Bankers vs. Brokers: Disintermediation and the New Financial Landscape of the 1970s

Few parts of American society were spared the effects of price instability in the 1970s, and the financial regulatory state was no exception. Inflation compromised Regulation Q, a rule that capped the rate of interest commercial banks could offer on deposits. Regulation Q mandated, for instance, that yields on passbook accounts never exceed five percent, with the idea that ceilings on interest were also ceilings on risk. If banks kept rates below a certain threshold, they would be unable to make the kind of risky loans that had led to a wave of insolvencies on the eve of the Great Depression. Regulation Q, then, stood alongside deposit insurance and various other New Deal financial reforms that prioritized long-term stability and security over market competition.^{Footnote 7}

In an era of rising prices, however, Americans began to reconsider limitations on interest. In the mid-1970s, the growing disparity between rate ceilings and the Consumer Price Index (CPI) sucked dry the returns Americans received on their money. The disconnect between prices generally and what banks were allowed to offer turned negative real interest into the financial norm.^{Footnote 8} As prices rose and real returns plummeted, Americans began to think differently about the rules of financial intermediation. Regulation Q had long been a small price to pay—a welcome intervention given the country’s experience with reckless financiers and market failure in the 1930s. By 1975, though, it became an outmoded regulatory constraint—an “antique,” according to one industry trade group—that was holding deposits hostage and preventing commercial banks from competing for higher yields.^{Footnote 9}

In 1977, Merrill Lynch, one of the nation’s largest investment banks, devised a product called a Cash Management Account (CMA), which freed deposits from the fetters of regulated interest. The CMA was a hybrid in every sense of the word. It retained all the features of a regular bank account, but broke with convention by anchoring deposits, checks, and credit to a bundle of high-yield securities in the money market. Out were the rate ceilings and in was a high-reward investment portfolio composed of short-term instruments like T-bills and commercial paper.^{Footnote 10} As such, the CMA gave ordinary Americans an escape hatch to Wall Street—a way around the rules that were shackling depository institutions. According to one senator, the CMA gave “little savers” the “only real opportunity to keep ahead of inflation.”^{Footnote 11}

Where new economic conditions met an old regulatory landscape, Merrill Lynch had seen a lucrative opportunity. The CMA was an immediate bonanza and was soon offered nationwide. By 1981, CMA assets were estimated at over $100 billion, and researchers believed that over half of this total came directly out of savings accounts or certificates of deposit. Unable to ignore the instrument’s wild popularity, rival investment firms jumped on the bandwagon and created their own money-market funds (MMFs), prompting a cascade of assets out of commercial banks. Economists came up with the term “disintermediation” to describe this migration of funds to Wall Street.^{Footnote 12}

By sidestepping Regulation Q, however, Merrill Lynch and its imitators raised serious questions about the future of banking. Since the New Deal the industry had been split in two by the Glass-Steagall Act, which separated depository banks that made low-risk commercial loans from investment banks like Merrill Lynch that sold stocks, bonds, and other securities on Wall Street.^{Footnote 13} If a firm took deposits, it stayed out of the money market, and if a firm sold shares in General Motors, it did not offer checking accounts to anyone who walked in the door. Glass-Steagall was just one of the legal partitions that spliced and diced the business of financial intermediation. But MMFs portended a sea change. They blew apart old rigidities by fusing together the two ends of the banking industry. They were a “chef’s salad for every financial taste,” according to one popular outlet, which carved out a more expansive vision of financial intermediation—called “universal” or “broad” banking by journalists. Above all, MMFs expressed a new yearning for one-stop financial shopping. Mutual funds started buying banks. Insurance companies like Prudential showed up on Wall Street. Even nonfinancial organizations like Sears entered the money market. Separate financial spheres were beginning to merge.^{Footnote 14}

MMFs were helping revolutionize American financial markets, but where did the law stand? And where did that leave the commercial banks hurting from disintermediation? Thus far, Congress had provided no guidance, and government agencies had merely announced that new products were under review. Glass-Steagall, though, remained on the books; and commercial banks firmly believed the CMA was slicing apart its legal requirements. But the actual language of the statute was less supportive of such a position. Glass-Steagall’s operative phrase—“no member bank”—was a limitation on one end of the industry. It obstructed commercial bank involvement on Wall Street very clearly, but failed to mention inverse situations when the securities industry encroached onto commercial banking. The law created separation by policing depository institutions, not the investment houses now offering MMFs. The big question was: Would commercial banks bow to the statutory language and allow other financiers to swallow their assets? Their livelihood seemed to depend on looking beyond old regulatory restrictions and finding a way to strike back. The stage was being set for a high-stakes confrontation between bankers and brokers.

