Segment 1 Of 3     Next Hearing Segment(2)

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House of Representatives,
Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises,
Committee on Banking and Financial Services,
Washington, DC.

  The subcommittee met, pursuant to notice, at 10:13 a.m., in room 2128, Rayburn House Office Building, Hon. Richard Baker [chairman of the subcommittee] presiding.

  Present: Chairman Baker, Representatives Lucas, Cook, Snowbarger, Riley, Hill, Sessions, Bachus, Roukema, Kanjorski, Vento, Roybal-Allard and LaFalce

  Chairman BAKER. I would like to call our hearing to order this morning, and welcome everyone. This morning's hearing is intended to, again, discuss further elements of importance with regard to financial systems services modernization--certainly not a new subject to either one of our witnesses this morning.

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  We were visiting just momentarily, saying that in their respective responsibilities perhaps they have been talking about this subject now for some 20 years. In reading the legislative history, it is apparent this subject has been discussed for the better part of a half-century. So this probably will not be the last hearing or the last discussion, I have a suspicion; but hopefully, it will be helpful to the subcommittee in understanding the real concerns that should be addressed in moving forward with the restructuring of the delivery of financial services in this country.

  I have a written statement which I will introduce into the record, but certainly wish to comment that this important discussion will lead, hopefully, to full committee consideration later in the spring. And I am optimistic that, by working together, we can come to some resolution that will indeed better serve consumers without enhancing the probability of risk to the taxpayer.

  With that, I will ask Mr. Kanjorski if he wishes to make any opening comment.

  [The prepared statement of Chairman Baker can be found on page 112 in the appendix.]

  Mr. KANJORSKI. Thank you very much, Mr. Chairman. And in light of your brief opening remarks, I will join you and ask permission to insert into the record my full statement.

  Mr. Chairman, I want to compliment you in starting this process. I want to assure all the participants, both on your side of the aisle and those who will testify, that I feel rather good about this whole process, insofar as I have looked at your bill, Mr. Leach's bill, and Mrs. Roukema's bill. And I look forward to the submission of the Administration's recommendations and their bill.
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  And I enter into these proceedings with an open mind, looking forward to being convinced. We have had a great beginning of dialogue at the session that you called last week. I look forward to more of those informative sessions. And with that, let us get on toward financial services reform in a big and important way. Thank you, Mr. Chairman.

  [The prepared statement of Mr. Kanjorski can be found on page 114 in the appendix.]

  Chairman BAKER. Thank you, Mr. Kanjorski. And on that note, the bank study group--I will take advantage to make a little paid announcement here--will have another meeting next Wednesday afternoon at 4:00. And Deputy Secretary Hawk will be visiting with the study group. So Members interested in hearing his perspectives, I would encourage you to participate in that opportunity.

  Would any other Member choose to speak?

  Mr. Snowbarger.

  Mr. SNOWBARGER. No, Mr. Chairman.

  Chairman BAKER. Mr. Cook.

  Mr. COOK. No.

  Chairman BAKER. Mr. Hill.
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  Mr. HILL. No, Mr. Chairman.

  Chairman BAKER. Mr. Bachus.

  Mr. BACHUS. No.

  Chairman BAKER. Mrs. Roukema.

  Mrs. ROUKEMA. No.

  Chairman BAKER. Mr. LaFalce.

  Mr. LAFALCE. No.

  Chairman BAKER. I would then like to welcome our first witness, the Comptroller of the Currency, certainly no stranger to the subcommittee. And I do appreciate your willingness to come back and again talk about this most difficult subject. Mr. Eugene Ludwig, welcome and good morning.


  Mr. LUDWIG. Thank you. Good morning. Mr. Chairman, and Members of the subcommittee, I welcome this opportunity to offer my views on financial modernization. I want to commend you, Mr. Chairman, Ranking Minority Member Kanjorski, Congressman LaFalce, and Congresswoman Roukema, for focusing attention on this important subject. I have a prepared statement that I would like to submit for the record. I want to summarize the key points today.
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  Over the past several decades, Congress has considered numerous proposals to modernize the laws that govern financial services in this country. For various reasons, all these efforts have been unsuccessful, and as a result, our Nation's banks continue to operate under an antiquated legal and regulatory framework.

  This year, we have a real opportunity to correct that problem. Consumers, communities, and the American economy stand to gain a great deal from meaningful reform. To achieve that reform, however, we must move beyond debating how to shuffle the boxes into which we have tried to cram banks, insurance companies, securities firms, and other financial services providers.

  Rather, we need to take a fresh look at the entire legal framework governing financial services. Our goal should be to promote a vigorously competitive financial marketplace, while safeguarding the safety and soundness of our financial institutions, fair access to financial services, and vital consumer protections.

  In an age of rapidly changing communications and computer technology, banks and other financial competitors must have the flexibility to serve an evolving economy and changing consumer needs. This is not just an academic argument. Government restrictions on financial institutions that are not clearly justified by safety and soundness or other public policy concerns, hurt the long-term health of our financial institutions. Equally important, these restrictions hurt small banks in particular, and the ability of all financial institutions to meet the needs of consumers, poor people, and small businesses. Simply stated, absent clearly demonstrable public policy concerns, it is not government's business to tell financial services providers how to structure their businesses.
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  Obviously, one relevant policy concern is the safety and soundness of our Nation's financial institutions. Over the past 15 years, we have learned through hard experience that effective supervision is our most important tool to ensure bank safety and soundness. In fact, many, including myself, believe that banking problems in the past 15 years resulted from outdated legal restrictions on bank activities, which pressured banks to take increasingly greater risks or become excessively-concentrated in those lines of businesses that were available to them.

  With that experience in mind, a consensus has developed that banks must be permitted to broaden their activities. But old habits and old ways of thinking die hard. There is no consensus on how banks should be permitted to structure those activities.

  Some argue that banks must be forced to use holding company affiliates rather than subsidiaries to avoid giving banks an unfair competitive advantage. They contend that banks benefit from a kind of subsidy through Federal deposit insurance and participation in the payments system and discount window, whereas bank holding companies are less likely to benefit to the same extent.

  This argument simply does not stand up to analysis. First, the best evidence is that no net subsidy exists. While banks gain some benefit from deposit insurance and participation in the payments system and discount window, they are also subject to significant regulatory burdens, including compliance costs, examination fees, deposit insurance premiums, FICO bond payments, and the obligation to hold a portion of their deposits in sterile reserves.

  The FFIEC estimates the cost of regulatory burden for the banking industry to be at least $9 billion per year. That is even without considering the cost of deposit insurance, foregone interest on sterile reserves, and interest payments on FICO bonds. This $9 billion translates into about 30 basis points, that is, 30 cents for every $100. These costs more than offset any net benefit from the safety net that banks might enjoy, which, in the case of deposit insurance, our economists estimate to be about four basis points, or 4 cents per $100.
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  Second, bank behavior is consistent with the economic analysis that shows no net subsidy. If a subsidy existed, we would expect banks to take full advantage of it in the way they structure their operations today. But that is not the case. Where banks have a clear choice of how to structure their non-banking operations, there is no clear pattern. Banks currently conduct activities such as mortgage banking and data processing sometimes through a holding company affiliate, sometimes directly in the bank, and sometimes in a bank subsidiary.

  Nor do banks fund themselves as if a subsidy exists. If bank-issued debt is subsidized, we would expect banks to issue all their debt at the bank level. Yet many companies issue debt at the holding company level, and sometimes then downstream the funds to the bank.

  If insured deposits give banks a significant funding advantage, one would expect to see uniform reliance on them to raise funds. In fact, less than 60 percent of commercial bank assets are backed by domestic deposits, and foreign deposits range from 0 to 61 percent of liabilities at the 10 largest holding companies.

  Further, if a funding subsidy existed, we would expect banks to dominate markets where they are competitors. In fact, exactly the opposite is true. Over the past half-century, banks have lost market share in core banking services, and they certainly do not dominate new markets for non-traditional bank activities.

  Proponents of the funding subsidy argument argue that requiring banks to provide new services through holding company affiliates limits the benefits of the subsidy and promotes a more level playing field. I strongly disagree. Even if there were a subsidy, a bank could pass it up to a holding company to fund an affiliate just as easily as it could pass it down to fund a subsidiary.
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  Containment of any theoretical subsidy depends not on where we place new activities in the financial organization chart, but on the restrictions we impose on transfers between a bank and its subsidiaries or affiliates, and on vigilant supervision. We could restrict transfer of any subsidy to a bank subsidiary just as effectively as to a holding company affiliate.

  Those who advance the subsidy argument point to the small bond rating differential between bank debt and holding company debt as evidence of the alleged funding advantage. But Standard and Poor's and Moody's, the ratings services, find the difference reflects the ability of the Federal banking agencies to limit payments from the bank to the holding company in times of distress, rather than a bank safety net benefit.

  Taken to its logical conclusion, the subsidy argument is not just an argument against giving financial firms the freedom to determine their own corporate structure. It is an argument against financial modernization itself. For proponents of the argument themselves suggest that there would be no way to prevent at least some benefit associated with the subsidy that banks supposedly enjoy from leaking to the holding company and affiliates. Thus, in order to truly prevent banking companies from exercising an unfair advantage, it would be necessary to confine banks and all their affiliates to a narrow range of activities.

  But we should not let an unsupported hypothesis that banks enjoy a subsidy dissuade us from pursuing financial modernization. And we should not let an unsupported hypothesis dissuade us from adhering to a fundamental principle that should underlie modernization. Financial institutions need the freedom to manage their activities and structure their operations in a way that best suits their needs and the needs of their customers. Allowing these institutions to engage in new activities on the one hand, but imposing an artificial structure on the other, will impede--rather than promote--safety and soundness. It will not limit any more effectively their use of the alleged subsidy, even if the subsidy actually existed. And it will impose substantial costs and inefficiencies on the financial services industry that limit the industry's ability to prosper, to serve America's consumers and communities, and to compete in the global marketplace.
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  Forcing all financial institutions into a single structure, such as the bank holding company, would certainly increase costs for small banks, in some cases so much that the activities would not be profitable for them at all. It would deprive all banks of potential sources of earnings that could help them weather economic downturns. And it would shrink the assets and earnings available to the bank to meet its obligation under the Community Reinvestment Act to serve the needs of all its customers, including low-and moderate-income customers and small businesses.

  In the absence of compelling public policy concerns, there is simply no justification for government depriving individual institutions of the freedom to choose how to provide financial services. There is every reason for government to leave these decisions to the discretion of the private sector. The result will be strong, healthy, well-diversified financial institutions that can weather economic downturns and continue to provide financial support to the Nation's economy and financial services to the Nation's businesses, communities, and citizens. Thank you very much.

  [The prepared statement of Mr. Ludwig can be found on page 121 in the appendix.]

  Chairman BAKER. Thank you, Mr. Ludwig. We very much appreciate your remarks.

  Our next witness this morning is, again, certainly no stranger to our subcommittee. Welcome, Ms. Helfer, Chairwoman of the FDIC. Welcome.


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  Ms. HELFER. Thank you very much. Mr. Chairman and Members of the subcommittee, I appreciate this opportunity to present the views of the Federal Deposit Insurance Corporation on financial modernization and related issues. I commend you, Mr. Chairman, and Congressman Kanjorski, for placing a high priority on the need to modernize and strengthen the Nation's banking and financial systems.

  Current restrictions on the financial activities of banking organizations are outdated. Their elimination would promote the efficient, competitive evolution of financial markets in the United States. One of the lessons of the 1980's is that geographic constraints and product restrictions do not insulate depository institutions from competitors, and can present safety and soundness problems because of the lack of diversification.

  Congress eliminated many geographic constraints by enacting the Riegle-Neal interstate legislation in 1994, but remaining product barriers limit the opportunities for financial institutions to diversify and to respond quickly and efficiently to changes in the marketplace. To maintain the safety and soundness of the financial system, institutions must be allowed to diversify. Expansion of bank and thrift powers must, however, be accompanied by appropriate safeguards for the insurance funds. In addition, any proposal for financial reform must also be examined for its impact on small communities, small businesses, and customers of financial institutions.

  Mr. Chairman, I have written testimony to submit for the record that examines financial modernization and related issues in detail. This morning I want to concentrate on one of those issues, which threatens to drive our consideration of financial modernization--the issue of whether banks receive a subsidy from the Federal safety net.
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  Concerns have been expressed that the existence of the Federal safety net--deposit insurance, access to the Federal Reserve's discount window, and access to the payments system--provides banks with funding advantages that could be passed on to bank subsidiaries, thereby resulting in the undesirable expansion of the safety net to activities for which it is not intended. I have asked the FDIC staff to analyze whether such a subsidy, in fact, exists. The analysis is ongoing, but based on the evidence we have now, the FDIC staff has reached several conclusions.

  It has long been widely accepted, and the FDIC agrees, that banks receive a gross subsidy from the Federal safety net. However, banks also incur costs, both direct and indirect, that offset this gross subsidy. The relevant question, therefore, is not whether banks receive a gross subsidy, but whether banks receive a net subsidy, after taking account of offsetting costs and restrictions, that they could pass on to the subsidiary or affiliate engaged in non-banking activities.

  It is extremely difficult to measure directly whether banks receive a net subsidy. However, on balance, the evidence indicates that, if a net subsidy exists, it is very small.

  In addition, during the 1990's, significant changes in law and practice have substantially reduced the gross subsidy that the safety net provides. These changes include minimum risk-based capital standards, the ''least-cost'' test for resolving bank failures, risk-based deposit insurance premiums, and restrictions in the Federal Reserve's ability to lend to under-capitalized institutions through the discount window.

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  As my written testimony discusses in detail, while quantification of the gross subsidy and offsetting costs is very difficult, the evidence shows a gross benefit of about ten basis points or less, and offsetting costs--interest-free reserve requirements, interest payments on bonds issued by the financing corporation, and other costs from regulation--that together, are considerably higher than ten basis points. The costs of regulation for commercial banks alone has been estimated to amount to more than 30 basis points.

