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The structure of the U.S. financial services industry has been transformed during the past two decades by the combined forces of new technologies, deregulation and financial innovation. Large banks, securities firms and life insurers have responded to these forces by pursuing a twofold consolidation strategy - acquiring direct competitors within their traditional industry sector and making cross-industry acquisitions in other sectors. The Gramm-Leach-Bliley Act of 1999 ratified the ongoing trend toward cross-industry consolidation and facilitated the creation of large financial conglomerates. Based on empirical studies and the experience of the past two decades, it is highly doubtful whether the predicted benefits of financial conglomeration (e.g., greater efficiency, profitability, safety and convenience) will actually be realized. In addition, financial conglomeration has intensified the problem of systemic risk in the financial markets and has increased the probability that the "too big to fail" ("TBTF") doctrine will be applied to major financial holding companies. Current supervisory approaches (including the proposed new Basel capital accord) are inadequate to cure the problems of supervisory forbearance and moral hazard that have been created by the TBTF policy. I propose a new plan for bank regulation and deposit insurance that will (1) insulate the deposit insurance funds from the cost of TBTF bailouts, (2) require financial conglomerates to internalize the costs of such bailouts, and (3) encourage greater market discipline over such institutions.

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