Two commercial banks—Banker’s Trust (BT) and Bank of America (BofA)—were the first to retaliate. Weirdly enough, an improv group named Chicago City Limits, which BT had hired as the entertainment for an employee dinner, best described the strategy of both banks. During their performance, the members of Chicago City Limits dressed in medieval garb and spoke fearfully of an “Evil Lord Steagall,” who later appeared in all black and captured several innocent victims. Luckily, a valiant knight named “Lord FastGo” came to the rescue and eventually thwarted Evil Lord Steagall. FastGo, it turned out, was the name of BT’s new division of securities traders. If Merrill Lynch and its imitators were going to bleed banks of their assets, BT and BofA were going to make a play for the riches of Wall Street, irrespective of the legal barricade outlined in Glass-Steagall.^{Footnote 15}

The first such move came in the summer of 1978,when BT’s FastGo division began selling commercial paper, one of the money-market instruments being bundled into MMFs. The second such move came in the spring of 1981, when BofA entered the emerging market for discount brokerage. Brokerage commissions had been fixed for decades by a cartel of participants on the New York Stock Exchange (NYSE). But in 1975 they were finally deregulated. This opened the market to “discount brokers” like Charles Schwab & Co., who made their name by offering rock-bottom commissions on trades.^{Footnote 16} In 1981, BofA announced plans to acquire Schwab. No regulations explicitly prohibited banks from offering commercial paper, discount brokerage, or any other type of financial securities. Glass-Steagall’s language was general. “No member bank” was a broad prohibition that failed to enumerate specific products that were out of bounds. BT and BofA had decided to push the envelope, hoping they might be allowed to enter new markets in the absence of express limitations. The banking offensive was thusly predicated on taking advantage of blank spots in the nation’s financial regulatory laws.^{Footnote 17}

The Securities Industry Association (SIA) promptly asked the Federal Reserve—the government agency in charge of regulating banks—to strike down the two moves. But in 1981, after month-long investigations at both firms, the Fed’s lawyers determined that commercial paper and discount brokerage were “functionally similar” to depository banking and therefore permissible under federal law. A furious SIA maintained that this was a ridiculous interpretation of the relevant statutes and decided to take the agency to court, hoping that federal judges would read the rules differently, put the brakes on deregulation, and protect Wall Street’s inviolable turf.

The pivotal question was where the relationship stood between administrative agencies and reviewing courts in the early 1980s. Were judges in a trusting mood? Were they prone to believe that “expert” regulators usually got it right? Did agency interpretations merit deference? Or should judges—as the apostles of legal interpretation—make the call for themselves? How far should the Fed’s administrative autonomy extend in the American legal system?^{Footnote 18}

If one had asked federal judges in the early 1970s, the answer would have been “not very far.” In 1970 the D.C. Circuit declared that reviewing courts needed to take a “hard look” at agency decisions.^{Footnote 19} Administrative action demanded a “thorough, probing, in-depth review,” the Supreme Court added in 1971.^{Footnote 20} This was a new motto for the federal judiciary. Since the New Deal, judges had granted regulators broad discretion to tackle the complex problems facing modern industrial society. Administrators were enlightened by their expertise and needed independence to engage in what James Landis called “the calm of scientific inquiry.”^{Footnote 21} But the judiciary’s faith in administrative discretion began to dissipate in the late 1960s. Amid fears of regulatory capture,^{Footnote 22} an “imperial presidency,”^{Footnote 23} and calls for openness in government more generally, the courts departed from traditions of deference and began to scrutinize agencies more aggressively. By 1970 it was clear to many judges that the “disinterested” experts hailed by New Dealers were out of touch and not to be trusted, and that the independent judiciary—because of its isolation from corrosive political pressure—could reengage and rectify the situation. Inspired by this “new era” of administrative law, judges used to their powers of review to dramatically expand citizen participation in the regulatory process. Barriers to legal standing were torn down. Federal appellate courts, especially the D.C. Circuit, demanded that agencies provide a laundry list of new procedural rights (like oral hearings, cross-examination, and other trial-type formalities) so that interested parties could contest their decisions more forcefully. Courts, moreover, were quick to reverse agency decisions on the merits, especially if they could show that administrators had failed to consider all the relevant factors and scientific evidence.^{Footnote 24}