  Practical evidence also argues that the net subsidy is small, or non-existent. Banking organizations often conduct activities in affiliates at the holding company level that could be conducted directly in the bank, or in a subsidiary of the bank, without any firewalls. Examples include mortgage banking, consumer finance, and commercial finance. If there were a material net subsidy, a rational banking organization would not carry out these activities in holding company affiliates. It would carry them out in the bank or in a subsidiary of the bank.

  Moreover, even if a small net subsidy exists, firewalls, such as those that require a bank's equity investment in a subsidiary to be deducted from the bank's regulatory capital, and the restrictions of Sections 23A and 23B of the Federal Reserve Act--which, among other things, limit the investments by a bank in an operating subsidiary to 10 percent of the bank's capital--serve to inhibit a bank from passing a subsidy either to a subsidiary or to an affiliate of the holding company.

  These firewalls are not impenetrable under all circumstances. In times of stress, firewalls tend to weaken. Our experience is that in such times, funding pressures can be exerted on the insured bank by its holding company as well as by subsidiaries of the bank. Nevertheless, the available evidence indicates that both bank subsidiary and holding company structures will work equally well in inhibiting a bank from passing a net subsidy to a subsidiary, as long as appropriate safeguards are in place to protect the insured bank.
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  In addition, from the perspective of safety and soundness, there may, in fact, be an advantage to the bank subsidiary model. Allowing a bank to put new activities in a bank subsidiary diversifies a bank's income stream. The bank benefits from the earnings of the subsidiary and, with appropriate firewalls, the down-side risk can be limited to excess regulatory capital--that is, above well-capitalized levels--with respect to investments in the subsidiary. In this way, the bank subsidiary structure can lower the risk to the insurance funds and may actually reduce any subsidy that arises from deposit insurance or the other elements.

  Given these facts, we have concluded that allowing banks to conduct financial activities in a bank subsidiary does not represent an undue expansion of the Federal safety net. Therefore, banking organizations should be free to choose how best to organize their activities in accordance with sound business judgments. Because any subsidy from the Federal safety net is, at most, de minimis, the subsidy argument should not drive financial reform.

  Nor should the subsidy argument be used--as it has been--as justification for reducing Federal deposit insurance coverage--or for eliminating Federal deposit insurance altogether through privatization. Such an argument diverts attention from the real issue of whether Federal deposit insurance continues to serve the interests of the American people. As we learned the hard way in the banking crises of the 1980's and 1990's, Federal deposit insurance assured the stability of the financial system when it was under great stress. Privatizing or reducing Federal deposit insurance would diminish our ability to assure financial stability in times of stress and, therefore, would be detrimental to the American public we serve.

  Reforms enacted by the Congress in 1991 have added market discipline to the deposit insurance system, and the FDIC continues to focus on other reforms that would further reduce the costs of resolving bank failures.
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  Mr. Chairman and Members of the subcommittee, my written statement discusses several other important issues that I, in conclusion, will only very briefly reference. We have significant concerns about the full-scale removal of the division separating banking and commerce. We support functional regulation of securities and insurance activities. We believe that regulation should be commensurate with risk--no more and no less. We also believe that there is room for oversight supervision to prevent critical safety and soundness issues from falling into the cracks, and to address potential systemic problems. That said, such oversight need not involve regular full-scope examinations of non-banking subsidiaries where there is adequate functional regulation, nor activity-by-activity or investment-by-investment regulation of non-banking subsidiaries.

  In conclusion, eliminating current restrictions on the financial activities of banking organizations requires balancing public policy goals and building a sound supervisory structure for the future. I believe that we can achieve genuine reform, while assuring a strong, competitive environment for financial services and, at the same time, addressing safety and soundness considerations.

  I applaud this subcommittee for its attention to these issues. The FDIC stands ready to assist you in any way we can. I look forward to your questions. Thank you.

  [The prepared statement of Hon. Ricki Helfer can be found on page 170 in the appendix.]

  Chairman BAKER. Thank you very much, Ms. Helfer.
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  Mr. Ludwig, I think it important to perhaps put boundaries around our current circumstance in framing the debate on commerce and finance, whether deposit insurance is a subsidy or not. All of this really needs to be viewed, I think, in light of where the banking marketplace is today.

  Reading reports from both you and the FDIC, it appears that there has been significant consolidation in the market, in many cases driven by the effort to lower operating costs and spreading it over a larger base of customers through consolidation.

  It appears that interest income versus fee income has taken a dramatic shift over the last decade, and banks to a large extent now are generating revenue from creative fees in many cases--under considerable pressure, I might add, as well.

  Additionally, the growth of the financial service sector in relation to the non-regulated financial service sector has lagged behind rather dramatically, and no one has to look very far beyond mutual funds to see where a lot of the Nation's money is now going.

  For these reasons, even though we now clearly are in a profitable period with banks perhaps better capitalized than at any time in recent memory--the insurance fund is obviously well financed--it may be odd to think about what happens with the next round of economic downturn. But it would appear there is a potential, unless there is product diversity, that banks with a limited core of business, with a limited line of products, in an arena where competitors are unfettered to be creative--that they really have to make some very meaningful changes in business plan, or else there is potential trouble down the road.
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  I find it ironic that some of the strongest voices in opposition to modernization proposals come from some of the community bank interests who appear to me to be the most at risk in this process. If we do not allow them to have product diversity, they in fact may be some of the initial losers in this circumstance. Could you comment?

  Mr. LUDWIG. I feel very strongly that financial modernization is the essence of safety and soundness today. We have a situation, and have had for the last 20 years, where a core banking business has either drifted away to the markets or banks find vigorous competitors that are not subject to the same restrictions they are.

  As a result, the problems we have seen in banking in the last 20 years, in my view, are a result of banks having to go further and further out on the risk curve in their core business of lending. First it was less-developed country debt, then it was highly leveraged transactions, or junk bond debt, then it was commercial real estate debt. They concentrated their lending and they went further out on the risk curve than they would have ordinarily gone because their core business of lending to large corporations drifted away. Large corporations now fund themselves in the commercial paper market, and they have other sources of capital.

  If we do not allow these institutions to diversify their income stream, what we do is exacerbate that problem. In one common sense way, bank diversification is a little like diversifying one's own portfolio. None of us, if we were investing, would pick one stock and put all our eggs in one basket. We just know as a common sense matter that we should spread risk. In some ways, it is the same for banks.

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  Moreover, we also find that this process of change has accelerated. We are living through the greatest change in financial services that has existed in our lifetime, and probably our parents' lifetime. Banking is an information technology business at its core, and information technology is, as we all know, dramatically changing--halving in cost every 18 months. And that is profoundly affecting financial institutions.

  So I do believe that if they are not allowed to diversify and get income streams that are stable through difficult times, we are actually causing a safety and soundness problem.

  Chairman BAKER. Ms. Helfer, I was interested in the closing portions of your testimony this morning, with regard to the commerce and finance issue. I believe it correct to say that moving forward in that arena is acceptable, but removing all barriers, in your perspective, is not advisable. Is that a fair summation?

  Ms. HELFER. We have examples from the 1980's of where we had given financial institutions much broader powers than they had either the experience or the expertise to deal with, and unfortunately we found that the taxpayer had to pick up the costs of some of those mistakes. I think moving into full-scale elimination of the barriers between banking and commerce, for that reason, should not be undertaken at this time. We need to give banks the opportunity to move into full-scale financial modernization, and then have the opportunity to look at that.

  With respect to whether there should be continuing opportunities for investment between banks and non-banking concerns, I would point you to--and I am sure you are aware of it, Mr. Chairman--the example of U.S. bank opportunities abroad. Under the Edge Act, which was put in place by Congress in 1919 to encourage U.S. bank activities and investment abroad and the export of U.S. products, U.S. banks have been able, through subsidiaries of the bank, to make portfolio and venture capital investments in any kind of company abroad.
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  Those kinds of portfolio and venture capital investments are permissable, up to a certain level, under the Edge Act and the regulations implementing it--essentially, up to 20 percent of the shares of the non-banking company, or in debt-for-equity swaps, it goes up to 40 percent. That kind of illustration of non-controlling portfolio or venture capital investments may very well be a good way to start, in an incremental way, looking at the relationships.

  Chairman BAKER. My concern is that there is nothing really historically that supports the separation of banking and commerce. Prior to 1956, the wall between commerce and finance did not exist. And even between 1956 and the holding company act in the 1970's, there was a broad array of exemptions that allowed the blending.

  If we look even to today's environment where individuals may own banks and commercial firms and consider our experience with unitary thrifts, or consider the example of derivatives, where a bank has a counter-party risk which is actually a commercial entity--is it a legal structure that blends commerce and finance, or is commerce and finance already blended?

  Is there any historical perspective that would make you conclude that that direction is imprudent? Or is it more a concern that we--speaking as a regulator--do not know yet what technology will develop, and there may be risks assumed before we can regulate them properly? Is it a regulatory issue, or is it a basic philosophic question?

  Ms. HELFER. I think your latter prepared statement of the issues--which is: ''We do not know how technology will develop, and once the genie is out of the bottle we cannot put it back in; and therefore, we should move cautiously.'' I agree with Alan Greenspan in that view.
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  You are certainly correct that historically there were not specific statutory restrictions, first until 1956, and not meaningfully until 1970. However, if you look at the historical record, you will see relatively limited affiliations between commercial and banking enterprises. And we have always in this country had some very real concerns about the undue concentration of economic wealth. That certainly is the illustration of the efforts with the first and second banks of the United States in the last century, both of which failed after approximately 20 years--failed in the sense that they were eliminated. Congress did not want to let them go forward.

  So I think I have very real concerns with respect to having a very large commercial enterprise and a very large financial institution fully affiliated in stressful--or very bad--economic times. Will there be a limitation on the general availability of credit, or will there be potential conflicts of interest? I think that is a question we have to understand and evaluate and see how we can deal with it, before we go forward to full-scale elimination of the barriers.

  Chairman BAKER. Thank you.

  Mr. Ludwig, on that same point, as to commerce and finance, I believe you also support an incremental approach rather than a wholesale change. Is your view of the constraint based on philosophic belief that the merger is not advisable, or regulatory concern that we may not yet have the tools to adequately gauge risks?

  Mr. LUDWIG. As regulators, we are paid worriers, so there is a tendency for us to be very cautionary. And in an area like this, I have not really settled on what you might say is a ''line'' here. But I think there are several things that one ought to focus on on both sides of the issue that are quite important.
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  First, we ought to be cautious about drawing a line so hard that we prevent financial entities from getting into businesses which today may seem different, but in fact are at the core of what they do. And in that area, I am really talking about technology. As recently as the 1970's, data processing was not viewed as a part of banking. That was a missed opportunity for the future because data processing and technology really are at the core of the modern financial institution, be it a small institution or a large institution. Financial institutions' ability to innovate in that area is really quite critical to their financial well-being, and also to their safety.

  So we have to be very cautious about the lines we draw and how hard we draw them in what I would call that ''gray'' area. We want to be careful about what activities a banking company gets into. I have said frequently and publicly that if an activity is one that we view as fundamentally unsafe for a bank, it ought to be unsafe for any organization which a bank is part of. But this structural business does not matter. We have to look at the activity----

  Chairman BAKER. But as to the function itself----

  Mr. LUDWIG.----But to the function itself.

  Chairman BAKER.----There is nothing inherently wrong with the concept of new products coming into a financial structure, as long as there is an adequate regulatory system that prices the risk accordingly?

  Mr. LUDWIG. We have to be very thoughtful as to how those new products come in. I think we have to do it in a measured way, and also in a way that takes into account pricing for risk, and so forth, as you have suggested.
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  So as I say, I have not fixed on what you might say is a ''line'' here. I think nothing is way too strong, and I think a free-for-all now is a very bad idea. But somewhere in between lies the right sort of ''line.'' It is a hard one to find, but it ought to be one where we are careful about pricing, we are careful about activity, we are careful about amount. And I do think that we will be able to come up with a line that makes sense.

  Chairman BAKER. Well, as to your list of worries, they all seem to center on basic risk to taxpayers, as opposed to some of the more historical arguments against this concept, such are concentration of assets. And I am just trying to find out where the concerns really are founded.

  Mr. LUDWIG. Sure.

  Chairman BAKER. Is it more, in the regulatory sense, risk to taxpayers and not knowing how to adequately price the risk?

  Mr. LUDWIG. It does seem to me what you said is absolutely correct; that historically we have not seen problems in this area; that the commerce and banking line is really a new set of issues, as of 1970, to a very great degree. And when one looks at the unitary thrift holding company experience, one does not find that problems have arisen.

  There has been a national concern over concentrations and big agglomerations of power. In that regard, I would say that, while I am a big supporter of the antitrust laws--and we sure do not want to have oligopolies and monopolies--the notion that the mixing of commerce and banking in and of itself will lead to this result is an idea one has to view with some caution.
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  If we look at the unitary thrift holding company experience, we do not find that bringing commerce and banking together produced that result. Ford owned a thrift; got rid of it. Sears and Roebuck tried to have a great conglomeration of retailing and financial services, but it split off the financial services companies. We also see in non-banking areas today a number of examples, like AT&T, where focusing on separate lines of business has been viewed ultimately as a better way to go about things than agglomerating everything in one huge entity.

  What we want to see is the kind of flexibility that allows business people to make choices to the greatest extent possible, consistent with public policy. That is why I agree with your risk analysis, your pricing analysis, so that we can have the best of all worlds. And that is, the greatest safety and soundness consistent with the maximum benefit to the consumer. That is why I am against drawing a hard line that says ''no mixing'', but at the same time I am wary that we not have a free-for-all.

  Chairman BAKER. Thank you. I will advise Members we are going to be pretty liberal with the 5-minute rule here. And I have set the standard.

  Mr. Kanjorski.

  Mr. KANJORSKI. Thank you very much, Mr. Chairman.

  I am not sure I am following the argument. If there is no subsidy in the system, then why are people going into banking or not going into banking? What is the draw to banking? Why do we not just open the system up in its entirety, take away deposit insurance in its entirety, take away the open window; or conversely, offer deposit insurance or the open window to all entities, if we are going to create a level playing field here to encourage people to develop product and to go off into any commercial activity that they wish?
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  I happen to see some fundamental attractiveness to having an open window and having deposit insurance, and particularly for community banks.

