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Why an Arizona Immigration Law Could Mean Trouble for Big Banks

A decision by the Supreme Court last week upholding an Arizona law imposing harsh penalties on businesses that hire illegal immigrants could foreshadow a serious regulatory headache for national banks that have local mortgage lending subsidiaries.

The majority opinion, written by Chief Justice John G. Roberts on behalf of the court’s five more conservative members, said that Arizona was allowed to add much tougher state penalties to those contained in a 1986 federal immigration law. In legal terms, the court held that federal law did not “pre-empt” the states from enacting and enforcing local licensing laws when it comes to employing illegal immigrants.

In reaching this conclusion, the majority opinion rejected the argument that Congress intended the federal system to be exclusive.

“Implied preemption analysis does not justify a ‘freewheeling judicial inquiry into whether a state statute is in tension with federal objectives;’ such an endeavor ‘would undercut the principle that it is Congress rather than the courts that preempts state law,’” the opinion declared, quoting past cases.

So what does this have to do with banking regulation?

The narrow reading of preemption in this case may undercut a broader reading the Supreme Court gave in 2006 to pre-empt a broad reading under the National Banking Act. That case was decided by a vote of 5-3, with Justice Clarence Thomas sitting out because his son and daughter-in-law worked for the bank in question.

The contest in the banking case was whether states could regulate the state chartered subsidiaries of nationally chartered banks. The state subsidiaries are used by national banks to make mortgage loans, auto loans, small business loans and provide investment advice.

The Supreme Court ruled in that case that the immunity from state regulation that nationally chartered banks enjoy under the National Banking Act extended to their operating subsidiaries. It read preemption broadly—perhaps too broadly—on the grounds that immunity from state regulation was a necessary consequence of provisions on the law that allowed national banks to own local operating subsidies.

It was decided, that is, by having the majority engage in a “freewheeling judicial inquiry into whether a state statute”

conflicted with federal objectives—rather than reliance on a clear statement by Congress of an intent to pre-empt local regulation.

So what’s changed since the banking pre-emption case was decided in 2006? Well, the Supreme Court’s membership has changed. Of those who voted for pre-emption in 2006, only Justices Kennedy, Ginsberg, Breyer and Alito remain. Justice Souter is gone. So the banking pre-emption majority no longer exists.

The Justices who opposed pre-emption in the 2006 case have also lost one of their ranks: Justice Stevens, who wrote the dissenting opinion.

But they still have Justices Scalia and Roberts, plus a likely vote from Justice Thomas (a consistent opponent of pre-emption).

The question is how Justices Sotomayor and Kagan might vote. Kagan sat out the recent immigration pre-emption case. Sotomayor dissented from the opinion that ruled against pre-emption—but used language that might not give comfort to banks.

“I do not mean to suggest that the mere existence of a comprehensive federal scheme necessarily reveals a congressional intent to oust state remedies,” Sotomayor wrote in her opinion.

What’s more, Sotomayor and Kagan both might be more disposed to allowing local regulation in light of the financial crisis. Especially if Republicans succeed in watering down the Consumer Finance Protection Agency, we might see liberal justices leaning against pre-emption in banking regulation.

So does this mean the 2006 ruling will be overturned?

I wouldn’t make that prediction now. But the immigration case certainly seems to be in tension with the banking case.

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