By the late 1970s, however, there were rumblings about the new obstacles courts were foisting on federal agencies. Legal scholars worried that by taking on such a “relentlessly activist role” the judiciary was threatening to clog the bureaucracy’s arteries and paralyze the administrative process. “I must confess,” wrote the dean of the University of Minnesota Law School in the mid-1970s, “that on reading recent cases, especially from the D.C. Circuit, I have a feeling that we are being due processed to death.” “We have created opportunities,” echoed Columbia’s Walter Gellhorn, “for the fruitless prolongation of administrative proceedings.”^{Footnote 25} One member of the Supreme Court was convinced. Then an Associate Justice, William Rehnquist had authored two opinions in the early 1970s that chastised lower courts for usurping their role as umpires and improperly meddling with the bureaucracy.^{Footnote 26} In 1978, in a case called Vermont Yankee Power Corp. v. Natural Resources Defense Council, Rehnquist delivered this message once again. In Vermont Yankee Rehnquist delivered a unanimous 7–0 rebuke to the D.C. Circuit, which had saddled the Nuclear Regulatory Commission (NRC) with a maze of new procedural requirements (none of which were required by statute). The lower court’s action amounted to “judicial intervention run riot,” Rehnquist wrote—a form of “Monday morning quarterbacking” that threatened to bring government to a standstill.^{Footnote 27} The American Bar Association called Vermont Yankee an “April shower on judicial review.” Rehnquist’s decision, added The Legal Times, is “nothing less than a major watershed” that established a “new tone” in administrative law—a tone of judicial restraint.^{Footnote 28}

But where did this leave the Federal Reserve and its decisions pertaining to BT and BofA? Most commentators seemed to think Vermont Yankee signaled the beginning of a counter-reformation that would put a lid on judicial review and restore the autonomy of federal agencies. But Joyce Green, a federal judge in Washington, D.C., was not so willing to give the Fed a pass. Speaking for the D.C. District Court in 1981, Green struck down BT’s sale of commercial paper. The agency had got it wrong, Green insisted, and it was her obligation to enlighten regulators with a sound interpretation of the relevant statutes. The broadly worded language of Glass-Steagall was perfectly clear. To Green, the phrase “no member bank” demonstrated that Congress had “intended to pass a flat prohibition.” The statute need not mention commercial paper explicitly because it “drew broad lines” that were wide enough to preclude the Fed’s revisionism. The act’s general purpose was unambiguous, and there were no exceptions to its limitations, even if administrators felt greater and greater heat from the private sector.^{Footnote 29}

A year later the D.C. Circuit reversed and made an opposing argument for deference. Citing a case called Skidmore v. Swift (1944), Judge Malcolm Wilkey chastised Green for giving “insufficient weight” to the agency’s authority. Skidmore was a mainstay of administrative law that had long given judges direction on how to calibrate the scope of judicial review. Under Skidmore there were a handful of factors—like an agency’s “thoroughness of consideration” and “validity of reasoning”—for reviewing courts to consider and that could make or break agency rules. Because the Fed had engaged in an “extensive inquiry” and provided “reasoned conclusions,” Wilkey believed the commercial paper ruling merited deference (or “Skidmore weight”). Hesitant to second-guess the agency, Wilkey needed to ensure only that the Fed’s interpretation was “reasonable,” i.e., not blatantly arbitrary or capricious. This was an easy call. The words “commercial paper” did not appear in the Glass-Steagall Act or its legislative history. Lacking such instruction from Congress, Wilkey respected the reasons provided by regulators. Judge Roger Robb dissented from the majority, censuring Wilkey for allowing the Fed to “contravene the fundamental policy” of the statute.^{Footnote 30}

But the SIA controversy had not met its end. The stakes were far too high. In 1982 commercial paper was a $166 billion market, and Wall Street was in no way eager to open the gates. The SIA immediately asked the D.C. Circuit for a rehearing en banc. When the court denied this request, the group filed for a writ of certiorari to the Supreme Court. The group did the same after the D.C. Circuit deferred to the Fed and allowed BofA to acquire Schwab.^{Footnote 31} Like commercial paper, discount brokerage was taking off as an industry. Schwab was earning more than $100 million annually and was projecting 15–20 percent growth for FY 1983.^{Footnote 32} With both appeals to the Supreme Court, the SIA was attempting to guard its private reserve—to maintain its legal grip on a market that had long been closed to competitors. It sheathed this rent-seeking behavior, however, in appeals to the democratic process. “In each of several recent sessions,” read the SIA’s petition to the Supreme Court, “Congress has enacted major reforms to the federal banking laws, but, in each instance, has determined not to modify existing restrictions on bank securities activities.” Jake Garn, chairman of the Senate Banking Committee, had introduced amendments to Glass-Steagall in the early 1980s. But none of Garn’s proposals made it into legislation.^{Footnote 33} The SIA believe it was undemocratic for deregulation to then proceeded administratively. The Fed’s initiative was reprehensible, the SIA claimed, because “Congress, not the administrative state, [sets] national policy.”^{Footnote 34}

The Supreme Court now had to answer if unelected bureaucrats could be the first movers. Would the nine justices give the Federal Reserve a free hand, as Vermont Yankee suggested they might? Or would the high court rein in administrative autonomy, as it had in the early 1970s? It remained to be seen how the nine justices would adjudicate the controversy between bankers and brokers, and how they would balance respect for expertise with the obligation of judicial review.