  Ms. HELFER. If you are directing the question to me, as I testified, there is a gross subsidy in the insured bank. And we have found that there are funding advantages, probably worth somewhere on the order of six basis points, in the insured bank for raising money through deposits or other means, because of the safety net.

  I focused on whether there was a net subsidy, and if there was, whether that subsidy could be effectively exported, and therefore the safety net be expanded to cover the activities and subsidiaries of the bank, such as the holding company.

  With respect to whether we think it is a good idea, or I think it is a good idea, to remove deposit insurance, I simply ask whether in the next banking crisis Congress wants to be faced with voting taxpayer money, as it did in the thrift crisis? I would think it is much better to have the kind of fully-capitalized insurance fund that we have and the working capital necessary to resolve bank failures as soon as they occur.

  Mr. KANJORSKI. But I am trying to find out who is the beneficiary there. I was under the impression historically that deposit insurance was to provide for safety for the unsophisticated investor, the widow, the person with small amounts of money, so they did not have maybe the wherewithal. Mr. Ludwig indicated that he does not put all his eggs in one basket. A lot of people have to, because they have no other choice.

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  Ms. HELFER. Right.

  Mr. KANJORSKI. And the expense of diversifying their basket, if you are a small net-worth holder is too great.

  Ms. HELFER. I think the answer is that deposit insurance was created for two purposes. One was to bring stability to the system as a whole at a time when we had 9,000 bank failures in a 3-year period. The second was to achieve that stability by telling people, ''We are going to give you insurance on some share of your savings, so you will not go and try to withdraw it all at once from the bank.''

  Mr. KANJORSKI. All right, let us break that apart now. Do you think there is any need in our present system, with the sophisticated nature of the system, to take care of the potential 9,000 failures in a 3-year period? Is that going to happen ever again, or could it happen ever again, if we did away with insurance to cover that aspect?

  Ms. HELFER. Well, we have the experience of the 1980's and 1990's when there were 1,617 bank failures, or banks that survived only with FDIC assistance. We did not see panics. We did not see runs on the banks. We saw that people were comfortable that they would, in fact, be able to get their savings out.

  Mr. KANJORSKI. OK. Should we put limits, then, on who these poor insurers are? Should we allow brokered funds to continue with unlimited amounts?

  Ms. HELFER. We already have limitations on brokered funds. They are not unlimited. That was put in in the legislation in 1989 to 1991.
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  Mr. KANJORSKI. They still were far in excess, however, of what an individual can have insured than we had originally anticipated.

  Ms. HELFER. Well, we have the $100,000 coverage from 1980, which Congress put in place. Actually, based on what has happened in the marketplace with inflation, that $100,000 coverage is worth probably about 55 percent of what it was worth in 1980. If we wanted to have equivalent coverage today, we would have to have $190,000.

  I am not advocating that. I think that today's limits are appropriate. I think they do protect the savings. For example, a small businessman that sells his business at the end of his career and chooses to put it into a bank, he may in fact have $75,000, $80,000, $90,000 that he wants to know would be secure.

  Mr. KANJORSKI. I seem to get lost in the idea when both you and Mr. Ludwig talk about banks, '' . . . banks are banks are banks,'' in my estimation. There is as much difference in existing banks as there are similarities.

  You seem to run off and talk about investment capital, the capacity to do world product to compete with corporate financing. The banks that serve rural and suburban American do not get involved in these activities.

  Mr. LUDWIG. Congressman, let me address that question. I would like to make a couple of comments on what Chairwoman Helfer has said. First of all, just to clarify, the chairwoman was saying that the FDIC has estimated that there might be as much as six basis points--that is six pennies on $100--of gross subsidy. But the issue really is net subsidy, as she pointed out very carefully in her testimony. Our research indicates, and it is pretty much in line with the FDIC research, that if there is a net subsidy, it is de minimis. In fact, every evidence we have indicates that there is no net subsidy; there is a negative net subsidy.
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  Now, to address your point about community banks, I am very concerned about community banks. I think the community banking sector of America is one of its great assets, and we would not want to do anything to hurt community banks. It is clear to me that the only way community banks survive as vigorus businesses into the next century is to have an operating subsidiary option for new products and services. If they do not have that, and are required instead to have a holding company structure, they are dead as dodos, in my view.

  The point which you were just raising as to whether they are going to actually be able to take advantage of these new products and services is a very good question. Many community bankers would say today, ''No, my business is only taking deposits and making loans.'' I have had some experience with those views. Originally, a number of community bankers said to me, ''Selling insurance is really not my business. That is not going to be a big deal.'' And, in fact, as we have seen the decade roll on, many of them now say, ''That is really, in a lot of ways, my future.''

  I am certain that in the future community banks are going to have to be able to sell a diversified basket of products and services. Those that think they are going to be able to be mono-line businesses, as they are today, are simply wrong. They are going to have to keep step with technology. And we find many community banks around the country that are leaders--not just that they are involved in technology and selling new products and services, they are leaders, in some ways ahead of the larger institutions. And I think we will see community banks keep step with technology and new products and services. But that is absolutely critical for them.

  Mr. KANJORSKI. Let me ask you a question, Mr. Ludwig. From the standpoint of regulatory cost, it is not a straight line, in the sense that the-smaller-the-bank/the-smaller-the-cost, in direct ratio of assets. The reality is that it costs a small bank a great deal more, percentagewise, for regulation than a large bank.
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  Mr. LUDWIG. Yes.

  Mr. KANJORSKI. Now, why are we not looking, therefore, to tier regulation to the size of the operation?

  Mr. LUDWIG. I am sorry?

  Mr. KANJORSKI. To create tiers, to create one for multi-billion banks when we allow them to do many more things and they can afford a different level of regulation; and then come down to another tier for smaller community banks and reduce the costs of supervision, and recognize that the likelihood that their failure would impact on the economic system itself is far less, and subject them to less cost and regulation?

  But what it seems to me is starting to happen--or at least, I hear--is that we are all worried about how competitive the large banks can be, and we are not too much worried about the small-and medium-sized banks that basically serve most of our communities.

  I mean, in Pennsylvania, I do not see the big banks stepping up to finance small businesses or to be risk-takers. As a matter of fact, I am struck with the fact that it seems that the larger the bank, the more they want a government guarantee or subsidy for a loan, or they do not want to touch it.

  Mr. LUDWIG. I want to make clear that we have taken a number of major steps to reduce burden specifically for smaller institutions. With CRA, banks below $250 million have a streamlined examination. In our safety and soundness examinations, we use the non-complex--or small-bank--procedures, which tier their examination in a much different way from the larger institutions' examination.
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  All of that is very important, consistent with doing a good hands-on job. But I actually think that we can have a win-win situation here: allowing these institutions to engage in new activities, but in a way that is consistent with their own overhead.

  One community banker put it to me this way: He said, ''What I am, in essence, is a ma-and-pa grocery store. And as a ma-and-pa grocery store, I cannot only sell Kellogg's corn flakes. If I sell one product in the America of the future, I am not going to make it. I have got to be able to sell meat and cheese and dairy and the whole works, and even New England beer and wine.''

  Mr. KANJORSKI. And Rice Krispies.

  Mr. LUDWIG. Pardon me?

  Mr. KANJORSKI. And Rice Krispies.

  Mr. LUDWIG. And Rice Krispies. He said, ''Look, I cannot make it as a ma-and-pa operation by having different holding companies, different corporate entities, different structures, people coming in different doors. That may be OK for a big supermarket chain, but for me, I am out of business.''

  His analogy was really quite a good one. Meat and poultry, beer and wine are all regulated. There are safety and soundness implications with meat sales and milk sales, and so forth, but they are regulated in a fashion that does not put the ma-and-pa operation out of business. What we have got to do--and I think you and I are exactly on the same page in this--is make sure that our supervisory focus is effective, but also takes into account the size of these institutions so they can indeed have a broad array of products they sell to the public, but do so in a way that is consistent with their own efficiency needs.
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  Mr. KANJORSKI. I just want to say that I think concentrating too much on whether it is a holding company or a subsidiary, I think you are persuading me, at least, that it does not make a great deal of sense to go to the holding company, go to the subsidiary. But now I am worried about how far your regulation is going to penetrate. Do you intend to go on and regulate all the subsidiaries of all the banks and the back-up stream if the bank is owned by a larger entity, to go up and regulate that entity? Or how are you going to break down these regulatory control areas?

  Mr. LUDWIG. We have found that you can rely on functional regulation. For example, a subsidiary of a bank selling securities today is subject to the SEC's jurisdiction. We have enough ability to look into such an operation and satisfy ourselves as to its safety and soundness, but not in such an intrusive way that it makes it unacceptable for the entity to proceed.

  In that regard, Congressman Kanjorski, I might note that a number of State banks around the country have subsidiaries that are engaged in a broad variety of activities today, including securities underwriting. There has been a marriage of their ability to do that with supervisory needs, mostly at the FDIC because they are State banks.

  Mr. KANJORSKI. I know I am taking a little time, Mr. Chairman. I just wanted to say I am disturbed about whether or not there is a real need for the banking structure to pay attention to small average people and small average businesses. I do not see it driven that way any more; neither in making the loans or in supporting those entities in a community effort.

  And I see it particularly crystalized in this ATM scandal. You know, when you think about it, if I am an average working person, I go to the ATM on my corner and I want to draw $50 out for groceries. I pay the $1.50 to my bank and $1.50 to the person who owns the ATM. If I want to draw $1,000 out, I pay $1.50 and $1.50. It seems to me that we are not paying a lot of attention to the fact that there is a tremendous expense on the average user, the average consumer, because banks really do not care about them anymore. They really do not need them, if you will, except for community banks. The large banks--I am sure they do not want me there. They do not need my checking account, and probably 95 percent of other Americans.
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  And I do not see that the market is going to drive that, or the change of the structure. And I am worried about, as I brought up with you the other night--I think this ATM scandal says a lot to where greed will take banks if we give them free rein. Why not charge $5?

  We were talking about the investment of ATMs. If there are eight billion transactions in an ATM, and if there is a dollar on the bank's side and a dollar on the owner's side of the ATM, that is $16 billion a year. That is far and above the fair return of the investment on ATM machines. So somebody is taking advantage of the monopoly or the location or the control in the use of putting out money in our system.

  And it is a strong indication to me that as soon as they see those monopolistic advantages they are going to continue to do it. Now, how is this system going to change that? If we change and modernize the system--and we want to do it--I mean, I am in favor of doing it, but I am worried about taking control away from the focus of making sure banking operates for 90-, 95-percent of the consumer population of America. I am worried about the corporations, but they can go to Wall Street. I am worried about the big banks losing the corporate client, but I am sure they can find some other investments, or they can get into the investment banking business.

  Our problem that I think we have to focus on more than anything else as we modernize the financial services industry is to make sure it is responsive to the people that really need small banking services.

  Mr. LUDWIG. I totally agree with you on that; we must make sure that the financial modernization we have is reflective of consumer needs and wants, and vigorously supports the small banking segment of the United States. Those are two of the five principles I enunciated earlier.
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  Mr. KANJORSKI. Do you have the regulatory capacity, rather than allowing a standard service charge, to allow a percentage service charge? At an ATM, it could be 5 percent of the withdrawal, or 2 percent of the withdrawal.

  Mr. LUDWIG. I was going to say, there are only two ways, it seems to me, you can address the ATM issue that you have surfaced. Either you have to have government imposition of fee limitations or fee structuring, or you have to have a very vigorous market. I do not believe we, in fact, today have the authority to limit or require a certain fee structure. That would have to be a new Congressionally-imposed mandate.

  I would say, however, that I am optimistic that if we have a modernization bill that is truly robust and truly supports the small institutions, including taking into consideration their own limitations in terms of excess costs, we will have sufficiently vigorous competition that this ATM fee issue will be a passing issue. There are two reasons for that. One is because I do believe that vigorous competition, if we get it right, will lower fees. I think that is how the economics work. But second, as I mentioned to you the other evening, I think we are in a transitory phase. As technology costs halve every 18 months--which they have for the last 25 years, and continue to do--it means that the services that an expensive ATM makes available to consumers today will be made available by much less expensive and more readily available units, including our home PCs or our office PCs, including taking down value--i.e., dollars on cards. Those charges will be de minimis over time to the consumer.

  So, we are in an awkward bubble period, in my view. And, as I say, there are two ways to deal with this issue, but I am hopeful that financial modernization, if it is done correctly, will help with this problem.
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  Chairman BAKER. Mr. Lucas.

  Mr. LUCAS. Thank you, Mr. Chairman.

  Mr. Ludwig, I think it is a fair statement to say that prior to 1933 we had what could be described as ''universal banks'' in this country. Listening to your comments now and on various occasions in the past, is it a fair question to ask whether you are advocating an eventual return to universal banking?

  Mr. LUDWIG. No, sir, I have been focusing on operating subsidiary and holding company affiliate structural questions, not on the question of universal banks.

  I would, however, go to your analogy to the 1930's because I think it is a very, very important analysis, and it is what I laud Chairman Baker, Congressman Kanjorski, and you, Congressman Lucas, for, and Congressman Bachus. And that is taking time to think about these issues and go into them in real depth. Why? Because in the 1930's, we had a situation where people with good hearts and good minds drew the wrong conclusions. We now know that, by reason of scholarship.

  Why did the banks fail in the 1930's? Was it because some of them were involved in securities activities? Modern scholars who have looked at that question very closely--Eugene White at Rutgers, George Benston, there are a number of other people who have looked at this carefully--found an interesting pattern. In fact, banks that had securities affiliates failed less, almost not at all, as compared to banks that did not. So, actually, the banks that had multiple activities were safer banks than those that did not. Actually, most of the failures occurred in unit banks that tended to be agricultural banks and were hit by the agricultural crises that rolled through the late 1920's and 1930's.
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  Moreover, the banks that offered securities through their affiliates during that period tended to offer higher-quality securities than non-banks. Those are simply the facts. And that is why a discussion of this nature that you are having--and I really commend you for it--looking at the facts and trying to dig up what is the reality here, is so very important.

