arena. First, real estate industry commentators state that authorizing banks to engage in these types of commercial activities violates the spirit of the Gramm-Leach-Bliley Act, which maintains a separation between banking and commerce. Second, they point to the various conflicts of interest that would result from allowing banks to participate in real estate brokerage and management. Essentially, the concern is for consumers, who may be pressured or required to use a certain financial company's mortgage products or lending services if purchasing property from it. In addition, buyers could be favored over sellers due to the value added to purchasing relationships. Third, and most important, real estate commentators question a financial organization's ability to broker and manage real estate with the same level of competence, expertise, and personal service as independent real estate agents. Brokerage is a highly specialized activity related to the link between buyers and the best property investments, not finding and/or arranging financing.
Commercial real estate professionals should stay informed on the progress of the Community Choice in Real Estate Act. For updated information on this act including the CCIM Institute's Statement of Policy, as well as other legislative issues affecting commercial real estate, visit the institute's Government Affairs Web page at edchiryoyaku.info/news/gov_index.html.