Chevron and the SIA Cases at the Supreme Court

In 1984, in a controversy over EPA’s first-ever attempt at emissions trading, the pendulum swung further toward judicial deference. At issue in Chevron U.S.A, Inc. v. Natural Resources Defense Council was an EPA policy that gave industry greater flexibility to comply with the agency’s air-quality controls. In 1979, Administrator Douglas Costle announced that nonattainment areas—those states that had been unable to meet EPA’s New Source Performance Standards (NSPS)—could experiment with something called the “bubble policy” to get in line.^{Footnote 35} Proponents hailed the bubble policy as a cost-effective alternative to “command-and-control” approaches to regulation. EPA’s first round of air pollution controls epitomized this rigid bureaucratic style. Previously, the agency had interpreted a “source” of air pollution under the Clean Air Act to mean specific equipment within individual firms. Under this interpretation, firms needed to make costly alterations to each smokestack or boiler that failed NSPS specifications. The bubble policy promised greater flexibility. It broadened what constituted a “source” of pollution to include whole plants, groups of plants, and even entire regions. By placing imaginary “bubbles” over these larger areas, it relieved firms of the painstaking task of ensuring all their discrete equipment met federal specifications. The bubble maintained the same air pollution standards, but gave firms room to devise more cost-effective ways of attaining them. The whole idea, of course, was that firms knew better than Washington bureaucrats where changes could be made at the lowest price, and needed flexibility to trade and experiment with various abatement strategies.^{Footnote 36}

The bubble policy was a poster child for effective regulatory reform during the Carter and Reagan administrations, but was predicated on an act of legal finesse that environmental groups immediately challenged. To implement the bubble, two EPA administrators—Douglas Costle and Anne Gorsuch—had reinterpreted what constituted a “source” of pollution under the Clean Air Act. The equipment or technology-based definition enforced by previous administrations was rigid and overly costly, according to new, cost-conscious leaders at EPA. But there appeared to be wiggle room to move in a new direction. Neither the Clean Air Act nor its legislative history explicitly defined the term “source,” and so the agency, in the absence of congressional intent, moved to broaden the reach of the statutory phrase. The question in Chevron was whether the Clean Air Act could be construed so elastically. Did agencies have authority to “adapt definitions” to new contexts; in the EPA’s case, to a political environmental more attentive to rising costs and prices? Or was there a single correct meaning, as the environmental lobbies claimed, that needed to remain on the books?^{Footnote 37}

In Chevron, Justice John Paul Stevens announced a two-step formula that allowed for flexible interpretations like the bubble policy. The first step for reviewing courts was to gauge legislative intent. If the meaning of the statute was clear, judges merely had to ensure that the agency’s reading followed the congressional mandate. If, however, Congress had not addressed the question at issue and left the statute ambiguous (think “source”), courts were compelled to follow step two and defer to agency interpretations as long as they were “reasonable” (i.e., not arbitrary or capricious). If Congress “has not commanded” one interpretation, Stevens explained, it made little sense to require a “static judicial definition” that prevented agencies from filling the gap in reasonable ways. At the core of Chevron deference were sweeping declarations of judicial restraint. “Policy arguments like the ‘bubble concept,’” Stevens wrote, “are more properly addressed to legislators or administrators, not to judges.” “Judges are not experts in the field, and are not part of either political branch of the government.” They had a duty, Stevens concluded, to “respect legitimate policy choices made by [administrators].”^{Footnote 38}

Stevens’s two-step framework was a doctrinal departure that contained revolutionary potential. Skidmore v. Swift (1944) was generally the starting point for judicial review of agency action. It pointed judges (like Malcolm Wilkey in the commercial-paper suit) to a variety of factors to determine how much “weight” was due to agency decisions. If those factors swayed a reviewing court, it was common for judges to defer to regulations provided they were “reasonable.” Chevron, though, had the potential to streamline the path to deference. Courts granted Skidmore deference after considering a bundle of different items, and it was often unclear what judges should weigh and when and to what extent they should weigh it. Chevron put deference into a two-step straightjacket—into a simpler rule predicated only on the question of legislative intent contained in step one: Had Congress clearly defined the statutory provision? Often, the answer was no. It was hard for Congress to speak with perfect clarity. Federal statutes, old and new, were ridden with complexities and internal ambiguities. If the two-step framework germinated within the judicial branch, agencies might have greater autonomy to mold these statutes as they saw fit.