  What they did in the 1930's was put in a law that has lasted 60 years. What you do in this Congress could last our lifetime, and it is very important that we get the facts right. But the facts of the 1930's were not a situation where agglomerations of power caused these failures. The fact is, it was the unit banks that were the ones that failed, not the ones that had securities affiliations.

  Ms. HELFER. If I could add something on the whole issue of universal banking. The real issue for universal banking, I think, is whether it is a good model for the United States and the active, vibrant, competitive marketplace of this country. I would argue it is not.

  In addition, the image of universal banking has been tarnished in recent years with the problems that German and French banks have had with losses in their non-banking-affiliated organizations. So I think there is a significant question going forward, and I think the facts are important.

  I agree with Comptroller Ludwig that it is very important that the subcommittee understand those precedents, because I do not believe that by saying--and I agree with Comptroller Ludwig--that the evidence of the past is that diversification is a good thing for financial institutions--that that will necessarily--nor should it--lead us to a universal banking model.
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  Mr. LUCAS. Thank you. Thank you, Mr. Chairman.

  Chairman BAKER. Thank you, Mr. Lucas.

  Mr. Bachus.

  Mr. BACHUS. I will address this question to the Comptroller or the Chairman, or either one of you. Comptroller, you have mentioned the unitary thrift institutions, which already can affiliate with unregulated commercial firms, with insurance firms, with security firms. Knowing that, and using that as an existing model--I mean, that is happening today. We have that example.

  Now, at the same time we are talking about merging BIF and SAIF, and a charter merger. The funds act has actually said that we will not merge them until we do away with the thrift charter, or either have a unified charter.

  Following that logic, what are the proposals? Are we going to charter down? Are we going to take powers away from the thrifts? Are we going to give more powers to the banks? Will this unified charter be more like a thrift, or more like a bank?

  And I guess my ultimate question is, what if we just gave the banks the thrift charter today where they could affiliate with commercial firms, security firms, insurance firms? How much of this bank modernization would we have if we just gave everybody those thrift powers, and what would be wrong with that? I mean, obviously, there has got to be a reason we do not propose that.

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  Mr. LUDWIG. The unitary thrift experience is indeed an intriguing one because you have depository institutions that are insured that have had parents as diverse as Ford Motor Company, Sears and Roebuck, and, I believe, some insurance companies.

  The thrift charter is a very robust one, as is their holding company structure. And it is fair to say that, while thrifts have had problems, as we all well know, the unitary thrift experience in terms of their ownership has not appeared to be one of those problems, but rather a source of capital. So it is a very intriguing example.

  Their charter is more robust than the bank charter. On the other hand, as I said before, as a bank supervisor I tend to be a little bit of a paid worrier. I mean, I tend to be cautious by nature, and have been made more so by the 4 years in the job. Expanding to quite the degree of complete no-holds-barred mixing of commerce and banking seems to me to be an awfully big step, and one that one wants to be cautious about. But, in fact, we have not seen problems arising from that commerce and banking mix in the thrift area to date, to the best of my knowledge.

  Ms. HELFER. Congressman Bachus, if I could add something, it is certainly true that the commercial enterprises that chose to put capital into thrifts at a time when they were under heavy stress were certainly very helpful in ultimately helping us stabilize the situation. However, I believe that the unitary thrift holding company example is a very, very limited example.

  First of all, you found that in several instances there were very large commercial firms that chose to invest in thrifts. The size differential was quite significant, so that you did not have a very, very large or an equal sized financial institution and commercial firm combining.
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  Second, you found that they were investing in financial companies--thrifts which had very limited business ranges, largely involved in real estate lending--not the full-scale commercial finance enterprises of the largest U.S. banking organizations.

  For that reason, I think we have to be wary about using that example as a basis for full-scale elimination of the barrier between commerce and banking.

  Mr. LUDWIG. I would like to be clear on one point here, which is the charter issue, per se. While it is the case, it seems to me, that the ability to mix banking and commerce--that is, have Ford Motor Company buy a thrift--is a significant difference between the two types of entities, that is really a structural issue. I think the bank charter is quite a robust charter, and in some ways really on a parallel with the thrift charter when you are talking about activities of the chartered entity itself. I just want to make that point and be precise about it, that we are really talking about the commerce and banking mix at the parent level.

  Mr. BACHUS. And I understand the differences, but I guess I am saying, are we going to grandfather these unitary thrifts?

  Ms. HELFER. Well, I mean, that is certainly an issue that has to be examined. Historically, for example, when the 1956 Bank Holding Company Act came into existence, the judgment was made by Congress to permit grandfathering of those organizations that would be directly impacted. And that is certainly an alternative that Congress has to evaluate in evaluating the various approaches to dealing with this.

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  Mr. BACHUS. And I understand. I think it is a limited example, but I just throw that out for discussion. I have one other question, if I could. We have talked about the advantage that banks have, whether or not it is the net-net advantage, or whatever. Is this not the whole justification for requiring CRA, that there is an advantage to having a bank charter? Is it not based on that? And is that in fact just a fiction?

  Mr. LUDWIG. Initially, CRA had been looked at as a reflection of the issue of banks taking deposits in communities and using those deposits elsewhere. The law does not make that distinction. The law takes more of a, you might say, ''convenience and needs'' approach, which is a traditional banking concept. It basically says, ''You are to serve your entire community,'' not drawing it so tightly as to whether or not you are using the deposits you have taken from the community elsewhere. It does not draw it that tightly, although that was the original focus.

  Having said that, it is fair to say that the CRA as it exists today, is tied to depository institutions that are federally insured. The one thing I will say about this program oft-criticized by the banking industry--and as you know, I have been a supporter of it--is it seems to me that there are a number of things that are very valuable here, and lessons we can learn. Here is a program that does not have a Federal bureaucracy; it relies on local control. It does not cost one nickel of taxpayer money, but it has done a great deal of good. And that is what makes me a supporter of the program.

  Mr. BACHUS. And we are talking about----

  Mr. LUDWIG. The Community Reinvestment Act.

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  Mr. BACHUS. All right.

  Mr. LUDWIG. But I would say this, sir. What I think is the genius about this act to date--and it is the line I think we want to see here--is that it is not about losing money, and it is not about not making a profit. We have to discipline ourselves as supervisors to hold to that line, which is the statutory line. It is about extending opportunity.

  So that, yes, the history of this was originally focused on taking deposits from the community. The statute is broader than that. And I, myself, in this financial modernization environment, am quite a supporter of it. I think that it has done a great deal of good.

  Mr. BACHUS. Yes. Now, I understand that. But I am saying, we say that the bank charter gives you access to the payment system, it gives you the discount window, it gives you what Greenspan said, the ''sovereign credit.'' And all this is an advantage to having the bank charter. And because we are giving you all these advantages, we are going to require CRA of you, these CRA obligations. But if we say there is no net advantage to any of that, what is the quid pro quo?

  Mr. LUDWIG. It raises the issue as to whether or not----

  Mr. BACHUS. I am not saying that it does not do some good things, but I think, is that not the premise that we have always assumed?

  Mr. KANJORSKI. If I may ask the gentleman to yield, he is exactly on point. If there is no subsidy, if there is no benefit to the open window and deposit insurance, there is no justification for CRA. We cannot make insurance companies--and we cannot make Mobil Oil, who take deposits or sell in the community or take premiums in the community. The only justification we have for CRA is the fact that some benefit is flowing to a special chartered entity by the Federal Government.
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  Ms. HELFER. Let me just, if I could, interject here that I think it is important, first of all, to recognize that we have said there is a gross subsidy in the insured bank. Congress enacted CRA, and Congress certainly did, I think to some extent, use as a justification, that banks have the advantages of access to deposit insurance and other elements of the safety net.

  Does that mean that banks are the only institutions in this country that have an obligation to provide services on a widespread basis to the community? I would argue, no. But I certainly believe that banks have increasingly been expanding the scope of their lending and service to communities.

  Mr. KANJORSKI. It is not a question of whether or not people have an obligation. It is whether or not we have a legal authority to impose an obligation.

  Mr. LUDWIG. I think there are two questions here. And your comments are very thoughtful. Congress has, in fact, imposed the obligation, and the obligation is not, by its terms, tied to whether or not there is a net benefit to the banks. The obligation is simply imposed.

  Now, as a policy matter, Congress could decide that since there is no net benefit it ought to be withdrawn. I would, frankly, argue the other way, which I think was where Chairwoman Helfer was going. My view is that, for whatever reason, you have imposed an obligation here that, net-net, has done a great deal of good. Banks have never earned more than they have in the last 3 years; and yet, at the same time, they have never done more good in low- and moderate-income areas than they have done in the last several years.
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  I think the issue might be whether or not this program is sufficiently good that it ought to be looked at as a model that could be used more broadly.

  Mr. KANJORSKI. If the gentleman will yield further, I can engage the Comptroller.

  Could you give me a legal rationalization of how the Congress would have the legal Constitutional authority to impose on an insurance company--or Mobil Oil--that they have to make investments in the community, other than the fact that there is a quid pro quo in the charter itself and the benefits that flow to that particular charter?

  The fact that we place the full faith and credit of the United States, the fact that we give deposit insurance, the fact that we have the open window--other than that, I do not think there is any legal hook that would justify CRA. And I think the argument that the two of you are making is that that is now vitiated by the reality of cost versus that there is no net-net subsidy.

  Mr. LUDWIG. No, I would make two arguments. Number one is that CRA arguably is one of those costs that nets the gross subsidy. As the Chairman has said, there is a gross subsidy from deposit insurance, but you net out the costs. And CRA is one of the parts of that cost.

  The second thing I would say is that if you actually look at the convenience and needs obligation that comes with a national bank charter--and I think it probably comes with most State charters--it is an obligation that predated deposit insurance and is inherent in the grant of the charter. There is no reason to assume that other entities should not have obligations--I mean that Congress could not impose obligations that are convenience-and-needs-like obligations.
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  Mr. BACHUS. Let me say this. I am not taking a position on how much benefit there is. I am just saying, if we say that there is this benefit and that, as a result of this benefit, we put this obligation on the banks, then that is a consistent argument. If we say that there is no benefit derived, then it would be inconsistent to say that there was a benefit.

  Mr. LUDWIG. The key is to differentiate between a gross subsidy--that is, is there some benefit to deposit insurance--and what we net out, CRA being one of the things we net out.

  Ms. HELFER. That's right.

  Mr. LUDWIG. I think that is a very good point you make. But I think I would go a step further and say that, irrespective of that, Congress has the right to impose such obligations.

  Mr. BACHUS. Oh, I am not arguing that.

  Mr. LUDWIG. It is a good point.

  Chairman BAKER. Mr. Vento.

  Mr. VENTO. Well, thanks, Mr. Chairman. That was interesting, to observe this discussion. Obviously, in a mixed economy I expect that we establish financial institutions and other entities to serve the people we represent in our mixed economy. And, I think very correctly, the initial franchise granted is a public purpose.

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  And I think, ostensibly, I would argue that the fact that we had to formalize CRA is an indication of the changing role of financial institutions to ensure. I think we just assumed in the past that they are in the community, the geographic area, and service would take place. But what we found is deposits were being taken in Minnesota, and being invested in the Grand Cayman Islands.

  And in fact, CRA is not the only requirement. I mean, as you look through the statutes, in terms of regulators, to serve the needs of the investment community, to serve the agricultural community, various sectors, they are specifically outlined in terms of requirements. And I am certain that if we find a problem without credit, or a credit crunch, that we get a litany of complaints, candidly, at the door, at the table of the regulator.

  So I think, in fact, the CRA is one of the regulatory requirements. Hopefully, it will be regularized. And it has been demonstrated to be a non-loss item, but even if it were, ostensibly, I think many of us could argue that that is the purpose, that it is one of the functions of extending credit; that is, it is necessary to serve the broader interests in our economy and of the people we represent.

  But let me just ask--and I am getting back to the topic at hand here--we have these bills with various degrees of commerce and banking. Is there an absolute need to have no limitation, in terms of commerce and banking, in order for financial entities, including insurance companies, investment banking, and commercial banking--Mr. Ludwig, is there a need for that to be no limit, in terms of the amounts and integration of those entities with commerce?

  Mr. LUDWIG. As I said earlier, Congressman Vento, it seems to me that we do not need, and I disincline toward, what I have described as a ''free-for-all,'' no limits at all in terms of how we mix commerce and banking, at least at this juncture.
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  Mr. VENTO. Ostensibly, I guess we are doing this because we say that there is the safety and soundness and the five reasons that you have listed, and perhaps others that the Chairman of the FDIC has listed--that we need to modernize. And what I am asking is, if we need to solve problems that do not exist, it puts us in an interesting position, because we do not know exactly where that policy path will lead at the end of the day.

  So, Chairwoman Helfer, do you feel any differently about that?

  Ms. HELFER. With respect to commerce and banking in particular, I think that we do have to be cautious in that area. And I think that with respect to whether it is necessary, I think your question is, to permit unlimited access to commerce and banking in order to allow the affiliations with insurance companies and securities firms----

  Mr. VENTO. Yes.

  Ms. HELFER.----I think the answer is, ''no.''

  Mr. VENTO. Well, I think it is fairly important, because we obviously are up against it. On the other hand, are we going to inherently hinder the basic proposition? If we say we are going to modify Glass-Steagall and then we do not permit 100 percent mixing of banking and commerce, does that in some way hinder the association or put some at a relative disadvantage? Now, we know we have to have a certain amount of it. I mean, I know that there is a certain amount.

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  Ms. HELFER. Yes, well, we can look at the universal banking model, which in some countries has essentially permitted unlimited affiliations. And that has not been, as I said, an unmitigated success, by any means at all. And the affiliations have created losses for the banks from the non-banking concerns, which have raised very real issues in recent years.

  Now, is it going to make the new entity, the new financial services company, uncompetitive?

  Mr. VENTO. Yes.

  Ms. HELFER. I do not believe so, because I believe that there is scope to engage in a full range of financial services activities. One of the very real problems that we have been facing is that there is an artificial distinction made between credit extended by a bank and credit extended by a securities firm. If we can eliminate those artificial distinctions and say it is credit that is provided by a financial institution, and permit a broader range of financial synergies, I think there will be very real competitive advantages.

  Mr. LUDWIG. Congressman Vento, I would also say that we have to be very cautious not to draw a hard and fast line. I give an example of the Apollo Trust Company of Pennsylvania, which contacted us because they wanted to use their home banking--which they offer both in terms of direct telephone line access and through the Internet--more widely. They wanted to use the Internet portion of it as a gateway for local citizens to be able to access things at the library, the town meeting calendar, and so forth, and provide a service to their customers so that when they did home banking they could do things on a broader scale. We okayed that. And there is a line that, if one draws it too finely, really freezes the bank out. In other words, is providing an Internet gateway commerce so that, therefore, we should prohibit it? That is why I think we want to be very cautious here. Apollo Trust provided great benefit to consumers. There is essentially no risk to the institution.
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  Mr. VENTO. Well, I think most of us agree with giving some running room, apparently even in the most restrictive bill; although I think that, in fairness, when you start talking about that, we have to recognize that the holding company model does not permit control. And so it has some other limitations that may not put it quite in the same category as the other commerce mixing.

  My other question really is that, if there were to be this absolute mixing of banking and commerce, what impact does that have on the FDIC, what impact does it have on the OCC, in terms of the nature of its regulatory regime? And I say that in a friendly regime. But my concern is, does that assume that there would by necessity be a greater degree of regulatory activity that would have to address the commerce side, as there is a greater mixing? Would you feel compelled, or would there be, even with an understanding of the best of all possible worlds with regard to functional regulation?

  So, I am just asking, what does that mean to the FDIC in terms of protecting taxpayers? You said we have had 1,600 banks that have had to be made whole by virtue of FDIC action over the last 15 years or so. The OCC has had other activities and experiences here, even with the firewalls. What does this mean, in terms of the nature of regulatory role?

  For instance, the Fed came in and said, ''We do not want to regulate Ford Motor Company. We do not want to regulate these other large entities.'' So I am asking you, what would it mean in terms of this particular policy path, in terms of absolute mixture with regard to regulation?

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  Mr. LUDWIG. I would give a three-part answer. First, any activity that we think is too risky for the bank should not be allowed in the banking organization, whether it is at the holding company level or the subsidiary level. The fundamental question is whether whatever mixing goes on is too risky or not.

  Mr. VENTO. What does that mean in terms of regulation?

  Mr. LUDWIG. Now, second, there are two issues in the regulatory arena. One is the separation--the firewall--between the bank and the non-traditional activity. That is an area of importance such that most of our time in a functional regulation environment would be spent making sure that firewall was firm.

  Having said that, I as a bank regulator have always taken the position that, regardless of where it is in the organization--if it is a holding company affiliate, if it is a bank subsidiary, whatever it is--I want to have sufficient feel and touch of that activity that I can be sure that the bank is not adversely impacted. Sometimes that feel and touch is talking to other supervisors. Sometimes it's looking at financial data. And sometimes--whether it is in the holding company, in the bank, or anywhere--we want to go in and take a look. And so I think you simply cannot not have the option of taking a look.

  Ms. HELFER. I think, from the FDIC's perspective, the issue continues to be potential conflicts of interest with respect to lending by the insured institution, and access to credit by the commercial enterprise. Many commercial enterprises are highly capital-intensive. And if there is a very large financial institution with which it is affiliated I think it does give rise to the question--not so much in good economic times, not so much now, but in bad economic times, in risky economic times--of what is the potential for these limitations on availability to credit, because of the parent organization or the affiliated organization needing credit?
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  That is just something that we would have to monitor, and we would have to monitor closely. But it is a big issue, I think, not a small issue. We found during the banking crisis that the firewalls tended to get ''squishy'' when significant problems were raised in the banking organization.

  So, I think the very real question for this subcommittee is: Is there a greater likelihood of conflict-of-interest where you have large capital-intensive commercial enterprises affiliated with large financial institutions? I do not know the answer to that question yet. I think that is something that we have to continue to evaluate. But it is, I think, a very serious question.

  Mr. VENTO. Well, Mr. Chairman, thank you for the extra time. I appreciate it. I think this is enormously important. And I think we need to also ask ourselves whether or not the regulators--with all their effort, all the extra personnel--whether they are touch-and-feel, or have a ''feel'' of this, as you put it; whether that is a leap in faith; how far we want to make that leap in terms of their ability to, in fact, deal with that issue?

  And I think if it is 25 percent, or 50 percent, or 7 percent, or whatever the basket is, it is a question that we have to resolve in our own minds, in terms of what the capability is. I mean, because we are dealing with a degree of regulation that has never existed in this country in these particular forms. Thank you, Mr. Chairman.

  Chairman BAKER. Thank you, Mr. Vento.

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  Mr. Cook.

  Mr. COOK. Thank you, Mr. Chairman. I want to express my delight in being on this subcommittee and being on the banking panel. I have enjoyed very much the statements this morning, and I wanted to commend you, Mr. Ludwig, for your statement that in the efforts to modernize financially there should be a focus on the consumer.

  And as I just hear comments from around, I feel that whether people are in the insurance business or in the banking business there is a lot of optimism expressed that Congress is really looking at this modernization issue. But I am not sure that totally extends to the public at large where there is, I detect at least, some skepticism and concern, particularly among people who really have relied on the safety in regulation and things that are in existence and who worry to the extent that some of these may be broken.

  But the question, too, I have today is directed specifically about deposit insurance. I would like to ask Chairwoman Helfer, in recent years we have seen the expansions of mutual funds, and people that have usually socked away money safely in banks putting it in mutual funds; and others, a lot of more sophisticated things, to get better returns. But, I think they still rely--or they are thinking in terms of the insurance--on what is often a nest egg over many, many years.

  Do you see a major difference in the role of deposit insurance with modernization that might come about? In other words, what cautions do you have?

  Ms. HELFER. Let me just say that I think some people do continue to be confused about what is insured and what is not. And that is a concern of ours. We hired an independent firm to do a survey last year, and announced that about 30 percent of the banks were not always fully communicative with people on what was insured and what was not.
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  But to be perfectly frank, the SEC did a survey 3 years before and found that people were confused--regardless of whether it was a bank or a securities firm selling the product--about whether it was insured or not. We have a whole effort underway this year to provide outreach to consumers and bankers to be sure they are educated on what their obligations are with respect to disclosure. And I would hope securities firms would understand those obligations, as well.

  With respect to deposit insurance, in the end, the great virtue and value of the deposit insurance system in the banking crisis is quite easily contrasted with the huge problems in the thrift industry. Because the FDIC had a fund that it could access immediately, it could look at and deal with the problems of failing banks quickly. It had the working capital to address those problems before there was a contagion or panic or concern.

  Look at the thrift industry. The Federal Home Loan Bank Board and the FSLIC--the old Federal Savings and Loan Insurance Fund--ran out of money. They could not address the problems with the failures; and Congress was uncertain how much money to vote, and ultimately quite reluctant to vote taxpayer money to support the problem--and that was understandable.

  But what it meant was that it was extraordinarily expensive to deal with those thrift failures, and to keep, essentially, these thrifts open and functioning even though they had negative net worth, and even though simply keeping them open cost more money. And it ultimately cost $150 billion in direct costs to the taxpayer--not counting indirect costs--to solve those problems.

  It is so much better to have the fund available. And I believe that many consumers across America do, in fact, rely on that FDIC seal in their financial institutions. They are comfortable that they will have a measure of their savings protected. I believe that it will continue to play a role, because we have not repealed the business cycle and we will see bank failures in the future at a higher level than we see them today.
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  Mr. COOK. Thank you. If I could just follow up on one additional question, and again, for the worried consumer, someone that just this week may get an advertisement to buy their auto insurance through a company that is now a subsidiary of a large bank, maybe something does go wrong with one of these subsidiaries. It is going to happen, I think. And you have alluded to this, bringing on the added risk.

  To what extent are the creditors of that subsidiary operation going to believe that the bank, that the parent bank, should stand behind any failure? And what implication does that have, for not just depositors, but of course, taxpayers?

  Ms. HELFER. I think those are very, very good questions, which is why I, in my testimony, very strongly stated that we need to make clear that the insured bank should be walled off, and that we should set limitations on the way in which the insured bank can provide support to the subsidiary organization. Those limitations would include requiring the insured bank to remain well-capitalized after making an investment in the subsidiary. They would require that Sections 23(A) and 23(B) of the Federal Reserve Act apply, which limits to 10 percent of the capital of the bank, the investments in the subsidiary organization.

  I think these would have to be made very clear, very publicly, so, in fact, it was well understood that there would not be support from the insured bank. And I believe we can do that, and we can supervise it.

  Now, as I said, firewalls can get ''squishy'' in very difficult economic times. But we found, in fact, that by and large, with a few exceptions, we were able to supervise these issues, even during the banking crisis. That is the first point I would make.
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  The second point I would make is that there is, in fact, a safety and soundness argument in favor of the subsidiary structure, simply because we would limit the down-side potential to the insured bank through the firewalls I described. However, there would be the up-side potential--that when the subsidiary organization had earnings, those would inure to the benefit of the parent insured bank and would ultimately reduce the cost of resolving bank failures under those circumstances.

  In addition, in a subsidiary of the bank, the bank itself would have the control and would be able to directly protect itself, essentially, through the management of the flow of funds. In a subsidiary of the holding company, the bank does not have that level of control.

  Mr. COOK. Thank you very much.

  Chairman BAKER. Thank you, Mr. Cook.

  Mr. Hill.

  Mr. HILL. Thank you, Mr. Chairman. And I would like to extend my apologies to both Mr. Ludwig and Ms. Helfer for my having to leave and come back.

  It seems to me as though this whole debate, as I have been observing it so far, is an industry-driven debate. The real debate about reform of financial services, while it is often framed in terms of benefits to consumers, really is not being driven by consumers. It is being driven by people in the industry.
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  And Mr. Ludwig, in your testimony you made a comment that I found interesting. And that is that in the current regulatory environment banks are moving further out on the risk curve; the implication being then, obviously, we are taking greater and greater risks. I guess I would ask you, where are these low-risk high-return investments that we would want banks to enter into in the other areas of financial services, that are going to encourage them to stop moving out on the risk curve?

  Mr. LUDWIG. First of all, let me be clear. The dynamic of the current environment leads them further out on the risk curve. I am hopeful that the efforts we have been engaged in--we, the FDIC, the Fed and others--to really work hard to make sure that we have strong underwriting standards, and so forth, have in fact had an effective and limiting role in terms of risk of some considerable proportion for now. But the dynamic is a bad one.

  Now, what other activities? I would not want to give a laundry list of activities because things are changing so rapidly with technology, but let me raise a couple of them. Insurance sales activities are much less risky. Every financial product has risk, but those sales activities are much less risky, for example, than lending activities. I think anybody involved in risk would agree with me on that.

  Moreover, there is advantage to diversification itself, irrespective of what the activity is, as long as the activity is engaged in in the right proportion and in the right way. Even if an institution engages in an activity that is higher on the risk curve than insurance sales, in the right proportion, balanced against core business, it may, net-net as a basket, be hugely beneficial.
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  We know what the cycle is with bank deposits and lending. I mean, banking is a cyclical business. And one would want to see in diversification, if not a completely counter-cyclical set of income streams, at least an offsetting income stream.

  So my comment is, yes, there are businesses that are less risky and marry nicely with the banking business; but second, the diversification itself is hugely beneficial.

  Mr. HILL. But is it not generally true. Would you not say that the whole financial services sector goes through the same cycles? They seem to parallel each other, rather than to be counter-cyclical, do they not?

  Mr. LUDWIG. To a point. One of the things that got me focused on this whole set of issues with respect to financial modernization was one of my very first meetings when I came into office. One of the people I sat down with--and I tried to sit down with a lot of people who had experience as supervisors--was the then-head of the Bank of England's supervisory service, a very internationally well-regarded fellow by the name of Brian Quinn, a senior regulator who had spent a lot of years in regulation. I asked him, ''Why is it that the British banks did not get into the same financial squeeze that the U.S. banks did in the last downturn?'' And he said, without missing a beat, ''Fee income, fee income, and, in particular, insurance income.'' I gather insurance income tends to be flatter through the trough of a cycle than the loan swing, and helps to pull the institution along. That was the experience in Great Britain.

  Mr. HILL. But the case could be made that Lloyd's of London argues the opposite with the British experience, if you look at property casualty underwriting in the picture, would it not?
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  Mr. LUDWIG. There is a clear difference between property and casualty underwriting, and insurance selling, and even life insurance underwriting, which has a much more stable history. I think one has to, in a very cautious and prudent way, look at individual businesses, the amounts people get involved in those businesses, and the actual financial realities of the company itself, in making the judgments as to what one ought to engage in and what one should not engage in.

  Mr. HILL. One other question on a different subject, and that is that you made the comment that community banks, in your view, are at risk if we require them to adhere to the holding company structure. And perhaps that question was asked earlier and I was not here. Many, many community banks now are part of holding companies. Many of them operate within that structure. Given that, is there something about that structure, creating subsidiaries of the holding company which would be sister companies, as opposed to subsidiaries of the bank, that I am missing here? I am having trouble understanding why that is going to add more to the cost and make it more difficult for them to function.

  Mr. LUDWIG. First of all, with Subchapter S opportunities for community banks, I think one will find community banks that are not operating in a holding company structure, and maybe even to an increasing degree.

  Second of all, the question is not what we have now, but what are we going to have in the future? A holding company, by its nature, is yet another corporate entity with another set of books and another board of directors and another set of disclosure forms, another set of supervisory responsibilities, all of which add cost.

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  One of the things that I find most interesting in this regard is the experience we had with interstate branching. Congress passed the Riegle-Neal Interstate Branching Law, and there was a lot of hue and cry at the time it would save a great deal of money; that eliminating what had been permitted--that is, banking in different States through separate banks--would actually, if it was converted into a branching structure, save money. And there was some debate about how much. Everybody knew there was a layer of burden, but nobody knew how much.