How clear were the statutes at issue in the SIA cases now before the Supreme Court? Justice Harry Blackmun, who authored the majority ruling on commercial paper, maintained that the meaning of Glass-Steagall was plain. Like Green, Blackmun argued there were no exceptions to the sweeping statutory language, even if, as BT’s attorneys argued, the Fed was “the expert in the business.” Sandra Day O’Connor, joined by Justices Brennan and Stevens, argued in a dissent that judges were ill-equipped for such complex financial matters:

The dissenters believed Chevron deference, which Stevens had announced only three days before the ruling on commercial paper, represented the correct approach. Indeed, there was an argument to be made that Glass-Steagall was at least partly ambiguous. Section 16 of the act suggested that commercial banks could sell securities in certain rare instances. If they behaved solely as a customer’s agent and avoided taking a direct ownership interest in securities, banks could sidestep Glass-Steagall’s otherwise blanket restrictions. The idea of Section 16 was that if banks avoided such an ownership interest, they would be immune from responsibility, shielded from risk, and could facilitate securities trades “without recourse.” At the Supreme Court, Blackmun had defined commercial paper as a “security,” but had left open the question of whether FastGo was illegally “underwriting,” “issuing,” “distributing,” or “selling” those securities per Section 21, or if the bank was acting within the narrow exception established by Section 16. Unwilling to make the call himself, Blackmun remanded this question back to the agency for additional fact-finding.^{Footnote 40}

The Supreme Court’s other SIA decision offered a preview of how a single ambiguity might transform the regime of American financial regulation. From the beginning of the discount brokerage controversy, the SIA had maintained that, by allowing BofA to absorb Schwab, the Fed had violated Section 20 of Glass-Steagall. That provision stipulated that no member bank be “affiliated in any manner with any corporation, association, business trust, or other similar organization engaged principally in the issue, flotation, underwriting, public sale, or distribution of stocks, bonds, debentures, notes, or other securities.” Discount brokerage amounted to the “public sale” of stock, according to Wall Street’s lawyers, and by this logic courts should prevent BofA from acquiring Schwab. But Justice Lewis F. Powell disagreed. “Public sale,” Powell wrote for the Supreme Curt, needed to be read in light of the terms surrounding it in Section 20. “Issue,” “flotation,” “underwriting,” and “distribution” all referred to situations that involved ownership interest, and so too did “public sale,” Powell argued, as Congress groups terms together only if they share a similar meaning. But brokers like Schwab never shouldered an ownership interest because they merely facilitated trades. They never actually held onto shares they sold. Provided Schwab sold stock “without resource” under Section 16, it could be absorbed by BofA. Powell had allowed a commercial bank to sell stock to the public and yet escape the public sale limitation of Section 20. Powell had allowed the exceptional language of Section 16—Glass-Steagall’s one ambiguity—to percolate into other unambiguous provisions.^{Footnote 41}

BT saw an entering wedge in Powell’s opinion. For several years the bank had instructed FastGo to repurchase commercial paper it had failed to sell to investors. But this was just the kind of practice that produced ownership interest—that led to the kind of direct liability that was impermissible according to the Supreme Court’s recent message on the boundaries of Section 16. In the summer of 1985 BT officially terminated the practice of repurchasing commercial paper and petitioned the Fed once again for permission to sell the security. The agency subsequently announced that BT was selling securities “without recourse” in compliance with federal law. An unblinking SIA challenged the latest endorsement of commercial banking privileges, ensuring that federal courts would need to grapple once more with the same legal questions.^{Footnote 42}

How would the Fed’s amended decision fare in yet another round of judicial review? Would future judges be as willing as Powell to identify ambiguities in the regulatory scheme? Would they bow to the Fed’s ruling and let Section 16 pry open the rest of Glass-Steagall? Or would they see beyond narrow exceptions to the broader legislative purpose (in the tradition of Joyce Green and Harry Blackmun)? Furthermore, how might Chevron affect the judicial calculus? Thus far, the new approach to deference had not been fully realized. Justice O’Connor had alluded to the two-step framework in a dissent, but only two of her peers had taken the bait. Stevens’s opinion read like a major watershed, but had not yet earned the jurisprudential clout that comes with custom and usage. There had been no outpouring of Chevron citations on the courts of appeal, and even the initial applications had been narrowly tailored.^{Footnote 43} Legal historians are aware, however, that judicial doctrines are not set in stone. They are subject, in the words of Edward Purcell Jr., to patterns of “shifting reinterpretation” and can take on different meanings over time. Would Chevron remain on the sidelines during the second round of securities litigation? Or would it grow in the intervening moment into a more powerful deference doctrine? When the second iteration of the SIA controversy reached the D.C. Circuit, it fell in the hands of a judge who was enthused by the ruling’s deregulatory potential.^{Footnote 44}