  As we are looking at that situation today, more and more entities are finding out that the layer of expense caused by a separate board, and a separate company, and a separate set of books--translated broadly--is a very significant amount of money. I think you are going to find the same thing with regard to product diversification.

  I am aware of it when we supervise. Every little rule, every set of regulations that we impose on a banking entity has costs, and it can have considerable costs in real human time and focus. Just taking focus away from what matters in terms of running their business to a set of books and a set of meetings that they may legally have to have, but that have no benefit at all, is a waste. And that waste costs, particularly for small banks that have a limited number of personnel, where the guy who has to read the regulations at the end of the day and go to the meetings and structure the meetings and worry about the books being right is a CEO who basically is running the show with 10 or 15 employees.

  Mr. HILL. Thank you, Mr. Chairman.

  Chairman BAKER. Thank you, Mr. Hill.

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  I want to try to get back to four or five basic concepts, as to your opinions of those concepts. For example, first, I think you both agree we must do something. Standing still is the worst choice of anything. Some progress, whether it is simply the repeal of Glass-Steagall as a beginning, must be made.

  Second, as to how far we go, Mr. Comptroller, you have talked about a ''soft line.'' Ms. Helfer, you have talked more in a financial-services-related kind of definition. You define the activities where, Mr. Comptroller, you may be looking more toward maybe a regulator-controlled type of activity: ''It is OK if we say it is OK''? Is that sort of where you are posturing at this moment?

  Mr. LUDWIG. Let me address both your comments. First of all, I am optimistic, given the kind of attention and focus that this subcommittee has shown in trying to deal with the facts, that we will have financial modernization legislation that is not just in name, but in reality, modernization legislation. What you and others have been considering is laudable.

  Having said that, I would not go so far as to say anything that has a label on the cereal box saying: ''financial modernization'' is a better thing than we have today. I think we have to be prudent and look inside the box and see what the cereal is inside.

  Chairman BAKER. Will ''Mikey'' eat it? Yes.

  Mr. LUDWIG. Whether we can eat it or choke on it. But I think we are headed in a positive direction and, as I indicated in my testimony, I think this is a fundamentally very good and important thing and undertaking.
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  Chairman BAKER. I am just trying to get to your concerns about, if we do it and what we are putting in the box is acceptable to you, to more closely define what are the acceptable elements.

  Mr. LUDWIG. I think that we have to be very prudent and try to live by these five principles, which are:

  The consumer, net-net, has to benefit.

  Community banks have to be strong and strengthened; they should not be weakened.

  We ought to make sure that there is continued access to credit and other financial services for all Americans, including poor people.

  We have to make sure that we really do have a vigorously-competitive environment, that we are not just, at the end of the day, layering on more burden, and, in fact, not producing a more vigorously-competitive environment.

  And we have to have a corporate structure, a flexible structure, that will undergird that and propel us into the future.

  All of that is critical to a modern financial environment. I think one has to assess what comes out of the meat grinder at the end and decide whether or not it meets those criteria.

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  Chairman BAKER. As to the functions in which the financial institution may engage, other than perhaps in my State--a casino owning a bank, for example--there are some obvious things we do not wish to have happen. There is nothing, per se, on its face, that represents an inherent risk, or guarantee of failure, to a financial institution, unless there are certain things: inappropriate management, ill-advised concentrations of investments, repeats of the decisions of the 1980's, for example. No one wishes to return to that.

  In talking with Mr. Greenspan some days ago, he expressed to me a view that perhaps we ought not to be so much concerned as to what they do, but rather as to the level of dependency on those activities for financial strength. Is that something that would be a concern?

  For example, whether you draw the line here, or you draw the line there, is that not quite arbitrary of us in the Congress determining what is the best investment practice for a very divergent and technologically-sophisticated market? How do we know where that line should be drawn?

  Second, if we are not prescribing activity, whether it is 7 1/2 percent or 25 percent of revenue, what does that have to do with safety and soundness? If you only have 25 percent of your revenue coming from the non-financial sector, and your capital is depleted, and you are making bad lending decisions, you are in trouble anyway. Are there not better models for risk assessment? The Fed uses a value-at-risk model that they are now looking at.

  I am concerned that whatever standard we set may be inadequate to properly regulate the risk. From day-to-day, portfolios change dramatically. Investment decisions change overnight. We cannot rely on a quarterly business report or a call report to tell us the financial solvency of that institution a week from now.
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  I think the boxes we are discussing seem to me to be entirely inadequate for the types of activities that are occurring in the market. But at the same time, there is nothing inherently wrong with individuals who are financially sophisticated engaging in a broader array of services and products, as long as we are sure that they are not inherently risky and do not lead to the failure of the institution. Is that incorrect? Would both of you like to comment?

  Ms. HELFER. The whole focus of regulation, particularly banking regulation, in recent years has been on the ability of the institution to monitor the risks that it chooses to undertake as a business matter. And our examinations increasingly look at: What kind of controls do they have in place with respect to those risks? How strong is the management in monitoring those risks? What kinds of stress testing is done to determine, in different worse economic times, what the impact will be and what the greater risks will be on the activity?

  In that sense, I think your comments are very, very well taken; which is--in the end--government is not the best organization to make a business judgment. It really ought to be businesses who make it, assuming that they make judgments in a safe and sound way and in a way that does not cause harm to the customers of the banks or to the communities in which they function. And therefore, I think this focus on risk--and the ability to assess risk--is very important.

  I do not need to remind any of you that banks lost money and failed in the 1980's and early 1990's the old-fashioned way: by making lousy loans. They made bad credit judgments. They did not understand the interest-rate risk exposures they had. And they did not understand the impact of the highly cyclical losses in the real estate environment, for example, on the ability of the borrowers to repay. At least, they did not understand it sufficiently.
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  Chairman BAKER. Also, was not in that mix the variable interest cost to them of their product, their money, and a relatively limited market opportunity, and they went further out on that lending risk curve than was advisable----

  Ms. HELFER. Right.

  Chairman BAKER.----On the hope that the client would pay it off, to generate profits for shareholders? And so the irony of the 1980's and 1990's from my perspective is that, because of the artificial limits, we forced them into imprudent decisions in the areas where they could go----

  Ms. HELFER. Yes, I think that is right.

  Chairman BAKER.----Rather than having a broader window of opportunity. It would be like being in a large grocery store and telling the person, ''You can only buy from this selection of enchiladas.'' That is going to get boring after a while, and you are going to look for a way to get around that restraint.

  But in any event, I think the rules of the 1980's and 1990's, although not clearly intended, were a co-conspirator in the failures, because we had them so narrowly limited.

  Mr. LUDWIG. That is absolutely right.

  Ms. HELFER. Oh, I think that is true. Banks were increasingly under competitive pressure from other kinds of organizations, particularly other financial organizations, and they were trying to find ways to deal with that competition. And unfortunately, some of the ways they found did not work.
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  Chairman BAKER. Right. Mr. Comptroller.

  Mr. LUDWIG. There is a lot of power and intellectual vigor in what you say. There is no doubt about it. And so I challenge my own caution in this area. But I must say that what is intriguing on both sides of this argument is this: that we do not have a definitive study, to the best of my knowledge, that shows that mixing commerce and banking is a bad thing. We also do not have a definitive study that shows it is, net-net, a good thing.

  And so my own caution in this area is not so much that I know the exact line--10 percent, 25 percent, 50 percent. I do think, however, that some judgment, something other than a free-for-all mixing, is just a prudent and cautious way to move in this area. And unfortunately, I cannot give you a tight intellectual argument as to why that need be, except generally--history, experience, and just an abundance of caution.

  Chairman BAKER. Well, if you do not know how deep the water is, you just go slow until you find out. But my problem is that what is being suggested, I believe, is the remedy for marginal enhancement of opportunity, in limiting risk potentially, centered on revenue. I do not think that an appropriate mechanism to ensure that those underlying activities are not going to cause untoward risk in the financial institutions.

  There needs to be a better risk-assessment model proposed before we do any of it. But once we have achieved that, then I do not see the logic to saying we cannot engage in a much broader array of services.

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  Mr. LUDWIG. I would say that the appeal of a line--10 percent, 20 percent, 25 percent, 30 percent--is that it causes the kind of diversification which I have asserted is, in and of itself, a beneficial thing. But having said that, with more study and more experience over time, one might find that with sufficiently-robust risk-modeling we can take different steps and have different percentages and different activities than one would have been willing to ab initio.

  Ms. HELFER. Also, I think, if I understand it, if you look at the sort of basket proposals and they say, just as an illustration--25 percent of the revenue can come from commercial enterprises--it leaves open the possibility that a very large bank can have a very large investment, even a 100-percent controlling investment, in a commercial enterprise. Whereas, if one wants to take--which I think is very important--a more cautious approach, one can permit venture-capital investments, non-controlling venture-capital investments, which permit banking organizations to have the upside potential, where you wall off the insured bank and assure that very-limited insured bank funds can be used for that purpose. And that may, in fact, provide the diversification without raising what will be, I think, some inequity in the way in which investments can be made, depending on the size of the organization.

  Chairman BAKER. Thank you.

  Mr. Kanjorski.

  Mr. KANJORSKI. I think Mr. Hill made an excellent point in his examination. It was the question of: How is this being driven? I tend to agree with him. It appears to be industry-driven. I do not really care whether a bank fails or succeeds. That is what our business system is all about, as long as the government does not lose money, and the depositors do not lose money.
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  We are not in the business to keep banks eternally above water. If they have got bad management, bad investors, that is what the system is supposed to do. It is supposed to take them out.

  Ms. HELFER. Absolutely.

  Mr. KANJORSKI. I think the thing we have to worry about is, who are they serving? And I think that is what Mr. Hill asked, and that was what I was talking about earlier. If I look back at the history, we have always had this idea of, when we talk about modernization, Mr. Ludwig, are we talking about peripheries to give better opportunity for the banks to make more money, or to be more vital in our economy and serve a wider range of needs of the economy? I would like the latter, not the former. I really do not care about the former. If they do not want to be in the banking business, they can cash their stock in and get in the stock market. It does not matter to me. They are big boys.

  But look at the history. When we had universal banking, prior to the 1930's crash, you could not fund real estate. We had to get into chartering a new institution, the thrifts, to encourage people to have ownership. As we have moved through, you can see everything from the Small Business Administration: When the banks decided that there was not enough money made in lending money to small businesses, they forced it on the government. Most recently, this President made us aware of the fact that banks were not interested in making small loans to small people, so we now have community development banks.

  We keep filling the vacuums that the bankers abdicate because they are cherry-picking. And that is our system. They should cherry-pick. That is what business is all about.
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  Now, if we give them extraordinarily large powers, without any obligations, who is going to fill the vacuums that are going to be left? Who is going to take care of the small businesses?

  I mean, you talked, Ms. Helfer, about venture capital. Have you ever studied the Small Business Investment Corporation charter used by the banks of the United States and how they use them? It is sinful. We are guaranteeing them how to play the market on secondary and tertiary public offerings. They are not providing venture capital to new businesses. We ought to take them out of the business. We are only opening up a great deal of low-interest money for venture capital operations to float secondary and tertiary original offerings to make money on. They are not in the venture capital business.

  Now, do we have the capacity, if we talk about regulation, to see that all these things get done? How large are your organizations going to end up being? Is that where we want to go? I would hope that banking modernization would put banks in a more competitive market, would cover the needs of the full economy, and would be filling some of the vacuums that government had to fill. We could get rid of the retail SBA business loan if the banking community took it up. And if not the banking community, who else is going to take it up?

  Then you move to the other side of the situation. If you are going to sell products of insurance out of a bank, now, we all know there are insurance companies and insurance companies. Poor ''Mrs. Jones'' that walks in, is she going to be subject to an insurance company from Podunk that is so narrowly-funded that if the first windstorm happens, they get wiped out of business and her value is gone, or is she going to get a class ''A'' rock-like insurance company? And we all know that there are different existing insurance companies.
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  Are you going to regulate as a regulator? Are you going to go in now and find out all these products? Are they taking a good insurance company, are they taking a fly-by-night insurance company? Are we going to allow this subsidiary of a bank to determine what insurance they are going to sell out because of the premium they make?

  I mean, we know in the boilerhouse operations of the stock market in the 1920's how we got into trouble. And maybe even today in some instances people are making recommendations to their clients to buy equities or other securities based on the premium draw. It has nothing to do with what they think about their client's chances of making profit or having security. They are very self-driven for profit.

  And what I am worried about when we end up having financial services modernization, is that we are just giving a lot of new powers to a lot of people who are not satisfied with the amount they are making now, who have an opportunity to make more, but, in fact will give less service to some of the economic institutions of our society, particularly on more local levels, small banks, small people, home ownership, and things like that.

  Now, unless we have something that says it is worthwhile, why should we not take more time and decide on how we can become more comprehensive? Or are we just going to do it around the edges so we end up with the industry getting the better opportunity?

  Mr. LUDWIG. I certainly support your premise, which is that what we ought to be doing here is producing a financial modernization bill that fundamentally supports consumers--be they low-, moderate-, or high-income--our consuming America, and the vigor of the economy, including small businesses and farms. I agree absolutely. That is exactly what financial modernization ought to be focusing on.
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  Mr. KANJORSKI. But, Mr. Ludwig, are they escaping from that business because it is not profitable enough and they want to go into greener pastures and want broader potential to do that? And when they do that, does that mean only more money is going to fly?

  You know, quite frankly, I would like to give them sufficient power and license with proper regulation for safety and soundness, that they could be innovative, they could be creative, that we would not have to come back and monitor. It is sort of embarrassing to me that we have to pass a CRA, when you think about it. That should have been a responsibility out there. But in reality, we all know, if we did not pass it--in Minnesota, all of their money would have gone to Pennsylvania.


  Mr. KANJORSKI. Are you working, toward the end of the Administration, to giving a more-balanced approach? That this just is not industry-driven, that this is not just safety- and soundness-driven, but it is also long-term-driven; and taking into consideration all these vacuums that have been created in our economy that the government has been periodically filling, and that our friends on the other side of the aisle do not like us to get into. But if we do not get into them, I do not know who makes this loan to this little lady.