Conceiving Administered Deregulation

Law school at the University of Chicago was a formative experience for Robert Bork. Bork had campaigned for New Deal Democrats as an undergraduate, but by the time he earned his J.D. in 1953 he had transformed into a free-market purist who looked askance at the growing number of rules being issued by federal regulatory agencies. A professor named Aaron Director had been instrumental in Bork’s transformation. At UChicago, Director was an antitrust scholar who believed firmly in the tenets of classical economics—especially in the idea that markets were perfectly competitive and always self-corrected.^{Footnote 45} To Director, it followed that restraints of trade were “inherently unstable” in a competitive marketplace, and, in turn, that the Sherman Act and various other antitrust laws were entirely pointless. Director’s approach was the beginning of “law and economics.”^{Footnote 46} It inculcated in students like Bork an undying faith in private ordering and an inherent skepticism of government intervention. After practicing law in the 1950s, Bork returned to the legal academy and extended many of his mentor’s critiques.^{Footnote 47}

By the early 1970s, Bork had attained scholarly stature, and was regarded as an expert not only of law and economics but also constitutional interpretation. Bork became the most ardent proponent of originalism—the form of interpretation that insists judges follow only the intent of the framers when adjudicating controversies. Bork thought that if judges adhered to original meaning, they would stop legislating from the bench and reading unenumerated protections into the Constitution. Originalism would be a lid on judicial overreach and the result-oriented tendencies of the federal courts.^{Footnote 48}

Bork’s antipathy for both regulation and judicial activism earned him a place on the D.C. Circuit during the Reagan administration. The D.C. Circuit had been a bastion of “legal liberalism” during the 1960s and 70s.^{Footnote 49} Led by the likes of David L. Bazelon and J. Skelly Wright, the court had gained notoriety for scrupulously reviewing agency decisions and for foisting a laundry list of new procedural requirements onto federal agencies. The legal advisers in the Reagan White House knew Bork would be a very different kind of judge. He was the perfect fit in an administration that was hostile to both red tape and an unruly judiciary. In February 1982, Bork began his career on the nation’s second-most important tribunal.^{Footnote 50}

Two of his conservative peers on the D.C. Circuit had already theorized about how the pillars of Bork’s philosophy—neoclassical economic theory and judicial restraint—could be blended together. Antonin Scalia, who was confirmed to the court in the summer of 1982, provided the first outline of such a vision. Scalia was a rising star in the field of administrative law. After a number of stints in the executive branch, he returned to academia in the late 1970s and began editing Regulation, a trade journal supported by the conservative American Enterprise Institute. The journal’s main contributors were legal scholars, economists, and policy experts, almost all of whom published to advocate for deregulation.

In 1981, just a year before his judicial appointment, Scalia wrote his own Regulation op-ed about the role government agencies should play in the deregulation movement. Titled “The Game Has Changed,” the op-ed argued that the proponents of deregulation needed to rethink their use of administrative power: “All those who seek to reverse the trend of increasing governmental control are not only less eager than their political opponents to grasp the levers of government power, but are also more likely to view all impediments to the exercise of that power as a victory for their cause.”^{Footnote 51} Scalia was chastising critics of regulation for their unwitting acceptance of a false assumption. Impeding the administrative state was not, as it seemed, the best way to implement a deregulatory agenda. Many proposals being billed as deregulation contained such a damaging tendency. Since 1975, opponents of “overregulation” in Congress had tried to pass something called the legislative veto, a controversial new procedure that would have sent all proposed regulations to Capitol Hill for rejection or approval.^{Footnote 52} Legislators had also floated something called the Bumpers Amendment, which would have eliminated deference to agencies and thrown regulations into perpetual litigation.^{Footnote 53} Underlying these proposals, Scalia argued in the pages of Regulation, was the idea that if you “enfeeble” administrators, you make it more difficult for them to pursue their agency’s mission and expand regulatory programs.

In “The Game Has Changed,” however, Scalia maintained that obstructionism was an imprudent strategy for the conservatives now in charge of the bureaucratic establishment:

The “accursed” regulatory bureaucracy could move in a different direction, but only if its autonomy remained intact. Now that agencies were being run by free marketeers, they should not be deplored and politically assaulted; they needed to be wielded energetically in order to tear down bureaucratic scaffolding. New administrators could help deconstruct the federal apparatus, but only if surrounding institutions in the federal system left their discretionary authority intact. Scalia was singing a tune written by New Dealers, but with a very different end in mind.^{Footnote 55}