  I do not hear from the banks complaining in many instances about small hard loans to make to people who have little equity and want to go into business. But then if the institution making those loans starts to have some success, then they scream ''level playing field.'' And I do not see the strong attempt to find how to start new technologies, new venture businesses and provide lines of credit for small business, until they start to succeed. Then the banks want to have the opportunity to get in there. Or, even better than that, they want the government to insure their profit or their loss so that they will have a profit.
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  Ms. HELFER. You know, I grew up in a town of fewer than 5,000 people in the middle of Tennessee, and I went to college on a scholarship. We were not rich folks. I simply did not have the same measure of negative experience with our one local bank that you are describing.

  Mr. KANJORSKI. No, with the local banks you will not.

  Ms. HELFER. Yes.

  Mr. KANJORSKI. I am not describing local banks. I am describing banks that are going to get larger and larger.

  Ms. HELFER. But, you know, I have been traveling across the country and meeting with community banks in all of the regions of the United States. Two weeks ago, I was in Seattle. And a banker from Montana who is from a town of 5,000--his house was three miles away from the closest house--talked about needing to be able to offer a range of products to his customers so he could serve their needs, because nobody else was going to in this little town in Montana.

  Mr. KANJORSKI. Ms. Helfer, I absolutely agree. I have no problem with those small banks. I have traveled the country and met with Montana banks and I know--I think the largest bank in Montana is $190 million or something in assets. We are not worried about them, and want to be able to give them product.

  But it goes back to what I originally talked about. We talked about banks, and banks. There are the gigantic, super conglomerates who can play in a very, very big field and become trusts or cartels with little difficulty if we do not write the law right and we give them that opportunity.
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  What we are talking about here in modernization--I think it is a misstatement to say this is being done for community banks. Community banks may get some benefit out of being able to do some additional products, but this is not the savior of community banking. This is to allow big banks in America to compete with Wall Street for corporate business.

  And maybe I am missing the point, and I am not saying that it should not happen, and I think we ought to encourage this, but this is not the relief act for community banks in America.

  Ms. HELFER. Well, I think that it is intended, if I understand the proposals, to offer a range of opportunities. And I very much focused on the financial side, as you will recall. I have expressed some concerns about concentrations of economic power, and I think those are issues that we have to continue to be concerned about, and that the antitrust laws should continue to be designed to deal with.

  But I do believe that everybody can ultimately benefit. You know, my sister is the county executive of our home county, and she went to New York to meet with some of the securities firms because our town needed to have a bond underwriter. Those folks can serve smaller towns, and in many cases are willing to.

  Mr. KANJORSKI. Absolutely.

  Mr. LUDWIG. I really hope that you continue to be a voice for the consumer and the small institution as this moves forward, Congressman, because I think it is very important. Interestingly, I am not persuaded at the end of the day that technological advance and modernization will necessarily, as long as the protections are in place, lead to agglomerations of power that are unmanageable. If you look at the IBM experience in technology or the AT&T recent experience in spinning off businesses, smaller organizations can be very effective competitors, provided that we do have the kind of antitrust and other protections that really are needed. It is something that I laud you for focusing on because I think that we want to make sure that the community bank is protected.
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  Mr. KANJORSKI. But we do know, Mr. Ludwig, because that is a political experience. Some administrations identify things called ''antitrust,'' and in other administrations they would not see an antitrust case if it hit them in the face.

  I mean, I think we went 7 or 8 years here without some administration ever identifying an antitrust case. And that sort of scares me, because that then says, ''Well, what political party is in power and who are the regulators?'' as to what kinds of constraints we are going to get or what attention we are going to give to the problem. And I hate to see that happen, in a way.

  My time is expired, so I appreciate it. I will let the other Members of the subcommittee get on. Thank you.

  Chairman BAKER. Thank you, Mr. Kanjorski.

  Mr. Hill.

  Mr. HILL. Thank you, Mr. Chairman.

  Chairman BAKER. If I might interrupt, too, those bells just meant we are in recess till one o'clock. So we are not missing a thing.

  Mr. HILL. Thank you. I have a book I carry around that tells me what all those bells and lights mean.
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  Just for the record, Mr. Chairman, I want to point out that small community banks in Montana sell insurance, and they sell mutual funds, and they sell securities, as well as providing banking services; just so that we do not leave people with the impression that in Montana people cannot have access to financial services though our communities are small. And I come from the large community of Helena that has 25,000 people, and all the banks there, I think, offer those services, as well.

  I am concerned about safety and soundness, too. And one of the things that I find interesting is that in the 1980's when we went through the crisis of the savings and loan industry and banks the insurance industry also went through a crisis. And while taxpayers were bailing out savings and loans and the depositors there, holding companies were bailing out insurance companies.

  Many, many insurance companies in the 1980's were having serious troubles. And they went out and acquired capital and were able to replenish their capital and go on operating, as a consequence of the financial strength of the holding companies that they were part of. Or they went into the markets and acquired additional capital.

  One of the concerns I have--and I am just going to come back to this--is that what we have been talking about here is banks holding subsidiaries. And while you suggest, Mr. Ludwig, that we are just talking about insurance sales, I have never met anybody that was selling insurance that did not think they could do a better job of underwriting it than the people who underwrite insurance. I mean, it just seems to go hand-in-hand.

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  And so I think it is normal to expect that we are going to get into the insurance underwriting in a big way. And I am concerned about, if underwriting functions of insurance are subsidiaries of banks, and they run into trouble, because it is a cyclical business--deep, deep cycles--that there is going to be capital available for them as freely as it is now for them to be able to sustain themselves.

  And let us not forget that there are consumers of their services that need protection, too. And in most instances they are protected by government institutions, usually on a State level, guaranty associations.

  So, I would just ask you, how do you see that playing out? I mean, if the structure that you argue for goes forward? What is happening in the international markets? We have talked a little bit about international markets, functional regulation. We talked about how this is a model that shows that we can have financial stability and we can have safety and soundness and security for consumers. How do they operate, in terms of the functional regulation? And how does that structure apply to insurance underwriting functions, particularly, but securities underwriting, too?

  Mr. LUDWIG. I am glad you asked that question. In fact, it is a very important point to be made. For a generation, U.S. policy has permitted our banks to operate abroad engaging in all the activities which are being discussed here--insurance underwriting, securities underwriting, securities sales, insurance sales. We have allowed our banks to engage in those activities abroad, both within the bank itself and within subsidiaries of the bank. And that experience has been, by and large, quite a good one. The OCC is involved in supervising national banks' foreign activities. We have had a London office for a very long time. This set of activities engaged in abroad, and the experience we have had with regard to banks and bank subsidiaries abroad, is a very telling situation, in terms of how these entities have operated.
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  Ms. HELFER. For the record, since I spent 7 years at the Federal Reserve regulating this area, insurance activities and securities activities, the broader range of underwriting activities certainly cannot be conducted in the bank abroad. They can be, and frequently are, conducted in subsidiaries of the bank.

  Let me say further that those authorities have not included property and casualty insurance underwriting. They include life insurance underwriting, which is, to a great extent, actuarially predictable risk.

  I agree with you, if your question is focused on property and casualty insurance underwriting. I think there are some significant issues there. It has proven to be a highly cyclical business with significant losses in the down cycle. And I think there are continuing questions about what risks are presented by that activity, and it is something that we would have to understand and be able to be on top of.

  In the end, under the legislation that is proposed, I think it would be up to the State insurance commissioners, who are currently the regulators of the various types of insurance, to be able to evaluate and continue to regulate those activities in a system of functional regulation.

  From our perspective, we need to make certain that the transactions between these organizations and the insured bank would not ultimately impair the insured bank to the extent that it would create significant losses to the insurance fund.

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  Mr. HILL. Your concern is the insured bank. My concern is the consumer here.

  Ms. HELFER. Right.

  Mr. HILL. And in the international marketplace where we have allowed banks to engage in those activities outside the United States, do they regulate in a fashion that is similar to the way we regulate those other functions? I am not talking about the banking functions, now.

  Ms. HELFER. Some do and some do not, is the answer. I think in some countries there is a pretty serious measure of insurance regulation and securities regulation, and in others, that is less true.

  Mr. HILL. And there is no difference in terms of outcomes, as a consequence of that different level?

  Ms. HELFER. Well, it is a very interesting question. I think there have been some losses, certainly, in some countries in some of these activities. What the regulators of the foreign activities of U.S. banks--which includes the Federal Reserve and, to a limited extent, the FDIC and the Comptroller--do is try to make certain that any losses in that area will, once again, not cause problems for the insured bank itself.

  But as I have stated already and I will repeat, banks lost money with commercial lending in the 1980's and 1990's. We cannot eliminate all risks in these activities. If we did, businesses would not be making money.

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  With respect to consumers, I think the appropriate functional regulator will have to make certain that the rights of consumers are fully protected.

  Mr. LUDWIG. I would like to come back to something that Chairwoman Helfer focused on in her testimony which I thought was quite right. That is, in all this discussion we assume a complete, absolute, catastrophic bust at the subsidiary level, which is certainly the right thing to focus on. But in most cases, you do not have a complete wipe-out. You have to look to some degree to the up-side when the bank itself has problems and has to look for a source of strength elsewhere and/or where the subsidiary may have some problems but it is not a wipe-out so that the bank has a source of strength in that subsidiary, that is, income streams that go up to the bank that support it, and/or assets in the subsidiary that have value. That militates in favor of a subsidiary structure over a holding company structure because the support flows directly to the bank.

  Mr. HILL. I understand that you approach this thing from a bank regulator's perspective, and so protection of the bank is the number-one thing. I just would repeat again, I think protection of the consumer is the number-one thing.

  And so, if you look at subsidiaries as a source of capital when the bank gets into problems, that puts the consumers of the insurance services at risk, or securities services, and vice-versa. If the subsidiary gets into trouble and you are talking about barriers to capital flowing back to those subsidiaries, that troubles me, too.

  And that is why I just have concern. I am just sorting through this intellectually, but that is why I have concern about those kinds of activities being subsidiary of banks.
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  Mr. LUDWIG. I do not think that the consumer interest and the safety and soundness interest are inimical. I honestly do not. I think they actually go hand-in-glove. Nobody wants failure; that does not benefit anyone. Moreover, these subsidiaries would largely fund themselves from the market and would have access to capital that would be equivalent to a holding company affiliate. But I think also, as Chairwoman Helfer said, one would expect, and one has seen, a level of functional regulation that would be consumer-oriented that would protect the consumer. It is essential that we see that.

  Mr. HILL. Thank you, Mr. Chairman.

  Chairman BAKER. Thank you, Mr. Hill.

  Mr. Vento.

  Mr. VENTO. Thank you, Mr. Chairman.

  One of the issues, of course, is the charter conversion for the thrifts. Comptroller Ludwig, do you feel that the thrift charter, as it exists nationally or in its various forms at the States, is in some sense superior to the Federal charter for banks, or what would be conceivably this Federal charter?

  Mr. LUDWIG. As I mentioned earlier, Congressman Vento, I think that the charter itself is not really the big difference. It is the ability of commercial companies to invest in thrifts that is the fundamental difference. I think the current national bank charter is a viable and robust charter. But I think that there is an ability which is really quite different on the thrift side where you can have Ford Motor Company own a thrift, something that is completely prohibited in the banking environment.
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  Mr. VENTO. Well, I think the issue is the magnitude of that within the thrift charter, which is an outstanding question we have to those who have thrift charters. And we have not received an answer to the question. But can you give us any idea of the magnitude of involvement of commerce and banking inherent in the existing thrift charters?

  Mr. LUDWIG. We can certainly provide you with detailed information on that. I do know, as I have said, that Ford, and Sears and Roebuck, have owned thrifts and could own them today as long as they meet the QTL test. And that is a big distinction between the two industries, particularly since the QTL test was modified recently in the last Congress. That is not at all available to the banks.

  Ms. HELFER. Also, Congressman Vento, if I could just add, the FDIC's staff has produced, actually a pretty thick document which goes into the differing issues associated with the charter in question. And I would be happy to provide you and Members of the subcommittee with copies of that book.

  Mr. VENTO. Well, I appreciate that. I think that would be helpful. But I think that I am trying to differentiate in terms of what the reality is, as opposed to what theoretically is possible. Because, you know, inherently, as you have mentioned in response to someone who asked about ''grandfathering,'' that is an issue that we have to deal with.

  But we also have, of course, another problem, in terms of what type of parameters we might deal with in terms of guidance to the State regulators.

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  Ms. HELFER. Well, I think there is a continuing issue about the dual banking system. I think it has served this country very well. I think we have benefited from having a State and Federal banking system. And that does raise the question of to what extent Federal law should preempt the authority of States to permit activities of financial institutions?

  I think that those are important questions for the subcommittee to consider. I personally favor recognizing the very positive impact of dual banking, and not preempting all the authority of the States in the chartering area at all.

  Mr. VENTO. Well, you know, it is inherent, obviously, in your responsibility with the deposit insurance, insofar as those institutions--or elements of those financial holding companies as they may evolve at the State level--would have deposit insurance. So, I mean, you have an additional responsibility, in terms of trying to follow that.

  Ms. HELFER. Oh, absolutely, and we want to make certain that financial institutions that are insured by the FDIC meet safety and soundness standards. Congress has done a lot in that area, because in 1991, Congress, in FDICIA, said the FDIC should review the non-banking activities that State banks engage in that are not permitted for national banks, to be sure that the activities do not raise safety and soundness issues and potential losses to the funds. And we do that, and have been doing it now for several years.

  Mr. VENTO. Yes. Mr. Chairman, Chairwoman Helfer and Comptroller Ludwig, we have, obviously, inherent in some of the bills measures that would, in fact, define what is ''financial'' in nature, as an example. And I assume that with regard to banking, would then be a qualified activity under the model of the bills that we have before us.
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  You have seen the bills, I assume--Mr. Baker's bill, Congresswoman Roukema's bill, other bills that have been put forth. Is that committee a workable structure, in terms of defining that? And what concerns would you have about that with regard to insured deposits in financial institutions?