Ken Starr, a former executive branch lawyer, believed Chevron was the legal lynchpin of Scalia’s vision. After joining the D.C. Circuit in 1983, Starr argued in a law review article that Chevron could give agencies the boost they needed to change course. The two-step framework amounted to a transfusion of institutional authority—out of the courts and into federal agencies—that would give administrators greater control over hazy legal provisions. Starr believed that with the benefit of Chevron deference an agency could claim the new privilege of “[changing] its mind about the meaning of a statute.” This privilege, in turn, would “make it easier for an administration to oust on old regulatory order” and thus “recast the regulatory state.” If Scalia was right—if critics of regulation needed to embrace the bureaucratic toolkit in order to pursue their agenda—Starr believed Chevron was a vital mechanism to help them do it. Together, Bork’s conservative peers on the D.C. Circuit were describing and actively encouraging the process I call “administered deregulation.”^{Footnote 56}

Still, their pleadings were hot air if Chevron remained on the sidelines. If the two-step framework did not take off—if it never grew into a doctrinal command—then Scalia’s and Starr’s vision would never come to fruition. If Chevron germinated into a legal mandate, however, then the new members of the D.C. Circuit might find the opportunity to activate its deregulatory potential.

As it turned out, the prospects for administered deregulation were increasingly promising by the end of 1984. Few judges had cited Chevron after it had been handed down, and when judges had drawn on Stevens’s opinion, they had applied it rather narrowly. But in the fall of 1984, one member of the D.C. Circuit championed a much broader reading. “The Supreme Court,” wrote Judge Patricia Wald, “has recently outlined our proper task in reviewing an administrative construction of a statute that the agency administers.”^{Footnote 57} “As we understand the Supreme Court’s most recent pronouncements in Chevron,” Wald continued, “our inquiry consists of two steps.” “If we conclude that ‘Congress did not actually have an intent’ . . . we are required to grant a considerable degree of deference.”^{Footnote 58} To Wald, Chevron was a set of authoritative instructions. It was a clear formula that now governed acts of administrative interpretation. Two opinions by Justice Byron White^{Footnote 59} and one by Chief Justice Warren Burger^{Footnote 60} indicated that two-step deference was also gathering steam at the Supreme Court. By 1985 there were more decisions and law review articles that embraced, in the words of Judge Wald, the “broader view of Chevron’s mandate.”^{Footnote 61} Stevens’s decision was slowly but surely becoming a powerful legal rule.^{Footnote 62}

While it would be easy to view Chevron’s rise as a product of deregulation, this article steers clear of such tempting behavioralist claims. Chevron was part of a longer, more textured legal history that belies the idea that Reagan-era jurists captured the law for political purposes. By the mid-1970s, most legal scholars and practitioners agreed that reviewing courts—particularly the D.C. Circuit—had been too hard on agencies and in doing so had threatened to inhibit the functioning of the regulatory process. This thinking produced the holding in Vermont Yankee. Chevron merely represented an additional step in the march toward judicial restraint. It was part of a broader effort to scale back judicial oversight of government agencies. Chevron’s raison d’être was deference, but deference, as Scalia and Starr were well aware, could help unleash deregulation. Deference would eliminate the “problem of judicial review,” Scalia noted again in 1986, when an agency moved in a “deregulatory direction.” Deregulation did not beget administrative law, but a new cohort of judges posited that the law—in certain instances—could be wielded and applied in a deregulatory manner.^{Footnote 63}

When Judge Bork intervened in the SIA controversy, he launched the process of administered deregulation in the financial sector. “We must look to Chevron,” Bork wrote in his 1986 decision on commercial paper, “to guide our application of judicial review.” Step one was easy. Congress had passed Glass-Steagall to prevent depository banks from selling securities, but it had never been explicit about sales of commercial paper. Of course, one could argue that the act’s general prohibitions were sufficiently broad. But Bork saw ambiguity in the statute’s lack of specificity. He accordingly moved to Chevron’s second inquiry: Had the agency filled the gap reasonably? Bork answered step two by addressing the interplay between Section 16, Glass-Steagall’s only loophole, and the act’s more restrictive provisions. He determined that agency interpretations could “impair one of the statute’s purposes but not others” and still be “reasonable.” As long as the Fed’s ruling satisfied at least one snippet of the regulatory framework, it could stand legal muster, even if it defied adjacent legal restrictions. “We defer as Chevron requires,” Bork wrote, “to the [Fed’s] reasonable conclusions.” He had, in the words of the SIA, “[transformed] narrow statutory exceptions into broad authorizations.”^{Footnote 64} But this was just the kind of move that was now permissible under Chevron. In June 1987, the Supreme Court endorsed Bork’s conclusions by denying cert. After nine years of litigation, BT was finally allowed to enter the market for commercial paper.^{Footnote 65}