  Ms. HELFER. Well, the committee structure adds another layer and, as I understand it, would essentially just say ''No'' on those activities that it thought would raise safety and soundness concerns.

  It is a somewhat awkward structure. The one that I have reviewed has eight Members. There would have to be a two-thirds vote to say ''No.'' Two of the Members include the Attorney General and the Secretary of Commerce.

  Mr. VENTO. I think that that is the Baker model.

  Ms. HELFER. OK, that is the Baker model. To be frank, this would very much be a collateral duty for them.

  We have the Federal Financial Institutions Examination Council. We also have the more informal working group on Financial Markets, where the chairs and heads of financial agencies meet regularly.

  Mr. VENTO. Well, putting aside the specifics, I mean, is it workable to have such a group supposedly being structured in that way, either assigning that duty to an existing group, or do we just simply need one regulator, like the Fed, in charge of getting us this answer, or for that matter, the FDIC, as I suggested to Mr. Volcker?
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  Ms. HELFER. Well, I think that the committee structure is something that can be explored as long as it has a relatively limited role. As I said in my testimony, there probably is room for oversight supervision to be sure things do not fall through the cracks, to be sure that there are not systemic issues raised.

  And that oversight supervision could be done, depending on the nature and the size of the institutions involved, by a variety of regulators. If they are very large banks which raise significant systemic issues, then perhaps the Federal Reserve would, in fact, be the logical regulator.

  Mr. VENTO. Well, I mean, I mention this because I think at the State level, as the chartering authority you actually sit in that particular role, as we assigned it to you under FDICIA, as you mentioned.

  Ms. HELFER. Yes, as Federal supervisor, but not as chartering authority.

  Mr. VENTO. And so, I mean, you are doing it alone. So I just think it is not so unusual to, in fact--of course, there are other reasons, other factors, which I will get into in a moment, if I have the time.

  Mr. Ludwig, did you have a comment on this aspect?

  Mr. LUDWIG. Yes. I do think that the committee structure has some virtues, frankly, however you structure the committee. The informal working group on financial markets that we participate in, both the Chairman and I, is a healthy thing, because you do get different perspectives. And particularly as one is looking at a set of financial activities that is broad and regulated from different perspectives, having those different perspectives brought together, I think has virtue.
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  Mr. VENTO. The other question that follows, of course, is in some of the testimony that we had, Mr. Chairman, there was an indication that, number one, there is a global leadership role here in terms of U.S. financial institutions and relating to others on a global basis.

  Obviously, the Comptroller and the Chairman of the Federal Deposit Insurance Corporation have a role here. How key is this in terms of our consideration as to who we should assign power to, in terms of this global issue and global leadership?

  In other words, if we assign this in one way or another, does it affect your ability as Comptroller to provide global leadership in terms of representation and role, with regard to the national banks and their position in the international marketplace? Or the same question really to Chairwoman Helfer.

  And then second, I mean, the other question I think, just to get it on the table--and you might want to deal with these together; I do not know--is, when we have economic crises, does the model that we choose in terms of regulation actually give you the ability to, in fact, respond to economic crisis if it, in fact, persists?

  One argument was that, ''Well, at the end of the day, the Federal Reserve Board has the money,'' so that if something happens, they have the money, they can go forward and they can put something on the table. I do not know what the Comptroller has or what the FDIC has. I thought you had some money, too.

  Ms. HELFER. About $34 billion.
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  Mr. VENTO. So, I mean, there may be a case here for intervention, or a role to be played in terms of dealing with our economy and, at the end of the day, trying not to let everything fall apart.

  So I would like you to, sort of, talk on the international role. And then the second one is, how do you deal with economic crisis? Is that a factor that we have to consider? Mr. Ludwig?

  Mr. LUDWIG. Let me give a several-part answer. One, four eyes see better than two. If there is one thing I have learned from 4 years in office, it is that a collegial relationship with various supervisors with different responsibilities is a very valuable thing. We all have different perspectives. The FDIC has a perspective, given its responsibilities, as does the Fed, as do we. So I think, fundamentally, four eyes see better than two, and six eyes see better than four, and so forth.

  Second, in terms of the international dimension, I go to the Basel Committee meeting every quarter. I have done that ever since I became Comptroller. And the OCC has a London office, and has been active internationally for generations. That is the nature of the banking business. We have banks, even medium-sized banks, that are major players in foreign countries, and have been since the turn of the century, almost 100 years. It is our responsibility to know what is going on.

  If one reposes all wisdom and all knowledge in one source, one is asking for problems, no matter how good the source is, whether it is us or someone else. I think there is virtue at the end of the day in some collegiality, and I think we have learned that.
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  We have a system today as a result of tradition and other sets of responsibilities, where we do have back-up supervision from FDIC. We do have working groups like the FFIEC that are involved in the regulatory mix. I think all that is healthy. To go to a more concentrated format today, given where Congress appears to want to go, is probably counter-productive.

  Ms. HELFER. And I certainly agree that there are enormous virtues in the collegial approach to supervision. I chaired the Federal Financial Institutions Examination Council for a time, and we were able to advance a number of issues more efficiently because we got together and talked about them.

  I believe you are raising very, very important questions about how are we going to make this new structure workable? How are we going to make it efficient? How are we going to make certain it can respond efficiently and effectively in very difficult economic times, which we may yet again be in?

  And I believe there are ways to reconcile these issues while giving the primary regulator principal authority for the insured bank and while giving the functional regulator the principal authority for the non-banking subsidiary, so that we can make certain nevertheless that we have a focal point for moving forward, particularly in response to a crisis.

  It is certainly true, as you said, that in 1987 when the market break occurred, the Federal Reserve immediately lent significant liquidity to the system to provide a basis for resolving the outstanding trading issues. And there is that role as lender-of-last-resort. The FDIC has, obviously, responsibility. We write the checks when banks fail, not the Fed.
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  So that I think there is a way to reconcile these roles, and I believe it is something that we need to continue to work on.

  Mr. VENTO. Well, Mr. Chairman, thank you for the extra time.

  Chairman BAKER. Yes, sir.

  Mr. Bachus.

  Mr. BACHUS. Yes, I will address this to Chairwoman Helfer, but also the Comptroller. On page four of your statement, you mentioned that the favorable economic times we have--and we have had since 1991, at least--provide a real challenge when we consider financial modernization proposals because, as you say, '' . . . the environment is so good that we do not consider that good times do not go on forever,'' which is absolutely true, and that we need to evaluate these under times of stress, or to try to do that. And that is a real challenge.

  In that regard, if we are talking about banks, the walls between banks and securities firms coming down, and more securities activities for banks, do we know, or do you have any estimate on presently what the total percentage of earnings is that banks and thrifts derive from securities and from money management investment services, derivatives, and maybe even insurance? Do we have those figures now?

  Ms. HELFER. I do not have a revenues estimate. I can tell you--and this is very difficult to calculate because some of the securities activities are permissible for the banks--what a back-of-the-envelope evaluation of FDIC economists in the last 2 days has come up with. And we can certainly look at this in more detail. Securities and insurance, including bank-permitted activities, probably account for something just under 5 percent of the total assets of the bank holding companies in this country. So we do not have significant exposure in that area from an asset position.
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  It is certainly true that some bank holding companies, however, have a much larger share of their earnings attributable to earnings from some of these activities.

  Mr. LUDWIG. I would add that significant development in banking in the last decade has been the increasing proportion of fee income, as compared to interest income, as a source of total revenue. Now, a significant portion of that has been fee income from things like refinancing homes, which basically is tied to the traditional business. But a significant portion of that, as well as increasing portion, has come from non-traditional activities such as mutual funds sales. I think it is a source of continued strength for these institutions. We are up to probably a little over a third of total revenue nationally being fee income.

  Mr. BACHUS. What I guess I am referring to, also, is if the economy turns down, the loan-loss rates are going to expand. Earnings on some of the traditional businesses would probably suffer. And then you wonder what their exposure is. Let's say 5 percent of their activities, or revenue flow, or earnings, comes from securities. What is the down side there?

  And I think when you set up, as you say, the challenge we have when we look at these proposals, it is to try to construct a model. And I think part of that is knowing how involved they are in these activities and what the down side is in these activities.

  We know to a certain extent what the down side is as bank regulators in the loan losses. I mean, you probably have models where you can predict, as interest rates rise or as the economy turns down, what effect that has on their loan-loss rates, and in fact even translate that into their earnings. But do we have that same expertise when it comes to what their losses in derivatives may be, or securities, or the fact that the stock market may have less value?
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  Mr. LUDWIG. I would make two comments on that. We do have some of that expertise, particularly with regard to derivatives. We have been racing to be relevant to those developments. At the same time, I do not think one can give you assurance that one has models for every business banks could conceivably get into.

  There are two things that one might, however, take as comforting. The first is that diversification in and of itself adds stability, and I think we have seen that internationally. The second thing is that one of the big developments technologically we have seen in the last decade has been an increasing effort, and to some degree success, in modeling risk and using capital allocation schemes, which are more sophisticated than has historically been the case.

  But one cannot have certainty in financial services in a dynamic market. That is why I think supervision is so very important: being hands-on, every day, seeing these changes. There is no substitute for it, because you cannot get the certainty that you'd like going to have.

  At the same time, let me say this century has been an interesting century in evaluating new risks in banks. At the turn of the century, for example, we did not permit commercial banks to make home mortgage loans. A community banker in Illinois came up to me, and he was up in years, and he said his dad had owned the bank before him. He said the bank had made the first auto loan, back in the early 1920's--at least, the first auto loan in Illinois, but he believed it was the first auto loan, period. And he said, ''Your examiner made my dad write that loan off as totally worthless because who could make a loan on a moving asset?'' That was just inconceivable. But at the same time, we saw that through the Depression auto loans grew from about $20 million to $600 million. What was the discredited business of retail banking early in this century was in fact the safer part of their business.
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  So, I think one has to be skeptical that we have all the answers. We do not. Or the models that work. We do not. But there is an advantage to diversification, and I think we have to modernize. Otherwise, we are left a little bit like King Canute trying to hold back the waves. And indeed, even worse, building dams that things work around. And then when they burst, you get real problems.

  Mr. BACHUS. Let me ask one final real short question. You can answer this as short as you want to. Chairwoman, you have talked about the need for oversight of the functional regulators. Are you envisioning maybe an umbrella regulator?

  Ms. HELFER. I hesitate to use that term, because I think it has come in the debate to mean full-scope regulation of everything, which is not what I am talking about, by any means at all.

  I am not talking about regular full-scope examinations by this oversight regulator, which I prefer to call it, of non-banking concerns; nor am I talking about activity-by-activity or investment-by-investment regulation; neither of which I think is necessary or appropriate.

  But I am talking about, in certain circumstances--and we can work out what those are--is that there may be some virtue in making certain that we do not have significant issues between and among the affiliated organizations, and that there are not systemic risks raised.

  Mr. BACHUS. Have you actually visualized how this would function?

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  Ms. HELFER. Well, I cannot say that I have a specific plan. I could certainly posit several approaches, one where you focus on the largest commercial banks and the potential for systemic problems, and turn perhaps to the Federal Reserve where they are involved, but turn to other regulators where we do not have those issues and we have other kinds of issues.

  Regardless of how we do it, we certainly believe, as the primary regulator of some 6,000 insured banks, that we need to have the authority to make certain that transactions with affiliated organizations will not in any way harm the insured banks and lead to significant losses in the insurance fund.

  When I say that, let me just reiterate what has been said several times today. We cannot, and probably should not, prevent all bank failures, or all failures of enterprises, because if we do that, we have over-regulated. What we want to make certain of is that the system is not impaired and that we do not have significant losses to the insurance fund that, obviously, might implicate the full faith and credit guarantee of the U.S. Government.

  But ultimately, these organizations are in the business of taking on risk. And individuals are willing to pay them to take on those risks. What we want to make certain of is that they can monitor those risks effectively.

  Mr. BACHUS. I appreciate the time you all spent with the subcommittee and your patience and the depth that you went to in your statements. And I commend you both.

  Ms. HELFER. Thank you.

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  Mr. LUDWIG. Thank you.

  Chairman BAKER. Thank you, Mr. Bachus.

  Mr. Ludwig, I read an article some time ago about the first bathtub. It was initially condemned as a public health hazard. So I found that to be of interest.

  In that progressive thought, I wanted to comment that the scope and purpose of our subcommittee's work here and in the coming weeks, will be to determine the best method to serve consumers. From the days of standing in the bank lobby, waiting in line to get your Friday afternoon check cashed, through drive-in windows, to the cursed ATM machines of today, consumers have won.

  And I think that the role of this subcommittee is to recognize that technology as it exists in today's world, as dramatic the enhancements as we have seen, is going to continue at an even more rapid pace. And I believe it unwise, from a consumer perspective, to arbitrarily wall off parts of our economy from the benefits of those innovations.

  It then becomes important that we empower the regulatory system with appropriate tools in order to ensure that systemic risk, that fraudulent marketing practices, that all of the things that we share common concern about, are, to the best of our abilities, prohibited.

  It does not mean, as you both have indicated, that we should insulate the system from failure. Needless to say, the market is a harsh and cruel place and there will be winners and losers. But in the end, if we allow an unfettered financial marketplace to move forward, coupling with technology when possible, under appropriate regulatory supervision, the consumers are going to see services and products at much better prices than anyone can contemplate today.
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  I recall buying a computer just a few months ago that, by the time I got home and opened the box, it was already, ''Where did you get this old thing?'' It is that fast a world that we are dealing with. And it is certainly true in financial services, more so than anywhere else.

  And, as Mr. Bachus has already indicated, I wish to express to each of you my sincere appreciation for your ability to hang in there for a rather long hearing; but I can also say to you that the Members who came, came with a sincere interest in knowing your perspectives and making them part of whatever the subcommittee may ultimately propose.

  Thank you very much.

  Ms. HELFER. Thank you.

  Mr. LUDWIG. Thank you very much, Mr. Chairman.

  [Whereupon, at 12:55 p.m., the hearing was adjourned.]

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