With Chevron, Bork also opened discount brokerage to eager commercial banks. Banks had flooded the Fed with applications after Justice Powell allowed BofA to acquire Schwab. National Westminster Bank was just one of the firms that had petitioned to offer new brokerage services. When NatWest received the agency’s blessing, the SIA predictably filed suit, arguing that Section 20 of Glass-Steagall forbade such a “public sale” of securities. On appeal at the D.C. Circuit, Bork deployed the interpretation of Justice Powell. Once again, he argued that Glass-Steagall was silent on the precise question at issue, and proceeded to the softer standard contained in step two. The Fed’s order was reasonable, Bork determined, because NatWest (like Schwab) did not take an ownership interest in stock and behaved instead as a “disinterested agent” per Section 16. Bork had deployed Powell’s interpretation but folded it into Chevron’s powerful deference framework, corroborating to the private sector that administered deregulation would proceed undisturbed.

It was hard to question Bork’s application of Chevron, for he had shown that the Fed’s decisions—on both commercial paper and discount brokerage—contained inklings of “reasonableness,” if only interstitially. It would be more difficult, however, for Bork to claim he had remained true to statutes that were still on the books. Bork knew, though, that Chevron’s quick crystallization lowered the bar for agencies’ legal interpretations. The Supreme Court affirmed as much when it let stand the decision from below.^{Footnote 66}

By the late 1980s, Chevron had lent a sense of finality to a controversy that had ping-ponged around federal court for almost a decade. Banks had sprinted ahead of old regulatory statutes since the 1970s and had been sanctioned in their actions by amiable regulators. But litigation by the deep-pocketed SIA had left open the possibility that the Fed’s interpretive moves would be struck down. Chevron eliminated that possibility. It settled—once and for all—the question of agency discretion, and erected a powerful shield that enabled the Fed to construct a new regulatory order. Following Bork’s pair of rulings, cracks in Glass-Steagall grew wider and wider. Citicorp, J.P. Morgan, and Chase Manhattan were among the big banks that ascertained the path of the law and applied to the Fed for permission to sell even more types of securities. The SIA challenged each of the agency’s subsequent endorsements, but repeated applications of Chevron, and the Supreme Court’s consistent denial of cert, drowned out the whimpers of Wall Street.^{Footnote 67}

Fissures had opened in American financial regulation. Securities divisions like FastGo and Schwab opened at a cross-section of depository banks. At first, the new divisions could account for no more than five percent of their firms’ total revenue, but regulators steadily raised this bar over time. As one congressman put it in the late 1980s, “Glass-Steagall doesn’t look the way it used to. . . . It has been so riddled with holes that it looks more like a piece of Swiss cheese than a statute intended to separate the markets of banking and commerce.” The weakening of financial regulatory controls was a “quiet revolution,” though, that occurred in the absence of congressional action. Different legislators had championed Glass-Steagall reform throughout the SIA controversy. But none of their proposals got off the ground. With Congress stuck in neutral, both the Fed and reviewing courts had faced immense pressure to serve as the engines of policy change. Financial markets were being transformed by a new economic context, and other countries had been quick to accommodate. The Thatcher government had moved quickly on deregulation, and Japanese banks, respectively, were emerging in a variety of securities fields. Inaction was simply unacceptable on the American side. To redraw the regulatory map, the Fed and the D.C. Circuit massaged the requirements of the law, even though legislators themselves had refused to do so.^{Footnote 68}

But administrative action and judicial decisions were stepping stones for more enduring policy reforms. The first steps toward one-stop financial shopping were slow and measured, but deregulation kept gaining steam with the legal threshold crossed. As the new securities divisions gained a tighter foothold at commercial banks, policymakers invoked them to support broader changes in financial regulatory policy. In the late 1990s they featured centrally in congressional debates that were much friendlier to Glass-Steagall restructuring. Elected officials saw them as proof that innovative financial markets had outgrown archaic regulatory controls. “Financial modernization,” Treasury Secretary Robert Rubin declared before the Senate Banking Committee, “is already taking place, and, in my view, will take place with or without legislation.” But “legislation,” Rubin insisted, “would carry the process forward in a more orderly fashion.”^{Footnote 69} Now was the moment, in the secretary’s estimation, for Congress to step in and retroactively validate what the market had already decided. But the modernization process to which Rubin referred—which continued apace after the 1999 Gramm-Leach-Bliley Act^{Footnote 70}—cannot be understood as a sterile phenomenon which incubated in a competitive vacuum within the private sector. Deregulation was nurtured by the administrative state and its new powers of interpretation ratified by the federal courts. Americans often hear the “genius” of the market contrasted with the crushing impact of the federal government, as if private and public are mutually exclusive and sit in perpetual opposition. Legal and political historians are aware, however, that the boundaries are far more permeable. It is up them to craft a more textured account of state and society in twentieth-century America.^{Footnote 71}